Corporate Governance of Banks : Is More Board Independence the Solution?

In the context of corporate governance reforms following the global financial crisis, policymakers have focused on how to reduce the bank manager' incentives to take risks in order to promote financial stability. On both sides of the Atlantic, legislation seeks to pursue this goal by enhancing the independence of boards of banks, particularly with regard to the remuneration committees.This paper shows that, even though regulatory intervention in the design of bankers' remuneration is economically justified, it is doubtful that assigning independent directors the task to discipline bank managers can solve the problem. Particularly, the independence of remuneration committees from the management is unhelpful so long as shareholders ultimately appoint the members of those committees. Both shareholders and bankers profit from the implicit subsidy of governments bailing out systematically relevant financial institutions. While the variable remuneration of bankers effectively induces them to take more risk than socially optimal, shareholders do not have the incentives to stop this behaviour. To address this externalities problem, we advocate a different approach to the corporate governance of banks, relying on uninsured creditors rather than on the shareholders. We propose to confer upon uninsured creditors the right to appoint a minority of members of the remuneration committee. This solution aims at enabling debt-holders to better monitor the pay structure and the risk management policies of a bank and protect their investment accordingly. This mechanism, however, is effective only if debt-holders are credibly committed not to ever benefit from a bailout. In order to overcome the moral hazard generated by the governments' safety net, the appointment rights of debt-holders should be conditional on the subscription of bail-in instruments