Financial crises, natural selection and governance structure: Evidence from the thrift crisis John W. Byrda Donald R. Fraserb* D. Scott Leeb Thomas G.E. Williamsc a
Department of Biology, Fort Lewis College, Durango, CO 81301 Mays College of Business, Texas A&M University, College Station, TX 77843-4218 c College of Business, William Patterson University, Wayne, NJ 07470
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Abstract We exploit the natural experiment provided by the thrift crisis of the 1980s to examine the influence of governance structure on firm survival. Using a sample of 86 publicly-traded thrifts, we show that a firm’s probability of surviving this economic crisis was enhanced by internal governance arrangements that aligned the interests of managers and shareholders. Firms that survived the crisis had a greater proportion of independent directors on the board. In addition, our evidence challenges the notion that affiliated directors help firms adapt to a more competitive business environment.
JEL classification: G34, G32, G33, G21
Comments welcomed.
*Corresponding author. Tel.: + 1-979-845-2020; fax: + 1-979-845-3884 E-mail address:
[email protected] We thank Beth Cooperman, Jon Karpoff, and participants in seminars at Texas A&M University and the University of Oregon for their helpful comments. Lee thanks the Private Enterprise Research Center for financial support.
1. Introduction Financial economists often draw parallels between corporate governance and Charles Darwin’s principle of biological evolution by natural selection. Firms are generally assumed to survive or fail because of the relative superiority or inferiority of their operating, financial, or governance characteristics. Walter Bagehot, editor of The Economist, drew the parallel between firm and species survival within a decade of Darwin’s 1859 publication of On the Origin of the Species.1 The notion spread rapidly and, in 1889, famed industrialist Andrew Carnegie wrote that while “the law [of competition] may be sometimes hard for the individual, it is best for the race, because it insures the survival of the fittest in every department.”2 In fact, Darwin credited two economists, Thomas Malthus and Adam Smith, with crucially influencing the formulation of his theory. Malthus’ insight that unchecked population growth would outrun any increase in food supply, led Darwin to conclude that a struggle for existence must arise, leading by natural selection to survival of the fittest. While Smith’s discussions of laissez-faire economics and the invisible hand echo throughout Darwin’s discourses on evolution.3 Kole and Lehn (1997) contrast the ubiquity of the notion of corporate evolution in the economic literature with the relative scarcity of supporting evidence and challenge researchers with an extensive list of unanswered questions about evolution and
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Walter Bagehot, “Physics and politics: or, thoughts on the application of the principles of ‘natural selection’ and ‘inheritance’ to political society,” D. Appleton & Co., NY. 2 Andrew Carnegie, “Wealth,” North American Review, June 1889. 3 Stephen Jay Gould, “Darwin and Paley Meet the Invisible Hand,” in Eight Little Piggies, pp. 138-152.
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governance structures. In this paper, we address one of these questions: is the long-run survival of firms related to their internal governance choices. In his study of firm survival and capital structure, Zingales (1998) notes that the appeal of natural experiments lies in “the external origin and unforeseen severity of abrupt shifts in an industry’s competitive environment.” These shifts allow us rare glimpses of firm characteristics related to the firm’s survival through dire times. From the biological perspective: “species live or die for definite and specifiable reasons… in normal times between mass extinctions, organisms evolve features to enhance success in continuous ecological struggle. The cause of mass extinction then hits in all its fury. Certain features are the passkeys to survival – tolerance of extreme climatic stress, for example. But these features must have evolved during normal times… for reasons unrelated to their later (and lucky) use in guiding their possessors through the unanticipated debacle of mass extinction.”4 If we could not anticipate debacles these “passkeys to survival” would indicate only dumb luck. However, humans, owing to intelligence, operate within the realm of cultural evolution.5 Thus, we have the ability to adapt to and even anticipate environmental changes. Therefore, prudence as well as luck, may be evident in the attributes of firms that survive crises. Previous studies of economic shocks include Mitchell and Mulherin (1996) who conclude that the “takeover wave of the 1980s entails an adaptation of industry structure to a changing economy.” Kole and Lehn (1999) study the impact of the Airline Deregulation Act of 1978 on the airline industry. They conclude that the internal 4
Stephen Jay Gould, “The Wheel of Fortune and the Wedge of Progress,” Eight Little Piggies, page 307.
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governance structures of incumbent firms evolve sluggishly because employees (with their finite planning horizons) are generally more committed to the preservation of the firm’s endangered culture than they are to the firm’s long-term survival.6 Yet, they show that the industry survived despite the failure of individual firms to adapt because new entrants (unimpeded by cultural precedents) quickly fill the niche created by the uncompetitive incumbents. This highlights an important and sometimes misunderstood parallel between firm survival and Darwin’s concept of natural selection. Evolution is driven by the survival of the species, not the adaptation of individuals. Thus, our analysis focuses strictly on the differences between the governance attributes of thrifts that failed and those of that did not fail in the face of the crisis. Kole and Lehn compare the governance characteristics of airlines that did and did not survive deregulation, but they are handicapped by a small sample (six survivors and 15 non-survivors). Zingales (1998) studies the trucking industry following the passage of the Motor Carrier Act of 1980. He finds that firms with relatively low financial leverage before deregulation (whom he dubs the “fattest”) were more likely to survive deregulation. Zingales provides a meticulous analysis and lucid insights into the costs of financial leverage associated with shocks to the competitive environment. However, in our opinion, his conclusion that his “findings challenge the commonly held assumption that
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Stephen Jay Gould, “Shades of Lamarck,” in The Panda’s Thumb, pp. 76-84. Societal resistance to even the most inevitable change exacerbates the inertia of corporate culture. The experience of General Dynamics following the end of the Cold War illustrates the difficulty that executives confront in attempting to adapt to economic shocks. Executives hired to undertake the unpleasant business of paring down the firm were lambasted by the popular and business press [Dial and Murphy (1995)].
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competition will necessarily lead to the survival of the fittest” is mistakenly based on fitness and fatness standards made obsolete by the shock of deregulation. We study a natural experiment provided by the thrift (savings & loan) crisis of the 1980s. It offers at least five advantages for studying internal governance configurations. First, focusing on a single industry eliminates the need to control for inter-industry differences. Second, focusing on the thrift industry minimizes the substitution effect between internal and external control mechanisms. Third, the concentration of the firm failures in time reduces the influence of intertemporal changes in economic conditions.7 Fourth, the sheer number of failures in the thrift industry during this period enhances the robustness of our statistical tests. Fifth and possibly foremost, crises are more likely to reveal the relative merits and costs of alternative governance systems that remain concealed during prolonged periods of prosperity. For example, if their primary governance role is supervisory, independent directors may be functionally comparable to automobile airbags. Their importance is difficult to detect on normal days, but it may still be optimal to install them even if crises occur infrequently. Using a sample of 26 failed and 60 non-failed publicly-traded thrifts during the period 1983-1990, we find that relative to their failed counterparts, the typical thrift that survived the crisis had a smaller percentage of affiliated board members and a greater percentage of independent board members. To our knowledge, our evidence of an inverse relation between the percentages of affiliated directors and thrift survival is the first of its kind. It is inconsistent with prior
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The sample failures are restricted to a 5-year span and 96% occurred within 4-years.
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conclusions that affiliated directors provide a valuable advisory role to the firms they direct (Klein, 1998) and thereby, casts doubt on the role of affiliated directors on the board. The direct relation between director independence and thrift survival corroborates evidence from other studies that shareholders fare better during significant corporate events, such as acquisitions (Byrd and Hickman, 1992, Cotter, Shivdasani and Zenner, 1997), poison pill adoption (Brickley, Coles and Terry, 1994), and corporate restructuring (Perry and Shivdasani, 2000), when their firm’s board is dominated by independent outside directors. Overall, these results broaden our understanding of the corporate events influenced by internal governance schemes and contribute to our understanding of the thrift crisis. In addition, our detection of systematic differences in the governance systems of firms that did and did not survive this industry-wide shock is consistent with the view that a competitive economic environment imposes a form of natural selection on the corporate entities operating within it and that the industry adapts to the change even though many individual thrifts fail. The remainder of the paper is structured as follows: Section 2 discusses the savings and loan crisis of the 1980s and the implications of that crisis for risk-taking. Section 3 introduces our hypotheses and testable implications. Section 4 describes our sample selection procedure and provides a statistical profile of the sample. We report the results of our analysis in section 5 and close with our conclusions in Section 6.
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2.
