Knowledge that Transforms

Do bank debtholders discipline excessive risk taking? I investigate this question by examining how a bank's incentives to take risks affect offering yield spreads and restrictive covenants in their debt contracts. Results suggest that bank charter values, which determine a bank's risk-taking incentives, significantly affect the likelihood of restrictive covenants in bank debt contracts. This effect was most pronounced during the 1980s, when greater competition and relatively less-stringent regulation increased the severity of moral hazard problems in the US banking industry. Overall, the results suggest that an important channel for market investors to discipline bank risk taking is through writing restrictive covenants in bank debt.

This paper tests a generalized version of the investor clientele hypothesis of Amihud and Mendelson [J. Finan. Econ. 17 (1986) 223]. This international trade-venue clientele effect hypothesis is supported for the Canadian cross-listed firms undifferentiated and differentiated by US trade venue, except for TSE shares cross-listed on NASDAQ. The hypothesized relationship between relative holding periods (measured using shares outstanding and share float) and effective half-spreads changes after TSE decimalization, and differs if the cross-listed shares have options traded on them. The empirical findings suggest that the TSE lost (won) executed order flow relative to the AMEX and to NYSE for shares with (without) options traded on them.

Money management is an activity in which agents are often evaluated on the basis of their relative performance. In this article, I consider an economy in which (i) investors use a relative performance rule to evaluate mutual fund managers and allocate money into funds, and (ii) fund managers receive an asset-based compensation. Such fund-picking rules and compensation schemes generate relative performance objectives for fund managers. I study the consequences of this for the mutual fund industry in terms of the number of competing funds and trading strategies. I show that, with respect to absolute performance maximization, relative performance objectives increase the riskiness of investment strategies and reduces the number of low-quality funds. Overall, relative performance objectives increase investors' expected return.

This paper investigates the profitability of relationship banking within the context of small business loans made by community banks. Theory implies that competition reduces the benefits of bank-borrower relationships, making relationship loans more risky and less profitable. I present evidence for community banks that is consonant with this implication.

We examine the relation between stock price performance and the identity of the investors buying the shares in private placements of equity. We find that although the shareholders not participating in the placement experience post-issue negative long-term abnormal returns, the participating investors purchase the shares at a discount and earn normal returns. For the non-participating investors, both announcement and long-term abnormal returns are significantly higher when the shares are placed with affiliated than only with unaffiliated investors. Additionally, when we exclude financially-distressed firms, we find insignificant announcement returns followed by negative long-term abnormal returns in placements to unaffiliated investors. On the other hand, consistent with affiliated investors having a certification effect, we find positive announcement returns and normal long-term returns following placements to affiliated investors. Thus, the disparity found in private placements between the positive announcement period and the negative post-issue long-term abnormal returns disappears when we control for financial distress and participating investor identity.

This article shows that risk-based deposit insurance premiums generate smaller procyclical effects than do risk-based capital requirements. Thus, Basel II's procyclical impact can be reduced by integrating risk-based deposit insurance. If deposit insurance is structured as a moving average of contracts, its procyclical effects can be decreased further. Empirical illustrations of this are presented for 42 banks over the period 1987 to 1996. The results confirm that lengthening the contracts' maturities intertemporally smooths premiums but raises the average premium level needed to compensate the insurer for greater systematic risk. The distribution of risk-based premiums across banks is skewed.

This study examines online multi-unit, discriminatory, ascending auctions of certificates of deposit. We find evidence suggesting that the most aggressive bids are likely to occur at the beginning and the end of the auctions. The opening of the auction serves an important role in price discovery. In addition, in multi-unit auctions last-minute bidding is a conditional strategy, and is used only when bidding is intense. Furthermore, we provide evidence suggesting that revenues are increasing in the depth of the market, in the concentration of early bids, and in bank participation relative to the size of the principal.

This paper shows how informed financial intermediaries can reduce their trading competition by designing optimal incentive compatible contracts for the sale of information. With fund management contracts—indirect sale of information—banks can credibly commit to collaborate and add noise into prices. This is a way to circumvent the Grossman and Stiglitz (1980) paradox: when information is costly, by committing to add noise, the banks can recover the cost of collecting information and enter the market. By contrast, when information is costless, even with a large number of sellers of information entering the market prices are not fully informative.

This paper examines whether monetary policy responsibilities alter the central bank's role as a bank supervisor. The analysis focuses on the United States, where the Federal Reserve System shares supervisory duties with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. Among the three institutions, the Fed is the only one responsible for monetary policy. Hence, the Fed's supervisory behavior—as captured by formal actions—is compared with the behavior of the other two agencies. The results suggest that the Fed's monetary policy responsibilities do alter its bank supervisory behavior: indicators of monetary policy affect the supervisory actions of the Fed, but do not affect the actions of the other two agencies.