Alan D. Morrison

Crises and Capital Requirements in Banking

We analyze a general equilibrium model in which there is both adverse selection of, and moral hazard by, banks. The regulator can screen banks prior to giving them a licence, audit them ex post to learn the success probability of their projects, and impose capital adequacy requirements. Capital requirements combat moral hazard when the regulator has a strong screening reputation, and they otherwise substitute for screening ability. Crises of confidence can occur only in the latter case, and contrary to conventional wisdom, the appropriate policy response may be to tighten capital requirements to improve the quality of surviving banks.

Corporate Governance and Banks: What Have We Learned from the Financial Crisis?

Recent academic work and policy analysis give insight into the governance problems exposed by the financial crisis and suggest possible solutions. We begin this paper by explaining why governance of banks differs from governance of nonfinancial firms. We then look at four areas of governance: executive compensation, boards, risk management, and market discipline. We discuss promising solutions and areas where further research is needed.

The Demise of Investment Banking Partnerships: Theory and Evidence

In 1970 the New York Stock Exchange relaxed rules that prohibited the public incorporation of member firms. Investment banking concerns went public in waves, with Goldman Sachs the last of the bulge bracket banks to float. We explain the pattern of investment bank flotations. We argue that partnerships foster the formation of human capital and we use technological advances that undermine the role of human capital to explain the partnerships going-public decision. We support our theory using a new data set of investment bank partnership statistics.

Financial Liberalisation and Capital Regulation in Open Economies

We model the interaction between two economies where banks exhibit both adverse selection and moral hazard and bank regulators try to resolve these problems. We find that liberalising bank capital flows between economies reduces total welfare by reducing the average size and efficiency of the banking sector. This effect can be countered by forcing international harmonisation of capital requirements across economies, a policy reminiscent of the “level playing field” adopted in the 1988 Basle Accord. Such a policy is good for weaker regulators whereas a laissez faire policy under which each country chooses its own capital requirement is better for the higher quality regulator. We find that imposing a level playing field among countries is globally optimal provided regulators’ abilities are not too different. We also show how shocks will be transmitted differently across the two policy regimes.

Interbank Competition with Costly Screening

We analyze credit market equilibrium when banks screen loan applicants. When banks have a convex cost function of screening, a pure strategy equilibrium exists where banks optimally set interest rates at the same level as their competitors. This result complements Broeckers (1990) analysis, where he demonstrates that no pure strategy equilibrium exists when banks have zero screening costs. In our set up we show that interest rate on loans are largely independent of marginal costs, a feature consistent with the extant empirical evidence. In equilibrium, banks make positive profits in our model in spite of the threat of entry by inactive banks. Moreover, an increase in the number of active banks increases credit risk and so does not improve credit market efficiency: this point has important regulatory implications. Finally, we extend our analysis to the case where banks have differing screening abilities.

Investment of Banking: Past, Present, and Future

1. That is, the total number of employees, excluding administrative staff. 2. The data in this paragraph are taken from the SIA, the Securities Industry Databank, and Factbook. 3. See A. D. Morrison and W. J. Wilhelm, Jr., (2007), Investment Banking: Institutions, Politics and Law, Oxford: Oxford University Press. by Alan D. Morrison, Said Business School, University of Oxford and William J. Wilhelm, Jr., McIntire School of Commerce, University of Virginia

Investment Bank Reputation and 'Star' Cultures

We develop a model in which individual and institutional reputation concerns conflict with one another to study why investment bank reputation concerns may have diminished in recent years. Unproven but talented bankers have incentive to signal their ability through actions that may or may not best serve their clients. In the spirit of Kreps (1990), we treat the bank as a hierarchical firm whose only asset is its institutional reputation for curbing behavior that is suboptimal for the client. The conflict between individual and institutional reputation concerns is more likely to resolve in favor of institutional reputation when firms recruit only the most talented people, and less so when unique ability is especially valuable. We discuss how technological change has contributed to a “star” culture that is unfavorable toward preservation of institutional reputation.We analyze the tension between individual and institutional reputation building. In our model, young agents with trust-based, fiduciary customer relationships can build a strong reputation by taking actions that showcase their talents, but are harmful to their customers. A long-lived professional services firm can resolve this problem by monitoring junior fiduciaries. In such firms, there is conflict between the objectives of the junior fiduciaries and those of the owners, whose fortune is tied up in the long-run reputation of the firm. We identify conditions under which institutional reputation is insufficient to ensure that this conflict is resolved efficiently. JEL Codes: L14, G20

Investment-Banking Relationships: 1933-2007

We study the evolution of investment bank relationships with issuers from 1933-2007. The degree to which issuers conditioned upon prior relationship strength when selecting an investment bank declined steadily after the 1960s. The issuers probability of selecting a bank with strong relationships with its competitors also declined after the 1970s. In contrast, issuers have placed an increasing emphasis upon the quantity and the quality of their investment banks connections with other banks. We relate the structural changes in bank/client relationships beginning in the 1970s to technological changes that altered the institutional constraints under which security issuance occurs.

Internal Reporting Systems, Compensation Contracts, and Bank Regulation

We examine the interdependency between loan officer compensation contracts and commercial bank internal reporting systems (IRSs). The optimal incentive contract for bank loan officers may require the bank headquarters to commit not to act on certain types of information. The headquarters can achieve this by running a basic reporting system that restricts information flow within the bank. We show that origination fees for loan officers emerge naturally as part of the optimal contract in our set-up. We examine the likely effect of the new Basel Accord upon IRS choice, loan officer compensation, and bank investment strategies. We argue that the new Accord reduces the value of commitment, and hence that it may reduce the number of marginal projects financed by banks.

Culture, Competence, and the Corporation

We provide an economic treatment of two central ideas from management studies: corporate culture, and corporate competence. We follow Weber and Camerers (2003) experimental work, which identifies both the importance of cultural norms in communication, and the efficiency costs of moving to an unfamiliar culture. We argue that communication through tacit, cultural, channels can mitigate principal agent problems within organizations. The cultural displacement associated with job changes therefore has an agency cost. This reduces employee mobility and binds the employees competences to the employer. Hence, the employer will finance training in general skills. If new information systems reduce the cultural specificity of communication channels then employees will become more mobile, and the burden of training will shift from employers to professional schools.