The Thrift Crisis The endogenous nature of governance choices makes it difficult to determine
whether product market competition affects governance choices or if a firm’s governance structure affects its competitive position and, eventually, its survival. Following Kole and Lehn (1999) and Zingales (1998), we address this problem by studying a natural experiment that profoundly shocked the competitive structure of an industry. Before the crisis, the only source of external discipline on thrift managers came from industry regulators. Regulations constrained manager’s operational activities to attracting local deposits and lending in the local home mortgage market. Regulated ceilings on deposit rates prevented rate-based competition for deposits and led to such farcical practices as offering toasters for new accounts. Thus, it is difficult to imagine that managers were subject to any discipline from the product market, and lending in the virtually default-free, mortgage environment did little to hone their discretionary skills. In fact, perceptions of the operating skills of thrift managers lead to an adage that they followed the rule of 3-6-3 (borrow at 3%, lend at 6%, golf at 3). In this highly regulated setting, fraternizing with the well-heeled members of the local country club may have been the thrift manager’s most effective means of competing for local deposits and loans. Effective barriers to entry from external competition were created by charter requirements and the market for corporate control was stifled by requirements for federal approval of mergers and acquisitions. In sum, thrift managers were so insulated from external discipline before the crisis that internal governance mechanisms were the only conceivable source of managerial discipline at hand.
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When interest rates began to fluctuate in the late 1970s, thrift depositors withdrew funds for deposit into money market funds when interest rates rose, and they rushed back to the thrifts when interest rates fell. Hamstrung by regulation and their long-term commitments in mortgage loans, thrift managers were unable to respond. Interest rate risk escalated to new levels in 1979 as oil prices doubled and the inflation rate surged into double digits. Government policymakers responded in the early 1980’s with the Depository Institutions Deregulation and Monetary Control Act (1980) and the Garn-St Germain Act (1982). These acts freed thrift managers to offer rates for deposits that competed with money market mutual funds. They also freed thrifts to offer consumer loans, commercial loans, and adjustable rate mortgages. This unprecedented deposit pricing and lending authority provided thrift managers a double-edged sword whose other edge was unprecedented exposure to credit risk. Moreover, during this period regulators exercised official forbearance toward troubled institutions, effectively condoning creative, regulatory accounting practices designed to mask an institution’s insolvency.8 Roused by this sudden liberalization, managers of incumbent and new thrifts generated a 50% increase in industry assets between 1982 and 1985. However, this indiscriminant growth coupled with the interest rate risk problem of the early 1980s led to a credit crisis in the mid 1980s.9 Contributing factors included the Tax Reform Act of 1986, which led to a decline in the value of commercial real estate collateral on property loans to which thrifts had become heavily committed. The concurrent collapse of oil 8
A recent study by the Federal Deposit Insurance Corporation (An Examination of the Banking Crisis of the 1980s and 1990s, Vol. 1, p. 70) reports that the thrift examination process and staff were not designed to deal with the new powers provided to the industry through deregulation. Moreover, White (1991) shows that the number of thrift field examiners was actually reduced in the early 1980s and that the number of onsite examinations (audits) also declined.
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prices in energy states such as Texas compounded problems for specialized real estate lenders. As thrifts plunged into undercapitalization, managers’ incentives for risk taking grew and were amplified by the appeal of deposit insurance [Gorton and Rosen (1995)]. Akerlof and Romer (1993) argue that regulatory laxity created incentives for manager – owners at undercapitalized thrifts to engage in looting through high compensation and dividends. Thus, the 1980s presented an immensely challenging environment to thrift managers. During the first half of the decade, the unprecedented freedom to modify portfolios often resulted in dramatic changes in exposure to credit and interest rate risk. Like Darwin’s proverbial finches, thrifts proliferated during these times of plenty, “however, the gold rush had a dark side. The record number of eggs, led to a record number of deaths.”10 From 1986 through 1995 (the period we study), the number of federally-insured thrifts roughly halved, declining from 3,234 to 1,645 (Curry and Shibut, 2000). The extent to which internal governance is related to the ultimate success or failure of the thrifts during this abrupt shift is the focus of the remaining portions of this paper. 3. Hypotheses and testable implications 3.1. The competing hypotheses We address two related questions. First, does corporate governance affect a firm's ability to survive changes in the competitive environment? Second, if corporate governance matters, which aspects appear to matter most?
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Benston (1985), Kane (1989), and White (1991) provide a more extensive analysis of the thrift crisis. Jonathan Weiner, “The Beak of the Finch,” page 102.
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If a firm's corporate governance is irrelevant, then we should detect no systematic differences in the governance configuration of firms that survive versus firms that fail in an industry consolidation. Alternatively, a firm’s governance configuration may influence its ability to survive an industry consolidation either positively or negatively. Some governance configurations may lend themselves to more cultural commitment or a reticence to change. Such reticence might prevent managers from adjusting to environmental changes and eventually end in their firm’s demise. Other governance configurations may encourage adaptation to or anticipation of changing environments. Such a capacity should improve a firm’s likelihood of survival during an industry consolidation. The rapid changes in the thrift industry during the early 1980s created a business environment for which many managers were unprepared. Particularly problematic were the opportunities and incentives for thrifts to aggressively pursue risky assets. The relative immunity that thrift managers enjoyed from external threats made the internal governance mechanisms of thrifts crucial. We turn now to a discussion of specific testable implications of the internal governance hypotheses and existing evidence relating the effectiveness of each characteristic. 3.2. Board composition Board of director approval is one of the first hurdles that corporate level decisions must clear. The board can help managers better understand changing markets as well as assess and approve a company’s strategic direction. Thus, active board oversight can improve decision quality and may prevent poor decisions from being implemented.
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3.2a. The monitoring role of independent directors Directors often are placed in one of three categories: inside (i.e., current and former officers of the company and their family members), affiliated outside or gray directors (i.e., not an employee but with some professional or financial tie to the company), and independent or outside directors (i.e., those with no link to the company other than their directorship). Previous research provides results consistent with independent outside directors defending the interests of shareholders. Byrd and Hickman (1992) studying bidders in acquisitions, Cotter, Shivdasani and Zenner (1997) studying the targets, and Brickley, Coles and Terry (1994) examining poison pill adoptions, all find higher event date abnormal stock returns for firms with higher percentages of independent directors. Rosenstein and Wyatt (1990) detect a positive stock price response to announcements of independent directors being added to a board. Weisbach (1988) shows that boards comprised largely of outside directors tend to confront poor performing managers earlier than other boards. Brickley and James (1987) demonstrate that a greater presence of outside directors reduces management consumption of perquisites when the bank takeover market is limited due to state regulations. While advisory roles are not generally attributed to independent directors (Fama and Jensen, 1983, and Mace, 1986), they may provide information and advisory skills to the board along with their monitoring function. In either case, we expect a higher probability of survival for thrifts whose boards contain a higher percentage of independent directors.
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3.2b. The advisory role of affiliated directors Considerable evidence of the board’s monitoring efficacy exists, but no clear evidence of its purported advisory role is available. Affiliated directors, while lacking the objectivity to be effective monitors, may provide information and advisory skills to the board. The structure of most corporate boards is consistent with this multi-functional view. Klein (1998) reports that, on average, 42% of the directors of large US corporations are either insiders (i.e., current or former employees of the company or their family members) or affiliated outsiders (i.e., they have a significant business or financial connection to the company or its managers). She also finds that affiliated directors hold a larger proportion of board seats in firms deemed to have greater information needs and concludes this is consistent with the purported informational role for affiliated directors. In contrast, Gilson (1990) provides evidence that appears inconsistent with this advisory acumen. He studies the evolution of board composition of 111 firms that filed for bankruptcy or privately restructured their debt between 1979 and 1985. Within one year of filing or restructuring, the median percentage of “quasi-insiders” on the board drops from 10% to 0%. Because Gilson’s quasi-insiders include directors with family ties to the manager, they are not a perfect substitute for our definition of affiliated directors. However, there is no difference between the rate of post-restructuring departure and appointment for these directors with family ties. Quasi-inside directors account for 13.3% of all board departures versus 6.5% of all board appointments. Affiliated lawyers and former managers comprise a majority of the quasi-insider departures (65.4%). These two groups comprise a significantly smaller portion (21.5%) of newly appointed affiliated
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directors. While subject to an obvious selection bias, this evidence provides no support for the notion of affiliated directors as valuable advisors. Blockholders who step in to restructure financially-distressed firms appear to remove and not replace affiliated directors. The thrift crisis provides a striking opportunity to reexamine the advisory role of affiliated directors, because the board’s information, advice, and connections were sorely needed by thrift managers in this rapidly changing environment. If affiliated outside directors serve a valuable advisory role, then thrifts with a higher percentage of affiliated outside directors should be better situated (than thrifts with smaller percentages of affiliated directors) to manage the risks and exploit the opportunities created by the industry-wide changes of the 1980s. According to the advisory hypothesis, thrifts whose boards have higher percentages of affiliated outside directors will have a lower probability of failure than will other thrifts. These monitoring and advisory hypotheses are not mutually exclusive or competing. Nothing precludes both affiliated and independent directors playing important complementary roles on corporate boards. While our results will not be entirely generalizable, they alleviate some of the selection bias problems encountered in interpreting Gilson (1990), because we have a group of firms that faced a common industry-wide crisis split into complementary subsamples that survived and did not survive the crisis.
