“Comment on Corporate Governance and Risk Management at Unprotected Banks: National Banks in the 1980s”

Authors: Charles W. Calomiris and Mark Carlson

Discussant: Joseph A. McCaheryGCCG Conference, Palo Alto

June 5, 2015

1. Objectives of the Paper

Examines: how banks design governance structures and risk management mechanisms to limit agency problems in order to attract investors.

Key contributions: Differences in level of ownership v. governance mechanisms to

resolve conflicts. Impact of more concentrated ownership less formal governance,

less risk taking but more related loans, dividend payments & reliance on more cash to resolve adverse selection problems.

Governance approach more risk taking via reliance on capital for risk management and lower managerial salaries.

Cash as strategy to signal effective risk management

1. Contribution of the PaperPaper focuses on sample of 206 banks, which consists of national banks in 37 cities that provided

information for September 1982 Call Report and at least one Examination Report prior to 1893.

Unique approach: use of Examination Reports that includes data on extent of ownership holdings of management and board, corporate governance practices, salaries of officers, number of shares held and loans to these individuals, as well as information about the loan book, collateral, bank liabilities and performance.

The paper contributes to the literature on how ownership and corporate governance structures influences insider lending and who receives insider loans.

Paper relates to the literature on how managerial ownership and executive compensation sensitivity to firm performance matters for risk taking.

Offers insight by showing the expansion of too-big-to-fail protection that is associated with a significant decline in banks’ holdings of cash assets and contrasts with historical banks’ reliance on cash as a credibly strategy to signal an effective risk management system.

2. Comments (C1)

Unaddressed endogeneity

It is difficult to understand what is exogenous and what is endogenous. In particular, managerial ownership is one corporate governance mechanism as much as board structure.

As the author’s acknowledge, it is hard to say that one determines the other. Both are the outcome of something else. We all know that family firms (which seem very similar to the historical manager/controlled banks) have worse board practices.

2. Comment (C2)Is the Manager the Controlling Shareholder?

It is key to know who is the controlling shareholder and its connection to management since it would be hard to argue that managerial ownership is a good corporate governance mechanism if the manager is the controlling shareholder.

The connection between the controlling shareholder and the manager is also important to determine how resources would be tunneled out: 1. If the manager is the controlling shareholder, then tunneling would be done by self loans or2. If the manager is not the controlling shareholder, then he will increase his salary as a way to tunnel assets.

2. Comment (C3)

• Managerial Turnover: is the instrument used in Table 6. There are questions about whether this is a good instrument since it does not meet the requirement in many cases.

• Also, there is only evidence for 37 cases, which is less than half of the data set.

• It is hard to be confident about the instrument unless we know about the other half of the CEOs that died and the connections between the manager and controlling shareholder.

• Prior literature indicates that if a firm has a large controlling shareholder, then he will typically run the firm (70% of firms) (LLS 1999; Levine 2004).

2. Comment (C4)

• IV Variables• Table 6 shows that there is a weak correlation

between the instrument Z variables and the X variables.

• Problem due to choice of IV variables Z (resulting from omitted variable bias).

3. Suggestions

• Controlling Shareholder• It may be worth finding out about the other

half of the CEOs that died and the connections between the managers and controlling shareholders in those cases.

Take Away

• Very interesting paper--From a corporate law and finance perspective, this

seems like a very interesting avenue for research.

• Attempt to find out about the other half of the CEOs that died and their connections to controlling owners

• Consider adjustments to IV variables Z