Bankers on the Board and CEO Turnover

• Date: 01 February 2020
• Published date: 01 February 2020
• DOI: http://doi.org/10.1111/ajfs.12288

Bankers on the Board and CEO Turnover*

Min Jung Kang**

Department of Accounting, Finance, and International Business, School of Management, University of

Michigan-Flint, United States

Andy (Y. Han) Kim

SKK Business School, Sungkyunkwan University, Republic of Korea

Jeung-Yoon Chang

SKK Business School, SungKyunKwan University, Republic of Korea

Received 1 January 2019; Accepted 23 December 2019

Abstract

The governance literature finds that independent directors from lending banks (commercial

bank directors or CBDs) bring both financial expertise and conflict of interest between share-

holders and debt holders. We examine how the presence of CBDs affects the implicit incen-

tive of CEO turnover. Using BoardEx and DealScan data, we hypothesize and find that CBDs

make the CEO turnover more sensitive to both performance and risk. Post-CEO turnover

analysis reveals that firm performance improves and risk decreases in the presence of CBDs.

Keywords CEO turnover; Banker directors; Board of directors; Commercial bankers; Corpo-

rate governance; Implicit incentive

JEL Classification: G34

*Special thanks are due to G. Geoffrey Booth and Jun-Koo Kang, who gave the authors great

support and encouragement. We also thank seminar participants at the SKKU–Peking Univer-

sity Forum; participants at the Korean Securities Association seminar; California State Univer-

sity, San Bernardino; Hofstra University; Korea University; Menlo College; Michigan State

University; Seoul National University; SKKU; and the University of Michigan-Flint. We thank

Joon Chae, Sungwook Cho, Henrik Cronqvist, Mara Faccio, C. Edward Fee, Gustavo Grullon,

Charles J. Hadlock, Jarrad Harford, Gerard Hoberg, Cliff Holderness, Mark Huson, Dirk Jenter,

Li Jin, Dong-Soon Kim, Joong Hyuk Kim, Jungwook Kim, Noolee Kim, Woo Chan Kim,

Woojin Kim, Ron Masulis, Michael Mazzeo, William L. Megginson, Hyun Seung Na,

Kwangwoo Park, Sheridan Titman, Fei Xie, and JunYang for insightful comments and

suggestions. We thank Dirk Jenter for graciously sharing CEO turnover data for the 1993–2001

period. The authors also appreciate Moody’s KMV for providing the expected default frequency

data for our sample firms. We are grateful to the excellent research assistance of Youngjae Jay

Choi, Brian He, Denise Heng, Joyce Tan, and Alvin Wei. All errors are our own.

Part of this paper comes from the first chapter of Min Jung Kang’s doctoral dissertation at

Michigan State University.

**Corresponding author: Department of Finance, School of Management, University of

Michigan-Flint, 303 E. Kearsley Street, 2138 Riverfront Center, Flint, MI 48502, United

States. Tel: +1-810-424-5313, email: kangmin@umich.edu.

Asia-Pacific Journal of Financial Studies (2020) 49, 119–152 doi:10.1111/ajfs.12288

©2020 Korean Securities Association 119

1. Introduction

Boards of directors play an important role in monitoring and advising top man-

agers (Adams et al., 2010). Above all, independent directors from commercial banks

(commercial bank directors or CBDs) receive much more attention from econo-

mists (Black and Scholes, 1973; Booth and Deli, 1999; Kroszner and Strahan, 2001;

G€

uner et al., 2008; Mitchell, 2015; S

ßis

ßli-Ciamarra, 2012; Hilscher and S

ßis

ßli-Cia-

marra, 2013; Kang and Kim, 2017; Kang et al., 2019), because they bring both

financial expertise and conflicts of interest between shareholders and debt holders.

Through career training in commercial banking, CBDs become experts in risk

management (Weinstein and Yafeh, 1998; John et al., 2008) and in processing

financial accounting information (Fama and Jensen, 1983; Weisbach, 1988). While

CBDs have a fiduciary duty to protect the shareholders’ interests that are by defini-

tion more risk-tolerant than debt holders’, they (especially those from lending

banks) have an equally important fiduciary duty to their employing banks to mini-

mize firm risk (Jensen and Meckling, 1976; Hilscher and S

ßis

ßli-Ciamarra, 2013;

Erkens et al., 2014; Kang and Kim, 2017). Kang and Kim (2017) find that CBDs

influence a CEO’s compensation structure to be less sensitive to firm risk. While

compensation is an explicit incentive, the threat of dismissal is an implicit incentive

to extract the best efforts of the agent (Gibbons and Murphy, 1990; Kwon, 2005;

Hallman et al., 2011). No paper has investigated the impact of CBDs on CEO turn-

over. Hence, we fill this gap in the literature.

