Bank Involvement in Firm Management, Panacea or a Pain?

Abstract:     
We investigate the impact of direct participation of banks on the board of borrowing companies in India. On the one hand, bank's proximity to decision-makers in the firm could mitigate the problem of expropriation by corporate insiders typical in emerging markets, thereby enhancing firm value. On the other hand, the possibility of greater intervention by banks even before bankruptcy could exacerbate the debt-equity conflict, hurting the firm's equity holders. India offers a unique setting for analyzing this tradeoff, with panel data on board composition combined with its weak institutional environment that is common to emerging markets. We find that firms with bank nominees on board tend to be larger, have greater leverage and more likely to be affiliated with business groups. These firms also tend to make fewer investments, take more loans and follow a more conservative dividend policy even when firms do not have good investment opportunities. On the other hand, firms with bank nominees that have value as going-concerns do not experience any lower bankruptcy risk compared to firms without nominees. Overall, bankers on board appear to be associated with diminished firm value, providing evidence consistent with bankers worsening agency problems between debt and equity.

Number of Pages in PDF File: 35

Keywords: Emerging market, Bankers on board, Corporate Governance

JEL Classification: G34, G21, G30

working papers series