Did GCG Improve Bank Performance during the Financial Crisis

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Did Good Corporate Governance Improve Bank Performance during the
Financial Crisis?
Article in Journal of Financial Services Research · April 2012
DOI: 10.1007/s10693-011-0108-9
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Forthcoming in Journal of Financial Services Research
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DID GOOD CORPORATE GOVERNANCE IMPROVE BANK
PERFORMANCE DURING THE FINANCIAL CRISIS?
Emilia Peni a,b,*, Sami Vähämaa a,b,**
a
University of Vaasa, Department of Accounting and Finance
b
University of Central Florida, Department of Finance
First Draft: August 2009
This Draft: March 2011
Abstract
This paper focuses on the effects of corporate governance on bank performance during the
financial crisis of 2008. Using data on large publicly traded U.S. banks, we examine
whether banks with stronger corporate governance mechanisms were associated with higher
profitability and better stock market performance amidst the crisis. Our empirical findings
on the effects of corporate governance on bank performance are mixed. Although the
results suggest that banks with stronger corporate governance mechanisms were associated
with higher profitability in 2008, our findings also indicate that strong governance may
have had negative effects on stock market valuations of banks amidst the crisis.
Nevertheless, we document that banks with strong corporate governance practices had
substantially higher stock returns in the aftermath of the market meltdown, indicating that
good governance may have mitigated the adverse influence of the crisis on bank credibility.
JEL classification: G01, G21, G30
Keywords: corporate governance; bank performance; financial crisis
We wish to thank an anonymous referee, Stanley D. Smith, James E. McNulty, and participants at the 2010
Eastern Finance Association Meeting for insightful comments and discussions. The authors gratefully acknowledge
the financial support of the Foundation for Economic Education and the NASDAQ OMX Nordic Foundation.
Emilia Peni further acknowledges the support of the Evald and Hilda Nissi Foundation, the Fulbright Center, and
the South Ostrobothnia Fund of the Finnish Cultural Foundation, and Sami Vähämaa is grateful for the support of
the Finnish Foundation for Advancement of Securities Markets, the Emil Aaltonen Foundation, and the Paulo
Foundation.
*
Address: University of Vaasa, Department of Accounting and Finance, P.O. Box 700, FI-65101 Vaasa, Finland;
Tel:. +358 6 324 8547; E-mail address: [email protected]
**
Corresponding author. Address: University of Vaasa, Department of Accounting and Finance, P.O. Box 700, FI65101 Vaasa, Finland; Tel.: +358 6 324 8197; E-mail address: [email protected]
1
1. INTRODUCTION
The financial crisis of 2008 is to a large extent attributable to excessive risk-taking by
banks. Given that corporate governance is essentially a mechanism for addressing agency
problems and controlling risk within the firm, it is not surprising that the recent initiatives and
statements by banking supervisors, central banks, and other authorities have emphasized the
importance of effective corporate governance practices in the banking sector (see e.g., Basel
Committee on Banking Supervision 2010; Board of Governors of the Federal Reserve System
2010a-b; OECD 2010). Thus, it is now widely acknowledged that shortcomings in bank
corporate governance may have had a central role in the development of the crisis. In this paper,
we aim to provide empirical evidence on the effects of corporate governance on bank
performance during the financial crisis. In particular, we use data on large publicly-traded U.S.
banks to examine whether banks with strong governance were associated with higher
profitability and better stock market performance amidst the crisis.
Previously, an extensive empirical literature has documented that firms with strong
corporate governance mechanisms are generally associated with better financial performance,
higher firm valuation and higher stock returns (see e.g., Ammann et al. 2011; Bebchuk et al.
2009; Bhagat and Bolton 2008; Brown and Caylor 2006, 2009; Chhaochharia and Laeven 2009;
Core et al. 2006; Cremers and Ferrell 2010; Cremers and Nair 2005; Gompers et al. 2003;
Johnson et al. 2009; Renders et al. 2010). The role of corporate governance in the banking
industry has been examined e.g. in Caprio et al. (2007), Cornett et al. (2009), de Andres and
Vallelado (2008), Hanazaki and Horiuchi (2003), Jiraporn and Chintrakarn (2009), Laeven and
Levine (2009), Macey and O’Hara (2003), Mishra and Nielsen (2000), Pacini et al. (2005),
2
Sierra et al. (2006), and Webb Cooper (2009). Consistent with the literature on non-financial
firms, these studies demonstrate that strong corporate governance has positive effects on the
financial performance and stock market valuation of banks. More generally, the prior studies
indicate that the same corporate governance attributes that affect non-financial firms are also
relevant in bank governance.
Given the existing empirical evidence on the positive influence of good governance on
bank performance, we hypothesize in this paper that the strength of corporate governance is
reflected in bank performance during the financial crisis. Specifically, we posit that banks with
stronger corporate governance mechanisms had (i) higher profitability, (ii) higher market
valuations, and (iii) less negative stock returns amidst the crisis. Nevertheless, it is also possible
that the link between good corporate governance and bank performance documented in the prior
literature is related to higher levels of risk-taking, in which case strong governance may lead to
poor performance during periods of market turmoil. The relationship between corporate
governance and bank risk-taking has been recently examined in Akhigbe and Martin (2008),
Fortin et al. (2010), and Pathan (2009). While Akhigbe and Martin (2008) document that risk
measures of financial firms vary inversely with the strength of corporate governance, the
findings of Pathan (2009) and Fortin et al. (2010) suggest that banks with strong governance
attributes may take more risk.
This paper is not the first to examine bank performance during the financial crisis.
