Board governance and solvency risk: the role of co-opted directors

Purpose Our study investigates how board co-option influences solvency risk in Australian and New Zealand banks. Board governance is considered one of the most critical variables impacting bank risk management practices and policies. Design/methodology/approach Our sample consists of commercial banks from both countries and data from 2011 to 2021. The results obtained were based on fixed-effect, 2SLS and GMM Models. Our results are robust to the other two measures of Board Co-option, Tenure-Weighted Co-Option and Residual Co-option, showing the applicability of our econometric model. Findings Results reveal that an increased proportion of co-opted directors on the board is associated with a notably reduced Z-Score ratio value, signifying an elevated level of solvency risk for banks. The evidence is consistent with the notion that co-opted directors bring about less effective board governance, escalating agency problems and enhancing solvency risk. Research limitations/implications The banks in these two countries must carefully establish a risk management framework under the Basel Accords to avoid risks like solvency risk. The regulators in the financial services industry may also devise mechanisms and regulate the banks under the second pillar of Basel-II and III, “Supervisory Review Process,” to avoid solvency risk management issues. Future researchers and scholars can extend the limits of future studies from two countries to various geographic locations, such as Europe, China and Southeast Asian regions. Practical implications Our study establishes the fact that banks in Australia and New Zealand are more exposed to solvency risk due to increasing board co-option phenomena at the board level. Social implications The unique measure of board co-option reveals the significance of board governance for bank risk management. To properly develop and implement bank risk management policies, the appointment and performance of board members must be actively monitored in Australian and New Zealand banks through a sensitive measure of board co-option. Originality/value Our study provides fresh insight and adds to the body of knowledge. It is a pioneering effort and a point of reference for forthcoming researchers, as there are either limited or no other such studies available in the literature to the best of our knowledge in terms of the relationship between Board co-option and solvency risk. A few previous studies are limited to US firms only.