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3.3. The role of equity ownership Ownership of a company’s stock by officers and directors as well as large holdings by outside investors can be a potentially important determinant of managerial behavior.11 The following section makes predictions based on whether the equity is held internally by executives, or externally by potential monitors. 3.3.a Internal ownership Managerial and director stock ownership increases the amount of their wealth dependent on stock price performance, and so aligns the interests of managers and directors with those of shareholders. Some empirical studies have detected a nonlinear relationship between managerial ownership and corporate performance (see, for example, McConnell and Servaes (1990) or Morck, Shliefer and Vishny (1988)). A possible explanation for this non-linearity has been suggested by Stulz (1988), who shows that high levels of managerial stock ownership can allow managers to insulate themselves from many governance mechanisms thereby accentuating the conflict between executives and shareholders. In the thrift industry, unintentional regulatory effects may have overwhelmed the entrenchment effects described by Stulz (1988), while still producing a non-linear relation between ownership and performance. Barth (1991) argues that the FHLBB’s relaxation of ownership concentration rules, federally insured deposits, and relatively low capital
11 In 1982, the FHLBB eliminated the regulatory prohibition against individuals and families owning more than 10% of a thrift’s outstanding stock and against businesses owning more than 25% of the stock. This change allowed investors to acquire large blocks of stock and created new incentives for managerial behavior and investor oversight.
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requirements combined to create a situation conducive to the pursuit of high-risk investment strategies. With large ownership stakes, but little invested capital at risk, owner/managers during this period clearly had an incentive to go for broke. Esty (1997a, 1997b) shows that this distortion of managerial risk-bearing incentives was greatly exacerbated by the period’s proliferation of thrift conversions from mutual to stock form and the distorting effect of deposit insurance. Once again, this shift in risk preferences underscores the importance of internal governance systems during this natural experiment. Examining the ownership structure of thrifts, Cebenoyan, Cooperman and Register (1999) detect a positive relation between the risk-taking of thrifts and managerial ownership from 1986 to 1995. Specifically, manager-owned thrifts engage in more risktaking than other thrifts, a behavior that was unprofitable during the lax regulatory period of the late-1980s and profitable during the more restrictive period of the early-1990s. Thus, if the thrift failures of the thrift crisis were driven by regulations that created perverse risk-taking incentives for managers with large equity stakes, the probability of thrift failure may be especially high for thrifts with greater insider holdings. Appealing to the reasoning of Stulz (1988), we specify typical non-linear models in our analysis of thrift ownership. 3.3.b External ownership Since the benefits of monitoring accrue to shareholders in proportion to their ownership stakes, outside investors who own large blocks are more likely to incur the costs of monitoring the activities of thrifts. Additionally, large block holders are often professional investors with an expertise in evaluating companies that results in lower
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monitoring costs than for the average investor. The presence of large blocks of stock held by investors outside of the company increases the likelihood that monitoring will occur, and thereby, increases the quality of managerial decisions. Therefore, larger block holdings by outside investors are likely to be associated with a lower probability of failure. 3.4 Managerial compensation Well-designed compensation contracts provide incentives that shift managerial preferences toward those of shareholders. In the manufacturing sector, Mehran (1995) finds a positive relation between firm performance and the percentage of equity-based compensation received by managers. Typically, executive compensation comes in three forms: salary, bonus, and stock options (or some other type of stock-based vehicle such as stock appreciation rights). Baker, Jensen and Murphy (1988) note that the level of compensation determines where a person works but the structure of the compensation package determines how hard they work. Therefore, we examine two aspects of managerial compensation. 3.4.a Compensation level hypothesis In well-functioning labor markets, higher quality executives receive higher compensation. The value of compensation paid primarily in the form of salary depends heavily on corporate solvency, thereby creating incentives for managers to incur less risk than shareholders prefer. During the thrift crisis, managers with preferences for less risk may have avoided some of the risk-bearing temptations that arose with deregulation, thereby protecting the solvency of their institutions. If we could link better management
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to firm survival unambiguously, evidence of higher CEO compensation (per unit of assets) for managers of non-failed thrifts would indicate that these firms had better managers. However, interpretation of such a result is obscured by the fact that ex-post results are the product of both managers’ ex ante choices and luck. 3.4.b Compensation structure hypothesis The structure of compensation contracts on thrift failure is more difficult to discern. Managers’ risk preference shifts toward that of shareholders as the proportion of compensation based on stock performance increases. However, the optimal proportion of compensation linked to performance that creates appropriate risk-taking incentives cannot be determined a priori. Barth’s (1991) argument, that high levels of executive stock ownership combined with deposit insurance and small equity investments induces plunging strategies among managers, applies to performance-based compensation as well. According to this view, thrifts where performance-based pay comprises a greater portion of managerial compensation are more likely to fail because managers take more risks thereby placing less weight on corporate solvency. Recognizing the possibility for increased risk-taking incentives with high levels of performance-based compensation, we test for a non-linear relation between corporate survival and the proportion of executive’s performance-based pay.
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4. The sample 4.1 Sample selection Barth, Beaver and Stinson (1991) note that “a comprehensive list of publiclytraded thrifts in not readily available.” Therefore, they compile a sample of 165 publiclytraded thrifts from ten separate data sources. We thank Mary Barth for generously sharing this sample.12 After screening this sample further for the stock market, accounting and proxy statement data needed in this study, we had a sample of 86 thrifts operating in the mid-1980s. Of these 86 thrifts, 36 survived through 1995 either in their original form or as a holding company. Another 24 financially-sound firms were either acquired or merged with other thrifts during the period 1986-1995.13 The remaining 26 thrifts either became bankrupt, were taken over by regulators, or were acquired by another thrift with the assistance of a government insurance or regulatory agency during the sample period. Table 1 shows how the entire sample changes over the sample period due to acquisitions and mergers of sound thrifts and failures. The highest incidence of failures (9 firms) occurs in 1990 followed by 7 in 1989. The failures are clearly clustered in time, potentially reflecting the surge in failure resolutions mandated by the passage of FIRREA in 1989. Over 60% of the failures occurred during a two-year span (1989 or 1990) and none fall outside a five-year window from 1988 to 1992. Acquisition and merger activity 12
Pages 60-61 of Barth, Beaver and Stinson (1988) for details of their sample selection process. concluded these firms were financially sound after reviewing press reports at the time of the transaction and records of government assistance in mergers and acquisitions and finding no press reports involving financial distress for any of the firms. Moreover, none of these transactions involved government 13 We
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of sound thrifts is relatively unclustered. Five acquisitions occur in both 1988 and 1994. At least one acquisition occurs in all years except 1990, the year that failures peaked. 4.2 Sample description Table 2 displays the geographical distribution of sample across the state that issued each thrift’s charter. California, with 17 thrifts, was the greatest contributor to the sample, while only a single thrift was provided by Texas. California’s prominence and Texas’ near absence reflects contrasts in their branching laws during this decade. California had relatively liberal branching laws that had allowed its thrifts to grow to the extent that going public became more likely. In contrast, the restrictive branching laws of Texas limited institutional size and reduced the likelihood that Texas thrifts would go public. 5. Results Tables 3, 4 and 5 provide pairwise comparisons of the size and internal governance attributes of our three subsamples. Table 3 contrasts failed and surviving thrifts, table 4 contrasts failed and acquired thrifts, and table 5 contrasts acquired and surviving thrifts. We have 288 observations across years for our sample of 86 thrifts, yet no single year contains data for all the thrifts in that sample. Lacking compelling grounds for focussing on any particular year, we base the statistics reported in tables 3 – 5 on the data closest to 1989 for each of the 86 thrifts in the sample. Any choice of focal year is unavoidably arbitrary, so we chose 1989 because the median of the observations occurred during that year. Nevertheless, the reported results proved insensitive to the use of other focal years.
assistance, a characteristic generally associated with financial distress at either or both of the firms. We elaborate on this point later in this section.
