Download Corporate Governance and Risk Management at Unprotected Banks

Corporate Governance and Risk Management at Unprotected Banks:
National Banks in the 1890s
CharlesW.CalomirisandMarkCarlson*
Abstract
Weexaminebankgovernanceandriskchoicesfromthe1890s,aperiodwithoutdistortionsfrom
deposit insurance or other government assistance to banks. We link differences in managerial
ownership to different corporate governance policies, risk, and methods of risk management.
Formal corporate governance and high manager ownership are negatively correlated. Managerial
salariesandself‐lendingaregreaterwhenmanagerialownershipishigher,andlowerwhenformal
governance is employed. Banks with high managerial ownership (low formal governance) target
lower default risk. High managerial ownership rather than formal governance is associated with
greaterrelianceoncashratherthanequitytolimitrisk.
Keywords:Managerownership,corporategovernance,rentseeking,riskpreferences,bankfailures
JELCodes:G21,G32,N21
*Calomiris(correspondingauthor):ColumbiaBusinessSchoolandNBER([email protected]).Phone:212‐
854‐8748.Fax:212‐316‐9219.MailingAddress:ColumbiaBusinessSchool,3022Broadway,UrisHall601,
NewYork,NY10027.
Carlson:BoardofGovernorsoftheFederalReserveandBankforInternationalSettlements
([email protected]).
WethankStijnClaessens,LucLaeven,RobertaRomano,PhilStrahan,andseminarorconferenceparticipants
attheNBERRiskofFinancialInstitutionSummerInstitute,theBoardofGovernors,theFederalReserve
BanksofAtlanta,Cleveland,andNewYork,theInternationalMonetaryFund,ColumbiaUniversity,Tilburg
University,Dartmouth,ErasmusUniversity,NewYorkUniversity,YaleUniversity,andtheUniversityof
Virginiaforcomments.IanniDrivasprovidedvaluableresearchassistance.Theviewsexpressedinthis
paperaresolelythoseoftheauthorsanddonotnecessarilyreflectthoseoftheFederalReserveBoard,the
BankforInternationalSettlements,ortheirstaffs.
1.Introduction
Incentivesofmanagersmayconflictwiththoseofoutsideshareholdersandcreditors,
particularathighlyleveragedandopaqueinstitutionssuchasbanks.Agencyproblemsariseboth
withrespecttotheoutrighttransferofresources(e.g.,excessivesalariesorsubsidizedaccessto
credit),aswellasimplicittransfersrelatedtoriskmanagementpractices(e.g.,inadequaterisk
managementeffortortransfersfromcreditorstostockholdersthrough“riskshifting”).Somerisk
shiftingbenefitsmanagersattheexpenseofallclaimantsonthebank,whileotherformsofrisk
shiftingbenefitstockholdersattheexpenseofcreditors.1Bankersdesigncontractingand
governancestructuresthatsufficientlyresolveagencyproblemssothattheycanattractfunding
fromminorityshareholdersanddepositors.
Examininghowbanksresolvethoseconflictsintoday’sbankingenvironmentthroughtheir
choicesofownershipstructure,governanceandrisk‐managementpractices,andportfoliostructure
iscomplicatedbygovernmentregulationofcapitalstructureandcorporategovernancepractices.
Also,protections,suchasdepositinsurance,too‐big‐to‐failpolicies,andalenderoflastresort,can
distortincentiveswhenmakinggovernance,ownershipstructure,andrisk‐managementchoices.To
investigatetheendogenousemergenceofcorporategovernancemechanismsthatlimitrentseeking
andcrediblymanagerisk,welookatbanksfromthe1890s,aperiodwhentherewasnodeposit
insurance,nolenderoflastresort,andvirtuallynogovernmentinterventionstosavebanks.
Wedosousingnationalbanks’ExaminationReports,adetailedbutseldomusedresource
thatprovidesconsiderableinformationaboutbanks’ownershipstructures,governancestructures,
1Riskshiftingor“assetsubstitution”referstochangesintheriskprofileofinvestmentsdesignedtotransfer
valuefromsomeclaimantstoothers.Forexample,thedecisiontoinvestlessinriskmanagementcanresultin
privatebenefitstobankersattheexpenseofoutsidesourcesoffunding(HolmstromandTirole,1997).Also,
anincreaseinthevarianceofreturnstypicallytransfersvaluefromcreditorstostockholders(Jensenand
Meckling,1976).Notethatthesetwokindsofriskshiftingdifferintheidentitiesofwinnersandlosers.
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toolsformanagingriskandlevelsofrisk.Thisinformationallowsustolinkdifferencesin
ownershipstructure(especiallytheextentofmanagerialownership)todifferencesincorporate
governancepolicies,riskoutcomes,andbanks’approachestoriskmanagement,includingtheir
portfoliostructurechoices.Wefindthatexogenousvariationinbanks’circumstancesresultin
importantdifferencesinownershipstructure,risktaking,andcorporategovernancechoices,which
inturnresultinimportantdifferencesacrossbanksintheextentofmanagerialrentextractionand
thestructureofbanks’assetsandliabilities.Banksthateschewformalcorporategovernancein
favorofconcentratedmanagerialownershiptendtoexperiencehighermanagerialrentextraction,
lowerdefaultriskondebt,highercashholdingsasafractionofassets,andlowerequitycapitalasa
fractionofliabilities.
2.Literaturereview
Thesimplestclassofagencyproblemsrevolvesaroundthetransferofresourcestoinsiders
whomaintainoperationalcontroloverthebank.2Bankmanagerswithsufficientcontrolrightsmay
paythemselvesexcessivesalariesorgivethemselvesaccesstocreditonsubsidizedterms.Fora
sampleofEastAsianfirmsinthemid‐1990s,Claessens,Djankov,Fan,andLang(2002)findthat
concentratedmanagementownershipincreasesfirmvaluewhenownershipandcashflowrights
arealigned,butincasesinwhichmanagersenjoygreatercontrolrightsthancashflowrights,
managerialownershipconcentrationisvalue‐destroying.
Controlrightscanalsogiverisetoagencyproblemswithrespecttoriskmanagement,
involvingdifferencesinportfoliochoice,asmodeledbyJensenandMeckling(1976),Myers(1977)
andMerton(1977),ordifferencesinrisk‐managementeffort,asmodeledbyHolmstromandTirole
(1997).Ingeneral,managerswhohavelargestakesintheperformanceoftheirbanksmaypreferto
takelessriskortoexertgreatereffortinmanagingriskinordertopreservetheirownfinancial
2SeeShleiferandVishny(1997)forageneralreviewofissuesincorporategovernance.
