Abstract
In this paper, a law reform is evaluated that aimed at improving the corporate governance of banks by tightening accountability and legal liability of outside directors. The causal effect of the reform on bank risk is identified by difference-in-differences and triple differences strategies. The estimation results show that banks subject to the reform increased capital and liquidity ratios. Hence, designing board-level governance can be an effective policy tool for altering the risk-taking behavior of banks.
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Notes
Germany has a two-tier board system: In addition to the managing board the vast majority of banking firms are legally obliged to form a supervisory board. This paper focuses on banks’ supervisory boards. Legally mandated supervisory boards consist of outside directors, since corporation and organization laws explicitly state that supervisory board members cannot hold executive positions in the supervised firm. Depending on the firm’s legal form and number of employees, employees must also be represented in the supervisory board (co-determination). Both supervisory board members in Germany and outside directors on the management board in other countries such as the U.S. are expected to monitor the senior executives and strengthen managerial accountability (Black et al. 2005a). Therefore, the terms ‘supervisory board’ and ‘outside directors’ are used interchangeably throughout the paper.
As a first step towards stricter liability, German legislative bodies in November 2010 passed a law that extends the limitation period for damage claims of banks against board members for breaches of duty from five to ten years (Bundesrat Drucksache 681/10).
Similar conclusions are reached for Korea, which is treated in a separate study (Black et al. 2005b).
The data is obtained from the Deutsche Bundesbank time series data base, October 2013.
See also Chen (2014) for a recent study on board independence in a quasi-experimental setting.
For a more detailed overview of savings banks and their role within the German banking system, see Hackethal (2004).
A few savings banks historically have been organized as private-law banks. Among 431 savings banks as of year-end 2009 six savings banks were chartered as private-law stock corporations.
As of year-end 2007, the mean customer loans-to-assets ratio of savings banks in the sample was about 59 percent, and the mean deposits-to-assets ratio was about 66 percent. See Table 5.
The only exception is Hamburg where the only savings bank is a private-law stock corporation.
See Niedersächsischer Landtag [State Parliament of Lower Saxony], Drucksache 15/1220. This section partially draws on Berger (2006), pp. 24, who gives a detailed overview of the reform.
The German Corporate Governance Code aims at strengthening trust of investors in the corporate governance of German listed stock corporations. It contains corporate governance rules of the German Stock Corporation Act (Aktiengesetz) and recommendations of best practices for ‘good’ corporate governance. These recommendations are not binding. However, management and supervisory boards are obliged once a year to confirm compliance with recommendations, or to explain the reasons for non-compliance.
Lutter (1991, pp. 126) holds a different view. He argues that the privileged status applies only in those federal states where laws concerning the status of civil servants are explicitly referenced in the savings banks law. He acknowledges, however, that this is against the commonly held view in the savings banks literature.
Anecdotal evidence on how serious the tightening of liability rules was is hard to come by. A comprehensive research of German news via Lexis Nexis and Google does not provide any information on actual liability cases in Lower Saxony after 2004.
Public guarantees required the chartering municipalities to maintain the business operations of savings banks under any circumstances and thus rendered defaults of savings banks impossible (Anstaltslast). Moreover, the chartering municipalities were directly liable to the creditors of savings banks (Gewährträgerhaftung).
Security reserves form the most important source of savings banks’ capital. See Section 3.2.1 for a description of savings banks’ capital components.
Since savings banks are public law entities and hardly rely on capital market funding, market data is not available for the vast majority of savings banks.
See German Council of Economic Experts (2004, pp. 302) for an overview of reform initiatives in the savings banks sector around 2004. One notable exception is Mecklenburg-Vorpommern which enacted some amendments in its savings banks law in March 2004, in order to preserve the status quo of its savings banks as public law entities (‘Lex Stralsund’). Excluding the savings banks chartered in Mecklenburg-Vorpommern does not affect the results of the following analysis.
See also Gropp et al. (2013) for an analysis of the impact of the abolition of guarantees on German savings banks.
Including private-law savings banks hardly affects the regression results, though.
Two federal states, Hamburg and Berlin, are not included in the analysis. The only savings bank in Hamburg is a private-law stock corporation (HASPA AG). The only savings banks in Berlin (Berliner Sparkasse) is integrated in Landesbank Berlin AG and does not publish separate financial statements.
Detailed variable definitions are given in the 1.
The number of observations for liquid assets/short-term funding is smaller than for the other ratios because, for some banks, Bankscope does not contain detailed information on the liquidity structure of liabilities.
When including control variables, six time-year observations drop out because no information on municipal deficits in Bremen is provided.
Due to multicollinearity, the Lower Saxony-2002 dummy is excluded.
Since Bankscope does not report savings banks’ lending from the associated Landesbank, we need to rely on total liabilities to banks. In addition to loans from Landesbanken, this balance sheet position is composed of various types of liabilities, most importantly forwarded loans of public development banks (Güde 1995).
See paragraphs 34, 41 Genossenschaftsgesetz.
