Shareholders’ Benefit from Bank Representatives on the Board
42 Pages Posted: 6 Jan 2020 Last revised: 18 Jan 2022
Date Written: January 18, 2022
We examine how the presence of representatives of a bank on a firm’s board of directors affects the firm’s risk and thus, the shareholder value. Our model uses a company with a debt-financed investment project and a managerial moral hazard problem, where the board determines the risk level. The board’s inability to commit to a specific risk level leads the shareholder representatives on the board to exploit the financial leverage and choose higher risk than is ex ante optimal, resulting in lower shareholder value. By appointing bank representatives—who prefer lower risk—to the board, shareholders of firms with risky debt counteract the excessive risk taking, thereby decreasing the expected managerial compensation and borrowing costs. Unlike previous studies, we illustrate a potential benefit of bank representatives on boards, i.e., increasing shareholder value. Additionally, the model predicts that exogenous increases in the borrowing costs and managerial compensation, which cause a higher potential benefit, can diversely affect the shareholders’ demand for bank representatives.
Keywords: board of directors, bank representative, risk, managerial compensation, borrowing costs
JEL Classification: D82, G32, G34, M40
Suggested Citation: Suggested Citation