The objective of the firm consists of maximising its market value, so economists like to think. In practice, however, some firms do not pursue this objective, because the agency problems generated by the separation of ownership and control emerge. The problems of asymmetric information and moral hazard, and the lacks of monitoring mechanisms could lead to managers’ opportunist behaviours. In this context, the managers pursue their own interests which are not aligning with the shareholders’ objectives, and therefore, they expropriate rents to the shareholders, decreasing the firm results, and harming the other stakeholders of the firm.
The internal mechanisms of corporate governance may not always be effective to align managers’ goals with the owners’ goals. As a consequence, some other external mechanisms based on the markets are necessary. In fact, there are some external factors which might systematically induce different performances between companies. Taking the constraints of technology into account, some firms are very efficient whereas others are not. The product market competition (Hart, 1983) and the financial market pressure (Jensen, 1989) are two external factors that are important in aligning managers’ goals with the aim of efficient production, and so, in generating improved productivity performance in companies.
This paper focuses on the corporate governance in banks, examining the role of loan market competition and financial market pressure in the bank performance. In banks, the agency problem inherent to the relationship between shareholders and bank managers is more acute due to the deposit insurance schemes, which could incentive managers to assume high risk. Banks are also different from other companies because they are looking after other people’s money, and they are exposed to special risks. Due to the financial intermediation carried out by the banks, the regulatory authorities and other stakeholders different from the shareholders, are interested in the corporate performance of the banks (Stoney and Winstanley, 2001). Moreover, the corporate governance of a bank affects, or could affect, to the sound of financial system as a whole, due to the systemic risk.
This work is based on the hypothesis that the external control mechanisms to discipline managers, such as market competition and financial pressure, are indeed necessary to supplement and improve the effectiveness of the internal control mechanisms, such as incentives schemes or board of directors, for example. In this sense, the EMU and the New Basel Capital Accord point out the importance of the market control to define the strategies and the operative policies by the European banks. The increasing competition, the technological advances and the new role of the supervision by the European System of Central Banks, transfer, even more, the control from the banking managers to the stakeholders (lenders and debtholders), the shareholders and the product market. The increasing importance of the ‘marketisation’ of EU banking intensifies the influence of the external market on banks’ internal resource allocation decisions (Gardener et al., 2001).
Moreover, Pillar 3 of the New Basel Capital Accord recognises that market discipline has the potential to reinforce capital regulation and other supervisory efforts to promote safety and soundness in banks and financial systems. Following the New Accord, market discipline imposes strong incentives for banks to conduct their business in a safe, sound and efficient manner (Basel Committee on Banking Supervision, 2001).
In the remainder of the paper, we first discuss the theoretical background and the existing evidence on the role of these two external factors, such as product market competition and financial market pressure, in increasing firm performance. Then we present an empirical investigation based on a large sample of Spanish banks. In particular, we pursue the issue of whether loan market competition can replace financial pressure as a ‘discipline device’. Finally, we summarise some general conclusions.
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Do market competition and financial pressure make banks perform well?