Beltratti and Stulz (2010) focus on bank stock returns in 31 countries over the period from July
2007 to December 2008, and document that large banks with lower leverage ratios had less
negative stock returns during the crisis. Interestingly, their results also suggest that banking
regulation differences across countries are not related to bank performance. Regarding corporate
3
governance attributes, Beltratti and Stulz (2010) find that banks with strong, shareholderfriendly boards performed worse amidst the market turmoil. Erkens et al. (2010) examine the
influence of board independence and institutional ownership on bank stock returns in 30
countries from January 2007 to September 2008. Their results indicate that banks with more
independent boards and larger institutional ownership had lower stock returns during the crisis.
Moreover, Erkens et al. (2010) document a positive relationship between institutional ownership
and bank risk-taking at the onset of the crisis. Finally, Fahlenbrach and Stulz (2011) investigate
the effects of chief executive officer (CEO) ownership and compensation incentives on the stock
returns and profitability of U.S. banks. They find that banks whose managers have larger equity
ownership were associated with lower stock returns and profitability in 2008. Although flaws in
managerial compensation incentives are often considered among the factors contributing to the
development of the financial crisis, the results documented in Fahlenbrach and Stulz (2011)
suggest that the CEO’s option compensation and cash bonuses are unrelated to bank
performance amidst the crisis.
In this paper, we use data on 62 large, publicly traded U.S. commercial banks to
empirically examine the association between corporate governance and bank performance
during the financial crisis. We apply the Gov-Score governance index of Brown and Caylor
(2006, 2009) to measure the strength of governance mechanisms within banks, and analyze the
effects of corporate governance on bank profitability, market valuation, and stock returns. Our
main findings can be summarized as follows. First, consistent with our research hypothesis, we
find that banks with stronger corporate governance mechanisms had significantly higher
profitability in 2008. This finding suggests that good governance may have moderated the
adverse influence of the financial crisis on financial performance. Second, our results indicate
4
that strong corporate governance practices may have had negative effects on stock market
valuations of banks during the crisis, as banks with stronger governance are found to be
associated with lower Tobin’s Qs and stock returns amidst the crisis. Thus, inconsistent with our
hypothesis, the empirical findings suggest that good corporate governance did not create
shareholder value in the banking industry during the market turmoil. Nevertheless, we also find
that banks with stronger corporate governance mechanisms provided substantially higher stock
returns in the immediate aftermath of the crisis from March 2009 onwards, indicating that good
governance may have mitigated the adverse effects of the financial crisis on bank credibility
among stock market participants.
The remainder of this paper proceeds as follows. The second section describes the data set
on large publicly traded U.S. banks. The third section presents the methodology and reports the
empirical findings on the association between corporate governance and bank performance
during the financial crisis. Finally, the last section provides concluding remarks.
2. DATA
The data used in our empirical analysis consist of the large, publicly traded U.S.
commercial banks that are included in the S&P 1500 index. After eliminating the banks with
insufficient financial and/or corporate governance information, we obtain a sample comprising
of 62 individual banks and 248 firm-year observations for the fiscal years 2005–2008. The
banks included in our sample are listed in Appendix 1. Despite the relatively small number of
individual banks, the sum of total assets of these banks totalled about $8.6 trillion at the end of
2008, and thereby the sample covers a substantial proportion of the total amount of banking
5
assets in the U.S. Our empirical analysis requires data on the banks’ (i) corporate governance
structures, (ii) financial statements, and (iii) stock prices. The corporate governance data used in
the analysis are obtained from Georgia State University, while the income statement and balance
sheet items are collected from Thomson Reuters Worldscope. The data on stock prices and
market capitalizations of banks are obtained from CRSP.
We apply the Gov-Score corporate governance index developed by Brown and Caylor
(2006, 2009) to measure the strength of governance. The Gov-Score index is based on 51
different firm-specific governance attributes, which present both internal and external
governance of the firm. The different governance sectors considered in the Gov-Score are
auditing, board of directors, charter/bylaws, director education, executive and director
compensation, ownership, progressive practices, and state of incorporation (for a detailed
discussion, see Brown and Caylor, 2006). Each of the considered individual corporate
governance attributes is given either a value of one or zero based on whether the governance
factor is at the minimally acceptable level or above it. The Gov-Score is then calculated as the
sum of the values of individual governance attributes, and may thus take values between zero
and 51, with higher values of the index corresponding to stronger corporate governance
practices. Given that the prior literature (see e.g., Black et al. 2006, Cremers and Ferrell 2010)
has suggested that corporate governance structures change slowly and the implications of the
governance practices can be seen with a lag, we use the Gov-Scores for year 2005 in our
empirical analysis. Hence, we assume in our analysis that the strength of corporate governance
can be quantified with the Gov-Score index, and moreover, that the strength of governance
mechanism incorporated in 2005 is reflected in bank performance during 2005–2008.
6
Considerable empirical evidence suggests that strong corporate governance has positive
effects on the firm’s financial performance, market valuation, and stock returns (see e.g.,
Ammann et al. 2011; Bebchuk et al. 2009; Bhagat and Bolton 2008; Brown and Caylor 2006,
2009; Chhaochharia and Laeven 2009; Cremers and Ferrell 2010; Gompers et al. 2003; Johnson
et al. 2009; Renders et al. 2010). Following the prior bank performance literature (e.g., Caprio et
al. 2007; Chiorazzo et al. 2008; Ciciretti et al. 2009; de Andres and Vallelado 2008; Outreville
2010; Sierra et al. 2006), we employ return on assets (ROA) and Tobin’s Q to measure the
financial performance and market valuation of banks. We calculate return on assets as the
earnings before interest and taxes divided by the book value of total assets. Tobin’s Q is
computed as the sum of market value of equity and the book value of liabilities divided by the
book value of total assets. In addition, we also calculate stock returns for three distinct
subperiods between March 2007 and December 2009 in order to examine the effects of
corporate governance on stock market performance during the financial crisis.
