Bank Representatives on the Board of Directors and their Influence on Risk and Managerial Compensation
44 Pages Posted: 6 Jan 2020 Last revised: 21 Jan 2020
Date Written: December 16, 2019
This paper examines the role of bank representatives on the firm’s board of directors and their influence on risk and managerial compensation. After the firm has taken on debt for a big-scale lump-sum investment project, the bank representatives are inclined to lower the project risk, which is contrary to the shareholder’s interests of taking on more risk. However, higher risk increases the expected managerial compensation. We use a one period discrete model to show that the bank representatives on the board can become beneficial from the shareholders’ perspective. This benefit occurs because the bank representatives on the board act as a commitment device for the board to implement less risk, which results in lower expected managerial compensation. The model predicts that shareholders benefit from bank representatives on the board of directors when they expect low project profitability.
Keywords: board of directors, bank representative, managerial compensation, risk
JEL Classification: D82, G32, G34, M40
Suggested Citation: Suggested Citation