The manner in which financial firms are governed directly affects the stability and sustainability of both the financial sector and the “...
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The manner in which financial firms are governed directly impacts the stability and sustainability of both the financial sector and the "real" economy, as the financial crisis and associated regulatory reform efforts have tragically demonstrated. However, two fundamental tensions continue to complicate efforts to reform corporate governance in post-crisis financial firms. The first relates to reliance on increased equity capital as a buffer against shocks and a means of limiting leverage. The tension here arises from the fact that no corporate constituency desires risk more than equity does, and that risk preference only tends to be stronger in banks, and in financial distress - which places a premium on evaluating who these capital providers are, and what their risk incentives look like. The second tension relates to reliance on increased board independence as a buffer between the risk management function and senior corporate management. The tension here arises from the fact that a growing empirical literature increasingly associates board independence with increased risk-taking and worse performance in the wake of the crisis, in addition to the more general concern that independent directors may lack industry-relevant expertise. This once again places a premium on evaluating who these outside voices in the boardroom are, and what capacities they bring to the table in the financial context. This essay explores these tensions in the context of financial firm governance and assesses the intellectual groundwork that remains to be done as a preliminary to identifying a coherent way forward.