Boards of directors, managerial incentive compensation and deregulation: A longitudinal study of the United States banking industry

As an industry moves into an increasingly deregulated context, managers are given more opportunities for managerial discretion. Managers become less subject to subsidized controls by regulatory agencies that have otherwise served as a substitute for internal governance mechanisms, and the issue of controlling agency problems becomes more critical to firms. Accordingly, firms are expected to change their governance mechanisms to manage greater potential for agency problems. Agency theory suggests an increased use of two primary governance mechanisms: managerial incentives and vigilant monitoring by boards of directors. Building on agency theory, this study investigates what governance choices firms make in response to deregulation. Specifically, this study examines: (1) the direction of changes in governance mechanisms; (2) the sequence of changes in governance mechanisms; and (3) whether boards of directors and blockholders influence the use of managerial incentives.;This study was performed in the context of the U.S. banking industry using longitudinal data. This study used multiyear panels beginning in 1981 and ending in 1990 using three-year intervals, resulting in four panels (1981, 1984, 1987 and 1990). This study employed a control group to examine whether the observed governance changes were the result of deregulation. Data was collected from proxy statements and CompuStat database. General linear models (GLM) repeated measures analysis, ordinary least squares (OLS) regression analysis, and logistic regression analysis were employed to test the hypotheses developed in this study.;The results of this study generally indicate that: (1) as the U.S. banking industry moved into an increasingly deregulated context, banking firms adapted their governance mechanisms by increasing their reliance on the use of managerial incentives and vigilant monitoring by boards of directors (i.e., restricted stock, stock option, and small board size); (2) banking firms adapted managerial incentives more quickly than vigilant board monitoring; and (3) boards of directors (i.e., high outsider ratio and small board) and blockholders (i.e., greater number of blockholders) positively influenced the use of managerial incentives. In summary, these findings indicate that deregulation in the U.S. banking industry influenced banking firms' governance choices. Boards and blockholders played a critical role in influencing the use of managerial incentives in response to deregulation.