Board co-option linked to higher solvency risk in Australian and New Zealand banks
image: The results of both fixed and random-effects models are presented in it. The regression results show that the statistical relationship between Cooption and z-score is negative and highly significant for both fixed-effects and random-effects models. This implies that the risk of solvency measured through Z-score is directly related to increased coopted board directors. A unit increase in cooption increases default risk by 1.473 units for fixed effects model and 1.012 units for random-effects model. These results for Australia and New Zealand banking sector corroborate with findings of Brogi and Lagasio (2022), Coles et al. (2014), Baghdadi et al. (2020) and Addo et al. (2021) which exhibit the same scenario for United States and European banking sector, where cooption enhance risk for banks and firms. It also shows the generalizability and applicability of our econometric model. Further it adds to applicability of theory of cooption to various geographic location like Australia and New Zealand around the globe.
Credit: Khalil ur Rahman (National University of Computer and Emerging Sciences – Lahore Campus, Pakistan) Mian Muhammad Atif and Akbar Azam (National University of Computer and Emerging Sciences – Lahore Campus, Pakistan)
Background and Motivation
Effective board governance is crucial for sound risk management in the banking sector, especially following the 2008 financial crisis. While board structure and independence have been widely studied, the phenomenon of board co-option—where directors are appointed after the CEO takes office—has received limited attention outside the United States. In Australia and New Zealand, recent cases of banking misconduct have raised concerns about governance quality. This study investigates whether co-opted boards contribute to higher solvency risk in banks across these two countries, addressing a significant gap in the literature and offering timely insights for regulators and practitioners.
Methodology and Scope
The research examines 28 commercial banks, 20 from Australia and 8 from New Zealand, over the period 2011-2021. Board co-option is measured using three proxies: the proportion of co-opted directors (BCO), tenure-weighted co-option (TBC), and residual co-option (RCB). Solvency risk is captured through the Z-Score, a widely accepted indicator of bank stability. The analysis employs fixed-effects, random-effects, 2SLS, and GMM models to ensure robustness and address endogeneity concerns. Control variables include bank size, profitability, loan loss reserves, CEO tenure, board gender diversity, and GDP growth.
Key Findings and Contributions
The study reveals a significant negative relationship between board co-option and bank solvency. A higher proportion of co-opted directors is associated with a lower Z-score, indicating elevated default risk. Results remain consistent across all three co-option measures and are robust to different econometric specifications. This aligns with findings from U.S. and European studies, suggesting that co-opted boards may weaken governance, reduce effective monitoring, and amplify agency problems. The research contributes the first empirical evidence on this relationship in the Australian and New Zealand banking contexts, extending the applicability of co-option theory beyond North America and Europe.
Why It Matters
Banks play a vital role in financial stability, and solvency risk is a key concern under the Basel Accords. The findings highlight how CEO-influenced board appointments can undermine governance and increase risk exposure. For regulators, this underscores the need to scrutinise board appointment processes as part of the Supervisory Review Process under Basel II/III. For investors and stakeholders, it signals the importance of board independence in safeguarding bank resilience. The study also responds to calls for stronger governance, considering recent banking misconduct in both countries.
Practical Applications
- Bank boards should review appointment policies to ensure director independence and mitigate co-option effects.
- Regulators in Australia and New Zealand could strengthen guidelines on board governance under Pillar II of the Basel frameworks.
- Investors may use board co-option as a marker for governance quality and risk exposure.
- Future research can expand into other risk types (e.g., liquidity, credit) and regions (e.g., Asia, Europe) to build a global understanding of co-option’s impact.
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