Bank Owners or Bank Managers: Who is Keen on Risk? Evidence from the Financial Crisis

We examine in this paper whether owner controlled banks or manager controlled banks suffered larger losses during the financial crisis. We show that banks operating in countries with better shareholder rights and banks with a controlling shareholder recorded larger losses during the crisis than banks operating in countries with poor shareholder rights and banks without a controlling shareholder. In the period before the crisis, however, the owner controlled banks show superior performance. Both imply that owner controlled banks incurred greater risks compared to manager controlled banks in the pre-crisis period. Economically these effects are large. The profits of banks owned by a majority shareholder operating in a country with strong shareholder rights declined about five times as much during the recent crisis compared to widely held banks operating in countries with weak shareholder rights. These effects are robust to including a wide variety of regulatory, bank specific and country specific variables. We also find that the probability of owner controlled banks to receive government assistance during the crisis is significantly higher than that of manager controlled banks. We obtain the results using a large dataset of OECD banks, for which we collected information on ownership concentration. In total, the sample consists of more than 1,100 banks for 25 OECD countries. In particular, in addition to most listed banks, the sample also includes many unlisted credit institutions. We think this is important for the broader applicability of the results, since unlisted banks represent the majority of banks in most countries around the world. The greater variability in ownership and corporate governance structures assists us in identifying the effects of governance on bank risk taking. The results contradict the popular sentiment that managers took advantage of insufficient control by shareholders to obtain compensation packages that disproportionately reward short-term risk taking (e.g. OECD, 2009). They do not support the idea that aligning the interests of management better with shareholders will reduce risk taking of banks. Instead they suggest the opposite. If management is better controlled by shareholders, banks may increase their risk taking. Indeed, one may be able to interpret the observed compensation schemes before the crisis as attempts by shareholders to induce management to increase their risk taking in line with the preferences of shareholders. At the same time, weakening the control of shareholders over management would not only reduce risk, but may entail significant efficiency costs for banks. Privately optimal management compensation schemes may not be socially optimal, as they do not take the externality of a higher probability of bank failure into account.

Gropp, Reint and Matthias Köhler (2010), Bank Owners or Bank Managers: Who is Keen on Risk? Evidence from the Financial Crisis, ZEW Discussion Paper No. 10-013, Mannheim.