FINANCIAL EXPERTS ON THE BOARD: DOES IT MATTER FOR THE PROFITABILITY AND RISK OF THE U.K. BANKING INDUSTRY?

• Author: Nicholas Apergis
• Date: 01 July 2019
• Published date: 01 July 2019
• DOI: http://doi.org/10.1111/jfir.12168

FINANCIAL EXPERTS ON THE BOARD: DOES IT MATTER FOR THE

PROFITABILITY AND RISK OF THE U.K. BANKING INDUSTRY?

Nicholas Apergis

University of Piraeus and University of Derby

Abstract

In this article, I explore the relation among board-level financial expertise, profitability,

and risk with panel data from the U.K. banking industry. The empirical findings

document that collectively, financial experts have a positive influence on the

performance of banks; contribute to higher risks, especially for large banks; and

improve the stock performance of banks. Moreover, the results highlight that board-

level qualified accountants have no statistical effect on profitability, whereas financial

and banking professors, as well as financial experts from other industries, have a positive

effect. Such findings imply that these two groups of professional financial experts may

more easily adopt group-level profit enhancements. Robustness checks confirm the

results for all types of banking institutions, except those with strong real estate

portfolios. Finally, certain commercial and/or policy implications of the results are

reported.

JEL Classification: C33, G20, G21, G24, G32

I. Introduction

Fama and Jensen (1983) argue that the board of directors has great responsibility for the

effective allocation and use of corporate resources, and financial reporting and

monitoring require a certain level of financial expertise across directors, given that a key

function of corporate governance is to ensure that firms avoid bankruptcy (Darrat, Darrat,

and Amyx 2015). Moreover, board member financial acumen is important in highly

regulated financial sectors, such as banking sectors (Kim, Mauldin, and Patro 2014), and

sound accounting helps promote stewardship and supply decision-making information to

internal and external users. As a result, accounting and finance expertise on the board are

expected to be substantially linked to high-quality reporting, as well as enhanced investor

confidence (Defond, Hann, and Hu 2005; Kim, Mauldin, and Patro 2014). Harris and

Raviv (2008) also show that financial experts on banking boards imply lower costs in

acquiring information about the complexity and risks of certain financial transactions,

thus mitigating any inefficiencies in monitoring senior management.

There is a strand of corporate governance literature that explicitly examines the

role personalcharacteristics play in the managerial experienceand technical knowledge of

The author expresses his deep gratitude to a reviewer of this journal for many helpful comments and

suggestions that enhanced the merit of this work. Special thanks also go to the editor for his constructive comments,

as well as for giving him the opportunity to revise his work.

The Journal of Financial Research Vol. 0, No. 0 Pages 1–28 2019

DOI: 10.1111/jfir.12168

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board directors, and the relation between these characteristics and firm performance

(Masulis, Wang, and Xie 2012; Kim, Mauldin, and Patro 2014). Other studies, however,

find only weak evidencethat the financial expertise of the board directorsaffects corporate

results in a statisticallysignificant manner (Defond, Hann, and Hu 2005;Hoitash, Hoitash,

and Bedard 2009).My study is close to the literature that exploreshow certain governance

mechanisms, such as board structure, affect the performance of banking institutions.

Raheja (2005) notes that in complex and risky firms, such as banks, board-level financial

experts reduce the verification costs of financial information, which promotes the

efficiency and reliability of the external audit function. Overall, based on agency theory,

the presence of such persons as directors serves the interests of capital providers. Having

accountants as financial experts on boards also emphasizes that the reporting of financial

information is of primaryinterest to creditors, shareholders, and potentialinvestors (Watts

and Zimmerman1986). In other words, it is the realization of accountingearnings, proxied

by the net profit margin, return on assets, and return on equity, that matters when

professionally qualified accountants are predominant on the board.

In contrast, others have documented the absence of any statistical association

between board structure and the performance of banking firms. Booth, Cornett, and

Tehranian (2002) provide evidence on the role of internal monitoring mechanisms, for

example, outside directors, for the banking industry. They document that the presence of

such mechanisms is not very strong compared to other sectors, such as the industrial

sector. Moreover, others assert that the proportion of directors who are employed by the

bank (i.e., inside directors), as well as all other directors (i.e., outside directors), does not

have a statistically significant effect on bank performance (Griffith, Fogelberg, and

Weeks 2002; Adams and Mehran 2008). Staikouras, Staikouras, and Agoraki (2007)

reach the same conclusion after examining the effect of the executive–nonexecutive

director ratio on bank performance.

My study is also closely related to the literature on the relation between board

member characteristics and the financial effectiveness of corporate governance. The

novelties of such an approach are manifold. First, evidence on the link between board-

level financial expertise and banks’financial performance is important in shaping future

governance guidelines and practices; however, no study, to the best of my knowledge,

has examined this issue. Second, selecting banks of different sizes and governance

structures provides within-sample variation and mitigates selection bias when using data

from publicly traded banks. Third, the appointment of financially equipped directors to

boards can be important for the viability of nonbank financial institutions that are also

involved in risky lending and developing risky financial products. Hence, the underlying

empirical findings could be important for firms outside of banking, such as those in the

insurance industry. Fourth, the use of panel methodology alleviates endogeneity

concerns resulting from unobserved bank-level heterogeneity.

At the same time, several European countries have enacted regulations since the

2007–2009 financial crisis that require senior managers and directors to demonstrate

expertise in financial matters. More specifically, the Basel Committee’s October 2010

Principles for Enhancing Corporate Governance, in collaboration with country

regulatory authorities, represents a consistent development in efforts to promote sound

corporate governance practices for banks. One of those practices was closely associated

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