Corporate Governance

Agency costs and corporate governance mechanisms: Evidence for UK firms Chrisostomos Florackis and Aydin Ozkan* University of York, UK Abstract In this paper, we aim to extend the empirical literature on the determinants of agency costs by using a large sample of UK listed firms. To do so, we employ two alternative proxies for agency costs: the ratio of total sales to total assets (asset turnover) and the ratio of selling, general and administrative expenses (SG&A) to total sales. In our analysis, we control for the influence of several internal governance mechanisms or devices that were ignored by previous studies.

Also, we examine the potential interactions between these mechanisms and firm growth opportunities in determining agency costs. Our results reveal that the capital structure characteristics of firms, namely bank debt and debt maturity, constitute two of the most important corporate governance devices for UK companies. Also, managerial ownership, managerial compensation and ownership concentration seem to play an important role in mitigating agency costs. Finally, our results suggest that the impact exerted by internal governance mechanisms on agency costs varies with firms’ growth opportunities.

JEL classification: G3; G32 Keywords: Agency costs; Growth opportunities; Internal Corporate Governance Mechanisms. * Corresponding author. Department of Economics and Related Studies, University of York, Heslington, York, YO10 5DD, UK. Tel. : + 44 (1904) 434672. Fax: + 44 (1904) 433759. E-mail: ao5@york. ac. uk. We thank seminar participants at University of York, and the 2004 European Finance Association Meetings for helpful comments and suggestions. 1 1. Introduction Following Jensen and Meckling (1976), agency relations within the firm and costs associated with them have been extensively investigated in the corporate finance literature.

There is a great deal of empirical work providing evidence that financial decisions, investment decisions and, hence, firm value are significantly affected by the presence of agency conflicts and the extent of agency costs. The focus of these studies has been the impact of the expected agency costs on the performance of firms. 1 Moreover, the implicit assumption is that, in imperfect capital markets, agency costs arising from conflicts between firms’ claimholders exist and the value of firms decreases if the market expects that these costs are likely to be realised.

It is also assumed that there are internal and external corporate governance mechanisms that can help reduce the expected costs and their negative impact on firm value. For example, much of prior work on the ownership and performance relationship relies on the view that managerial ownership can align the interests of managers and shareholders and hence one would observe a positive impact exerted by managerial shareholdings on the performance of firms. The positive impact is argued to be due to the decrease in the expected costs of the agency conflict between managers and shareholders.

Despite much valuable insights provided by this strand of literature, however, only very few studies directly tackle the measurement issue of the principal variable of interest, namely agency costs. Notable exceptions are Ang et al. (2000) and Sign and Davidson (2003), which investigate the empirical determinants of agency costs and focus on the role of debt and ownership structure in mitigating agency problems for the US firms. In doing so, they use two alternative proxies for agency costs: the ratio of total sales to total assets (asset turnover) and the ratio of selling, general and administrative expenses (SG&A) to total sales.

In line with the findings of prior research they provide evidence for the view that managerial ownership aligns the interests of managers and shareholders and, hence, reduces agency costs in general. However, there is no consensus on the role of debt in mitigating such problems and associated costs. Ang et al. (2000) point out that debt has an alleviating role whereas Sign and Davidson (2003) an aggravating one. The objective of this paper is to extend the investigation of these studies by analysing empirically the determinants of agency costs in the UK for a large sample of 1

See, for example, Morck et al. (1988); McConnell and Servaes (1990); and Agrawal and Knoeber (1996) among others. 2 listed firms. Following the works of Ang et al. (2000) and, Sign and Davidson (2003), we model both proxies of agency costs: asset turnover and the (SG&A) ratio. More specifically, we empirically examine the impact of capital structure, ownership, board composition and managerial compensation on the costs likely to arise from agency conflicts between managers and shareholders. In doing so, we also pay particular attention to the role of growth opportunities in influencing the effectiveness of internal governance mechanisms in reducing agency costs. In carrying out the analysis in this paper, we aim to provide insights at least in three important areas of the empirical research on agency costs. First, in investigating the determinants of agency costs, the analysis of this paper incorporates important firmspecific characteristics (internal corporate governance devices) that possibly affect agency costs but were ignored by previous studies.

For example, we explore the role the debt maturity structure of firms can play in controlling agency costs. It is widely acknowledged that short-term debt may be more effective than long-term debt in reducing the expected costs of the underinvestment problem of Myers (1977). 3 Accordingly, in our analysis, we consider the maturity structure of debt as a potential governance device that is effective in reducing the expected costs of the agency conflict between shareholders and debtholders. Similar to Ang et al. 2000) that investigate if bank debt creates a positive externality in the form of lower agency costs, we also check if the source of debt financing matters in mitigating agency problems. Another potentially effective corporate governance mechanism we consider relates to managerial compensation. Recent studies suggest that compensation contracts can motivate managers to take actions that maximize shareholders’ wealth (see, e. g. , Core et al. , 2001; Murphy, 1999 among others). This is based on the view that financial “carrots” motivate managers to maximize firm value.

That is, a manager will presumably be less likely, ceteris paribus, to exert insufficient effort and risk the loss of his job the greater the level of his compensation. Several empirical studies provide evidence for the effectiveness of managerial compensation as a corporate governance mechanism. For instance, 2 As explained later in the paper, the two proxies for agency costs that are used in our analysis are more likely to capture the agency problems between managers and shareholders. However, we do not rule out the possibility that they may also capture the agency problems between shareholders and debtholders. It is argued that firm with greater growth opportunities should have more short-term debt because shortening debt maturity would make it more likely that debt will mature before any opportunity to exercise the growth options. Consistent with this prediction, there are several empirical debt maturity studies that find a negative relation between maturity and growth opportunities (see, e. g. , Barclay and Smith, 1995; Guedes and Opler, 1996; and Ozkan, 2000 among others). 3 Hutchinson and Gul (2004) find that managers’ compensation can moderate the negative association between growth opportunities and firm value.

In this paper, we examine the effectiveness of managerial compensation as a corporate governance mechanism by including the salary of managers in our empirical model. We also acknowledge that there have been concerns about excessive compensation packages and their negative impact on corporate performance. Accordingly, we investigate the possibility of a non-monotonic impact the managerial compensation may exert on agency costs. Second, our empirical model captures potential interactions between corporate governance mechanisms and growth opportunities.

Following McConnell and Servaes (1995) and Lasfer (2002), we expect the effectiveness of governance mechanisms in reducing agency problems to be dependent on firm’s growth opportunities. In particular, if agency problems are associated with greater information asymmetry (a common problem in high-growth firms), we expect the effectiveness of corporate governance mechanisms in mitigating asymmetric information problems to increase in high-growth firms (Smith and Watts, 1992 and Gaver and Gaver, 1993).

However, if, as argued by Jensen (1986), agency problems are associated with conflicts over the use of free cash flow (a common problem in low-growth firms), we expect governance mechanisms that are likely to mitigate such problems to play a more important role in low-growth firms (Jensen, 1986). Last but not least, in contrast to previous studies that focus on the US market, we provide evidence for UK firms. Although the UK and the US are usually characterized as having a similar “common law” regulatory system (see, e. g. , La Porta et al. 1998), the UK market bears significant distinguishing characteristics. 4 It is argued that several of these characteristics may contribute to a more significant degree of managerial discretion and, hence, higher level of managerial agency costs. For example, despite the relatively high proportion of shares held by financial institutions, there is a great deal of evidence that financial investors do not take an active role in corporate governance. Similarly, UK boards are usually characterized as corporate devices that provide weak disciplinary function.

More specifically, weak fiduciary obligations on directors have resulted in nonexecutives playing more an advisory than a monitoring role. 5 Consequently, the investigation of agency issues and the effectiveness of the alternative governance 4 For a more detailed discussion about the characteristics of the prevailing UK corporate governance system see Short and Keasey (1999); Faccio and Lasfer (2000); Franks et al. (2001); and Ozkan and Ozkan (2004). 5 Empirical studies by Faccio and Lasfer (2000), Goergen and Rennebog (2001), Franks et al. 2001) and Short and Keasey (1999) provide evidence on the weak role of institutions and board of directors in reducing agency problems in the UK. 4 mechanisms in the UK, in a period that witnesses an intensive discussion of corporate governance issues, would be of significant importance. Our results strongly suggest that managerial ownership constitutes a strong corporate governance mechanism for the UK firms. This result is consistent with the findings provided by Ang et al. (2000) and Sign and Davidson (2003) for the US firms.

Ownership concentration and salary also seem to play a significant role in mitigating agency related problems. The results concerning the role of capital structure variables on agency costs are striking. It seems that both the source and the maturity structure of corporate debt have a significant effect on agency costs. Finally, there is strong evidence that specific governance mechanisms are not homogeneous but vary with growth opportunities. For instance, we find that executive ownership is more effective as a governance mechanism for high-growth firms.

This result is complementary to the results obtained by Smith and Watts (1992), Gaver and Gaver (1993) and Lasfer (2002), which support the view that high-growth firms are likely to prefer incentive mechanisms (e. g. managerial ownership) whereas low-growth firms focus more on monitoring mechanisms (e. g. short-term debt). The remainder of the paper is organized as follows. In section 2 we discuss the related theory and formulate our empirical hypotheses. Section 3 describes the way in which we have constructed our sample and presents several descriptive statistics of that.

Section 4 presents the results of our univariate, multivariate and sensitivity analysis. Finally, section 5 concludes. 2. Agency costs and Governance Mechanisms In what follows, we will discuss the potential interactions between agency costs and internal corporate governance mechanisms available to firms. Also, we will analyze how firm growth opportunities affect agency costs and the relationship between governance mechanism and agency costs. 2. 1 Debt Financing Agency problems within a firm are usually related to free cash-flow and asymmetric information problems (see, for example, Jensen, 1986 and Myers and Majluf, 1984).

It is widely acknowledged that debt servicing obligations help reduce of agency problems of this sort. This is particularly true for the case of privately held debt. For example, bank 5 debt incorporates significant signalling characteristics that can mitigate informational asymmetry conflicts between managers and outside investors (Jensen, 1986; Stulz, 1990; and Ross, 1977). In particular, the announcement of a bank credit agreement conveys positive news to the stock market about creditor’s worthiness.

Bank debt also bears important renegotiation characteristics. As Berlin and Mester (1992) argue, because banks are well informed and typically small in number, renegotiation of a loan is easier. A bank’s willingness to renegotiate and renew a loan indicates the existence of a good relationship between the borrower and the creditor and that is a further good signal about the quality of the firm. Moreover, it is argued that bank debt has an advantage in comparison to publicly traded debt in monitoring firm’s activities and in collecting and processing information.

For example, Fama (1985) argues that bank lenders have a comparative advantage in minimizing information costs and getting access to information not otherwise publicly available. Therefore, banks can be viewed as performing a screening role employing private information that allows them to evaluate and monitor borrowers more effectively than other lenders. In addition to debt source, the maturity structure of debt may matter. For example, short-term debt may be more useful than long-term debt in reducing free cash flow problems and in signalling high quality to outsiders.

For example, as Myers (1977) suggests, agency conflicts between managers and shareholders such as the underinvestment problem can be curtailed with short-term debt. Flannery (1986) argues that firms with large potential information asymmetries are likely to issue short-term debt because of the larger information costs associated with long-term debt. Also, short-term debt can be advantageous especially for high-quality companies due to its low refinancing risk (Diamond, 1991). Finally, if yield curve is downward sloping, issuing short-term debt increases firm value (Brick and Ravid, 1985).

Consequently, bank debt and short-term debt are expected to constitute two important corporate governance devices. We include the ratio of bank debt to total debt and the ratio of short-term debt to total debt to our empirical model so as to approximate the lender’s ability to mitigate agency problems. Also, we include the ratio of total debt to total assets (leverage) to approximate lender’s incentive to monitor. In general, as leverage increases, so does the risk of default by the firm, hence the incentive for the lender to monitor the firm6. 6 Ang et al. 2000) focus on sample of small firms, which have do not have easy access to public debt, and examine the impact of bank debt on agency costs. On the contrary, Sign and Davidson (2003) focus on a sample of large firms, which have easy access to public debt, and examine the impact of public debt on 6 2. 2 Managerial Ownership The conflicts of interest between managers and shareholders arise mainly from the separation between ownership and control. Corporate governance deals with finding ways to reduce the magnitude of these conflicts and their adverse effects on firm value.

For instance, Jensen and Meckling (1976) suggest that managerial ownership can align the interest between these two different groups of claimholders and, therefore, reduce the total agency costs within the firm. According to their model, the relationship between managerial ownership and agency costs is linear and the optimal point for the firm is achieved when the managers acquires all of the shares of the firm. However, the relationship between managerial ownership and agency costs can be non-monotonic (see, for example, Morck et al. , 1988; McConnel and Servaes, 1990,1995 and, Short and Keasey, 1999).

It has been shown that, at low levels of managerial ownership, managerial ownership aligns managers’ and outside shareholders’ interests by reducing managerial incentives for perk consumption, utilization of insufficient effort and engagement in nonmaximizing projects (alignment effect). After some level of managerial ownership, though, managers exert insufficient effort (e. g focus on external activities), collect private benefits (e. g. build empires or enjoy perks) and entrench themselves (e. g. undertake high risk projects or bend over backwards to resist a takeover) at the expense of other investors (entrenchment effect).

Therefore the relationship between the two is non-linear. The ultimate effect of managerial ownership on agency costs depends upon the trade-off between the alignment and entrenchment effects. In the context of our analysis we propose a non-linear relationship between managerial ownership and managerial agency costs. However, theory does not shed much light on the exact nature of the relationship between the two and, hence, we do not know which of the effects will dominate the other and at what levels of managerial ownership.

We, therefore, carry out a preliminary investigation about the pattern of the relationship between managerial ownership and agency costs. Figure 1 presents the way in which the two variables are associated. [Insert Figure 1 here] agency costs. Our study is more similar to that of Ang et al (2000) given that UK firms use significant amounts of bank debt financing (see Corbett and Jenkinson, 1997). 7 Clearly, at low levels of managerial ownership, asset turnover and managerial ownership are positively related. However, after managerial ownership exceeds the 10 per cent level, the relationship turns from positive to negative.

A third turning point is that of 30 percent after which the relationship seems to turn to positive again. Consequently, there is evidence both for the alignment and the entrenchment effects in the case of our sample. In order to capture both of them in our empirical specification, we include the level, the square and the square of managerial ownership in our model as predictors of agency costs. 2. 3 Ownership Concentration A third alternative for alleviating agency problems is through concentrated ownership.

Theoretically, shareholders could take themselves an active role in monitoring management. However, given that the monitoring benefits for shareholders are proportionate to their equity stakes (see, for example, Grossman and Hart, 1988), a small or average shareholder has little or no incentives to exert monitoring behaviour. In contrast, shareholders with substantial stakes have more incentives to supervise management and can do so more effectively (see Shleifer and Vishny, 1986; Shleifer and Vishny, 1997 and Friend and Lang, 1988).

In general, the higher the amount of shares that investors hold, the stronger their incentives to monitor and, hence, protect their investment. Although large shareholders may help in the reduction of agency problems associated with managers, they may also harm the firm by causing conflicts between large and minority shareholders. The problem usually arises when large shareholders gain nearly full control of a corporation and engage themselves in self-dealing expropriation procedures at the expense of minority shareholders (Shleifer and Vishny, 1997).

Also, as Gomez (2000) points out, these expropriation incentives are stronger when corporate governance of public companies insulates large shareholders from takeover threats or monitoring and the legal system does not protect minority shareholders because either of poor laws or poor enforcement of laws. Furthermore, the existence of concentrated holdings may decrease diversification, market liquidation and stock’s ability to grow and, therefore, increase the incentives of large shareholders to expropriate firm’s resources.

Several empirical studies provide evidence consistent with that view (see, for example, Beiner et al, 2003). In order to test the impact of ownership concentration on agency costs, we include a variable that refers to the sum of stakes of shareholders with equity stake greater than 3 8 per cent in our regression equation. The results remain robust when the threshold value changes from 3 per cent to 5 per cent or 10 per cent. 2. 4 Board of Directors Corporate governance research recognizes the essential role performed by the board of directors in monitoring management (Fama and Jensen, 1983; Weisbach, 1988 and Jensen, 1993).

The effectiveness of a board as a corporate governance mechanism depends on its size and composition. Large boards are usually more powerful than small boards and, hence, considered necessary for organizational effectiveness. For instance, as Pearce and Zahra (1991) point out, large powerful boards help in strengthening the link between corporations and their environments, provide counsel and advice regarding strategic options for the firm and play crucial role in creating corporate identity. Other studies, though, suggest that large boards are less effective than large boards.

The underlying notion is that large boards make coordination, communication and decision-making more cumbersome than it is in smaller groups. Recent studies by Yermack, 1996; Eisenberg et al. , 1998 and Beiner et al, 2004 support such a view empirically. The composition of a board is also important. There are two components that characterize the independence of a board, the proportion of non-executive directors and the separated or not roles of chief executive officer (CEO) and chairman of the board (COB).

Boards with a significant proportion of non-executive directors can limit the exercise of managerial discretion by exploiting their monitoring ability and protecting their reputations as effective and independent decision makers. Consistent with that view, Byrd and Hickman (1992) and Rosenstein and Wyatt (1990) propose a positive relationship between the percentage of non-executive directors on the board and corporate performance. Lin et al. (2003) also propose a positive share price reaction to the appointment of outside directors, especially when board ownership is low and the appointee possesses strong ex ante monitoring incentives.

Along a slightly different dimension, Dahya et al. (2002) find that top-manager turnover increases as the fraction of outside directors increases. Other studies find exactly the opposite results. They argue that non-executive directors are usually characterized by lack of information about the firm, do not bring the requisite skills to the job and, hence, prefer to play a less confrontational role rather than a more critical monitoring one (see, for example, Agrawal and Knoeker, 1996; Hermalin 9 nd Weisbach, 1991, and Franks et al. , 2001)7. As far as the separation between the role of CEO and COB is concerned, it is believed that separated roles can lead to better board performance and, hence, less agency conflicts. The Cadbury (1992) report on corporate governance stretches that issue and recommends that CEO and COB should be two distinct jobs. Firms should comply with the recommendation of the report for their own benefit. A decision not to combine these roles should be publicly explained.

