Better Governance of Financial Institutions
The Harvard Law School Forum on Corporate Governance and Financial Regulation 2013-04-03
Banks are special, so is corporate governance of banks. It differs considerably from general corporate governance. Specific corporate governance needs exist also for insurance companies and other financial institutions. This article, Better Governance of Financial Institutions, analyzes the economic, legal and comparative research on governance of financial institutions and covers the reforms by the European Commission, the European Banking Authority, CDR IV and Solvency II up to the end of 2012. External corporate governance, in particular by the market of corporate control (takeovers), is more important for firms than for banks, at least under continental European practice.
For financial institutions, the scope of corporate governance goes beyond the shareholders (equity governance) to include debtholders, insurance policy holders and other creditors (debt governance). Some include the state as stakeholder, but the role of the state is better understood as setting the rules of the game in a regulated industry. From the perspective of supervision debt governance is the primary governance concern. Equity governance and debt governance face partly parallel and partly divergent interests of management, shareholders, debtholders and other creditors, and supervisors. Economic theory and practice show that management tends to be risk-averse for lack of diversification but may be more risk-prone because of equity-based compensation in end games and under similar circumstances. Shareholders are risk-prone and interested in corporate governance. Debtholders are risk-averse and interested in debt governance. Supervisors are risk-averse and interested in maintaining financial stability and in particular in preventing systemic crises.