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Corporate Governance in Costa Rican Banks

Lafuente, E., Garcia-Cestona, M. (2007) CEO Turnover, Forced Chairman Replacements and Firm Performance: Case of the Costa Rican Banking System. SSRN Working Paper Series.

Summary:

Governance mechanisms are the organisational controls that reduce conflicts amongst the firm’s stakeholders pursuing the maximisation of their welfare. Corporate governance and its link to firm performance has emerged as an important academic issue. Nevertheless, most empirical evidence in this field focuses on big corporations or listed firms operating in developed markets (Becht et al. (2002)). Moreover, literature that examines the effectiveness of corporate governance systems in emerging markets is scarce.

Concerning the banking industry, and despite its relevance there are still few papers focusing on banks’ corporate governance. Although banks show significant operating differences with respect to firms in other industrial sectors, the lack of research about governance in this sector is especially surprising since banks play a strategic role in an economy. Banking firms also face problems derived from inefficient control and monitoring since there is a clear conflict of interests between shareholders and depositors.

In this paper, we examine the impact that the activation of certain governance mechanisms has upon changes in firm performance. In particular, we study CEO turnover, changes in the board of directors and chairman removal. We are also aware of the presence of joint endogeneity problems commonly found in corporate governance literature. To overcome this, we employ the system generalised method of moments (GMM) regression technique. To attain this goal we use a robust dataset available from the Costa Rican Central Bank for the period 1999 – 2004.

This paper increases the literature dealing with corporate governance in banks. The main contribution indicates that corporate governance also matters in emerging economies as is the case of the Costa Rican banking firms. Our results reveal that the direction and intensity of the effects on performance changes are also conditioned by the underlying characteristics of the governance mechanisms under analysis.

In particular, empirical findings confirm that CEO and chairman replacements are relevant governance mechanisms that help in explaining improvements in firm performance. For the CEO turnover, results indicate that the appointment of a CEO from outside the firm creates the conditions for organisational change and it facilitates the introduction of new policies within the firm, leading to higher positive changes in firm performance.

Concerning the board of directors, our results support that unpredicted changes in the board imply an adaptation process by the new board members, leading to create costs related to this learning process that might outweigh the benefits derived from this type of governance intervention. When considering the replacement of the chairman, the results show that the impact that the appointment of a chairman from outside the banking firm has on future firm performance relies on the type of departure. Thus, a natural departure followed by the appointment of a new chairman from outside the board may create a conflict within the board, since the board members can generate barriers to prevent any change in the board routines and processes. To the contrary, the appointment of a chairman from outside the banking firm after a forced departure creates value, since the change in the executive leadership may lead to improve the monitoring tasks of the board and the corporate decision making process, captured by financial activities different from the traditional intermediation role of banking firms.

The results of this paper give support to the argument that different banks in Costa Rica make use of different governance mechanisms. On the one hand, privately owned banks prefer to hire individual from outside the bank after a departure (both in CEO and Chairman positions) to improve performance. On the other hand, the nature of the stakeholders in the rest of types of banks seems to increase the role of external control mechanisms. This finding opens up a line for future research, where new studies could attempt to further explore the observed differences in the implementation of governance mechanisms by firms that either operate in emerging markets or that have different ownership structure.

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