The Role of Lending Banks in Corporate Governance

I explore the governance role of lending banks in borrowing firms. I focused on two main roles of banks in corporate governance: Their role in the forced replacement of poorly performing CEOs, and their positive effect on firm performance through monitoring. Banks monitor corporate borrowers in order to contain their downside risk exposure on existing loans and loan commitments. One of my assumptions is that the level of bank loans outstanding is a proxy for the power of a lending bank to both monitor and exert governance control.;The first chapter investigates the role of banks in corporate governance via forced replacement of poorly performing CEOs. Specifically, I examine the sensitivity of the likelihood of CEO replacement to performance across firms with different levels of bank lending intensity. An average level of bank loans outstanding implies 25% to 46% increase in forced turnover probability if a firm's performance is poor. This increase is much larger, 67% to 90%, when an underperforming firm violates loan covenants. Detailed anecdotes about Iridium and Krispy Kreme support the empirical results. I found that existence of directors affiliated with lending banks does not change performance-forced turnover sensitivity. The findings suggest that banks play a key governance role in the case of poorly performing firms through replacement of CEOs.;In the second chapter, I have investigated whether lending bank monitoring increases the performance of borrowing firms. Lending bank monitoring is an important governance mechanism especially for smaller firms. For S&P 600 small cap companies an average level of bank loans outstanding increases their industry adjusted return-on-assets by 1.12%. For larger, S&P 500 and S&P 400 mid cap firms, there is no such increase. There appears to be a self-selection with respect to bank financing among large firms. Those that do not borrow from public debt markets and that expect bad performance borrow from banks. While lending bank monitoring has an enhanced effect on the performance of smaller firms with relatively high levels of managerial entrenchment, this effect appears not to be statistically significant.