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Ethical Reputation of Financial Institutions: Do Board Characteristics Matter?

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Abstract

This paper examines the association between board characteristics and the ethical reputation of financial institutions. Given the pivotal governance role of the board of directors and the value-relevance of ethical corporate behavior, we postulate a positive relationship between ethical reputation and board features that foster more effective monitoring and oversight. Using a sample of large financial institutions from 13 different countries, we run several alternative panel regressions of ethical reputation on board characteristics and firm-specific controls. Our results demonstrate that the ethical reputation of financial institutions is positively associated with board size, gender diversity, and CEO duality, while being negatively related to the busyness of the board members and a composite index reflecting poor monitoring. Nevertheless, inconsistent with our hypothesis, we also document that financial institutions with less frequent board meetings have better ethical reputation. Overall, our empirical findings suggest that stronger board oversight may promote ethical behavior in the financial industry.

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Notes

  1. As noted, e.g., by Mitchell et al. (1992), ethical problems in the financial industry may be related to conflicts of interest, handling of confidential information, quality of financial reporting, lending practices, antitrust compliance, compensation schemes, insider abuse, insider trading, and money laundering. Recent notorious examples of unethical behavior in the financial industry include the Libor manipulation scandal, tax evasion controversies, and fraudulent mortgage foreclosure practices in the U.S.

  2. Garcia-Sanchez et al. (2015) argue that the firm’s ethical commitment is governed by the composition of the board. They further assert that improvement of the firm’s ethical reputation is one of the important reasons behind the implementation of ethics codes.

  3. Ethical reputation is a more generic concept than ethical behavior, ethical conduct, or ethicality.

  4. The hypotheses for how each individual board characteristic should be related to ethical reputation are presented in “Board characteristics” Section.

  5. Ethical behavior is considered to be a central component of corporate social responsibility, and consequently, the two concepts are closely linked and somewhat overlapping (see, e.g., Friedman 1970; Epstein 1989).

  6. Sonnenfeld (2004) anecdotally notes that many of the high-profile scandals involving unethical and illegal accounting practices (e.g., Enron, Worldcom, and Vivendi) have involved firms in which the CEO and the board Chair positions were held by separate individuals.

  7. Almost 50 % of the firm-year observations in our sample are from the U.S. and some countries are represented by a single bank, and therefore, it is infeasible to use country dummies for each individual country. Nevertheless, it should be noted that most of the financial institutions included in the sample have substantial operations in the U.S.

  8. A closer look at our data indicates that for some institutions the number of board meetings increased considerably during the financial crisis. For instance, the maximum of 47 meetings were held by the board of UBS in 2008, which met only seven times annually during the pre-crisis years 2005–2007.

  9. For brevity, we do not tabulate the correlation coefficients for the control variables. The full correlation matrix is available from the authors upon request.

  10. We conduct the univariate tests also by comparing differences between the first and last quartiles and tertiles. The results of these additional tests are similar in terms of both signs and statistical significance.

  11. In further analysis, we observe that financial institutions which were experiencing severe problems during the global financial crisis increased the frequency of board meetings in 2008 and 2009.

  12. Although we include seven board characteristics in the regressions under both setups, our estimates should not be affected by multicollinearity. As can be seen from Table 2, albeit being statistically significant, the correlation coefficients between the board characteristics included in both setups are relatively low in magnitude (|ρ| < 0.31). Furthermore, the variance inflation factors for all the board variables under both setups are below 5, suggesting that the estimates should not be influenced by multicollinearity.

  13. A few words of caution are in order. The small number of financial institutions and the short-time dimension of our sample combined with the large number of parameters to be estimated in the two-way fixed effects specifications impair the statistical precision of the coefficient estimates. Hence, the results of the regressions which include both year and firm fixed effects should be interpreted with caution.

  14. Again, it is important to emphasize that the small number of observations impairs the statistical precision of the coefficient estimates of the two-way fixed effects regressions.

  15. It is worth noting that board characteristics change slowly over time, and therefore, the one-year lagged values of the board characteristics are highly correlated with the contemporaneous values. The only board characteristic that displays significant within-firm variation during our sample period is Board meetings; troubled financial institutions increased the frequency of board meetings amidst the financial crisis.

  16. For brevity, we do not tabulate our robustness checks. The results of these additional tests are naturally available from the authors upon request.

