Board Monitoring, Regulation, and Performance in the Banking Industry: Evidence from the Market for Corporate Control

• Author: Kevin Keasey,Jens Hagendorff,Michael Collins
• DOI: http://doi.org/10.1111/j.1467-8683.2010.00815.x
• Date: 01 September 2010
• Published date: 01 September 2010

Board Monitoring, Regulation, and Performance

in the Banking Industry: Evidence from the

Market for Corporate Controlcorg_815381..395

Jens Hagendorff*, Michael Collins, and Kevin Keasey

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: The specif‌ic monitoring effect of boards of directors versus industry regulation is unclear. In this

paper, we examine how the interaction between bank-level monitoring and regulatory regimes inf‌luences the announce-

ment period returns of acquiring banks in the US and twelve European economies.

Research Findings/Insights: We study three board monitoring mechanisms – independence, CEO-chair duality, and

diversity – and analyze their effectiveness in preventing underperforming merger strategies under bank regulators of

varying strictness. Only under strict banking regulation regimes, do boardindependence and diversity improve acquisition

performance. In less strict regulatory environments, corporate governance is virtually irrelevant in improving the perfor-

mance outcomes of merger activities.

Theoretical/Academic Implications: Our results indicate a complementary role between monitoring by boards and bank

regulation. This study is the f‌irst to report evidence consistent with complementarity by investigating the effectiveness

(rather than the prevalence) of governance arrangements across regulatory regimes.

Practitioner/Policy Implications: Our work offers insights to policymakers charged with improving the qualityof decision-

making at f‌inancial institutions. Attempts to improve the ability of bank boards to critically assess managerial initiatives are

most likely to be successful if internal governance is accompanied by strict industry regulation.

Keywords: Corporate Governance, Regulation, Banks, Mergers, Acquisitions, Performance

INTRODUCTION

It is a widely-held view that banks and other closely-

regulated f‌irms are not subject to the same contracting

costs between managers and shareholders as less tightly

regulated companies (Booth, Cornett, & Tehranian, 2002;

Kole & Lehn, 1999; Mallin, Mullineux, & Wihlborg, 2005). If

regulation restricts managerial discretion and its scope to

adversely affect shareholder wealth, the requirement on

shareholders to put in place board mechanisms to monitor

managers is somewhat reduced (Baysinger & Zardkoohi,

1986; Shleifer & Vishny, 1997). Thus, regulation may act as a

substitute for monitoring by boards. Alternatively, if strict

regulatory environments promote f‌irm-level governance

that is effective in controlling for agency cost, a complemen-

tary relationship exists between governance and regulation.

The purpose of this paperis to analyze the monitoring effects

of boards of directors versus bank regulators in preventing

value-destroying acquisition strategies in the US and

Europe. The regulatory regimes of Europe and the US vary

in terms of their sensitivity to bank risk-taking, disciplinary

powers, and enforcement mechanisms.

Mergers and acquisitions (M&A) provide a suitable

setting in which to examine the effectiveness of manage-

ment monitoring. This is becauseM&A are important mana-

gerial initiatives that are subject to board scrutiny and have

observable performance effects. Further, Jensen (1986)

argues that acquisitions intensify the conf‌licts of interest

between managers and shareholders in public corporations.

Agency explanationsof M&A emphasize that the market for

corporate control may yield sizable personal gains to man-

agers at the expense of shareholder wealth (Masulis, Wang,

& Xie, 2007; Morck, Shleifer, & Vishny, 1990). In the case of

banking, a large merger performance literature reports that,

while bidding bank shareholders tend to realize wealth

*Address for correspondence: The University of Edinburgh, 29 Buccleuch Place,

Edinburgh EH8 9JS, UK. E-mail: jens.hagendorff@ed.ac.uk

381

Corporate Governance: An International Review, 2010, 18(5): 381–395

© 2010 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2010.00815.x