Empirical studies by Vafeas and Theodorou (1998), and Weir et al. (2002), though, which study that issue for the case of the UK market, provide results that do not support Cadbury’s stance that the CEO – COB duality is undesirable. In the context of the UK market, UK boards are believed to be less effective than the US ones. For instance,. To test the effectiveness of the board of directors in mitigating agency problems we include three variables in our empirical model: a) the ratio of the number of non-executive directors to he number of total directors, b) the total number of directors (board size) and c) a dummy variable which takes the value of 1 when the roles of CEO and COB are not separated and 0 otherwise. 2. 5 Managerial Compensation Another important component of corporate governance is the compensation package that is provided to firm management. Recent studies by Core et al. (2001) and Murphy (1999) suggest, among others, that compensation contracts, whose use has been increased dramatically during the 90’s, can motivate managers to take actions that maximize shareholders’ wealth.

In particular, as Core et al. (2001) point out, if shareholders could directly observe the firm’s growth opportunities and executives’ actions no incentives would be necessary. However, due to asymmetric information between managers and shareholders, both equity and compensation related incentives are required. For example, an increase in managerial compensation may reduce managerial agency costs in the sense that satisfied managers will be less likely, ceteris paribus, to utilize insufficient effort, perform expropriation behaviour and, hence, risk the loss of their job.

Despite the central importance of the issue, only a few empirical studies examine the impact of managerial compensation components on corporate performance. For example, Jensen and Murthy 7 Such a result may be consistent with the governance system prevailing in the UK market given the fact that UK legislation encourages non-executive directors to be inactive since it does not impose fiduciary obligations on them. Also, UK boards are dominated by executive directors, which have less monitoring power.

Franks et al. (2001) confirm this view by providing evidence on a non-disciplinary role of nonexecutive directors in the UK. 10 (1990) find a statistically significant relationship between the level of pay and performance. Murphy (1995), finds that the form, rather than the level, of compensation is what motivates managers to increase firm value. In particulars, he argues that firm performance is positively related to the percentage of executive compensation that is equity based.

More recently, Hutchinson and Gul (2004) analyze whether or not managers’ compensation can moderate the negative association between growth opportunities and firm value8. The results of this study indicate that corporate governance mechanisms such as managerial remuneration, managerial ownership and non-executive directors possibly affect the linkages between organizational environmental factors (e. g. growth opportunities) and firm performance.

Finally, Chen (2003) analyzes the relationship between equity value and employees’ bonus. He finds that the annual stock bonus is strongly associated with the firm’s contemporaneous but not future performance. Managerial compensation, though, is considered to be a debated component of corporate governance. Despite its potentially positive impact on firm value, compensation may also work as an “infectious greed” which creates an environment ripe for abuse, especially at significantly high levels.

For instance, remuneration packages usually include extreme benefits for managers such as the use of private jet, golf club membership, entertainment and other expenses, apartment purchase etc. Benefits of this sort usually cause severe agency conflicts between managers and shareholders. 9 Therefore, it is possible that the relationship between compensation and agency costs is non-monotonic. Similar to the case of managerial ownership, we carry out a preliminary investigation about the pattern of the relationship between salary and agency costs.

As shown in figure 2, the relationship between salary and agency costs is likely to be non-linear10. In our empirical model, we include the ratio of the total salary paid to executive directors to total assets as a determinant of agency costs. Also, in order to capture potential 8 Rather, the majority of the studies in that strand of literature reverse the causation and examine the impact of performance changes on executive or CEO compensation (see, for example, Rayton, 2003 among others). Concerns about excessive compensation packages and their negative impact on corporate performance have lead to the establishment of basic recommendations in the form of “best practises” in which firms should comply so as the problem with excessive compensation to be diminished. In the case of the UK market, for example, one of the basic recommendations of the Cadbury (1992) report was the establishment of an independent compensation committee. Also, in a posterior report, the Greenbury (1995) report, specific propositions about remuneration issues were made.

For example, an issue that was stretched was the rate of increase in managerial compensation. In the case of the US market, the set of “best practises” includes, among others, the establishment of a compensation committee so as transparency and disclosure to be guaranteed (same practise an in the UK) and the substitution of stock options as compensation components with other tools that promote the long-term value of the company 10 A similar preliminary analysis is carried out so as to check potential non-linearities concerning the relationship between the rest of internal governance mechanisms and agency costs.

Our results (not reported) indicate that none of them is related to agency costs in a non-linear way. 11 non-linearities, we include higher ordered salary terms in the regression equation. Finally, we include a dummy variable, which takes the value of 1 when a firm pays options or bonuses to managers and 0 otherwise. Including that dummy variable in our analysis enables us to test whether or not options and bonuses themselves provide incentives to managers.

As Zhou (2001) points out, ignoring options is likely to incur serious problems unless managerial options are either negligible compared to ownership or almost perfectly correlated with ownership. [Insert Figure 2 here] 2. 6 Growth Opportunities The magnitude of agency costs related to underinvestment, asset substitution and free cash flow differ significantly across high-growth and low-growth firms. In the underinvestment problem, managers may decide to pass up positive net present value projects since the benefits would mainly accrue to debt-holders.

This is more severe for firms with more growth-options (Myers, 1977). Asset substitution problems, which occur when managers opportunistically substitute higher variance assets for low variance assets, are also more prevalent in high-growth firms due to information asymmetry between investors and borrowers (Jensen and Meckling, 1976). High-growth firms, though, face lower free cashlow problems, which occur when firms have substantial cash reserves and a tendency to undertake risky and usually negative NPV investment projects (Jensen, 1986).

Given the different magnitude and types of agency costs between high-growth and low-growth firms, we expect the effectiveness of corporate governance mechanisms to vary with growth opportunities. In particular, if agency problems are associated with greater underinvestment or information asymmetry (a common problem in high-growth firms), we expect corporate governance mechanisms that mitigate these kinds of problems to be more effective in high-growth firms (Smith and Watts, 1992 and Gaver and Gaver, 1993).

However, if, as argued by Jensen (1986), agency problems are associated with conflicts over the use of free cash flow (a common problem in low-growth firms), we expect governance mechanisms that mitigate such problems to play a more important role in low-growth firms (Jensen, 1986). Several empirical studies that model company performance confirm the existence of potential interactions between internal governance mechanism and growth opportunities. For example, McConnell and Servaes (1995) find that the relationship between firm value and leverage is negative for high-growth firms and positive for low12 growth firms.

Their results also indicate that equity ownership matters, and the way in which it matters depends upon investment opportunities. Specifically, they provide weak evidence that on the view that the allocation of equity ownership between corporate insiders and other types of investors is more important in low-growth firms. Also, Lasfer (2002) points out that high-growth firm (low-growth firms) rely more on managerial ownership (board structure) to mitigate agency problems. Finally, Chen (2003) finds that the positive relationship between annual stock bonus and equity value is stronger for firms with greater growth opportunities.

In order to capture potential interaction effects, we include interaction terms between proxies for growth opportunities and governance mechanisms in our empirical model and, also, employ sample-splitting methods (see, for example, McConnell and Servaes, 1995 and Lasfer, 2002). Based on previous empirical evidence the prediction we make is that mechanisms that are used to mitigate asymmetric information problems (free cash flow problems) are stronger in high-growth firms (low-growth firms). 3. Data and Methodology 3. 1 Data For our empirical analysis of agency costs we use a large sample of ublicly traded UK firms over the period 1999-2003. We use two data sources for the compilation of our sample. Accounting data and data on the market value of equity are collected from Datastream database. Specifically, we use Datastream to collect information for firm size, market value of equity, annual sales, selling general and administrative expenses, level of bank debt, short-term debt and total debt. Information on firm’s ownership, board and managerial compensation structure is derived from the Hemscott Guru Academic Database.

This database provides financial data for the UK’s top 300,000 companies, detailed data on all directors of UK listed companies, live regulatory and AFX News feeds and share price charts and trades. Specifically, we get detailed information on the level of managerial ownership, ownership concentration, size and composition of the board, managerial salary, bonus, options and other benefits. Despite the fact that data on directors are provided in a spreadsheet format, information for each item is given in a separate file. This makes data collection for the required variables fairly complicated.

For example, in order to get information about the amount of shares held by executive directors we have to combine two different files: a) the 13 file that contains data on the amount of shares held by each director and b) the file that provides information about the type of each directorship (e. g. executive director vs. nonexecutive director). Also, we have to take into account the fact that several directors in the UK hold positions in more than one company. Complications also arise when we attempt to collect information about the composition of the board and the remuneration package that is provided to executive directors.

The way in which our final sample is compiled is the following: we start with a total of 1672 UK listed firms derived from Datastream. This number reduces to 1450 firms after excluding financial firms from the sample. After matching Datastream data with the data provided by Hemscott, the number of firms further decreases to 1150. Missing firmyear observations for any variable in the model during the sample period are also dropped. Finally, we exclude outliers so as to avoid the problem with extreme values. We end up with 897 firms for our empirical analysis. 3. Dependent Variable In our analysis we use two alternative proxies to measure agency costs. Firstly, we use the ratio of annual sales to total assets (Asset Turnover) as an inverse proxy for agency costs. This ratio can be interpreted as an asset utilization ratio that shows how effectively management deploys the firm’s assets. For instance, a low asset turnover ratio may indicate poor investment decisions, insufficient effort, consumption of perquisites and purchase of unproductive products (e. g. office space). Firms with low asset turnover ratios are expected to experience high agency costs between managers and shareholders11.

A similar proxy for agency costs is also used in the studies of Ang et al. (2000) and Sign and Davidson (2003). However, Ang et al. (2000), instead of using the ratio directly, they use the difference in the ratios of the firm with a certain ownership and management structure and the no-agency-cost base case firm. Secondly, following Sign and Davidson (2003), we use the ratio of selling, general and administrative (SG&A) expenses to sales (expense ratio). In contrast to asset turnover, expense ratio is a direct proxy of agency costs.

SG&A expenses include salaries, commissions charged by agents to facilitate transactions, travel expenses for executives, advertising and marketing costs, rents and other utilities. Therefore, expense ratio should 11 The asset turnover ratio may also capture (to some extent) agency costs of debt. For instance, the sales ratio provides a good signal for the lender about how effectively the borrower (firm) employs its assets and, therefore, affects the cost of capital 14 reflect to a significant extent managerial discretion in spending company resources.

For example, as Sign and Davidson (2003) point out, “management may use advertising and selling expenses to camouflage expenditures on perquisites” p. 7. Firms with high expense ratios are expected to experience high agency costs between managers and shareholders12. 3. 3 Independent Variables Our empirical model includes a set of corporate governance variables related to firm’s ownership, board, compensation and capital structure. Several control variables are also incorporated. For example, we use the logarithm of total assets in 1999 prices as a proxy for firm size (SIZE).

Also, we include the market-to-book value (MKTBOOK) as a proxy for growth opportunities. Finally, we divide firms into 15 sectors and include 14 dummy variables accordingly so as to control for sector specific effects. Analytical definitions for all these variables are given in Table 1. [Insert Table 1 here] 3. 4 Methodology We examine the determinants of agency costs by employing a cross sectional regression approach. Following Rajan and Zingales (1995) and Ozkan and Ozkan (2004), the dependent variable is measured at some time t, while for the independent variables we use average-past values.

Using averages in the way we construct our explanatory variables helps in mitigating potential problems that may arise due to short-term fluctuations and extreme values in our data. Also, using past values reduces the likelihood of observed relations reflecting the effects of asset turnover on firm specific factors. Specifically, the dependent variable is measured in year 2003. For accounting variables and the market-tobook ratio we use average values for the period 1999-2002. Ownership, board and compensation structure variables are measured in year 2002.

Given that equity ownership characteristics in a country are relatively stable over a certain period of time, we do not expect that measuring them in a single year would yield a significant bias in our results (see also La Porta et al. , 2002, among others). 12 An alternative proxy for agency costs between managers and shareholders, which is not used in our paper though, is the interaction of company’s growth opportunities with its free cash flow (see Doukas et al. , 2002). 15 Our approach captures potential interaction effects that may be present.

For example, as explained analytically in section 2. 6, the nature of the relationship between the alternative governance mechanisms or devices and agency costs may vary with firm’s growth opportunities. To explore that possibility, we firstly interact our proxy for growth opportunities (MKTBOOK) with the alternative corporate governance mechanisms. In this way, we test for the existence of both main effects (the impact governance variables on agency costs) and conditional effects (the impact of growth opportunities on the relationship between governance variables and agency costs).

Additionally, we split the sample into high-growth and low-growth firms and estimate our empirical models for each sample separately. Then we check whether the coefficients of governance variables retain their sign and their significance across the two sub-samples. 3. 5 Sample Characteristics Table 2 presents descriptive statistics for the main variables used in our analysis. It reveals that the average values of asset turnover ratio and SG&A ratio are 1. 24 and 0. 45 respectively. The mean value for managerial ownership is 14. 4 per cent of which the average proportion of stakes held by executive (non-executive) directors is 10. 68 per cent (4. 06 per cent). The ownership concentration reaches the level of 37. 19 per cent, on average, in the UK firms. Also, the average proportion of non-executive directors is 49. 5 per cent and the average board size consists of 6. 97 directors. Finally, we were able to identify only 73 firms out of the final 897 (8. 1 per cent) in which the same person held the positions of CEO and COB. As far as the capital structure variables are concerned, the average proportion of bank debt on firm’s capital structure is 55. 5 per cent and that of short-term debt is 49. 53 per cent. Finally, the average market-to-book value is 2. 09. In general, these values are in line with those reported in other studies for UK firms (see, for example, Ozkan and Ozkan, 2004 and Short and Keasey, 1999). [Insert Table 2 here] The results of the Pearson’s Correlation of our variables are reported in Table 3. Our inverse proxy for agency costs, asset turnover, is clearly positively correlated to managerial ownership, executive ownership, salary, bank debt and short-term debt.

Ownership concentration is also positively related to asset turnover but the correlation coefficient is not statistically significant. On the contrary, board size and non-executive 16 directors are found to be negatively correlated with asset turnover. Finally, as expected, asset turnover is found to be negatively correlated with both growth opportunities and firm size. The results for our second proxy for agency costs, SG&A, are qualitatively similar with a few exceptions (e. g. short-term debt) but with opposite signs given that SG&A is a direct and not an inverse proxy for agency costs. Insert Table 3 here] 4. Empirical Results 4. 1 Univariate analysis In Table 4 we report univariate mean-comparison test results of the sample firm subgroups categorized on the basis of above and below median values for managerial ownership, ownership concentration, board size, proportion of non-executives, bank debt, short-term debt, total debt, salary, firm size and growth opportunities. Firms with above median managerial ownership (ownership concentration) have asset turnover of 1. 34 (1. 31) whereas those with below median managerial ownership (ownership concentration) have asset turnover of 1. 5 (1. 17). These differences are statistically significant at the 1 per cent (5 per cent) level. The results for executive ownership, salary, bank debt and short-term debt are also found to be statistically significant and are in the hypothesized direction. Specifically, we find that firms with above median values for all the above mentioned variables have relatively higher asset utilization ratios. On the contrary, there is evidence that firms with larger board sizes indicate significantly lower asset utilization ratios. Insert Table 4 here] In panel B of the same table we report the results using SG&A expense ratio as a proxy for agency costs. Results are in general not in line with the hypothesized signs with notable exceptions those of ownership concentration and growth opportunities. For example, firms with above median ownership concentration (MKTBOOK) have an SG&A expense ratio of 0. 41 (0. 55) whereas firms with below median ownership concentration (MKTBOOK) have an SG&A expense ratio of 0. 49 (0. 36).

However, the results for managerial ownership, salary and short-term debt suggest that these governance mechanisms or devices are not effective in protecting firms from excessive SG&A 17 expenses. Sign and Davidson (2003) obtains a set of similar results, for the case when agency costs are approximated with the SG&A ratio. Overall, the univariate analysis indicates several corporate governance mechanisms or devices, such as managerial ownership, ownership concentration, salary, bank debt and short-term debt, which can help mitigate agency problems between managers and shareholders.

Also, consistent with previous studies, we find that the relation between governance variables and agency costs is stronger for the asset turnover ratio than the SG&A expense ratio. The analysis that follows allows us to test the validity of these results in a multivariate framework. 4. 2 Multivariate analysis In this section we present our results that are based on a cross sectional regression approach. We start with a linear specification model, where we include only total debt from our set of capital structure variables (model 1).

In general, the estimated coefficients are in line with the hypothesized signs. Specifically, consistent with the results of Ang et al. (2000) and Sign and Davidson (2003), we find both managerial ownership and ownership concentration to be positively related to asset-turnover. The coefficients are statistically significant at the 5 per cent and 1 per cent significance level respectively. On the contrary, the coefficient for board size is negative, which probably indicates that firms with larger board size are less efficient in their asset utilization.

Also, the results for our proxy for growth opportunities (MKTBOOK) support the view that high-growth firms suffer from higher agency costs than low-growth firms. Finally, there is strong evidence that managerial salary can work as an effective incentive mechanism that helps aligning the interests of managers with those of shareholders. Specifically, the coefficient for salary is positive and statistically significant to the 1 per cent level. Therefore, compared to previous studies, our empirical model provides evidence on the existence of an additional potential corporate governance mechanism available to firms. Insert Table 5 here] In model 2 we incorporate two additional capital structure variables, the ratio of bank debt to total debt and the ratio of short-term debt to total debt, in order to test whether debtsource and debt-maturity impacts agency costs. Also, we split managerial ownership into executive ownership (the amount of shares held by executive directors) and non-executive 18 ownership (the amount of shares held by non-executive directors). We do this because we expect that equity ownership works as a better incentive mechanism in the hands of executive directors rather in the hands of non-executive directors.

According to our results, bank debt is positively related to asset turnover. Also, in addition to debt source, the maturity structure of debt seems to have a significant effect on agency costs. The coefficient of short-term debt is positive and statistically significant at the 1 per cent significance level. Furthermore, there is evidence that from total managerial ownership, only the amount of shares held by executive directors can enhance asset utilization and, hence, align the interest of managers with those of shareholders.

