Bank board changes in size and composition: Do they matter for investors?

• Published date: 01 March 2022
• Author: Eleuterio Vallelado,Myriam García‐Olalla
• Date: 01 March 2022
• DOI: http://doi.org/10.1111/corg.12397

ORIGINAL ARTICLE

Bank board changes in size and composition: Do they matter

for investors?

Eleuterio Vallelado

1

| Myriam García-Olalla

2

1

Department of Financial Economics and

Accounting, Universidad de Valladolid,

Valladolid, Spain

2

Department of Business Administration,

Universidad de Cantabria, Santander, Spain

Correspondence

Eleuterio Vallelado, Department of Financial

Economics and Accounting, Universidad de

Valladolid, Av. Valle de Esgueva, 6, 47011,

Valladolid, Spain.

Email: evallelado@uva.es

Funding information

European Commission, Grant/Award Number:

620132-EPP-1-2020-1-ES-EPPJMO-

MODULE; Ministry of Science and Innovation

of Spain, Grant/Award Numbers:

PID2020-114797GB-100,

PID2020-113367RB-100

Abstract

Research Question/Issue: This research seeks to explain whether changes in bank

board size and/or composition signal the effectiveness of the board in terms of

monitoring and advising.

Research Findings/Insights: Our contribution provides empirical evidence on the

negative reaction of investors to board changes, identifies the variables that explain

this reaction, and finds that banks with experienced executive directors on their

board are candidates to announce increases in board size. Our empirical analysis is

based on 608 announcements by banks headquartered in 19 European countries

over the period 2003–2015. We apply the Event Studies methodology, Heckman's

analysis, system estimator regressions, and probit analysis.

Theoretical/Academic Implications: Our results allow us to conclude that investors

perceive changes in board composition as an ineffective response to bank problems,

except when the changes increase the number of non-executives. Bank shareholders

positively value board changes when the bank has a powerful corporate executive

officer and negatively value those banks with high dividends that announce these

changes. Banks with higher interest margin and higher executive experience and

seniority are more prone to make changes in board size and composition, while those

with powerful corporate executive officers, executive directors distracted by their

responsibilities on other boards, higher non-executive attrition, where all non-

executives are male, with one-tier boards, headquartered in a large country, or those

delisting from stock markets will avoid changes in board size.

Practitioner/Policy Implications: This study offers insights to policy makers inter-

ested in enhancing banks' corporate governance. Boards should improve the informa-

tion and transparency of their announcements to signal the effectiveness of board

decisions. In addition, it provides insights about the influence of Board Chairs who

hold the position of corporate executive officer in the design and effectiveness of

banks' corporate governance.

KEYWORDS

corporate governance, bank board size and composition, board announcement, market

reaction

Received: 31 March 2020 Revised: 8 June 2021 Accepted: 2 July 2021

DOI: 10.1111/corg.12397

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reprodu ction in any medium,

provided the original work is properly cited.

© 2021 The Authors. Corporate Governance: An International Review published by John Wiley & Sons Ltd.

Corp Govern Int Rev. 2022;30:161–188. wileyonlinelibrary.com/journal/corg 161

1|INTRODUCTION

Our research seeks to explain whether changes in bank board size

and/or composition signal the effectiveness of the board in terms of

monitoring and advising. Our contribution lies in providing empirical

evidence on the reaction of investors to board changes, in addition to

identifying the variables related to the characteristics of the board,

director attributes and bank financial characteristics that influence the

announcement of bank board changes in terms of composition

and size.

Board reforms are justified to enhance stakeholders' (mainly

shareholders and regulators) interest amidst the significant scandals in

banks' corporate governance over the past two decades. However,

relating banks' board changes with stakeholder rights enhancement is

no easy task. Therefore, we are motivated to empirically evaluate the

market reaction when banks announce changes in the composition

and size of their boards and to identify explanations for such reac-

tions. Our paper highlights the negative market reaction to board

changes and the causality of such reaction and provides evidence

about when a bank will most likely announce changes in its board,

contributing to the existing literature on bank boards.

