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1 August 2013 CFA Institute Journal Review

Does Board Structure in Banks Really Affect Their Performance? (Digest Summary)

  1. Marc L. Ross, CFA

The size, independence, and gender diversity of bank boards have the potential to affect bank performance. The authors study the impact of these characteristics by looking at a sample of the top 300 publicly traded bank holding companies that are focused on commercial banking.

What’s Inside?

The authors examine the effect of board size, independence, and gender diversity on bank performance by using well-established metrics and testing their findings for robustness to sensitivity checks. They conclude that larger board size and a greater degree of director independence detract from performance, that gender diversity improves performance to a degree, and that board structure matters more for banks with less market power. The board structure of large banks does not seem to have an influence because of the large degree of oversight from regulators and investors.

How Is This Research Useful to Practitioners?

Banks play a critical role in the efficient allocation of resources in the economy, discharging an important fiduciary duty to shareholders, depositors, and regulators. Accordingly, the way they are overseen on an ongoing basis is critical. The authors seek to fill a void in the existing literature on the role of bank board effectiveness, the findings of which have been inconclusive.

They investigate the impact of board size, gender diversity, and director independence on bank financial performance as embodied in several key financial ratios. Their study encompasses a large sample over a long time period and takes into account the impact of the Sarbanes–Oxley Act of 2002 (SOX) and the Great Recession. They note that the performance of banks with low market power (e.g., less concentration in loan and deposit markets than their larger peers) is more likely to be affected by board characteristics.

The authors conclude that governance matters for banks with low market power; regulation and public scrutiny may prevent any meaningful relationship between board structure and performance at larger banks, which face less competition. Gender diversity on the board plays a positive role but less so in the periods following SOX and the financial crisis. They go on to observe an inverse correlation between independent directors and financial performance, perhaps because of information asymmetry and regulation. Finally, they note that as a result of inefficiencies, the larger the size of the board, the less positive the bank’s performance.

Regulators and policymakers will find the conclusions both sobering and well researched. Bank analysts will similarly benefit from these findings by gaining an understanding of the qualitative effects behind the numbers.

How Did the Authors Conduct This Research?

The sample includes more than 200 of the largest publicly traded bank holding companies located in the United States during the period from 1997 to 2011. Measures of bank performance under consideration include return of average assets, return on average equity, pretax operating income, net interest margin, Tobin’s q, and stock returns. Board structure is measured in terms of size, director independence, and gender diversity.

The authors establish and test hypotheses relating to key variables of governance. A two-step generalized method of moments approach is used to deal with issues of unobserved heterogeneity, simultaneity, and reverse causality. Additionally, the authors test the robustness of their findings with multiple proxies of bank performance.

Abstractor’s Viewpoint

Corporate governance in banks is a seminal issue, but the effects on performance of gender diversity, board structure, independence, and size may vary by circumstance. Indeed, gender diversity, although it is a benefit to performance, shows itself to be less effective in the aftermath of SOX and the Great Recession than at other times. Similarly, board structure matters more for smaller banks that have limited market power and/or are immune to a takeover. At issue is how regulation might cause the governance process to be suboptimal. Responsible adherence to regulations, nonetheless, is a function of competence and has assumed greater importance as a result of market turmoil in the recent past.

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