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Edited by James R. Barth, Chen Lin and Clas Wihlborg
Chapter 19: Corporate Governance and Prudential Regulation of Banks: Is There Any Connection?
Lawrence J. White 19.1 INTRODUCTION In the aftermath of the financial crisis of 2007–2009, a number of ‘narratives’ about the causes of the crisis have developed. One specific narrative will be the topic of this chapter: that a major (if not the major) cause of the crisis was poor corporate governance of the largest banks and other large financial institutions of the United States. This narrative argues that the poor governance encouraged the senior managements of these institutions to undertake excessively risky strategies that may have benefitted these managements but that were not in the long-run interests of the shareholder-owners of these institutions. The strategies caused these institutions to ‘blow up’, and the financial crisis followed. An immediate implication of this narrative is that better corporate governance – a better alignment of the interests of senior management with the interests of their shareholders – would have prevented (or at least ameliorated) the crisis, and that better governance is necessary for the prevention of future such crises. One manifestation of this belief is the inclusion of measures that are intended to improve corporate governance – especially for financial institutions – in the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (P.L. 111-203). This chapter will argue that this corporate governance narrative is largely misguided and reflects an inadequate understanding of modern finance and financial theory.1 This lacuna applies to the understanding of the role of debt and therefore leverage in a corporation’s capital structure in potentially encouraging the owners of the...
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