Corporate governance and the systemic risk of financial institutions

• This paper examines the linkage between corporate governance and systemic risk.
• Financial institutions with stronger corporate governance have higher systemic risk.
• Financial institutions with shareholder-friendly boards have higher systemic risk.
• Good corporate governance had strong positive effect on systemic risk in 2008.

This paper studies the relationship between corporate governance and the systemic risk of financial institutions. Specifically, using a sample of large U.S. financial institutions from 2005 to 2010, we examine whether the strength of corporate governance mechanisms can explain the cross-sectional variation in systemic risk around the recent financial crisis. Our empirical findings indicate that financial institutions with stronger and more shareholder-focused corporate governance structures and boards of directors are associated with higher levels of systemic risk. Thus, our results suggest that good corporate governance may encourage rather than constrain excessive risk-taking in the financial industry.