Levent Guntay

Inside Debt, Bank Default Risk and Performance during the Crisis

In this paper, we examine whether the structure of the chief executive officer’s (CEO) compensation package can explain default risk and performance in bank holding companies (BHCs) during the recent credit crisis. Using a sample of 371 BHCs, we show that in 2006 higher holdings of inside debt relative to inside equity by a CEO after controlling for firm leverage is associated with lower default risk and better performance during the crisis period. We present evidence that before the crisis banks with higher inside debt ratios also have supervisory ratings that indicate stronger capital positions, better management, stronger earnings, and being in a better position to withstand market shocks in the future. Such ex-ante evidence can explain the observed relationship between inside debt, default risk, and performance during the crisis.

Testing for Systemic Risk Using Stock Returns

The literature proposes several stock return-based measures of systemic risk but does not include a classical hypothesis tests for detecting systemic risk. Using a joint null hypothesis of Gaussian returns and the absence of systemic risk, we develop a hypothesis test statistic to detect systemic risk in stock returns data. We apply our tests on conditional value-at-risk (CoVaR) and marginal expected shortfall (MES) estimates of the 50 largest US financial institutions using daily stock return data between 2006 and 2007. The CoVaR test identifies only one institution as systemically important while the MES test identifies 27 firms including some of the financial institutions that experienced distress in the past financial crisis. We perform a simulation analysis to assess the reliability of our proposed test statistics and find that our hypothesis tests have weak power, especially tests using CoVaR. We trace the power issue to the inherent variability of the nonparametric CoVaR and MES estimators that have been proposed in the literature. These estimators have large standard errors that increase as the tail dependence in stock returns strengthens.

Taking the Risk Out of Systemic Risk Measurement

An emerging literature proposes using conditional value at risk (CoVaR) and marginal expected shortfall (MES) to measure financial institution systemic risk. We identify two weaknesses in this literature: (1) it lacks formal statistical hypothesis tests; and, (2) it confounds systemic and systematic risk. We address these weaknesses by introducing a null hypothesis that stock returns are normally distributed. This allows us to separate systemic from systematic risk and construct hypothesis tests for the presence of systemic risk. We calculate the sampling distribution of these new test statistics and apply our tests to daily stock returns data over the period 2006-2007. The null hypothesis is rejected in many instances, consistent with tail dependence and systemic risk but the CoVaR and MES tests often disagree about which firms are potentially “systemic.” The highly restrictive nature of the null hypothesis and the wide range of firms identified as systemic makes us reluctant to interpret rejections as clear evidence of systemic risk. The

Blockholders, Debt Agency Costs and Legal Protection

We investigate how investor protection influences the blockholder-bondholder conflict. We focus on family blockholders, the typical blockholders with high control motivations and the most common type of concentrated ownership, because blockholder-bondholders agency conflicts are clearest in this case. On one hand, family blockholders can mitigate debt costs through their undiversified investments, inter-generation presence, and firm survival concerns. On the other hand, they can exacerbate debt costs because of their unique power position to extract private benefits, leading to higher bankruptcy risk. The ultimate impact depends on how family blockholders are disciplined, specifically by the investor protection laws. Using international bond issues for 1,072 international firms from 23 countries we find that the presence of a family blockholder increases debt costs but the ultimate impact depends on investor protection: family firms in low investor protection countries suffer from higher debt costs compared to non-family firms, while family firms in high investor protection countries benefit from lower debt costs. Familys presence in management further increases debt costs but we find no effect from superior voting rights. We find no impact from institutional blockholdings and there is no evidence that they discipline family blockholders. The results show the importance of investor protection for debt agency conflicts.