Essays on financial stability and corporate finance
- Autores: Mónica López Puertas
- Directores de la Tesis: Óscar Gutiérrez Arnaiz (dir. tes.)
- Lectura: En la Universitat Autònoma de Barcelona ( España ) en 2011
- Idioma: inglés
- Tribunal Calificador de la Tesis: Vicente Salas Fumás (presid.), Josep Tribo Gine (secret.), Klaus Schaeck (voc.)
- Materias:
- Enlaces
- Tesis en acceso abierto en: TESEO
- Resumen
Stability concerns are at the center of banking sector policy research, since banks are critically important for industrial expansion, for the corporate governance of firms, and for capital allocation (Levine, 1997, 2004). The resent financial crisis has put forward the importance of a well functioning banking system for economic growth. The outcome of the current crisis has been worse than in any similar period since the great depression of the 1930s and has focussed attention on the inadequacies of the contemporary model of financial regulation, both at the national and at the global level (Avgouleas, 2008). Excessive risk-taking in the financial sector has been considered one of the main causes of the crisis, but the deeper question is what drives excessive risk taking? The general argument is that flawed regulation, excessive competition, perverse incentives and poor internal governance are important drivers of excessive risk, and are at the root of the most significant economic crisis since the Great Depression (Eichengreen, 2010). Among these factors, poor corporate governance of banks has increasingly been acknowledged as an important cause of the recent financial crisis. In turn theoretical and empirical research suggests that agency problems and the corporate governance of banks depend on the firm¿s ownership structure (La Porta et al. 1999, Bebchuk and Hamdani 2009) and that different types of owners will pursue different strategic objectives. Thus, the type of bank shareholder, as well as of the bank¿s organizational design, is likely to affect the bank¿s risk preference as well as the mechanisms aimed at achieving the preferred level of risk. However, the bulk of research on the relationship between ownership structure and bank risk has focused on the direct effect on bank risk of ownership concentration, without considering different types of owners, the underlying mechanisms of the relationship, or how the ownership structure of a bank interacts with external governance mechanisms to shape bank risk. The objective of this thesis is to further investigate the role of bank ownership structures on risk taking and financial stability.
The first chapter develops a theoretical model of oligopolistic competition in order to better understand the effects of inter-bank rivalry on welfare, financial stability, risk-taking behavior and performance. We propose a duopoly model of retail banking competition between a profit-maximizing bank (commercial bank) and a bank exhibiting expense preference behavior (stakeholder bank). We establish the nature of the competition between banks, following the work of Singh and Vives (1984), and show that the strategic decision variable when banks offer a differentiated product is quantity rather than price (when the product is homogeneous, competition is also in quantities). Thus, we add to the literature by introducing ownership structure and welfare considerations into the analysis of the relationship between competition and financial stability. The main conclusions of this first chapter are, first, that stakeholder banks are less risk-inclined, obtain a higher market share, and offer higher interest rates than commericial banks (Prop. 1). Second that the presence of stakeholder banks increases systemic financial stability and social welfare (Prop. 2). Furthermore, we show that there is an optimal degree of expense preference that maximizes the economic profits of commercial banks, suggesting that commercial banks would benefit from more aggressive strategic behavior, which could be achieved through managerial incentives. Finally, our result suggest that banks (independent of their ownership structure) are less stable and less profitable when competing against an stakeholder bank. Our findings have certain policy implications. First, financial policy should differ across financial systems as well as across banks and regulation should be set in a more or less restrictive way, depending on bank ownership and the proportion of stakeholder banks in the system. Second, policy-makers aiming to maximize social welfare may favor a stakeholder approach in the retail banking sector. Propositions 1 and 2 are empirically validated in chapters 2 and 3, respectively.
