Corporate control, bank risk taking, and the health of the banking industry
qRonald C. Anderson
a,1, Donald R. Fraser
b,*aDepartment of Finance and Real Estate, Kogod College of Business Administration, American University, 4400 Massachusetts Avenue, NW, Washington, DC 20016-8044, USA
bDepartment of Finance, Lowry Mays College and Graduate School of Business, Texas A&M University, College Station, TX 77843-4218, USA
Received 17 April 1998; accepted 13 July 1999
Abstract
We present evidence that managerial shareholdings are an important determinant of bank risk-taking. Managerial shareholdings are positively related to total and ®rm speci®c risk in the late 1980s when banking was relatively less regulated and when the industry was under considerable ®nancial stress. However, following legislation in 1989 and 1991 designed to reduce risk-taking and also re¯ecting substantial improvements in bank franchise value, managerial shareholdings and total and ®rm speci®c risk became negatively related in the early 1990s. In contrast, systematic risk was unrelated to managerial ownership in both periods.Ó2000 Elsevier Science B.V. All rights reserved.
Keywords:Bank risk taking; Ownership structure; Franchise value JEL classi®cation:G21; G28; G30
www.elsevier.com/locate/econbase
qThe paper has bene®ted from the suggestions of J. Bizjak, J. Byrd, D. Dubofsky, D. Ellis, S. Lee, and A. Mahajan. Naturally, all remaining errors are the responsibility of the authors.
*Corresponding author. Tel.: +1-409-845-2020; fax: +1-409-845-3884.
E-mail addresses:Ron.Anderson@mciworld.com (R.C. Anderson), d-fraser@tamu.edu (D.R.
Fraser).
1Tel.: +1-202-885-1945; fax: +1-202-885-1946.
0378-4266/00/$ - see front matterÓ2000 Elsevier Science B.V. All rights reserved.
PII: S 0 3 7 8 - 4 2 6 6 ( 9 9 ) 0 0 0 8 8 - 6
1. Introduction
The ®nance literature abounds with attempts to quantify and explain risk taking behavior at commercial banks. Following Merton (1977) much of this research focuses on the incentives created by the ®xed-rate deposit insurance system for banks to increase the amount of risk in their asset and liability portfolio (an incentive system referred to as the moral hazard problem). More recently, Keeley (1990, p. 1183) ®nds evidence to support the hypothesis that ``increases in competition caused bank charter values to decline, which in turn caused banks to increase default risk through increases in asset risk and reductions in capital.'' While there are other explanations of risk-taking focusing on bank (or share- holder) behavior, there is little explicit consideration of the role of bank man- agement in these decisions. Yet it is management rather than shareholders who make the portfolio decisions that determine the risk structure of a bank.
Identifying the link between managerial risk preferences and share owner- ship is a complex task. Conceptually, it might be expected that managers with small ownership stakes in their banks would behave in a risk averse rather than value maximizing way, as they seek to protect the value of their ®rm-speci®c human capital. As their shareholdings increase, however, they have more in- centives to engage in risk taking, especially under a ®xed rate deposit insurance system that existed prior to 1993 and in a period such as the late 1980s when charter or franchise values were diminished. At some substantial levels of shareholdings, however, managers may become entrenched and no longer make value maximizing decisions. To the extent that managerial entrenchment becomes important, the risk/share ownership relationship may thus become curvilinear.
We provide evidence on the managerial shareholdings-risk relationship from bank stock price data drawn from two distinct time periods with quite distinct regulatory regimes and bank charter values. We conjecture that a positive re- lationship should exist in the 1987±1989 period as the ®xed rate deposits sys- tem, lax regulation, and low charter-values encouraged managers to take on additional risk. In contrast, in the latter period, 1992±1994, management risk taking was constrained by additional regulations, including risk-adjusted de- posit insurance premiums and also by substantially increased bank charter values.
