Does Bank Stakeholder Orientation Enhance Financial Stability? Evidence from a Natural Experiment

Using the staggered enactment of US state constituency statutes, which provides plausibly exogenous variations in directors’ fiduciary duties, we find that stakeholder orientation significantly reduces bank risk. This relation cannot be explained by reverse causality, local economic conditions and coincidental state antitakeover laws and banking deregulation policies. Consistent with lower risk-taking, we find that banks reduce risk through increasing capital and lending to safer borrowers. Furthermore, stakeholder orientation improves bank performance only for those banks that take excessive risk. Finally, banks that previously received a statute passage fared significantly better during the crises. Overall, our findings highlight the importance of bank directors’ fiduciary duties in safeguarding financial stability, and more broadly, support the increasing calls for greater emphasis on stakeholder interests in the current bank regulatory and governance reforms.