Corporate Governance and Bank Failures

The assignment requires students to analyze the role of corporate governance in bank failures during the recent financial crisis. The students need to read and understand various research papers and articles, which are provided in the reference section, that discuss the relationship between corporate governance and bank performance, risk-taking, and bankruptcy risk. The assignment aims to provide a comprehensive understanding of the topic and how it is related to the recent financial crisis.

Running head: CORPORATE FINANCE
Corporate Finance
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Abstract:
The essay discovers the capability along with the attributes of corporate governance assisting
the forecast of business bankruptcy further than the traditional approach forecast models
having base on the business nature. The results obtained from the study suggested internal
directors of the organisation’s board is inversely related to the risk of bankruptcy in the
businesses. The result provided that a weak system of corporate governance might increase
the probability of bankruptcy even in organizations that have better financial operations.
Evidences acquired from the study suggest that structure of instructions in some of the
businesses are in such a manner that the influence of managing directors was greater in
bankruptcy firms than the non-solvent companies. The essay examines the effect of business
characteristics that have upon the attributes of corporate governance such as size of board and
director’s independence and risk of corporate bankruptcy.

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Introduction:
Ever since the bookkeeping introduction during the initial 21st century, the issues of
corporate governance and ethics have largely engrossed the attentions of investigators,
experts and rule makers. WorldCom inflated the proceeds by $3.8 billion by incorrectly
categorizing the expenditure as the investments. Enron on the other hand was regarded as the
portrait of business scam and fraud that moved the debt off from its records of accounts and
offered a deceptive financial position (Wang and Lin 2010, pp.1-27). The current essay is
based on the study of association among the corporate governance and bankruptcy risk.
Discussion:
Corporate governance is referred as a means of supervision and process of control to
guarantee that the directors of company work in accordance with the benefits of shareholders
(Saad 2010, pp.105-114). The structures, procedures, culture or systems offer successful
organizations operations.
The major causes of company going bankruptcy is the insufficient internal control that
originates from the corporate governance. Due to the separation of organization from the
control and supervision conversation, the shareholders are unable to deal with the
administration conversation and the board of directors are under obligation of securing the
benefits of shareholders (Zare et al. 2013, pp.786-792). Therefore, the formation of board of
directors and structure of direction are regarded as the vital mechanism in supervising the
financial functions of firms as they act as guide for directors to implement control internally
in the process of corporate governance.
On assessing the relation among the corporate governance indexes and its bankruptcy
a number of experimental lessons have been issued relating to board of directors and
organizations operations (Nakano and Nguyen 2012, pp.369-387). Taking into the account

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the separation of possession from the internal control, the shareholders are unable to make
interference in the affairs of management and the board of directors are under obligation of
protecting the benefits of shareholders (Zheng and Das 2018, pp.6-54). However, there are no
major cause of believing that the directors act in best manner to secure the benefits of
shareholders. If the directors increase their benefits in company’s profitability costs the
benefits of shareholders might face hazard. According to the agency theory stated by Eling
and Marek (2014, pp.653-682) the directors are not considered trustworthy hence, monitoring
the mechanism of supervision it is necessary to overcome probable differences among them.
In the literature of finance there is no ordinary term for bankruptcy. Bankruptcy
represents financial situations, failure of organization, incapable of paying debts. As stated by
Fracassi (2015, pp.231-245) bankrupt firms represents those firms that have ceased their
business operations because of transferring bankruptcy or have ceased present business
operations because of loss suffered by creditors. In the words of Li, Jahera and Yost (2013,
pp.204-227) bankruptcy refers to a situation when an organization is unable to meet its debt
obligations. In majority of the cases bankruptcy occurs due to state financial and economic
problems.
By virtue of Admati (2017, pp.131-50) examined the relationship amongst features of
corporate governance and bankruptcy. The findings have demonstrated that the managing
director’s influence decreases the occurrence of financial crisis probability in the next five
years however the features of corporate governance does not have significant impact on the
occurrence of financial crisis and bankruptcy. Conclusive evidences have suggested that the
influence of managing directors have the impact on the organizations system of internal
control to avoid financial maladies and the occurrence of bankruptcy. The conclusion
provides a strong indication that manager decreases the probability of crisis and financial
disorders are in accordance with the earlier theory and empirical evidences.