2
wealthortheirfirm‐specifichumancapital(seethediscussioninDemsetz,Saidenberg,andStrahan,
1997;LaevenandLevine,2009).Insomecases,particularlyinthepresenceofsafetynetsubsidies,
diversifiedoutsideequityholderswithsufficientstakesinbanksmayseektoincentivizemanagers
totakemoreriskandmayemploypayschemesthatrewardrisktaking(seeLaevenandLevine,
2009;Cheng,Hong,andScheinkman,2013;BaiandElyasiani,2013).
Alternatively,therecouldbestatesoftheworldinwhichbankmanagersthathadbeen
managingriskcarefullymaybecomeexcessivelyrisklovingwithoutbeingprovidedperformance
incentives,suchasstatesinwhichtheirequityinterestinthebankbecomessufficientlysmallasthe
resultofbanklosses.Inthewakeoflossesthatreducenetworthandincreaseleverage,bankers
withsubstantialequitysharesandcontrolrightsmayprefertoincreaseassetrisk.3Thismoral‐
hazardprobleminriskmanagementcanbemitigatedthroughvariousmeasures,includingshort‐
termdebtcontracting;afirst‐come,first‐servedruleforbankliquidation;andactionsbybankers
thatcrediblysignalgoodriskmanagement,includingthemaintenanceofaminimumamountof
cashorrisk‐freeassets(Acharya,Mehran,andThakor,2013;Bhattacharya,Boot,andThakor,1998;
CalomirisandKahn,1991;Calomiris,Heider,andHoerova,2014;DiamondandRajan,2001).If
bankdebtholdersareprotectedbydepositinsuranceorotherguarantees,however,moralhazard
canbeexacerbatedbecausebankdebtholderslosetheirincentivetomonitorandcontrolbanks’
risktaking(Bhattacharya,Boot,andThakor,1998).
Avarietyofempiricalstudieshavelookedatmanagerialownership,governance,andrisk
taking.Anginer,Demirguc‐Kunt,Huizinga,andMa(2013)studyaninternationalsampleofbanks
for2003‐2011andfindthatstrongerformalgovernancetendstobeassociatedwithlowerbank
3Insufficientlybadstatesoftheworld,bankersmayalsochoosetocommitfraudorabscond(Calomirisand
Kahn,1991).GortonandRosen(1995)arguethat,inastateoftheworldinwhichindustryprospectsare
declining,managersmayboostprofitstohidethepoorprospectsfromshareholders.
3
capitalratios,andthatmanagerswithlargestakestendtochoosehigherbankcapitalizationratios.4
Forsamplesofpubliclytradedfirmsmoregenerally,Holderness,Kroszner,andSheehan(1999)
findthat,in1935and1995,highermanagerialownershipisassociatedwithlowerrisk.
Followingtherecentfinancialcrisis,anumberofstudieshaveexaminedtheextenttowhich
corporategovernanceandmanagerincentiveschemesinfluencedhowbanksfaredduringthecrisis
(Acharyaetal.2009;Berger,Imbierowicz,andRauch,2012;EllulandYeramilli,2010;Fahlenbrach
andStulz,2011;andSeniorSupervisorsGroup,2008).AsMehran,Morrison,andShapiro(2011)
note,thesestudiesgenerallyfindthatmanagersprovidedwithincreasedincentivestotakerisk
generallydidso.
Althoughsomemodelsofriskmanagementfocusonconflictsofinterestbetweenbankers
andcreditors,inothermodels,managerialconflictsofinterestaffectallsourcesofoutsidefunding
sources.(ExamplesoftheformerincludeJensenandMeckling,1976;Myers,1977;andMerton,
1977,whileexamplesofthelatterareAcharya,Mehran,andThakor,2013;CalomirisandKahn,
1991;HolmstromandTirole,1997;andCalomiris,Heider,andHoerova,2014.Ageneralreviewof
theissueisJohnandSenbet,1998.)Underthosecircumstances,commitmentstoimprovingthe
bank’scorporategovernance–forexample,thepresenceofoutsidedirectorsontheboard
(directorswhoarenotmanagersofthebank)orthe“bonding”ofmanagement–shouldimprove
4Theyfind,however,thatin2006,thepayoffofriskreversedthiseffectformanagerswithsufficientlylarge
stockoptionwealth.LikeAnginer,Demirguc‐Kunt,Huizinga,andMa(2013),Saunders,Strock,andTravlos
(1990)findvariationovertimeintheextenttowhichhighermanagerialownershipisassociatedwithmore
orlessrisktaking.Saundersetal.findthatduringtheperiod1979‐1982greatermanagerialownershipwas
associatedwithhigherrisk,whichtheyattributetothederegulatoryenvironment.Consistentwiththat
interpretation,BrunoandClaessens(2010)showthatlegalregimesthatareexcessivelystrictcanbevalue
destroying;bettercorporategovernancecombinedwithmoreflexiblelegalenvironmentscanleadto
superioroutcomesthroughtheabilitytoundertakevalue‐creatingrisk.
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managerialeffortinmonitoringandcontrollingthebank’sborrowers,andalsomitigatetheriskof
bankerdefalcation,whichbenefitsbothoutsidestockholdersanddebtholders.
Corporategovernancepoliciesofbanksshouldariseendogenously,inparttoreducethe
costsrelatedtothetwosetsofconflictsofinterestinrisktaking–thatis,theconflictbetween
shareholdersanddebtholders,andtheconflictbetweenmanagersandoutsiders(JohnandSenbet,
1998,HermalinandWeisbach,2003).Understandinghowgovernancepoliciesrespondtosuch
conflicts,andwhateffectsownershipstructureandgovernancepolicieshaveonrisktaking,is
highlychallenginginthecurrentregulatoryenvironment,inwhichpoliciessuchasdeposit
insurance,too‐big‐to‐fail(TBTF)bailouts,andlegalrestrictionsoncontrollingownershipinterests
inbanks,removethedisciplinaryincentivesofdebtholdersandlimittheabilityofequityholdersto
concentrateownership(ontheeffectsofTBTF,forexample,seeAcharya,et.al2009).5
3.Researchapproach,samplechoice,andhypotheses
Tounderstandhowownershipstructureaffectscorporategovernance,andhowownership
structureandcorporategovernanceaffectbanks’riskmanagement,weexaminethelinksamong
ownership,governance,andriskmanagementduringaperiodpriortotheestablishmentofa
regulatorysafetynetforbanks.DuringtheNationalBankingEra(1863‐1914),government
protectionwasabsent,andthelatitudeforvoluntarygovernancedecisionsbybankswasgreat.We
observelargecross‐sectionaldifferencesintheownershipstructurechoicesofnationalbanks,as
wellasgreatvariationintheirchoicesfororganizingcorporategovernance.Banksalsostructured
theirportfoliosverydifferentlyfromoneanother,anddisplayedimportantdifferencesintheir
managementofrisk–indicatedbothbybalancesheetratiodifferencesandthedifferencesinbank
failureexperienceduringthemostseverebankingcrisisofthisera,thePanicof1893.