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5.1 Comparing thrifts that failed to thrifts that survived the crisis Panel A of table 3 indicates that thrifts that failed during this period were similar in size to thrifts that survived the crisis. The only significant variation detected in the mean of the ratio of market capitalization to total assets. The marginal significance (at the 10% level) of the parametric test is uncorroborated by the nonparametric significance test. In contrast, panels B and C reveal significant differences in the board composition and equity ownership of independent board members across failed and surviving thrifts. Thrifts that failed during the thrift crisis had significantly fewer independent directors and more affiliated directors than thrifts that survived. Further, independent directors at surviving firms held nearly three times as much equity as their counterparts at failed thrifts. This evidence is consistent with the literature that suggests that firms whose boards are dominated by independent directors are more likely to act in the interest of shareholders. 5.2 Comparing thrifts that failed to thrifts that were acquired during the crisis Panel A of table 4 indicates that whether measured in terms of total assets or market capitalization, thrifts that failed during this period were significantly larger than their counterparts that were acquired. As in table 3, the market capitalization to total assets ratio is marginally lower for the failed thrift sample. The remaining panels of table 4 reveal differences between failed and acquired thrifts in all three dimensions of internal governance that we study. In contrast to thrifts that failed, the boards of thrifts acquired during the crisis were dominated by independent
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directors. For a typical 10-member thrift board, failed thrifts had 4 independent directors in comparison to the 6 independent directors typical to their acquired counterparts. In failed thrifts these two seats were generally occupied by affiliated directors and to a lesser extent by inside directors. Affiliated directors occupied nearly twice as many board seats at failed thrifts (27%) as they occupied at acquired thrifts (15%). Failed thrifts also filled a greater proportion of their board seats with insiders (35% versus 24%), although the significance of this difference is detected only through the nonparametric test. Inside directors of failed thrifts held nearly twice as much equity (11% versus 6%) as their counterparts at acquired thrifts. This pattern is reversed for independent directors, with independent directors of failed thrifts owning roughly 1% of their firm’s equity compared to the 2% holdings of their counterparts at acquired thrifts. CEOs of failed thrifts received more total compensation ($335,634) than CEOs at acquired thrifts ($238,493). This difference is driven by their fixed compensation, with CEOs at failed thrifts receiving $316,573 versus the $175,269 received by CEOs at acquired thrifts. Yet, CEOs at acquired thrifts are actually better compensated than their counterparts at failed thrifts when we control for the assets under their management. The evidence presented in tables 3 and 4 is broadly consistent with the internal governance directives of Jensen (1993) and others. Thrifts that failed during the thrift crisis had governance structures that were poorly aligned with the interests of nonmanagement shareholders relative to firms that survived either as independent firms or as targets of acquisitions.
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5.3 Comparing thrifts that were acquired to thrifts that survived the crisis The preceding analysis begs the question of whether thrifts that were acquired are failures or survivors in the context of natural selection. We address this question through two comparisons. First, we repeat the analysis of preceding tables to determine whether acquired and surviving thrifts are similar in their size and internal governance structures. Second, we compare the long-term return performance of both failed thrifts and acquired thrifts relative to a benchmark portfolio of the returns of thrifts that survived the thrift crisis. Panel A of table 5 shows that acquired thrifts were significantly smaller than thrifts that survived as independent firms. CEOs of acquired firms received greater fixed and total compensation than their counterparts at surviving thrifts, but this difference is driven by thrift size. CEOs of acquired thrifts are compensated at least as well as their counterparts at surviving thrifts when we control for assets under management. Absent other differences in the characteristics considered, it is plausible that size and the consequent ease of purchase is the only essential difference between thrifts that were acquired during the crisis and thrifts that remained independent. The acid test of this conjecture for finance practitioners is whether these dichotomous outcomes benefit or harm shareholder interests. Panel A of table 6 compares the buy-and-hold return of each acquired thrift from January 1, 1985 through the date of their last trade to the mean buy-and-hold return of the 36 surviving thrifts over the same time period. The mean difference is positive and
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insignificant (p-value = 0.21), so we conclude that shareholders of thrifts acquired during the thrift crisis would have prospered at least as well as shareholders of thrifts that survived the crisis. Therefore, we do not differentiate between thrifts that survived and thrifts that were acquired during the remainder of the paper. Panel B of table 6 applies panel A’s procedure to thrifts that failed during the thrift crisis. The buy-and-hold return of each failed thrift is cumulated from the beginning of 1985 through their last trade then it is compared to the mean buy-and-hold return of the 36 surviving thrifts over the same time period. Not surprisingly, the individual differences are uniformly negative and the mean difference is significant and exceeds 100%. 5.4 Comparing thrifts that failed to thrifts that did not fail during the crisis Our separate analyses of the size, governance characteristics, and stock returns of our samples that thrifts acquired during the thrift crisis and thrifts that survived the crisis differ only on the basis of asset size. Therefore, subsequent analyses treat these two categories as a single category of non-failed thrifts. Table 7 documents the univariate differences between the size and governance characteristics between 26 failed thrifts and 60 non-failed thrifts. The summary statistics indicate that failed thrifts were larger and more poorly capitalized than thrifts that did not fail. The most conspicuous difference between failed and non-failed thrifts was their board composition, with failed thrifts filling a greater proportion of their seats with inside and affiliated directors as by extension, a smaller proportion with independent directors. On average, the boards of thrifts that did not fail during the thrift crisis were dominated by independent directors. Figure 1 displays the
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differences in the proportion of board seats held by director type at failed versus nonfailed thrifts. Failed thrift boards were dominated by inside and affiliated directors, in contrast to the independent director dominated boards of the non-failed thrifts. The equity holdings of independent directors at non-failed thrifts unambiguously exceed those of their counterparts at failed thrifts. This suggests that independent directors at the thrifts which avoided failure had stronger incentives to monitor than their counterparts at failed thrifts. The equity holdings of inside directors at thrifts that failed appear marginally greater than those of their counterparts at non-failed thrifts. And the fixed compensation of CEOs whose thrifts failed exceeded that of their peers at non-failed thrifts, but only in absolute terms. When we control for assets under management the direction of this difference swings toward the CEOs of non-failed thrifts and is only marginally significant. 5.5 Caveats and quandaries We have encountered two criticisms of our use of firm failure as an indicator of inferior management strategy. First, Jensen (1993) argues that managers too often squander shareholder value because they are loath to exit unprofitable situations, thus events that we label failures may be mislabeled strategic exits. While we agree with this argument in principle, the failed thrifts’ buy-and-hold returns discussed in the preceding paragraph provides an unambiguous test of this conjecture. All 26 of the differences between the failed and surviving thrifts were negative consistent with an alternative hypothesis that thrift exits during this crisis were not value enhancing.
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Second, the strategy chosen by managers of the failed thrifts might have been optimal ex ante considering the deposit insurance incentives for risk-taking that prevailed during this period. However, such speculations seem comparable to arguing that equipping automobiles with airbags is suboptimal because of the infrequency of collisions. Not only did the crisis occur, Kane (1989) contends that it was predictable some three years in advance. In the context of this study, the thrift crisis extinguished the environment upon which such speculations about ex ante optimality are based. 5.6 Multivariate results Our logistic regression analysis shows the relation between internal governance mechanisms and institutional survival during the thrift crisis in a multivariate setting. The binary dependent variable in these models is assigned the value one for failed thrifts and zero for non-failed (i.e., acquired or surviving) firms. Thus, a negative coefficient implies that increases in the associated variable increase the likelihood of a thrift surviving or being purchased in an non-regulator-assisted acquisition, and a positive coefficient indicates a higher probability of failure. The variables used to test our hypotheses about the importance of corporate governance to survival include: the percentage of affiliated and independent directors; the stock ownership of each director class; the presence of unaffiliated blockholders; CEO compensation per million dollars of assets; and whether the same individual occupies both the CEO and Chairman’s post. Other variables control for potentially important nonfinancial characteristics of the sample firms as well as economic conditions during the sample period. The firm specific control variables, which have been shown to be important in other studies of thrifts, include: whether the thrift is headquartered in a state
24
with liberal regulations; firm size (measured as the natural log of total assets), type of charter (federal or state); whether the firm was founded within the last five years; and whether the thrift was converted to stock from mutual form during or after 1980. The final set of control variables reflects the economic activity or economic conditions in the state in which each sample firm is chartered. The specific state-level economic variables considered include standard economic measures such as personal income, per capita income, non-farm income, state population growth as well as more specific measures including mining income, oil and gas income, mining employment (includes oil and gas exploration) and permits for new home construction. The actual variables used in the regression models are the percent change over the 3-year or 5-year period immediately before the sample year for each observation, or the standard deviation over the 3-year or 5year period immediately before the sample year. Models were estimated with one control variable and with combinations of variables. The tabulated results include the set of economic control variables with statistically significant coefficients. Table 8 presents results from three models that differ only in their inclusion of board composition variables. These results are based on all 288 observations for the sample of 86 thrifts. The coefficient estimates are corrected for the intertemporal dependence of repeated observations drawn from the same firms, and coefficient standard errors are computed using the robust technique of Huber (1967) and White (1980). All three models in table 8 are significant with p-values for the Chi-squared test of less than 1%. The pseudo-R-squared for the models range from 56% to 60%. Overall, the results reported in table 8 confirm the univariate indications that thrifts with proportionally more independent directors were less likely to fail during the thrift crisis.