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According to Nakano and Nguyen (2012, pp.369-387) it is noticed that if there is a
significant amount of association between the director’s independence and board financial
risk situations. Evidences suggest that organizations that faces bankruptcy risks had less
number of unbounded members in their director’s board. Evidences suggest that
organizations rescue from risk of bankruptcy depending upon the stability and individuality
rate of the members of directors. Studies conducted by Darrat et al. (2016, pp.163-202)
provides an evidence that the relation of an organizations control and possession structures is
associated with the financial risk.
The findings have suggested that companies that faces financial crisis had less amount
of possession concentration. Studies have suggested that there is a considerable negative
relation among the influence of managing director and bankruptcy risk conditions reflecting
the managing director as the major influencing factor (Manzaneque, Priego and Merino
(2016, pp.111-121). Additionally, the findings have showcased that the corporate governance
variables comprise of unbounded directors, possession of management, internal auditing,
internal control and internal proficiency in auditing does not possess any noteworthy relation
with the organizations bankruptcy risk situations.
There is a reverse and noteworthy association among the managing director’s
influence and financial risk situations. The bankruptcy risk occurrence probability is lower in
organizations that are having high influence of managing director. Tricker and Tricker (2015,
135-156) have invested the effect of other corporate governance features on the size and
director’s independence in company board. The findings have represented a noteworthy and
negative association between the size and ratio of unbound members in possession
concentration and board independence. Furthermore, there is also a noteworthy and positive
relationship amongst the magnitude of director’s panel and organization size. The findings

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have suggested that there is an important and negative relationship amid the ratio of unbound
directors and risk of bankruptcy.
Evidences obtained suggest that structure of directions in some of the companies are
in such a manner that the influence of managing directors was greater in bankruptcy firms
than the non-solvent companies. Therefore, there is a noteworthy and positive association
between the influence of managing director and bankruptcy risk. A momentous and adverse
relationship between the board proportions of directors and bankruptcy risk with no
significant relation among the outer possession and bankruptcy risk. As mentioned by
Elshandidy and Neri (2015, pp.331-356) a weak system of corporate governance might
increase the probability of bankruptcy even in organizations that have better financial
operations. Their findings have investigated the role and features of board of directors along
with their composition way in respect to organizations success and ability to pay off debts.
Empirical studies have reflected that both the procedure and features of director’s board
drives an organization towards bankruptcy.
As opinion by Mandzila and Zéghal (2016, p.637) the most stated and referred
reasons, relating to organization bankruptcy is the lack of internal control that arises from the
organizations weak dominance. There are yet some organizations that possess frail financial
operations due to financial crisis and organizations weak dominance. Empirical findings have
suggested that business firms that have experienced financial crisis are largely because of
weak management.
On general circumstances organizations with concentrated possessions are less likely
to be discharged from the list of stock exchange due to bankruptcy. Study conducted by
Liang et al. (2016, pp.561-572) proposed a vital negative association between the possessions
concentration and occurrence of bankruptcy situations. When the disorder and financial crisis