In model 3 we estimate a non-linear model by adding the square of salary. As explained earlier in the paper, a priori expectations, which are supported by preliminary graphical investigation, suggest that the relationship between asset turnover and salary can be non-monotonic. Our results provide strong evidence that the relationship between salary and asset turnover is non-linear. In particular, at low levels of salary, the relationship between salary and asset turnover is positive. However, at higher levels of salary, the relationship becomes negative.

This result is consistent with studies that suggest that extremely high levels of salary usually work as an “infectious greed” and create agency conflicts between managers and shareholders. The coefficients of the remaining variables are similar to those reported in models 1 and 2. Finally, in model 4 we allow for a non-linear relationship between executive ownership and agency costs. However, our results do not support such a relationship and, therefore, the square term in our following models13.

To sum up, the results of Table 5 indicate that managerial ownership (executive ownership), ownership concentration, salary (when it is at low levels), bank debt and short-term debt can help in mitigating agency problems by enhancing asset utilization. Also, the coefficients for the control variables market to book and firm size, negative and positive respectively, suggest that smaller and non- growth firms are associated with reduced asset utilization ratio and, hence, more severe agency problems between managers and shareholders.

As discussed earlier in the paper, there is a possibility that the nature of the relationship between the alternative governance mechanisms or devices and agency costs varies with firm’s growth opportunities. In Panel A of Table 6, we explore such a In trial regressions, which are not reported, the cubic term of executive ownership is also included in our model. Once more, the results do not support the existence of a non-monotonic relationship. 13 19 possibility by interacting those governance mechanisms found significant in models 1-4 with growth opportunities, proxied by market-to-book ratio.

Our empirical results support the existence of two interaction effects. We find that executive ownership is an effective governance mechanism especially for high-growth firms (the coefficient EXECOWNER* MKTBOOK is positive and statistically significant). This result is consistent with the study of Lasfer (2002), which suggests that the positive relationship between managerial ownership and firm value is stronger in high-growth firms. On the contrary, the coefficient SHORT_DEBT*MKTBOOK is found to be negative and statistically significant.

This means that the efficiency of short-term debt in mitigating agency problems is lower for high-growth firms. A possible explanation may be that short-term debt basically mitigates agency problems related to free cash flow. Given that high-growth firms do not suffer from severe free cash-flow problems (but mainly from asymmetric information problems), the efficiency of short-term debt as governance device decreases for these firms. One could argue, though, that short-term debt should be more important for the case of highgrowth firms since it helps reduce underinvestment problems.

However, it seems that this effect is not very strong for the case in our sample. A similar result is obtained in McConnell and Servaes (1995) who find that the relationship between corporate value and leverage is positive (negative) for low-growth (high-growth) firms14. [Insert Table 6 here] Secondly, we use the variable MKTBOOK so as two split the sample into two subsamples. We label the upper 45 per cent in terms of MKTBOOK as “high-growth firms” and the lower 45 per cent as “low-growth firms”. Then, we re-estimate our basic model for the two sub-samples separately (Table 6, panel B).

The results of this exercise confirm the existence of an interaction effect between executive ownership and asset turnover. In particular, the coefficient of EXECOWNER is positive and statistically significant only in the case of the sample that includes only high-growth firms. As far as short-term debt is concerned, it is found to be positive and statistically significant in both samples. 14 The idea in McConnell and Servaes (1995) is that debt has both a positive and a negative impact on the value of the firm because of its influence on corporate investment decisions.

What possibly happens is that the negative effect of debt dominates the positive effect in firms with more positive net present value projects (i. e. , high-growth firms) and that the positive effect will dominate the negative effect for firms with fewer positive net present value projects (i. e. , low-growth firms). 20 To summarize, the results of our multivariate analysis suggest, among others, that executive ownership and ownership concentration can work as effective governance mechanisms for the case of the UK market.

These results are in line with the ones reported by the studies Ang et al. (2000) and sign and Davidson (2003). Also, we find that, in addition to the source of debt, the maturity structure of debt can help to reduce agency conflicts between managers and shareholders. The fact that previous studies have ignored the maturity structure of debt may partly explain their contradicting results concerning the relationship between capital structure and agency costs. Furthermore, we find that salary can work as an additional mechanism that provides incentives to managers to take valuemaximizing actions.

However, its impact on asset turnover is not always positive i. e. the relationship between asset turnover and salary is non-monotonic. Finally, there is strong evidence that the relationship between several governance mechanisms and agency costs varies with growth opportunities. Specifically, our results support the view that the positive relationship between executive ownership (short-term debt) is stronger for the case of high growth (low growth) firms. 4. Robustness checks Given the significant impact of growth opportunities on agency costs (main impact) and on the impact of other corporate governance mechanisms (conditional impact), we further investigate the relationship between growth opportunities, governance mechanisms and agency costs. At first, we substitute the variable MKTBOOK with an alternative proxy for growth opportunities. The new proxy is derived after employing common factor analysis, a statistical technique that uses the correlations between observed variables to estimate common factors and the structural relationships linking factors to observed variables.

The variables which are used in order to isolate latent factors that account for the patterns of colinearity are following variables: MKTBOOK = Book value of total assets minus the book value of equity plus the market value of equity to book value of assets; MTBE = Market value of equity to book value of equity; METBA = Market value of equity to the book value of assets; METD = Market value of equity plus the book value of debt to the book value of assets. 21 These variables have been extensively used in the literature as alternative proxies for growth opportunities and Tobin’s Q.

As shown in Table 7 (panel A) all these variables are highly correlated to each other. In order to make sure that principal component analysis can provide valid results for the case of our sample, we perform two tests in our sample, the Barlett’s test and the Kaiser-Meyer-Olkin test. The first test examines whether or not the intercorrelation matrix comes from a population in which the variables are noncollinear (i. e. an identity matrix). The second test is a test for sampling adequacy.

The results from these tests, which are reported in panel B, are encouraging and suggest that common factor analysis can be employed in our sample since all the four proxies are likely to measure the same “thing” i. e. growth opportunities. Panel C presents the eigenvalues of the reduced correlation matrix of our four proxies for growth opportunities. Each factor whose eigenvalue is greater than 1 explains more variance than a single variable. Given that only one eigenvalue is greater than 1, our common factor analysis provides us with one factor that can explain firm growth opportunities.

Clearly, as shown in panel D, the factor is highly correlated with all MKTBOOK, MTBE, METBA and METD. We name the new variable GROWTH and use it as an alternative proxy for growth opportunities. Descriptive statistics for the variable GROWTH are presented in panel D. [Insert Table 7 here] Table 8 presents the results of cross-section analysis after using the variable GROWTH as proxy for agency costs. In general, the results of such a task are similar to the ones reported previously.

For instance, there is strong evidence that executive ownership, ownership concentration, salary, short-term debt and, to some extent, bank debt are positively related to asset turnover. Also, there is some evidence supporting a non-linear relationship between salary and asset turnover. Finally, our results clearly indicate that agency costs differ significantly across high-growth and low-growth firms and, most importantly, there is a significant interaction effect between growth opportunities and executive ownership.

However, we can not provide any evidence on the existence of an interaction between asset turnover and short-term debt. [Insert Table 8 here] 22 In panel B of table 8, we split our sample into high-growth and low-growth firms on the basis of high and low values for the variable GROWTH. Specifically, we label the upper 45 per cent in terms of GROWTH as “high-growth firms” and the lower 45 per cent as “low-growth firms”. Then we estimate our basic model for each sub-sample separately. The results are very similar to the ones reported in Table 6 (panel B), where we apply a similar methodology.

As an additional robustness check, we use a third proxy for growth opportunities, a dummy variable that takes the value of 1 if the firm is a high-growth firm and 0 otherwise, and re-estimate the models 6 and 7 of Table 8. The definition used in order to distinguish between high-growth and low-growth firms is the following: Firms above the 55th percentile in terms of the variable GROWTH are called high-growth firms. Firms below the 45th percentile in terms of the variable GROWTH are called low-growth firms.

Finally, firms between the 45th and 55th percentile are excluded from the sample. The results (not reported) are qualitatively similar to the ones reported in Table 8. For example, there is evidence for the existence of an interaction effect between executive ownership and growth opportunities but not for the one between short-term debt and growth opportunities. Also, we re-estimate the models reported in Table 8 after substituting the total salary paid to executive directors for the total remuneration package paid to executive directors.

We are doing so given that the total remuneration package that is paid to managers includes several other components. For instance, the components of compensation structure have been increased in number during the last decade and may include annual performance bonus, fringe benefits, stock (e. g. preference shares), stock options, stock appreciation rights, phantom shares and other deferred compensation mechanisms like qualified retirement plans (see Lynch and Perry, 2003 for an analytical discussion). Once more, the results do not change substantially.

Finally, in Table 9 we substitute the annual sales to total assets with the ratio of SG&A expenses to total sales. As already mentioned earlier in the paper, this ratio can be used as a direct proxy for agency costs. Our results, as presented in Table 9, indicate that executive ownership, ownership concentration and total debt help reduce discretionary spending and, therefore, the agency conflicts between managers and shareholders. Sign and Davidson (2003) do not find any evidence to support these results. Also, we find that agency costs and growth opportunities are positively related i. . the coefficient of the variable GROWTH is positive and statistically significant to the 5 per cent statistical level. 23 Finally, our results support the existence of an interaction effect between growth opportunities and executive ownership. However, once more, our analysis does not indicate the existence of an interaction effect between short-term debt and growth opportunities. [Insert Table 9 here] 5. Conclusion In this paper we have examined the effectiveness of the alternative corporate governance mechanisms and devices in mitigating managerial agency problems in the UK market.

In particular, we have investigated the impact of capital structure, corporate ownership structure, board structure and managerial compensation structure on the costs arising from agency conflicts mainly between managers and shareholders. The interactions among them and growth opportunities in determining the magnitude of these conflicts have also been tested. Our results strongly suggest managerial ownership, ownership concentration, executive compensation, short-term debt and, to some extent, bank debt are important governance mechanisms for the UK companies.

Moreover, “growth opportunities” is a significant determinant of the magnitude of agency costs. Our results suggest that highgrowth firms face more serious agency problems than low-growth firms, possibly because of information asymmetries between managers, shareholders and debtholders. Finally, there is strong evidence that some governance mechanisms are not homogeneous but vary with growth oppo

The first version of the UK Code on Corporate Governance was produced in 1992 by the Cadbury Committee. The authoritative definition of Corporate Governance in the context of the Code:

‘Corporate administration is the system by which companies are directed and controlled. Boardss of managers are responsible for the administration of their companies. The stockholders ‘ function in administration is to name the managers and the hearers and to fulfill themselves that an appropriate administration construction is in topographic point. The duties of the board include puting the company ‘s strategic purposes, supplying the leading to set them into consequence, oversing the direction of the concern and coverage to stockholders on their stewardship. The board ‘s actions are capable to Torahs, ordinances and the stockholders in general meeting. ‘

The board of managers leads and controls a company and hence an effectual board is the cardinal to the success of the company. The Department of Trade and Industry ( 2004 ) agreed that effectual boards are as much concerned with public presentation as with conformity in run intoing the demands of company jurisprudence and using the rules and commissariats of the Combined Code. However, the UK Corporate Governance Code ( 2008 ) concluded a similar standard as Combined Code ( 2004 ) on board effectivity.

‘Firstly, there should be a formal, strict and crystalline process for the assignment of new managers to the board. Second, all managers should be able to apportion sufficient clip to the company to dispatch their duties efficaciously. Third, all managers should have initiation on fall ining the board and should regularly update and review their accomplishments and cognition. The board should be supplied in a timely mode with information in a signifier and of a quality appropriate to enable it to dispatch its responsibilities. Fourthly, the board should set about a formal and strict one-year rating of its ain public presentation and that of its commissions and single managers. Last, all managers should be submitted for re-election at regular intervals, capable to continued satisfactory performance. ‘

The UK Code on Corporate Governance ( 2010 ) besides stated that the intent of corporate administration is to ease effectual, entrepreneurial and prudent direction that can present the long-run success of the company. Good Administration has ever association with success companies and would assist companies pull investing capital. The apprehension of corporate administration that the work of Cadbury Committee insisted: ‘The state ‘s economic system depends on the thrust and efficiency of its companies. Therefore the effectivity with which boards discharge their duties determines Britain ‘s competitory place. ‘ ( Cadbury, 1992 ) Furthermore, the Cadbury Committee emphasized the freedom driven within a model of effectual answerability, which is the kernel of any system of good corporate administration ( Cadbury, 1992 ) . There is an increasing realisation the higher criterions of corporate administration are non merely necessary to guarantee answerability, but besides to positively better corporate public presentation ( Clarke, 2007 ) . More sophisticated methodological analysiss are now being applied with more promising consequences, with ‘an increasing organic structure of finance literature proposing companies with superior administration offer better comparative investing public presentation or lower investing hazard ‘ ( Clarke, 2007 ) .

Clarke ( 2007 ) found that the board of managers is the fulcrum of corporate administration: the critical link in which the lucks of the company are decided. Stiles and Taylor indicated the same point of view in 2001: ‘The board is the nexus between the stockholders of the steadfast to-day operations of the organisation ‘ .

The effectivity of non-executive managers

Corporate administration has become a heated-discussed subject in developed economic systems late as a consequence of widespread failures of the planetary fiscal system ( Shleifer and Vishny, 1997 ) . There is small uncertainty about the primacy of this status as it is normally accepted that a ‘lack of monitoring by independent, disinterested non-executive managers has been a major cause for the assorted corporate dirts that we have witnessed ‘ ( High degree Group of Company Law Experts, 2002 ) . Kakabadse et Al. ( 2010 ) observed that ‘the struggle of involvement that occurs by holding a board dwelling about wholly of insider executive managers means that independent rating of company determinations is earnestly compromised ‘ . In the point of position, lawfully, the foreigner non-executive managers, who are expected to dispatch the responsibilities of trueness, attention and good concern judgement, are every bit responsible for the direction of the corporation ( Lorsch and Maclver, 1989 ) . On the other manus, practically, Weimer and Pape ( 1999 ) suggest that the non-executive managers advise the inside executive managers on a major policy determinations while bearing the involvements of stockholders. In the facet of Agency theory, it assumes that the presence of independent non-executive managers on the company boards should assist to supervise direction on behalf of stockholders by presenting an independent voice in the council chamber ( Solomon, 2010 ) . It would cut down the ill-famed struggles of involvement between stockholders and direction. So, an independent board needed to be created both competent and free from prejudice. Harmonizing to Firth et Al ‘s research findings in 2007, boards with a big proportion of non-executive managers are more likely to implement performance-related wage strategies. They conclude that the independent non-executive managers help to aline the involvements of stockholders and the CEO via the compensation of CEO.

However, the non-executive managers have non escaped unfavorable judgment during the planetary fiscal crisis. Burgess ( 2009 ) observed that ‘the quality of former non-executive managers in RBS has been questioned as many of them had limited banking experience and could barely be regarded as independent, peculiarly when the bank had a really powerful CEO doing it hard for the non-executive managers to stand up to him ‘ . In the recent research findings, Lawler and Finegold ( 2005 ) revealed that there are no important relationships between board effectivity and the pattern of holding a non-executive chair or that of holding an independent individual functioning as a leader. It indicates that a good functioning corporate administration system is more than merely seting a construction in topographic point. Although the jurisprudence puting the regulations of board responsibilities, it still have a big portion of the existent administration and control of corporations occurs that non written into Torahs. It would be utile to hold an equal apprehension of agent or direction motive and behavior within a corporate scene ( Marnet, 2007 ) .

It is reported in the 6th International Conference on Corporate Governance and Board Leadership ( 2003 ) that on the footing of in-depth interviews with 60 board members of Belgian listed companies, the managers were asked to sum up what they believe are elements of a good board of managers. The quality of the board meetings and board composings are two most important elements of a good board of managers. A good manager must fix the information good including the information and format before the meeting. Besides managers must demo involvement in what the company and its concern units are making. Furthermore, the quality of treatments or arguments is important for an effectual board meeting. Each manager should hold an chance to talk up freely and lend in the meeting. Berghe and Levrau ( 2005 ) said that the board of managers must be critical but to continue a comfy and constructive clime during the board meeting. The study besides emphasizes the determinations made by board of managers may non be dominated by direction or stockholders. It should be considered good and might look on the board agenda more than one time. On the other manus, the function of board of managers is, as one manager explained, “ We need to be able to see the present, whilst maintaining an oculus on the hereafter ” . An effectual board of managers must hold the bravery to take hazards. Furthermore, supervising and control is a 2nd function of boards. They should purely supervise the development of the results, and confront these with the fiscal programs.

Most of the recent codifications strengthen the independency of board. On the one manus, they adopt an addition in the proportion of independent managers on the board. On the other manus, they advocate a more extended and restrictive definition of independency. That is to state, most of concerns express a strong belief of independency that has potency to forestall future dirts. However, manager ‘s independency is non plenty. In-depth analysis of the corporate dirts at Enron, WorldCom and others has revealed that the happening of struggles of involvement throughout the concatenation of monitoring was one of the cardinal issues in those prostrations. ‘Not merely at board or corporate degree, but besides at the degree of the external proctors struggles of involvement seemed to hold flourished, taking to state of affairss wherein the personal involvements of the parties involved prevailed over corporate and societal involvements ‘ ( Van den Berghe and Baelden, 2003 ) . The dirts have demonstrated that good administration will non come by composing codifications of best pattern and supervising the formal application of these recommendations. Some of these companies complied with all the necessary ordinances, but yet, it went incorrect. In fact, there are a batch of corporate administration advocators who province the sentiment that an independent manager should non merely happen himself officially in the right place, but needs besides ”something more ” than the features determined in the corporate administration codifications and recommendations ( Berghe and Baelden, 2005 ) .

