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Crisis performance of European banks – does management ownership matter? Auckland Finance Meeting, 18-20 December 2014 Dr.Sc.(Econ.), Senior Economist Hanna Westman

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Overview of my presentation (the work and views are my own and does not necessary reflect the opinions of the Bank of Finland)

•  Motivation –  Weaknesses identified in the banking sector as the financial

sector unravelled –  Identified gap in the academic literature

•  Methodology –  Hypothesis to be explored –  Data set –  Variables –  Specification of regressions

•  Main findings •  Policy implications

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Motivation

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European banking sector weaknesses revealed during the financial crisis

•  Banks had grown ever bigger in size. •  Banks had grown in scope and their organisational

complexity and opacity had increased. •  Banks became difficult to monitor, supervise and

manage. •  Leverage had strongly increased and the average

maturity of funding had shortened. •  Excessive risks had been taken across business lines

and in the shadow banking sector. •  The implicit government guarantee grew larger and

the too-big-to-fail problem was aggravated.

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Source: The Final Report of the High-level Expert Group on the structure of the EU banking sector, i.e. the Liikanen Report.

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Evidence of impact of managerial incentives on US data inconclusive

→ Weaker performance •  Greater drop in stock price

performance and lower profitability in banks with CEO ownership (Fahlenbrach & Stulz, 2011).

•  Shareholder friendly boards weakened crisis performance (Beltratti & Stulz, 2012)

→  Stronger performance •  CEO ownership does not have

an impact on default risk, whereas lower level manager ownership increases default risk (Berger et al., 2014).

•  Insider ownership mitigates risk-taking (Cheng et al., 2010).

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•  Managers are more risk averse than shareholders (Gropp & Köhler, 2010)

•  Ownership align interests with shareholders; induce excessive risk-taking or superior performance?

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The impact of management ownership might vary with the strategy of the bank

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Most likely in

Traditional bank

Large diversified

bank

Small diversified

bank

Non-traditional

bank

X X (X)

(X) (X) X

X

Safety net Incentives to monitor

Incentives to take risk

Opacity Ability to monitor

Ability to take risk

Complexity Ability to monitor

Ability to take risk

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Hence also the joint impact of ownership and strategy is assessed

•  As proposed in the survey on corporate governance of

banks by de Haan & Vlahu (2015, forthcoming), drawing on Westman (2011) done on a pre-crisis data set of European banks.

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Impact of bank strategy

Impact of management

ownership Joint

impact

1 2

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Assessment in period of severe stress provides new insights

•  Risks taken in normal times are only realised much later or in times of severe stress. → Assessing impact of management ownership on pre-crisis

performance only as done in Westman (2011) is not sufficient.

•  Distinguishing between the early crisis period (2007-2009) and later crisis period (2010-2012/13) gives additional insights on potential impact on recovery.

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The expected impact of management ownership on bank crisis performance

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Methodology

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Data is available for 200 European banks

•  Listed and unlisted Bank Holding Companies, commercial and investment European banks.

•  Pre-crisis ownership data available on the BankScope DVDs from 2004, 2005 and 2006.

•  Consolidated financial data for at least 2005 to 2012 is available in BankScope as of May 2014. –  Banks majority owned by other European bank dropped.

•  Outlier observations dropped –  Outside the 5% and 95% percentile in the profitability (risk-

adjusted profitability and default risk) variables. –  Interest income to total operating income or loans to total

earning assets is not within the range of 0 to 100%

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Hand-collected data on management ownership pre-crisis

•  Management remuneration schemes include various components, of which stock ownership is one. –  Ownership generally seen as promoting long-run objectives,

whereas bonuses induce short-termism.

•  Ownership data collected from the BankScope database DVDs from 2004, 2005 and 2006.

•  “Management and employees” or “Individuals and families” owners cross-checked and recoded.

•  MGT is a dummy variable taking the value 1 if any of the eight owners listed in the BankScope database was a member of the management team.

•  21 banks with management ownership in the sample.

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Banks are categorised in four groups according to their strategy

1.  Banks are categorised into traditional, non-traditional banks or diversified banks.

2.  Diversified banks are categorised into small and large.

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Traditional banks (41 banks)

Diversified banks (77 banks)

Non-traditional banks (40 banks)

Small diversified banks (42 banks)

Non-interest income / Other assets than loans / Off-balance sheet items

Size

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Two model specifications are used in the main analysis

1.  Impact of management ownership on bank crisis performance

2.  Impact of management ownership on bank crisis performance, while accounting for bank strategy

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[ ] [ ] 11111 −−−− ++++= tititititi BANKSTRATEGYMGTPERF ,,,,, *** εβββα

PERFi,t =α +β1 *MGTi,t−1"→" +β2 *MGTi,t−1 *SMALLDIVi,t−1 +β3 *MGTi,t−1 *LARGEDIVi,t−1"→" +β4 *MGTi,t−1 *NONTRADi,t−1

"→" +β * STRATEGYi,t−1$% &'+β * BANKi,t−1$% &'+εi,t−1

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Main findings

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Main findings

•  Some indication of support for Hypothesis 1 and 2. –  The drop in performance appear to be more dramatic in banks

with management ownership. –  Still the performance appear to remain on a superior level and

appear to improve in the latter period.

•  Strong support for Hypothesis 3 and 4 –  There is a negative impact of management ownership on the

crisis performance of traditional and large diversified banks i.e. banks benefiting from a safety net.

–  There is a positive impact of management ownership on the crisis performance of non-traditional and small diversified banks i.e. opaque banks not benefiting from a safety net.

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Weak results, which need further assessment

•  Results does not support for Hypothesis 5. –  Large diversified banks do not perform worse than traditional

banks. –  Further examination to ensure that it is the safety net that drives

the negative impact of management ownership rather than complexity or opacity.

•  Shift in performance from early crisis period to latter crisis period to be added, to better assess the impact on recovery in performance (hypothesis 6).

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Impact of management ownership on performance in early crisis period

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(2007-2009)

1

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Impact of management ownership on performance in latter crisis period

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1

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Joint impact of management ownership and strategy on 2007-2009 performance

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2

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Joint impact of management ownership and strategy on 2010-2012 performance

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2

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A number of robustness checks are made

•  The management ownership variable is refined. –  The bank is categorised as a bank without management

ownership if the management received ownership only in 2005. –  If there was management ownership before the year 2005, but

not in the later years, the bank is categorised as having management ownership.

•  Blockholder ownership used as an indication of inside control.

•  Banks that switch strategy during the crisis dropped. •  The continuous variables underlying the strategy

variables rather than the strategy variables used. •  The results are in line with the main findings.

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Policy implications

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Policy implications

•  Important to tailor regulation in the domain of corporate governance to bank characteristics.

•  Alternatively, measures to reduce the safety net to a minimum could be imposed. –  Higher and better quality capital requirements are implemented. –  New recovery and resolution regimes are implemented. –  Structural reforms have been implemented in the US and the

UK. Negotiation on the European Commission proposal ongoing.

•  Discussion needed of whether aligning incentives to shareholder interest only is good corporate governance, particularly if safety net sizable.

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Thank you!

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