Our evidence is generally consistent with these arguments. We ®nd that:
1. Total and ®rm speci®c risk are positively and signi®cantly related to mana- gerial holdings between 1987 and 1989.
2. Total and ®rm speci®c risk are negatively and signi®cantly related to man- agerial holdings between 1992 and 1994.
3. Systematic risk is unrelated to ownership in both periods.
Existing evidence on the relationship between managerial shareholdings and risk is inconclusive, perhaps re¯ecting dierences in risk measures, dierent
time periods in the analysis, and dierent approaches to analyzing the rela- tionships. Saunders et al. (1990), using capital market measures of risk, provide support for the hypothesis that banks in which managers hold a large fraction of the stock exhibit signi®cantly higher risk-taking behavior over the 1978±
1988 period, and that the incremental risk was more prevalent following deregulation. Demsetz et al. (1997) also ®nd a positive (and nonlinear) rela- tionship between market risk measures and managerial shareholdings over the 1991±1995 period, though only at low franchise value banks. In contrast, Chen et al. (1998) ®nd a negative and nonlinear relationship between managerial ownership and bank risk over the 1988±1993 period.
Gorton and Rosen (1995) focus on the risk/managerial shareholdings rela- tionship as it is aected by both entrenchment and by shifts in the economic conditions of the banking industry. They argue that ``bad'' managers take excessive risk in periods when the industry is unhealthy (as re¯ected in low franchise values). Their model predicts a nonlinear relationship between managerial shareholdings and risk, with risk initially increasing with share- holdings and then declining as entrenchment becomes a signi®cant motivating factor. Their results, drawn from the 1980s period of low franchise values, are generally consistent with their model. While their model implies that risk will decline in the 1990s as bank franchise values increase, the time period en- compassed by their study did not permit analysis of this issue. Our sample period and model does, however, allow us to address this important issue.
Section 1 describes the sample and the variables used in the analysis, while Section 2 presents the empirical model. Section 3 discusses the results and Section 4 concludes the paper.
2. Sample and variables description 2.1. The sample
Our sample consists of a panel of 150 banks covering the period from 1987 through 1994. The banks were initially selected from the November 1988 Compact Disclosure CD-ROM. Information is gathered on all banks listed in standard industry classi®cation of national commercial banks (6021), state commercial banks (6022), and commercial banks not classi®ed elsewhere (6029). The search of the Compact Disclosure database yielded a total of 604 individual banks.
Return information from the Center for Research in Security Prices (CRSP) daily tapes is used to calculate the market based measures of risk. CRSP covers 423 of the original 604 banks taken from Compact Disclosure. The remaining 181 banks for which we could not obtain CRSP data are banks that delisted, traded on regional exchanges, or were ``pink sheet'' ®rms. Once we identify
those ®rms carried by the CRSP database, the remaining years of the time series are collected from Compact Disclosure.
Because many of the ®rms in the remaining sample are traded infrequently, we follow Esty (1997) and discard 156 banks whose equity went untraded for 75 days or more during a year. The discarded banks have, on average, 129 days per year where no trades took place.2Because we want to analyze the relation between bank risk and managerial holdings under dierent conditions we re- strict the sample to the same set of banks during both periods. As a conse- quence, we require that each bank exist over the 8 year sample period, a constraint that requires us to drop 117 ®rms from the sample, resulting in a
®nal sample of 150 banks with 8 years of data per bank or 1200 bank-years3 (this sample selection procedure does, of course, eliminate failed banks as well as acquired banks).4
2.2. Variable description
Consistent with prior studies, we de®ne management holdings as the ag- gregate percentage of shares held by all ocers and directors of the bank as reported in Compact Disclosure. This ownership measure is the year-end holdings of ocers and directors for the preceding year as reported in the bankÕs proxy statement. Anderson and Lee (1997) demonstrate that Compact Disclosure is a reliable surrogate for the data provided in corporate proxy statements. However, in their analysis, they show that Compact Disclosure only reports the largest class of shares for ®rms with multiple equity classes. As a consequence, we verify the Compact Disclosure information with that of the annual proxy statement for years 1987, 1989, 1992, and 1994.
We use a single-index (market returns) market model to estimate the return- generating process for bank stocks.5From the model, we estimate three dif-
2The typical trading year consists of 250±255 trading days. Thus, the ®rms deleted from the sample trade on about 50% of the available days. For several of the banks, the number of days where trading did not occur exceeds 200 days per year.
3The average number of years that the discarded banks are in the sample is 3.2 years with a range of 1±7 years. Over 64% of these banks are newly listed after 1991 on the CRSP tapes. The remaining banks delisted prior to 1991 due to failures, mergers or acquisitions.