5Theso‐calledseparationofbankingandcommerceplacesspecialconstraintsonwhoispermittedto
exerciseacontrollinginterestinabank.
5
Differencesinownership,governancechoices,portfoliosandrisks,underacommonand
relativelylaissez‐faireregulatoryenvironment,makenationalbanks’experiencesinthe1890san
ideallaboratoryforexamininghowmanagerownershipandboardoversightarerelatedtorent
seeking,portfoliochoice,andfailurerisk.Anotheradvantageoffocusingonnationalbanksisthat,
despitetheirdifferencesinlocation,theyoperatedunderidenticallegalconstraints.Forexample,
nationalbanksallissuednationalbanknotesandaccepteddeposits.Nationalbanksmadeloansbut
wereprohibitedfromundertaking“guarantees”(suchasbankersacceptances).Also,unitbanking
lawsrestrictedeachbanktooperatingonlyoneoffice,whichlimitedbanksize.Forallthese
reasons,nationalbanks’businessmodelsweresimilar(incontrasttotoday’sbankingsystem,in
whichsmallbanksfocusonlendinganddeposittaking,whileglobaluniversalbanksundertakea
muchwiderrangeofactivitiesforaquitedifferentcustomerbase).
CorporategovernanceinthehistoricalU.S.bankingcontexthasbeenthesubjectof
numerouspriorstudies.Oneofthemostimportantthemesofthatliterature,whichisnotpresent
tothesameextentinothercontexts,hasbeentheconnectionbetweenstockownershipandthe
recipientsofbanklending.Intoday’sbanks,therearestrictlimitsonloanstoofficersanddirectors,
anditisconsideredinappropriatetoprovidebettertermstoloansofferedtoofficers,directors,or
otherlargestockholders.HistoricallyintheUnitedStates,banksoftenactedas“loanclubs”for
insiders,whowereoftenlargeshareholderswithsignificantformalorinformalcontrolrights.
Generally,theliteraturehastakenabenignviewofinsiderlending,arguingthatitfacilitated
valuecreationandriskmanagementbecauseinsidershadstrongincentivestoscreenandmonitor
oneanother(LamoreauxandGlaisek,1991;Lamoreaux,1994;Meissner,2005;HaberandMaurer,
2007;HansmannandParglender,2012;Freeman,Pearson,andTaylor,2012).Bodenhorn(2013)
findsthatbankvalueincreasedwiththenumberofindividualblockholders,butdeclinedwiththe
numberofinstitutionalblockholders–thatis,blockholderswhowerenotpartoftheloanclub.
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Loansclubsincreasedthevalueofbankstockbecauseinsidersvaluedpreferentialaccesstolending
thatwasattachedtotheirblockholdingstatus.6
Asweshow,nationalbanks,likethestate‐charteredbanksstudiedbyLamoreaux,
Bodenhorn,andothers,engagedinlargeamountsofinsiderlending.Ourdataonnationalbanks
allowustoinvestigatehowdifferencesthataffectedownershipandgovernancerulesalsoaffected
theamountandqualityofinsiderlending.
Thedataweusecomeprimarilyfromnationalbanks’ExaminationReports,asourcewhich,
toourknowledge,hasbeenlittleused,andneverusedforquantitativeanalysisofthequestionswe
addresshere.TheseReportsprovideverydetailedpicturesofthebanksandthebankexaminers’
viewsaboutthem.TheydescribetheequityownershipofmanagersandofBoardmembers(and
identifywhethermanagersareontheBoard).Thereissubstantialheterogeneitywithrespectto
ownershipstructureamongthenationalbanksinoursample.Somemanagersownaconsiderable
portionofthesharesofthebank,whileinothercasesthemanagersownonlyasmallfraction.We
alsohaveinformationaboutavarietyofcorporategovernancemeasuresthatcouldbeusedto
provideoversightofbankmanagers,suchasthefrequencyofboardmeetings,thenumberof
outsidedirectorsontheboard,andwhethertherewasanindependentloanreviewcommitteethat
includedoutsidedirectors.Wealsoknowwhetherthemanagerswererequiredtopostsurety
bonds,whichprotectedotherequityholdersintheeventoffraud.Thereportsalsoprovideafairly
detailedpictureofthebalancesheet,aswellascontainingtheexaminer’sassessmentsofvarious
6Interestingly,19thcenturycorporatecharteringrulesoftenemployedvotingrightsrulesthatreducedthe
votingpoweroflargeshareholders,largelytoreduceconcentrationofcontrolovercorporations.Although
thesedeparturesfromoneshare‐onevoteruleswerecommonformanyfirms,theywerelesscommonfor
banks(Hilt,2008;Hilt,2013).Thismayhavereflectedthedesirabilityofencouraginginsiderblockholding,as
wellastherelativeabsenceofthepoliticalconsequencesofcontroloverabankoncebanksbecamechartered
freely(roughlyaroundthesecondquarterofthe19thcentury).
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measuresofassetquality,forward‐lookingexpectationsofloss,andqualitativeevaluations.Thus,
weareabletoexaminetherelationshipbetweenownershipandgovernancechoices,aswellasthe
impactofbothonriskpreferencesatthebank.Therichnessofthedatapermitsustoprovidean
integratedpictureofthelinkagesamongownership,governance,andfinancialstability.
Forouranalysis,wegatherdatafrom206banksfrom37fairlylargecitieslocatedmainlyin
theWesternandSouthernpartsoftheUnitedStates.7Thoseregionssawthegreatestfinancial
turmoilandthehighestratesofbankfailureduringthePanicof1893.Byselectingallthenational
banksfrom37similarcitiesintheseregionsweintendtoconstructasampleofreasonably
comparablenationalbanksintermsoftheireconomicenvironmentandlendingactivities.We
combinetheinformationintheExaminationReportswithstandardbalancesheetdatafromtheCall
Reports(regulatoryreportswhichcontainedinformationonthebanks’balancessheetsfiledabout
fivetimesayear),aswellasotherlocation‐specificcontrolsdrawnfromvariouscensusesandother
sources.Weexaminethebanks’situationsintheearly1890s,justpriortothePanicof1893.
