Jens Hagendorff

Board Monitoring, Regulation, and Performance in the Banking Industry: Evidence from the Market for Corporate Control

The specific monitoring effect of boards of directors versus industry regulation is unclear. In this paper, we examine how the interaction between bank-level monitoring and regulatory regimes influences the announcement period returns of acquiring banks in the US and twelve European economies. We study three board monitoring mechanisms (independence, CEO-chair duality and diversity) and analyze their effectiveness in preventing underperforming merger strategies under bank regulators of varying strictness. Only under strict banking regulation regimes, board independence and diversity improve acquisition performance. In less strict regulatory environments, corporate governance is virtually irrelevant in improving the performance outcomes of merger activities. Our results indicate a complementary role between monitoring by boards and bank regulation. This study is the first to report evidence consistent with complementarity by investigating the effectiveness (rather than the prevalence) of governance arrangements across regulatory regimes. Our work offers insights to policymakers charged with improving the quality of decision-making at financial institutions. Attempts to improve the ability of bank boards to critically assess managerial initiatives are most likely to be successful if internal governance is accompanied by strict industry regulation.

Corporate Governance and Bank Risk-taking

Manuscript type. Review. Research Question/Issue. Bank governance has become the focus of a flurry of recent research and heated policy debates. However, the literature presents seemingly conflicting evidence on the implications of governance for bank risk‐taking. The purpose of this paper is to review prior work and propose directions for future research on the role of governance on bank stability. Research Findings/Insights. We highlight a number of key governance devices and how these shape bank risk‐taking: the effectiveness of bank boards, the structure of CEO compensation, and the risk management systems and practices employed by banks. Theoretical/Academic Implications. Prior work primarily views bank governance as a mechanism to protect the interests of bank shareholders only. However, given that taxpayer‐funded guarantees protect a substantial share of banks’ liabilities and that banks are highly leveraged, shareholder‐focused governance may well subordinate the interests of other stakeholders and exacerbate risk‐taking concerns in the banking industry. Our review highlights the need for internal governance mechanisms to mitigate such behavior by reflecting the needs of shareholders, creditors, and the taxpayer. Practitioner/Policy Implications. Our review argues that the relationship between governance and risk is central from a financial stability perspective. Future research on issues highlighted in the review offer a footing for reforming bank governance to constrain potentially undesirable risk‐taking by banks.

The value of board diversity in banking: evidence from the market for corporate control

We examine the value of board diversity in the US banking industry as a mechanism to enhance the decision-making capabilities of a board. We employ a sample of mergers to assess if measures of diversity as displayed by the bidding banks board are linked to the market performance of acquisitions. We find positive announcement returns to mergers approved by boards whose members are diverse in terms of their occupational background. By contrast, age and tenure diversity are associated with wealth losses surrounding acquisition announcements, while gender diversity does not lead to measurable value effects. Interestingly, boards with more banking expertise are not more effective at monitoring bank managers. Our results do not support calls for more representation of industry-specific expertise on bank boards and, instead, show that occupational diversity may play an important role in protecting shareholder wealth.

CEO Bonus Compensation and Bank Default Risk: Evidence from the U.S. And Europe

We investigate the link between the incentive mechanisms embedded in CEO cash bonuses and the riskiness of banks. For a sample of U.S. and European banks, we employ the Merton distance to default model to show that increases in CEO cash bonuses lower the default risk of a bank. However, we find no evidence of cash bonuses exerting a risk-reducing effect when banks are financially distressed or when banks operate under weak bank regulatory regimes. Our results link bonus compensation in banking to financial stability and caution that attempts to regulate bonus pay need to tailor CEO incentives to the riskiness of banks and to regulatory regimes.

Income Diversification and Bank Performance During the Financial Crisis

Advocates of diversifying bank income sources often argue that diversification improves the resilience of banks during periods of distress. To test this proposition, we analyze the impact of income diversification on the performance of Italian banks during the recent financial crisis. Using detailed data on the composition of bank income, we show that institutions that were diversified within narrow activity classes before the crisis experienced large declines in performance during the financial crisis. By contrast, diversification across broad activity classes, such as lending and capital market activities, did not cause performance losses during the crisis. Our results support limiting banks’ ability to diversify within narrow business lines, while permitting banks to diversify across broader activity classes.

The Wolves of Wall Street: Managerial Attributes and Bank Business Models

We investigate the role of executive-specific attributes (or ‘styles’) in explaining bank business models beyond pay-per-performance incentives. We decompose the variation in business models and document that the ‘style’ of members of a bank’s top management team is reflected in key bank policy choices. Manager styles far outrank executive compensation and other observable manager variables in terms of their ability to describe variation in bank business models. Bank manager styles also explain differences in risk and performance across banks. Finally, we combine manager styles from various bank policies to derive manager profiles that are associated with manager’s personal risk preferences, board characteristics and whether or not managers will be appointed as CEO during their careers.