4We replicated the analysis reported later in the paper for samples that included a number of banks that failed during our analysis periods (principally 1987±1989). While these results are less powerful, the classi®cations based upon statistical signi®cance do not change.
5In a prior version of this paper, we used a two-index model incorporating both market returns and interest rates. The results are not signi®cantly or materially dierent from the single index model and, as a result, we use the simpler model. In our two index model, We did not correct for autocorrelation of our interest rate series since Flannery and James (1984) and Unal and Kane (1994) demonstrate that such a correction does not materially eect the calculations. Also, we do not orthogonalize the interest rate and market returns series in view of evidence provided by Giliberto (1985) that such adjustments can bias results.
ferent measures of ®rm risk: Total risk is the standard deviation of the bankÕs daily returns; systematic risk is the component of risk that captures the in¯u- ence of underlying economic and ®nancial conditions that aect the entire banking industry. Firm speci®c risk measures the stock price volatility that is unique to an individual bank and is related to the nature of its loan, invest- ment, deposit, and capital structure. Firm speci®c risk is measured as the standard deviation of the residuals of the market model for each ®rm. Sys- tematic risk is measured as the dierence between total and ®rm speci®c risk.6
More speci®cally, the risk measures are calculated as follows:
Total risk1 n
X xiÿx2r1=2; 1
wherexis the daily return of bank I.
Firm specific risk1 n
X eiÿe2e1=2; 2
wheree's are the residuals of the single-index market model.
Total riskaibi market returns ei:
Market returns are proxied by the CRSP equal-weighted returns.
Systemic riskTotal riskÿFirm specific risk: 3
Since the market experienced substantial volatility in October 1987, we calculate our risk measures with and without the last 15-days of October 1987.
The regressions yield statistically similar results, therefore we include the Oc- tober 1987 ``crash'' in all of our calculations. We also estimate the equations with weekly returns. These results (not reported here) are not materially dif- ferent from the daily returns results.
Demsetz and Strahan (1997) argue that frequency of trading is a proxy for the speed with which new information is captured in stock price and that this variable should be correlated with the variances of a bankÕs assets, liabilities, and o-balance sheet portfolios. We measure frequency of trading as the av- erage daily volume of shares traded for each bank divided by the total number of shares outstanding for the bank.
6We calculate our risk measures using banks daily returns and as a result, may introduce some measurement error into our ®rm speci®c and systematic risk dependent variables. Kmenta (1986) notes that any errors present in the ®rst-stage regression model (determining the dependent variable) are also introduced into the second-stage model. He indicates however, that measurement errors from the ®rst-stage regression are ``merged'' into the disturbance term in the second-state regression. Consequently, the second-stage regression with the merged disturbance term satis®es all of the basic assumptions of ordinary least squares techniques and any measurement error in our dependent risk measures are not of signi®cant importance.
Size may play an important role in determining risk levels at banking or- ganizations because larger banks are more capable of diversifying risk, both geographically and by industry, than small banks. Moreover, larger banks have greater access to capital markets and thus more ¯exibility to adjust to unexpected liquidity and capital shortfalls. We might expect larger banks to have lower risk levels than smaller banks if their portfolios are merely larger replications of those at small banks. However, if large banks dier from small banks in the composition of their asset base or portfolios (holding greater amounts of risky-type loans, for example or greater o-balance sheet risk), their overall risk levels may be higher than that of small banks. Demsetz and Strahan (1997) report that large bank holding companies oset the potential bene®ts of diversi®cation through adopting more risky loan portfolios and operating with more leverage. The natural log of the book value of total assets is used as our measure of bank size.
We use KeeleyÕs (1990) adaptation of TobinÕsQas a proxy for the health of the individual banking ®rm.Qis equal to the sum of market value of common equity (price per share times number of shares) plus the book value of liabilities divided by the book value of assets. Keeley argues that thisQ measure is a proxy for franchise value. He ®nds that banks with higherQvalues have lower default risk as measured by lower risk premiums on their large, uninsured certi®cates of deposit. Moreover, Demsetz et al. (1997) ®nd that risk at indi- vidual banks is inversely related to thisQmeasure.
