U N I V E R S I T Y O F S O U T H C A R O L I N A , W H A R T O N F I N A N C I A L
I N S T I T U T I O N S C E N T E R , A N D C E N T E R – T I L B U R G U N I V E R S I T Y
D E U T S C H E B U N D E S B A N K
B A N G O R U N I V E R S I T Y
C o n f e r e n c e “ C o r p o r a t e G o v e r n a n c e o f F i n a n c i a l I n s t i t u t i o n s ”
A m s t e r d a m
N o v e m b e r 2 0 1 2
This paper represents the authors’ personal opinions and does not necessarily reflect the views of Deutsche Bundesbank or its staff.

Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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 The recent financial crisis highlights the importance of risk taking by banks and the larger consequences of excessive risk taking for society as a whole.
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Much of the blame for the crisis and suggested remedies have focused on corporate governance arrangements.
 While others have argued for and studied restrictions on inside ownership and executive compensation, we take a different approach and look at executive board composition.
 While there are studies of board composition elsewhere, we focus on banks, where risk taking is of first-order importance.
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Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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How does executive board composition affect bank risk taking?
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Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Paper has a (management) team perspective
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Management board forms a team that interacts dynamically.
Composition of the “team” is crucial in shaping outcomes.
(e.g., Holmstrom (1982, BJE); Bolton and Dewatripont (2005, MIT press))
Composition: Socioeconomic characteristics
• age
•
• gender education
 We study a country with two-tier board system (Germany)
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Executive board
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Direct responsibility for the management of the company.
Runs the corporation, makes decisions and reports to the supervisory board.
Supervisory board
Monitors the management, i.e. gives consent to certain transactions.
Appoints and dismisses members of the executive board on behalf of the shareholders.
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We focus on the composition of the executive board
This generalizes directly to other nations with two-tier board systems (of which there are many)
The results may generalize to executive members of the board in one-tier board countries
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Policy relevance.
Impact of governance arrangements in banking on wider society, as illustrated by the recent financial crisis.
Hau and Thum (2009, EP); Illueca, Norden, and Udell (2012, AEA Paper)
Literature generally excludes regulated industries.
Bertrand and Schoar (2003, QJE); Fich (2005, JB); Farrell and Hersch (2006, JCF)
Adds to the emerging evidence on governance arrangements in banking.
Fahlenbrach and Stulz (2011, JFE); Adams and Mehran (2012, JFI).
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Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Perception of young managers’ overconfidence and old managers’ wisdom
Expect strong effect of experience on risk taking behavior
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Knowledge of risky situations and ability to control risk increases with age
Grable et al. (2009, JBER), Russo and Schoemaker (1992, SMR) , Gervais and Odean (2001, RFS)
Empirical evidence points towards a negative relationship
Campbell (2001, JF), Sahm (2007, FRB) and Grable et al. (2009, JBER)
HI: Risk taking decreases in executive board age
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Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Perception of risk loving male and risk averse female managers
Anecdotal evidence on women being more prudent in financial decision making (e.g., microfinance)
Important in light of recently passed, proposed (and then scrapped) minimum quotas for women on boards and on executive teams in Europe
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Growing debate on the effect of gender on economic outcomes e.g. Croson and Gneezy (2009, JEL) , Schubert, Brown, Glyser, and Brachinger (1999 AER P&P)
Investment literature suggests women are more risk averse e.g. Barber and Odean (2001, QJE), Niederle and Vesterlund (2007, QJE), Goel and Thakor (2008, JF)
Governance: female directors are less risk averse and reduce performance
Adams and Funk (2012, MS); Ahern and Dittmar (2012, QJE)
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Little evidence on the effect in banking except for loan officers
