Banks with more equity tend to lend more, create more liquidity, and have higher probabilities of surviving crises (Thakor 2014). Moreover, adverse shocks to bank equity predict contractions in lending and aggregate output, and lower bank equity ratios slow recoveries from crises (Baron et al. 2019 Berger and Bouwman 2013; and Jorda et al. 2017). These strong linkages between bank equity, bank lending, and economic activity raise a critical question: what factors shape the differing degrees to which banks issue new stock to replenish bank equity in response to a crisis?
In a recent paper (Goetz et al. 2020), we address a debate concerned with the impact of bank ownership structure on the degree to which banks sell stock to replenish equity following adverse shocks. In the presence of large private benefits of control, a bank’s controlling owners may resist new stock issuances to protect those rents (Barclay and Holderness 1989, Doidge et al. 2009). From this ‘dilution reluctance’ perspective, greater insider ownership will reduce stock sales, potentially making the economy less resilient to aggregate shocks. In contrast, other research suggests that banks with greater insider ownership can more effectively coordinate the actions of diverse stakeholders with differing interests during crises, allowing such banks to sell more stock than banks with less insider ownership. The overall impact of insider ownership on stock sales in times of crisis, therefore, is an open empirical question.
We evaluate the role of insider ownership in shaping the sale of stock of US banks in response to the 2008 Global Crisis, which adversely affected bank valuations and put pressure on banks to raise new capital. We compile a unique database on the ownership structure and equity issuances of private and public banks. We hand-collect data on the ownership of 566 US bank holding companies (BHCs), where we focus on the role of insider owners, i.e. bank directors and executives. Thus, we define ‘insider ownership’ as the proportion of the BHC’s stock owned by bank directors and executives. We also calculate ‘common stock sales’ for each BHC as the total amount of funds raised through common stock sales as a proportion of bank equity. Since the US Treasury implemented the Capital Purchase Program (CPP) in the last quarter of 2008 (Q4/2008) and the first quarter of 2009 (Q1/2009), which encouraged banks to sell preferred stock to the Treasury, we focus on the sale of common stock during the post-Q1/2009 period and control for preferred stock sales through the CPP. Using these data, we explore how insider ownership shaped banks’ common stock issuances following the onset of the Global Crisis.
We find that greater insider ownership is associated with less common stock sales following the onset of the crisis (see Figure 1). The estimates suggest an economically large relationship. For example, consider two otherwise identical banks, where the ‘high’ insider ownership BHC has one standard deviation greater insider ownership than the ‘low’ BHC. The estimates suggest that the ‘high’ insider ownership bank would have common stock sales as a proportion of bank equity that are about 22% greater than ‘low’ insider ownership bank. The results are both robust to using several statistical strategies for addressing concerns about reverse causality and consistent with the idea that insiders are reluctant to dilute control rights by selling common stock.
Figure 1 Differential effect on cumulative sale of common stock by insider ownership
Notes: The figure plots the differential effect of insider ownership on the cumulative sale of common stock over the quarters Q2/2007 to Q1/2011. The coefficients are obtained from a regression of the cumulative sale of common stock in a quarter, scaled by equity capital in Q1/2007 on a set of quarter fixed effects and the interaction of these quarter fixed effects with an indicator variable, taking on the value of one if insider share is above the sample median. The figure plots the coefficient on these interaction terms for all quarters as well as the 99 % confidence interval for each estimate.
We next conduct two tests to assess whether the relationship between ownership structure and equity issuances varies across banks in a manner that is consistent with the ‘dilution reluctance’ view. The ‘dilution reluctance’ view posits that insider’s private benefits of control exert a first-order influence on their reluctance to dilute those control rights through equity issuances. We first examine whether banks that provide greater private benefits to insiders are also banks that are more reluctant to dilute insider control through equity issuances following the onset of the crisis. To measure the private benefits of control, we compute the share of loans to bank insiders and the level of bank opacity, since greater opacity hinders effective governance by non-insiders, offering greater private benefits of control. Consistent with this private benefits view, the impact of ownership structure on equity issuances is larger among banks that offer more private benefits to insiders, i.e. among banks that lend more to insiders and are less transparent.
Second, we examine whether insider owners are more reluctant to dilute their control rights through equity issuances when the expected positive impact of issuances on the banks is smaller. Specifically, as the expected benefits from selling new shares in the form of increased bank stability and market valuations falls, insiders will become increasingly reluctant to issue stock and sacrifice private benefits of control. According to this perspective, the insider owners of banks that are harder hit by shocks and hence less likely to benefit from equity injections will be more reluctant to sell stock. We use two measures of the degree to which each BHC is adversely affected by the Global Crisis. We use information on BHCs’ branch networks and determine BHCs’ exposure to declines in housing prices during the financial crisis. The second measure uses information on BHCs’ investment in mortgage-backed securities, as the crisis induced market participants to view these assets as “toxic” and value them accordingly.
We again find evidence consistent with the dilution reluctance view: bank insiders are reluctant to reduce their private benefits of control by issuing equity, especially when the positive effects of stock sales are likely to have smaller positive effects on bank valuations. We find that the negative impact of insider ownership on stock sales is stronger among banks more adversely affected by the Global Crisis.
Our study speaks to recent policy reforms of bank regulations that have increasingly emphasized the quality of bank capital and not just its quantity. For example, Basel III introduced a minimum common equity requirement with the goal of ensuring that banks not only have a sufficient quantity of capital but also a sufficient amount of the most efficient and effective loss-absorbing liability: common equity. These regulatory changes, however, have not yet considered ownership structure. Our work stresses the importance of ownership structure, finding that ownership structure shapes common equity issuances in response to a crisis and hence affects a bank’s resilience to adverse shocks. This highlights the value of considering ownership structure when designing bank regulations and assessing banks’ abilities to absorb losses and cushion the impact of losses on the economy.
Authors’ note: The views expressed are our own and do not reflect those of the ECB or the Eurosystem.
Barclay, M J and C G Holderness (1989), “Private benefits from control of public corporations”, Journal of Financial Economics 25(2): 371-395.
Baron, M, E Verner and W Xiong (2019), “Salient crises, quiet crises”, SSRN Working Papers.
Berger, A N and C H Bouwman (2013), “How does capital affect bank performance during inancial crises?”, Journal of Financial Economics 109(1): 146-176.
Doidge, C, G A Karolyi, K V Lins, D P Miller and R M Stulz (2009), “Private benefits of control, ownership, and the cross‐listing decision”, Journal of Finance 64(1): 425-466.
Goetz, M, L Laeven and R Levine (2020), “Do Bank Insiders Impede Equity Issuances?”, CEPR Discussion Paper No. 14913.
Jordà, Ò, B Richter, M Schularick and A M Taylor (2017), “Bank capital redux: solvency, liquidity, and crisis”, NBER working paper w23287.
Thakor, A V (2014), “Bank capital and financial stability: An economic trade-off or a Faustian bargain?”, Annual Review of Financial Economics 6(1): 185-223.