Abstract
This paper examines the governance of Spanish banks regarding two main issues. First, does poor economic performance activate governance interventions that favor the removal of executive directors and the merger of non-performing banks? And, second, does the relationship between governance intervention and economic performance vary with the ownership form of the bank? We find a negative relationship between performance and governance intervention for banks, but the results change for each form of ownership and each type of intervention. Internal-control mechanisms work for Independent Commercial banks, but Savings banks show weaker internal mechanisms of control and the only significant relationship between performance and governance intervention that appears is for mergers. The Spanish Savings banks, with a peculiar form of ownership that, in fact, implies a lack of ownership, give voice to several stakeholder groups with no clear allocation of property rights. Nevertheless, their economic performance is not generally affected. Product-market competition compensates for those weaker internal governance mechanisms, and non-performing banks are not fully protected from disappearing.
1. Introduction
This paper presents empirical evidence on the effective use of governance mechanisms for disciplining non-performing managers and directors of Spanish Commercial banks (shareholder-oriented banks) and Savings banks (non-profit commercial banks). The paper provides evidence on how, in both types of institutions, lower economic performance increases, in an economically significant way, the likelihood of directors’ turnover and/or the likelihood that the bank will merge or will be acquired. The topic of corporate governance is receiving heightened attention. 1 Although much of what is said also applies to banks, it is true that the banking firm has significant differences with respect to corporations in other economic sectors, and this justifies a special interest in its governance problems (Prowse, 1997; Adams and Mehran, 2003). For example, there is a clear conflict inside the banks between the interests of the shareholders and the interests of the depositors, with the former being willing to take high-risk projects that increase share value at the expense of the value of the deposits. Small deposits are insured and banks are regulated, to avoid crisis of confidence and bank runs, although it increases the moral hazard problem, as was seen in the Savings and Loan crisis in the US. Whether regulation substitutes or complements traditional governance mechanisms and controls is a subject of debate, but it is generally agreed that the external controls coming from takeovers and productmarket competition turn out to be weaker in banks than in other firms (Prowse, 1997). Good governance relies more on the workings of internal mechanisms, such as the supervision and the control exercised by the board of directors, along with the regulatory constraints. Our paper focuses on those governance mechanisms that are implemented by the board, such as the replacement of managers and directors when a bank’s economic performance does not meet the owners’ expectations. 2 Following previous work on this subject, 3 it is assumed here that internal-control works properly if the probability of a significant board turnover, or the dismissal of a top executive, is inversely related to the economic performance of the bank, measured in terms of accounting rates of return. 4 We also consider a friendly merger of banks as an intermediate control mechanism, somewhere in between the internal mechanisms and the external ones. This is so because mergers must be approved by the governance bodies of the bank, and also because the target bank’s assets are transferred to the acquiring company. For this scenario, it is assumed herein that good governance will predict that the likelihood that a bank merges (and, therefore, its assets be transferred to another bank) increases with a lower economic performance of the target bank.