Thispanicisausefulmomenttofocusuponbecauseitbroughtthemostseveredistressfor
banksofanyofthecrisesduringtheNationalBankingEra.Thatepisoderesultedinthehighest
numbersofbankfailuresofanyofthecrises,andwasoneofthreeepisodesduringtheNational
BankingErathatwitnessedasuspensionofconvertibilityinNewYork.Althoughmostofthebanks
7ThesampleisregionallyfocusedontheWestandtheSouthduetoourinterestinobservinghowdifferent
governancestructuresfaredinthepanicof1893(whichprimarilyproducedbankfailuresinthoseregions).
Nevertheless,thestructuresweobserveinoursamplearesimilartowhatothersreportforthetime.For
instance,BodenhornandWhite(2014)findthatcorporateboardsofstatecharteredbanksinNewYork,a
quitedifferentsample,wereofsimilarsizetotheonesweobserveandusedsimilaroversighttools.Hilt’s
(2014)descriptionoftheevolutionofcorporateboardsintheUnitedStatesfromtheearly1800salso
suggeststhatthecorporateboardsinoursamplewereinlinewithgeneralpracticesofthetime.Giventhese
similarities,webelieveourfindingsarelikelytobegenerallyapplicabletobanksintheperiod.
8
inoursampleavoidedfailure,therewasenoughfailureriskduringthisepisodetoprovide
substantialobservablecross‐sectionalvariation–somethingthatisabsentduringmostofthe
NationalBankingEra.
Welookfirstattheinterplaybetweenownershipandgovernancebygaugingtheextentto
whichthestructureofownershipaffectsbanks’choicesofcorporategovernancepolicies.We
hypothesizethathighermanagerialownershipreducestheextentofformalcorporategovernance
(welabelthisHypothesis1).Wetreatmanagerialownershipasanendogenousvariableand
instrumentmanagerialownershipusingmanagerialturnoverevents.(SeeHermalinandWeisbach
(2003)foradiscussionofendogeneityissuesrelatedtothestructureofboardsandmanagement
control.)Thepatternsweobservearerobustacrossspecificationsthatweighdifferentaspectsof
corporategovernancedifferently,andwereportresultsforasimplescorethatgivesequalweight
toeachdimension.Allfiveoftheformalcorporategovernancepolicychoicesweconsiderare
mutuallypositivelycorrelatedwithoneanother,andeachofthemisnegativelycorrelatedwiththe
degreeofmanagerialownership–factsthatareconsistentwithviewingmanagerialownership
concentrationasasubstituteforformalgovernancetoolsinresolvingconflictsofinterestbetween
managersandthesourcesofoutsidefundingforthebank.
Takingintoaccounttheendogeneityofgovernanceandownershipstructure,weexamine
therentseekingbehaviorofbankersthatalternativelychoosetosolvetheirgovernancechallenges
throughconcentratedownershiporformalcorporategovernancepolicies.Weexpect(Hypothesis
2)thatgreatermanagerialownershipresultsingreateropportunitiesformanagerialrent
extractionthroughhigherwagesandloanstomanagersandalsohigherdividends(giventhat
managers’interestsarecloselyalignedwithshareholders).Wefindthatmanagers’salariesrelative
toassetstendtobehigherwhentheyownagreaterportionofoutstandingstock,whichreflects
theirgreaterabilitytoextractrents.Interestingly,thetotalproportionofloansmadetoinsiders
(officersandoutsidedirectors)isnotaffectedbythestructureofownershiporgovernance,but
9
ownershipandoversighthaveastrongimpactonwhichinsidersreceivethoseinsiderloans.When
managershavegreaterequityownership,moreinsideloansareallocatedtothem;whenoutside
directorsexercisegreateroversightincorporategovernance,agreaterproportionoftheinside
loansarereceivedbythem.Greatermanagerialownershipalsoresultsinhigherdividends.
Wealsoconnectownershipstructureandcorporategovernancechoicestobanks’risk
preferencesandtheirbalancesheetchoices.Inparticular,weshowhowownershipand
governanceaffectedbankportfoliostructure,performance,andfailureprobabilitiesduringthe
Panicof1893.Wehypothesizethat,astheresultofriskaversion,greatermanagerialownership
(whichreducesthediversificationofmanagerialwealth)resultsinlowerbankrisktaking
(Hypothesis3).
Ourresultsonrisktakingindicatethatmanagerswhoownagreaterproportionofthe
bank’sstocktakelessriskaccordingtoanymeasureofriskweemploy.Forexample,withrespect
toforward‐lookingmeasuresofrisk,managerswithlargeequitystakesintheirbanksarelesslikely
torelyuponhigh‐cost“borrowedfunds”andarealsolesslikelytobeinvolvedinrealestate
lending.Bothactivitieswereperceivedbycontemporariesasindicativeofhighriskandsuch
perceptionsaregenerallyborneoutinthePanic.Moreover,wefindthatanoutsideestimateofthe
riskinessofthebank’soverallportfolio,theforecastedlossesanticipatedbythebank’sexaminer,
paintsasimilarpicture;greatermanagementstakesareassociatedwithlowerexpectedlosses.We
viewtheseresultsasconsistentwiththeideathatmanagerswithalargershareoftheirwealth
investedinthebankweremorerisk–averseintheirriskmanagementpractices.Banksthatchose
lowermanagerialstakesandmoreformalgovernancepoliciestendedtoundertakegreaterlevelsof
risk.Thatfindingisconsistentwiththeviewthatoutsidedirectors,whorepresenttheinterestsof
diversifiedoutsideequityholders,preferaslightlyhigherlevelofrisk.Thepreferenceforlower
riskappearstohavebeenbeneficialduringthePanicof1893aswefindthatbankswithhigher
10
managerownershipandlessrelianceonformalcorporategovernancewerelesslikelytofail.This
effectisduelargelytohowthesebanksstructuredtheirbalancesheets.