Monitoring of managerial risk taking may come from the nature of own- ership of the banks as well as from the regulatory structure, depositors, and from other sources. We proxy the structure of ownership by including the percentage of shares held by unaliated or outside blockholders. These blockholders consist of all unaliated shareholders who own 5% or more of the voting shares. Blockholdings data is gathered from the 1987, 1989, 1992, and 1994 corporate proxy statements.
3. Empirical method
We use a model similar to Saunders et al. (1990) to test our hypothesis Riska0a1 Holdings a2 KeeleysQ
a3 Outside blockholdings a4 ln Total assets
a5 Frequency eI: 4
Since there is some evidence (see McConnell and Servaes, 1991; Gorton and Rosen, 1995 for example) that the relationship between managerial holdings and bank risk is nonlinear, we estimate an additional piecewise version of this model, (as in Gorton and Rosen) and report both coecients in the relevant
tables.7We split our sample into two distinct periods: 1987±1989 and 1992±
1994, inclusive. The 1987±1989 period is characterized as an unhealthy period for the banking industry and one of regulatory laxity. The period from 1992 to 1994 is typi®ed as a healthy banking industry and as one with increased reg- ulatory constraints.
We use panel data techniques since the regression disturbance term is likely to have a serially related component, a cross-sectionally related component, or both. To account for serial correlation and heteroskedasticity, we employ time- series cross-sectional (TSCS) regression analysis. The TSCS procedure adds the individual and time-speci®c random eects to the variance±covariance matrix of the disturbance term. As a result, the variance±covariance matrix of the dis- turbance term is no longer a diagonal matrix with the same value at each di- agonal element as with OLS, but a full matrix in which each element can assume a unique value. We use the Fuller and Battese (1974) TSCS method which ef-
®ciently estimates our parameters using generalized least squares.8; 9Hausman Speci®cation tests, comparing ®xed eect to random eect panel data tech- niques, suggest that the two techniques provide signi®cantly indierent regres- sion results. Therefore, we employ a random eects model for our analysis.
4. Empirical results 4.1. Descriptive statistics
Table 1 contrasts the market risk measures, managerial holdings, KeeleyÕs Q, outside blockholdings, total assets, and frequency of trading for the 1987±
1989 and 1992±1994 periods. While neither total risk nor ®rm speci®c risk measures dier signi®cantly between the two periods, each of the other vari- ables does dier between the two periods. Systematic risk declined substantially between the two periods. Managers hold slightly fewer (9.63% vs. 11.15%) shares in the 1992±1994 period. Moreover, the banks in the 1992±1994 period
7We also estimated a model that included holdings and (holdings)2. The (holdings)2variable was not signi®cant in any of the regressions.
8We also run all of our regressions using ordinary least squares. In many instances, the signi®cance of the parameter estimates increased substantially compared to those found using panel data techniques, suggesting substantial loss of eciency with OLS estimation.
9We tested causality in our panel data set by using a cross-lagged regression model employed by Davidson et al. (1997) and Batemean and Strasser (1983). In the ®rst equation of the model, we regress our risk measures on lagged values of itself and the corresponding insider holding measure.
For the second equation, the holding measure is regressed against lagged value of itself and the corresponding lagged value of risk. Signi®cant coecients of the cross-lagged parameters then indicate the direction of causality. Out tests provide an inconclusive result because neither of the cross-lagged parameters are signi®cant.
are larger in total assets (signi®cant at the 1% level) and have stock that is traded more frequently (signi®cant at the 1% level). Outside blockholdings are also higher in the 1992±1994 period (signi®cant at the 1% level).
Signi®cant dierences in the mean and median values of KeeleyÕsQobserved in the 1987±1989 and 1992±1994 periods corroborate other (anecdotal) evi- dence suggesting that bank health improved in the early 1990s. While the dierences may not seem great, the inclusion of the book value of liabilities and the book value of assets in KeeleyÕsQmeasure mitigates large ¯uctuations over time. Another perspective on changes in market valuation of banking ®rms is given by the ratio of the market value of equity to the book value of equity.
