Subprime Governance: Agency Costs in Vertically Integrated Banks and the 2008 Mortgage Crisis

This study uses the 2008 mortgage crisis to demonstrate how the relationship between vertical integration and performance crucially depends on corporate governance. Prior research has argued that the vertical integration of mortgage origination and securitization aligned divisional incentives and improved lending quality. We show that vertical integration improved loan performance only in those firms with strong corporate governance and that this performance-integration relationship strongly decreases and actually reverses as governance quality decreases. We interpret these findings as suggesting that the additional control afforded by vertical integration can, in the hands of poorly monitored managers, offset gains from aligned divisional incentives. These findings support the view that corporate governance influences the strategic outcomes of a firm, in our case, by influencing the effectiveness of boundary decisions.