Director ‘s Training

The Tyson Report on the Recruitment and Development of non-executive Directors in 2003 provinces that as non-executive managers ‘ duties and liabilities addition, companies should put more in preparation. Companies that score high Markss on studies of good corporate administration normally devote considerable clip to developing their non-executive managers. The Combined Code ( 2008 ) considered the information and professional development as an indispensable requirement for managers. The chief rule observed that ‘all managers should have initiation on fall ining the board and should regularly update and review their accomplishments and cognition ‘ . It is suggested in the Combined Code ( 2008 ) that ‘the managers should continually update their accomplishments the cognition and acquaintance with the company required to carry through their function both on the board and on board commissions ‘ . On the other manus, the company should supply the necessary resources for developing and updating the manager ‘s cognition and capablenesss. In the Code Provisions, it is suggested that the president should supply the new managers a ‘full formal and tailored ‘ initiation when they join the board. The company still needs to offer an chance for major stockholders to run into the new non-executive manager.

The Institute of Directors ( 2009 ) discovered that the effectivity of freshly appointed non-executive managers should be improved by rapidly constructing their cognition of the organisation. The organisation should supply an initiation for those non-executive managers help them cognize where they can utilize the accomplishments and experience they have gained elsewhere for the benefit of the company. In the Review of the Role and Responsibilities of Non-Executive Directors, Derek Higgs ( 2003 ) recommends that a comprehensive, formal and trim initiation should ever be provided to new non-executive managers to guarantee an early part to the board. Basically, non-executive managers will already hold relevant accomplishments, cognition, experience and abilities. However, widening and reviewing their cognition and accomplishments will add to their credibleness and effectivity in the council chamber ( IoD, 2009 ) .

The David Walker ‘s 2nd study with fiscal recommendation in December 2009 recognized the importance of larning lesA­sons from the prostration of the Bankss, while at the same clip admiting the deficiency of grounds presently available as to the overall effectivity of non-executive managers on boards. The study is much made of the demand for behavioral alteration with an accent on the civilization within the council chamber and the importance of constructive challenge of the manageA­ment. One of the of import proposals concerned with the initiation, preparation and the development of non-executive managers. However, the function of a manager peculiarly that independent non-executive manager is fundamenA­tally different to that of a senior operational director from whose ranks most non-executives are recruited. The function requires a holistic position of the organisation, non merely one specific functional country. Edward Walker-Arnott ( 2010 ) observed ‘non-executives require an expressed grasp of their typical function as administration histrions, including their responsibility to rigorously challenge and measure the competency of the executive squad on behalf of stockholders ‘ . This position may non come of course to many managers as they make the passage from executive to non-executive functions.

Walker-Arnott ( 2010 ) besides implied that independent non-executive managers as a distinguishable professional grouping could benA­efit from specifying themselves. The peculiar group of managers would integrate approA­priate director-level preparation. It would besides advance values of independency, challenge, and public service amongst its practicians. It is possible to hold an external initiation procedure that non-execA­utive managers were to the full acknowledged of their administration duties, including their legal responsibilities and the outlooks of stockholders and other stakeholders.

For new reachings, the quality of the initiation procedure is critical. It needs to give managers an ‘early feel ‘ for the concern and an apprehension of the issues they are likely to be covering with whilst, in the interim, giving them an early chance to do a positive part and add value to the board ( DTI, 2004 ) . A high quality executive squad will non digest the managers for a long clip in footings of board kineticss therefore it is important for new non-executives to catch up the measure every bit rapidly as possible. ICI ‘s attack gives us an illustration of the successful application on initiation procedure. Peter Ellwood, Chairman of ICI, believes that a proper initiation procedure for new managers makes sound commercial sense: ‘The Board is jointly responsible for the success of the Company. The relentless hunt for universe category public presentation must get down within the Boardroom. To work optimally, non-executive managers need to truly understand non merely the concern but besides their personal and corporate duties. They have to hold a feel for the company, non merely turn up to meetings. We are looking for them to hold an apprehension of what drives the concern and how they personally can do an effectual part ‘ . In pattern, at ICI, the procedure of initiation is designed to suit for both single and the specific spreads in their cognition or experience. For illustration, the initiation arranges new managers to run into as many people in the company as they can, across the sections such HR, Finance every bit good as out in the field. They are advised to hold a travel to admit to the concern and will go on to make this throughout their clip on the board. The ICI thought it is of import for new managers whether they are maintaining up to rush. ‘Each new manager has a formal initiation session led by the Company Secretary, augmented by the Assistant Secretary and person at a senior degree with a good trade of company experience, explicating the issues for ICI ‘ ( DTI, 2004 ) . The Sessionss chiefly covered such as Risk, Regulation and Practice, including fiducial responsibilities, responsibilities of attention and diligence, how the board is managed, what makes an effectual board, the Combined Code and other ordinances. New managers become more effectual as subscribers more rapidly. The experience is valuable for new managers. Peter Ellwood is undoubted of the benefits to the concern: ‘It ‘s bottom line common sense to give new managers a thorough initiation. It ‘s non rocket scientific discipline but good pattern, because it means that the people fall ining the board will be more effectual. ‘ He still emphasized the initiation will add new manager ‘s value and do them effectual much more rapidly and use their endowment for benefit of the concern and its stockholders at the beginning. The Boardroom late carried out a study of taking institutional stockholders in order to inform the development of its personalized development programmes for managers and senior executives ( DTI, 2004 ) . The responses from the stockholders perspective highlight one of the importance is that an effectual initiation procedure with strong support for doing initiation preparation compulsory for new managers.

Director ‘s Skills and Qualifications

By and large talking, concern experience is of import for a non-executive manager. However, an effectual board is necessary formed by a assortment of backgrounds. The Higgs Report assumed that ‘the interplay of varied and complementary positions amongst different members of the board can significantly profit board public presentation ‘ . Harmonizing to the premise, non-executive managers would be chosen by different genders, nationality, expertness and experience. The responses from research and audience indicate the grounds that there is a deficit of good people to take on non-executive functions. In some fortunes, the board seems to hold sufficient supply of endowment nevertheless the job is non being good dealt with. It has been suggested that campaigners for non-executive managers is narrow. It is clearly that the company is interested in enrolling the best people for this place. However, it is hard for board to separate the virtues of them without prejudice and subjective judgement. The Higgs research shows that ‘Non-executive managers are typically white males approaching retirement age with old public limited company manager experience. There are less than 20 non-executive managers on FTSE 100 boards under the age of 45. In the telephone study for the Review, seven per cent of non-executive managers were non British, and one per cent was from black and cultural minority groups ‘ .

The study still mentioned the proportion of genders in non-executive managers: ‘The really low figure of female non-executive managers is striking in comparing with other professions and with the population of directors in UK companies overall. The labour force study investigates that across the corporate sector as a whole, around 30 per cent of directors overall are female. Merely six per cent of non-executive stations are held by adult females, and there are merely two female presidents in the FTSE 350.

However, the diverseness and mix of experience and gender would beneficial for the board in playing an consultative function in determination devising and puting scheme program. With the similar backgrounds non-executive frequently tend to believe in a similar but narrow facet. In add-on, it is reported that in some countries adult females managers tend to be more strongly represented in functions such as human resources, alteration direction and client attention which are non regarded as traditional paths to the board.

The enlisting or replacing of the non-executive managers is non merely sing the basic accomplishments and making of single but besides the diverseness and mix background to do board effectivity.

On other manus, as the Higgs Review observed, ‘Currently, few executive managers or talented persons merely below board degree sit as non-executive managers in other companies. Of more than 5,000 executive managers in UK listed companies, presently 282 hold a non-executive manager station in a UK listed company. There are many benefits of making so. The company that employs the person on a full-time footing will profit from the single gaining a broader position and developing accomplishments and attributes relevant to any future function as a manager. Conversely, the board of the company having the single benefits from executive experience elsewhere. This encourages the sharing and airing of best pattern. ‘ ( Higgs, 2003 )

In the Tyson Report ( 2003 ) , it is said that main executives of big companies appointed qualified directors to actively nurture non-executive managers ‘ endowment from their “ marzipan ” direction ranks to function on their divisional, regional or subordinate boards. The study besides states that head executives besides are willing to promote such persons to accept non-executive managers ‘ places on the boards of non-competitor companies. However, as the duties and liabilities required on non-executive managers addition, the commitment clip of non-executive managers ‘ places augments. Therefore, the main executives are hence likely to go more loath to let their most promising directors to presume them ( Tyson, 2003 ) .

In the yesteryear, the directors ‘ endowment has non been traditional beginning of non-executive manager campaigners, whilst the companies on a regular basis claim that people are their valuable plus. It is besides agreed by Higgs ( 2003 ) that the issues dealt with in such countries are of import 1s for the board and that direction roles in such countries encourage accomplishments and property that is extremely relevant to the council chamber. It is reported that merely 20 of the FTSE 250 presently have the human resource map on the board. Afterwards, when the Higgs Review was published, Geoff Armstrong, Director General of the Chartered Institute for Personnel & A ; Development ( CIPD ) said: ‘There is a huge pool of endowment within the human resource profession. Such persons would convey a new dimension to the non-executive function and guarantee that an organisation ‘s cardinal driver of value – viz. its people – is taken earnestly at board degree. They would convey a fresh and much-needed position to the decision-making procedure. ‘ The CIPD believes that human resources professionals could besides convey critical expertness to the wage commission.

The Armstrong Institutes observed that ‘Pay and wages is their stock-in-trade – it would do a batch of sense. Equally, choice, initiation, preparation and public presentation direction are countries of expertness which could be applied with value to both executive and non-executive managers ‘ . The Tyson study ( 2003 ) discovered that ‘lawyers and advisers working in consultative functions to concern are another beginning of non-executive manager ‘s endowments as are those who have retired from accounting houses and are no longer restricted from keeping non-executive managers places ‘ . It should be encouraged by professional service houses to allow their senior people accept non-executive assignments. The probe indicates that presently merely 14 per centum of FTSE 100 non-executive managers have accountancy makings and less than three per centum have jurisprudence makings. Furthermore, since adult females are better represented in professional services than in top direction places in the corporate sector, an addition in non-executive managers ‘ assignments from such houses is likely to intend an addition in adult females functioning in non-executive managers places. In a word, the accomplishments and experience of non-executive managers is a valuable plus on companies, which could non merely go more effectiveness through preparation and initiation but besides take a professional consultative function in another companies.

Drumhead

The thesis is what makes board effectual. After the dirts at Enron Corp. , Tyco International Ltd, Adelphia Communications Corp. , and WorldCom Inc. before this decennary ( Solomon, 2007 ) , there is a turning involvement in the corporate administration systems of developing and transitional economic systems. The Combined Code ( 2008 ) emphasized that ‘all managers should have initiation on fall ining the board and should regularly update and review their accomplishments and cognition ‘ which represent one of most important parts of the board effectivity. However, many surveies focus on non-executive managers ‘ independency and pay strategies but non on the initiation programme and accomplishments and making update. Although much of the literature ignores the being of manager initiation programme there is grounds to propose corporate should take more attending on it. In the Higgs study about reappraisal of the function and effectivity of non-executive managers ( 2003 ) , there is an initiation checklist which provides a counsel of initiation. As a standard, the research will look into the initiation programme presenting in the corporate administration of the one-year study. Therefore, the thesis will bridge the spread in the literature by following the Combined Code and other study to analyze whether each company have an eligible initiation programme harmonizing to the standards and been disclosed suitably in the one-year study.

Organizational Effectiveness “Researchers analyzing what CEOs and managers do have pointed to control, innovation, and efficiency as the three most important processes managers use to assess and measure how effective they, and their organizations, are at creating value (L. Galambos, 1988)”. Control is essential over the external and internal environment by knowing what the demand for a business is. A tool to help make these decisions with control is to conduct a trend analysis. An analysis will reveal patterns be it internal or external of an organization.

To identify current patterns along with the status of the organization managers are able to determine how to restructure the business in or to produce product or services in the most efficient way possible. This may include adding additional skills, technologies, or current assets to the current workforce anything that will produce the best output of an organization in the most efficient way. An organization must be innovative when introducing their product or services to the market.

This may require management to demand radical changes to the organization by improving or changing processes, advertising, and just acquire the capability to adjust to any environment the organization has to confront be it internal or external. An organization does not need to use the three methods to assess and measure organizations effectiveness it would depend on what needs attention, but it is always good for an organization to know the health of their organization pertaining to the three measures. Table 1 (Jones. , 2010) L-3 communications. Revenue: Over $5 bil. Employees: Over 10,000 Fortune 1000, Fortune 500, Russell 3000 Industry: Aerospace & Defense , Consumer Electronics , Consumer Goods , Manufacturing SIC Codes: 3663 NAICS Codes: 334220 L-3 is a prime contractor in Command, Control, Communications, Intelligence, Surveillance and Reconnaissance (C3ISR) systems, aircraft modernization and maintenance, and national security solutions. L-3 is also a leading provider of a broad range of electronic systems used on military and commercial platforms.

Our customers include the U. S. Department of Defense and its prime contractors, U. S. Government intelligence agencies, the U. S. Department of Homeland Security, U. S. Department of State, U. S. Department of Justice, allied foreign governments, domestic and foreign commercial customers and select other U. S. federal, state and local government agencies (Company Profile, 2013)”. Currently L-3’s concern is to operate in an efficient manner to maintain and increase their target market.

L-3’s similar companies are Raytheon Company, Lockheed Martin Corporation, Northrop Grumman Corporation, and The Boeing Company. They are giants in their field and are companies that are veterans to the profession. With a majority of veteran companies, the challenges are similar with L-3 the continually changing environment. Example: the changing technology, changing target markets causes the reluctance of change in the internal cultures of these large companies and L-3 is not immune to this challenge.

The best approach to use for L-3 is the metrics that would help improve organizational effectiveness. This is the internal system approach see [ Table 1 (Jones. , 2010) ]. This method includes improving the communication process between the levels of management. Elevate problems in a timely manner to upper management. The internal health of the company is beneficial information ( be it negative or positive) quickens decision-making process which in turn allows the organization to continue with planed processes.

One of the main issues to correct is the workforce to shift into using new tools, processes, and just looking at the organizations requirements differently for the organization is changing, nothing is consistent with change. This constant change without training causes decrease in motivation, create conflicts and certainly prevents L-3’s output to its’ market, and in the end a delay in output to the market does disrupts the external environments. Thus, processes need to be re-evaluated and restructured.

Replacing the aging tools with current tools results in a streamline and automates processes. “The Benefits of Process Automation: Improved Efficiency. Many business processes p systems, departments, or even external business partners. Manual effort, poor hand-offs between departments or partners, and the general inability to monitor overall progress results is a significant waste for most processes. Process automation eliminates or significantly reduces these problems with a resultant reduction in labor hours, time p, and increased throughput.

Increased Productivity. By automating processes that are currently being implemented manually, individuals can work more efficiently and can take on new or additional workloads. Process automation allows us to rise to the challenge of being asked to do more with less. Shorter Cycle Times. Time is money. By automating processes, they are kept moving, hand-offs are facilitated, consistency is assured, and cycle times to complete the process are shortened. Getting the product or service to the end user or to market quicker can result in significant financial benefits.

Consistent Process Implementation. Consistency comes from having a documented process that is understood and followed every time. Process automation makes the process easy to understand and enforces adherence to the process steps. This eliminates missed steps often found in manual processes, resulting in consistent, reliable measures that assist in making decisions and implementing process improvements. Corporate Governance and Compliance. Process compliance, regulatory compliance, and corporate governance are ever increasing in importance.

Organizations must demonstrate consistency and show that effective controls and business monitors are in place to ensure processes are sound and will provide financial accountability, visibility, and reduce risk and fraud. Process automation can help your company with compliance issues surrounding regulations like the Sarbanes-Oxley Act, Combined Code for Corporate Governance, Bilanz Reform, and more. Noncompliance or lack of adequate controls can cost your company big-time.

Process automation ensures your processes are followed as they are laid out. Ability to Quickly Implement Change. Another benefit of automated process is that the reliable, consistent information provided can enable you to recognize the need for change or improvement quickly and then be able to make that change and put it into effect in a faster and more controlled manner than you could with a manual process. The ability to change quickly provides an important business advantage. Improved Customer Service and

Satisfaction. Customers are much more satisfied when they receive timely, top quality products and services. Process automation enables you to build consistency into your products and services, facilitate continuous improvement, and get the product or service to your customer faster. Happy customers are repeat customers. Reduced Costs and Improved Profits. All of the above benefits result in direct bottom-line results of reduced costs, ability to take on more work, and improved profitability.

All things any company is seeking (A. Moudry, 2013)”. To establish organizational effectiveness, management L-3 needs to focus on structuring their workforce, internal employee management systems, and the organization and abilities (including the organizational culture) to the plan. This is a crucial point to any strategy and engagement from all involved dictates whether organizational effectiveness, management is a success. References: A. Moudry, J. (2013, March 16). Real Benefits of Automated Processes.

Retrieved from NEXTGENPINEW. COM: http://www. nextgenpinews. com/files/Real%20Benefits%20of%20Automated%20Processes. pdf Company Profile. (2013, March 14). Retrieved from L-3: http://www. l-3com. com/about-l-3/company-profile. html Jones. , G. R. (2010). The Organization and Its Environment. In G. R. Jones. , Organizational Theory, Design, and Change, Sixth Edition. Prentice Hall. Copyright © 2010 by Pearson Education, Inc. L. Galambos. (1988). “What Have CEO’s Been Doing? ”. Journal of Economic History, 18, 243–258.

The Coca-Cola Corporation is dedicated to reverberation political orientation of communal authorization. The Board is designated by the stockholders to oversee their concentration in the enduring strength and the mostly achievement of the production and its economic power. The Board provides as the eventual declaration industry organic structure of the concern, excepting for persons affairs retained to or reciprocally shared with the stockholders. The Board elects and administers the associates of superior organisation, who are charged by the Board with accomplish the production of the corporation.

The Corporate Governance scheme, all along with the contracts of the all of the Board committee and the solution readying of the Board afford the construction for communal domination at The Coca-Cola Company.

Ethical motives Conformity

The nucleus of the political orientation and public presentation plan at The Coca-Cola concern is our marks of Business behavior. The system conducts the concern behavior ; involves unity and dependability in all substances. All of the executives and decision makers are indispensable to analyze and recognize the system and prosecute its instructions in the administrative Centre and liberally proportioned society.