The mean values of the sample banksÕ market-to-book ratio is 1.375 in the 1992±1994 period as compared to 1.118 in the 1987±1989 period. This dier- ence is statistically signi®cant at the 1% level. Similar dierences are observed
Table 1
Descriptive statisticsa
Variable 1987±1989
(N450) 1992±1994 (N450) Test
statistics Pooled (N900)
Total risk (%) Mean 2.119 2.129 0.14 2.124
Median 1.935 1.815 1.26 1.880
Systematic risk (%) Mean 0.129 0.044 )9.53 0.087
Median 0.050 0.030 )5.15 0.040
Firm speci®c risk (%) Mean 1.988 2.080 1.35 2.036
Median 1.770 1.795 0.50 1.785
Managerial holdings (%) Mean 11.15 9.63 )2.15 10.39
Median 7.06 6.33 )1.80 6.71
Total assets ($,000,000) Mean 10,714 16,212 2.77 13,463
Median 2535 3564 3.76 3035
KeeleyÕsQ Mean 1.008 1.030 9.27 1.019
Median 1.007 1.026 9.68 1.014
Outside blockholdings Mean 5.40 6.64 1.90 6.01
Median 0.00 0.00 )0.04 0.00
Frequency of trading (%) Mean 0.186 0.233 3.87 0.209
Median 0.126 0.183 5.24 0.156
aThis table shows the sample characteristics for our 900 observations or bank-years segregated from 1987 to 1989, from 1992 to 1994, and combined or pooled. Total risk is the standard deviation of daily returns expressed in percent for each bank with data taken from the CRSP tapes. Sys- tematic risk is the dierence between total risk and ®rm speci®c risk. Firm speci®c risk is the standard deviation of the residuals expressed in percent from the single-factor market model for each ®rm. Managerial holdings are the aggregate holdings, in percent, of all ocers and directors of the bank. Total assets are the year-end book value of total assets. KeeleyÕsQis the market value of common equity plus the book value of liabilities divided by the book value of assets. Outside Blockholdings is the percent of shares held by all unaliated, ®ve-percent holders of the ®rmÕs shares. Frequency of trading is the average daily volume of shares traded divided by shares out- standing. Test statistics aret-tests for dierence of means andZ-tests for dierence of medians.
Signi®cantp-values are listed to the right of each test statistics.
*Signi®cant at the 5% level.
**Signi®cant at the 1% level.
for the median values of the market-to-book ratios (1.360 vs. 1.10, statistically signi®cant at the 1% level).
4.2. Regression results
Table 2 presents the results from the TSCS regression of each of the market risk factors on managerial holdings and other hypothesized determinants of risk.10 Separate risk estimates are employed for the 1987±1989 and 1992±
1994 periods. The equations are all statistically signi®cant at the 1% level, as judged by theirF-values, with adjustedR2s that vary between 17.99% and 50%.
The explanatory power of the equations is generally greater for the latter period.
We present in Table 2 both the linear and piecewise linear versions of our model, since each provides separate insights into the in¯uence of equity holdings on managerial risk-taking. Insider holdings are statistically signi®cant in the linear model for each of the equations. Increased managerial share- holdings are associated with greater total and ®rm speci®c risk in the 1987±
1989 period. However, increased managerial shareholdings are associated with a decline in total and ®rm speci®c risk in the 1992±1994 period following regulatory constraints imposed by the Financial Institutions Reform, Recov- ery, and Enforcement Act (FIRREA) in 1989 and the Federal Deposit In- surance Corporation Improvement Act (FDICIA) in 1991.
As shown in the piecewise regressions, the increased risk associated with larger managerial holdings in the 1987±1989 period does not become signi®- cant until holdings exceed the 25% level, though the positive relationship for 5±
25% ownership is signi®cant at the 10% level. Apparently, managers incentives to exploit underpriced deposit insurance in the earlier period did not overcome their risk aversion associated with a desire to retain their employment until their shareholdings became substantial.11In contrast, the negative association between insider holdings and risk in the latter period takes place at very low (<5%) level of managerial shareholdings.12; 13In contrast, there appears to be
10All of the analyses reported in Table 2 are also done with the entire sample without screening for infrequent trading. While the results are less robust, the basic conclusions remain unchanged.
11These results are consistent with those of Cebenoyen et al. (1999) who ®nd, using accounting data for savings and loans, that ``manager-owned thrifts have greater risk, but only at levels of ownership above a threshold of about 23±28% ownership'' (p. 51).
