Corporate Governance and the Insolvency Risk of Financial Institutions

Abstract

We investigate whether corporate governance is related to insolvency risk of financial institutions. Using a large sample of U.S. financial institutions over the 2005–2010 period, we find that corporate governance is positively related with insolvency risk of financial institutions as proxied by Merton’s distance to default measure and credit default swap spread. We also find that “better” corporate governance increased insolvency risk relatively more for larger financial institutions and during the period of the global financial crisis. Our findings suggest that too-big-to fail and deposit insurance policies encourage excessive risk taking by financial institutions.

Keywords: corporate governance, boards, insolvency risk, bank risk-taking, financial crisis

JEL Classification: G01, G20, G21, G30, G32, G34