The policy is managed by the company ‘s Ethics & A ; Compliance committee. This cross-functional superior disposal group supervises the full rules and acquiescence plans and resolutenesss system violations and ordinance. Our Ethics & A ; Compliance workplace has working liability for sophistication, treatment, analyzing and appraisal associated to the Code of industry perform and conformity concerns. Relates internationally obtain a mixture of moral codification and conformity direction options controlled by the Ethics & A ; Compliance Office. The company often screen and reexamine the concern to attest conformity with the system and the act. Coca-cola besides sustains a changeless remainder of best-in-class values about the universe that administrate how the company examine and keep Code concerns. In 2008, it modifies the Code to advance advancement its efficiency.

More than 20,000 contacts concluded more than 30,000 personally and web-based Ethical motives and Compliance counsel conference from August 2007 in the path of June 2008. All correlatives will obtain in the flesh Code of company performs counsel in 2008. The company has skilled the contacts Code of covering accomplish, European Union competition jurisprudence, Latin American resistance jurisprudence, economic dependability, logical ownerships and spirited minds, drug-free bureau and avoids bureau ill will.

In 2006, company revolved out a simplified cosmopolitan anti-bribery conformance plan with partizan schemes, preparation and reappraisal. In accretion, it extended the conformity plan in the part of United State operates approved with opinionative policies, direction and audits.

Coca-cola associates, bottling co-workers, suppliers, habitues and clients can inquire questions about the Code and former moralss and , or statement likely breach, through Ethical motives emanation, a cosmopolitan Web and telephone studies and exposure service. Phone calls are toll-free, and Ethical motives Line is accessible 24 hours a twenty-four hours, seven yearss a hebdomad, with gettable transcribers.

Corporate Social Duty

Coca-cola Greece was recently documented for its commercial corporate duty efforts with 3 honours at the honored CSR differentiation Awards formal process. The CSR high quality Awards place achievement transversally all industries, non merely nutrient and drink, and are honoured by a committee includes of converting stakeholders, such as nongovernment associations and disposal representatives. The grasp of quality in 3 kind ‘s exhibits the compulsion of the coca-cola Company has for transporting the promises of subsist confidently phase to life at occupation and in the society.

Continuous Achievement Award

Human Resources Award

Environment Award

Vision 2020

The world is changing all around us. To protract to win as a concern for the following 10 old ages and beyond, we need to be required to gaze frontward, place with the inclination and services that will calculate out the concern in the chance and advancement rapidly to form for what ‘s to come. We have to acquire prepared for tomorrow today. That ‘s what the 2020 Vision is all sing. It produces a permanent purpose for the production and supplies coca-cola with a “ Route map ” for capturing reciprocally with the bottling spouses.

Coca-colas Roadmap commences by agencies of the mission, which is lasting. It proclaims the ground as a corporation and provides as the standard oppose which the company see the public presentation and declarations.

To stimulate the universe…

To promote minutes of assurance and pleasance…

To bring forth appraisal and compose a diverseness.

The Company ‘s vision is to supply the construction for the Roadmap and conducts each and every characteristic of the trade by explicating what the company necessitate to carry through in order to protract achieving sustainable, high quality development.

“ Peoples: Be an tremendous circumstance to make occupation where individuals are enthused to be the best they can be.

Portfolio: convey to the universe a portfolio of excellence drink trade names that predict and convince people ‘s demands and desires.

Spouses: cultivate a charming system of consumers and providers ; jointly they produce common, permanent value.

Planet: Be a painstaking national that makes a differentiation by functioning concept and maintain sustainable communities.

Net income: exploit long-standing reaching to stockholders while being attentive of its all duties.

Productiveness: Be an extremely efficient, thin and fast-moving organisation. ”

Management of Financial Risk

Harmonizing to one-year study, it ‘s clearly apparent that, certain financial hazards faced by Coca-Cola Hellenic occur from unfavorable fluctuations foreign Exchange rates, in involvement rates, merchandise monetary values and other market hazards. Company Board of Directors has accepted the Treasury Policy and graph of Authority, which reciprocally afford the organized model designed for every exchequer and exchequer associated minutess.

Given the Group ‘s operation public presentation, they are showing to a major measure of foreign currency hazard. Coca-colas foreign currency revelation comes up from disagreeable transforms in trade rates with the euro, the US dollar and the exchanges within its non-euro Kingdoms. Operation constitutions begin largely from the stuffs acquired in exchanges such as the US dollar or euro which can steer to maximal cost of trade in the functional currency of the state.

Conversion constitutions occur as several of its processing includes efficient currencies other than euro, and any alteration in the functional currency against the euro impacts our amalgamate income statement and balance sheet when consequences are converted into euro.

Coca-cola exchequer program involves the lie of come oning Twelve month estimated operational results contained by the distinguishable least ( 25 % ) and maximal ( 80 % ) exposure phases. Beat around the bushing off from a Twelve month p may originate, subject to convert greatest coverage degrees, granted the estimated minutess are highly believable. Where available, we use derivative fiscal instruments to cut down our cyberspace revelation to currency changeableness. These conventions by and large established in one twelvemonth.

The Team represents to market hazard happening from changing involvement rates, foremost and first in the euro zone. Intermittently they estimate the needed combination of fixed and drifting rate duty and accommodate the involvement disbursals based on the needed combination of debt. They cope up the involvement rate outgo by agencies of an agreement of lasting and drifting rate debt, involvement rate switch and pick cap understandings. Though they have denial topographic point of mark for the mixture of set to drifting rate liabilities, traditionally they have been excess demoing to drifting rates as this has be inclined to move as a expected evade against on the whole concern hazard.

Recognition hazard is inhibited by a probationary process as to the option of likely oppose parties for exchequer traffics. The Company ‘s recognition hazard is handled by establishing a permitted opposition party and state confines, detailing the highest experience that they organized to acknowledge with respect to single counterparties or states. The limitations are reconsidered and observed on an expected footing.

The common scheme is to keep a least measure of liquidness engages in the construction of currency on the balance sheet when prolonging the stableness of our liquidness engages in the assortment of idle dedicated comfortss, to do certain that the Company incorporate cost-efficient admit to enough economic assets to convene the fiscal support desires. These embrace the everyday backup of all its procedure in add-on as the support of the resource expense plan. In order to relieve the chance of liquidness restrictions, Company make an attempt to prolong a least of a‚¬250 million of financial headway. Monetary headway refers to the excess engaged support gettable, subsequently than sing hard currency flows from working public presentation, dividends, acquisitions, revenue enhancement disbursal, involvement disbursal and capital outgo demands.

Hazards in this Quadrant are categorized as premier Hazards and are rated High precedency. They are important hazards that intimidate the achievement of concern intents. These hazards are reciprocally considerable in significance and likely to originate. They should be condensed or removed with defensive reins and must be organize appraisal and testing.

Detect and Monitor Risks

Hazards in the quarter-circle are momentous, but they are fewer possible to originate. To do certain that the hazards stay small chance and are administered by the concern appropriately, they require detecting on a revolving base. Detective powers must be positioned into a topographic point to do certain that these high effect hazards will be identified in front of they harvest up. These hazards are 2nd chief concern behind premier hazards.

Hazards in the quarter-circle are non really of import, but contain a superior possibility of go oning. These hazards should be watched decently to attest that they are being decently supervised and that their deduction has non distorted due to changing concern fortunes.

Hazards in this quarter-circle are every bit unlikely to take topographic point and non considerable. They involve least observant and oversee if non attendant hazard class.

In Further the consequent issues, which may extensively act upon the trade, fiscal circumstance or consequences of operations in future periods? The hazards explained below are non the individual hazards confronting Coca-Cola Company. Further risks non presently recognized by company or that they soon consider being inappropriate besides may efficaciously unfavorably impact the concern, economic status or consequence of operations in future periods.

Current hazard faced by Coca-cola

Customers, communal physical status functionaries and authorities functionaries are suitably increasing concerned about the public fittingness effects connected with stalwartness, chiefly between adolescent public. And besides, few research workers, fittingness protagonists and nutritionary process are heartening clients to diminish outgo of sugar-sweetened drinks, together with those sugared with HFCS or other alimentary sweetenings. Rising community anxiousness refering these affairs ; likely new dues and law-making system concerns the advertisement, labelling or handiness of the drinks ; and harmful publicity consequential from definite or endangered authorised public presentation in resistance to the coca-cola or other companies in its industry relating to the advertisement, labelling or trade of sugar-sweetened drinks might diminish demand for company ‘s drinks, which may perchance act upon its profitableness.

H2o ( H2O ) is the major component in significantly all of the coca-cola merchandises. It is besides a partial beginning in several parts of the universe, confronting supreme differences from over use, mounting taint, broken disposal and conditions alteration. As demand for H2O prolongs to heighten all-around the universe, and as H2O becomes scarcer and the high quality of gettable H2O deteriorates, Company ‘s categorization might obtain increasing production costs or face possible boundaries which could destructively alter the productiveness or net purposeful returns in the drawn-out tally.

The non-alcoholic drinks concern milieus is hurriedly developing as a consequence of, among other things, alterations in clients dispositions, together with altered based on wellness and nutrition concerned and obesity anxiousnesss ; variable consumer gustatory sensations and needs ; alterations in clients criterion of life ; and spirited merchandise and pricing demands. As good, their fabrication is being affected by the tendency toward consolidation in the market conduit, particularly in Europe and the United States. If they are unable to successfully accommodate to this quickly altering environment, the company ‘s portion of gross revenues, capacity growing and overall economic class could be depressingly affected.

Hazard factors which the Company may confront in future

Coca-cola relies on informations based cognition system and strategies, include the Internet, to patterned advance, broadcast and store electronic information. Particularly, Coca-cola depends on its information engineering communications for digital advertisement public presentation and electronic substructure in its countries about the universe and between Company forces and our bottlers and other clients and providers. Defence misdemeanor of this substructure can make system breaks, closures or unauthorised revelation of classified information. If they are non capable to forestall such breaches, Company ‘s operations could be disrupting, or they might undergo economical harm or loss because of doomed or misappropriated information.

The gross revenues of the merchandises are inclined to several extents by clime fortunes in the markets in which they function. Queerly wintry or rainy weather conditions at some point in the summer months could hold a probationary effect on the insist for all its merchandises and contribute to lower gross revenues, which could hold an inauspicious consequence on our consequences of operations for such periods )

Risk analysis &  direction techniques

Risk direction often concentrates on affairs of insurance. Conversely, there are figure of farther chief considerations when measuring countries of hazard into a large concern… ab initio ; they require every bit dependability and the infrastructural proficiency to do the patterned advance. Second, they should wholly acknowledge their association, and its patterned advances and aims. And thirdly, they must be dwelling of support and keep up from the association and the administrative squad.

Coca-cola Amatol ( CCA ) comes under the class of being hazard witting, but non obsessed by dictatorial status. CCA is increasing its hazard direction representation to pull off enterprise-wide and supply to the eventual productiveness of the concern. This consequence will be achieved non merely by prolonging sound concern determinations but besides all the manner through constellation of the organisation ‘s schemes with its stockholders ‘ and investors ‘ aspiration to do certain that efficient concern authorization is in topographic point.

CCA, inside the broader coca-cola construction, is on an ERM expedition. They are determined to take out the conventional split and ‘soloed ‘ attack that regularly exists in organisations and they are duty so by taking an blessing and ownership of the hazard direction procedure.

At CCA they know the significance of the indispensable values of the ERM procedure. They are: a dedication to the journey ; an sensible model that embraces a general linguistic communication ; a unvarying attack to- no affair the nature of the concern unit or its aims ; a statement signifier that identifies stakeholders, corresponds the class and aims ; and drives literary alteration ; and guaranting advice of the result through an riddance of ‘black holes ‘ or ‘silos ‘ .

Risk Management Plan

There are four phases to put on the line direction planning. They are: A·

Hazard acknowledgment

Hazards Quantification

Hazard reaction

Hazard Monitoring and Control

There are several definite hazard direction techniques as there are kind of industry, but one time a hazard has been recognized and considered, mostly attempts at warranting the hazard autumn into four indispensable grouping in malice of the model. The initial, bar, can be every bit easy as non perpetrating in activity that manufactures the hazard, but this non merely eradicates hazard but possible benefits every bit good. Hazard decrease through concrete stairss is far more general, and the specifics will be associated to the type of concern and hazard involved. Hazard transference is besides extremely advantageous as when an accessible pick ; it involves outsourcing the trouble to an extra article such as in the class of get of insurance. Ultimately, hazard saving is predictable in a few instances where the hazards are either unlikely, or the costs of explanatory or reassigning the hazard are inordinate.

Communicating with interest holders

Many of coca-cola stakeholders consist of all those who are by and large influenced by or who most influenced the means the company run the large concern. This includes clients, consumers, contractors, and workers, Government & A ; supervisors, NGOs plus the confined communities in which the company operates.

Coca-cola regularly connect with its major stakeholders as exposed in Diagram

In add-on, they conceded a elaborate probe in March 2007 to sort the most of import countries of concern for its stakeholders. This implicated a sequence of focal point groups with clients aged 18 and over and with work force of both CCE and CCGB. It besides incorporated the interviews with consumers, non-governmental administrations and the media.

The survey exposed a strong understanding of appraisal between the diverse stakeholder groups and provided an obvious graph of the countries of liability they most require to concentrate on all these countries.

Coca-cola stakeholder survey has besides helped out to polish its chance scheme on communal and ecological issues. On every key subject it contains ‘Next Step ‘ – the act which has to be taken in the undermentioned twelvemonth to attest that the concern persists to do an optimistic impact.

Consumer Communication

On June 11 2010 Coca-cola has published that the Coca-cola Poland has completed a first move a caput frontward in how it instructs clients sing recycling, by incorporating its ‘Recover-Recycle ‘ activity into every chief coca-cola labelled or supported immense events this twelvemonth.

A huge My Coke trying plan, which happened between April and September 2010, is one of the cardinal promoting public presentations where coca-cola Poland will describe to clients about the net income of recycling through Recover-Recycle.

Decision

There is no uncertainty that the Coca Cola is the 2nd largest drinks company in the universe. However, it should work on above mentioned lacks to get the better of them and strive to do its rivals lagged behind. The Company coca-cola have a corporate ( Head Office ) subdivision that is apt for giving the Company a mostly class and provided that sustain to the provincial formation. Means considered pick at the Coca-Cola Corporation are completed by a managerial Committee of 12 concerned Officers. This committee assisted to organize the six strategic precedences set out in old. The fiscal resources allotment for the Vision 2020 had been discussed under the six P ‘s as laid out by the company. International through to grass-roots and the community, Coca-Cola has strengthened its place as a football insider and this helps to construct the trade name and corporate repute of Coca-Cola. Last twelvemonth, Coca-cola saw its gross revenues decreased in UK market. In order to re make the gross revenues, Coca-cola to specify new communicating program such as ‘Recover-Recycle ‘ activity.

The Roles of Corporate Governance in Bank Failures during the Recent Financial Crisis Berger, Allen N. 1 | Imbierowicz, Bjorn2 | Rauch, Christian3 July 2012 Abstract This paper analyzes the roles of corporate governance in bank defaults during the recent financial crisis of 2007-2010. Using a data sample of 249 default and 4,021 no default US commercial banks, we investigate the impact of bank ownership and management structures on the probability of default.

The results show that defaults are strongly influenced by a bank’s ownership structure: high shareholdings of outside directors and chief officers (managers with a “chief officer” position, such as the CEO, CFO, etc. ) imply a substantially lower probability of failure. In contrast, high shareholdings of lower-level management, such as vice presidents, increase default risk significantly.

These findings suggest that high stakes in the bank induce outside directors and upper-level management to control and reduce risk, while greater stakes for lower-level management seem to induce it to take high risks which may eventually result in bank default. Some accounting variables, such as capital, earnings, and non-performing loans, also help predict bank default. However, other potential stability indicators, such as the management structure of the bank, indicators of market competition, subprime mortgage risks, state economic conditions, and regulatory influences, do not appear to be decisive factors in predicting bank default.

JEL Codes: G21, G28, G32, G34 Keywords: Bank Default, Corporate Governance. Bank Regulation 1 University of South Carolina, Moore School of Business, 1705 College Street, Columbia, SC, USA, Phone: +1803-576-8440, Wharton Financial Institutions Center, and CentER, Tilburg University, Email: aberger@moore. usc. edu 2 Goethe University Frankfurt, House of Finance, Grueneburgplatz 1, Frankfurt am Main, Germany, Phone: +49-69798-33729, Email: imbierowicz@finance. uni-frankfurt. de 3 Goethe University Frankfurt, House of Finance, Grueneburgplatz 1, Frankfurt am Main, Germany, Phone: +49-69798-33731, Email: christian. . rauch@googlemail. com The authors would like to thank Lamont Black, Meg Donovan, Xiaoding Liu, Raluca Roman, Sascha Steffen, Nuria Suarez, Larry D. Wall, and participants at the 29th GdRE International Symposium on Money, Banking and Finance for useful comments. 1 Why do banks fail? After every crisis, this question is asked by regulators, politicians, bank managers, customers, investors, and academics, hoping that an answer can help improve the stability of the financial system and/or prevent future crises.

Although a broad body of research has been able to provide a number of answers to this question, many aspects remain unresolved. After all, the bank failures during the recent financial crisis of 2007-2010 have shown that the gained knowledge about bank defaults is apparently still not sufficient to prevent large numbers of banks from failing. Most studies of bank default have focused on the influence of accounting variables, such as capital ratios, with some success (e. g. Martin, 1977; Pettway and Sinkey, 1980; Lane, Looney, and Wansley, 1986; Espahbodi, 1991; Cole and Gunther, 1995, 1998; Helwege, 1996; Schaeck, 2008; Cole and White, 2012). However, almost no research to date has empirically analyzed the influence corporate governance characteristics, such as ownership structure or management structure, have on a bank’s probability of default (PD). 1 This is perhaps surprising for two reasons. The first is the calls for corporate governance-based mechanisms to control bank risk taking during and after the recent financial crisis (e. . , restrictions on compensation and perks under TARP, disclosure of compensation and advisory votes of shareholders about executive compensation under DoddFrank, guidance for compensation such as deferred compensation, alignment of compensation with performance and risk, disclosure of compensation, etc. by the G20, or more recent discussions in the UK regarding a lifetime ban from the financial services industry on directors of collapsed banks), which are largely without basis in the empirical literature on bank defaults.