The second chapter analyses the implications of bank ownership structures for bank risk- taking incentives and for the effect of competition and regulation on bank stability. Excessive risk taking has been considered one of the main causes of the financial crisis, underscoring current efforts to reform bank regulation and supervision to shape bank risk. Yet, there is no evidence that any universal set of best practices is appropriate for all banks or that successful regulation and supervision of commercial banks, for example, will be equally effective for cooperatives or savings banks. We differentiate between commercial and stakeholder banks, and explore whether the relationship between risk and regulation depends on the ownership structure of the bank in particular, and on the proportion of each type within the financial system, in general. Our main findings are as follows. First, we show that stakeholder banks are less risk- inclined than commercial banks, and that they make their rivals, especially commercial banks, less stable (we provide empirical support to proposition 1 in Chapter1). This finding holds after controlling for competition, institutional characteristics and bank regulation. Second, our results show a negative direct effect of competition on bank stability, supporting the competition-fragility view. Moreover, we show that this negative effect is contingent on bank ownership structure. Specifically, we find that the effect of competition on stability is significantly more negative for commercial banks than for stakeholder banks, as well as for any bank operating in a system with a higher proportion of stakeholder banks. Finally, we find that capital requirements, activity restrictions and deposit insurance have a negative effect on bank stability, but that the impact of these regulatory measures on bank risk depends on the bank ownership structure. We find that stringent measures of capital regulation decrease the stability of commercial banks, but have no effect on the stability of stakeholder banks. In addition, we show that capital requirements increase bank stability in economies with a high proportion of stakeholder banks. The effect of activity restrictions on bank stability is negative for stakeholder banks but positive for commercial banks. Furthermore, we find that the negative effect of activity restrictions on bank stability increases with the proportion of stakeholder banks in an economy. Finally, deposit insurance has a negative impact on bank stability, and the effect is stronger for commercial banks.
Overall, our findings suggest that it is important to consider bank ownership structure when analyzing bank stability. This result may have important implications for academics and policy-makers, as it indicates that ignoring ownership structure can lead to erroneous conclusions about the effects of competition and of banking regulation on bank stability.
The third chapter examines the proposition that increasing the proportion of stakeholder banks in a country enhances its financial stability at the country level, using logit and fixed effects models. We analyze from a macro-perspective whether it is desirable, in terms of systemic financial stability, to have a mixed banking system incorporating both commercial and stakeholder banks. Most of the literature on the relationship between bank ownership structure and bank risk carries implications for systemic financial stability, by implicitly assuming that the system as a whole will be safer when individual banks are safer. For instance, if cooperative banks are more stable than commercial banks, under this approach it will be argued that cooperative banks help to increase financial stability. However, this is not so straightforward in practice. We posit that the presence of a safer type of bank may generate an externality affecting the stability of other banks. As a consequence, it is not clear whether the presence of a safer type of bank helps to increase the overall systemic financial stability. We find empirical support for the idea that the presence of stakeholder banks helps to increase financial stability at the systemic level (we provide empirical support to proposition 2 in chapter1). We therefore conclude that the ownership structure of banks influences systemic financial stability, and that stakeholder banks appear to enhance stability.
While focusing on the effect of stakeholder banks on systemic financial stability, we consider the effect of several other characteristics, including competition, concentration and regulatory measures, with some interesting findings. First, there is an academic debate about whether bank competition leads to more or less stability in the banking system. While the franchise value paradigm suggests that competition reduces financial stability, the risk-shifting hypothesis argues that competition increases financial stability. Our findings suggest that competition and concentration helps to increase systemic financial stability. These findings seem to indicate that competition and concentration must be considered to be measuring different aspects (see Berger et al., 2004; Beck et al., 2006; Schaeck et al., 2009; Jiménez et al., 2007). In terms of regulation, we consider the effect of activity and entry restrictions, as well as the effect of capital restrictions and the independence of the supervisory authority bank on systemic financial stability. Our results show that the probability of going into a systemic crisis is influenced by the degree of openness of the financial system. However, limitations to diversification of activities and assets, capital restrictions, or the independence of the supervisory banks have no significant influence.
Our key finding of a positive effect of the presence of stakeholder banks on systemic financial stability is important for both academics and policy makers. Our results put forward that the economic arguments that suggest that one specific form of organizing banking activity, namely that of commercial banks, is superior, are inconclusive. There are advantages and disadvantages to all governance models. Irrespective of the strengths and weaknesses of particular governance models, we show that there is a systemic advantage - in terms of financial stability - to having a mixed system of business models and a strong critical mass of stakeholder banks. Our results suggest that policy-makers should not take or support actions that could jeopardize the existence of stakeholder banks.
In the forth chapter, we propose that, to gain insight into the determinants of bank risk, it is crucial to understand not only the preferences in terms of risk taking for different types of shareholders, but also the mechanisms (such as executive compensation) through which shareholders are able to implement their desired level of risk, the ability of shareholders to influence these mechanisms, and the inherent limitations (at the bank level) to achieving the preferred risk level. We find empirical support for the logic that banks with different types of controlling shareholders differ in their risk preferences, as well as in their abilities - and limitations - to achieve their desired level of risk. Moreover, rather than assuming a direct relationship between ownership concentration and bank risk, we explore the mechanisms underlying this relationship. Our results suggest that executive compensation is an important mechanism through which shareholders can induce the preferred risk level. This chapter adds to existing research, in that we combine the literature on bank ownership and risk taking with the literature on the risk-taking effect of executive compensation, to better assess the determinants of bank risk. Considering endogenous feedback effects of bank risk on the structure of compensation, we examine the relationship between executive compensation and risk-taking, as well as the role of ownership structure on both executive compensation and risk-taking. In doing so, we use two characteristics of compensation, namely, pay-performance sensitivity (delta), and pay- risk sensitivity (vega) that have been suggested as influencing bank risk (Coles, Daniel, and Naveen, 2006).