Banksseekingtoreducetheriskofdefaultontheirdebtscanusetwoalternativerisk
managementtoolsincombination:ahighercash‐to‐assetratio(ontheassetsideofthebalance
sheet),orahigherequity‐to‐assetratio(ontheliabilitysideofthebalancesheet).8Wehypothesize
(Hypothesis4)thatbankswithgreatermanagerialownershipandlessrelianceonformalcorporate
governancewillchoosetorelymoreoncashassetholdingstoreducetheirdefaultriskbecause
holdingcashcompensatesfortheabsenceofoutsideoversightofriskmanagementinensuring
propermanagerialriskmanagement(Calomiris,HeiderandHoerova,2014).Insomestatesofthe
world–ifhiddenlossesarelarge,makingresultingmanagerialstakesunobservablysmall–
managersmayprefertoundertakemoreriskthanoutsideshareholdersanddepositors(e.g.,when
managerialeffortatlimitingriskiscostly).Forthatreason,theabsenceofformalcorporate
governanceoversightofmanagementmaygiverisetotheneedformorecashholdings,asawayto
preservethecredibilityofriskmanagementduringbadtimes.9Banksthatlackformalgovernance
8Allnationalbankswerecharteredwithdoubleliabilityrequiredforstockholders.Thatmeantthat
stockholderscouldbeassessedforanadditionalamountequaltothepaidincapitalofthebankifthebank
wereplacedintoreceivership.Consequently,theactualamountofequitythatactedasabufferagainstloss,
fromthestandpointofbankdepositors,wasmorethantheamountofpaidincapitalandaccumulated
retainedearnings.Totakeaccountofdoubleliability’seffectonbankrisk,weexperimentedwithincluding
theratioofpaidincapitaltototalnetworthinourregressions.Wefindthatthisvariablewasnotstatistically
significant,anditsinclusiondidnotalterourotherfindings.Intheresultsreportedhere,weexcludeit.
9Thisresultreliesonthefactthatcashdepositsinotherbanks,unlikeequity(whichisanaccounting
categorysubjecttomanipulation),areobservable(andwereactuallyverifiedbyexaminers),andmost
importantly,cashdepositsarenotsubjecttoriskshiftingbythebankthatpossessesthem.Therelative
relianceoncashorequitymayalsoreflectadverse‐selectioncostsofissuingequity(asinMyersandMajluf
1984).CalomirisandWilson(2004)showthatbankspreferlessonequitywhentheyfacehigheradverse‐
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willsufferfromgreaterassetsubstitutionrisk,andgreateradverse‐selectionproblems(ifthey
weretoattempttoraiseadditionalsourcesofoutsideequity).Greaterassetsubstitutionriskfrom
alackofformalgovernancethereforewilltendtoleadbankstorelymoreoncashasameansof
signalinggoodriskmanagementpractices.10Wefindthatbankswithhighermanagerialownership
concentrationreliedmoreoncashassets,andlessonequity.
Tofacilitatetheexpositionofthevarioustestsofthesefourhypotheses,Table1
summarizesthemandthetestsweperforminourempiricalwork.Theremainderofthepaperis
organizedasfollows.Section4discussesthedatasourcesandthesample.Thatsectionalso
explainstheconstructionofourcorporategovernancemeasuresandthevariablesweuseas
indicatorsofrentseekingandriskpreferences.Thebaselineempiricalanalysisiscontainedin
Section5whileavarietyofrobustnesschecksarepresentedinSection6.Section7concludes.
selectioncostsofraisingequityinthemarket.Asinthecaseofriskmanagementincentiveproblems,adverse‐
selectioncostsofequityissuesalsoimplyagreaterrelianceoncash.Furthermore,weexpectproblemsof
asymmetricinformationtobemitigatedbytheuseofboardoversight.Boardmeetings,aloanreview
committee,andbondingshouldbeassociatedwithgreatertransparencyandhencelowercostsofequity
offerings.Althoughwebelievethatasymmetricinformationmitigationwasanadditionalbenefitofformal
corporategovernance,wedonotemphasizethischannelinourempiricalcross‐sectionalanalysisbecauseof
theabsenceofequityofferingsforallthebanksinoursample,whichindicatesthatdifferencesinadverse‐
selectioncostsareunlikelytoexplaincross‐sectionaldifferencesinbanks’useofcash.
10Usingrulestorequirebankstoholdaportionoftheirassetsascashtocontrolassetsubstitutionriskisthe
maintheoreticalconclusionofCalomiris,HeiderandHoerova(2014).Acharya,Mehran,andThakor(2013)
alsosuggeststhatforcingbankstoholdastockofsafeassets(suchasTreasurysecurities)isusefulfor
controllingrisk‐shiftingincentives,althoughtheysuggestthatsuchholdingsshouldbeproportionaltoequity
ratherthantotalassets.Mostpreviousworktendedtofocusontheuseofcapitaltomanageincentiveswith
cashandsafeassetsviewedasrelatedonlytoliquiditymanagement(see,forinstance,thediscussionin
Bhattacharya,Boot,andThakor,1998).
12
4.Datasourcesandvariabledefinitions
WegatheravarietyofinformationonindividualbanksusingCallReportsandExamination
Reports.Herewedescribethedatasourcesandthedefinitionsofthevariablesusedinthisstudy.
4.1.Thesample
Oursamplecontains206bankinginstitutions,whichconsistsofallthenationalbanks
locatedin37cities.AsweusedinformationfromboththeCallReportandexaminerreports,and
willultimatelybeinterestedinhowbanksfaredduringthePanicof1893,weneedbankstohave
bothreportsavailablepriortothePanic.Thus,tobeincludedinoursample,thebanksneededto
haveprovidedinformationfortheSeptember1892CallReportandtohavehadatleastone
ExaminationReportcompletedpriortoMay1893(theonsetofthePanic).ThosearetheReports
thatprovidetheinformationusedfortheanalysis.11
The37citiesincludemanyofthelargeronesintheWesternandSouthernpartsofthe
UnitedStates.12Anumberofthemweredesignatedas“reservecities”forpurposesofregulatory
cashreserverequirements.Depositsheldatbanksinreservecitiescouldcountaspartofa
“country”bank’slegalreserveandthesedepositsoftenservedaspartoftheregionalpayment
system(seeJames1978forfurtherdetail).Someoftheothercities,eventhoughtheywerenot
11TwobanksfiletheSeptember1892CallReportbutclosepriortoMay1893.Fortheseinstitutions,weuse
theexaminationreportnearestclosure,solongasitwasfiledatleastfourmonthspriortoclosure.
12Thecitiesare:Birmingham,AL;Mobile,AL;SanDiego,CA;LosAngeles,CA;Denver,CO;Pueblo,CO;
Indianapolis,IN;DesMoines,IA;Dubuque,IA;Lexington,KY;Louisville,KY;NewOrleans,LA;Minneapolis,
MN;Rochester,MN;St.Paul,MN;Stillwater;MN;KansasCity,MO;St.Joseph,MO;Helena,MT;Lincoln,NE;
Omaha,NE;Albuquerque,NM;Fargo,ND;Cincinnati,OH;Portland,OR;Knoxville,TN;Memphis,TN;
Nashville,TN;Dallas,TX;ElPaso,TX;SanAntonio,TX;SaltLakeCity,UT;Spokane,WA;Tacoma,WA;
Milwaukee;WI;Racine,WI;andCheyenne,WY.
13
technicallyreservecities,wereimportantenoughregionallythatotherbankshelddepositsthere.