The second is the literature showing that governance mechanisms can have a very strong influence on bank performance in terms of risk taking (e. g. , Saunders, Strock, and Travlos, 1990; Gorton and Rosen, 1995; Anderson and Fraser, 2000; Caprio, Laeven, and Levine, 2003; Laeven and Levine, 2009; Pathan, 2009, Beltratti and Stulz, 2012). It is therefore the goal of this paper to analyze the roles of corporate governance, including both ownership structure and management structure, in bank defaults. The results are key to underpinning the recent calls for changes in corporate governance to control risk.

As well, the results may add a new dimension to the extant literature on the effects of corporate governance                                                              1 An exception is Berger and Bouwman (2012), which controls for institutional block ownership, bank holding company membership, and foreign ownership in models of bank survival and market share. However, the paper does not focus on these variables, nor does it include the ownership of directors and different types of bank employees, which are the key corporate governance variables of interest here. 2 on bank performance.

Although this body of research has clearly established the causalities between corporate governance and bank risk taking, no study has so far used corporate governance structures to help explain bank defaults or to distinguish default from no default banks. Our paper attempts to fill this void. To analyze the influence of corporate governance structures on bank defaults, we analyze 249 US commercial bank defaults during the period of 2007:Q1 to 2010:Q3 in comparison to a sample of 4,021 no default US commercial banks. We use five sets of explanatory variables in multivariate logit regression models of default.

First, we include the impact of accounting variables on banks’ probability of default (PD). These accounting variables are well represented in the established literature on bank default. Second, we employ various corporate governance indicators to measure banks’ ownership structure and management structure. For ownership structure, we use the shareholdings of different categories of bank management, whether the CEO is also the largest shareholder, whether the bank or its holding company is publicly traded, and whether the bank is in a multibank holding company.

For management structure, we use the numbers of outside directors, chief officers, and other corporate insiders (all normalized by board size), the board size itself, and if the Chairman of a bank is also the CEO. For the purposes of this paper, we define “chief officers” as all bank managers with a “chief officer” position, such as the Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Lending Officer (CLO), or Chief Risk Officer (CRO). Third, we incorporate measures of market competition.

We thereby account for the large literature on bank market power which is inconclusive on the effects of higher market power on bank stability, depending on whether the traditional “competition-fragility” view or the “competition-stability” view dominates, as discussed in Section II A. We also account for the bank’s competitors’ subprime loan exposure – a factor often cited as a major source of default risk in the recent crisis – which could help the bank by weakening or eliminating some of its competition.

Fourth, we employ economic variables at the state level – GDP growth and the house price inflation – the latter of which is believed to have contributed to instability in the banking system due to banks being able to only partially recover collateral in defaulted mortgage loans. Finally, we account for potential differences among federal bank regulators. Our results confirm the extant bank failure literature by finding that accounting variables such as the capital ratio, the return on assets, and the portion of non-performing loans, help predict bank default. Our key new finding is that the ownership structure of a bank is also an important predictor of bank PD. Specifically, three bank ownership variables prove to be significant predictors of bank failure: the shareholdings of outside directors (directors without other direct management executive functions within the bank), the shareholdings of chief officers, and the shareholdings of other corporate insiders (lower-level management, such as vice presidents). Interestingly, the effects differ among these three groups.

While our results suggest that large shareholdings of outside directors and chief officers decrease a bank’s probability of default, larger shareholdings of lower-level management significantly increase bank PD. We find that these ownership structure variables add substantial explanatory power to the regressions, raising the adjusted R-Squared of the logit equations by more than half relative to the accounting variables alone. We offer explanations for these perhaps unexpected findings.

We hypothesize that lower-level managers with large shares may take on more risk because of the moral hazard problem, whereas this problem may not apply as much to outside directors and chief officers because they are vilified in the event of a default. However, our other corporate governance indicators for management structure do not appear to significantly influence bank default probabilities. Perhaps surprisingly, bank market power, competitors’ subprime loan exposure, state-level house price inflation and income growth, and different primary federal regulators also have little or no influence on bank failure.

These results are robust to different specifications, time periods prior to default, as well as a possible sample selection bias caused by the types of banks for which corporate governance data are available. In an additional analysis, we develop a variable based on the individual shareholdings of outside directors, chief officers, and other corporate insiders as a single default predictor variable. This measure confirms that the ownership structure of a bank has significant predictive power for bank default, especially if observed some time period prior to default.

Overall, our results add substantially to the question of why banks fail, and also contribute to the aforementioned discussion of corporate governance-based mechanisms to control bank risk taking. The remainder of the paper is structured as follows. In Section I, we provide an overview of the relevant literature regarding corporate governance and bank stability. In Section II A, we describe the composition of our data set. Section II B contains the summary statistics on anecdotal evidence of the reasons behind bank failures during the financial crisis of 2007-2010.

We describe the ownership and management structures of the banks in our sample in Section II C. 4 Section II D contains summary statistics on the accounting, competition and economic data. Section III reports our main multivariate results, and in Section IV we develop and test a single indicator of bank ownership structure to predict default. Section V concludes. I. Literature Overview Our paper builds upon and expands the existing literature in two closely connected areas of research: bank defaults and the influence of corporate governance structures on bank risk taking.

The literature on bank default mostly focuses on testing a wide variety of bank accounting variables on banks’ default probabilities in discriminant analyses and regressions of dependent binary default indicator variables. Examples that precede the recent financial crisis are Meyer and Pfifer (1970), Martin (1977), Whalen and Thomson (1988), Espahbodi (1991), Thomson (1991, 1992), Cole and Fenn (1995), Cole and Gunther (1995, 1998), Logan (2001), and Kolari, Glennon, Shin and Caputo (2002). The predominant findings are that the default probability increases for banks with low capitalization and other measures of poor performance.

Following this body of research, there are only few papers to date analyzing the relevant drivers of bank default during the recent financial crisis: Torna (2010), Aubuchon and Wheelock (2010), Ng and Roychowdhury (2011), Berger and Bouwman (2012), and Cole and White (2012). Torna (2010) focuses on the different roles that traditional and modern-day banking activities, such as investment banking and private equity-type business, have in the financial distress or failure of banks from 2007 to 2009 in the US. The paper shows that a stronger focus on these modern-day activities significantly increase a bank’s PD.

Aubuchon and Wheelock (2010) also focus on bank failures in the US, comparing the 2007-2010 period to the 1987-1992 period. They predominantly analyze the influence of local macroeconomic factors on banks’ failure probability. Their study shows that banks are highly vulnerable to local economic shocks and that the majority of bank failures occurred in regions which suffered the strongest economic downturn and the highest distress in real estate markets in the US. Ng and Roychowdhury (2011) also analyze bank failures in the US in the crisis period 2007-2010.

They focus on how so called “add-backs” of loan loss reserves to capital can trigger bank instability. They show that add-backs of loan loss reserves to regulatory capital increase banks’ likelihood of failure. Berger and Bouwman (2012) focus on the effects of bank equity capital on survival and market share during both financial crises (including 5 the recent crisis) and normal times. They find that capital helps small banks survive at all times, and is important to large and medium banks as well during banking crises.

Finally, Cole and White (2012) perform a test of virtually all accounting-based variables and how these might add to bank PD, using logit regression models on US bank failures in 2009. Using the standard CAMEL approach, they find that banks with more capital, better asset quality, higher earnings and more liquidity are less likely to fail. Their results also show that bank PD is significantly increased by more real estate construction and development loans, commercial mortgages and multi-family mortgages.

Although our paper is closely related to these studies – especially to the post-crisis research and in terms of sample selection, observation period, and methodology – we strongly expand the scope of the existing analyses to include corporate governance variables and other factors and are therefore able to substantially contribute to the understanding of bank failure reasons. Our most important contribution is the analysis of detailed ownership and management structure variables in the standard logit regression model of default.

The distress of the banking system in the wake of the recent financial crisis has triggered a discussion about the role of corporate governance structures in the stability of financial institutions. Politicians (e. g. , the Financial Crisis Inquiry Commission Report, 2011), think tanks (e. g. in the Squam Lake Working Group on Financial Regulation Report, February 2010), NPOs (such as in the OECD project report on Corporate Governance and the Financial Crisis, 2009), and academic researchers (an overview of scholarly papers regarding corporate governance and the financial crisis is provided by e. g.

Mehran, Morrisson and Shapiro, 2011) have recently not only intensely discussed, but also strongly acknowledged, the importance of corporate governance for bank stability. The discussions resulted in a number of actions from regulators addressing corporate governance in banks, such as restrictions on compensation and perks under TARP, various compensation guidelines set forth by the G20, or “clawback” clauses for executive compensation in addition to guidance for deferred compensation in Dodd-Frank. Banks even started to implement voluntary “clawback” clauses for bonus payments (such as Lloyds TSB) in addition to these mandatory clauses.

However, the finding that corporate governance has implications for bank stability was already established long before the recent financial crisis. Several studies such as Saunders, Strock and Travlos (1990), Gorton and Rosen (1995), and Anderson and Fraser (2000) show that governance characteristics, such as shareholder composition, have substantial influence on banks’ 6 overall stability. Their findings support that bank managers’ ownership is among the most important factors in determining bank risk taking.

The general finding in all studies is that higher shareholdings of officers and directors induce a higher overall bank risk taking behavior. Saunders, Strock and Travlos (1990) show this for the 1979-1982 period in the US, and Anderson and Fraser (2000) confirm this for the 1987-1989 period. Although Gorton and Rosen (1995) obtain the same result for the 1984-1990 period, they additionally show that the relationship between managerial shareholdings and bank risk depends on the health of the banking system as a whole: it is strongly pronounced in periods of distress and might reverse in times of prosperity.

Pathan (2009) provides empirical evidence for the period 1997-2004 that US bank holding companies assume higher risks if they have a stronger shareholder representation on the boards. Based on these findings, we have strong reason to believe that corporate governance structures might also have an influence on bank default probability. In light of the recent financial crisis, some studies, such as Beltratti and Stulz (2012) and Erkens, Hung and Matos (2012), analyze bank ownership structures with special regard to bank risk. Testing an international sample of large publicly traded banks, Beltratti and Stulz (2012) find that banks with better governance (in terms of more shareholder-friendly board structures) performed significantly worse during the crisis than other banks and had higher overall stability risk than before the escalation of the crisis. Specifically, they find that banks with higher controlling shareholder ownership are riskier. This result is confirmed by Gropp and Kohler (2010).

Erkens, Hung and Matos (2012) analyze the influence of board independence and institutional ownership on the stock performance of a sample of 296 financial firms (also including insurance companies) in over 30 countries over the period 2007-2008. They find that banks with more independent boards and greater institutional ownership have lower stock returns. Also testing an international sample, Laeven and Levine (2009) show that banks with a more diversified and outsidercontrolled shareholder base have an overall lower risk structure than banks with a highly concentrated hareholder base in which most of the cash-flow rights pertain to one large (inside or outside) owner. Kirkpatrick (2008) also establishes that weak corporate governance in banks 2 Another corporate governance-related body of research focuses on compensation structures in banks with special regard to risk. Among the most recent works on bank management compensation and risk taking behavior are Kirkpatrick (2009), Bebchuk and Spamann (2010), DeYoung, Peng, Yan (2010), Fahlenbrach and Stulz (2011), and Bhattacharyya and Purnanandam (2012). leads to inadequate risk management, especially insufficient risk monitoring through the board, a factor which contributed greatly to the bank instabilities during the crisis. 3 Although the existing body of research has clearly established a connection between governance and bank risk taking behavior, none of the studies investigates the influence certain governance characteristics might have on bank default. The risk variables most often investigated are the stock price (e. g. , Beltratti and Stulz, 2012), returns (e. g. Gropp and Kohler, 2010), lending behavior (e. g. , Gorton and Rosen, 1995), or general stability indicators, such as the Z-score (e. g. , Laeven and Levine, 2009). Standard governance proxy variables are managerial shareholdings (e. g. , Anderson and Fraser, 2000), bank insider shareholdings (Gorton and Rosen, 1995), the ownership percentage of the single largest shareholder (Beltratti and Stulz, 2012), or the shareholder friendliness of the board (as developed by Aggarwal, Erel, Stulz, and Williamson, 2009, and used by e. g.

Beltratti and Stulz, 2012). Our paper offers three important contributions to the literature. We are the first paper to combine a range of these factors by investigating the influence the ownership and management structures in banks may have on their default probability. We are the first paper to differentiate between top- and lower-level shareholdings as well as between outside and inside director shareholdings. Finally, our paper is the first to analyze the influence of management structures on bank default probability. II. Data A. Sample Selection

Our main data set is a collection of more than ten different data sets merged manually on the bank level. We start with the population of US commercial banks using the FFIEC Call Report data set to collect bank balance sheet, income statement, and off-balance sheet data for each 3 As noted above, Berger and Bouwman (2012) include institutional block ownership, bank holding company membership, and foreign ownership as control variables in models of bank survival and market share. They do not find strong, consistent results for any of these variables. 8 bank. We exclude systemically important financial institutions (SIFIs), commercial banks with at least $50 billion in total assets (as defined by Dodd-Frank), as none of these institutions failed during the crisis, perhaps because of the TARP bailout and/or extraordinary borrowing from the discount window. 5 These data are augmented by two additional data sets containing general economic indicators on the state level. The real estate price development is measured using the quarterly returns of the seasonally-adjusted Federal Housing Financing Agency (FHFA) house price inflation index for the state.

The quarterly percentage change in state GDP is taken from the Federal Reserve Bank of St. Louis “Federal Research Economic Database” (“FRED”). The fourth data set we use contains detailed information on the annual census-tract- or MSA (Metropolitan Statistical Area)-level mortgage lending in the United States. This data set is referred to as the “Home Mortgage Disclosure Act” or “HMDA” data set, obtained through the Federal Financial Institutions Examination Council (FFIEC).

This data contains the total amount and volume of mortgage loans by year and census tract/MSA, both on an absolute level as well as broken down by borrower characteristics. We classify each mortgage granted to a borrower with an income of less than 50% of the median income in the respective census tract or MSA as “subprime. ” Although we acknowledge that borrowers falling into this income group might also be classified as “prime” borrowers in some cases, we believe it to be a fair assumption that mortgage borrowers of this category can be deemed as rather high-risk borrowers, and hence we group these as “subprime. We include the ratio of originated subprime mortgage loans to total originated mortgage loans in our data set calculated on census tract or MSA level. We use the subprime variable and the Herfindahl Hirschman Index (HHI) of local market concentration as measures of competition. The HHI is based on the FDIC Summary of Deposits data on the branch level. We use each bank’s share of deposits by branch in each rural county or MSA market for these calculations, and take weighted averages across markets for banks in multiple local markets using the proportions of total deposits as the weights. 4 Merged or acquired banks are treated as if the involved banks had been merged at the beginning of the observation period, by consolidating the banks’ balance sheets. As a robustness check, we exclude all merged and acquired banks from our data set. Results remain unchanged. 5 We also exclude all savings institutions with a thrift charter obtained through the Office of Thrift Supervision. This also includes all failed thrifts and thrift SIFIs (such as Washington Mutual and IndyMac).

We do so for reasons of comparability and to obtain a homogenous sample of commercial bank failures only. 6 We use total deposits in calculating the HHI because it is the only variable for which bank location is available. 9 In a next step, we collect data on corporate governance, specifically, ownership and management measures. The information is taken from four sources: the Mergent Bank Database, the SEC annual bank reports publicly available through the SEC’s EDGAR website, the FDIC Institutions data, and CRSP.

The Mergent data base contains detailed ownership and management information for 495 US commercial banks (both stock-listed and private). We specifically use information on each bank’s shareholders, their directors, and officers as well as on the other corporate insiders. To expand the sample, we complement the Mergent data base with the information given in the annual reports filed with the SEC of each bank with registered stock. The information on whether a bank is in a multibank holding company or not is taken from the FDIC Institutions data set, obtained through the official FDIC website.

Public banks are all banks or banks in bank holding companies (BHCs) with SEC-registered shares which are publicly listed and traded on a United States stock exchange over the observation period. We treat subsidiaries of multibank holding companies as public banks if their respective BHC is publicly listed. Information on trading and listing is obtained from CRSP. Banks with (CUSIP registered-) shares which have been sold in private placements are treated as privately-owned banks. All banks without a stock listing and without a stock-listed BHC are treated as private banks.

In a last step, we have to determine which banks failed within our observation period. As we only focus on US commercial bank failures in the recent financial crisis of 2007-2010, we use the FDIC Failed Institutions list as reported by the FDIC. 7 This list contains a detailed description of each failure of an FDIC-insured commercial bank or thrift, including the name of the bank, the exact date of failure (i. e. , when the bank was put into FDIC conservatorship), its location, the estimated cost of the failure to the FDIC, as well as information on the acquiring institution or liquidation of the failed bank.

This list allows us to compile the data set of all failed institutions which are eligible for the analyses in our paper. To gather additional information on each failure, we use multiple sources. First, we employ the Material Loss Reports (MLRs) published by the FDIC as part of their bankruptcy procedure for all material bank failures. 8 In it, the FDIC provides a detailed report on the causes for the failure of the bank, whether or not the failure was caused by the bank’s management and its (lack of)                                                              7 As obtained through the FDIC website: http://www. dic. gov/bank/individual/failed/banklist. html The FDIC publishes Material Loss Reports for all bank defaults which result in a “material loss” to the FDIC insurance fund. On January 1st 2010, the threshold for a “material loss” to the FDIC fund was raised from $25 million to $200 million. 8 10 risk management, and whether or not the failure could have been anticipated by the regulatory and supervisory authorities of the bank. For failed institutions for which no MLR was published, we gather news wire articles, press releases or reports from newspapers located in each bank’s local market.

The information we take from these multiple sources is: the exact failure reason, whether or not bad risk management was among the causes for the failure, whether or not regulatory action had been taken against the failed bank (especially cease-and-desist orders), and whether or not the failure came as a surprise to the regulatory and supervisory authorities. We use one additional source to determine the surprise of each bank’s failure: stability reports (“LACE Reports”) published by Kroll Bond Ratings, an independent firm specialized in rating banks and other financial services firms.

