Prudential bank regulation complicates monetary policy because it has cyclical effects on the growth of bank credit, which can be a channel through which monetary policy is transmitted to the economy. Employing a panel of 36 advanced and developing countries for the period 1973–2015, we find that changes in regulation have been procyclical with respect to credit surges and counter-cyclical with respect to credit stops. As a result, monetary policy risks being too loose over the credit cycle. The economic effects of prudential regulation on credit have been meaningful given the large-scale bank liberalizations undertaken by many countries. The result is robust to dealing with a wide range of sensitivity tests and endogeneity concerns. In designing regulations, policymakers need to consider transmission mechanisms through which they might affect the real economy and undermine the goals of monetary policy.

Bank capital requirements reduce the probability of bank failure and help mitigate taxpayers’ sharing in the losses that result from bank failures. Under Basel III, direct capital requirements are supplemented with liquidity requirements. Our results suggest that liquidity provisions of banks are connected to bank capital and that changes in liquidity indirectly affect the capital structure of financial institutions. Liquidity appears to be another instrument for adjusting bank capital structure beyond just capital requirements. Consistent with Diamond and Rajan (2005), we find that liquidity and capital should be considered jointly for promoting financial stability.

This paper investigates the effectiveness of equity-based compensation in mitigating the effects of agency costs on the valuation of single-segment and multi-segment firms. In a sample of 4182 firm-year observations during the period 1993–1998, we find that firms with high equity-based compensation have higher valuation than firms with low equity-based compensation. This is true in both single-segment and multi-segment firms. The effect of equity-based compensation for multi-segment firms, where agency costs are expected to be higher, is much greater than for single-segment firms. Also, the negative value-effect of diversification is less for firms with high equity-based compensation.

A majority of U.S. banks between 1973 and 2012 held equity capital significantly beyond the required minimum. We study the risk-return tradeoff in connection with a bank’s capital structure, and identify several new significant market factors that drive the level of equity capital in banks. During normal growth periods, bank leverage is negatively related to a level of competition and loan portfolio diversification, while high bank leverage is associated with low past liquidity. During recessions and expansions, the roles of those factors change following distortions in risk-return tradeoff. In distress, when banks approach regulatory capital requirements, market determinants of book leverage lose their significance; however, leverage does not decrease until a bank is within 1% of the minimal capital threshold.

We use estimates of the Black—Scholes sensitivity of managers' stock option portfolios to stock return volatility and the sensitivity of managers' stock and stock option portfolios to stock price to test the relationship between managers' risk preferences and hedging activities. We find that as the sensitivity of managers' stock and stock option portfolios to stock price increases, firms tend to hedge more. However, as the sensitivity of managers' stock option portfolios to stock return volatility increases, firms tend to hedge less.

We test for a link between bank risk-taking and regulatory enforcements against US banks for financial misconduct. Misconduct-related enforcements are associated with increased bank risk-taking on several measures of risk, and there is some evidence that the impact of enforcements on risk-taking is accentuated in the presence of powerful CEOs and a higher proportion of institutional investor ownership and mitigated when executive boards are larger, older, more independent, more gender diverse, busier, and where independent directors are relatively inexperienced. The results are robust to alternative measures of bank risk-taking, and alternative estimation techniques, including controlling for endogeneity bias.