Thus,manyofthebanksinoursampleplayedimportantrolesasintermediariesininterbank
markets.Nevertheless,oursampleincludesanumberofbanksfromsmallercitiesaswell.
4.2.Primarydatasources
TheExaminationReportsprovideawealthofinformation.13Themostvitalmaterialforour
purposesisthedetailedinformationregardingtheextentofownershipbythebank’smanagement
anditsboard,aswellastheinformationaboutcorporategovernancepractices.TheExamination
Reportlistsallthebankdirectorsandmajorofficers(President,Vice‐President,Cashier),the
numberofsharesheldbytheseindividuals,andanyloanstotheseindividuals.Salariesofthe
officerswerenotedandwhethertheofficerswererequiredtoputupasuretybond.Theexaminer
alsocommentedonwhethertheboardexercisedanyoversightoftheofficers.
TheExaminationReportsalsoconsideredavarietyofaspectsofthebalancesheetbeyond
whatwascoveredbytheCallReport.Thatinformationincludedadditionalquantitativedetail
abouttheloanbook,suchastheamountofloansthatweredemandortimeloans,theamountof
loanssecuredbyrealestate,andtheamountsecuredbyothercollateral.14Therewasalso
informationonthebank’sliabilitiesincludingadditionaldetailonwhetherthebankborrowedfrom
otherbanks(aformofhigher‐interest,short‐term,“hot”money).
Finally,theexaminerprovidedinformationonbankperformance,whichcombinedhard
factsaboutthebankwithhisownjudgments.Specifically,theexaminersevaluatedthequalityof
13CalomirisandCarlson(2014)provideadetailedsummaryofthecontentsoftheExaminationReports.See
alsoRobertson(1995)formoreinformationontheexaminationprocess.
14Althoughrealestatelendingwas“prohibited”bynationalbanks,nationalbanksnonethelessfoundwaysto
lendagainstrealestate.Aloanmadewithoutrealestateascollateralcouldbecomecollateralizedbyreal
estateifthecreditworthinessoftheborrowerdeteriorated.
14
theloanbookbylistingthevolumeofslowandoverdueloansandprovidinganestimateof
expectedlossesonthebanks’assets–whichincludedloans,aswellasotherassets.Theexaminers
alsonotedtheamountanddateofthemostrecentpaymentofdividends,aswellaswhetherfunds
thatwereretainedwouldcovercurrentandfuturelossesorbuildupthebank’snetworth.
Formostofourbalancesheetdata,weuseinformationfromtheSeptember1892Call
Report.WhilesomeadditionalinformationisavailableontheExaminationReport,theCallReport
hastheadvantageofprovidingdataforallthebanksatthesamepointintime,whichreduces
concernsaboutspuriousdifferencesduetoseasonalorothertime‐relatedfactors.
Wealsoincludeanumberofvariablesrelatedtotheeconomicenvironmentinwhichthe
bankoperated.Theseincludecountylevelvariablesfromthevariouscensuses,suchaspopulation
andtheshareofincomefromagriculture.
Allvariables,theirdefinitions,andtheirsourcesappearinTable2.Summarystatisticsfor
thesevariablesappearinTable3.
4.3.Ownershipandgovernancevariables
Theindividualsmostresponsibleforrunningthebankwereitsseniormanagers,in
particularthepresident,vice‐president,andcashier(essentially,thechiefoperatingofficerofthe
bank).Theyplayedalargeroleinmakingloansandarrangingthefundingofthebank.These
individualstendedtoownsharesinthebankandwerefrequentlyalsoontheboardofdirectors
(thePresidentofthebankwasrequiredbylawtoserveontheBoard).Akeyvariableinour
analysisistheshareofthebank’sstockownedbytheofficersofthebank.Wefocus,inparticular,
onthefractionofoutstandingbanksharesownedbythepresident,vice‐president,andcashier.15
15Weobtainthenumberofoutstandingbanksharesbydividingbankcapitalby100(asbankcapitalwas
typicallycarriedatbookvaluebasedonsharepricesof$100pershare).Inafewcasestheexaminer
indicatedthenumberofsharesoutstandingandthesereportsconfirmthatourprocedureiscorrect.Inafew
15
Theaverageportionofsharesownedbythesethreeofficers,asreportedinTable3,was25percent.
ThehistograminFigure1providesabetterindicationofthedistributionofmanagerialownership.
Atmanybanksinthesample,ownershipbythemanagersisfairlymodest;thethreetopmanagers
ownedlessthan6percentofoutstandingsharesforabout30percentofthesample.Therearealso
casesofsignificantownershipconcentration;thetopthreemanagersownedatleasthalfthe
outstandingsharesinnearly10percentofthesample.
ThebehaviorofmanagerscouldbeconstrainedbytheBoardofDirectors.Boardsrangedin
sizefrom4membersto23members.WhilethePresidentofthebankwasalwaysontheBoardand
otherbankofficersfrequentlysatontheboard,themajorityoftheboardmembersconsistedof
outsidedirectors—individualsthatwerenotofficersorotheremployeesofthebank.Someoutside
boardmembersownedsignificantstakesinthebank.Anumberwereprominentbusinessmenthat
mightprovidebusinesstothebank.16Ahistogramofownershipbyoutsidedirectorsisshownin
Figure2.Theaverageportionofsharesownedbyoutsidedirectorswas15percentbutitreached
ashighas57percent.Presumably,thelargertheportionofsharesownedbytheoutsidedirectors,
themoretheycouldinfluencethebehaviorofmanagers.Theownershipbyallotherindividualsis
showninFigure3.Ascanbeseenfromthisfigure,individualswhoareneithermanagersnorbank
managersownamajorityofthesharesinabouttwo‐thirdsofthebanksinoursample.
TherewerealsootherwaysthattheBoardcouldexertcontrolovermanagers.Thebank
couldmaintainanactiveindependentdiscountcommittee(definedbyregulatorsasonecontaining
atleastoneoutsidedirectortoreviewandapproveloansproposedbythemanagers).Sucha
committeewasmaintainedby60percentofbanks.Anotherwayofexertingcontrolwasby
meetingfrequently.Boardsthatmetinfrequently,suchassemi‐annually,presumablyexertedlittle
othercasestheexaminerreportedthatthevalueofcapitalhadpreviouslybeenwrittendownandshares
revalued.Webelievethatwehavemadealltheappropriatecorrectionsforthesewrite‐downs.
16Forinstance,aMr.ProctorandaMr.GambleservedontheboardoftheCitizensNationalinCincinnati.
