Corporate governance and performance of financial institutions

•Better corporate governance reduces excessive risk-taking and improves the performance of U.S. financial institutions.•Better governance components reduce non-performing loans and improve Tobin's Q.•Better governance increases the provisions and reserves for asset losses, suggesting income smoothing.•The evidence is supported by different robustness checks.

We examine how corporate governance affects financial institutions in the U.S. between 2002 and 2009. First, we find that better governance is negatively related to excessive risk-taking and positively related to the performance of U.S. financial institutions. Specifically, sound overall and specific governance practices are associated with less total non-performing assets, less real estate non-performing assets, and higher Tobin's Q. Second, we show that better governance contributes to higher provisions and reserves for loan/asset losses of financial institutions, supporting the income smoothing hypothesis. Moreover, the results are similar without the financial crisis period, and different robustness checks confirm the analysis.