We employ several control variables to account for the potentially confounding effects of
bank-specific characteristics such as size, leverage, and risk on profitability and market
valuation. The control variables used in our main regressions are: (i) bank size (SIZE) which is
measured by the logarithm of the bank’s total assets, (ii) leverage (LEV) which is defined as the
ratio of total liabilities to total assets, (iii) the amount of lending activities (LOANTA) which is
measured by ratio of total lending to total assets, (iv) stock return volatility (VOLA) which is
calculated as the annualized standard deviation of monthly stock returns, and (v) a dummy
variable (LOSS) that equals one for banks that report negative earnings during the fiscal year.
(insert Table 1 about here)
7
Table 1 reports the descriptive statistics of the data used in the main analysis. The
descriptive statistics are reported separately (i) for the complete sample of 248 firm-year
observations, (ii) for the crisis year 2008, (iii) for banks with stronger corporate governance
mechanisms, and (iv) for banks with weaker corporate governance. The stronger governance
subsample consists of banks with above median Gov-Scores (GOV 33) and the weaker
governance subsample consists of banks with below median Gov-Scores (GOV 32). The table
also reports p-values for two-tailed t-tests and Wilcoxon rank-sum tests of the null hypothesis
that there is no difference between the stronger and weaker governance subsamples.
As can be noted from the table, the Gov-Scores of the banks included in the sample range
from 24 to 40 with a mean governance score of 31.44. Bank profitability, as measured by ROA,
varies between –6.08 and 5.11 percent, with a mean of 1.91 percent. The mean ROA of 0.31
percent in 2008 demonstrates the vast decline in bank profitability during the financial turmoil.
The means and medians for the stronger and weaker governance subsamples indicate that banks
with stronger corporate governance mechanisms have significantly higher profitability,
suggesting that strong governance may improve bank performance. Tobin’s Q, our measure of
market valuation, has a mean value of 1.06 and ranges from 0.91 to 1.28. It should also be noted
that both the mean and the median Qs are below one in 2008 amidst the meltdown of financial
markets. In a univariate setting, a t-test and the Wilcoxon rank-sum test suggest that there is no
difference in market valuation between the stronger and weaker governance subsamples.
Although our sample consists of the largest banks in the U.S., the banks included in the
sample are heterogeneous in terms of size. The logarithm of total assets (SIZE) varies from 7.15
(i.e., $1.27 billion) to 14.60 ($2.18 trillion). The subsample descriptive statistics and comparison
tests indicate that banks with stronger corporate governance tend to be significantly larger than
8
banks with weaker governance mechanisms. The mean leverage ratio (LEV) is 0.90 and ranges
from 0.73 to 0.98. There is no statistically significant difference in financial leverage between
the stronger and weaker governance subsamples. Our sample represents a diverse range of
lending activity with the proportion of total loans to total assets (LOANTA) varying between
16.54 and 93.65 percent.
Interestingly, both the mean and the median LOANTA figures suggest that the banks with
stronger corporate governance structures are associated with a lower amount of lending. The
annualized stock return volatility (VOLA) has a mean of 28.20 percent during the sample period.
Not surprisingly, Table 1 demonstrates that the volatility of bank stocks was extremely high in
2008, with a mean estimate of 57.24 percent. The mean and the median volatility estimates
indicate that the banks with stronger corporate governance have lower stock return volatility,
albeit the difference in means is not statistically significant. Finally, the reported statistics for
the LOSS dummy variable suggest that there is no difference between the stronger and weaker
governance subsamples in the likelihood to report losses.
(insert Table 2 about here)
Table 2 presents the pairwise correlations between the variables used in the analysis. Our
test variable GOV is strongly positively correlated with bank size and negatively correlated with
loans to total assets (LOANTA) and stock return volatility (VOLA). Thus, consistent with the
prior literature and Table 1, the correlations indicate that larger banks tend to have stronger
governance structures. The correlations between GOV and the performance measures ROA
(0.067) and Tobin’s Q (–0.049) are insignificant. As expected, our dependent variables ROA and
9
Q are positively correlated with each other. Furthermore, Table 2 suggests that both bank
performance measures are strongly negatively correlated with VOLA and LOSS which, in turn,
exhibit a strong positive correlation with each other. Finally, based on the correlations, the
proportion of loans to total assets seems to decrease with bank size.
3. CORPORATE GOVERNANCE AND BANK PERFORMANCE
3.1. Financial performance and market valuation
To examine the effects of corporate governance on bank performance during the financial
crisis, we estimate alternative versions of the following panel regression specification:
PERF j , t
1
GOV j ,t
2
GOV j ,t
YEAR 2008
j
3
SIZE j ,t
4
LEV j , t
(1)
2008
5
LOANTA
j ,t
6
VOLA j , t
7
LOSS
j ,t
y
YEAR jy
j ,t
y 2006
where PERFj,t denotes one of the alternative performance measures (ROA or Tobin’s Q) for
bank j at time t, GOVj,t is the Gov-Score of Brown and Caylor (2006, 2009), SIZEj,t is the
logarithm of total assets, LEVj,t is financial leverage measured as the ratio of total liabilities to
total assets, LOANTAj,t is loans to total assets, VOLAj,t is the logarithm of annualized volatility of
stock returns, LOSSj,t is a dummy variable that equals one for banks that report negative
earnings during year t, and YEARjy is a dummy variable for fiscal years controlling for the
possible change in bank performance over time. Throughout the panel regressions, we use
standard errors that are corrected for clustering at the bank level.