The results of this chapter show that bank ownership structures influence both bank risk and CEO compensation contracts, and that the latter influence (and are influenced by) bank risk. On average, banks in which CEOs receive high-vega and low-delta contracts (risk-sensitive compensation schemes) are riskier than those banks in which CEOs are less encouraged , or have fewer incentives, to take risk (low-vega and high-delta contracts). We also find evidence that banks controlled by undiversified shareholders, as is the case of family-controlled banks, implement low-risk-sensitive compensation schemes (low-vega, high-delta incentives contracts) as a manifestation of their preference for lower levels of risk. However, these banks face higher limitations on achieving lower risk, compared to other banks, and as a result, they end up being riskier. We also show that there are no significant differences between the compensation schemes and risk profiles of banks controlled by undiversified shareholders, and banks with dispersed ownership. Since all banks in our sample are publicly traded, this result is in line with the idea that the market aligns the risk-taking behavior of any type of shareholder-controlled bank (with the exception of family-controlled banks), in such a way that ownership structure is no longer a determinant of risk differentials. Another possible interpretation for this finding is that lower risk preferences, combined with higher abilities and lower limitations on achieving it, lead to similar executive compensation schemes and risk levels, as the combination of higher risk preference with lower abilities and higher limitations. Finally, we find a positive relationship between delta and vega. These results suggest that banks tend to use high-vega contracts to mitigate managerial risk-aversions that arise from high-delta contracts, and high-delta contracts to moderate the high risk-taking induced by high-vega contracts.
Our results contribute to the existing literature in several ways. As far as we know, this is one of the first studies to analyze the role of managerial incentives as an underlying mechanism through which shareholders may attain the desired level of risk. Thus, we make an attempt to open the ¿black box¿ of governance processes and practices that shareholders use to deal with the lower risk appetite of managers. Further, we distinguish between banks with different types of controlling shareholders in terms of their risk preferences, abilities to influence the incentive scheme, and inherent limitations at the bank level to achieving the preferred level of risk. In doing so, we integrate wealth-concentration effects and the principal¿agent perspective, and enhance the theoretical model by introducing inherent limitations to manage risk. Moreover, we contribute to the literature on the link between executive compensation and financial stability (Houston and James, 1995; DeYoung et al. 2010; Mehran and Rosenberg, 2007; Chen et al. 2006) by providing evidence of the relationship between managerial compensation and risk. Finally, while most empirical studies examining the effect of executive compensation on bank risk use relatively rudimentary measures of compensation (Coles, Daniel, and Naveen, 2006), we use two characteristics of executive compensation, delta and vega, that theoretically influence bank risk (Coles, Daniel, and Naveen, 2006). At best, the measures used in most existing studies are noisy measures for vega and delta (Core and Guay, 2002).
The results of this chapter have implications for policymakers and add to the current debate on the influence of executive incentives on bank risk. In the search for explanations of the current financial crisis, compensation systems and their inherent incentives for risk-taking have received much criticism and are subject to new regulatory oversight in most countries. Our results suggest that banking executives respond in economically meaningful ways to the incentives present in their compensation contracts. For instance, while family-controlled banks aim to implement low-risk policies through low risk-sensitive executive compensation contracts, institutionally controlled banks implement risk-sensitive executive compensation contracts as a means to achieve a high level of risk. This finding suggests that regulators may consider bank ownership structures when setting regulatory constraints on bank executive incentives. Government intervention to limit risk-taking incentives in financial executive compensation contracts could, at best, strengthen, and at worst interfere with, the compensation-based risk mitigation behavior already being exhibited by banks controlled by large shareholders unable to diversify, and with preferences toward lower risk. Rather, regulation for these types of bank may focus on solving their inherent limitations, since they partially explain their higher risk profile. To conclude, our findings suggest that government prescription should consider bank differences in ownership structure to account for differences in risk preferences, and ability and limitations on achieving the desired level of risk. Therefore, the general principle of uniform regulation across all banks may not be appropriate when regulating executive incentive contracts in the banking industry.