25
Model 1 includes variables for both the proportion of affiliated (i.e., gray) outside directors and independent outside directors. The coefficient estimate for the proportion of independent directors is negative and significant indicating that a higher proportion of independent directors is associated with a higher probability of non-failure (survival or acquisition without regulatory assistance). In model 1 the coefficient estimate for the proportion of gray directors is positive and significant at only the 6%level. The sign of the coefficient indicates that boards with more gray directors had a higher likelihood of failure during the thrift crisis than firms with fewer gray directors. This weak result may be due to the very high correlation between the proportion of independent and gray directors (ρ = 57%). Table 7 revealed no difference in board size between failed and non-failed thrifts, and only a slight difference between those groups in their proportions of inside directors. Thus, among our sample firms board composition strategies vary almost exclusively according to the proportion of affiliated outside directors versus independent outside directors. Models 2 and 3 address this possibility of co-linearity affecting the coefficient estimates by including just one of the board composition variables. In model 2 the coefficient estimate for the proportion of independent directors is again negative and significant (p-value = 0.001). This result is consistent with the arguments of Baysinger and Butler (1985) and the evidence of Byrd and Hickman (1992) and Shivdasani (1993) that independent outside directors can serve an effective role in controlling managerial behavior and enhancing shareholder during major corporate events. In model 3 the coefficient estimate for the proportion of affiliated directors is positive and highly significant (p-value = 0.001). This result suggests that affiliated directors served a
26
detrimental role in thrift failures during the thrift crisis and contrasts with Klein’s (1998) evidence of affiliated directors’ efficacy as advisors and information providers. The coefficient estimate for the equity ownership of inside directors is not significant in any of the three models. The coefficient estimate for equity ownership of gray directors is positive and significant in all models. This indicates that as affiliated directors hold more stock there is a higher probability of failure among those firms they direct. This evidence appears to contradict our conventional notions that greater equity ownership helps align the interests of managers (or directors) and shareholders. The coefficient estimate for equity ownership of independent directors is negative and significant in all models. This result agrees with standard theories about equity ownership aligning the interests of managers (or directors) and shareholders. Completing our findings pertaining to the thrifts’ board and ownership structures, we detect no relation between the presence of an unaffiliated blockholder and the probability of a thrift’s survival during the thrift crisis. Turning to CEO attributes, we find that thrifts were significantly more likely to fail if their CEO also served as Chairman. This evidence contradicts the argument made by Brickley, Coles and Jarrell (1997) that the unitary management position is optimal. It confirms earlier evidence that found an association between accounting performance measures and dual leadership (Pi and Timme, 1993). The CEOs of thrifts that subsequently failed received significantly less compensation relative to the assets managed than their counterparts at non-failed thrifts. One plausible explanation for this compensation differential is that better managers were identified and paid more than less
27
effective managers. We find no relation between the probability of failure and the proportion of the total compensation that was salary (or salary and bonus). Firm-specific attributes related to thrift failure include firm size, charter type, age, and recent conversion from mutual to stock form thrift. Consistent with our univariate statistics, the logistic regression confirms that large thrifts were more likely to fail during this period, as were thrifts with Federal charters. However, the interaction variable between these two attributes reveals that thrifts that were both large and federally chartered were actually less likely to fail. Unseasoned thrifts (those with five or fewer years of existence) were significantly more likely to fail during the thrift crisis. Perplexingly, we find that thrifts recently converted from mutual form were less likely to fail during the thrift crisis. This result contradicts Esty (1997a) who detects increased risk taking following mutual to stock form conversions during the 1980s. State-specific attributes related to thrift failure include the state's disposition toward bank regulations, growth in housing permits issued, change in population and change in oil and gas income. Our analysis indicates that thrifts based in states with liberal banking regulations were less likely to fail even after controlling for the growth in housing starts. This result is inconsistent with the hypothesis that the greater powers granted to thrifts by deregulation was a principal cause of the thrift crisis. It is, however, consistent with our findings that corporate control variables are important in affecting firm failure prospects in a deregulated environment. As expected, thrifts with higher growth in housing starts are less likely to fail. Rapid growth in housing produces strong demand for mortgage related credit which is the focus of thrift lending and reflects strong underlying economic fundamentals which should be associated with limited default loss on thrift 28
loans. Growth in oil and gas income is associated with a lower probability of failure. Greater population growth increases the likelihood of failure. 5.6 Robustness checks Table 9 provides a robustness check of the methodology employed in table 8 by repeating that analysis with a single observation for each firm. The single observation selected was from 1989, the median year in our sample period, or the year closest to 1989 for each firm. The overall significance of the model remains, but the individual significance of several explanatory variables falls. When we include both the proportion of independent and the proportion of affiliated directors in the regression, neither coefficient estimate is significant. These variables are highly negatively correlated, ρ = –0.57, so we replicate the model isolating the proportion of independent directors and the proportion of affiliated directors. Consistent with our previous analysis, firms with larger proportions of independent directors were less likely to fail during the thrift crisis. When isolated, the proportion of affiliated directors resumes its significance, indicating that thrifts with larger proportions of affiliated directors were more likely to fail during the thrift crisis. The remainder of table 9 reveals an expected erosion in the significance of many of the other firm-specific and state-specific variables due to the decline in degrees of freedom associated with the smaller sample. Firm age and the state’s growth in housing permits appear foremost among these variables. As before, unseasoned firms are more likely to fail and high growth in the building sector of a thrift’s home state provide a powerful inoculation against failure in the thrift crisis.
29
In addition to the tabulated results we examined several other specifications of equity ownership. We tested quadratic and piecewise forms of inside, gray, and independent director equity ownership (McConnell and Servaes (1990) and Morck, Shliefer, and Vishny (1988)). In no case did these alternative specifications alter or inform the results presented in tables 8 and 9. We also combined the equity stakes of inside and gray directors and used it in place of separate ownership variables. The results reflected the explanatory power of the gray ownership variable, albeit with less significance. We also estimated the multivariate model with the addition of a supervisory goodwill dummy variable and a fraud dummy variable. The supervisory goodwill variable reflects the potential influence of government inducements in the early 1980s to healthy thrifts to acquire insolvent institutions. (White, 1991). The fraud dummy was designed to capture the potential bias in our sample caused by looting behavior as proposed by Akerlof and Romer (1993). Classification was based on a Lexis-Nexis search. Fraud was reported for three of our failed institutions while three of the failed and fourteen of the survivor institutions were reported as having been involved in supervisory goodwill mergers. The addition of these two variables does not materially change the results reported in tables 8 and 9. Finally, we estimate a random-effects model of our broken panel data. These results, which are not tabulated, are qualitatively identical to those reported for logit regressions in tables 8 and 9. The estimation was based on the STATA ‘xtreg’ procedure.
30
6. Conclusions We use the thrift crisis of the 1980s as a natural experiment to study the role that internal governance systems play in a firm’s ability to adapt to economic shocks. Board composition, outside director stock ownership, and CEO compensation contracts are all significantly related to the survival rate of thrifts during this turbulent period, and they remain so after we control for thrift-specific factors (size, age, form of charter, and for recent conversions from mutual form) and state-specific factors (regulatory liberality, economic conditions, and whether the thrift is state or federally chartered). We find that the probability of failure decreases as the percentage of board seats held by independent directors increases. In contrast, the probability of failure increases as the percentage of affiliated outside directors increases. The evidence that director independence decreases the likelihood of thrift failure corroborates other evidence that independent directors defend shareholder interests, but our evidence of the detrimental impact of affiliated directors on the probability of survival of thrifts is unique. It casts doubt on the role of affiliated directors on the board and is in variance with Klein (1998), who concludes that affiliated directors provide valuable information and advice to the firms they direct. It also suggests that director classification schemes that use a simple two-way classification system (e.g., inside and outside directors) may be missing potentially important relationships. We find that director ownership of stock has a different effect for affiliated and independent outside directors. For affiliated directors higher equity ownership is associated with a higher probability of failure, while for independent directors the
31
opposite is true. These results suggest that stock ownership tends to strengthen independent outside directors’ incentives to make decisions that enhance shareholders’ wealth. The results for affiliated directors raise questions about their role on thrift boards during this period. Overall, our results add to the growing body of evidence that independent directors support the interests of shareholders in corporate-level decisions such as takeovers or, in our case, defining strategic direction during a time of severe turbulence. Our evidence also suggests that much work remains to be done before we will have a clear understanding of the role of affiliated directors on corporate boards.