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takes place the mechanism of supervision is very essential as the increase in control need
influences the possession way of investors.
When the financial crisis increases, there is more expectation of possession
concentration (Skeel 2014, p.1015). In contrast studies have suggested that possession
concentration accompanies several costs but it is necessary to understand that possession
concentration does not create any strong motive to increase the value of company. The
possession concentration enforces more costs because of excessive concentration and
potential powers to discharge the minority shareholders from the possession on organizations.
The low possession concentration will result in positive motivating impact on the economic
functions of the organizations.
Findings by Skeel (2014, p.1015) in respect of relation among the possession structure
and company operations represents that possession structure creates a vital impact on the
effects of joint stock organizations in a manner that there is a strong and constructive link
among the profitability and possession concentration. The existence of concentration in the
organization possession results in absolute control on the day to day affairs of the companies.
Additionally, the shareholders may reduce the problems of companies by controlling the
administration functions by virtue of sufficient information.
As stated by Du Plessis, Hargovan and Harris (2018, pp. 657-678) businesses that are
rescued from the financial crisis are reliant on the role of independent directors in the
director’s board. There is a considerable amount of association between the independent
director’s board arrangement and situations of financial crisis. The businesses that have faced
financial crisis possessed less directors board members. Empirical evidences have suggested
that companies with additional number of independent directors and extra internal possessors
are less likely to be discharged from the list of stock exchange. This is because if the number

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of outer directors are more then there is a less likely chances of fraud and bankruptcy.
Businesses that have more number of independent directors are less likely to breakdown with
less probability of crisis.
As per Agrawal and Cooper (2017, pp.165) provides that a director’s board with less
number of members have considerable amount of correlation with the bankruptcy. A
comparative study shows that companies with bankruptcy and those that are successful have
the tendency of having more number of members in their board. A board with more number
of members might contain high management power with higher company functions.
Alternatively, the fall in the size of board of directors possess direct relation with the
bankruptcy occurrence in the organizations facing crisis.
The head of director’s board must supervise the managing directors, regulate the
agendas and direct the board session of directors. On noticing that the managing director
benefits differing from shareholders then the influence of managing director is problematic.
As indicated by Larcker and Tayan (2015, pp.176-209) businesses that have unbound head of
director’s board has the better functions than the companies that are under the influence of
managing directors. The influence of managing director does not weaken the operations but
might create an influence on the market understanding relating to the control rate that is
excited on the financial reporting procedure. On finding that the influence of managing
director decreases the supervision on the management results in probable increase in
bankruptcy risks. In other words, there is a significant amount of association among the
managing directors influence and risk of bankruptcy.
Berger, Imbierowicz and Rauch (2016, pp.729-770) defines the impact of corporate
governance does not remain even through all the organizations and there are one size that fits
the entire practice of corporate governance. Evidences obtained from the non-banking strong

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businesses recognized in the preceding study might not provide an explanation relating to the
efficiency of the convinced features of governance for circumstances in which businesses are
about to become financially troubled or insolvent.
At least there are two reasons behind such differences. At first governance
arrangements that are operative and valuable for some business may be unproductive and
counterproductive for other business (Berger, Imbierowicz and Rauch 2016, pp.729-770).
Secondly, organizations performance cannot be considered as the sole factor that causes
bankruptcy and poor performance might not necessarily result in immediate bankrupt
position. Bankruptcy is associated with the numerous conditions such as firms fixed costs
operating and leverage, percentage of illiquid assets and sales sensitivity.
Evidences from the preceding paragraph suggest that a bigger board structure is more
probable to lessen the likelihood of bankruptcy, varying from the proposal laid down in
readings that bigger board can be less operational than smaller boards (Saad 2010, pp.105-
114). The results obtained from the study suggest that fall in the likelihood of bankruptcy
happens on conditions when the multifaceted organizations engage bigger board.
Conclusively, the improved advisory volume of the bigger size of board seems to be
comparatively advantageous to the highly multifaceted companies when facing severe
financial burden.
Conclusion:
The literature significantly contributes by offering an inclusive examination of the
impact that the organization features, mainly the amount of firm complication and business
requirement for special understanding have on the association among the corporate
governance and bankruptcy risk. It is noticed that having a larger board lowers down the risk
of bankruptcy.

