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This paper represents the authors’ personal opinions and does not necessarily reflect the views of Deutsche Bundesbank or its staff. Allen N. Berger UNIVERSITY.

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Presentation on theme: "This paper represents the authors’ personal opinions and does not necessarily reflect the views of Deutsche Bundesbank or its staff. Allen N. Berger UNIVERSITY."— Presentation transcript:

1 This paper represents the authors’ personal opinions and does not necessarily reflect the views of Deutsche Bundesbank or its staff. Allen N. Berger UNIVERSITY OF SOUTH CAROLINA, WHARTON FINANCIAL INSTITUTIONS CENTER, AND CENTER – TILBURG UNIVERSITY Thomas Kick DEUTSCHE BUNDESBANK Klaus Schaeck BANGOR UNIVERSITY Conference “Corporate Governance of Financial Institutions” Amsterdam November 2012 Board Composition and Bank Risk Taking

2 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. The recent financial crisis highlights the importance of risk taking by banks and the larger consequences of excessive risk taking for society as a whole. Much of the blame for the crisis and suggested remedies have focused on corporate governance arrangements. While others have argued for and studied restrictions on inside ownership and executive compensation, we take a different approach and look at executive board composition. While there are studies of board composition elsewhere, we focus on banks, where risk taking is of first-order importance. 2 Introduction – Hypotheses – Data and Methodology – Results – Conclusion

3 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Research Question: How does executive board composition affect bank risk taking? 3 Board Composition and Risk Taking Introduction – Hypotheses – Data and Methodology – Results – Conclusion

4 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Paper has a (management) team perspective  Management board forms a team that interacts dynamically.  Composition of the “team” is crucial in shaping outcomes. (e.g., Holmstrom (1982, BJE); Bolton and Dewatripont (2005, MIT press))  Composition: Socioeconomic characteristics age gender education We study a country with two-tier board system (Germany)  Executive board Direct responsibility for the management of the company. Runs the corporation, makes decisions and reports to the supervisory board.  Supervisory board Monitors the management, i.e. gives consent to certain transactions. Appoints and dismisses members of the executive board on behalf of the shareholders.  We focus on the composition of the executive board This generalizes directly to other nations with two-tier board systems (of which there are many) The results may generalize to executive members of the board in one-tier board countries 4 Board Composition and Risk Taking Introduction – Hypotheses – Data and Methodology – Results – Conclusion

5 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Focus on banks and risk taking  Policy relevance.  Impact of governance arrangements in banking on wider society, as illustrated by the recent financial crisis. Hau and Thum (2009, EP); Illueca, Norden, and Udell (2012, AEA Paper)  Literature generally excludes regulated industries. Bertrand and Schoar (2003, QJE); Fich (2005, JB); Farrell and Hersch (2006, JCF)  Adds to the emerging evidence on governance arrangements in banking. Fahlenbrach and Stulz (2011, JFE); Adams and Mehran (2012, JFI). 5 Introduction – Hypotheses – Data and Methodology – Results – Conclusion

6 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Age  Perception of young managers’ overconfidence and old managers’ wisdom  Expect strong effect of experience on risk taking behavior Theory and literature also suggest inverse association between age and risk taking  Knowledge of risky situations and ability to control risk increases with age Grable et al. (2009, JBER), Russo and Schoemaker (1992, SMR), Gervais and Odean (2001, RFS)  Empirical evidence points towards a negative relationship Campbell (2001, JF), Sahm (2007, FRB) and Grable et al. (2009, JBER) Age hypothesis HI: Risk taking decreases in executive board age 6 Board Composition and Risk Taking Introduction – Hypotheses – Data and Methodology – Results – Conclusion

7 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Gender  Perception of risk loving male and risk averse female managers  Anecdotal evidence on women being more prudent in financial decision making (e.g., microfinance)  Important in light of recently passed, proposed (and then scrapped) minimum quotas for women on boards and on executive teams in Europe Theory and literature is ambiguous  Growing debate on the effect of gender on economic outcomes e.g. Croson and Gneezy (2009, JEL), Schubert, Brown, Glyser, and Brachinger (1999 AER P&P)  Investment literature suggests women are more risk averse e.g. Barber and Odean (2001, QJE), Niederle and Vesterlund (2007, QJE), Goel and Thakor (2008, JF)  Governance: female directors are less risk averse and reduce performance Adams and Funk (2012, MS); Ahern and Dittmar (2012, QJE)  Little evidence on the effect in banking except for loan officers Agarwal and Wang (2009, Working Paper) and Beck, Behr, and Güttler (forthcoming,RoF) 7 Board Composition and Risk Taking Introduction – Hypotheses – Data and Methodology – Results – Conclusion

8 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Gender Hypotheses HII a: A higher representation of female executives reduces risk taking HII b: A higher representation of female executives increases risk taking 8 Board Composition and Risk Taking Introduction – Hypotheses – Data and Methodology – Results – Conclusion

