IV Bank Governance Structures, Financial Expertise of Supervisory Board Members, Overconfidence, and Bank Risk Taking
Abstract In this study, we analyze whether financial expertise in internal bank governance benefits the financial institution by reducing risk and increasing stability. Whereas behavioural finance theory scrutinizes the benefit of financial expertise, empirical studies substantiate that financial experts do add value. Based on a study of more than 400 German banks, we observe that the financial expertise of supervisory board members reduces stability and increases loan portfolio risk. This finding is robust across ownership types. With regard to performance, the results demonstrate that supervisory board competence impacts banking groups in different ways. In general, our results lead to the question how effective universal expertise in internal governance is; therefore, we propose that financial institutions should have experts for specific responsibilities and areas on their supervisory boards.
In 1999 and 2006, the Basel Committee on Banking Supervision had already emphasized the high relevance of board competence for an effective governance system (Basel Committee on Banking Supervision, 1999b, 2006a). As one of its principles for an effective governance system, the committee demands that “board members should be qualified for their positions, have a clear understanding of their role in corporate governance and be able to exercise sound judgment about the affairs of the bank” (Basel Committee on Banking Supervision, 2006a). The recent 2008 banking crisis sheds additional light on the significance of governance structure in general and board expertise in particular: inappropriate risk management, incomplete risk information, and insufficient industry expertise were...
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