The Impact of Mega-Catastrophes on Insurers: An Exposure-Based Analysis of the U.S. Homeowners’ Insurance Market

Insurance is a key risk-sharing mechanism that protects citizens and governments from the losses caused by natural catastrophes. Given the increase in the frequency and intensity of natural catastrophes over recent years, this article analyzes the performance effects of mega-catastrophes for U.S. insurance firms using a measure of market expectations. Specifically, we analyze the share price losses of insurance firms in response to catastrophe events to ascertain whether mega-catastrophes significantly damage the performance of insurers and whether different types of mega-catastrophes have different impacts. The main message from our analysis is that the impact of mega-catastrophes on insurers has not been too damaging. While the exact impact of catastrophes depends on the nature of the event and the degree of competition within the relevant insurance market (less competition allows insurers to recoup catastrophe losses through adjustments to premiums), our overall results suggest that U.S. insurance firms can adequately manage the risks and costs of mega-catastrophes. From a public policy perspective, our results show that insurance provides a robust means of sharing catastrophe losses to help reduce the financial consequences of a catastrophe event.

Systemic Size, Bank Risk and Systemic Crises

This paper analyzes the relationship between systemic size, measured as the ratio of bank assets to GDP, and bank risk. Based on an international sample of banks, we demonstrate that systemic size does not affect bank risk-taking. However, and consistent with explanations that systemically large banks maximize the value of the financial safety net, we show that systemically larger banks engaged in more aggressive risk-taking during the recent crisis. The risk effect of systemic size during the recent crisis is higher for more leveraged banks, relatively undiversified banks and banks which have issued little or no subordinated debt. Crucially, the risk effect of systemic size during the recent crisis does not extend to other crisis periods. The recent crisis, therefore, appears to have been unique in terms of its behavioral implications for systemically large banks. Our results caution that regulatory attempts to restrict the risk-taking of systemically large banks should take the form of contingent regulations that come into effect under rare events such as the recent crisis.Banks are growing ever larger compared to their national economies. We show that increases in relative bank size (measured as bank liabilities divided by national GDP) are linked to banks displaying higher tail risk exposures. Further, as banks grow in relative size, exposure to tail risks is shifted to debtholders and taxpayers without wealth gains for shareholders. These results apply to both systematic tail risks and to tail risks that are more bank-specific and under manager-control. In terms of the latter, we find evidence indicating that manager interests contribute to shaping the tail risk exposure of relatively large banks.

When Banks Grow Too Big for Their National Economies: Tail Risks, Risk Channels, and Government Guarantees

This paper analyzes the relationship between systemic size, measured as the ratio of bank assets to GDP, and bank risk. Based on an international sample of banks, we demonstrate that systemic size does not affect bank risk-taking. However, and consistent with explanations that systemically large banks maximize the value of the financial safety net, we show that systemically larger banks engaged in more aggressive risk-taking during the recent crisis. The risk effect of systemic size during the recent crisis is higher for more leveraged banks, relatively undiversified banks and banks which have issued little or no subordinated debt. Crucially, the risk effect of systemic size during the recent crisis does not extend to other crisis periods. The recent crisis, therefore, appears to have been unique in terms of its behavioral implications for systemically large banks. Our results caution that regulatory attempts to restrict the risk-taking of systemically large banks should take the form of contingent regulations that come into effect under rare events such as the recent crisis.Banks are growing ever larger compared to their national economies. We show that increases in relative bank size (measured as bank liabilities divided by national GDP) are linked to banks displaying higher tail risk exposures. Further, as banks grow in relative size, exposure to tail risks is shifted to debtholders and taxpayers without wealth gains for shareholders. These results apply to both systematic tail risks and to tail risks that are more bank-specific and under manager-control. In terms of the latter, we find evidence indicating that manager interests contribute to shaping the tail risk exposure of relatively large banks.

Does Distance Impede Regulatory Monitoring? Evidence from the Banking Industry

We examine how the information environment influences bank regulatory monitoring. Using the distance between banks and regulatory field offices as a proxy for information asymmetry, we show that an increase in distance reduces the quality of financial reporting. To establish causality, we use a quasi-natural experiment that exploits multiple exogenous shocks to distance, an instrumental variable approach as well as the enactment of the FDICIA Act of 1991 as a shock to the information environment. We provide evidence that regulators make use of local informational advantages to enforce better quality financial reporting. We further show that despite informational advantages, regulators choose when to increase regulatory scrutiny and chose not to do so during the financial crisis. Overall, our study underscores the importance of local information in regulatory monitoring.