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Regulating Bank Governance: Mandating CEO-Chairman Division at Too-Big-to-Fail Banks

posted by Adam Levitin

For a while, the battle over whether to split the JPMorgan Chase CEO and Chairman positions looked like the corporate governance battle of the year, but seems to have ended with a whimper, rather than a bang. The media coverage of the issue, however, largely overlooked the unique, bank-specific aspects of corporate governance. Specifically, what's at stake in the corporate governance of a too-big-to-fail bank like JPMorgan Chase is not just the share price, but also the public fisc.  There is a strong federal regulatory interest in having good governance at too-big-to-fail banks because of our explicit (FDIC) and implicit (bailout) insurance of too-big-to-fail banks. This suggests that federal bank regulators and Congress should be pushing to ensure that too-big-to-fail banks conform with best practices in corporate governance. To the extent good governance at a too-big-to-fail bank includes division of the CEO and Chairman positions, ensuring such a division should be on the regulatory agenda. Financial regulation may need to include governance regulation.

I don't want to be naively optimistic about how much of a difference good governance can make at too-big-to-fail banks; I'm not sure how much it might really matter from the perspective of the public fisc. It might well be that the big banks are simply too large to manage, and the marginal difference from governance reforms is inconsequential:  even the most skilled capitan can't make a Panamax tanker execute tight slaloms.

Beyond this, to the extent that good governance means responsiveness to shareholders, it might produce bad results. As Bill Bratton and Michael Wachter have observed, in 2005-2006, JPMorgan Chase's stock was a dog and Countrywide was a market darling precisely because JPM was staying out of the most aggressive mortgage lending, while Countrywide was leading the way:  shareholders can suffer from excessive short-termism.  

Still, if we think governance matters, then even if shareholders can be part of the problem, so too can entrenched management frustrate optimal governance.  Mark Roe has an interesting and timely paper on why corporate governance won't work at too-big-to-fail banks, even to the limited extent it does at regular industrial firms.  I share Roe's skepticism:  the too-big-to-fail banks are also too-big-to-takeover and too-big-to-govern.  Can anyone really imagine a Carl Icahn making a successful run at JPMChase or even Citi?  No one has the financing to do so.  The only place to get that kind of financing is from the too-big-to-fail banks themselves, and they aren't going to finance that sort of venture.  

So this raises a quandary: what are we to do about too-big-to-fail banks that are also too-big-to-govern?  The obvious answer is break 'em up, but its clear that there isn't the political will to do so at this moment.  And, as Roe notes, breaking them up will ultimately result in some units of too-big-to-fail banks ceasing to be profitable, as their margin of profitability stems from and only from their too-big-to-fail benefit (that's why they can't be spun-off).  

Our stop-gap solution is to pretend that we can regulate them into safety and will be merciless with Orderly Liquidation Authority if they falter.  It's not clear who, if anyone, really believes that will work (or even be invoked) when push comes to shove.  The banks will constantly push to water down the safety and soundness regulation, and there is unlikely to be an equal counterpush absent further crises.  And OLA isn't truly credible, not least because no one wants to find out of it actually works.  It's far easier and less risky just to bail out the banks, and there are usually lots of subtle ways in which this can be done without resorting to a TARP move.  

But perhaps there's another solution:  we can try to regulate for better governance. If the shareholder reform mechanism is hopelessly broken--if management entrenchment techniques have simply become too powerful for proxy fights and other modes of shareholder expression to work--then it may be up to the regulatory process to fix the problem. Put another way, if management's victory in Delaware corporate law is too complete, the only avenue open for reform is through federal legislation or regulation. Management's sucess in Delaware might have the hydraulic effect of forcing reform of corporate law on the federal stage. (See here for Roe's discussion of the dynamics of the state-federal competition.) This sort of change has not happened yet, of course, but the case of too-big-to-fail banks presents a special case where the dynamics could potentially be different.  

The Dodd-Frank Act reforms impose various financial regulations on banks.  But we could also impose governance regulations on them.  Indeed, to the extent we understand that the government is inherently in the position of a creditor of the banks, it makes sense to regulate for good governance. (See here and here for Fred Tung's interesting discussions of debt governance.) Governance regulation can be a form of financial regulation.

Thus, perhaps the FDIC (or maybe the Fed for bank holding companies should be mandating divided chairman/CEO positions, non-staggered boards, lack of poison pills, minimum qualifications for risk committee members, minimum independent directors, proxy access, and limits on board control over board nominee slates, etc. (name your favorite governance reform).

Regulating for governance in too-big-to-fail banks would be a real change in bank regulation as practiced, but the seeds already exist in the current bank regulatory framework: the bank chartering process already requires certain qualifications for officers and directors. Perhaps its time to take the historical bank regulatory framework seriously, not just in terms of governance regulation, but in other aspects as well, such as the social purpose of granting limited purpose private banking charters.   

Comments

You have to question the "Too Big To Manage" theory given that the problems are usually created by misaligned incentives at the principal level. What good does it do to bring the CEO closer to the principal? Any positive effects would be the result of getting incentives right, and what is the relationship between that and size?

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