12We explored the possibility that the negative association between managerial ownership and risk taking is driven by low franchise banks by dividing the sample into high and low franchise banks and replicating the regression analysis. We are unable to detect any meaningful dierences in the relationships based upon bank franchise values.
13Decreases in the risk taking preference of managers in the 1992±1994 period may also re¯ect increased stock option value of managers associated with higher franchise value.
Table2 Timeseries,crosssectionregressionresultsofcapitalmarketmeasuresonmanagerialholdingsa Totalrisk LinearPiecewiselinear 1987±19891992±19941987±19891992±1994 PanelA:Regressionwithtotalriskasthedependentvariable.Totalriskisthefractionalstandarddeviationofdailyreturnsoveraone-yearholdingperiod Intercept0.07990.19170.08980.2016 (5.04)(12.87)(5.20)(13.26) Insiderholding0.0202)0.0120±± (3.50)()1.78) Hold(0±5%)±±)0.0558)0.1160 ()0.29)()2.36) Hold(5±25%)±±0.0185)0.0024 (1.89)()0.23) Hold(>25%)±±0.0321)0.0166 (2.02)()0.79) KeeleyÕsQ)0.0392)0.1040)0.0389)0.1024 ()2.70)()8.21)()2.67)()8.07) Outsideblockholdings)0.0007)0.0008)0.0007)0.0008 ()0.55)()0.64)()0.53)()0.65) ln(Totalassets))0.0015)0.0041)0.0020)0.0046 ()3.62)()9.80)()3.92)()9.49) Frequency0.00950.00660.00870.0067 (3.25)(2.35)(2.92)(2.38) F-statistic20.7070.7416.2352.51 Adj.R2 17.9943.7119.1844.54 N450450450450 ChowtestsorF-tests: Holdings 1987±1989Holdings 1992±1994:14.78 Hold(0±5%) 1987±1989Hold(0±5%) 1992±1994:1.13 Hold(5±25%) 1987±1989Hold(5±25%) 1992±1994:9.74 Hold(>25%) 1987±1989Hold(>25%) 1992±1994:12.93
Systematicrisk PanelB:Regressionwithsystematicriskasthedependentvariable.Systematicriskisthedierencebetweentotalriskand®rmspeci®crisk Intercept)0.0057)0.0009)0.0055)0.0007 ()2.76)()1.81)()2.49)()1.39) Insiderholding)0.0006)0.0001±± ()0.96)()0.66) Hold(0±5%)±±)0.0015)0.0002 ()0.24)()0.14) Hold(5±25%)±±)0.0003)0.0006 ()0.31)()1.73) Hold(>25%)±±)0.00090.0011 ()0.54)(1.67) KeeleyÕsQ0.0007)0.00080.0007)0.0008 ()0.40)()1.58)(0.37)(1.73) Outsideblockholdings)0.0001)0.0001)0.0002)0.0001 ()0.31)()1.46)()0.32)()1.62) ln(Totalassets)0.00040.00010.00040.0001 (9.14)(9.91)(7.09)(7.83) Frequency0.00260.00140.00260.0014 (6.71)(13.98)(6.58)(13.70) F-statistic22.5693.4916.3067.70 Adj.R219.3650.7419.2650.98 N450450450450 ChowtestsorF-tests: Holdings 1987±1989Holdings 1992±1994:0.29 Hold(0±5%) 1987±1989Hold(0±5%) 1992±1994:1.36 Hold(5±25%) 1987±1989Hold(5±25%) 1992±1994:0.05 Hold(>25%) 1987±1989Hold(>25%) 1992±1994:0.55 Firmspeci®crisk PanelC:Regressionwith®rmspeci®criskasthedependentvariable.Firmspeci®criskisthefractionalstandarddeviationoftheresidualsfromthetwo-index marketmodel Intercept0.08650.19270.09510.2022 (5.48)(13.41)(5.52)(13.27) InsiderHolding0.0208)0.0117±± (3.59)()1.74) Hold(0±5%)±±)0.0451)0.1139
Table2(Continued) Totalrisk LinearPiecewiselinear 1987±19891992±19941987±19891992±1994 ()0.85)()2.31) Hold(5±25%)±±0.0191)0.0017 (1.97)()0.16) Hold(>25%)±±0.0318)0.0180 (1.99)()0.85) KeeleyÕsQ)0.0410)0.1034)0.0407)0.1016 ()2.83)()8.14)()2.80)()7.99) Outsideblockholdings)0.0007)0.0008)0.0006)0.0007 ()0.54)()0.62)()0.52)()0.62) ln(Totalassets))0.0019)0.0042)0.0023)0.0047 ()4.49)()10.07)()4.53)()9.70) Frequency0.00700.00540.00630.0055 (2.40)(1.98)(2.12)(1.97) F-statistic25.3772.2619.5453.64 Adj.R221.3544.2422.4345.07 N450450450450 ChowtestsorF-tests: Holdings 1987±1989Holdings 1992±1994:15.91 Hold(0±5%) 1987±1989Hold(0±5%) 1992±1994:1.55 Hold(5±25%) 1987±1989Hold(5±25%) 1992±1994:10.29 