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Brickley, James A., Jeffrey L. Coles, and Rory L. Terry, 1994. The board of directors and the enactment of poison pills, Journal of Financial Economics 35, 371-390. Byrd, John W. and Kent A. Hickman, 1992. Do outside directors monitor managers? Journal of Financial Economics 32, 195-221. Carnegie, Andrew. 1889. Wealth, North American Review, June. Cebenoyan, A. Sinan, Elizabeth S. Cooperman, and Charles A. Register, 1999. Ownership structure, charter value, and risk-taking behavior for thrifts, Financial Management 28, 43-60. Cotter, James F., Anil Shivdasani, and Marc Zenner, 1997. Do independent directors enhance target shareholder wealth during tender offers?, Journal of Financial Economics 43, 195-218. Crawford, Anthony J., John R. Ezzell, and James A. Miles, 1995. Bank CEO payperformance relations and the effect of deregulation, Journal of Business 68, 231-256. Curry, Timothy and Lynn Shibut, 2000. The cost of the savings and loan crisis: Truth and Consequences, FDIC Banking Review 13, 26-35. Darwin, Charles R., 1859. On the origin of the species by means of natural selection. D. Appleton and Co., NY. Demsetz, Harold and Kenneth M. Lehn, 1985. The structure of corporate ownership: causes and consequences, Journal of Political Economy 93, 1155-1177. Denis, David J. and T. A. Kruse, 1998. Managerial discipline and corporate restructuring following performance declines. Unpublished manuscript (Purdue University, West Lafayette, IN). Dial, Jay and Kevin J. Murphy, 1995. Incentives, downsizing, and value creation at General Dynamics, Journal of Financial Economics 37, 261-314. Esty, Benjamin C., 1997a. Organizational form and risk taking in the savings and loan industry, Journal of Financial Economics, 44, 25-55. Esty, Benjamin C., 1997b. A case study of organizational form and risk shifting in the savings and loan industry, Journal of Financial Economics, 44, 57-76. Fama, Eugene F. and Michael C. Jensen, 1983. Separation of ownership and control, Journal of Law and Economics 26, 301-325. Federal Deposit Insurance Corporation, 1997. History of the Eighties: Lessons for the Future; Volume 1, An Examination of the Banking Crises of the 1980s and Early 1990s, Washington, D. C., FDIC.
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Figure 1. Percentage of board seats held by inside, a independent directors at failed thrifts (indicated b circle) and non-failed thrifts (indictated by the in
Insiders 29%
35%
Independen
37%
53% 18%
Affiliated 28%
37
Table 1 Calendar time distribution of sample Year of failure or acquisition of 50 publicly-traded thrifts during the period 1986-1994. An additional 36 thrifts that survived the period intact are not included in the table. The 24 institutions that were acquired during the 10-year window were financially-sound at the time of acquisition. All 26 thrift failures resulted from bankruptcy or regulatory intervention and occur within a 6-year interval from 1987 to 1992. Non-Failed Year
Failed
1986
Acquired
Surviving
0
1
n.a
1987
2
2
n.a.
1988
2
4
n.a.
1989
4
2
n.a.
1990
9
0
n.a.
1991
6
3
n.a.
1992
3
1
n.a.
1993
0
6
n.a.
1994
0
5
n.a.
Totals
26
24
36
38
Table 2 Distribution of sample firms by state of charter of 86 publicly-traded thrifts. The sample includes 26 thrifts that failed through bankruptcy or regulatory intervention and 24 financially-sound thrifts acquired during the 10-year window from 1986-1994. The remaining 36 thrifts survived the period as independent firms. State AL AR AZ CA CO CT FL GA HI IL MA MD MI MO NC NE NH NJ NV OH OK PA PR RI SC TN TX UT VA WA WI Totals
Total 2 1 1 17 2 2 12 3 1 3 4 2 3 1 1 1 2 2 1 1 2 5 1 1 1 1 1 1 7 3 1 86
Failed 0 1 1 7 1 0 2 0 0 1 2 1 0 0 1 0 1 0 0 0 1 1 0 0 0 1 1 0 4 0 0 26
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Acquired 2 0 0 1 1 0 5 1 1 1 1 0 1 0 0 0 1 0 1 1 1 2 0 1 0 0 0 0 1 2 0 24
Surviving 0 0 0 9 0 2 5 2 0 1 1 1 2 1 0 1 0 2 0 0 0 2 1 0 1 0 0 1 2 1 1 36
Table 3 Comparison of 26 failed and 36 surviving thrifts. Descriptive statistics for the size and governance characteristics of 62 publicly-traded thrifts. Contrasts 26 thrifts that failed during the thrift crisis through bankruptcy or regulatory intervention with 36 thrifts that survived the 10-year study period as independent firms. Significance of the differences between the subgroups’ statistics reflect parametric t-tests and the Wilcoxon rank-sum Z-test. Parametric tests for differences in total assets and market capitalization are based on the natural logs of those figures. Total assets and market capitalization data are in millions of dollars. Failed Surviving Panel A: Size thrifts thrifts Difference Total assets mean 4,593 5,416 –823 median 2,033 1,181 852 Market capitalization mean 98 176 –78 median 43 41 2 Market capitalization/total assets mean 2.71% 3.90% –1.19% c median 2.13% 3.32% –1.19% Panel B: Board characteristics Board size
mean median mean median mean median mean median
10.4 9.5 35.1% 34.9% 27.4% 25.0% 37.6% 42.2%
10.7 9.5 30.7% 30.0% 16.6% 17.1% 52.7% 50.0%
–0.3 0.0 4.4% 4.9% 10.8% a 7.9% a –15.1% a –7.8% a
mean median Total equity held by affiliated directors mean median Total equity held by independent directors mean median Total equity held by all directors mean median Unaffiliated blockholders’ equity: mean median
11.0% 7.3% 2.9% 0.4% 1.1% 0.6% 15.1% 10.9% 13.9% 10.2%
7.9% 4.9% 1.4% 0.3% 2.9% 1.7% 12.2% 9.8% 19.0% 18.9%
3.1% 2.5% 1.5% 0.1% –1.8% a –1.1% a 2.9% 1.1% –5.1% –8.7%
Proportion of inside directors Proportion of affiliated directors Proportion of independent directors Panel C: Equity ownership Total equity held by inside directors
Panel D: Compensation Total compensation: Fixed compensation: Performance-based compensation: Total compensation per $million assets: Fixed compensation per $million assets: Performance-based compensation per $million assets Performance-based compensation as a portion of total compensation
mean median mean median mean median mean median mean median mean median mean median
335,634 308,138 316,573 296,746 24,061 32.3 157.2 154.4 146.2 144.2 11.0 0.5 6.8% 0.05%
a
Statistically significant at the 1 percent level. Statistically significant at the 5 percent level. c Statistically significant at the 10 percent level. b
40
380,657 282,984 283,506 211,795 97,151 0 285.0 169.4 215.7 162.9 69.3 0.0 12.8% 0.00%
–45,023 25,154 28,067 84,951 –73,090 0 –127.8 –15.0 –69.5 –18.7 –58.3 0.5 –6.0% 0.05%
Table 4 Comparison of 26 failed and 24 acquired thrifts. Descriptive statistics for the size and governance characteristics of 50 publicly-traded thrifts. Contrasts 26 thrifts that failed during the thrift crisis through bankruptcy or regulatory intervention with 24 financiallysound thrifts that were acquired between 1987 and 1995. Significance of the differences between the subgroups’ statistics reflect parametric t-tests and the Wilcoxon rank-sum Z-test. Parametric tests for differences in total assets and market capitalization are based on the natural logs of those figures. Total assets and market capitalization data are in millions of dollars. Panel A: Size Total assets Market capitalization Market capitalization/total assets Panel B: Board characteristics Board size Proportion of inside directors Proportion of affiliated directors Proportion of independent directors
mean median mean median mean median
Failed thrifts 4,593 2,033 98 43 2.71% 2.13%
Acquired thrifts 1,250 698 39 27 3.82% 3.61%
mean median mean median mean median mean median
10.4 9.5 35.1% 34.9% 27.4% 25.0% 37.6% 42.2%
9.5 9.0 27.7% 23.6% 15.0% 13.8% 57.3% 60.0%
0.9 0.5 7.4% 11.3% b 12.4% a 11.2% a –19.7% a –17.8% a
11.0% 7.3% 2.9% 0.4% 1.1% 0.6% 15.1% 10.9% 13.9% 10.2%
6.0% 3.8% 1.5% 0.5% 2.1% 1.4% 9.5% 6.4% 18.5% 21.0%
5.0% b 3.5% 1.4% –0.1% –1.0% c –0.8% c 5.6% c 4.5% –4.6% –10.8%
335,634 308,138 316,573 296,746 24,061 32 157.2 154.4 146.2 144.2 11.0 0.5 6.8% 0.05%
238,493 200,463 175,269 159,325 63,234 0 365.9 204.6 230.7 177.4 135.1 0.0 14.4% 0.00%
Panel C: Equity ownership Total equity held by inside directors