16
influence.Theboardmetmonthlyormorefrequentlyinnearlytwo‐thirdsofthebanksinour
sample.Incasesinwhichthemanagerscomprisedasignificantportionoftheboard,therewas
presumablylittleindependentoversight;whenoutsidedirectorsdominatedtheboard,theycould
presumablyexertmorecontrol.Inoursample,themedianportionoftheboardthatconsistedof
outsidedirectorswas71percent;wecreateanindicatorvariableequaltoonewhentheportionof
directorsareoutsidersisabovethemedianandiszerootherwise.Ourmeasuresoftherelianceon
independentdirectors,oftheexistenceofaloanreviewcommittee,andofthefrequencywith
whichitmetaresimilartoothermeasuresusedtoanalyzecorporateriskmanagementinmodern
financialinstitutions,suchasthe“activeboardriskcommittee”ofEllulandYerramilli(2010).
Anotherwayofinfluencingbankmanagementwasrequiringmanagerstopostsurety
bonds.Thesebondswouldofferthedirectors(orreceiver)awayofrecoveringfundsintheevent
themanagercommittedsomespecifiedact,typicallysometypeoffraudthatcausedlossestothe
bank.Bondscouldbepersonalorprovidedthroughasuretybondagency(whichoftenrequired
thatthepersonbeinginsuredpostsometypeofcollateral).17Suretybondsweremostoften
requiredforthecashier,whooversawthebooksandforwhomthepossibilityoffraudwas
thereforehighest(nearly60percentofcashierspostedbonds).Othermanagersalsowererequired
topostsuchbonds(thePresidentpostedabondin33percentofoursampleandthevice‐president
didsoin12percentofthesample).
InFigure4,weillustratetherelationshipbetweenmanagerownershipandoneofthe
indicatorsofcorporateoversight:thefractionoftheBoardconsistingofoutsidedirectors.The
negativerelationshipbetweenthesetwomeasuresindicatesthatmoremanagerownershiptends
tobeassociatedwithlessformaloversight(Hypothesis1).Moreover,notonlyareeachofthe
measuresofBoardoversightnegativelycorrelatedwithmanagerownership,asshowninTable4,
buttheyareallpositivelycorrelatedwitheachother.Althoughweinvestigatedtheimpactofeach
17FormoreinformationonsuretybondsseeLunt(1922).
17
ofthesemeasuresofBoardcontrolonmanagerialbehavior,itisusefulforourpurposestocreate
anindexthataggregatesthedifferentmeasuresintoasinglecorporategovernanceindex.Wedoso
bysummingthefiveindicatorvariables.18
Thecombinedgovernancescoreisstronglynegativelycorrelatedwiththemanagement
ownershipshare,andthepartialcorrelationbetweenthosevariablesislargeandstatistically
significanteveninthepresenceofmanycontrolvariables,asshowninTable5,whichreportsan
OLSregressionthattreatscorporategovernanceasthedependentvariable.Ofcourse,ownership
shareisnotexogenousand,therefore,Table5doesnotpermitastructuralorcausalinterpretation.
Wereturntoestimatethejointrelationshipamongownershipshare,governance,andother
endogenousvariablesbelow.
Examinersseemtohaveunderstoodthatbankscouldachievegoodmanagementofrisk
withorwithoutactiveoversightofmanagementbytheBoard.Belowareexcerptsfromthe
ExaminationReportsoftwobanks,onewiththeminimumcorporateoversightscoreof0andthe
otherwiththemaximumscoreof5.Inneithercasedidtheexaminerhaveconcernsaboutthe
managementofthebankorthesoundnessofthebank,eventhoughtheexaminerwasawareofthe
cleardifferencesintheoversightbeingexercisedbytheBoard.
Oversightscoreof0‐CommentontheBoard:
Frequentmeetingsarenotheldbythedirectorsofthisbankandrecordsonlyshow
thatformalmeetingsareheldtodeclaredividends.Nomentionbeingmadeoftheir
having examined or approved loans and discounts at such times, and there is no
report of discount and examining committee having acted. The management is
apparentlywithMr.Gates,thepresidentofthebank.
CommentontheOfficers:
Officers are capable, prudent and of good reputation and their management is
efficientandsuccessful,thatmanagementbeinginthehandsofMr.HenryGatesthe
18Wealsotriedaggregatingthefiveindicatorsbytakingthefirstprinciplecomponent,similartoElluland
Yerramilli(2010).Allthefiveindicatorshadpositiveandroughlyequalweights.Thus,thefirstprinciple
componentwasnotsodifferentthanthesimpleaveragesowestickwiththeaverageforsimplicity.
18
presidentwhohashadover30yearsexperienceinthebankingbusinessinthiscity.
Nobondsrequired.19
Oversightscoreof5‐CommentontheBoard:
Directors meet monthly. Minutes full and explicit. Have discount board and
examiningcommittee.Discountboardpass[es]uponallloans.
CommentontheOfficers:
Officersarecapable,prudent,ofgoodreputation.Theirmanagementsuccessful;the
bondsarefurnishedbyLouisvilleBondCo.andincustodyofLexingtonTrust.20
4.4.Financialandportfoliomeasures
Anumberofmeasuresarepotentiallyofinterestascontrolsinourregressionsanalyzing
ownership,governanceandriskmanagement,whileothersserveasendogenousvariablesthatwe
analyze(i.e.,thecashassetsratioandtheequity‐to‐assetsratio).Twopotentialcontrolvariables
arebanksizeandbankage.Smallerbanks,ceterisparibus,generallywillbemorecloselyheld
eitherbecauseoflimitedbankmanagerwealthorbecauseoffixedcostsinestablishingformal
governanceprocedures.Theproblemwithusingbanksizeasacontrolvariable,however,isthat
sizeisitselfanendogenousvariablethatislikelytoreflectchoicesthatarecorrelatedwiththe
endogenousvariablesbeinganalyzed.Forexample,asweshowintheappendix,inasimplemodel
ofriskmanagementeffortchoice,foragivenlevelofmanagerialwealth,themaximumsizeofthe
bankwillbeconstrainedunlessthebankadoptsformalcorporategovernancetools.Thus,rather
thanincludingassetsizeinourregressions,weincludethepopulationsizeofthecityinwhichthe
bankislocated,whichisanexogenousinfluenceonbankassetsizethatisnotaffectedbycorporate
governancechoice.
Bankriskmanagementpracticesmayalsoreflectheterogeneityinbankgoalsorexperience.
Youngbanksmaylackexperience,ormayhavedifferentpreferencesormorelimitedopportunities.
19ExaminerreportofNovember14,1892fortheNebraskaNationalBankofOmaha,NE,charter2665.
20ExaminerreportofAugust18,1892fortheFayetteNationalBankofLexington,KY,charter1720.
