Shareholders' benefit from bank representatives on the board

We examine how the presence of bank representatives on a firm's board of directors influences the firm's risk, debt, and ultimately, shareholder value. Our theoretical model uses a firm undertaking a debt-financed investment project, where the board determines the risk level after the debt has been arranged. The board's inability to commit to the project risk ex ante incentivises shareholder representatives to exploit financial leverage, leading to higher risk than is optimal and resulting in diminished shareholder value. By appointing bank representatives—who prefer lower risk—shareholders of firms with risky debt counteract excessive risk-taking, thereby enhancing shareholder value. Notably, reputation costs faced by shareholder representatives when associated with project failure make the shareholders worse off under a board that can commit to project risk, as these costs lead to more conservative risk choices. In contrast, a board that cannot commit but includes bank representatives allows for balanced risk management. Our findings demonstrate that shareholders benefit from this latter arrangement. Unlike previous studies, we find that balanced risk management is a potential benefit for shareholders when bank representatives are board members. Thus, our findings underscore that it is shareholders, not the lending bank, who desire bank representatives on their boards.