Examining the Effect of Board Characteristics on Agency Costs and Selected Performance Measures in Banks

ABSTRACT To date the empirical research examining the association between measures of corporate governance and accounting performance measures has yielded inconsistent results. We believe that the mixed results are due in part to the inclusion of firm across various industries. This study continues the stream of research studying agency theory and the relationships between board of director characteristics and firm performance. We address these issues by developing a set of models in a single, regulated industry. Focusing on the banking industry over a five-year period allows us concentrate on the measures rather than potential variations across industries. Our findings contradict the hypotheses developed under the agency theory approach and lead us to believe the relationships should be studies under a different lens. INTRODUCTION The corporate form of ownership is an integral part of the US capital market structure. Under the corporate structure, shareholders (principals) entrust management (agents) with their investment. Because the utility functions of the principals and agents can differ, the separation of ownership and control allows for potentially self-serving or opportunistic behavior by management. These behaviors result in poor financial performance, excessive compensation, and other agency costs, such as those seen in the Tyco scandal. There is a need to oversee managers and to align the interest of managers with those of shareholders. In publicly traded US corporations, this role is delegated to the company's board of directors, and some of the blame for the problems in the executive suites has been put on board of directors for failing to exercise appropriate managerial oversight. Corporate governance is described as "the set of mechanisms that influence the decisions made by managers when there is a separation of ownership and control" (Larcker et al, 2007:964). One of those monitoring mechanisms is the board of directors. At the most basic level, the board of directors is responsible for ensuring top management's actions are consistent with the interests of the shareholders (Fama and Jensen, 1983). In fact, board members not only have the legal authority to monitor the actions of top executives, but also the fiduciary responsibility to look out for the interests of shareholders. "Unfortunately, experience has shown that some executives do not sincerely believe in or want good corporate governance. They view it as a constraint on their ability to make their preferred decisions" (DiPiazza and Eccles, 2002: 101). This attitude on the part of top executives may be what leads to the creation of an ineffective board. Recently, however, shareholders, regulators, and large institutional investors have voiced growing criticism of boards, particularly with regard to the perceived failure to exercise effective managerial oversight, meaning managers are facing a new governance arena. DiPiazza and Eccles (2002: 98) state, "(k)een attention is being paid today to corporate governance because that is where a culture of accountability begins and where it can be effectively fostered. What once seemed little more than a rubber stamp for executive decisions is now recognized as a value driver that can make or break a company. " The end result is the focus of more attention on the effectiveness of board of directors in monitoring executives' actions, and the underlying motivation for our looking at board characteristics and their relationship to common measures of financial performance and agency costs. To date the empirical research examining the association between measures of corporate governance and accounting performance measures has yielded inconsistent results. We believe that the mixed results are due in part to the inclusion of firm across various industries. Economic and regulatory factors can impact various industries differently. …