Which Executive Characteristics Create Value in Banking? Evidence from Appointment Announcements

• Author: Duc Duy (Louis) Nguyen,Jens Hagendorff,Arman Eshraghi
• Date: 01 March 2015
• DOI: http://doi.org/10.1111/corg.12084
• Published date: 01 March 2015

Which Executive Characteristics Create Value

in Banking? Evidence from

Appointment Announcements

Duc Duy (Louis) Nguyen, Jens Hagendorff*, and Arman Eshraghi

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study seeks to understand how the characteristics of executive directors affect the market

performance of US banks. To explore the expected performance effects linked to executive characteristics, we measure any

changes in the market valuation of banks linked to announcements of executive appointments.

Research Findings/Insights: Our study has two important f‌indings. First, we show that age, education, and the prior work

experience of executives create shareholder wealth while gender is not linked to measurable value effects. Second, these

wealth effects are moderated by the level of inf‌luence of incoming executives, with their magnitude diminished under

independent boards and higher if the incoming executive is also appointed as CEO. Our results are robust to the treatment

of selection bias.

Theoretical/Academic Implications: By illustrating the wealth effects linked to executive appointments, our study con-

tributes to the current debate on whether and how individual executives matter for f‌irm performance and behavior. The

f‌indings also shed light on the value of human capital in the banking industry.

Practitioner/Policy Implications: This study offers important insights to policymakers charged with ensuring the compe-

tency of executives in banking. Our f‌indings advocate policies that mandate banks to appoint highly qualif‌ied executives

with relevant banking experience.

Keywords: Corporate Governance, Banks, Executives Characteristics, Market Value

INTRODUCTION

There is a considerable debate amongst the public,

policymakers and academics as to whether individual

executives matter for f‌irm performance and behavior. A

growing body of research demonstratesthat executive direc-

tors are a heterogeneous group and suggests that executive

behavior is governed by more than economic trade-offs.

Studies have shown that executives affect the performance

of f‌irms (e.g., Adams, Almeida, & Ferreira, 2005; Bennedsen,

Perez-Gonzalez, & Wolfenzon, 2008; Custodio & Metzger,

2013; Kaplan, Klebanov, & Sorensen, 2012) and their policy

choices (e.g., Bertrand & Schoar, 2003; Custodio & Metzger,

2014; Malmendier, Tate, & Yan, 2011). Other studies argue

that individual executives have little impact on f‌irm perfor-

mance and behavior because seemingly unique executive-

specif‌ic “styles” may in fact be shaped by the board of

directors and that new executives are appointed with

desired characteristics to take a f‌irm in the direction deter-

mined by the board (Fee, Hadlock, & Pierce, 2013). This

study sheds new light on whether and how executives

matter by demonstrating thatvariations in observabledemo-

graphic and experience characteristics of executives have

market valuation effects.

With existing work mostly limited to non-f‌inancial f‌irms,

there is an inherent lack of analysis concerning the banking

sector. Since banks are complex institutions and may require

employees with specialized skills (Philippon & Reshef,

2012), selecting the right executives could give banks a sig-

nif‌icant competitive edge as well as contribute to the growth

of the economy. Recently, the banking sector has received

much criticism for its contribution to the f‌inancial crisis that

started in 2007. Many blame incompetent banking execu-

tives for engaging in activities that endangered the safety

and soundness of the f‌inancial system and gave rise to

*Address for correspondence: Jens Hagendorff, University of Edinburgh, 29

Buccleuch Place, Edinburgh EH8 9JS, UK. Tel:01316502796; E-mail: jens.hagendorff@

ed.ac.uk

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© 2014 John Wiley & Sons Ltd

doi:10.1111/corg.12084

unprecedented government support of the banking sector.

By the same token, certain bank executives have been cred-

ited with steering their organizations successfully through

the f‌inancial crisis.1

In this study, we focus on executive directors2who are

responsible for the day-to-day running of the bank. Since

executive directors have substantial discretion over their

decisions, their individual characteristics such as prior expe-

rience could make an important difference to bank out-

comes (e.g., Kim & Lu, 2014; Landier, Sauvagnat, Sraer, &

Thesmar, 2013). In contrast, non-executive directors, who

are responsible for monitoring and advising the CEOs, are

not involved in managing the bank on a daily basis. Hence,

compared with non-executive directors, executives have

more inf‌luence and their characteristics are more likely to

have measurable implicationsfor the market performance of

banks.