Hold(>25%) 1987±1989Hold(>25%) 1992±1994:14.16 aThistablepresentsregressionestimatesofbankriskonmanagerialholdings,bankhealth,andseveralcontrolvariables.Holdingsaretheaggregate fractionofsharesheldbyocersanddirectorsofthebank.KeeleyÕsQisthemarketvalueofequityplusthebookvalueofliabilitiesdividedbythe bookvalueofassets.Outsideblockholdingsisthepercentofsharesheldbyallunaliated,®ve-percentholdersofthe®rmÕsshares.Totalassetsarethe year-endbookvalueoftotalassetsforeach®rm.Frequencyistheaveragedailyvolumeofsharestradeddividedbytotalsharesoutstanding.t-statistics aregiveninparenthesesandp-valuestotherightofeachsigni®cantestimate.ChowtestistheF-statisticresultfromatestexaminingwhethertherisk andholdingsrelationissigni®cantlydierentbetweenthe1987±1989and1992±1994periods. *Signi®cantatthe1%level. ***Signi®cantatthe5%level. ** Signi®cantatthe10%level.
no statistically signi®cant relationship between ownership and systematic risk in either of the two periods.
We perform a Chow orF-test to determine whether the change in the risk±
holdings relationship is signi®cantly dierent between the 1987±1989 and 1992±1994 periods. Speci®cally, the unrestricted model allows the coecient value of each independent variable to vary between the two subperiods. The restricted model, however, allows each parameter value to vary between the two periods with the exception of holdings; the holdings term has the same coecient value across the two periods. The resulting null hypothesis is that the coecient of holdings in the 1987±1989 period is equal to the coecient of holdings in the 1992±1994 period. See Johnston (1984) for additional de- tails on tests of structural change. The results of the tests strongly reject the null hypothesis and indicate that the relationship between managerial hold- ings and total and ®rm speci®c risk signi®cantly changed from 1987±1989 to 1992±1994.
The coecient of KeeleyÕs Q is negative and statistically signi®cant, indi- cating that high franchise value banks have less total and ®rm speci®c risk.
Indeed, Keeley'sQis statistically signi®cant at the 1% level in its association with total and ®rm speci®c risk in each of the regression equations. Two other variables that appear to in¯uence bank risk are size and trading frequency.
Larger banks appear to have less total and ®rm speci®c risk in both time pe- riods, though more systematic risk. These results suggest that portfolio di- versi®cation and managerial expertise characteristics associated with bank size more than oset the greater potential total and ®rm speci®c risk of individual activities at larger banks. Banks with more frequently traded stock also appear to have higher levels of risk, ceteris paribus. Outside blockholdings do not appear to in¯uence managerial risk taking.
4.3. Further analysis
Our results suggest that total and ®rm speci®c risk and managerial holdings are positively related in the 1987±1989 period and negatively related in the 1992±1994 period. This change in the managerial holdings to risk relationship could re¯ect relatively constant risk and changes in managerial holdings.
However, our analysis indicates that managerial holdings change little on an individual bank basis. Managerial holdings drop by 1.95% per bank from 1987 to 1994. Moreover, only 2.5% of the sample experience a drop in holdings from greater than 20% in 1987 to less than 10% in 1994. We have no banks in the sample that increase holdings from less than 3% in 1987 to over 6% in 1994.
