The Influence of 2008 Financial Crisis on Corporate Governance among the Banks

Chapter Three

Results

In this section, the study will present the major finding on each variable starting with variables that relates to the internal agency structures, board composition, committee representation and the issue of compensation of the board members.  Out of the 24 banks that were included in the study, only two issue reports on a semi-annual basis while others disclosure accounts on a quarterly basis, but no change has been observed since the year 2003. In regard to the information bank disclosure in their annual reports, there have been focuses on corporate social responsibility (CSR) and sustainability. However, on average, no improvement was shown on the CSR information disclosure. The slight change observed was on Dexia and Barclays, which both published the reports on 2007 but failed to do so in 2003 and 2011. However, it is interesting to note that none of the US based banks revealed such information in 2011 though most of the European firms offered reports.

The existence of the dual share and "poison pill" classes normally restrict the ability of the shareholders to disciplines the firm management through voting on major issues or via outright takeovers. Hence, the mechanism nurtures ownership and management entrenchment, though an obvious risk exists that the agency issues will be heightened together with higher rates. In the banks included in the survey, only four had the poison pills while only two banks had multiple shares classes. However, no significant changes were observed in the two variables.  The banks that maintained multiple shares classes in 2003 did so in 2007 and 2011, and a similar pattern was noted when it comes to the provision of the poison pills. The geographical data shows that banks with poison pill provisions were incorporated in the United States while banks with dual share classes were European; one from Italy and the other from the United Kingdom.

The rights of the stakeholders to vote to the remuneration of the executives commonly known as say-on-pay are of the variable where significant change over time was noted.  In the annual reports and the filing from the US Securities and Exchange Commission, only four banks in the sample reported that executive remuneration was subjected to stakeholder approval in 2003 while five banks were in 2007. Nonetheless, 21 out of the 24 banks studied sought stakeholder approval in 2011. Among the banks in the US, the rise is complete with all banks offering the stockholder the right to vote and approve the compensation package. It is important to emphasize the impact of the financial crisis has on the bank embracing the say-on-pay functions.

In regard to the board size, no radical change within the sample of the bank was observed. However, the average size was reduced to 14, 8 in 2011 compared to 16, 0 and 16, 3 in 2003 and 2007 respectively. The variance of the board size fell from 15, 9 to around 10, 7 in 2007 and 2003. This is shown in the fact that the largest board size reduction from 22 in the year 2003 and 23 in 2007 to 21 in 2011. It was also found that 10 banks increased their board size between the year 2003 and 2007 while only three boards were considered large in 2011. The majority of the banks reduced the size of their board in the period between 2007 and 2011.

In terms of turnover, described as the number of new directors on the board compared to the number of directors who resigned the previous period, the aggregate figure increased from 42.8 percent between the year 2003 and 2007and 52 percent in 2011. However, it is important to note that four major banks, including Lloyds, Dexia, UBS and RBS, were severely impacted by the turnover. In addition, the degree of director independence on the company board remained steady between the period 2003 and 2011 and only increased slightly from 67 percent to 73.7 percent. Nevertheless, the board with the least autonomous board appeared to have converged near the average. In regard to board diversity within the director and the number of nationalities represented on the board, there was a slight growth in the aggregate number of nationalities on the board in 2011 relative to previous periods. It is worth noting that the average continental European or United Kingdom bank had four nationalities represented on the board of directors in the year 2011 compared to only two among United States-based banks. However, the difference is attributable to the size of the US-based bank relative to the European banks.

When looking at the bank board committee, it is noticeable that a change in focus might have taken place during the 2007/08 financial crisis. In each of the three years, all the banks studies had an audit and compensation committees. The average size remained stable between 4, 5 and 5, 0 members, an aspect that was detected across the other banks. However, the findings appear different when it comes to the board risk committees. During the period between 2003 and 2007, more than half of the listed bank had a board committee that was responsible for monitoring risks assumed by the company. Though the aggregate committee size member among the banks was stable at around five each year, the prevalence of the risk board in 2011 was high in both Europe and America. In regard to the executive compensation, it was noted that most of the executives saw their total reimbursement rise in the period between 2003 and 2007, while a large share was received after the upsurge of the financial crisis. However, the tendency has been captured in the base salary which is unrelated to executive achievement or the company’s performance. As a result, the composition of the executive pay packages seems to have changed in a meaningful manner between 2003 and 2011.

Discussion

In this part, the thesis will discuss the result of the study in light of the institutional change. The section will provide particular focus on the change in a regulative aspect that changed the operating environment for the banks in regard to the governance change within the period. However, due to the interdependency of the issue, a number of developments will be focused on this section. Different categories motivate different approaches in this section, though much focus will be on the regulative aspect of corporate governance.

