Do all new brooms sweep clean? Evidence for outside bank appointments

Abstract

We investigate whether bank executive directors appointed from outside the bank ("outsiders") improve post-succession performance and whether some outsiders are better predisposed than others to turn around a bank's performance. In the case of banks, this question is highly relevant because regulatory authorities may regard the replacement of the management team as a chance to clean up financially distressed banks. Our sample compromises all universal banks for the period 1993 to 2014. ContributionFirst, the results of our study contribute to the existing literature on the post-succession effects of executive turnovers by documenting a performance differential between outsiders with strong and poor managerial abilities in the years following their appointment. Second, we add to the literature examining managerial ability by extracting managerial ability from the risk-return efficiency of executive directors' previous banks. Third, we add to the literature dealing with the financial crisis by measuring the performance effects separately for the pre-and post-crisis period. ResultsOur study documents the negative performance effects in the years following the appointment of an outsider on banks making such appointments. We find that executives with poor managerial abilities ("bad outsiders") underperform at their new banks during the post-appointment period whereas executives with strong managerial abilities ("good outsiders") do so only at the very beginning of the post-appointment period. Thus, not all executive directors appointed from outside are equally capable of improving bank performance. Our results further suggest that the performance differential between good and bad outsiders strengthens in the post-crisis period. We systematically rule out that these performance differentials following external appointments are driven by appointing good outsiders to boards of banks with a low risk exposure. Banks in bad financial shape are more likely to appoint executive directors from the outside than those in good shape. It is, however, not clear whether all of these appointments necessarily lead to the desired turnaround. We analyze the performance effects of new board members with external boardroom experience (outsiders) by distinguishing between good and bad managerial abilities of executives based on either ROA or risk-return efficiency of their previous employers. Our results show that banks appointing bad outsiders underperform other banks while those appointing good outsiders do so to a lesser extent. The performance differentials are highly pronounced in high-risk banks and in the post-crisis period.

Board characteristics, ownership structures and bank profitability: Evidence from Sri Lanka

“…Large sized boards tend to cause coordination and decision-making inefficiencies outweighing the benefits from increased monitoring (Liang, et al, 2013). This complies with the findings of Altass (2022), Ayadi, et al (2018), Kick, et al, (2017), Liang, et al, (2013Hagendorff, et al (2010) and Kaymak & Bektas (2008), who observe a similar effect in the USA, Europe, Middle East and Asia. Hence, this supports the expected hypothesis and the existing regulations in Sri Lanka that allows banks to determine the appropriate board size at their discretion within a range of seven to 13 members.…”

“…Studies observe a U-shaped effect as boards with members beyond a certain number become less cost efficient (Andres & Vallelado, 2008;Titova, 2016). This is because small boards exert more responsive decision making, improved coordination, less bureaucratic controls, and a lower cost of running the board (Altass, 2022;Ayadi, et al, 2018;Kick, et al, 2017;Liang, et al, 2013;Hagendorff, et al, 2010;Kaymak & Bektas, 2008). Accordingly, it is expected that a small board with diversified expertise can create more contributions for improved financial performance.…”

“…The overall level of economic activity drives corporate strategic plans to be in line with macroeconomic fluctuations. Several studies claim that the GDP growth rate favourably affects banking profitability across the world as economic expansions facilitate increased lending and yield better returns (Kick, et al, 2017;Vallascas, et al, 2017;Tan, 2016).…”