Thus, managers that are characterized as entrenched in the 1987±1989 period are still characterized as entrenched in the 1992±1994 period and unentrenched managers also maintain this characterization throughout the period.
We ®nd that the change in the relation between managerial holdings and total and ®rm speci®c risk apparently began in 1990. Regression analysis on a year-by-year basis suggests that the positive relation between risk and mana- gerial ownership holds for 1987, 1988, and 1989. In addition, the inverse re- lation between risk and holdings occurs only in 1992, 1993, and 1994.
However, we are unable to detect any statistically signi®cant relation for 1990 or 1991, suggesting that managerial behavior started to change during this period.
We further investigated the change in risk taking propensity by applying the 1987±1989 coecients of our basic model to the franchise value and other exogenous variables actually observed in the 1992±1994 period. Given the prior discussion about changing risk taking behavior, we would expect that the predicted risk levels in the 1992±1994 period using the 1987±1989 coecients would be higher than the actual levels observed. This was the case for both total and ®rm speci®c risk. Indeed, the predicted level of total risk was 46%
above the actual level while the predicted level of ®rm speci®c risk was 27%
higher. In contrast, the predicted level of systematic risk was slightly lower.
Our results thus far suggest that the relation between managerial share- holdings and total risk changes between the pre- and post periods. However, board characteristics and structure dier substantially among ®rms, suggesting that inside director preference for risk may be substantially dierent from that of an independent director. As a result, we randomly sampled 50 ®rms from our sample and gathered detailed board of director data from annual proxy statements. We classi®ed board members following the taxonomy of Brickley et al. (1994). Inside directors are employees, retired employees, and family members of an executive within the ®rm. Examples of aliated directors are attorneys, investment bankers, and consultants. Lastly, independent directors are directors whose only relationship to the ®rm is their directorship.
We then estimated again our regression model from Table 2 with this sample of 50 banking organizations with the insider holdings variable now de®ned as the shares held by inside and aliated directors. The results (available from the authors) are not materially dierent, with the relationship between managerial holdings and risk remaining positive in the 1987±1989 period and again be- coming negative in the 1992±1994 period. For total risk, for example, the in- sider holdings coecient for 1987±1989 is 0.0202 in Table 2, signi®cant at the 1% level, and 0.0153, signi®cant at the 5% level for the rede®ned insider holdings variable. For the 1992±1994 period, Table 2 shows an insider coe- cient of)0.120, signi®cant at the 1% level, while the rede®ned insider coecient for the 50-bank sample is)0.0096. For the piecewise regressions, the patterns are again similar, though the positive and statistically signi®cant insider holdings coecient in 1987±1989 occurs in the 5±25% ownership range (vs. > 25% in Table 2) and the insider holdings coecients in the 1992±1994 period are not statistically signi®cant.
5. Conclusions and implications
Our results suggest that managerial shareholdings do in¯uence bank total and ®rm speci®c risk. However, the association is dierent in the 1987±1989 period when banks were less regulated and under ®nancial stress than in the 1992±1994 period following legislation (FIRREA and FIDICIA) designed to restrict risk-taking and after the industry returned to pro®tability. Managers with substantial equity holdings took more risk in the 1987±1989 period. In contrast, managers with substantial equity position took less risk in the 1992±
1994 period in response to regulatory changes designed to reduce incentives for risk-taking and improvements in the ®nancial health of the banking industry.
Evidence from the other variables also provides potentially important insights into bank risk-taking. Franchise value appears to be an important determinant of bank risk-taking: banks with high franchise values are less likely to take risk than banks with low franchise value. In contrast, outside blockholders have, at best, limited in¯uences on bank risk taking.
While it does appear that managerial shareholdings do in¯uence bank risk taking and that this relationship is dierent in the 1992±1994 period then in the 1987±1989 period, identifying the causes of the change must be done in a more tentative way. Large increases in franchise values in the 1990s suggest reduced incentives for banks to take risk, as do signi®cant changes in the bank regu- latory regime designed to reduce bank risk taking. Further evidence on whether the enhanced regulatory restrictions have been sucient to control manage- ment incentives to take risk will be provided the next time that bank franchise values decline substantially.
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