Internal Agency Structures

Disclosure

Within the category of internal agency structures, there are a number of variables that are connected to the disclosure, reporting and the CSR and sustainability disclosure. Disclosure is perceived to reduce the information gap between the agents and the principals, thus solving the agency issues. It serves as a significant role for the shareholders in surveying the company operations.  Although pressure on the bank to comply with the disclosure in accordance with the regulative pillar has been pinpointed, no such changes have been found in the above-noted variables related to the disclosure. It has been noted that most banks have remained unchanged at the annual and quarterly reporting throughout the time of the study. Nonetheless, the pressure has not been directly focused on the increase in disclosure frequency; instead it focuses on the quality of the financial reporting by the banks. Therefore, the outcomes are not necessarily contradictory. This is because the frequency of reporting does not necessary correlate with the quality of the information reported.  It should be mentioned that reporting frequency acts as an ambiguous role in regard to corporate governance practices. As noted earlier, the CSR disclosure and sustainability has not shown any significant change between the period of 2003 and 2013. Furthermore, the frequency of financial reporting on Corporate Social Responsibility and sustainability makes it easy for the stakeholders to survey the operations of the banks. Furthermore, the CSR and sustainability disclosure may also reflect an increased awareness and focus within the company on the issue of the wider stockholders society. When the results are connected to institutional change, it is noticeable that the regulative pressure exerted by the government and regulatory firm have improved the quality of reporting the quality of the financial reporting especially. In addition, when observing the both annual and quarterly reports, it was apparent that there is a significant shift in the general contents of disclosure which is an indication of the pressure to comply with the regulative aspect that demand improved disclosure, detail in financial reporting and subsequent increase in the number of pages in the company financial reports.

Capital Market Control

In the capital market, the poison pills and dynamics of the dual share classes showed no changes over the period between 2003 and 2011. From the agency perspective, the existence of poison pills and the dual share expropriates shareholder of power over the company and is essential in supporting entrenchment of the current owners. However, no specific pressure has been pinpointed from the shareholders to raise the capital market dominance during the observation period.

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Influence on Pay

In the internal agency, say on-the pay, is critical variable where most significant changes are visible. Nonetheless, it should be noted that the say-on-pay strategy is not only a concern in the internal control agency but also indirectly serves as the way for the shareholders to monitor and exert their influence and control over executive compensation, an aspect that further shows the occurrence of the say-on-pay may be driven by pressure from the changes in a number of several institutional pillars. The noted increase in the prevalence of say-on-pay after the 2007/2008 financial crisis appears to be based on outcome of pressure from the regulative aspect introduced by the crisis, primarily introduced through legislation and exerted through changes in corporate governance codes. It is essential to point out the difference between binding and non-binding say-on-pay votes. The latter is regarded as an advisory vote on the executive compensation. Nonetheless, it is largely affected by the confidence of the board and when the compensation plan fails to support the majority stakeholder. On the other hand, the other delegates the power of approval of the compensation plan to the stakeholders. In this study, the banks with non-binding votes were all based in the US, UK, Spain, and Germany.

In 2011, there was noticeable rapid rise in the number of the banks with say-on-pay votes, which was fundamentally driven by direct pressure from the regulations established through legislation and the national corporate governance codes that explicitly demanded the adoption of the say-on-pay votes.  For instance, the say-on-pay strategies in Italy, Sweden and Netherland were established as per the recommendation of the national corporate governance code after the 2008 financial crisis. Non-binding votes on the other hand were introduced in two nations in accordance with the provision of the Consumer Protection Act and the Dodd-Frank Wall Street reform in the US, and the Sustainable Economy Act enacted in Spain.

Other countries such as Switzerland, France and Germany introduced voluntary say-on-pay for shareholders due to the absence of direct legislation on corporate governance.  Although no regulation was established, the increased pressure from the institution on the companies to improve governance through executive compensation and disclosure forced the adjustments.  In Germany, it appears that the development was largely driven by the changes in the normative and regulative pillar through the establishment of the Act on the appropriateness of the Management Board Remuneration that established voluntary non-binding say –on-pay vote for the financial institutions listed in the Germany in 2009. However, in the France the debates on legislation related to say-on-pay have not proceeded as quickly as in other countries. No particular pressure from the institution to establish non-binding say-on-pay votes has been pinpointed on the national level during the period of the study.