If CBDs bring more financial expertise to the board, CEO dismissal would be

more sensitive to firm performance (the financial expertise hypothesis). On the

other hand, if CBDs bring conflicts of interest to minimize firm risk, CEO turnover

would be more sensitive to firm risk (the conflict of interest hypothesis). These two

hypotheses are not necessarily mutually exclusive, and testing them would reveal a

complete picture of the impact of CBDs on CEO incentives.

Using the intersection of BoardEx, DealScan, and CRSP/Compustat data from

1999–2008, we find that CEO turnover is more sensitive to performance when

CBDs are present. The effect is stronger for affiliated banker directors (ABDs).

While the average investor response to forced CEO turnover news is negative, such

announcement return is significantly positive if CBDs are present, and even more

so if prior performance was poor. Additionally, we track down the cases of forced

CEO turnovers and analyze subsequent performance under new CEOs. We find sig-

nificant improvements in operating performance for firms with CBDs, and this is

especially true when prior performance was poor. These results coherently support

the financial expertise hypothesis.

We also find supporting evidence for the conflict of interest hypothesis. The

likelihood of CEO dismissal increases as firm risk increases, especially when ABDs

are present. Our post-turnover risk analysis shows that for firms with CBDs,

idiosyncratic risk after the CEO turnover year further decreases when the prior risk

is high.

120 ©2020 Korean Securities Association

M. J. Kang et al.

Overall, we find that CBDs, especially ABDs, are a double-edged sword in pro-

viding a CEO’s implicit incentive. Their financial expertise makes CEO turnover

more sensitive to firm performance, but their conflict of interest makes the turnover

sensitive to risk, which may be against shareholders’ interests.

The remainder of this paper is organized as follows: Section 2 provides a literature

review and the main hypotheses. Section 3 describes our data and empirical methods.

Section 4 presents the main empirical findings and Section 5 concludes our study.

2. Literature and Hypotheses Development

Previous research suggests that effective boards show higher sensitivity to performance

when firing a CEO (see Weisbach, 1988; Dahya et al., 2002; Adams and Ferreira, 2009;

Dimopoulos and Wagner, 2016; Agrawal and Nasser, 2019). Wang et al. (2015) suggest

that directors’ industry expertise improves the board’s oversight role, which increases

CEO turnover–performance sensitivity. Since commercial bankers amass greater finan-

cial expertise and better debt market expertise (Fama, 1980; Diamond, 1984; Booth and

Deli, 1999; Byrd and Mizruchi, 2005; Dittmann et al., 2010), we predict that these

CBDs are better positioned to effectively work as monitors, leading CEO turnovers to

be more sensitive to firm performance (Kang and Shivdasani, 1995). In addition, ABDs

show intensive monitoring due to their affiliation with their own firm (Kang and Kim,

2017). Therefore, we predict the following:

Hypotheses 1. For firms with CBDs, forced turnover is more sensitive to firm

performance and this effect would be more pronounced as there are more ABDs.

Bankers are different from entrepreneurs in perceiving and managing risks

(Sarasvathy et al., 1998). They focus more on controlling risks and try to avoid situ-

ations where they may face higher levels of risk (Mitchell, 2015; Kang and Kim,

2017; Kang et al., 2019). This is because an increase in a bank’s tail risk imposes

more hardship and costs on its operation (Stulz, 2015; Srivastav et al., 2017). Thus,

a banker’s sensitivity to firm risk even as a board member may be a natural

response. Hence, ABDs should be particularly sensitive to risk measures for CEO

turnover decisions, which leads to our second prediction:

Hypotheses 2. ABDs will be more sensitive to firms’ risks on CEO turnover.

With respect to CEO turnover announcement, stock prices rise when forced dis-

missals are congruent with shareholders’ interests (Huson et al., 2001). And this

effect is stronger when CEOs are dismissed in firms with poor prior firm perfor-

mance or with good corporate governance (Furtado and Rozeff, 1987; Weisbach,

1988; Bonnier and Bruner, 1989; Huson et al., 2001). We predict that such a forced

turnover announcement effect will be more positive for firms with CBDs because

CBDs provide industry-specific financial expertise, are trained to monitor actively,

©2020 Korean Securities Association 121

Bankers on the Board and CEO Turnover