With this aim in mind, we investigate how investors evaluate

bank board changes using stock market reactions to announcements,

implicitly assuming that market prices incorporate the expected costs

and benefits of the announced event. Our paper provides empirical

evidence to the debate regarding the relationship between board

size or composition and bank performance by (a) quantifying the

reaction of shareholders to changes in board size and composition,

(b) identifying the most relevant characteristics of directors to

explain the observed investor reaction, and (c) finding bank financial

variables that contribute to introducing changes in board size and

composition.

Our contribution helps to emphasize that while the board of

directors is a key mechanism of governance in both financial and non-

financial companies, it plays an essential role in banking. Bank boards

are crucial to understanding bank governance due to the complexity

and opacity of the banking business. Banks' board announcements are

signs intending to disentangle such opacity. They play a unique role in

balancing the interests of the bank's stakeholders: shareholders,

debtholders, and the regulator. Sound bank corporate governance

increases monitoring efficiency and quality advising, particularly

necessary in troubled times such as a financial crisis.

The financial literature identifies two main roles for bank boards:

monitoring and advising. The board's duty is to supervise bank execu-

tives so that they make decisions in line with the best interests of

shareholders (the principal-agent problem), while also bearing in mind

that risk-taking is in consonance with the bank's risk appetite and its

long-term stability (the principal-regulator problem). The board's

monitoring and advising roles should thus be related to board size and

composition. Better alignment of the interests of shareholders,

debtholders, and the regulator will provide for a more effective bank

board (Mehran & Mollineaux, 2012). Thus, board size and composition

should be periodically revised and adjusted to the needs of each bank.

We contribute to the corporate governance literature by testing

whether the announcements of changes in board size and composi-

tion are related to improvements in board effectiveness for a sample

of European banks.

1

If the bank is in trouble, the board becomes

even more relevant to provide solutions. In this situation, the

expertise and knowledge of directors are key to provide advice and

strategic guidance. If the bank's board does not possess such

know-how, it needs to appoint new directors or replace ineffective

directors with ones having the required expertise and knowledge.

Thus, when a board reduces its size, this should be due to the lack of

capabilities of the director leaving the board or the existence of

redundancies on the board that can only be explained by the

entrenchment of the CEO.

Therefore, our contribution analyzes how the announcements in

board size and/or composition are explained by the characteristics

of its directors: age, experience, education, distraction, gender,

nationality, tenure and attrition, and/or how boards function.

Anderson et al. (2011) find that investors place valuation premiums

on board heterogeneity in complex firms (for instance, banks). How-

ever, if a board increases its number of outside members, but the

new directors do not contribute to improving board talent or if they

are too busy serving on several boards, then a higher proportion of

outside members on the bank's board does not help to improve its

monitoring or advisory capabilities. Linck et al. (2008) find that

boards tend to add independent directors via expansion rather than

replacement.

Within this context, we examine the stock market reaction as

an indicator of investor expectations regarding the effectiveness of

the board in terms of monitoring and advising.

2

Our sample consists

of 608 announcements made by 75 European banks between 2003

and 2015. We use the Event Study methodology to compute the

market abnormal returns of banks around the time of the announce-

ments of changes in board composition and/or size. Furthermore,

we analyze whether the stock market reaction to the announcement

is influenced by increases or decreases in size and if it differs

depending on whether the changes occur in executive or non-

executive directors. However, no other studies have delved into the

explanations for such abnormal returns. We subsequently investigate

whether these returns may have been driven by other relevant

variables using a regression model. Finally, we use a probit analysis

to investigate the characteristics of the board that may influence the

decision to change.

We find that investors react negatively and significantly to

announcements that modify bank boards on the days around the

event. However, increasing the size of the board with more

non-executive directors generates positive abnormal returns in the

post-event and short windows around the announcement. Thus,

investors consider that additional non-executives may improve board

capabilities for monitoring and advising. However, investors show

confidence in announcements when the bank has a powerful CEO

who is also the chairman of the board and in banks with higher

seniority executives, but penalize those banks whose announcements

include a large increase in the number of directors over the current

162 VALLELADO AND GARCÍA-OLALLA