Agarwal and Wang (2009, Working Paper) and Beck, Behr, and Güttler (forthcoming,RoF)
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Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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HII a: A higher representation of female executives reduces risk taking
HII b: A higher representation of female executives increases risk taking
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Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Education affects knowledge of and perception of risk e.g. risk management techniques taught in business schools
International efforts to encourage banks’ appointment of knowledgeable directors: Basel Committee on Banking
Supervision (2006)
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Stereotype of MBA graduates’ aggressive management style
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More risk taking suggested for household decisions
Carducci and Wong (1998, JBP); Grable (2002); Christiansen, Joensen, and Rangvid (2008, RoF)
MBA literature is ambiguous
More sophisticated project valuation techniques, Graham and Harvey (2001, JFE)
But aggressive style and more leverage, Bertrand and Schoar (2003, QJE)
Negative relationship suggested for corporate outcomes
Financing and acquisition policies: Güner, Malmendier, and Tate (2008, JFE)
Failure of financial institutions: Fich and Fernandes (2009, Working Paper)
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Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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HIII a: Better educated executives engage in less risk taking
HIII b: Better educated executives engage in greater risk taking
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Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Proprietary data from the Deutsche Bundesbank
Complete and detailed information on executives’ age, gender, and education
Time horizon 1994-2010
19,750 bank-year observations for 3,525 banks
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Difference in difference matching estimation – exploits exogenous variation via mandatory retirements
Matching criteria
 size (+/- 20 percent of the treatment bank’s size in terms of total assets)
 performance (+/- 20 percent of the treatment bank’s ROE)
 board size held constant
 bank type (public banks, cooperative banks, and private banks)
 time period (year)
Sample excludes ‘bad’ banks (banks with interventions, capital support, distress merger banks)
Final sample: 10,719 bank-year observations for 2,490 banks
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RWA/Total Assets – risk on and off the balance sheet
Used in regulatory treatment and in empirical literature
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Difference-in-difference estimator
Y i
:
Post:
Treated:
X it
:
Measure of risk taking for bank i in year t
Dummy for Post change period in board composition
Dummy if the bank experienced a Board change
Control variables
Focus:
Interaction term: Post × Treated captures the effect of an executive board change due to retirements in the period after the change takes place. The slope coefficient of the interaction term therefore allows isolating effect of the change in executive board composition on the risk measure.
We consider at most one executive board change of each type per bank.
We examine the seven-year time window surrounding the executive board change and consider the three years prior to, the three years following, and the actual year of the executive board change.
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Total assets
Capacity to absorb risk, too-big-to-fail
Charter value (core deposits/Total assets)
Affects risk taking, e.g. Dell’Ariccia and Marquez (2006, JF)
Capital adequacy ratio
Affects moral hazard and monitoring incentives
Morrison and White (2005, AER),
Allen, Carletti, and Marquez (2011, RFS)
Merger dummy
May reflect changes in risk attitudes
Powerful CEO (tenure)
Influential CEOs affect risk taking
Adams, Almeida, and Ferreira (2005, RFS)
Executive board size
Expect less risk taking for large boards
Sah and Stiglitz (1986, JPE)
Share of customer loans and off balance sheet items in total assets
Control for bank balance sheet composition and business model
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Growth of total assets (deflated)
Banks that experience substantial growth msy run a higher degree of risk
GDP growth (county)
Control for macroeconomic environment, booms coincide with increased risk-taking e.g. Dell’Ariccia and Marquez (2006, JF)
Population (log, state)
Controls for market size
Interest rate spread
Spread between 10 and 1 year bonds
Time trend
Mitigate serial correlation concerns
Bertrand, Duflo, and Mullainathan (2004, QJE)
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Treatment Group
(1)
Mean S.D.
Mean
Control Group
(2)
S.D.
Mean
All banks
(3)
S.D.