These reports contain a rating scheme for each bank (based on a number of standard rating indicators) ranging from A (best) to F (worst). As the ratings are published quarterly, we are able to determine whether or not a bank has a rating better than “F” in the quarter prior to failure. We deem any failure as “surprising” if either the MLR specifically states that it was surprising or the LACE report shows that the failed bank’s rating was better than “F” in the quarter prior to failure.

This leaves us with a data set of 249 default banks and 4,021 non-default banks. All bank failures occur in the period 2007:Q1 to 2010:Q3. For the regressions we obtain a total of 79,984 bankquarter observations in an unbalanced panel. As corporate governance information cannot be obtained for all banks, we exclude all failed and non-failed banks from our subsample of banks with corporate governance data for which we cannot obtain reliable information on the desired ownership and management variables.

Our final subsample of banks with corporate governance data consists of 85 default banks and 243 no default banks, recorded over the same period, for a total of 5,905 bank-quarter observations. A detailed description of all of the explanatory variables used in the regressions is provided in Table 1. (Table 1) B. Anecdotal Evidence on Bank Defaults We first investigate the causes of bank failures on an anecdotal level. We do so to better understand the different reasons for bank failures and to ensure that our sample of bank failures is not biased by e. . too many cases of fraud or regulatory intervention. We draw on the 11 aforementioned Material Loss Reports (MLRs) and news sources to determine that the reasons for bank failures can be clustered into six distinct groups: “General Crisis Related,” “Liquidity Problems Only,” “Loan Losses Only,” joint “Liquidity Problems and Loan Losses,” “Fraud,” and “Other. ” The MLRs and other sources reporting on the failures mentioned these six groups of failure reasons almost exclusively.

If MLRs and/or news reports do not contain a specific failure reason, but instead mention that the failure came as a result of the general economic conditions or the crisis, we label the failure as “General Crisis Related. ” As shown in Table 2, Panel A, we find that 95 out of 249 banks fall into this category. If it is explicitly mentioned that either only liquidity problems, or only loan losses, or a combination of both was the cause for the failure, we cluster the banks in the respective groups “Liquidity Problems Only,” “Loan Losses Only,” or “Liquidity Problems and Loan Losses. We find that only one bank was put into FDIC conservatorship as the result of liquidity problems only. In contrast, 106 banks’ failures were triggered by loan losses only and 22 banks defaulted after the joint occurrence of both liquidity problems and loan losses. Finally, we find that 5 banks failed or were taken into FDIC conservatorship due to management fraud. For 20 banks, a specific failure reason could not be determined; we thus label their failure reason as “Other. These anecdotal results show that loaninduced losses played a dominant role for banks’ stability during the recent financial crisis, as opposed to liquidity problems. The FDIC also publishes the estimated cost of the failure to the FDIC insurance fund. We collect and report these numbers to show the economic importance and which failure types are the most costly. The overall estimated cost of all failures in our sample to the FDIC insurance fund amount to approximately $6. 75 billion. In 2009 the fund incurred the highest cost with an estimate of $2. 6 billion from 119 failures; however, the highest insurance costs per institution were incurred in 2008, with only 20 failures resulting in an estimated cost of $2. 61 billion. The 106 loan lossinduced failures are the most costly group with a total of $2. 08 billion. Interestingly, defaults due to both loan and liquidity losses seem to be much more expensive per institution as compared with loan loss-only failures. Although the overall contribution of the insurance cost to the overall estimated FDIC losses of the loan and liquidity loss group is only slightly smaller with $2. 3 billion, this group consists of only 22 banks, as compared to the 106 bank failures in the loan loss-only group. (Table 2) 12 In a second step, we collect anecdotal evidence on the role of the banks’ management and the regulatory agencies prior to bank failure. Specifically, we determine whether or not bad risk management contributed to the default. Whenever the MLRs, other official FDIC releases, or newspaper articles mention that the bank suffered from managers’ bad risk management, we classify the respective bank as a “Bad Risk Management” bank prior to default.

Panel B in Table 2 shows that this is the case for only 18% of all defaults. The fact that not even a fifth of all bank defaults during the recent financial crisis happened due to inadequate risk control systems (or failures thereof) calls for a detailed investigation of alternative reasons for bank failures, such as the banks’ ownership and management structures. We also gather information on the actions taken by the regulatory and supervisory agencies prior to the default. Supervisory actions prior to default (especially cease-and-desist orders to prevent the bank from failing) are used in only 7. % of all defaults. Based on the MLRs and the LACE ratings, we also find that only 13. 6% of all bank failures came as a surprise and were neither anticipated by a rating agency nor by the supervisory authority. According to Panel B in Table 2, one explanation for this rather low percentage of surprises might be that most of the surprising failures occurred at the onset of the financial crisis, when market participants have not been able to predict the severity of the crisis, while in 2009 and 2010 more banks failed but this was expected more often.

Taken together, Panel B in Table 2 shows that our sample of bank failures does not put too much weight on potentially distorting factors as for example regulatory intervention or fraud and emphasizes the requirement of an investigation of alternative reasons for bank failures, such as the banks’ ownership and management structures. C. Corporate Governance and Bank Defaults Table 3 shows summary statistics of the ownership and management data of our sample banks.

We report summary statistics for the total sample, as well as broken down by default and no default banks, bad risk management, banks subject to cease-and-desist orders prior to default, and surprising versus non-surprising failures. We define “Outside Directors” as members of a bank’s board of directors, who do not perform any function other than being a board director in the respective bank. The literature on corporate governance also refers to this group as “independent directors. As noted above, we define “Chief Officers” as all bank managers with a “chief 13 officer” position. “Other Corporate Insiders” are all bank employees holding lower-level management positions in a bank, such as vice presidents, treasurers, or department heads. Note that these “Other Corporate Insiders” are neither “Chief Officers” nor members of the bank’s board of directors. The shareholdings are determined based on the Mergent data base or SEC filings. The data contain name, title, and the amount of shares held by each manager.

The shareholding variables are normalized by the number of the bank’s outstanding shares and the numbers of outside directors, chief officers and other employees are scaled by the board size. 9 Table 3 reports that, on average, default banks have much lower shareholdings of outside directors, slightly lower shareholdings of chief officers, and much higher shareholdings of other corporate insiders, as compared to no default banks. Additionally, the CEO is the single largest shareholder in some of the default banks. This is never the case in no default banks.

In terms of management structures, we find that default banks have smaller boards, fewer outside directors and more chief officers relative to their board size, and the Chairman is less often also the CEO than in no default banks. (Table 3) These values paint an interesting picture of the ownership and management characteristics of default and no default banks in our sample. Table 3 provides empirical evidence that default banks tend to be characterized by fewer shareholdings of outside directors and chief officers and larger shareholdings of lower level management.

A tentative conclusion of these descriptive results could be that the incentives are set very differently in default and no default banks. In no default banks, more than 80% of all shares are held by chief officers, who are responsible for the continuation of bank’s operations in the long term, or by outside directors, who are responsible for the oversight of these operations. Furthermore, outside directors and chief officers are publicly known figureheads of the banks. This might imply that their personal reputation is connected to the bank’s performance and survival, at least to some extent.

In contrast, lower-level management, such as vice-presidents or treasurers, hold more than 50% of all shares in default banks. This group is neither publicly known nor held responsible in public for the failure of the bank, even though they may exert a tremendous amount of direct influence on the actual risk 9 Note that the scaling with the board size does not imply that the sum of the three variables adds up to one because other corporate insiders are not members of the board while also chief officers are not always members of the board. 14 taking of the bank in its daily operations. 0 The position of lower level management is equivalent to equity holders in the classic Merton (1977) firm value model which states that shareholders of insured banks have a moral hazard incentive to increase variance of returns, since the assets of the bank can be put to the FDIC in the event of default. This incentive may be less for the outside directors and chief officers who are publicly known and vilified in the event of default as compared to opaque lower level management. Accordingly, Table 3 suggests that outside directors and chief officers behave more responsibly in terms of risk taking when they have large stakes in the bank.

In contrast, other non-executive corporate insiders tend to increase risk taking when they hold shares of the bank. We investigate this result in more detail in the next section in a multivariate setting. Looking at the ownership structures of default banks with bad risk management, we find that they have fewer outside director shareholdings, fewer other corporate insider shareholdings and larger chief officer shareholdings as compared to banks where bad risk management is not mentioned.

These exact same shareholder structures are featured by default banks against which cease-anddesist orders had been issued in comparison to banks without such orders before failure. Regarding the management structures of banks with bad risk management prior to default, we find that they are characterized by smaller board sizes, fewer chief officers and fewer outside directors relative to their size.

Again, the exact same characteristics can be seen in banks against which cease-and-desist orders had been issued before default, except for the board size, which is slightly higher in banks with cease-and-desist order. These numbers allow for two tentative interpretations regarding the existence of bad risk management: first, banks run by managers facing little oversight through fellow corporate insiders or outside shareholders are more likely to be able to exercise bad risk management, causing the bank to fail.

Second, the regulators might be aware of the bad risk management situation in these banks, but act to no avail, i. e. issue ceaseand-desist orders against the banks without being able to save them from defaulting. Interestingly, the ownership and management characteristics of bad risk management and ceaseand-desist-banks are also mostly shared by banks whose failure came as a surprise to markets and regulators. As compared to banks whose failures were more predictable, they have fewer outside                                                              10

We acknowledge that there are a few exceptions, such as Nick Leeson, Jerome Kerviel, and Bruno Iksil, who became known to the public. However, individual traders have to severely cripple their financial institutions (with losses, only attributable to them, in the billions) before being in the news. Additionally, all of these now infamous cases were based on fraudulent risk taking, as opposed to risk taking within the allowed boundaries. The news on these tail events also supports the notion that lower-level employees may have a tremendous impact on bank risk. 5 directors and other corporate insiders as shareholders. In terms of management, they have slightly smaller boards, more chief officers and outside directors relative to their board size. Only the number of shares held by chief officers is lower for surprising failure banks, a characteristic in which they differ from the bad risk management and cease-and-desist order banks. These governance features can be a sign of limited outside control of the bank’s executive management.

As a result, executive managers might have been able to hide the true financial situation of the bank from regulators (in spite of a possibly higher scrutiny expressed by the cease-and-desist orders) and other stakeholders until the very end, either in an attempt to rescue the bank or for mere fear of admitting the failure of the bank. These structures might also allow for gambling for resurrection in an attempt to save the bank. Without outside control, the managers could have taken on excessive risks with promising high returns in a last effort to rescue the bank.

We finally report information if the bank is publicly traded versus privately owned and if it is organized in a multibank holding company as this also describes a bank’s ownership structure. We also include these factors because publicly traded banks and banks in multibank holding companies might have access to additional capital markets besides only the bank’s internal funds (or the internal funds of the holding company) which, especially in times of distress, might serve as a source of financial strength.

About 27% of all default and 41% of all no default banks in our sample were publicly traded over the observation period. Only 12% of the default banks and 14% of the no default banks were part of a multibank holding structure. We find similar numbers for the risk management, cease-and-desist order and non-surprising failure groups. Table 3 indicates that certain corporate governance characteristics, such as limited outside control of management through fellow top-level employees or through independent outside directors as hareholders, can foster bad risk management and the concealment of a bank’s true financial situation. If managers are inadequately monitored, they lack incentives to act in the best interest of shareholders. The fact that a small number of banks failed surprisingly might be an indication that it can be difficult for the regulator to recognize or anticipate problems if the managers are willing and able to conceal them. Our results are therefore in line with the findings of Anderson and Fraser (2000), who show that management shareholdings and risk taking are positively related.

The results are also consistent with e. g. Laeven and Levine (2009), who show that banks with more concentrated ownership and management structures also exhibit higher overall risk 16 taking. We therefore substantially extend this body of literature by showing that the management shareholdings also have implications for the most extreme case of bank risk, which is default. D. Summary Statistics of Accounting, Competition and Economic Variables Table 4 provides summary statistics on the variables other than the corporate governance variables.

It shows that default banks differ strongly from no default banks, especially in terms of general characteristics, business focus, and overall stability. As can be seen in the table, default banks are on average larger than no default banks as measured by asset size, have a lower capital ratio, lower loan volume relative to their assets, stronger loan growth as well as weaker loan diversification as measured by the loan-concentration HHI. On the funding side, default banks rely more on brokered deposits and less on retail deposits than no default banks.

Not surprising, default banks also perform worse in terms of overall stability than no default banks: they have a negative return on assets and a much higher non-performing loan ratio. Interestingly, default banks have a lower exposure to mortgage-backed securities (MBS) than no default banks. Note that default banks do not have any off-balance sheet derivative exposure (not shown in the table), which is why we exclude this factor in our regression analyses. (Table 4) Table 4 also shows the differences in accounting data between default and no default banks for our sample with available corporate governance data.

While most differences and values are very comparable between our full data sample and our corporate governance sample, one difference is asset size. The banks for which we are able to obtain ownership and management data are larger than the average banks in the full sample. However, this is to be expected, as mostly large banks register shares with the SEC, which in turn requires them to publish ownership and management data. We will therefore also test our results with respect to a possible sample selection bias in our following analyses with a specific focus on bank size and publicly traded shares.

Finally, in the last three columns, the table shows the development of accounting variables from two years prior to default until the quarter immediately preceding the default. In line with expectations, we observe on average a very strong decline of the capital ratio, the return on assets, and the loan growth, paired with a strong increase in the ratio of non-performing loans 17 over the last two years before default. This confirms a rapid decline in bank profitability and a deterioration of stability.

Interestingly, banks seems to strongly increase the amount of retail funding in the form of brokered deposits, from roughly 9% two years before default up to 18% in the quarter before default. At the bottom of Table 4, we show summary statistics for the market competition and state economic condition variables. For market competition, we report the deposit-based HHI of market concentration and the subprime lending ratio of originated subprime mortgage loans to total originated mortgage loans on census tract or MSA level.

The state economic condition variables include the house price inflation indicator, calculated using the average quarterly returns of the seasonally-adjusted Federal Housing Financing Agency (FHFA) house price inflation index for the bank’s states, and the quarterly percentage changes in state GDP. 11 Comparing the values for default and no default banks, we find that default banks face slightly higher market concentration, competitors with lower subprime exposure, a steeper decrease in house price values and a slightly lower GDP growth than no default banks.

These differences are confirmed for our subsample of banks for which corporate governance data is available, with the exception of market concentration, which is slightly lower for default banks than for no default banks. We do not detect any substantial change in the market competition variables over the twoyear period leading up to defaults. Market concentration only increases marginally, subprime risk remains virtually unchanged. We see slightly stronger variations in the two state economic indicators.

The FHFA house price index stays negative throughout the period, decreasing slightly in the year before the default but moving to a slightly higher value in the quarter before default. The same goes for the GDP growth, which turns negative in the year before default, but moves back up to slightly positive values in the quarter before default. We will forego a detailed analysis of these univariate statistics and instead rely on the multivariate regression results to interpret the variables’ influence on bank defaults in greater detail. 11 We use the state economic variables from the states in which the banks have deposits.

For banks with branches in different states, we calculate the weighted exposure to each state through the FDIC Summary of Deposits data, as previously used for the HHI calculation, to obtain a weighted exposure to the state economic variables. 18 III. Multivariate Analysis A. Methodology In this section, we investigate the possible influence factors have on bank failure in a multivariate logistic regression framework with an indicator variable for bank failure in the default quarter as dependent variable and a number of predictor variables.

By choosing this model specification, we follow a broad body of literature having established this approach as standard procedure (e. g. , Campbell, Hilscher, and Szilagyi, 2008), which was pioneered for banks by Martin (1977). We include a total of five sets of explanatory variables: accounting variables, corporate governance variables, market competition measures, state economic indicators, and bank regulator variables. We combine these sets of variables to test eleven different model specifications, in which each specification is comprised of either a different set of variables or a different subsample.

As reported in Table 4, we have a main sample of 249 bank defaults and 4,021 no default banks. We also have a subsample comprised of 85 default banks and 243 no default banks for which we obtain corporate governance data of a bank’s ownership and management structures. The different model specifications alternate between these two data samples. We include both subsamples in our analyses to show that our data does not suffer from selection biases – i. e. , that similar results hold for banks with and without available corporate governance data.

We test the contribution the different variable sets or combinations thereof have on the explanatory power of our model of bank default. We additionally test each model for three different time periods: the quarter immediately preceding the default, as well as one and two years prior to default. By also testing the time component, we follow a body of research (e. g. , Cole and Gunther, 1998; Cole and White, 2012) which shows that the predictive power of binary regression models in the context of bank defaults varies over time.

Table 5 contains eleven models together with an additional model in which we account for a possible sample selection bias. Models I and II test only the influence of accounting variables on bank defaults, separately for all banks (Model I) and the subsample of banks with available corporate governance data (Model II). These models most closely resemble the extant empirical literature on bank defaults. Models III and IV focus on the corporate governance sample only. They incorporate accounting variables in addition to six corporate governance ownership variables (Model III) and five corporate governance management variables (Model IV).

Model V subsequently investigates the joint influence of the accounting and all the corporate governance variables on bank default. Models VI-VIII expand 19 this setting by adding market competition variables, the bank’s local market power and its competitors’ subprime loan exposure (Model VI), by adding economic indicators for the state house price inflation and the quarterly change in state GDP (Model VII), and by adding possible effects stemming from different primary federal bank regulators (Model VIII), respectively.

Models IX and X jointly incorporate these three variable sets together with accounting data and exclude corporate governance variables. Model IX does so for all banks, and Model X includes only the sample of banks with available corporate governance data. In Model XI, we include all variables. The final model, labeled “Heckman Selection Model,” presents a robustness check using a Heckman Selection model which will be explained later in more detail.

In running these tests, we are primarily interested in three questions: First, how do the different sets of variables and combinations thereof contribute to the overall explanatory power of the regression? Second, which variables are statistically significant in explaining bank failures? Finally, at what point in time prior to the actual default date do sets of variables or individual variables have the largest explanatory power in predicting bank defaults?

