The Research Of Implicit Contracts In Banking Corporate Governance

In this paper, we set the objective of bank corporate governance is to make a trade-off between efficiency and stability, on this basis, we study the effect of implicit contracts in bank corporate governance mechanism. Implicit contract is an informal agreement based on future relationship value, the main feature of implicit contract is self-executing, that is, the transaction is done at large extent through self-coordination among participants. For all the companies, including bank corporate, to achieve the governance goals requires corporate governance mechanisms designed well. As the bank corporation is typically a type of knowledge-based enterprise, the corporate governance concept of Zinglaes(1997) is more appropriate. He defines corporate governance as the complex set of constraints that shape the ex-post bargaining over the quasi-rents generated by a firm, and governance structure is such a mechanism that creat the rents and distribute the rents. In this perspective, there is a clear lack about the complete contract under the framework of the discussion on corporate governance, because complete contract assumes that all problems can be arranged in advance, there is no room for renegotiation, and in this case, the necessity of existence of corporate governance will be lost. In the real case, explicit contracts can not fully specify all the matters, and the costs of contract enforcement will increase significantly with the complexity of contracts. As the incomplete contract theory has not established a unified theoretical foundation, this article tries to study the design of bank corporate governance on the role of implicit contracts. Second, we think that if the banking corporate governance is designed only to stress the importance of efficient, then the whole finance system will be unstable. To smooth the endogenous risk in the operating of banks, we think that banks should abandon some consideration about efficient promping. In addition, long-term explicit contracts mostly contains ambiguous provisions, partly because self-executing is more efficient than relying on courts or a third party. This constitutes a crucial theoretical reason for our research.Given that the objective of bank corporate governance is to obtain trade-off between efficiency and stability, and the basic principle of economics tells us that the efficiency increasing is mainly achieved through the effective allocation of resources. As the bankin company is a knowledge-type enterprise, effective resources allocation relies on the power allocation within the bank. In the banks, sources of power mostly depend on the core resources of management staff, which makes the design of bank corporate governance contracts facing greater asymmetric information. It is difficult for explicit contracts, such as salary contracts, to specify all possible circumstances, which allows management staff of the bank to have great discretional power. On the one hand, shareholders expect that the discretion can bring higher profits for the bank; on the other hand, they fear that the discretion will become a major source of failure. The conflict between efficiency and stability is reflected on how to monitor and control the discretional power in corporate governance. This paper argues that implicit contracts in bank corporate governance can undertake this task. The theoretical foundation is that on the one hand core resources of bank corporations enhance the bargaining power between management staff and shareholders, but on the other hand management staff's fear of losing core resources advantage will prevent them from opportunistic impulse. In the bank, the maintenance mechanism of stability backed by implicit contracts is characterized and achieved by management staff participating in different types of games and forming the embedded network, and in the design of corporate governance contracts, the banks can actively influence the formation of micro-embedded network to build a hidden "firewall".After raising the question, this paper collates and reviews the literature related to this research. From the perspective of previous research on corporate governance, game theory and incentive theory have provided sophisticated tools for corporate governance, particularly given a convincing explanation for adverse selection and moral hazard problem in the corporation's organizations, and provided corresponding guideline for corporate governance activities. As corporate governance is essentially a projection of power and power adjustment in reality, changes of power allocation within the bank is the result of adapting to market competition. With the advances in technology, improvement of financial markets and especially the deregulation, the bank is faced with fierce competition. In this case, the bank's management staff becomes the key. Their human capital, including their knowledge and customer relationship, becomes the source of the bank's value, which significantly increases the bargaining power of management staff. Therefore power allocation within the bank should be matched with information structure; otherwise it will directly affect the performance of bank corporate governance. Under these circumstances, the boundaries of bank corporate governance have correspondingly changed, and in the corporate governance design the management staff that holds the core resources should be considered. This paper summarizes the implicit contracts of corporate governance design in previous literature and finds that the studies have mostly focused on incentive effects of implicit contracts instead of formal contracts. However, the formation and maintenance mechanism of implicit contracts, especially those which affect