10
Table 3 reports the estimation results of alternative versions of Equation (1) with ROA as
the dependent variable. Models (1) and (2) are parsimonious versions of Equation (1) that
include only two control variables (SIZE and LEV) and year fixed-effects. The estimated
coefficients for GOV are positive and statistically significant at the 5 percent level in both
regression specifications, thereby suggesting that strong corporate governance mechanisms
improve bank profitability. More importantly, consistent with our hypothesis, the coefficient for
the interaction variable GOV×YEAR2008 is positive and statistically highly significant, indicating
that strong governance had a positive effect on bank performance during the financial crisis. The
estimates also suggest that bank profitability decreases with increasing leverage (LEV) and, as
expected, that profitability was severely affected by the crisis in 2008 (YEAR2008). It can be
further noted from the table that both model specifications have relatively good explanatory
power for bank profitability with adjusted R2s of about 37 percent.
(insert Table 3 about here)
Models (3) and (4) include the full set of bank-specific control variables. The adjusted R2s
of these regressions are about 65 percent, and the F-statistics are significant at the 1 percent
level, indicating a good fit of the models. Again, the coefficient estimates for GOV are positive
and statistically significant, and also the coefficient for the interaction variable GOV×YEAR2008
is positive and highly significant. Therefore, consistent with our hypothesis, the estimates
indicate that good corporate governance generally improves bank performance, and moreover,
that the positive effect of good governance on profitability was particularly strong in 2008.
These results indicate that strong internal corporate governance mechanisms within banks may
11
have moderated the adverse effects of the financial crisis on bank performance. As can be
further noted from Table 3, profitability of banks is negatively associated with leverage (LEV)
and the proportion of total loans to total assets (LOANTA). The highly significant negative
coefficients for the YEAR2008 dummy variable yet again demonstrate the substantial impact of
the financial crisis on bank performance.
Table 4 presents the regression results for the effects of corporate governance on Tobin’s
Q. Similar to Table 3, we first estimate reduced versions of Equation (1) with only two control
variables and year fixed-effects (Models 1 and 2). Consistent with the prior literature (see e.g.,
Ammann et al. 2011; Brown and Caylor 2006; Cremers and Ferrell 2010; Gompers et al. 2003;
Johnson et al. 2009), our estimates indicate that the strength of corporate governance is
positively associated with market valuations, as the coefficient estimates for GOV are positive
and statistically significant in both regression specifications. Interestingly, however, the
coefficient for the interaction variable GOV×YEAR2008 is negative and statistically significant at
the 1 percent level, thereby suggesting that strong corporate governance mechanisms may have
reduced the market valuation of banks in the midst of the financial crisis. The estimated
coefficients for the control variables are highly significant, thus indicating that market valuation
decreases with bank size (SIZE) and increases with leverage (LEV). The F-statistics of both
regression specifications are significant at the 1 percent level and the adjusted R2s are about 42
percent.
(insert Table 4 about here)
12
The full set of control variables is included in Models (3) and (4). As can be noted from
Table 4, the estimated coefficient for GOV is positive and statistically significant in Model (4),
and consistent with Model (2), the coefficient for GOV×YEAR2008 in Model (4) is negative and
statistically significant at the 1 percent level. The fiscal year dummies suggest that bank
valuations were, on average, significantly lower in 2007 and especially in 2008. Inconsistent
with our hypothesis, the estimates of Models (2) and (4) indicate that the depressed market
valuation in 2008 amidst the market meltdown is largely attributable to banks with stronger
corporate governance structures. However, it should be noted that this finding is broadly
consistent with Beltratti and Stulz (2010), Erkens et al. (2010), and Fahlenbrach and Stulz
(2011), who document that strong governance attributes are negatively associated with stock
market performance during the crisis. Regarding the additional control variables, it can be noted
that the market valuation of banks decreases with increasing amount of lending (LOANTA),
increasing volatility (VOLA), and with negative earnings (LOSS). The adjusted R2s of about 51
percent and highly significant F-statistics again indicate a good fit of the estimated regression
specifications.
Overall, the results reported in Tables 3 and 4 demonstrate that corporate governance
affects bank performance. Consistent with the prior literature, our findings indicate that strong
governance generally improves financial performance and also has positive effects on market
valuation. However, we find mixed evidence for our hypothesis that good corporate governance
improved bank performance during the financial crisis. Although our findings suggest that
banks with stronger corporate governance mechanisms were associated with significantly higher
profitability during the financial crisis, our results also indicate that strong governance may have
had negative effects on market valuations of banks amidst the crisis. Thus, inconsistent with the
13
research hypothesis, our results suggest that strong corporate governance does not necessarily
create shareholder value in the banking industry during periods of severe market stress.
Our empirical findings on the influence of corporate governance on bank performance are
robust to several sensitivity tests. First, in order to ensure that the results are not affected by a
few extreme observations, we winsorized the dependent variables (ROA and Q) as well as the
control variables (SIZE, LEV, LOANTA, and VOLA) at the 1 percent and 99 percent levels and
then re-estimated all regression models. The estimation results based on the winsorized data are
consistent with those reported in Tables 3 and 4. Most importantly, the coefficients for the
corporate governance variables are positive and statistically significant in the four regressions
with ROA as the dependent variable, and positive and significant for GOV in Models (1), (2),
and (4), and negative and significant for GOV×YEAR2008 in all the regressions with Q as the
dependent variable.
