Board Accountability and Risk Taking in Banking: Evidence from a Quasi-Experiment

Germany has a two-tier board system: In addition to the managing board the vast majority of banking firms are legally obliged to form a supervisory board. This paper focuses on banks’ supervisory boards. Legally mandated supervisory boards consist of outside directors, since corporation and organization laws explicitly state that supervisory board members cannot hold executive positions in the supervised firm. Depending on the firm’s legal form and number of employees, employees must also be represented in the supervisory board (co-determination). Both supervisory board members in Germany and outside directors on the management board in other countries such as the U.S. are expected to monitor the senior executives and strengthen managerial accountability (Black et al. 2005a). Therefore, the terms ‘supervisory board’ and ‘outside directors’ are used interchangeably throughout the paper.

As a first step towards stricter liability, German legislative bodies in November 2010 passed a law that extends the limitation period for damage claims of banks against board members for breaches of duty from five to ten years (Bundesrat Drucksache 681/10).

Similar conclusions are reached for Korea, which is treated in a separate study (Black et al. 2005b).

The data is obtained from the Deutsche Bundesbank time series data base, October 2013.

See also Chen (2014) for a recent study on board independence in a quasi-experimental setting.

For a more detailed overview of savings banks and their role within the German banking system, see Hackethal (2004).

A few savings banks historically have been organized as private-law banks. Among 431 savings banks as of year-end 2009 six savings banks were chartered as private-law stock corporations.

As of year-end 2007, the mean customer loans-to-assets ratio of savings banks in the sample was about 59 percent, and the mean deposits-to-assets ratio was about 66 percent. See Table 5.

The only exception is Hamburg where the only savings bank is a private-law stock corporation.

See Niedersächsischer Landtag [State Parliament of Lower Saxony], Drucksache 15/1220. This section partially draws on Berger (2006), pp. 24, who gives a detailed overview of the reform.

The German Corporate Governance Code aims at strengthening trust of investors in the corporate governance of German listed stock corporations. It contains corporate governance rules of the German Stock Corporation Act (Aktiengesetz) and recommendations of best practices for ‘good’ corporate governance. These recommendations are not binding. However, management and supervisory boards are obliged once a year to confirm compliance with recommendations, or to explain the reasons for non-compliance.

Lutter (1991, pp. 126) holds a different view. He argues that the privileged status applies only in those federal states where laws concerning the status of civil servants are explicitly referenced in the savings banks law. He acknowledges, however, that this is against the commonly held view in the savings banks literature.

Anecdotal evidence on how serious the tightening of liability rules was is hard to come by. A comprehensive research of German news via Lexis Nexis and Google does not provide any information on actual liability cases in Lower Saxony after 2004.

Public guarantees required the chartering municipalities to maintain the business operations of savings banks under any circumstances and thus rendered defaults of savings banks impossible (Anstaltslast). Moreover, the chartering municipalities were directly liable to the creditors of savings banks (Gewährträgerhaftung).

Security reserves form the most important source of savings banks’ capital. See Section 3.2.1 for a description of savings banks’ capital components.

Since savings banks are public law entities and hardly rely on capital market funding, market data is not available for the vast majority of savings banks.

See German Council of Economic Experts (2004, pp. 302) for an overview of reform initiatives in the savings banks sector around 2004. One notable exception is Mecklenburg-Vorpommern which enacted some amendments in its savings banks law in March 2004, in order to preserve the status quo of its savings banks as public law entities (‘Lex Stralsund’). Excluding the savings banks chartered in Mecklenburg-Vorpommern does not affect the results of the following analysis.

See also Gropp et al. (2013) for an analysis of the impact of the abolition of guarantees on German savings banks.

Including private-law savings banks hardly affects the regression results, though.

Two federal states, Hamburg and Berlin, are not included in the analysis. The only savings bank in Hamburg is a private-law stock corporation (HASPA AG). The only savings banks in Berlin (Berliner Sparkasse) is integrated in Landesbank Berlin AG and does not publish separate financial statements.

Detailed variable definitions are given in the 1.

The number of observations for liquid assets/short-term funding is smaller than for the other ratios because, for some banks, Bankscope does not contain detailed information on the liquidity structure of liabilities.

When including control variables, six time-year observations drop out because no information on municipal deficits in Bremen is provided.

Due to multicollinearity, the Lower Saxony-2002 dummy is excluded.

See Fischer et al. (2014) and Körner and Schnabel (2013) for detailed accounts of the institutional background.

Since Bankscope does not report savings banks’ lending from the associated Landesbank, we need to rely on total liabilities to banks. In addition to loans from Landesbanken, this balance sheet position is composed of various types of liabilities, most importantly forwarded loans of public development banks (Güde 1995).

See paragraphs 34, 41 Genossenschaftsgesetz.

Additional regressions (results not displayed) employing the log of the numerators and denominators of capital, liquidity and risk-asset ratios show that, after 2005, savings banks held less capital, less liquid assets, less risk-weighted assets and less total assets compared to cooperative banks. The relative decrease in risk-weighted assets is stronger than the decrease in total assets. These findings might be explained by (i) savings banks retaining fewer profits than cooperative banks in the upturn, possibly due to increased profit distribution to municipalities and/or donations and sponsorship, and (ii) a rebalancing of savings banks’ loan portfolios in the upturn towards borrowers with lower risk weights (relative to cooperative banks). Due to the lack of appropriate data, we are not able to further investigate these explanations.