Additional regressions (results not displayed) employing the log of the numerators and denominators of capital, liquidity and risk-asset ratios show that, after 2005, savings banks held less capital, less liquid assets, less risk-weighted assets and less total assets compared to cooperative banks. The relative decrease in risk-weighted assets is stronger than the decrease in total assets. These findings might be explained by (i) savings banks retaining fewer profits than cooperative banks in the upturn, possibly due to increased profit distribution to municipalities and/or donations and sponsorship, and (ii) a rebalancing of savings banks’ loan portfolios in the upturn towards borrowers with lower risk weights (relative to cooperative banks). Due to the lack of appropriate data, we are not able to further investigate these explanations.
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Acknowledgments
We thank an anonymous referee, Thomas K. Bauer, Daniel Baumgarten, Alfredo R. Paloyo, Christoph M. Schmidt and Isabel Schnabel for their valuables comments and suggestions. We also benefited from comments by participants of the RGS Workshop at RWI Essen, the Brown Bag Seminar at the University of Mainz, the RGS Doctoral Conference in Economics 2011 in Dortmund, the Annual Congress of the European Economic Association 2011 in Oslo and the Annual Congress of the Verein für Socialpolitik 2011 in Frankfurt. Financial support from the Leibniz Association through RGS Econ and from FAZIT Foundation is gratefully acknowledged. The opinions expressed in this paper reflect the personal views of the author and not necessarily those of the German Council of Economic Experts.
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A Appendix
A Appendix
1.1 Variable Description
1.1.1 Measures of Bank Risk
Security reserves/total assets
Profits retained and accumulated divided by total assets in percent. Source: own calculations based on Bankscope.
Book equity/total assets
Book equity divided by total assets in percent. Book equity is total assets minus total liabilities. Book equity of public-law savings banks typically consists of security reserves, balance sheet profits and capital contributions of ‘silent’ (i.e. non-controlling) partners (Stille Einlagen). Source: own calculations based on Bankscope.
Supplemented capital/total assets
The sum of equity, subordinated debt and profit participation rights (Genussrechte) divided by total assets in percent. Source: own calculations based on Bankscope.
Liquid assets/total assets
Liquid assets divided by total assets in percent. Liquid assets are: cash, treasury securities and bills of exchange eligible for advances from central banks, due from banks on demand, bonds and other fixed-income securities eligible for advances from central banks, shares and other non-fixed income securities, recovery claims against public authorities. Source: own calculations based on Bankscope.
Liquid assets/short-term funding
Liquid assets divided by short-term funding in percent. Short-term funding comprises: due to banks on demand, savings deposits, other customer deposits on demand. Source: own calculations based on Bankscope.
Risk-weighted assets/total assets
Risk-weighted assets divided by total assets in percent. Since information on Basel I risk-weighted assets is generally not publicly available, the numerator was estimated following Padberg (2005): First, if possible, Basel I risk weights were directly assigned to the balance sheets positions of the annual reports. Second, an average risk weight was assigned to those balance sheet positions not granular enough to be directly matched with Basel I risk weights. These positions include money market securities, bonds and notes of non public-sector issuers, customer loans other than loans to the public sector and collaterized real estate loans as well as irrevocable credit lines. Based on publicly available data for a subsample of banks, Padberg (2005) suggests an average risk weight of 0.65 (savings banks) and 0.72 (cooperative banks), respectively. Source: own calculations based on Bankscope.
1.1.2 Control Variables
High Landesbank downgrade
Dummy variable indicating a saving bank whose Landesbank experienced a high downgrade (6 or 7 notches) due to the abolition of public guarantees. The downgrade is the difference between issuer ratings of Landesbanken before 18 July 2005 and issuer ratings announced on 01 July 2004 to be valid after 18 July 2005. It ranges from 4 to 7 notches. Source: Fitch Ratings.
Liabilites to banks/total assets
Liabilities to banks divided by total assets in percent. Source: own calculations based on Bankscope.
Log insolvency proceedings
Log of number of firms that filed for insolvency proceedings in each federal state. Source: own calculations based on data obtained from the Federal Statistical Office (Destatis).
Municipal debt
Sum of the debt of municipalities in each federal state in EUR 1,000, divided by the population of the federal states. Source: own calculations based on data obtained from the Federal Statistical Office (Destatis).
Municipal deficits
Sum of the deficits (income minus expenditure) of municipalities in each federal state in EUR 1,000, divided by the population of the federal states. Source: own calculations based on data obtained from the Federal Statistical Office (Destatis).
Net interest margin of cooperative competitors
Mean net interest margin of cooperative banks in each federal state. Net interest margin is interest income from lending and money market transactions minus interest expenditures divided by total loans. Source: own calculations based on Bankscope.
Real GDP growth
Yearly difference in log real GDP of the federal states. Source: own calculations based on data obtained from the Federal Statistical Office (Destatis).
Population density
Number of inhabitants per km2 in each federal state. Source: own calculations based on data obtained from the Federal Statistical Office (Destatis).
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Körner, T. Board Accountability and Risk Taking in Banking: Evidence from a Quasi-Experiment. J Financ Serv Res 52, 155–190 (2017). https://doi.org/10.1007/s10693-016-0252-3
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DOI: https://doi.org/10.1007/s10693-016-0252-3