Furthermore, our results are robust to alternative variable definitions. We replaced GOV
with a dummy variable that identifies the banks with Gov-Scores in the highest quartile (i.e.,
banks with the strongest corporate governance). Again, the estimation results are broadly
consistent with our main findings. In the ROA regressions, the coefficients for GOV are positive
and significant in Models (3) and (4), and the coefficient for GOV×YEAR2008 is positive and
highly significant in Models (2) and (4). In the regressions with Tobin’s Q as the dependent
variable, the estimated coefficients are positive and significant for GOV and negative and
significant for GOV×YEAR2008 in all four model specifications. We also replaced ROA and Q
with alternative variables. Our main results hold if return on assets is calculated as the ratio of
net income to total assets and if Tobin’s Q is computed as the book value of assets plus the
market value of equity less the book value of equity divided by the book value of total assets.
14
Thus, we conclude that our empirical findings are not sensitive to alternative variable
definitions. Overall, the sensitivity tests provide further evidence to suggest that the strength of
corporate governance is positively associated with financial performance and negatively
associated with Tobin’s Q amidst the financial crisis.
3.2. Stock returns
The preceding analysis indicates that banks with stronger corporate governance
mechanisms had lower stock market valuations during the meltdown of financial markets in
2008. As the next step of the analysis, we examine the effects of corporate governance on bank
stock returns around the financial crisis. First, we divide the banks into two subsamples based
on the strength of corporate governance, and then calculate the mean and median stock returns
in these subsamples for three distinct periods around the crisis. The banks with above median
Gov-Scores comprise the stronger governance subsample and the weaker governance subsample
consists of banks with below median Gov-Scores. The first period of analysis is from March
2007 to February 2008 and represents the onset of the crisis. The second period spans from
March 2008 to February 2009, and thereby covers the period of the severe market stress.
Finally, the third period extends from March 2009 through December 2009, and thus represents
the stock market developments in the immediate aftermath of the crisis.
(insert Table 5 about here)
15
The mean and median bank stock returns in different phases of the financial crisis are
reported in Table 6. Interestingly, the table shows that banks with stronger corporate governance
mechanisms slightly underperformed relative to banks with weaker governance at the onset and
during the crisis. The documented more negative stock returns for banks with stronger
governance are consistent with the Tobin’s Q regressions reported in Table 4, and also broadly
consistent with the empirical findings reported in Beltratti and Stulz (2010), Erkens et al.
(2010), and Fahlenbrach and Stulz (2011). However, both the t-tests and the Wilcoxon rank-sum
tests indicate that the observed differences in stock returns between the stronger and weaker
governance subsamples are not statistically significant. Contrary to the research hypothesis, our
findings suggest that good corporate governance did not improve the stock market performance
of banks during the financial crisis.
Nevertheless, as can be noted from Table 6, banks with stronger corporate governance
mechanisms provided substantially higher stock returns in the aftermath of the market meltdown
from March 2009 onwards. The mean (median) stock return for the banks in the stronger
governance subsample was about 86 percent (63 percent) during the ten month period from
March 2009 to December 2009, while the corresponding mean (median) return for the banks in
the weaker governance subsample was about 11 percent (13 percent). The t-tests and the
Wilcoxon rank-sum tests indicate that the differences in stock returns between the two
subsamples during the third period are statistically highly significant. Hence, our findings
suggest that better corporate governance may have mitigated the adverse effects of the financial
crisis on bank credibility among stock market participants.
(insert Table 6 about here)
16
To further examine the association between corporate governance and bank stock returns,
we estimate the following cross-sectional regression specification separately for the three
periods around the financial crisis:
rj
1
GOV j
2
BETA j
3
SIZE j
4
MB j
j
(2)
where rj denotes stock return for bank j, GOV is the Gov-Score of Brown and Caylor (2006,
2009), BETA is the beta coefficient estimated against the S&P 500 index using 36 monthly
return observations, SIZE is the logarithm of total assets, and MB is the market-to-book ratio
calculated as the ratio of market value of equity to book value of equity. An extensive literature
has documented that our control variables BETA, SIZE, and MB can explain a vast proportion of
cross-sectional variation in stock returns.
The estimates of Equation (2) are reported in Table 7. Consistent with Table 6 and
inconsistent with our research hypothesis, the regression results indicate that the strength of
corporate governance mechanisms is not statistically significantly related to bank stock returns
during the first two analysis periods (03/2007 02/2008 and 03/2008 02/2009). However, the
coefficient estimate for GOV is positive and significant at the 5 percent level in the third period
(03/2009 12/2009). Hence, consistent with Table 6, our regressions indicate that the stock
prices of the banks with stronger corporate governance structures recovered more quickly from
the financial turmoil. The adjusted R2s of the stock return regressions vary between 29 and 49
percent. Regarding the control variables, it can be noted from Table 7 that the estimated
coefficients for MB are positive and significant in all three regression specifications, while the
coefficients for BETA and SIZE exhibit considerable variation across the turbulent periods.
17
Interestingly, the coefficient estimate for BETA is negative in the first period, thereby indicating
that higher levels of systematic risk decreased bank stock returns at the onset of the financial
crisis. Moreover, it should be noted that the coefficient for SIZE is negative and highly
significant, suggesting that the largest banks had the lowest stock returns amidst the crisis.
