Examining the Effect of Board Characteristics on Agency Costs and Selected Performance Measures in Banks

Abstract

ABSTRACT To date empirical research examining association between measures of corporate governance and accounting performance measures has yielded inconsistent results. We believe that mixed results are due in part to inclusion of firm across various industries. This study continues stream of research studying agency theory and relationships between board of director characteristics and firm performance. We address these issues by developing a set of models in a single, regulated industry. Focusing on banking industry over a five-year period allows us concentrate on measures rather than potential variations across industries. Our findings contradict hypotheses developed under agency theory approach and lead us to believe relationships should be studies under a different lens. INTRODUCTION The corporate form of ownership is an integral part of US capital market structure. Under corporate structure, shareholders (principals) entrust management (agents) with their investment. Because utility functions of principals and agents can differ, separation of ownership and allows for potentially self-serving or opportunistic behavior by management. These behaviors result in poor financial performance, excessive compensation, and other agency costs, such as those seen in Tyco scandal. There is a need to oversee managers and to align interest of managers with those of shareholders. In publicly traded US corporations, this role is delegated to company's board of directors, and some of blame for problems in executive suites has been put on board of directors for failing to exercise appropriate managerial oversight. Corporate governance is described as the set of mechanisms that influence made by managers when there is a separation of ownership and control (Larcker et al, 2007:964). One of those monitoring mechanisms is board of directors. At most basic level, board of directors is responsible for ensuring top management's actions are consistent with interests of shareholders (Fama and Jensen, 1983). In fact, board members not only have legal authority to monitor actions of top executives, but also fiduciary responsibility to look out for interests of shareholders. Unfortunately, experience has shown that some executives do not sincerely believe in or want good corporate governance. They view it as a constraint on their ability to make their preferred decisions (DiPiazza and Eccles, 2002: 101). This attitude on part of top executives may be what leads to creation of an ineffective board. Recently, however, shareholders, regulators, and large institutional investors have voiced growing criticism of boards, particularly with regard to perceived failure to exercise effective managerial oversight, meaning managers are facing a new governance arena. DiPiazza and Eccles (2002: 98) state, (k)een attention is being paid today to corporate governance because that is where a culture of accountability begins and where it can be effectively fostered. What once seemed little more than a rubber stamp for executive is now recognized as a value driver that can make or break a company. The end result is focus of more attention on effectiveness of board of directors in monitoring executives' actions, and underlying motivation for our looking at board characteristics and their relationship to common measures of financial performance and agency costs. To date empirical research examining association between measures of corporate governance and accounting performance measures has yielded inconsistent results. We believe that mixed results are due in part to inclusion of firm across various industries. Economic and regulatory factors can impact various industries differently. …

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