mean median Total equity held by affiliated directors mean median Total equity held by independent directors mean median Total equity held by all directors mean median Unaffiliated blockholders’ equity: mean median Panel D: Compensation Total compensation: Fixed compensation: Performance-based compensation: Total compensation per $million assets: Fixed compensation per $million assets: Performance-based compensation per $million assets Performance-based compensation as a portion of total compensation
mean median mean median mean median mean median mean median mean median mean median
a
Statistically significant at the 1 percent level. Statistically significant at the 5 percent level. c Statistically significant at the 10 percent level. b
41
Difference 3,343 a 1,335 a 59 b 16 c –1.11%b –1.48%
97,141 b 107,675 b 136,304 a 137,421 a –39,163 32 –208.7 b –50.2 b –84.5 a –33.2 b –124.1 0.5 –7.6% 0.05%
Table 5 Comparison of 24 acquired and 36 surviving thrifts. Descriptive statistics for the size and governance characteristics of 60 non-failed, publicly-traded thrifts. Contrasts 24 financially-sound thrifts that were acquired between 1987 and 1995 with 36 thrifts that survived as independent firms. Significance of the differences between the subgroups’ statistics reflect parametric t-tests and the Wilcoxon rank-sum Z-test. Parametric tests for differences in total assets and market capitalization are based on the natural logs of those figures. Total assets and market capitalization data are in millions of dollars. Acquired Surviving Panel A: Size thrifts thrifts Difference Total assets mean 1,250 5,416 –4,167 b median 698 1,181 –483 b Market capitalization mean 39 176 –137 c median 27 41 –14 c Market capitalization/total assets mean 3.82 3.90% –0.08% median 3.61 3.32% 0.29% Panel B: Board characteristics Board size
mean median mean median mean median mean median
9.5 9.0 27.7% 23.6% 15.0% 13.8% 57.3% 60.0%
10.7 9.5 30.7% 30.0% 16.6% 17.1% 52.7% 50.0%
–1.2 –0.5 –3.0% –6.4% –1.6% –3.3% 4.6% 10.0%
mean median Total equity held by affiliated directors mean median Total equity held by independent directors mean median Total equity held by all directors mean median Unaffiliated blockholders’ equity: mean median
6.0% 3.8% 1.5% 0.5% 2.1% 1.4% 9.5% 6.4% 18.5% 21.0%
7.9% 4.9% 1.4% 0.3% 2.9% 1.7% 12.2% 9.8% 19.0% 18.9%
–1.9% –1.1% 0.1% 0.2% –0.8% –0.3% –2.7% –3.4% –0.5% 2.1%
Proportion of inside directors Proportion of affiliated directors Proportion of independent directors Panel C: Equity ownership Total equity held by inside directors
Panel D: Compensation Total compensation: Fixed compensation: Performance-based compensation: Total compensation per $million assets: Fixed compensation per $million assets: Performance-based compensation per $million assets Performance-based compensation as a portion of total compensation
mean median mean median mean median mean median mean median mean median mean median
238,493 200,463 175,269 159,325 63,234 0 365.9 204.6 230.7 177.4 135.1 0.0 14.4% 0.0%
a
Statistically significant at the 1 percent level. Statistically significant at the 5 percent level. c Statistically significant at the 10 percent level. b
42
380,657 282,984 283,506 211,795 97,151 0 285.0 169.4 215.7 162.9 69.3 0.0 12.8% 0.0%
–142,164 b –82,521 –108,237 b –52,470 b –33,927 0 80.9 35.2 15.0 14.5 65.8 0.0 1.6% 0.0%
Table 6 Buy-and-hold returns for 26 acquired thrifts and 24 failed thrifts relative to a benchmark portfolio of 36 thrifts that survived (remained independent) the thrift crisis. Comparison of buy-and-hold returns for thrifts that do not remain independent due to takeover (panel A) or due to bankruptcy or regulatory intervention (panel B), and a portfolio of 36 thrifts that survived as independent firms beyond January 1, 1995. The returns are cumulated daily returns beginning January 1, 1985 and ending on CRSP’s last trading date. The benchmark return is the mean of the 36 buy-and-hold returns of the surviving thrifts cumulated over the same period as the exiting firm to which it is being compared. Panel A: Acquired thrifts
Date of last trade
Alabama Federal Thrift Assoc. American Thrift Assoc. - FL Atico Financial Corp. Boston Five Cents Savings Bank - MA Buckeye Financial Corp. Central Holding Co. Central Pennsylvania Savings Assoc. Columbia Federal Savings Bank First American Federal Thrift Assoc. First Federal Bank FSB - NH First Federal Thrift - VA First Western Financial Corp. Fortune Financial Group, Inc. Freedom Federal Savings Bank – Oak Brk Guarantee Financial Corp. – CA Heart Federal Thrift Assoc. – CA Home Federal Bank FSB - FL Home Federal Thrift Assoc. Co. - Rock International Holding Cap Landmark Savings Assoc – Pittsburgh Local Federal Thrift Assoc. - OK Mid State Federal thrift Old Stone Corp. Pacific First Financial Corp.
1993-12-31 1988-04-29 1991-03-28 1993-10-13 1991-01-24 1994-04-08 1994-09-30 1988-04-29 1993-12-31 1988-06-30 1986-04-07 1994-10-31 1994-06-23 1988-08-02 1987-10-30 1991-03-28 1987-07-24 1993-06-30 1994-03-31 1992-06-30 1989-08-21 1993-12-13 1993-01-28 1989-12-01
43
Return of Return of Difference acquired thrift surviving thrifts 2.760 0.829 -0.442 -0.046 0.247 0.435 1.153 2.417 1.283 0.938 0.071 0.742 0.871 0.572 0.956 3.404 1.178 1.356 1.626 -0.330 -0.097 1.358 -0.840 1.581
1.308 0.054 -0.132 1.471 -0.313 1.173 1.424 0.054 1.308 0.093 0.307 1.254 1.341 0.097 0.022 -0.132 0.309 0.980 1.123 0.271 0.314 1.250 0.976 0.165 mean t-statistic pr(t)
1.452 0.775 -0.310 -1.516 0.560 -0.738 -0.272 2.363 -0.025 0.845 -0.235 -0.512 -0.471 0.475 0.934 3.536 0.870 0.376 0.502 -0.601 -0.411 0.108 -1.816 1.416 0.304 1.279 0.214
Table 6 (continued) Panel B: Failed thrifts
Date of last trade
American Federal Thrift Assoc. Atlantic Financial Federal Atlantic Permanent Federal Thrift Centrust Savings Bank Comfed Savings Bank – Lowell, MA Financial Corp. of America Financial Corp. – Santa Barbara First Federal Thrift Assoc. - TX Germania F A Gibraltar Financial Corp. Great American First Savings Bank Heritage Financial Corp. Home Federal Thrift Assoc. - CA Home Owners Federal Thrift Assoc. Investors Thrift Assoc. Landmark Land, Inc. Mercury Thrift Assoc. Metropolitan Federal Thrift TN North Carolina Federal Thrift Perpetual American Bank FSB- VA Savers Bancorp Inc. Savers Federal Thrift Assoc. - AR Second National Building & Loan Sooner Federal Thrift Assoc. Transohio Financial Corp. Western Thrift Assoc. - AZ
1989-05-09 1990-01-10 1989-02-14 1990-01-22 1990-12-14 1988-09-08 1990-05-30 1988-05-04 1990-06-15 1990-03-28 1991-11-14 1990-09-26 1992-04-10 1990-07-03 1991-12-12 1991-10-23 1990-05-15 1991-04-26 1990-03-02 1991-07-17 1991-05-13 1987-01-13 1992-12-03 1989-08-24 1992-07-17 1989-06-16
44
Return of failed Return of Difference thrift surviving thrifts -0.987 -0.953 -0.778 -0.828 -0.992 -0.988 -0.996 -0.934 -0.951 -0.991 -0.998 -0.969 -0.988 -0.994 -0.992 -0.961 -0.983 -0.990 -0.922 -0.932 -0.989 -0.958 -0.919 -0.969 -0.979 -0.968
0.120 0.060 0.133 0.028 -0.320 0.087 -0.028 0.045 -0.007 -0.019 -0.012 -0.314 0.226 -0.056 -0.061 -0.008 -0.049 -0.093 0.017 -0.048 -0.086 0.336 0.622 0.320 0.423 0.203 mean t-statistic pr(t)
-1.107 -1.013 -0.911 -0.856 -0.671 -1.074 -0.968 -0.979 -0.943 -0.972 -0.986 -0.655 -1.213 -0.938 -0.931 -0.953 -0.934 -0.897 -0.939 -0.884 -0.903 -1.294 -1.541 -1.289 -1.402 -1.170 -1.016 -25.620 0.000
Table 7 Comparison of 26 failed and 60 non-failed thrifts. Descriptive statistics for the size and governance characteristics of 86 publicly-traded thrifts. Contrasts 26 thrifts that failed during the thrift crisis through bankruptcy or regulatory intervention with 60 financiallysound thrifts that survived through 1995 or were acquired without regulatory assistance. Significance of the differences between the subgroups’ statistics reflect two-way parametric t-tests and the Wilcoxon ranksum Z-test. Parametric tests for differences in total assets and market capitalization are based on the natural logs of those figures. Total assets and market capitalization data are in millions of dollars.
