Governance Change Under the Interactional Impact of Deregulatory and Institutional Forces

Prior research demonstrates that deregulation leads to changes in the governance systems of firms. Although researchers highlight deregulation as a significant source of governance change, the way in which institutional forces interplay with regulative change seems to have been largely ignored. Over the years, compensation consultants and critics have emphasized incentive plans as innovative compensation schemes that better align the interests of managers with the concerns of owners. In fact, the number of firms that adopt incentive plans has significantly increased in the U.S. since the-mid 1970s. Similarly, board reform critics, institutional investors, and shareholder activists have persistently advocated board independence as a vital component of sound monitoring systems over the last couple decades. Thus, to the extent that these institutional trends coincide with deregulatory periods of major U.S. industries such as airlines, banking, railroads, and public utilities, one might argue that the changes observed in governance systems of firms after deregulation are equally identifiable in other firms that have not experienced regulative changes. In other words, the observed changes in governance systems of firms following deregulation can be attributed to the impact of institutional trends. Thus, there is a need to reexamine the impact that deregulation has on corporate governance by investigating the interplay between regulative changes and institutional trends. Therefore, we attempt to delineate between the effect of deregulation and the effect of institutional forces in the governance change process. In doing so, we extend and supplement prior research on the deregulation-governance adaptation link by incorporating a broad scope of governance variables that include both compensation and monitoring systems. Using a sample of banks in the U.S. banking industry and a matched sample of non-regulated firms observed between 1981 and 1990, we find evidence that deregulation acts as a catalyst on institutional forces. Results demonstrate that institutional forces and deregulation have similar but distinct effects on changes in governance mechanisms. Our findings establish an enhanced understanding that institutional trends point the way for legitimized changes while deregulation provides a catalyst for the rapid adoption of those legitimized practices. Our study indicates the importance of analyzing the impact of institutional forces and the catalytic nature of deregulation in the study of the governance adaptation-deregulation linkage. Furthermore, we explore the sequence of governance change firms follow in the governance adaptation process. Results indicate that banks adjust compensation systems first and alter monitoring systems later. Our findings suggest that firms make initial changes to incentive systems followed by relatively slow progress toward changes to monitoring systems. Thus, our research clarifies the firms’ inclination of changing highimpact elements and less resisted systems early in the adaptation process. Additionally, our study reveals that incentives and monitoring act as substitutes in the short-term but act as complements in the long-run.