W.G. Simpson, A.E. Gleason International Review of Economics and Finance 8 1999 281–292 285
board and corporation. This would probably reduce the effectiveness of the control mechanisms of the governance structure. The issue of CEO duality has received
considerable attention because the practice is commonly observed in many large corporations Kesner, Victor, Lamont, 1986. Supporters argue that CEO duality
provides better strategic vision and leadership than an independent chairman.
H
A
: The probability of financial distress is lower for a banking firm with a dual chairman of the board and CEO, ceteris paribus.
3.5. Hypothesis V: CEO equity ownership A major premise of Jensen 1993 is that the CEO should pursue the interests of
the shareholders. The argument against a combination of the chairman of the board and the CEO is that the manager will be too powerful and not have interests aligned
with shareholders. The fact that a CEO would be able to control other officers who were on the board follows the same line of reasoning. A parallel consideration is the
equity ownership position of the CEO. The amount of equity a CEO holds should increase the alignment of the interests of the CEO with the interests of shareholders.
H
A
: A banking firm where the CEO has a lower equity ownership position has a lower probability of financial distress, ceteris paribus.
4. Statistical methodology
4.1. Sample design and data sources The sample consisted of those banking firms listed in the SNL Quarterly Bank
Digest SNL Securities, 1993, which also had proxy statements available for 1989.
The sample included only banking firms that were publicly traded because these were the only firms with publicly available ownership data. The SNL Quarterly Bank Digest
provides data on most publicly traded banking firms and includes approximately 375 firms. Only firms that did not have complete financial data or a proxy statement were
omitted.
The following ownership and board structure measures were taken from 1989 proxy statements:
1. the percentage equity ownership of all officers and directors as a group, 2. the number of directors on the board,
3. the percentage of insiders on the board, 4. the combination of the CEO and the chairman of the board into one position,
and 5. the percentage equity ownership of the CEO.
A surrogate for financial distress and the control variables were taken from the SNL Quarterly Bank Digest
for the end of the year 1993. This procedure produced a sample of 287 banking firms with complete information.
The time structure of the regression equations reflects the proposition that the
286 W.G. Simpson, A.E. Gleason International Review of Economics and Finance 8 1999 281–292
effect of ownership and board structure will not be observed immediately in bank performance but will take three to five years to present. The measures of ownership
and board structure were taken as of the end of the first quarter 1989 because the proxy information was prepared at that time. The ownership and board structure in
place at the beginning of 1989 was expected to influence the probability of financial distress at the end of 1993, approximately five years later. The regression equations
are cross-sectional with one lagged independent variable, the measure of ownership or board structure.
4.2. Tests of hypotheses The hypothesized relationships were tested with the following ordered logistic
equation: logit p
2
1 p
3
1 p
4
5 a 1 b GOV
i
1 g9x
i
1 e
i
where p
1
5 ProbY
i
5 1 | GOV
i
, x
i
, p
2
5 ProbY
i
5 2 | GOV
i
, x
i
, p
3
5 ProbY
i
5 3 | GOV
i
, x
i
, p
4
5 ProbY
i
5 4 | GOV
i
, x
i
, Y
i
5 a variable representing the SNL rating of the ith banking firm 1 5 no
risk of financial distress, 2 5 little risk of financial distress, 3 5 some risk of financial distress, and 4 5 strong risk of financial distress,
GOV
i
5 an indicator of ownership or board structure for the ith banking firm,
x
i
5 a vector of control variables that will impact the probability that Y
i
5 n
, b
5 a parameter to be estimated,
g 9 5
a vector of parameters to be estimated, a 5
an intercept term, and e
i
5 the error term.
The term logitp
2
1 p
3
1 p
4
represents cumulative probabilities and the model predicts the probability of more financial distress with changes in the relevant effects variables.
The logit term on the left hand side of the equation equals log{p
2
1 p
3
1 p
4
1 2 p
2
2 p
3
2 p
4
}, which is the log of the ratio of the cumulative probabilities that a particular banking firm will have a high level of risk to the cumulative probabilities
that the firm will have no risk of financial distress. The estimation procedure assumed a common slope parameter associated with the
relevant effects variables and used maximum likelihood regression.