Executive board characteristics
Board age composition
Board gender composition
Board education composition
50.03
0.03
0.05
4.87
0.10
0.13
50.00
0.02
0.01
5.01
0.11
0.07
50.01
0.02
0.03
4.96
0.10
0.10
Powerful CEO
Board size
# decreases in age
# increases in females
# increases in education
7.22
3.74
855
28
46
7.49
1.99
7.04
2.59
0
0
0
7.24
1.70
7.10
3.00
855
28
46
7.33
1.89
Bank characteristics and macroeconomic environment
Total assets (log, deflated)
Charter value
Capital adequacy ratio
GDP growth (per capita)
Merger dummy
Risk measures
RWA/TA
HHI (log)
19.93
17.81
19.90
1.59
0.03
58.00
3.39
1.47
8.11
130.20
3.58
0.16
14.93
0.38
19.09
16.69
12.52
1.68
0.06
60.62
3.24
1.21
6.69
4.31
3.32
0.23
10.92
0.25
19.38
17.08
15.12
1.64
0.05
59.70
3.29
1.36
7.24
77.35
3.41
0.21
12.54
0.31
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Average Age:
Share of females:
Share of PhDs:
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Age composition Gender composition Education composition
(1) (2) (3)
Executive board change
Post period
Board change * Post period
Timetrend
Total assets (log, deflated)
Charter value
Capital adequacy ratio
RWA/TA
-0.02
0.13
0.55***
-0.24***
-2.15***
-0.16***
-0.21***
RWA/TA
0.99
0.59***
0.96*
0.79***
-20.97***
-0.17***
-1.49***
RWA/TA
-1.48**
0.23
-2.26***
0.93***
-12.14***
-0.18***
-1.01***
GDP growth (county)
 Data are consistent with hypothesis HI o
0.08***
0.34
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0.08***
-0.35
0.02
-0.05
-0.05**
Customer loans/Total assets o
Growth of total assets (deflated)
Board size
0.61***
0.00
o
0.70*** o o
0.37***
0.01
0.41***
0.01
0.04
-0.48
Interest rate spread
Population (log, state)
Average exeuctive board age
Average Ph.D. representation
Average female representation
Observations
R-squared
Number of banks
Number of board changes
-1.05***
68.10***
No
Yes
Yes
6,440
0.452
1,578
569
48.63***
Yes
Yes
No
3,073
0.615
652
24
-24.66*
Yes
No
Yes
1,229
0.358
260
25
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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Panel A: Age composition
Age Range
Number of executive board changes
Panel B: Gender composition
Average job experience (all executives)
Number of executive board changes
Pre board change
11.80
15.33
569
Post board change
11.85
7.70
t-test
-0.25
7.74***
Do women select into particular types of banks?
Capital adequacy ratio prior to board change
Proportion of female executives prior to board change
Proportion of female CEOs prior to board change
Panel C: Education composition (Ph.D.)
Off balance sheet/Total assets
Fee income
Core deposits/Total assets
Number of executive board changes o Finding is not significant. increase in female board representation
Treatment group Control group
14.27
12.80
0.03
0.04
Pre board change
0.02
0.02
Post board change
7.94
7.80
12.65
6.81
9.52
16.88
-3.81***
-0.14
-1.75*
1.26
-2.04**
-3.07***
25 o New female executive board members are less experienced (Ahern and Dittmar, 2012, QJE) – could explain why risk taking increases. o Female executives appointed to boards of banks with significantly higher capital ratio before the change, so may have greater ability to absorb risk.
o Better educated executive board members diversify income streams.
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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 Robustness tests
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Exclusion of all loss-making banks from the estimations
Reason: poorly performing banks may have incentives to restructure executive boards in specific ways to restore profitability (Schaeck et al., 2012, RoF)
•
Alternative risk measure: Herfindahl Hirschman Index of loan concentration
Reports the degree of concentration in banks’ loan portfolio  indicator of risk exposure
•
•
Alternative matching procedures
Adding of capital adequacy ratios as matching criterion
Narrowing of matching band for all criteria: between 90% and 110%
•
•
Additional regressions where
Merged banks are omitted
Poorly capitalized banks are omitted
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Placebo test
Idea: pretense of a board change at a point in time when it in fact did not occur
Redefinition of Treatment dummy to unity two years prior to the actual executive board change
Main results are robust to alternative specifications.
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Board Composition and Risk Taking
Introduction – Hypotheses – Data and Methodology – Results – Conclusion
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
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Socioeconomic characteristics of executive board composition matter for banks’ risk-taking.
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Decreases in executive board age and more female representation are associated with more risk taking, and more education is associated with less risk taking.
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Female results may in part reflect differences in experience and in initial conditions.
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Robustness of empirical results to different specifications
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Better disentangling of age, gender, and education effects
Testing for career concerns and overconfidence
Alternative control groups
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