performance of governance within the corporation, have been discussed occasionally and are generally explained by the reputation model.Under normal circumstances, this paper studies incentive effects and the possible cause of opportunistic behavior of explicit contracts of bank corporate governance. In order to facilitate the research, this paper takes salary mechanism as a typical explict mechanism as the research objective. We distinguish different salary mechanism as strong explict governance contract and weak explict governance contract according to the strength of incentive in long run. The result shows that the management staff of banking companies displays different kinds of opportunism impulse according to defferent governance contracts, that is, pure explict governance contracts embody some inherent feature that can lead to bank failures inevitably. As explicit contracts can not guarantee the stability of the bank, this paper introduces implicit governance mechanism and examines its punishment mechanism, formation and maintenance mechanism via micro-embedded games. This paper comprehensively considers different games that the management staff participating, this makes the study more realistic and we abstract them for two types:effort selection game and social game. The analytical results show that if the management staff depends on each other in the pay-off of these two types of games, then this micro-level mutual embedding can lead to efficient results, even though the game is time-limited. This is quite meaningful in realizing the objective of bank corporate governance. Because this paper mainly examines the effort level of the bank's management staff in credit risk assessment, the improvement of such effort level helps to gain the trade-off between efficiency and stability for the bank. The micro-embedded model has a special significance for the bank, also because the bank, different from other types of corporations, mainly operates on its own reputation which constitutes the bank's greatest asset. Similarly, opportunistic behavior makes it difficult to engage in successful business for the management staff after leaving the bank, which will greatly constrain the non-cooperative behavior in the effort selection games. When implicit contracts of the bank corporation are extended to dynamic cases, the analysis still indicates that management staff's participation in the two types of games can achieve a weak welfare improvement. Furthermore, either the bank or the management staff does not suffer from the embedded relationship.For the application of implicit contracts of bank corporate governance, this paper studies the formation and maintenance mechanism of corporate culture based on the embedded model. This paper believes that organizational network within the bank built by micro-embedded games enables the management staff to make progress in coordination and thus increases organizational efficiency. Corporate culture essentially reflects the consistent faith within the corporation, and the formation of faith represents the accumulation of organizational capital in the corporation. This part of analysis shows that if social activities organized by the bank can effectively distinguish the costs that the management staff inputs to participate in such activities, such corporate culture construction could generate the opposite effect of increasing organizational efficiency. This indicates that the maintenance of corporate culture should pay more attention to the pooling equilibrium, rather than the separating equilibrium that highlights different types of people. This paper collects data by questionnaire and empirically analyzes corporate culture performance of different corporations. In the sample banks, the analysis shows that better corporate culture corresponds to a higher level of corporate performance, which coincides with the theoretical analysis results.Implicit governance contracts in banking companies display their worth on the premise that explicit governance contracts have been designed desirably. Although implicit contracts are critical for the performance of bank corporate governance, unlike explicit contracts, implicit contracts can not be reflected by precise governance documents. The implementation of implicit contracts can not be verified in terms of contract theory language. This paper analyzes the interaction mechanism between implicit governance contracts and explicit governance contracts in the bank. The starting point of analysis is that implicit contracts should be compatible with explicit contracts to some extent in the bank corporate governance mechanism design. On the one hand, the maintenance mechanism of implicit contracts constitutes the foundation of implementation of explicit contracts; on the other hand, changes in explicit contracts will also alter the equilibrium results achieved by implicit contracts. In order to analyze conveniently, this paper studies the bank corporate governance mode as a specific choice of explicit contracts. Particular corporate governance modes are rooted in specific social, historical and cultural background, and this can be verified by the emergence and development of market-monitoring corporate governance mode and shareholders-monitoring corporate governance mode. In different bank corporate governance modes, implicit contracts enable members in the organization to obtain a cognitive and normative understanding of particular situations, coordinate their behavior and guide them to take actions consistent with the objective of organization. Finally, on the bases of researching the role of implicit contract in the banking corporate governance, we discuss the design principles and implementation pathway about China'banks, and gives the relevant research proposals.