The regression results reported in Table 7 hold in two robustness checks. First, we
estimated truncated versions of Equation (2) with GOV and BETA as the only independent
variables. The estimates of these regressions are similar to Table 7; although being insignificant
in the first two periods, the estimated coefficient for GOV is positive and highly significant in
the third period that presents the immediate aftermath of the crisis. Second, we winsorized the
stock returns as well as the control variables (BETA, SIZE, and MB) at the 1 percent and 99
percent levels in order to ensure that our results are not affected by outliers. Again, the
coefficients for GOV are insignificant in the first two periods, while the coefficient estimate in
the third period is positive and statistically significant.
4. CONCLUSIONS
In this paper, we examine the association between corporate governance and bank
performance during the financial crisis of 2008. Using data on large publicly traded U.S. banks,
we examine the effects of corporate governance on profitability, market valuation, and stock
returns amidst the crisis. In our empirical analysis, we apply the corporate governance index of
Brown and Caylor (2006, 2009) to measure the strength of governance with banks. Given the
extensive prior literature on the positive influence of good corporate governance on firm
performance (see e.g., Ammann et al. 2011; Brown and Caylor 2006, 2009; Caprio et al. 2007;
18
Core et al. 2006; Gompers et al. 2003; Johnson et al. 2009; Sierra et al. 2006; Renders et al
2010), we hypothesize that banks with stronger governance mechanisms are associated with
better financial and stock market performance during the crisis.
Our empirical findings on the effects of corporate governance on bank performance during
the financial crisis are mixed. Consistent with the research hypothesis, we find that banks with
stronger corporate governance mechanisms had higher profitability in 2008, suggesting that
good governance may have moderated the adverse influence of the financial crisis on financial
performance. Nevertheless, our results also indicate that strong corporate governance practices
may have had negative effects on stock market valuations of banks during the crisis, as banks
with stronger governance are associated with lower Tobin’s Qs and stock returns amidst the
crisis. Thus, inconsistent with the hypothesis, our findings suggest that good corporate
governance did not create shareholder value in the banking industry during the market
meltdown. However, we also document that banks with stronger corporate governance
mechanisms provided substantially higher stock returns in the immediate aftermath of the
market turmoil from March 2009 onwards. This finding indicates that, at least in the aftermath
of the financial crisis, good corporate governance practices may have mitigated the adverse
effects of the crisis on bank credibility among stock market participants.
19
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23
Table 1 Descriptive statistics.
The table reports the descriptive statistics for the sample. GOV is the Gov-Score of Brown and Caylor
(2006, 2009), ROA is return on assets, (Tobin’s) Q is the sum of market value of equity and the book
value of liabilities divided by the book value of total assets, SIZE is the logarithm of total assets, LEV is
financial leverage measured as the ratio of total liabilities to total assets, LOANTA is loans to total assets,
VOLA is the annualized volatility of stock returns, and LOSS is a dummy variable that equals one for
banks that report negative earnings during the fiscal year. The descriptive statistics are reported
separately (i) for the complete sample of 248 firm-year observations, (ii) for the financial crisis year
2008, (iii) for banks with stronger corporate governance, and (iv) for banks with weaker corporate
governance. The stronger governance subsample consists of banks with above median Gov-Scores and
the weaker governance subsample consists of banks with below median Gov-Scores. The reported pvalues are for two-tailed t-tests and Wilcoxon rank-sum tests of the null hypothesis that there is no
difference between the stronger and weaker governance subsamples
GOV
Stronger governance
Weaker governance
ROA
2008
Stronger governance
Weaker governance
p-value
Q
2008
Stronger governance
Weaker governance
p-value
SIZE
2008
Stronger governance
Weaker governance
p-value
LEV
2008
Stronger governance
Weaker governance
p-value
Mean
31.435
35.387
27.484
1.913
0.313
2.114
1.712
(0.049)
1.061
0.996
1.058
1.064
(0.505)
9.989
10.117
10.940
9.038
(0.000)
0.899
0.897
0.900
0.898
(0.581)
Median
32.500
35.000
28.000
2.210
1.179
2.392
2.049
(0.017)
1.058
0.978
1.063
1.052
(0.811)
9.495
9.521
10.914
8.905
(0.000)
0.902
0.897
0.903
0.901
(0.468)
St. Dev.
4.469
1.779
2.336
1.608
2.251
1.439
1.743
Min
24.000
33.000
24.000
-6.083
-6.083
-4.967
-6.083
Max
40.000
40.000
32.000
5.108
4.508
5.108
4.073
0.074
0.066
0.072
0.075
0.905
0.905
0.915
0.905
1.275
1.268
1.193
1.275
1.625
1.667
1.618
0.930
7.147
7.731
8.437
7.147
14.598
14.477
14.598
11.893
0.031
0.031
0.029
0.034
0.727
0.809
0.813
0.727
0.977
0.977
0.948
0.977
24
Table 1 Continued.
LOANTA
2008
Stronger governance
Weaker governance
p-value
VOLA
2008
Stronger governance
Weaker governance
p-value
LOSS
2008
Stronger governance
Weaker governance
p-value
Mean
66.348
67.588
62.550
70.146
(0.000)
28.198
57.239
26.368
30.028
(0.235)
0.121
0.403
0.121
0.121
(1.000)
Median
69.000
70.025
67.121
71.268
(0.000)
19.469
48.929
16.308
22.977
(0.013)
0.000
0.000
0.000
0.000
(1.000)
St. Dev.
12.637
12.558
14.831
8.465
Min
16.541
18.291
16.541
50.492
Max
93.650
85.799
82.298
93.650
24.246
31.551
24.040
24.410
6.884
17.979
6.929
6.884
170.558
170.558
170.558
152.341
0.327
0.495
0.327
0.327
0.000
0.000
0.000
0.000
1.000
1.000
1.000
1.000
25
Table 2 Correlations.