Case Study: Say-on-Pay at the USB Bank

The USB bank established an autonomous non-binding say-on-pay vote on the remuneration in 2009 after the pressure was exerted by the regulative, cultural and normative pillars. Different from other banks, USB decided to embrace the say-on-pay mechanism without legislation or a direct recommendation from corporate governance code, pointing out overlapping institutional pressures and the dual role of the say-on-pay votes that covers both executive payment and internal agency structures.

In 2007/08 crisis, USB growth was rapid especially in regard to fixed income. This was the major reason for why USB was among the first banks to report significantly poor market performance. The bank faced substantial losses, the largest for any European lender before the bailout of more than $59.2 billion was offered by the Swiss government since the bank was on the brink of bankruptcy. The bailout was highly criticised by the Swiss public, who expressed their opposition to the bonuses paid just a year after the government was forced to rescue the bank from bankruptcy. Furthermore, criticism was further directed at the executive compensation package both from the shareholders and the politicians. However, pressure increased when other firms voluntarily introduced a non-binding say-on-pay vote in 2009. Though the organization represented a small number of the shareholder, Ethos holds a significant amount of power over the organisation including the USB bank, which far surpasses that of the normal shareholders.  Therefore, the pressure cannot be only attributed entirely to stakeholder involvement, but as a mixture of the best corporate governance from an outside research institution, as well as shareholder activism.

In addition, the pressure exerted by the public and Ethos, the introduction of the say-on-pay votes at USB was largely influenced by the pressure from politicians, and the government. The adoption of the non-binding say-on-pay votes by USB was a result of the legislation threat, though the bank was already preparing a future legal framework for the say-on-pay vote strategy. The introduction of the strategy had broader importance in that it created an arena for the shareholders to express discontent with the top management.  This is illustrated by Ethos's actions against the former management due to their role during the financial crisis and the important stance towards the compensation reports less than a year after its introduction.

The inherent interdependence of the institutional and legal pressures makes it hard to phase out one pressure that compelled USB to adopt say-on-pay. The development of new laws that governed financial institution such as the Dodd-Frank Reform Act, the Consumer Protection Act and the Basel III played central role. The case study highlights the significance of the independence between the regulative pressures from the institution exerted on the banks and between the categorization of corporate governance. In this case, the say-on-pay strategy is considered to be in light of internal agency structures and closely linked to the executive remuneration. As a consequence, this has strengthened the shareholder capability to influence the firm corporate governance and make key decisions, especially those touching on payment. The say-on-pay strategy has established an environment in which a shareholder can express their views and influence the composition of the board and firms committees at USB bank. In short, the case illustrate how pressure from the regulative and institutional pillars plays a key role in transforming agency problems and shaping  the corporate governance structure within a firm thus preventing outcomes witnessed during the 2007/08 financial crisis, which brought many financial institution to the brink of bankruptcy.

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Board and Committees Compositions

Board Members Turnover, Size and Meeting

The board turnover is supposed to act a proxy for changes in the functioning of the board and the overall corporate governance activity, and also as a measure of the director entrenchment. In the time between 2007 and 2011, a small increase in the board turnover was evident compared to the period between 2003-2007, which indicates an increase in the board and the overall corporate governance activity, but also a reduction in director entrenchment. The turnover among the director has been in response to the transformation in the regulative pillars exerted by the stockholder to improve the risk management, compensation, and the general corporate governance practices.

Increased turnover could be attributed to the replacement of the directors found to be responsible for the failure during the crisis, and who lost the confidence of the shareholders to steer the company effectively. Further details indicate that banks that experienced huge director turnover after the crisis were severely affected by the 2007 crisis both in terms of reputation and financially. However, the common factor among the top four banks in the turnover between 2007 and 2011 is that they were forced to accept new regulation measures and government bailouts. Thus, it appears that the ownership change forced by the government bailouts played an important role in increasing the director turnover rate after the financial crisis.

The annual number of meetings was found to be essential since it serves as a proxy for monitoring the changes in the board function and the overall corporate governance. A large number of board meetings indicate closer governance and monitoring of the firms and pending operational changes within the company. The result indicated an increase in the number of board meeting in the period between 2007 and 2011 and only three banks had fewer board meeting in 2011 compared to 2007. However, such banks were found to be stable thus managed the crisis better. However, four banks that had increased the number of meeting between 2007 and 2011 included USB, Citi, Dexia and BoA, are the banks that managed the crisis most poorly. However, it has been found that the need to comply with new regulation triggered an increase in board meeting frequency in an attempt to enhance the corporate governance practices. In regard to the size of the board, an insignificant decrease during the crisis period has been noted, from an aggregate of 16, 3 in 2007 to 13, 8 in 2011. Out of the sample studied, only three banks experienced an increase in board size between 2007 and 2011. The reduction in board size has been found to be counterproductive.

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