The accounting variables include measures of the bank’s size, return on assets, capitalization, loan portfolio composition, funding structure, securities business, and off-balance sheet activities. By doing so, we follow a large number of articles on bank default (e. g. ; Lane, Looney, and Wansley, 1986; Whalen and Thomson, 1988; Espahbodi, 1991; Logan, 1991; Thomson, 1991; Cole and Gunther, 1995, 1998; Kolari et al. , 2002; Schaeck, 2008; Cole and White, 2012) who show that accounting variables have significant explanatory power in predicting bank default.

By including the log of total assets, the ratio of equity to assets, and the return on assets, we follow Cole and Gunther (1995, 1998), Molina (2002) and others who show that these variables can serve as valid indicators for size, capitalization, and profitability. To measure the composition and stability of the bank’s loan portfolio, we include five accounting variables. We use the ratio of total loans to total assets, excluding construction and development (C&D) loans, as well as the ratio of C&D loans only to total assets.

In doing so, we follow Cole and White (2012), who show that C&D loans have strong explanatory power in predicting bank defaults, especially in the recent financial crisis. We account for this finding by investigating the singular influence of C&D loans in a bank’s overall loan portfolio on the likelihood of bank failure, as well as incorporating the ratio of the bank’s remaining loans to its assets. We also include a loan concentration index, the growth of a bank’s loan portfolio and the ratio of non-performing loans to total loans in the 20 regressions to account for concentration and credit risk.

Short-term funding and illiquidity risks are measured by the ratios of short-term deposits to assets and brokered deposits to assets, respectively. We additionally include the ratio of mortgage-backed securities (MBS) to assets. Finally, the ratio of unused commitments to assets is included as a measure for off-balance sheet risks. We do not include the off-balance sheet derivative exposure of the banks in our analyses as no default bank in our data sample has any exposure to these in any time period. The corporate governance variables are taken from the set of measures introduced above.

To account for the bank’s ownership structure, we include the number of shares held by outside directors, chief officers, and other corporate insider shareholders (defined as in section II. C). Each of these variables is standardized by the number of shares outstanding of the respective bank. We also include a dummy variable indicating whether or not the bank’s CEO is also its single largest shareholder. In addition, we include dummy variables for whether a bank is organized in a multibank holding company, and whether the bank or its BHC is publicly traded.

As mentioned before, publicly traded banks and banks in multibank holding companies might have access to further capital markets which might serve as an additional sources of financial strength. 12 By including these ownership variables in our multivariate regression framework, we account for the previous literature on the relationship between banks’ ownership structures and bank stability, such as Saunders, Strock and Travlos (1990), Gorton and Rosen (1995), Anderson and Fraser (2000), Caprio, Laeven and Levine (2003), Laeven and Levine (2009), and Pathan (2009).

We thereby moreover investigate if the stark differences in the descriptive statistics between default and no default banks in terms of ownership structure also hold in a multivariate setting. To further proxy for the bank’s management structure, we include the number of outside directors, the number of chief officers, the number of other corporate insiders, all scaled by the bank’s board size, to account for relative differences in management and oversight among banks. 3 We additionally employ (the logarithm of) the number of members of the board of directors (“Board Size”) and an indicator variable if the CEO of the bank is also its Chairman. We are thereby the first to explicitly investigate the impact of a bank’s management structure on bank default. 12 As a robustness check, we replace the multibank holding company (BHC) dummy with a dummy variable indicating whether or not the bank is part of any BHC structure, either single-bank or multibank. The results remain unchanged. 13

As a robustness test, we also standardize the number of outside directors, chief officers, and other corporate insiders variables by the asset size of the bank. The results remain unchanged. 21 The set of variables on bank competition contains the Herfindahl Hirschman Index (HHI) of bank market power on MSA or rural county level, its squared value, as well as the ratio of originated subprime mortgage loans to total mortgage loans originated on census tract/MSA level. We use the HHI as a proxy for the competition a bank faces in its local market.

To calculate the HHI, we define the deposits held by each bank’s branches as the product market, the rural county level or MSA in which the bank’s branches are located as the local market, and each quarter as the temporal market. Using the standard HHI calculation method, we sum up each bank’s squared market share in each market and quarter. For banks which are active in multiple markets, we use the weighted average across each market to determine the HHI. A broad body of research has shown that competition is an important stability factor for banks.

According to the literature, higher market power may result in either a higher or a lower probability of bank failure. In the traditional “competition-fragility” view, higher market power increases profit margins and results in greater franchise value with banks reducing risk taking to protect this value (e. g. , Marcus, 1984; Keeley, 1990; Demsetz, Saidenberg, and Strahan, 1996; Hellmann, Murdock, and Stiglitz, 2000; Carletti and Hartmann, 2003; Jimenez, Lopez, and Saurina, 2007). Thus, a higher HHI may result in a lower probability of failure.

In contrast, in the “competition-stability” view, more market power in the loan market may result in higher bank risk and a higher probability of failure as the higher interest rates charged to loan customers make it harder to repay loans and exacerbate moral hazard and adverse selection problems (e. g. , Boyd and De Nicolo, 2005; Boyd, De Nicolo, and Jalal, 2006; De Nicolo and Loukoianova, 2007; Schaeck, Cihak, and Wolfe, 2009). Martinez-Miera and Repullo (2010) furthermore argue that this effect may be nonmonotonic.

We control for this possibility by also incorporating the squared value of local market power. Berger, Klapper, and Turk-Ariss (2009) argue that the effects of both views may be in place – banks with more market power may have riskier loan portfolios but less overall risk due to higher capital ratios or other risk-mitigating techniques – and find empirical evidence of these predictions. In addition to the HHI, we also include in our analyses the ratio of originated subprime mortgage loans to total mortgage loans originated to account for the particularities of the recent financial crisis.

As is known now, the excessive origination of mortgages to borrowers with subprime creditworthiness led to high losses for banks in the recent financial crisis. Additionally, prior research establishes that real estate loans in general also played an important role for bank stability in earlier crises (e. g. , Cole and Fenn, 1995). We include the average subprime mortgage loan ratio in a bank’s census tract to measure the subprime risk exposure of 22 the bank’s local competitors.

Based on the aforementioned literature and the characteristics of the recent financial crisis, we hypothesize that stronger subprime exposure of a bank’s competitors could increase the competitors’ risk structures and therefore also their default risk, which might have helped the observed banks survive the crisis by weakening their competitors. The set of v

Caltex was incorporated in 1936 as the consequence of a amalgamation between U.S. based oil companies Socal and Texaco. Caltex is the largest seller of crude oil merchandises and top convenience retail merchant in Australia. Caltex besides have operations in different states. The chief end of the concern is safe and dependable supply for all clients. We continue to construct our place as Australia ‘s taking provider of crude oil fuels by farther investing in our supply concatenation and selling assets. Caltex is an independent company listed on the Australian Securities Exchange ( ASX ) and incorporated in Australia. Chevron Corporation holds a 50 % involvement in Caltex Australia Limited. The staying 50 % ownership of Caltex is made up of more than 27,000 stockholders. Although Chevron has a big retention, Caltex operates with an independent board and direction. ( Caltex 2011 )

Corporate administration refers to the set of rules and procedures by which a company is governed. These rules provide guidelines sing the way in which the company can be controlled so that it can carry through its ends and aims in a mode that adds to the value of the company and is besides good for all stakeholders in the long term. Stakeholders would include everyone from the board of managers, stockholders to clients, employees and society. Corporate administration is concerned carry oning the concern with all unity, being crystalline, doing all necessary determinations, following with all the Torahs of the land and committedness of transporting concern in an ethical mode. More over corporate administration is besides known to be one of the standards that foreign investors are mostly depending on when make up one’s minding on which companies to put in. Additionally, the portion of monetary value of the company is besides known to be positively influenced by corporate administration. ( Economictimes 2009 )

Cardinal Elementss of Corporate Governance

For such big houses like Caltex, there are many cardinal elements of corporate administration that are important for the company and they help in guarding against corporate failures. These elements include:

Transparency

Conflict of involvements

Issue of Integrity

To guard against corporate failures these countries should be taken attention of in order to avoid any unanticipated amendss to the company.

Transparency:

Stakeholders will hold more assurance in the direction if a company is crystalline plenty and studies stuff facts in existent clip. Cost of capital would travel down because stakeholders will be more willing to put in the company. Jointly, all these factors enable the house ‘s productive capacity and productiveness to better ( Economybuilding 2011 ) .

For investors, transparence provides greater protection in all facet of corporate administration. An investor would cognize how the house is executing if there is transparence in the organisation. In add-on to that transparence in compensation of employees and managers, gross revenues inducements and other human resource patterns decreases the opportunity for misdirection and unethical patterns, which may harm the house. Effective corporate administration besides helps attracts and retain employees ( Webster 2013 ) .

Organizations must follow with the rules of transparence to carry on concern in true, just, symmetrical and timely mode all the information reflecting the direction and activities. These regulations should non be set merely as a formal construct of being of corporate administration regulations. ( Iconsejeros 2005 )

Conflict of Interest:

The companies which are non focussed towards the involvement of stockholders by and large experience failure because they value their involvement at the disbursal of others. In the long tally, to be successful a house requires protecting and valuing the involvements of stockholders instead than the house ‘s involvement. ( Turner n.d. )

Ranging from local to planetary, in public and corporate domain, struggle of involvement occurs at all degrees of administration. Decision doing procedures are frequently distorted by struggles of involvement and generate unfavourable or inappropriate results for the house, thereby sabotaging the operation of public establishments and markets. However, the current tendency towards ordinance, which seeks to forestall and pull off struggles of involvement, has its monetary value. The suppression of decision-making procedures, the loss of expertness among decision-makers and a barbarous circle of misgiving are the drawbacks. ( Handschin 2012 )

Large houses should hold a process established for the control and declaration of any struggle of involvement which may originate within the organisation. Audit commission or the Remunerations commissions should reexamine if any state of affairs of struggle of involvement arises between the company and its stockholders, managers or officers. ( Iconsejeros 2005 )

Stockholders can non supervise themselves the directors that they hire, so they appoint board of managers to do certain no struggle of involvement arises which may travel against the stockholders of the house. In order to avoid any failures house should do certain that their board is independent, resourceful and have the necessary experience to judge the actions of senior direction. ( Kayanga 2008 )

Issue of Integrity:

Presently, the chief issue in the field of corporate administration is non whether most listed companies follow the assorted commissariats but the chief focal point is whether the top direction of large organisations is seen as possessed of unity in the eyes of public. ( Applied-Corporate-Governance 2013 )

Recent high profile concern failures raise issues which are dejecting from many positions, domestic and international. These failures raised inquiries sing the responsibilities and patterns of managers, directors, hearers, attorneies, investing bankers, analysts and evaluation bureaus. Assurance sing cheque and balances support the operation of our market has been shaken severely. These issues threaten the credibleness of corporate and fiscal leading. The most major deductions of recent events of failure relate to corporate administration and public presentation of Board of Directors. Bottom line for all big organisations is that board is responsible for the entity ‘s unity as it is the ultimate authorization for the governed entity. Individually, every manager needs to take duty for the unity of the organisation he or she serves. Directors must see the organisation ‘s unity as an extension of their ain. ( Stalwart 2002 )

Nowadays corporate governance is seen as the key of attracting investors. Capital flow seems directed towards the companies, which practice fair and transparent ways of governing their organizations. With the changing global business scenario the need of understanding and effective practice of fair and technologically advance corporate governance has also increased. In my speech I will first explain the notion of Corporate Governance.

ICAEW (2002) has explained corporate governance in a very effective and comprehensive manner as “ Corporate governance is commonly referred to as a system by which organizations are directed and controlled. It is the process by which company objectives are established, achieved and monitored. Corporate governance is concerned with the relationships and responsibilities between the board, management, shareholders and other relevant stakeholders within a legal and regulatory framework.”

Sir Adrian Cadbury (1992) defined corporate governance as ‘the whole system of controls, both financial and otherwise, by which a company is directed and controlled’.

There are no hard and fast rules for corporate governance, which can be prescribed for all the countries. These rules can be different for different countries according to their needs and cultural settings. According to ICAEW (2002) with all the contrasts present in the rules and regulations of different countries emphasis is given to generic corporate governance principles of responsibility, accountability, transparency and fairness.

Responsibility of directors who approve the strategic direction of the organization within a framework of prudent controls and who employ, monitor and reward management.

Accountability of the board to shareholders who have the right to receive information on the financial stewardship of their investment and exercise power to reward or remove the directors entrusted to run the company.

Transparency of clear information with which meaningful analysis of a company and its actions can be made. The disclosure of financial and operational information and internal processes of management oversight and control enable outsiders to understand the organization.

Fairness that all shareholders are treated equally and have the opportunity for redress for violation of their rights. According to Meigs et al. (1999) this information meets the needs of users of the information-investors. Creditors, managers, and so on-and support many kinds of financial decision performance evaluation and capital allocation, among others. (P.07)

Corporations resolutely focus on maximizing profits and a ‘legal obligation to act in the best interests of their shareholders. By and large, this excludes acting ethically or socially responsibly…’(Slapper and Tombs, 1999).

(Shah, 2002) states that some Trans-national corporations make more in sales than the GDPs (Gross Domestic Product) of many countries. In fact, of the 100 hundred wealthiest bodies, 51 percent are owned by corporations. While this can be seen as a success story from some viewpoints, others suggest that these and other large corporations are largely unaccountable for the many social and environmental problems that they leave in their wake, and that their size means that their effects are considerable.

It is not that every single corporation is inherently bad or greedy, but commonly, the very large, multinational corporations who naturally have vested interests in international development and trade policies (like any group) are able to deploy enormous financial resources in an attempt to get favorable outcomes. The political power that is therefore held by such a small number of people impacts the planet significantly. As a result a few of these corporations make up some of the most influential sources of political and economic power.

Naturally, with such influence it is not clear  ‘who’ the regulator is. And as Clarkson’s (1999) earlier quote suggests money and power, in corporate activity, are paired. And where profit supersedes safety and power supersedes regulation there stands the conflict of interests, for the victims of corporate crime. These are for the most part neither wealthy nor powerful although, when they are liability is certainly applied copiously.

For example in the case of Enron the former chief accounting officer, Richard Causey was indicted on charges of ‘ fraud, conspiracy, insider trading, lying to auditors and money laundering for allegedly knowing about or participating in a series of schemes to fool investors into believing Enron was financially healthy’ (findlaw.com). The ‘victims’ in this case were the investors who were identifiable and influential.

Violations, which impact on financial systems, are subject to more scrupulous legislative administration, compared with social infringements (snider 1991 cited in Slapper and Tombs 1999:89). Increased attention to corporate crime would mean relating to large companies as ‘criminals’ (Slapper and Tombs, 1999). An issue, (Sullivan, 1995 cited in Clarkson, 1998) renders impossible on the basis that ‘crimes can only be committed by human, moral agents’.

Media attention will focus on financial aspects of corporate crime due to its impact on a political scale and the sensational-factor that is the ‘respectable’ figures committing crime as well a the belief/knowledge that ‘scandal sells’. Scandal, is common reference for this financial aspect but noting the influence of language Slapper and Tombs (1999) note that this sets a’ scale’ for perceptions, rendering it uncommon/unusual. Another scale, which has been set in the last few decades, is the increasing complains of the least risk disclosure by the companies in their annual reports and financial statements. This is also accompanied by the misuse of the accounting techniques by the executive officers and managers of the corporations. As in case of Enron the technique of off balance sheet reporting was used in negative manner.

Investors are often aware of the risks they take and in itself, off-balance-sheet financing is no vice. Companies can use it in perfectly legitimate ways that carry little risk to shareholders. The trouble is that while more companies are relying on off-balance-sheet methods to finance their operations, investors are usually unaware that a company with a clean balance sheet may be loaded with debt — until it is too late. (Morgenson, 2001)

A change is required in the regulations. The accounting firm should not perform the consulting and auditing services both. The Companies should be required by the Government to increase their degrees of disclosure. The top-level management should be held more responsible by tightening up the regulations. They should also be held responsible in case of any frauds and regulatory violations of their subordinates. This in turn will give rise to the sense of responsibility in the people related at all levels. (Hanson, 2002)

References

1. Cadbury Sir Adrian, (1992). Report of the Committee on the Financial Aspects of Corporate Governance, Gee & Co Ltd., UK
2. Clarkson, Max (Editor), The Corporation and Its Stakeholders: Classic and Contemporary Readings, University of Toronto Press, 1998.
3. ICAEW, (2002). What is Corporate Governance? Institute of  Chartered Accountants in England and Wales, Retrieved 30/10/2007 from <http://www.icaew.co.uk/index.cfm?AUB=TB2I_78822,MNXI_78822>
4. Hanson, K., (2002). Lessons from the Enron Scandal, interview about Enron by Atsushi Nakayama, a reporter for the Japanese newspaper Nikkei, March 5, 2002, Retrieved 30/10/2007 from http://www.scu.edu/ethics/publications/ethicalperspectives/enronlessons.html
5. ICAEW, (2002). Corporate governance developments in the UK, Institute of    Chartered Accountants in England and Wales, Retrieved 30/10/2007 from <http://www.icaew.co.uk/index.cfm?AUB=TB2I_78921|MNXI_78921&route=11295|P|47492|47496|78921>
6. Meigs, Robert F., Williams, Jan, R., Haka, Susan F. & Bettner, Mark S., (1999). Accounting: The Basis for Business Decisions, Eleventh Edition, Irwin Mc Graw-Hill, p. 07
7. Moregenson, G., (2001). Are New Woes Lurking in Financial Nether World? The Associated Press, December 23, 2001, Retrieved 30/10/2007 from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/isthisdebt.htm
8. Slapper, G.,  & Tombs, S., Longman, (1999). Getting Away with Murder, Corporate Crime, Reviewed by Chris Moore, Issue 47, May 2000
9. Shah, A., (2002). Corporations and the Environment, Page Last Updated Saturday, May 25, 2002, Retrieved 30/10/2007 from <http://www.globalissues.org/TradeRelated/Corporations/Environment.asp#Corporateinterestsandactionscanharmtheenvironment>