Bankers on the Board and CEO Incentives

Abstract

The Sarbanes‐Oxley Act demanded the presence of more financial experts on corporate boards to improve governance. Directors from lending banks require particular attention because of the conflicts of interest between shareholders and debtholders despite their financial expertise. In this paper, we examine whether commercial banker directors work in the best interests of shareholders in providing incentives to the CEO. We find that the CEO's compensation VEGA is lower if an affiliated banker director is on the board. Further, we find that commercial banker directors increase debt‐like compensation (Sundaram and Yermack, 2007) and make it less sensitive to risk.

Bankers on the Board and CEO Turnover

“…Since commercial bankers amass greater financial expertise and better debt market expertise (Fama, ; Diamond, ; Booth and Deli, ; Byrd and Mizruchi, ; Dittmann et al , ), we predict that these CBDs are better positioned to effectively work as monitors, leading CEO turnovers to be more sensitive to firm performance (Kang and Shivdasani, ). In addition, ABDs show intensive monitoring due to their affiliation with their own firm (Kang and Kim, ). Therefore, we predict the following:…”

“…Bankers are different from entrepreneurs in perceiving and managing risks (Sarasvathy et al , ). They focus more on controlling risks and try to avoid situations where they may face higher levels of risk (Mitchell, ; Kang and Kim, ; Kang et al , ). This is because an increase in a bank’s tail risk imposes more hardship and costs on its operation (Stulz, ; Srivastav et al , ).…”

“…Through career training in commercial banking, CBDs become experts in risk management (Weinstein and Yafeh, ; John et al ., ) and in processing financial accounting information (Fama and Jensen, ; Weisbach, ). While CBDs have a fiduciary duty to protect the shareholders’ interests that are by definition more risk‐tolerant than debt holders’, they (especially those from lending banks) have an equally important fiduciary duty to their employing banks to minimize firm risk (Jensen and Meckling, ; Hilscher and Şişli‐Ciamarra, ; Erkens et al ., ; Kang and Kim, ). Kang and Kim () find that CBDs influence a CEO’s compensation structure to be less sensitive to firm risk.…”

“…While CBDs have a fiduciary duty to protect the shareholders’ interests that are by definition more risk‐tolerant than debt holders’, they (especially those from lending banks) have an equally important fiduciary duty to their employing banks to minimize firm risk (Jensen and Meckling, ; Hilscher and Şişli‐Ciamarra, ; Erkens et al ., ; Kang and Kim, ). Kang and Kim () find that CBDs influence a CEO’s compensation structure to be less sensitive to firm risk. While compensation is an explicit incentive, the threat of dismissal is an implicit incentive to extract the best efforts of the agent (Gibbons and Murphy, ; Kwon, ; Hallman et al , ).…”

“…Boards of directors play an important role in monitoring and advising top managers (Adams et al , ). Above all, independent directors from commercial banks (commercial bank directors or CBDs) receive much more attention from economists (Black and Scholes, ; Booth and Deli, ; Kroszner and Strahan, ; Güner et al , ; Mitchell, ; Şişli‐Ciamarra, ; Hilscher and Şişli‐Ciamarra, ; Kang and Kim, ; Kang et al , ), because they bring both financial expertise and conflicts of interest between shareholders and debt holders.…”