mean median mean median mean median
Failed thrifts 4,593 2,033 98 43 2.71% 2.13%
Non-failed thrifts 3,751 840 122 33 3.87% 3.50%
Difference 842 1,193b –24 9 –1.16%b –1.37%
mean median mean median mean median mean median
10.4 9.5 35.1% 34.9% 27.4% 25.0% 37.6% 42.2%
10.2 9.0 29.5% 27.6% 16.0% 14.3% 54.5% 52.8%
0.2 0.5 5.6% 7.3%c 11.4%a 10.7%a –16.9%a –10.6%a
mean median Total equity held by affiliated directors mean median Total equity held by independent directors mean median Total equity held by all directors mean median Unaffiliated blockholders’ equity: mean median
11.0% 7.3% 2.9% 0.4% 1.1% 0.6% 15.1% 10.9% 13.9% 10.2%
7.1% 4.5% 1.4% 0.3% 2.6% 1.5% 11.1% 8.7% 18.8% 18.9%
3.9% c 2.8% 1.5% 0.1% –1.5%a –0.9%b 4.0% 2.2% –4.9% –8.7%
335,634 308,138 316,573 296,746 24,061 32 157 154 146 144 11.0 0.05 6.8% 0.05%
323,792 212,506 240,211 182,933 83,580 0 317 173 222 169 95.63 0.00 13.4% 0.00%
11,842 95,632 71,362c 113,813b –59,519 32 –160c –19 –75.52 c –25 –84.64 0.05 –6.6% 0.05%
Panel A: Size Total assets Market capitalization Market capitalization/total assets Panel B: Board characteristics Board size Proportion of inside directors Proportion of affiliated directors Proportion of independent directors Panel C: Equity ownership Total equity held by inside directors
Panel D: Compensation Total compensation: Fixed compensation: Performance-based compensation: Total compensation per $million assets: Fixed compensation per $million assets: Performance-based compensation per $million assets Performance-based compensation as a portion of total compensation a b c
mean median mean median mean median mean median mean median mean median mean median
Statistically significant at the 1 percent level. Statistically significant at the 5 percent level. Statistically significant at the 10 percent level.
45
Table 8 Logistic analysis of governance characteristics of failed and non-failed thrifts The dependent variable, FAIL, is equal to 1 if the institution failed between 1987 and 1995, and 0 otherwise. The regressors include variables for the corporate control mechanisms, asset and liability powers, firm size, type of charter, firm age, and the effect of local economic conditions. The local economic condition variables include the percentage change in the number of new housing permits issued, population change, and change in oil and gas industry income in the state in which the thrift is chartered. The p-values (in parentheses) are estimated using robust standard errors that are computed assuming the observations are independent across firms but not between years for each firm. Explanatory Variables
Model 1 b
Intercept % Board Seats Held by Independent Directors % Board Seats Held by Affiliated Directors % Equity Held by Inside Directors % Equity Held by Affiliated Directors % Equity Held by Independent Directors D(Unaffiliated Blockholders) D(CEO is Chairman) Total CEO Compensation / Total Assets (CEO’s Salary + Bonus) / CEO’s Total Comp. D(Firm Age < 5 Years) ln(Total Assets) D(Federally Chartered Institution) D(Charter in Liberal Regulatory State) Interaction [D(Federal Charter) x ln(Total Assets)] D(Converted from Mutual to Stock Form) Annual Growth (Housing Permits in Home State) 3-yr % Change in population in charter state 3-yr % Change in oil & gas income in charter state Number of firm-years of data Likelihood Ratio (χ2) Pseudo R2 a
Statistically significant at the 1 percent level. Statistically significant at the 5 percent level. c Statistically significant at the 10 percent level. b
46
Model 2
Model 3
-15.95 (0.172) a -9.28 (0.001)
-26.55 (0.010)
a
-21.83 (0.037) b -7.08 (0.035) c 5.32 (0.056) -2.40 (0.457) b 23.44 (0.015) b -37.60 (0.036) -0.079 (0.905) a 2.28 (0.008) b -0.012 (0.018) -1.76 (0.363) a -8.55 (0.000) a 4.12 (0.007) a 41.84 (0.002) a -3.01 (0.009) a -5.36 (0.002) c 1.57 (0.063) a -5.69 (0.005) b 72.83 (0.045) c -0.77 (0.083) 288
-2.38 (0.448) a 26.57 (0.004) b -40.39 (0.018) -0.195 (0.762) b 2.05 (0.014) a -0.014 (0.005) -2.51 (0.195) a -8.19 (0.000) b 3.76 (0.024) a 39.69 (0.006) a -3.64 (0.002) a -5.05 (0.007) b 1.64 (0.046) a -5.61 (0.006) b 72.68 (0.043) c -0.80 (0.051) 288
9.55 (0.001) 0.63 (0.842) b 22.78 (0.048) b -46.50 (0.019) -0.082 (0.899) a 2.24 (0.005) c -0.008 (0.073) -1.08 (0.590) a -7.28 (0.000) a 3.88 (0.005) a 38.38 (0.001) b -2.05 (0.014) a -4.94 (0.001) c 1.55 (0.086) a -4.99 (0.002) 59.98 (0.066) c -0.67 (0.078) 288
44.91 (0.0004) 60%
44.79 (0.0003) 58%
59.47 (0.0000) 56%
a
Table 9 Logistic analysis of failed and non-failed thrifts using a single observation for each firm Logistic regressions with single observation per thrift. The single observation is from 1989 or the observations closest to 1989 for each firm. The dependent variable, FAIL, is equal to 1 if the institution failed between 1987 and 1995, and 0 otherwise. The regressors include variables for the corporate control mechanisms, asset and liability powers, firm size, type of charter, firm age, and the effect of local economic conditions. The local economic condition include the percentage change in the number of new housing permits issued, population change, and change in oil and gas industry income in the state in which the thrift is chartered. The p-values (in parentheses) are estimated using robust standard errors that are computed assuming the observations are independent across firms but not between years for each firm. Explanatory Variables Intercept % Board Seats Held by Independent Directors % Board Seats Held by Affiliated Directors % Equity Held by Inside Directors % Equity Held by Affiliated Directors % Equity Held by Independent Directors D(Unaffiliated Blockholders) D(CEO is Chairman) Total CEO Compensation / Total Assets (CEO’s Salary + Bonus) / CEO’s Total Comp. ln(Total Assets)
Model 1 -37.81 b
Model 2 -31.75 b
Model 3 -42.73 a
(0.012)
(0.032)
(0.008)
-5.52
-7.41 b
(0.107)
(0.027)
9.08 b
4.67 (0.259)
(0.018)
-4.42
-4.36
-1.41
(0.299)
(0.352)
(0.755)
13.07
13.60 b
13.45
(0.072)
(0.042)
(0.112)
-66.26 b
-69.65 b
-72.30 b
(0.020)
(0.021)
(0.025)
2.18
1.45
3.36
(0.442)
(0.626)
(0.245)
1.85 b
1.59 c
2.00 b
(0.019)
(0.071)
(0.012)
-0.003
-0.005
-0.001
(0.427)
(0.373)
(0.588)
-0.41
-1.59
1.24
(0.907)
(0.630)
(0.733)
5.63 a
5.30 b
5.45 a
(0.008)
(0.018)
(0.008)
D(Federally Chartered Institution)
46.75 a
44.49 b
45.18 a
(0.008)
(0.021)
(0.006)
Interaction [D(Federal Charter) x ln(Total Assets)]
-6.08 a
-5.76 b
-5.89 a
(0.010)
(0.025)
(0.008)
-5.63 a
-5.76 a
-5.07 a
(0.000)
(0.000)
(0.000)
1.73 b
1.88 b
1.40
(0.033)
(0.017)
(0.099)
-2.63 c
-3.07 c
-1.60
(0.083)
(0.061)
(0.132)
D(Firm Age < 5 Years) D(Converted from Mutual to Stock Form) D(Charter in Liberal Regulatory State) Annual Growth (Housing Permits in Home State) 3-yr % Change in population in charter state 3-yr % Change in oil & gas income in charter state Number of firms Likelihood Ratio (χ2) Pseudo R2 a
Statistically significant at the 1 percent level. b Statistically significant at the 5 percent level. c Statistically significant at the 10 percent level.
47
-4.56
-3.95
-4.91
(0.161)
(0.241)
(0.094)
61.88
61.34
54.05
(0.139)
(0.162)
(0.143)
-1.12 c
-1.34 b
-0.89
(0.085)
(0.035)
(0.148)
86
86
86
34.46
33.35
31.85
(0.011)
(0.010)
(0.016)
50.4%
49.2%
47.2%