9 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Education  Education affects knowledge of and perception of risk e.g. risk management techniques taught in business schools International efforts to encourage banks’ appointment of knowledgeable directors: Basel Committee on Banking Supervision (2006)  Stereotype of MBA graduates’ aggressive management style Theory and literature is ambiguous  More risk taking suggested for household decisions Carducci and Wong (1998, JBP); Grable (2002); Christiansen, Joensen, and Rangvid (2008, RoF)  MBA literature is ambiguous More sophisticated project valuation techniques, Graham and Harvey (2001, JFE) But aggressive style and more leverage, Bertrand and Schoar (2003, QJE)  Negative relationship suggested for corporate outcomes Financing and acquisition policies: Güner, Malmendier, and Tate (2008, JFE) Failure of financial institutions: Fich and Fernandes (2009, Working Paper) 9 Board Composition and Risk Taking Introduction – Hypotheses – Data and Methodology – Results – Conclusion

10 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Education hypotheses HIII a: Better educated executives engage in less risk taking HIII b: Better educated executives engage in greater risk taking 10 Board Composition and Risk Taking Introduction – Hypotheses – Data and Methodology – Results – Conclusion

11 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Data  Proprietary data from the Deutsche Bundesbank  Complete and detailed information on executives’ age, gender, and education  Time horizon 1994-2010  19,750 bank-year observations for 3,525 banks Estimation setup  Difference in difference matching estimation – exploits exogenous variation via mandatory retirements  Matching criteria size (+/- 20 percent of the treatment bank’s size in terms of total assets) performance (+/- 20 percent of the treatment bank’s ROE) board size held constant bank type (public banks, cooperative banks, and private banks) time period (year) o Sample excludes ‘bad’ banks (banks with interventions, capital support, distress merger banks) o Final sample: 10,719 bank-year observations for 2,490 banks Risk measure  RWA/Total Assets – risk on and off the balance sheet  Used in regulatory treatment and in empirical literature 11 Board Composition and Risk Taking Introduction – Hypotheses – Data and Methodology – Results – Conclusion

12 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Methodology and Identification  Difference-in-difference estimator Y i : Measure of risk taking for bank i in year t Post: Dummy for Post change period in board composition Treated: Dummy if the bank experienced a Board change X it : Control variables Focus: Interaction term: Post × Treated captures the effect of an executive board change due to retirements in the period after the change takes place. The slope coefficient of the interaction term therefore allows isolating effect of the change in executive board composition on the risk measure. We consider at most one executive board change of each type per bank. We examine the seven-year time window surrounding the executive board change and consider the three years prior to, the three years following, and the actual year of the executive board change. 12 Introduction – Hypotheses – Data and Methodology – Results – Conclusion

13 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Controls  Total assets Capacity to absorb risk, too-big-to-fail  Charter value (core deposits/Total assets) Affects risk taking, e.g. Dell’Ariccia and Marquez (2006, JF)  Capital adequacy ratio Affects moral hazard and monitoring incentives Morrison and White (2005, AER), Allen, Carletti, and Marquez (2011, RFS)  Merger dummy May reflect changes in risk attitudes  Powerful CEO (tenure) Influential CEOs affect risk taking Adams, Almeida, and Ferreira (2005, RFS)  Executive board size Expect less risk taking for large boards Sah and Stiglitz (1986, JPE)  Share of customer loans and off balance sheet items in total assets Control for bank balance sheet composition and business model 13 Introduction – Hypotheses – Data and Methodology – Results – Conclusion

14 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate.  Growth of total assets (deflated) Banks that experience substantial growth msy run a higher degree of risk  GDP growth (county) Control for macroeconomic environment, booms coincide with increased risk-taking e.g. Dell’Ariccia and Marquez (2006, JF)  Population (log, state) Controls for market size  Interest rate spread Spread between 10 and 1 year bonds  Time trend Mitigate serial correlation concerns Bertrand, Duflo, and Mullainathan (2004, QJE) 14 Introduction – Hypotheses – Data and Methodology – Results – Conclusion

15 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Descriptive statistics 15 Introduction – Hypotheses – Data and Methodology – Results – Conclusion Treatment GroupControl GroupAll banks (1)(2)(3) Executive board characteristics MeanS.D.MeanS.D.MeanS.D. Board age composition50.034.8750.005.0150.014.96 Board gender composition0.030.100.020.110.020.10 Board education composition0.050.130.010.070.030.10 Powerful CEO7.227.497.047.247.107.33 Board size3.741.992.591.703.001.89 # decreases in age8550 # increases in females280 # increases in education460 Bank characteristics and macroeconomic environment Total assets (log, deflated)19.931.4719.091.2119.381.36 Charter value17.818.1116.696.6917.087.24 Capital adequacy ratio19.90130.2012.524.3115.1277.35 GDP growth (per capita)1.593.581.683.321.643.41 Merger dummy0.030.160.060.230.050.21 Risk measures RWA/TA58.0014.9360.6210.9259.7012.54 HHI (log) 3.390.38 3.24 0.25 3.290.31

16 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. 16 Introduction – Hypotheses – Data and Methodology – Results – Conclusion Average Age: Share of females: Share of PhDs:

17 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Main Results 17 Introduction – Hypotheses – Data and Methodology – Results – Conclusion Age compositionGender compositionEducation composition (1)(2)(3) RWA/TA Executive board change-0.020.99-1.48** Post period0.130.59***0.23 Board change * Post period 0.55*** 0.96* -2.26*** Timetrend-0.24***0.79***0.93*** Total assets (log, deflated)-2.15***-20.97***-12.14*** Charter value-0.16***-0.17***-0.18*** Capital adequacy ratio-0.21***-1.49***-1.01*** GDP growth (county)0.08*** 0.02 Merger dummy0.34-0.35-0.05 Powerful CEO0.02*0-0.05** Customer loans/Total assets0.61***0.37***0.41*** Off balance sheet items/Total assets0.11***0.19***0.01 Growth of total assets (deflated)0.000.010.04 Board size0.70***0.38-0.48 Interest rate spread-1.05***-0.62***-0.08 Population (log, state)68.10***48.63***-24.66* Average exeuctive board ageNoYes Average Ph.D. representationYes No Average female representation Yes No Yes Observations6,4403,0731,229 R-squared0.4520.6150.358 Number of banks1,578652260 Number of board changes5692425  Data are consistent with hypothesis HI o Executive board changes that cause a decrease of average age raise a bank’s risk profile significantly o Supports theory: Executives have different attitudes towards risk as they age.  Data are consistent with hypothesis HI o Executive board changes that cause a decrease of average age raise a bank’s risk profile significantly o Supports theory: Executives have different attitudes towards risk as they age.  Data are consistent with hypothesis HII b o Executive board changes that increase the representation of female executives also increase risk taking o We can not rule out male executives could change behavior following arrival of female executives!  Data are consistent with hypothesis HII b o Executive board changes that increase the representation of female executives also increase risk taking o We can not rule out male executives could change behavior following arrival of female executives!  Data are consistent with hypothesis HIII a o Increasing representation of highly-educated executives (PhD degree) decrease bank risk o Supports idea of better risk management techniques or more conservatism among highly educated executive s  Data are consistent with hypothesis HIII a o Increasing representation of highly-educated executives (PhD degree) decrease bank risk o Supports idea of better risk management techniques or more conservatism among highly educated executive s

18 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Panel A: Age compositionPre board change Post board changet-test Age Range11.8011.85-0.25 Number of executive board changes569 Panel B: Gender composition Average job experience (all executives)15.337.707.74*** Number of executive board changes24 Do women select into particular types of banks? Comparing treatment and control banks prior to the increase in female board representation Treatment group Control group Capital adequacy ratio prior to board change14.2712.80-3.81*** Proportion of female executives prior to board change0.030.02-0.14 Proportion of female CEOs prior to board change0.040.02-1.75* Panel C: Education composition (Ph.D.)Pre board change Post board change Off balance sheet/Total assets7.946.811.26 Fee income7.809.52-2.04** Core deposits/Total assets12.6516.88-3.07*** Number of executive board changes25 Exploring the mechanisms 18 Introduction – Hypotheses – Data and Methodology – Results – Conclusion Age heterogeneity, captured by executive board age range: o Finding is not significant. Age heterogeneity, captured by executive board age range: o Finding is not significant. o New female executive board members are less experienced (Ahern and Dittmar, 2012, QJE) – could explain why risk taking increases. o Female executives appointed to boards of banks with significantly higher capital ratio before the change, so may have greater ability to absorb risk. o New female executive board members are less experienced (Ahern and Dittmar, 2012, QJE) – could explain why risk taking increases. o Female executives appointed to boards of banks with significantly higher capital ratio before the change, so may have greater ability to absorb risk. o Better educated executive board members adjust the liability composition towards more stable funding sources. o Better educated executive board members diversify income streams. o Better educated executive board members adjust the liability composition towards more stable funding sources. o Better educated executive board members diversify income streams.

19 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Robustness tests  Exclusion of all loss-making banks from the estimations Reason: poorly performing banks may have incentives to restructure executive boards in specific ways to restore profitability (Schaeck et al., 2012, RoF)  Alternative risk measure: Herfindahl Hirschman Index of loan concentration Reports the degree of concentration in banks’ loan portfolio  indicator of risk exposure  Alternative matching procedures Adding of capital adequacy ratios as matching criterion Narrowing of matching band for all criteria: between 90% and 110% o Additional regressions where Merged banks are omitted Poorly capitalized banks are omitted  Placebo test Idea: pretense of a board change at a point in time when it in fact did not occur Redefinition of Treatment dummy to unity two years prior to the actual executive board change Main results are robust to alternative specifications. 19 Introduction – Hypotheses – Data and Methodology – Results – Conclusion

20 Board Composition and Risk Taking Berger, Kick, and SchaeckDraft – Please do not circulate. Conclusion Socioeconomic characteristics of executive board composition matter for banks’ risk-taking. Decreases in executive board age and more female representation are associated with more risk taking, and more education is associated with less risk taking. Female results may in part reflect differences in experience and in initial conditions. Robustness of empirical results to different specifications Future work Better disentangling of age, gender, and education effects Testing for career concerns and overconfidence Alternative control groups 20 Introduction – Hypotheses – Data and Methodology – Results – Conclusion


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