Banking on a Strong Corporate Governance Process

Otis Baskin
Otis Baskin

Why are banks so fond of boards with independent directors?  What is the big deal?

Actually, banks are interested for the same reason as minority and non-executive owners in a successful multi-generational family business.  Independent directors with real fiduciary responsibility have an obligation to work in the interests of all owners; not just those running the business, not one branch of the family, but everyone whose capital is at risk – including banks.

In business school, it is called Agency Theory:  the potential that managers of a business will make decisions that are better for themselves than for owners who don’t manage the business.  Things like executive compensation and perquisites are often a concern for owners who don’t share in them.  How can all owners be sure they aren’t paying too much to run their business?  Would dividends and other distributions be greater if management didn’t spend so much on their “pet projects?”

These are the same issues that banks worry about. The Warwick Business School study I cited previously concludes that when businesses don’t have a strong corporate governance process with independent directors, banks react by imposing their own controls through more restrictive lending terms.  Family owners who are not convinced their capital is being managed properly may attempt to impose their own controls by second guessing management and raising doubts with other shareholders.  Sometimes their behavior becomes a strain on the cash position of the business if dissident owners want to be bought out.

At the very least, dissenting voices can disrupt family harmony.

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