Chapter 5: Corporate Governance: A Review of the Role of Banks
* Hans Degryse, Steven Ongena and Günseli Tümer-Alkan I INTRODUCTION In many countries, banks are the most important providers of external ﬁnance, in particular for small and medium-sized enterprises (SMEs). Hence, the banks’ role in the ﬁnancing and governance of ﬁrms is relevant for the smooth functioning and growth of an economy. Banks not only interact with ﬁrms through debt ﬁnancing, in some countries they also play an important role as ﬁrms’ large shareholders and board members. The goal of this chapter is to provide an overview of the role of ﬁnancial institutions in the governance of ﬁrms through the diﬀerent corporate governance mechanisms. We aim to address the question: ‘How do banks act as debt ﬁnanciers, large shareholders, and board members?’ Along the way, we also indicate how banks diﬀer from other players’ role in the corporate governance of ﬁrms. Banks and ﬁrms enter into a relationship to overcome problems of asymmetric information. Without such a relationship ﬁrms may be ﬁnancially constrained. Diamond (1984) shows that the raison d’être for ﬁnancial intermediaries may be the reduction in the cost of monitoring information and therefore the resolution of incentive problems in the debt markets. Banks screen ﬁrms’ loan applications, and monitor ﬁrms by designing loan contracts and by interacting frequently. Also, as ﬁrst argued by Fama (1985), bank loans signal the creditworthiness of ﬁrms to other market players, and thereby reduce the information costs for the other contracts. In this chapter, we provide a brief...
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