  17. In our main analysis, we have used a dummy variable for non-U.S. financial institutions to control for potential country-level differences. Furthermore, we have also estimated regressions with firm fixed effects which should account for omitted and potentially unobservable variables, such as regional differences in regulations and norms.

  18. The estimates of these regressions should be interpreted cautiously due to the very small number of observations.

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Acknowledgments

We wish to thank five anonymous referees, Susana Álvarez-Otero, John Boatright, Carmen Correa, Stanley D. Smith, Steen Thomsen, and seminar and conference participants at the University of Central Florida, Pablo de Olavide University, the 55th Southern Finance Association Meeting, the 51st Eastern Finance Association Meeting, the XXII Finance Forum, the 18th IESE International Symposium on Ethics, Business and Society, and the 7th Workshop of the Nordic Corporate Governance Network for valuable comments and suggestions. The financial support of the Academy of Finland, the Foundation for Economic Education, the Marcus Wallenberg Foundation, the NASDAQ OMX Nordic Foundation, the OP-Pohjola Bank Research Foundation, and the Pablo de Olavide University (Research Project APPB813098) is gratefully acknowledged. Part of this paper was written while L. Baselga-Pascual was visiting the University of Vaasa and S. Vähämaa was visiting the University of Central Florida.

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Authors and Affiliations

  1. Department of Financial Economics and Accounting, Pablo de Olavide University, Ctra. de Utrera Km. 1, 41013, Seville, Spain

    Laura Baselga-Pascual & Antonio Trujillo-Ponce

  2. Deusto Business School, University of Deusto, Camino de Mundaiz 50, 20012, San Sebastian, Spain

    Laura Baselga-Pascual

  3. Department of Finance and Statistics, Hanken School of Economics, P.O. Box 287, 65101, Vaasa, Finland

    Emilia Vähämaa

  4. Department of Accounting and Finance, University of Vaasa, P.O. Box 700, 65101, Vaasa, Finland

    Emilia Vähämaa & Sami Vähämaa

Authors
  1. Laura Baselga-Pascual
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  2. Antonio Trujillo-Ponce
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  3. Emilia Vähämaa
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  4. Sami Vähämaa
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Corresponding author

Correspondence to Sami Vähämaa.

Appendix 1: List of Financial Institutions

Appendix 1: List of Financial Institutions

  1. 1.

    Australia and New Zealand Banking Group

  2. 2.

    Banco Bilbao Vizcaya Argentaria

  3. 3.

    Banco Santander

  4. 4.

    Bank of America

  5. 5.

    Bank of New York Mellon

  6. 6.

    Bank of Nova Scotia

  7. 7.

    Barclays Bank

  8. 8.

    BNP Paribas

  9. 9.

    Capital One Financial Corporation

  10. 10.

    Charles Schwab

  11. 11.

    Citigroup

  12. 12.

    Commonwealth Bank of Australia

  13. 13.

    Credit Agricole

  14. 14.

    Credit Suisse

  15. 15.

    Daiwa Securities Group

  16. 16.

    Deutsche Bank

  17. 17.

    Fannie Mae

  18. 18.

    Fifth Third Bancorp

  19. 19.

    Freddie Mac

  20. 20.

    Fubon Financial Holding

  21. 21.

    Goldman Sachs

  22. 22.

    HSBC

  23. 23.

    Intesa Sanpaolo

  24. 24.

    Invesco

  25. 25.

    Itausa-Investimentos Itau

  26. 26.

    JPMorgan Chase

  27. 27.

    Lloyds Banking Group

  28. 28.

    Macquarie Group

  29. 29.

    Mitsubishi UFJ Financial Group

  30. 30.

    Morgan Stanley

  31. 31.

    National Australia Bank Limited

  32. 32.

    Orix Corporation

  33. 33.

    Royal Bank of Canada

  34. 34.

    Royal Bank of Scotland

  35. 35.

    Sallie Mae

  36. 36.

    Société Générale

  37. 37.

    State Street Corporation

  38. 38.

    Sumitomo Mitsui Financial Group

  39. 39.

    T. Rowe Price

  40. 40.

    Toronto Dominion Bank

  41. 41.

    UBS

  42. 42.

    US Bancorp

  43. 43.

    Wells Fargo & Company

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Baselga-Pascual, L., Trujillo-Ponce, A., Vähämaa, E. et al. Ethical Reputation of Financial Institutions: Do Board Characteristics Matter?. J Bus Ethics 148, 489–510 (2018). https://doi.org/10.1007/s10551-015-2949-x

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