Financial Institutions, Board Representation and Corporate Decision making

In large joint stock companies, characterised by the separation of ownership and control, corporate governance mechanisms are intended to provide shareholders with some reassurance that managers will try to achieve outcomes that are in their interests (Shliefer and Vishny, 1997). With ongoing concerns about the effectiveness of such mechanisms, considerable academic research and policy
discussions on corporate governance reform has centred on the role of corporate boards of directors (Adams et al. 2010).

Corporate governance reform has emphasised the extent to which boards are independent of senior managers on the basis that such outside directors, acting as autonomous guardians of shareholder wealth, should ensure that resources are utilised effectively
Dominguiz-Martinez et al., 2008). However, an extensive literature has analysed the impact of board independence on firm performance and shareholder value and found little consistent evidence that the monitoring is effective (McKnight and Weir, 2009; Nicholson and Kiel, 2007).

Research suggests that the key aspect regarding the effectiveness of boards is the extent of information asymmetry between independent directors and the executive directors (Holmstrom, 2005). Access to information by independent directors is hampered by the time independent directors can devote to monitoring (Fich and Shivdasani, 2006) and the eagerness of CEOs to reveal it (Hermalin and Weisbach, 1998).

However, some proponents of agency theory predict that another type of director may also help overcome the asymmetric information in corporate decision-making and curb managerial opportunism (Stearns and Mizruchi, 1993). In the UK, financial institutions are important investors, holding a large proportion of the shares issues by corporations (Kay report, 2012). Consequently, their trading decisions can have a big impact on corporations. Indeed, agency theory predicts that such institutions should have an incentive to monitor managers properly if their substantial block-holdings make the cost-benefit trade-off worthwhile. However, while such institutional investors control large amounts of equity, their holdings are well-diversified, meaning insignificant holdings in any one company. Therefore, they have been traditionally viewed as ‘passive’ rather than ‘active’ investors. Indeed, they may not see themselves as owners of corporate resources at all; equity is just another asset to be traded (Padgett, 2012).

However, there has been a long-standing view that institutional investors could be made more effective in governing corporations since such institutions have informational and analytical advantages in monitoring management Both Brav, et al., (2008) and Clifford (2008) found that when hedge funds managers chose to follow an interventionist strategy, financial performance was improved. Recently, there has been a push by regulators in the UK, and other market-based governance jurisdictions for institutional investors to become more active stewards of companies rather than passive traders (Kay, 2012).

However, it can be argued that, if the financial institution has an ownership block, their board representatives have an incentive to incur the monitoring costs needed to overcome information asymmetries present in firms and challenge management recommendations
surrounding corporate decisions (Duchin et al, 2010). However, there is little work in this area.

This project aims to address this gap in the corporate governance literature by analysing the presence of representatives of financial institutions on boards, and their influence, if any, on corporate decision-making. Through this, more can be learned about the effectiveness of boards as monitoring mechanisms.