Andreas Kokkinis

The Law on Corporate Governance in Banks

Corporate governance in financial institutions has come under the spotlight since the banking crisis in the UK in 2008-9.

Exploring the effects of the ‘bonus cap’ rule: the impact of remuneration structure on risk-taking by bank managers*

ABSTRACT This article explores the effects of the bonus cap rule on UK banks to assess its impact on incentives faced by senior managers to make risky decisions. It is demonstrated that the ratio of variable to fixed remuneration is only one of the factors that determine the intensity of financial incentives to make risky decisions. More crucially, the steps taken by major UK banks to evade the effects of the cap by introducing fixed pay allowances, which are paid in shares but are legally structured as fixed remuneration, have created additional risk-taking incentives. Indeed, it is shown that paying part of executive remuneration in shares as such, is a significant driver of risk-taking. It follows that there is no reason to believe that the bonus cap has achieved any improvement in incentives and, therefore, that EU law’s emphasis on the ratio of variable to fixed remuneration is misplaced.

Corporate Law and financial instability

Virtually all large banks and other financial institutions in the UK and internationally are public limited liability companies whose shares are listed on one or several stock exchanges. As such, their corporate governance and, in particular, the incentives faced by their directors and senior managers are to a significant extent determined by corporate and securities law rules such as directors’ duties, directors’ liability in insolvency, takeover regulation, disclosure obligations, shareholder rights and rules on executive remuneration. At the same time, systemically important financial institutions in the UK are licensed, regulated and supervised by the Prudential Regulation Authority (PRA).

A PRIMER ON CORPORATE GOVERNANCE IN BANKS AND FINANCIAL INSTITUTIONS: ARE BANKS SPECIAL?

This chapter serves as an introductory chapter to the present volume on bank corporate governance. As such, it seeks to capture some of the specific corporate governance problems banks face, and to provide a useful background for the discussion of more detailed aspects of the topic in the forthcoming chapters. Of course, the views expressed herein are the author’s own and other contributors to the volume may not agree with them. The analysis mainly focuses on UK banks that are listed on the London Stock Exchange, in other words, on large systemic banks. The corporate governance of banks is an area under continuous development which has changed dramatically in recent years both nationally and internationally. As all listed companies, UK banks are expected to comply with the UK Corporate Governance Code. In addition, the 2009 Walker Review introduced a series of governance recommendations specific to banks and other financial institutions. Many of these have since then been implemented by the PRA and now form part of the PRA Handbook. More recently, the report of the Parliamentary Commission on Banking Standards urged for broader changes to bank corporate governance including the approved persons’ regime and directors’ duties. In parallel, the fourth Capital Requirements Directive (CRD IV), impacts on bank corporate governance with regard to executive remuneration. Many of these issues will be explored in depth in the following chapters of this volume. The principal aim of this chapter is to illustrate that the private ordering model of bank corporate governance.

PREFACE: THE LAW OF THE CORPORATE GOVERNANCE OF BANKS AND FINANCIAL INSTITUTIONS

The corporate governance of banks and financial institutions came under the spotlight in the wake of the global financial crisis 2008–09, the subsequent conduct scandals such as the manipulation of the London Inter-Bank Offered Rate by several UK and international banks, and other miss-selling, corruption and financial crime scandals. Although misjudgements in risk and sub-optimal corporate behaviour are not uncommon in the corporate sector, the utility and systemic risk profiles of the banking sector, in particular, are important attributes that warrant public concern with any failings in the internal governance of banks that could culminate in excessive risk-taking or sub-optimal corporate behaviour. In this volume, we address key themes in the internal governance of banks and financial institutions that we believe are of topical interest. The law and Corporate Governance Code discussed in this volume are stated as at March 2014. In Chapter 1, Andreas Kokkinis discusses the governance structure of most widely held banks and financial institutions, and the incentives that may result in excessive risk-taking. He reveals that conventional agency-based corporate governance frameworks may be unsuitable for banks and financial institutions as they arguably do not address the governance challenges in banks and financial institutions and may indeed entail counter-productive incentives exacerbating governance problems. In Chapter 2, Edward Walker-Arnott discusses the importance of the board as collectively managing and making key decisions in banks and financial institutions, and argues that neither company law nor financial regulation address the issue of collective responsibility and how that can be boosted to improve board stewardship. This thought-provoking chapter takes stock of recent policy discussions and proposals for legislative reforms but critically asks if new law and new provisions in governance codes are really on the right track. In Chapter 3, John Lowry and Rod Edmunds shift the focus from collective directorial responsibility by asking whether individual directorial responsibility for banks and financial institutions could be enhanced via the application of the directors’ disqualification regime. They highlight that to date it has not been applied notwithstanding some clear political pronouncements (including those of UK’s Business Secretary, Dr Vince Cable) that it should be harnessed to prevent certain named directors in the UK’s failed banks (RBS and HBOS in particular) from holding directorships in the immediate future. As the chapter indicates, the reasons why disqualification proceedings have not been initiated is all the more intriguing in the