2
The relevant
effects vector x
i
is composed of the variables described in Table 1. The coefficient of primary interest is b
. The hypothesized relationships between ownership and board structure and the probability of financial distress in terms of
the regression coefficients are: H
: H
A
: I. Management and board equity ownership
b b
. II. Board size
b b
, III. Insiders on the board
b b
, IV. CEO duality
b b
. V. CEO equity ownership
b b
.
W.G. Simpson, A.E. Gleason International Review of Economics and Finance 8 1999 281–292 287
Table 1 Variable definitions and descriptive statistics
Definition of the variable Mean
Minimum Maximum
SD Sign
Y 5 SNL Safety Rating 1.321
1.000 4.000
0.777 GOV
1i
5 common shares
0.164 0.001
0.694 0.141
1 owned by directors and
officerstotal common shares GOV
2i
5 number of directors
14.596 4.000
37.000 5.786
2 GOV
3i
5 number of insiders on
0.176 0.000
0.800 0.102
2 boardtotal board members
GOV
4i
5 1 if CEO and COB
0.568 0.000
1.000 0.496
1 same person, 0 otherwise
GOV
5i
5 common shares
0.0359 0.000
0.621 0.0685
1 owned by the CEOtotal
common shares X
1i
5 book value total assets
1.714 bil 70.6 mil
187.6 bil 5.2 bil
2 X
2i
5 nonperforming assets
0.0190 0.0011
0.2010 0.0235
1 total assets
X
3i
5 market value per share
1.465 2
18.750 3.629
1.304 2
book value per share X
4i
5 book value of total
0.082 0.013
0.145 0.018
2 equity capitaltotal assets
Sign, the hypothesized sign of the regression coefficient in the estimated equations. SD, Standard Deviation of the variable.
4.3. Empirical variables One indicator that measures the potential for financial distress for banking firms
is the CAMELS rating developed by federal regulators. Unfortunately, this indicator is not publicly available. However, SNL Securities calculates an indicator called the
SNL Safety Rating , which is similar to a CAMELS rating. The SNL Safety Rating
measures the risk of each banking firm based on capital adequacy, asset quality, the risk profile of the loan portfolio, earnings, and value assessed by the stock market.
The SNL Safety Rating goes from A1 to D2, similar to a bond rating. The SNL Safety Rating
was used to proxy the probability of financial distress as follows: A1, A, and A2 5 1 indicating no risk; B1, B, and B2 5 2 indicating little risk; C1, C,
and C2 5 3 indicating some risk; and D1, D, and D2 indicating strong risk. The terminology no risk, little risk, some risk, and strong risk follows that used by SNL
Securities. The SNL Safety Rating is highly correlated with the probability of default
measure developed by Thomson 1992.
3
The financial distress indicator was hypothesized to be a function of the ownership and board structure variables in addition to the following control variables:
1. the size of the banking firm measured by total assets, 2. the default risk of the asset portfolio measured by the ratio of nonperforming
assets to total assets,
288 W.G. Simpson, A.E. Gleason International Review of Economics and Finance 8 1999 281–292
3. the risk evaluation of the equity markets measured by the market valuebook value ratio, and
4. financial leverage measured by the book value of equity to book value of total assets ratio.
The number of control variables was parsimonious by design but the equations show that most of the variables had high explanatory power.
The calculation of the governance structure variables was straightforward except for the percentage of insiders on the board. A strict definition of insiders was applied
which included current officers of the banking firm, former officers of the banking firm, and corporate counsel. Board members were considered insiders only if it was
obvious from the proxy statements.
Table 1 provides a list of all empirical variables with descriptive statistics and the expected sign of the regression coefficients. The banks with publicly traded stock are
much larger than the average bank as indicated by the average total assets of 1.714 billion for the sample banking firms. All of the firms in the sample were bank holding
companies.
5. Empirical results