The table reports pairwise correlations for the variables used in the empirical analysis: (i) The dependent variables are bank
performance measures ROA (return on assets) and Q (Tobin’s Q). (ii) The strength of corporate governance is measured by GovScore (GOV). (iii) Firm-specific control variables are defined as follows: SIZE is the logarithm of total assets, LEV is financial
leverage measured as the ratio of total liabilities to total assets, LOANTA is loans to total assets, VOLA is the annualized volatility
of stock returns, and LOSS is a dummy variable that equals one for banks that report negative earnings during the fiscal year
ROA
0.067
Q
-0.049
0.585 ***
SIZE
0.592 ***
-0.069
-0.236 ***
LEV
0.101
-0.132 **
0.129 **
0.124 *
GOV
ROA
Q
SIZE
LEV
LOANTA
VOLA
***, **, and * denote significance at the 0.01, 0.05, and 0.10 levels, respectively
LOANTA
-0.295 ***
-0.163 **
-0.121 *
-0.279 ***
-0.188 ***
VOLA
-0.129 **
-0.619 ***
-0.561 ***
-0.041
0.089
0.061
LOSS
0.041
-0.767 ***
-0.517 ***
0.120 *
0.118 *
0.123 *
0.611 ***
26
Table 3 Corporate governance and profitability.
The table reports the estimates of the following panel regression specification:
ROA j ,t
1
GOV j ,t
2
GOV j ,t
YEAR 2008
j
3
SIZE j ,t
4
LEV j ,t
2008
5
LOANTA
j ,t
6
VOLA j ,t
7
LOSS
j ,t
y
YEAR jy
j ,t
y 2006
where ROAj,t denotes return on assets for bank j at time t, GOVj,t is the Gov-Score of Brown and Caylor
(2006, 2009), SIZEj,t is the logarithm of total assets, LEVj,t is financial leverage measured as the ratio of
total liabilities to total assets, LOANTAj,t is loans to total assets, VOLAj,t is the logarithm of annualized
volatility of stock returns, LOSSj,t is a dummy variable that equals one for banks that report negative
earnings during year t, and YEARjy is a dummy variable for years. The t-statistics (reported in
parenthesis) are based on standard errors corrected for clustering at the bank level
Variable
Constant
GOV
Model (1)
9.413 ***
(2.67)
0.052 **
(2.30)
GOV × YEAR2008
Model (2)
9.469 ***
(2.64)
0.049 **
(2.35)
Model (3)
6.892 ***
(3.53)
0.039 ***
(2.63)
Model (4)
7.039 ***
(3.33)
0.030 ***
(3.42)
-0.062
(-1.36)
-4.396 **
(-2.02)
-0.009 **
(-2.22)
-0.126
(-1.46)
-2.911 ***
(-6.79)
0.035 ***
(5.04)
-0.062
(-1.36)
-4.157 **
(-2.01)
-0.009 **
(-2.20)
-0.153
(-1.51)
-2.908 ***
(-6.80)
-0.104
(-1.28)
-8.223 **
(-2.16)
0.014 **
(2.20)
-0.104
(-1.28)
-8.159 **
(-2.15)
YEAR2006
-0.077 ***
(-7.76)
-0.077 ***
(-7.78)
-0.064 ***
(-5.89)
-0.066 ***
(-5.52)
YEAR2007
-0.456 ***
(-113.31)
-0.456 ***
(-110.41)
-0.162 ***
(-4.38)
-0.156 ***
(-3.78)
YEAR2008
-2.319 ***
(-665.58)
-2.768 ***
(-13.73)
-0.962 ***
(-5.90)
-2.047 ***
(-9.09)
Adjusted R2
0.367
0.365
0.649
F-stat.
24.899 ***
21.280 ***
51.697 ***
***, **, and * denote significance at the 0.01, 0.05, and 0.10 levels, respectively
0.649
46.700 ***
SIZE
LEV
LOANTA
VOLA
LOSS
27
Table 4 Corporate governance and market valuation.
The table reports the estimates of the following panel regression specification:
Q j ,t
1
GOV j ,t
2
GOV j ,t
YEAR 2008
j
3
SIZE j ,t
4
LEV j ,t
2008
5
LOANTA
j ,t
6
VOLA j ,t
7
LOSS
j ,t
y
YEAR jy
j ,t
y 2006
where Qj,t denotes Tobin’s Q for bank j at time t, GOVj,t is the Gov-Score of Brown and Caylor (2006,
2009), SIZEj,t is the logarithm of total assets, LEVj,t is financial leverage measured as the ratio of total
liabilities to total assets, LOANTAj,t is loans to total assets, VOLAj,t is the logarithm of annualized
volatility of stock returns, LOSSj,t is a dummy variable that equals one for banks that report negative
earnings during year t, and YEARjy is a dummy variable for years. The coefficients for GOV and
GOV×YEAR2008 are multiplied by 100 in order to facilitate interpretation. The t-statistics (reported in
parenthesis) are based on standard errors corrected for clustering at the bank level
Variable
Constant
GOV
Model (1)
0.900 ***
(26.83)
0.173 ***
(4.91)
Model (2)
0.888 ***
(20.41)
0.252 ***
(6.82)
-0.013 ***
(-6.67)
0.304 ***
(5.05)
-0.314 ***
(-43.31)
-0.013 ***
(-6.71)
0.290 ***
(5.45)
GOV × YEAR2008
SIZE
LEV
LOANTA
VOLA
LOSS
Model (3)
0.929 ***
(17.32)
0.079
(1.02)
Model (4)
0.921 ***
(15.33)
0.132 **
(2.05)
-0.013 ***
(-11.08)
0.432 ***
(3.81)
-0.000 *
(-1.89)
-0.031 *
(-1.79)
-0.051 ***
(-4.26)
-0.203 ***
(-3.30)
-0.013 ***
(-11.12)
0.419 ***
(3.84)
-0.000 *
(-1.94)
-0.029 *
(-1.74)
-0.051 ***
(-4.48)
YEAR2006
0.000
(0.66)
0.000
(0.55)
YEAR2007
-0.056 ***
(-111.52)
-0.056 ***
(-117.93)
-0.043 ***
(-10.10)
-0.044 ***
(-10.29)
YEAR2008
-0.102 ***
(-127.36)
-0.004 *
(-1.94)
-0.044 ***
(-2.64)
0.018 **
(2.27)
-0.002
(-1.50)
Adjusted R2
0.415
0.420
0.509
F-stat.