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The study provides suggestion that devising a bigger percentage of internal directors
lowers the hazard of insolvency and bankruptcy in businesses. The evidence from the
principle mechanisms investigation reflects that organizations that eventually file for
bankruptcy suffer from the bad structure of corporate governance well before the bankruptcy
occurrence.

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Reference List:
Admati, A.R., 2017. A skeptical view of financialized corporate governance. Journal of
Economic Perspectives, 31(3), pp.131-50.
Agrawal, A. and Cooper, T., 2017. Corporate governance consequences of accounting
scandals: Evidence from top management, CFO and auditor turnover. Quarterly Journal of
Finance, 7(01), pp.165.
Berger, A.N., Imbierowicz, B. and Rauch, C., 2016. The roles of corporate governance in
bank failures during the recent financial crisis. Journal of Money, Credit and Banking, 48(4),
pp.729-770.
Darrat, A.F., Gray, S., Park, J.C. and Wu, Y., 2016. Corporate governance and bankruptcy
risk. Journal of Accounting, Auditing & Finance, 31(2), pp.163-202.
Du Plessis, J.J., Hargovan, A. and Harris, J., 2018. Principles of contemporary corporate
governance pp. 657-678. Cambridge University Press.
Eling, M. and Marek, S.D., 2014. Corporate governance and risk taking: Evidence from the
UK and German insurance markets. Journal of Risk and Insurance, 81(3), pp.653-682.
Elshandidy, T. and Neri, L., 2015. Corporate governance, risk disclosure practices, and
market liquidity: comparative evidence from the UK and Italy. Corporate Governance: An
International Review, 23(4), pp.331-356.
Fracassi, C., 2015. FIN 395.10 (UNIQUE 03525) Empirical methods in corporate finance
pp.231-245.
Larcker, D. and Tayan, B., 2015. Corporate governance matters: A closer look at
organizational choices and their consequences pp.176-209. Pearson Education.

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Li, H., Jahera Jr, J.S. and Yost, K., 2013. Corporate risk and corporate governance: another
view. Managerial Finance, 39(3), pp.204-227.
Liang, D., Lu, C.C., Tsai, C.F. and Shih, G.A., 2016. Financial ratios and corporate
governance indicators in bankruptcy prediction: A comprehensive study. European Journal
of Operational Research, 252(2), pp.561-572.
Mandzila, E.E.W. and Zéghal, D., 2016. Content analysis of board reports on corporate
governance, internal controls and risk management: evidence from France. Journal of
Applied Business Research, 32(3), p.637.
Manzaneque, M., Priego, A.M. and Merino, E., 2016. Corporate governance effect on
financial distress likelihood: Evidence from Spain. Revista de Contabilidad, 19(1), pp.111-
121.
Nakano, M. and Nguyen, P., 2012. Board size and corporate risk taking: further evidence
from Japan. Corporate Governance: An International Review, 20(4), pp.369-387.
Saad, N.M., 2010. Corporate governance compliance and the effects to capital structure in
Malaysia. International Journal of Economics and Finance, 2(1), pp.105-114.
Skeel Jr, D.A., 2014. Rediscovering Corporate Governance in Bankruptcy. Temp. L. Rev., 87,
p.1015.
Tricker, R.B. and Tricker, R.I., 2015. Corporate governance: Principles, policies, and
practices pp.135-156. Oxford University Press, USA.
Wang, C.J. and Lin, J.R., 2010. Corporate governance and risk of default. International
Review of Accounting, Banking and Finance, 2(3), pp.1-27.
Zare, R., Kavianifard, H., Sadeghi, L. and Rasouli, F., 2013. Examining the Relation between
Corporate Governance Indexes and its Bankruptcy Probability from the Agency Theory

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Perspective. International Journal of Economy, Management and Social Sciences, 2(10),
pp.786-792.
Zheng, C. and Das, A., 2018. Does Bank Corporate Governance Matter For Bank
Performance And Risk-Taking? pp.6-54. New Insights of an Emerging Economy.