Banks take costly actions (such as capitalization, liquidity holding, and advanced risk management) to avoid financial distress and creditor runs. While directly affecting a bank’s risks, such actions can also signal the bank’s fundamentals. We show that prudential regulations have an informational impact: sufficiently tight regulations can eliminate inefficient separating equilibria in banks’ signaling game, thereby changing the information available to creditors and their incentives to run. When accounting for this informational impact, tightening regulations can improve banks’ payoffs and be considered bank incentive-compatible. We support this novel, information-based rationale for regulations with evidence from the US liquidity requirement.

Abstract This paper examines the relationship between banks’ capitalization strategies and their corporate governance and executive compensation schemes for an international sample of banks over the 2003–2011 period. Shareholder-friendly corporate governance, in the form of a separation of the CEO and chairman of the board roles, intermediate board size, and an absence of anti-takeover provisions, is associated with lower bank capitalization, consistent with shareholder incentives to shift risk towards the financial safety net. Higher values of executive option and stock wealth invested in the bank are associated with higher capitalization as a potential reflection of executive risk aversion, but the risk-taking incentives embedded in executive compensation packages are associated with lower capitalization.