30.232 ***
26.523 ***
29.490 ***
***, **, and * denote significance at the 0.01, 0.05, and 0.10 levels, respectively
-0.002
(-1.42)
0.510
26.721 ***
28
Table 5 Corporate governance and stock returns.
The table reports the mean and median bank stock returns for three periods: (i) March 2007 to February
2008, (ii) March 2008 to February 2009, and (iii) March 2009 to December 2009. The stronger
governance subsample consists of banks with above median Gov-Scores and the weaker governance
subsample consists of banks with below median Gov-Scores. The reported p-values are for two-tailed ttests and Wilcoxon rank-sum tests of the null hypothesis that there is no difference in stock returns
between the stronger and weaker governance subsamples
All banks
Stronger governance
Weaker governance
Difference
p-value
03/2007 – 02/2008
Mean
Median
-30.07
-29.37
-31.53
-31.55
-28.61
-26.37
-2.92
-5.18
(0.590)
(0.559)
03/2008 – 02/2009
Mean
Median
-55.40
-57.24
-56.79
-58.60
-54.01
-53.98
-2.78
-4.63
(0.694)
(0.569)
03/2009 – 12/2009
Mean
Median
46.47
36.91
85.73
63.21
11.01
12.86
74.72
50.36
(0.001)
(0.000)
29
Table 6 Corporate governance and stock returns.
The table reports the estimates of the following cross-sectional regression specification:
rj
j
1 GOV j
2 BETA j
3 SIZE j
4 MB j
where rj denotes stock return for bank j, GOVj is the Gov-Score of Brown and Caylor (2006, 2009),
BETAj is the beta coefficient calculated against the S&P 500 index, SIZEj is the logarithm of total assets,
and MBj is the market-to-book ratio calculated as the ratio of market value of equity to book value of
equity. The t-statistics (reported in parenthesis) are based on White’s heteroskedasticity consistent
standard errors
Variable
Constant
GOV
BETA
SIZE
MB
03/2007 – 02/2008
-0.200
(-0.96)
-0.007
(-1.32)
-0.084 **
(-2.37)
-0.002
(-0.15)
0.143 ***
(5.59)
03/2008 – 02/2009
-0.457 **
(-2.34)
0.012
(1.61)
-0.057
(-1.63)
-0.063 ***
(-3.24)
0.179 ***
(4.60)
Adjusted R2
0.294
0.487
F-stat.
7.341 ***
15.506 ***
***, **, and * denote significance at the 0.01, 0.05, and 0.10 levels, respectively
03/2009 – 12/2009
-2.451 ***
(-3.43)
0.045 **
(2.01)
0.754 ***
(3.02)
0.037
(0.51)
0.305 ***
(3.10)
0.464
12.897 ***
30
Appendix 1 List of banks.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
View publication stats
Associated Banc-Corp.
Astoria Financial Corp.
Bank Mutual Corp.
Bank Of America Corp.
Bank Of Hawaii Corp.
Bank Of New York Mellon Corp.
Boston Private Financial Holdings Inc
Brookline Bancorp Inc
Capital One Financial Corp.
Cascade Bancorp
Citigroup Inc
City National Corp.
Comerica Inc
Community Bank System Inc
Cullen Frost Bankers Inc
Dime Community Bancshares Inc
East West Bancorp Inc
Fifth Third Bancorp
First Commonwealth Financial Corp.
First Financial Bancorp
First Horizon National Corp.
First Midwest Bancorp Inc
First Niagara Financial Group Inc
Firstmerit Corp.
Flagstar Bancorp Inc
Glacier Bancorp Inc
Huntington Bancshares Inc
Irwin Financial Corp.
Keycorp
M & T Bank Corp.
Marshall & Ilsley Corp.
New York Community Bancorp Inc
Northern Trust Corp.
PNC Financial Services Group Inc
Privatebancorp Inc
Provident Bankshares Corp.
Regions Financial Corp.
South Financial Group Inc
Sovereign Bancorp Inc
Sterling Bancshares Inc
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
Sterling Financial Corp.
Suntrust Banks Inc
Susquehanna Bancshares Inc
SVB Financial Group
SWS Group Inc
Synovus Financial Corp.
TCF Financial Corp.
Trustco Bank Corp. NY
Ucbh Holdings Inc
Umpqua Holdings Corp.
United Bankshares Inc
US Bancorp
Wachovia Corp.
Washington Federal Inc
Washington Mutual Inc
Webster Financial Corp.
Wells Fargo & Co
Westamerica Bancorporation
Whitney Holding Corp.
Wilmington Trust Corp.
Wintrust Financial Corp.
Zions Bancorporation