Knowledge that Transforms

After a large bank merger, the compensation of the surviving bank's CEO often increases materially. Theories of executive compensation based on managerial productivity and optimal incentives suggest that changes in CEO compensation are related to the potential gains from merger. Alternatively, compensation gains might result from an increase in bank size regardless of whether the merger creates value. We examine mergers among billion-dollar banks in the 1990s and find results consistent with managerial productivity. Specifically, we show empirically that changes in CEO compensation after mergers are positively related to anticipated gains from merger measured at the announcement date. Other changes in the structure of compensation are also consistent with hypotheses based on managerial productivity and incentive restructuring.

Do families keep control of their firms because they, operating in an environment with weak protection of minority shareholders, fear being exploited by management after the IPO? Or is ownership concentration due to the value families attach to control? We find a positive relation between use of security designs that separate votes from capital and frequency of family-controlled firms in Sweden and other countries. It is not caused by differences in legal regimes or in minority protection. Since control blocks are never sold piecemeal to preserve control value, ownership remains highly concentrated. Family-controlled firms trade at a discount because of the misallocation of control rights to heirs who make inefficient decisions, not because of extraction of pecuniary benefits.

The on-going reform of the Basel Accord relies on three “pillars”: a new capital adequacy requirement, supervisory review and market discipline. This article develops a simple continuous-time model of commercial banks' behavior where interaction between these three instruments can be analyzed. We study the conditions under which market discipline can reduce the minimum capital requirements needed to prevent moral hazard. We also discuss regulatory forbearance issues.

We estimate the relationship between the Spanish business cycle and the capital buffers held by Spanish commercial and savings banks in an incomplete panel of institutions covering the period 1986–2000, which comprises a complete cycle. After controlling for other potential determinants of the surplus capital we find a robustly significant negative relationship between the position in the cycle and capital buffers. From a quantitative standpoint, an increase of 1 percentage point in GDP growth might reduce capital buffers by 17%. This relationship is, moreover, asymmetric, being closer during upturns.

This paper uses our new database on bank regulation and supervision in 107 countries to assess the relationship between specific regulatory and supervisory practices and banking-sector development, efficiency, and fragility. The paper examines: (i) regulatory restrictions on bank activities and the mixing of banking and commerce; (ii) regulations on domestic and foreign bank entry; (iii) regulations on capital adequacy; (iv) deposit insurance system design features; (v) supervisory power, independence, and resources; (vi) loan classification stringency, provisioning standards, and diversification guidelines; (vii) regulations fostering information disclosure and private-sector monitoring of banks; and (viii) government ownership. The results, albeit tentative, raise a cautionary flag regarding government policies that rely excessively on direct government supervision and regulation of bank activities. The findings instead suggest that policies that rely on guidelines that (1) force accurate information disclosure, (2) empower private-sector corporate control of banks, and (3) foster incentives for private agents to exert corporate control work best to promote bank development, performance and stability.

This paper presents a dynamic model of imperfect competition in banking where the banks can invest in a prudent or a gambling asset. We show that if intermediation margins are small, the banks' franchise values will be small, and in the absence of regulation only a gambling equilibrium will exist. In this case, either flat-rate capital requirements or binding deposit rate ceilings can ensure the existence of a prudent equilibrium, although both have a negative impact on deposit rates. Such impact does not obtain with either risk-based capital requirements or nonbinding deposit rate ceilings, but only the former are always effective in controlling risk-shifting incentives.

This paper tests a new hypothesis that bank managers issue public debt, at least in part, to convey positive, private information and refrain from issuance to hide negative, private information. This “positive selection” hypothesis is tested against the traditional “adverse selection” hypothesis. We find evidence for “positive selection,” using ratings migrations, equity returns, bond issuance, and balance sheet data for US bank holding companies. The results add to our understanding of “market discipline” in monitoring bank holding companies and also inform upon how proposed regulatory requirements that banking organizations frequently issue public debt might augment “market discipline.”

We test a new hypothesis that may help explain the procyclicality of bank lending. The institutional memory hypothesis is driven by deterioration in the ability of loan officers over the bank's lending cycle that results in an easing of credit standards. We test this hypothesis using data from individual US banks over 1980–2000: over 200,000 bank-level observations on commercial loan growth, over 2,000,000 loan-level observations on interest rate premiums, and over 2000 bank-level observations on credit standards and loan spreads from bank management survey responses. The empirical analysis supports the hypothesis, although there are differences by bank size class.