Corporate Governance and Bank Diversification

1. Corporate Governance and Bank Diversification Authors: Hsin-Yu Liang, I-Ju Chen and Sheng-Syan Chen Discussant: Chak Wong

2. Major contributions • Investigate and contrast the effects of corporate governance structures on specialized and diversified banks. • Diversified banks are found to have very different governing structures: • Lower ownership • Lower institutional holdings • Higher board independence • Higher outside director’s holding • Higher percentage of CEO equity based pay • Higher CEO equity based pay has a significant impact on bank value discount

3. Why financial firms? • Banks are heavily regulated. • Multiple principal-agency relationships • Financial conglomerates are not easy to monitor due to opaqueness of financial intermediaries. • The agency problem can more than offset the benefits from diversification and information advantage of conglomerates.

4. Discussion points • Instead of diversification, can the result be attributed to other variables like the size of the banks? • Diversified banks tend to be larger. Larger companies tend to have more diversified ownership, ceteris paribus. • As the bank grows larger, insider shares tend to be diluted. • Since the selection criteria is only $100 million, how many of the banks are small ones owned by the founding member who is the CEO as well? That could explain the high CEO ownership for specialized banks.

5. Discussion Points • Can it be the case that only large diversified banks can afford to have an independent board? It may be necessary to pay substantially, either in cash or in kind such as improved banking relationship, to find qualified directors. This may be difficult for specialized banks.

6. Why are diversified banks more difficult to monitor? • Contrast this with another type of financial firms, monoline insurances, which have a single line of business, which turn out to be very hard to monitor. • If diversified banks are under valued, they can easily form specialized subsidiaries, listing them separately, filing financial statements separately, and realizing the gain. A lot of the diversified banks have an investment banking arm, why haven’t they done such an easy exercise to realize the value?

7. Endogeneity • Is it possible that governance mechanism and bank diversification is endogenously determined? • i.e. only a certain form of governance mechanism allows the bank to be diversified. • E.g. without the help of outside directors, it may be difficult to evaluate an acquisition target. So only board with outside directors can allow the banks to be diversified. So this can have nothing to do with agency problems.

8. Endogeneity for CEO pay, entrenchment and lower value of firm • Weaker institution needs longer term CEO. The causation may be the other way. • Weaker banks cannot afford to pay higher cash payments, and must use equity as a payment. It can only pay in the form of equity. E.g. UBS in 2008. • To attract qualified CEO to join weak institutions, better terms, i.e. better job security, higher equity payments, etc. must be offered. • Therefore can the causation be the other way?

9. Independent board members • For large financial institutions, can it be the case that the outsiders are really insiders that have long term banking relationship with the firm?

10. Unwilling or unable • Can it be that the large diversified conglomerates are just difficult to monitor or manage?