Bank Governance

Principles of Financial Regulation (New York/Oxford: Oxford University Press, 2016)

European Corporate Governance Institute (ECGI) - Law Working Paper No. 316/2016

31 Pages Posted: 11 Jun 2016 Last revised: 15 Jun 2016

See all articles by John Armour

John Armour

University of Oxford - Faculty of Law; University of Oxford - Said Business School; European Corporate Governance Institute (ECGI)

Dan Awrey

Cornell Law School; European Corporate Governance Institute

Paul L. Davies

University of Oxford- Faculty of Law

Luca Enriques

University of Oxford Faculty of Law; European Corporate Governance Institute (ECGI)

Jeffrey N. Gordon

Columbia Law School; European Corporate Governance Institute (ECGI)

Colin Mayer

University of Oxford - Said Business School; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Jennifer Payne

University of Oxford - Faculty of Law

Date Written: July 1, 2016

Abstract

According to a common narrative, in addition to inadequate capital and liquidity, the failure of banks in the financial crisis also reflected their poor governance. By governance we mean broadly the oversight that comes from banks’ own shareholders and other stakeholders of the way in which they are run. The problem of bank governance stems from the way in which banks are financed and regulated, from the externalities bank failures produce, and from the nature of their assets. In the period leading up to the financial crisis, it was believed that regulation would cause banks to internalize the costs of their activities, meaning that what maximized bank shareholders’ returns would also be in the interests of society. Consequently large banks used the same governance tools as non-financial companies to minimize shareholder-management agency costs, namely independent boards, shareholder rights, the shareholder primacy norm, the threat of takeovers, and equity-based executive compensation. Unfortunately, such tools had the adverse effect of encouraging bank managers to take excessive risks: as we describe in this chapter, banks that had the most ‘pro-shareholder’ boards and the closest alignment between executive returns and the stock price were those which took the most risks prior to, and suffered the greatest losses during, the crisis. Consequently, a significant rethink about the way in which banks are governed is required. The structure and function of bank boards, the compensation of bank executives and the function of risk management within organizations needs careful crafting if governance reforms are to address not exacerbate bank failures.

Keywords: Financial regulation, bank governance, executive compensation, financial sector pay, independent directors, board structure

JEL Classification: G21, G28, G32, G38, K22

Suggested Citation

Armour, John and Awrey, Dan and Davies, Paul L. and Enriques, Luca and Gordon, Jeffrey N. and Mayer, Colin and Payne, Jennifer, Bank Governance (July 1, 2016). Principles of Financial Regulation (New York/Oxford: Oxford University Press, 2016); European Corporate Governance Institute (ECGI) - Law Working Paper No. 316/2016. Available at SSRN: https://ssrn.com/abstract=2793112

John Armour (Contact Author)

University of Oxford - Faculty of Law ( email )

St Cross Building
St Cross Road
Oxford, OX1 3UL
United Kingdom
+44 1865 281616 (Phone)

HOME PAGE: http://www.law.ox.ac.uk/people/john-armour

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

HOME PAGE: http://www.sbs.ox.ac.uk/about-us/people/john-armour

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Dan Awrey

Cornell Law School ( email )

Myron Taylor Hall
Cornell University
Ithaca, NY 14853-4901
United States

European Corporate Governance Institute ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Paul L. Davies

University of Oxford- Faculty of Law ( email )

Harris Manchester College
Oxford, OX1 3TD
United Kingdom

Luca Enriques

University of Oxford Faculty of Law ( email )

St Cross Building
St Cross Road
Oxford, OX1 3UL
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http:/www.ecgi.org

Jeffrey N. Gordon

Columbia Law School ( email )

435 West 116th Street
Ctr. for Law and Economic Studies
New York, NY 10027
United States
212-854-2316 (Phone)
212-854-7946 (Fax)

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Colin Mayer

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 1865 288112 (Phone)
+44 1865 288805 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Jennifer Payne

University of Oxford - Faculty of Law ( email )

Oxford
United Kingdom

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