We argue that executive characteristics such as age, edu-

cation, and employment history are performance relevant.In

our analysis, we examine whether the stock market reaction

to the appointment of a new executive is driven by the

characteristics of the appointee. Focusing on the appoint-

ment of a new executive offers an appropriate setting in

which to examine the value of characteristics that the

appointee brings to the hiring bank. In an eff‌icient capital

market, the market reaction is indicative of the anticipated

future performance conditional on relevant information

(Perez-Gonzalez, 2006; Warner,Watts, & Wruck, 1988). Thus,

market returns will be higher when an appointee with desir-

able characteristics is hired because investors believe that

this appointee will improve performance. In this study, we

do not look at internal appointments of executives because

the identif‌ication of any causal effects between appointee

characteristics and announcement returns are not straight-

forward in this case. From a resource-based perspective, the

marginal addition in terms of human capital to the f‌irm is

likely to be smaller when internal candidates (who most

likely already contribute to bank decision making in senior

positions) are appointed compared to an externally

appointed director.

Our sample consists of 252 executive appointment

announcements by 145 US banks. Exploring this dataset,

we examine whether the stock market reaction to the

appointment announcement is affected by seven character-

istics of the appointee: (1) age, (2) gender, (3) the number

of prior executive directorships, (4) the number of current

non-executive directorships (busyness), (5) the number of

non-banking industries (in which the appointee has expe-

rience), (6) an Ivy League education, and (7) an MBA

degree.

There are two main econometric challenges we facein our

analysis. First, a bank’s decision to make a top executive

appointment could be driven by endogenous factors, e.g.,

when a bank is not performing well and faces shareholder

pressure to improve performance by making new appoint-

ments (Berger, Kick, & Schaeck, 2014; Fee et al., 2013). We

therefore exclude appointments where the press coverage

indicates an appointment following investor dissatisfaction

with management or corporate strategy. The second chal-

lenge is that, given that we are interested in the expected

performance effects linked to a new appointment, our

sample only contains single appointment announcements

which involve external appointments (i.e., executives who

have previously not worked for the sample bank). This

might introduce a selection bias when the decision to make

a single (rather than multiple) appointment announcement

or the decision to choose an external (rather than an internal)

appointee correlates with factors associated with announce-

ment returns. We address this second challenge using the

Heckman (1979) two-step procedure and the f‌indings we

report in this paper are robust to controlling for selection

bias.

Our key f‌indings are as follows. First, announcement

returns following appointments are statistically positive,

suggesting that the addition of top managers, on average, is

valuable for US banks. Second, we examine whether the

market reaction to executive appointments is inf‌luenced by

characteristics of the executive. Overall, our f‌indings

suggest that the age, education, and prior experience of the

executives create shareholder wealth in the US banking

sector. In contrast, gender, non-banking experience or an

MBA degree do not lead to any measurable market returns.

In addition, the appointment of executives who hold non-

executive directorships with outside f‌irms at the time of the

appointment results in negative returns, consistent with the

hypothesis that busy executives have less attention to focus

on an individual bank (Fich & Shivdasani, 2006).

Third, our analysis of interaction terms shows that the

wealth effects linked to executive characteristics are moder-

ated by how much inf‌luence the incoming executive is

expected to hold over the bank. Thus, the expected perfor-

mance effects of top executives are reduced as bank boards

become more independent. By contrast,the expected perfor-

mance effects are higher for CEOs, conf‌irming that the CEO

is the most important decision maker in the bank.

Overall, our study makes three signif‌icant contributions

to the literature. First, we contribute to a growing literature

that uses manager f‌ixed effects to address the question of

how important executive “styles” are to various corporate

outcomes (Adams et al., 2005; Bamber, Jiang, & Wang, 2010;

Bertrand & Schoar, 2003; Frank & Goyal, 2007; Graham, Li, &

Qiu, 2012). It is empirically challenging to quantify the

effects of individual executives on f‌irm performance. Fee et

al. (2013) argue that executive turnover, which forms the

empirical basis to work out executive styles, may frequently

be endogenous (e.g., when they follow a period of

underperformance). When focusing on “exogenous” CEO

replacements brought about by CEO retirements and

deaths, the authors do not f‌ind evidence of manager f‌ixed

effects in corporate policy choices. This raises the question

whether or not the results of the managerstyles literature are

biased and that whether, more broadly, executives matter for

corporate outcomes.

Our paper offers an alternative route to showing that

executives indeed matter. Unlike Fee et al. (2013), we do not

focus on executive “styles”, but on demographic and expe-

rience variables of executives. We show that the majority of

executive appointments are linked to valuegains around the

announcement date. By analyzing the variation in short-term

returns following executive appointments, we can exclude

events other than the appointment causing the observed

effect. We thus interpret our results as evidence demonstrat-

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© 2014 John Wiley & Sons Ltd Volume 23 Number 2 arch 2015

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