19
Tocaptureanyoralloftheseinfluences,wecontrolforbankage.Ourmeasureisthelogofthe
numberofyearssincethebankwasestablished(thiscouldbethedatethebankbecamenationally
chartered,orthedateitwasfounded,dependingonwhetheritwasaconversionofastatebank).21
Wehaveconsiderableinformationaboutassetportfolios.Loanswereobviouslyarelatively
riskyassetbutalsoarelativelyhigh‐earningasset.Onebasicandoften‐usedassetratiothat
capturesbothriskandearningpotentialistheshareofassetsconsistingofloans.TheExamination
Reportsprovideadditionalinformationabouttheloanportfolio.DuringtheNationalBankingEra,
realestateloanswereconsideredriskierloans.Nationalbankswerenotsupposedtooriginate
mortgages;however,theywereallowedtohavemortgagesloansiftherealestatewasbeingusedto
collateralizeapreviouslyexistingloan.Thus,weemployrealestateloansrelativetototalloansasa
measureoflendingrisk.Wearealsointerestedinthedegreeofinsiderlending.Weconstructtwo
measures:theshareofallloansthataremadetoinsiders(whetherboardmembersormanagers)
andtheshareofloanstoinsidersthataremadetomanagersratherthanoutsidedirectors.
Previousresearchonbankriskmanagementhasidentifiedtheproportionsofdifferent
typesofbankdebtsasanimportantindicator(CalomirisandMason,1997;2003;2008;Calomiris,
MasonandWheelock,2011;Carlson,2010).Abank’sliabilitystructuremayreflectexogenous
liquidityrisksfacedbybanks(e.g.,ahigherproportionofcheckingdeposits).Liabilitystructure
alsomaycaptureendogenouschangesinthecompositionofdebtsinreactiontochangesin
unobservedcharacteristicsofbanks’assetrisks(e.g.,banksthatrelyonborrowedfundsmayfindit
hardtoraisefundsfromothersources),andweincluderelianceonhigh‐interestrateborrowed
21Ageturnsouttobeahighlysignificantcontrolvariableinmanyoftheregressionsreportedbelow,
althoughitsinterpretationisnotobvious.Intheregressionsreportedbelow,greaterageisassociatedwith
highermanagerialownershipandlowerformalgovernance,withlowerdefaultrisk,withloweruseofequity
andgreateruseofcash,andwithlowermanagerialsalariesandhigherdividends.
20
fundsasanendogenousvariableinouranalysisasanindicatorofrisk.22Insomespecifications,we
includetheproportionofliabilitiesconsistingofindividualdepositsandtheproportionofdeposits
incheckingdeposits,asopposedtosavingsortimedeposits,ascontrols.
Wehavesomepotentiallyusefulinformationabouttheearningsandexpensesofthebanks
inoursample.OneoftheexpenseslistedintheExaminationReportsisthesalariespaidto
managers.Aslargerbankstendtopayhighersalaries,wescalesalariesbytheassetsofthebank.
Wealsoobservedividendpayments.Weanalyzedividendsasadependentvariable;highdividend
paymentsaresometimesviewedasanindicationofadisciplinedcorporategovernance
environment.Ofcourse,dividendsalsoreflectdifferencesinprofitability;thatis,theymaybeused
tosignalmanagement’sbeliefthatearningswillpersist.Also,dividendpaymentdifferencesmay
reflectdifferentgrowthopportunities;retainingprofitsraisestheamountofequityinvestedinthe
bank,whichceterisparibus,lowersthebank’sdefaultrisk,andthusincreasesthecapacityofthe
banktogrowitsassets.Toanalyzedividendpayouts,weconsidertheratioofdividendpayments
relativetosharesoutstandingifdividendswerepaidduringthepastsix(bankstypicallypaid
dividendssemi‐annually,inJuneandDecember).Asanalternative,wealsolookedatwhetherthe
bankpaidoutdividendsduringthepastsixmonthsandobtainedfairlysimilarresults.
4.5.Risk
Weconsiderseveralindicatorsofcontributorstothedefaultriskofthebank.Someofthese
areitemsnotedearlier,suchasmakingrealestateloansorrelyingonborrowedfunds.Wealsouse
anoutsideexpert’sviewonthequalityoftheassets.Theexaminersprovidedestimatesoflikely
22Oftenthisborrowingtooktheformofrediscountingnotesorhavingbillspayable,butcouldalsotakethe
formofcollateralizedcertificatesofdeposit.WhiletheformerarenotedontheCallReport,thelattertypeis
notedonlyintheExaminationReports.Astheamountsarenotalwaysnoted,weinsteaduseanindicatorfor
whetherornotthebankmadeofthis“hot”money.
21
lossesonassets(notjustloansbutonsecuritiesandotheritemsaswell,suchasnon‐income
generatingassetssuchasfurnishings)andweusetheforecastoflossesrelatedtoassetsasa
measureofrisk.Wealsomeasuredefaultriskbasedonoutcomes,inparticularwhetherthebank
wasforcedtocloseitsdoorsbetweenOctober1892andDecember1893.
Thetwoprimarytoolsofriskmanagementforbanksweretheequity‐to‐assetratioandthe
cashassets‐to‐total‐assetsratio.Equity,ornetworth,ismeasuredasthesumofpaidincapitalplus
cumulativeretainedearningsheldassurplusorundividedprofits.Therewerenoequityratio
requirements,althoughbankswererequiredtomaintainminimumamountsofcapitalandsurplus.
Estimatingthedemandforcashassetsiscomplicatedbythelegalminimumrequirementsofcash
relativetodeposits.Cashreserverequirementsspecifiedacertainlevelofcashanddepositsin
reservecitybanksrelativetodepositsandnetduetobanks.Aswefindinouranalysisofreserve
holdings,however,regulatoryconstraintsonholdingsofcashreserves(discussedinmoredetail
below)didnotappeartobebindingonbanks’demandsforcashassets.
4.6.Othercontrolsandinstruments
Wealsoincludeanumberofvariablestocontrolforlocalconditions.Asnotedabove,we
includethepopulationofthecityasreportedonthe1890census.Atthecountylevel,wegather
otherinformationfromthe1890censusontheeconomicenvironment,includingforexample,the
shareofcountyincomefromagriculture.Atthestatelevel,weincludeanindicatorforsignificant
(greaterthan$1millionin1891)goldandsilvermininginthestateasreportedinthe1892
StatisticalAbstractoftheUnitedStates,andalsoforwhetherthestateachievedstatehoodatan
earlydate.Inincorporatingsuchinfluences,weimaginethatcorporategovernancepracticesmay
beinfluencedbysectoralcompositionandbythematurityofthelocaleconomy.
Aswediscussfurtherbelow,weemployedtwopotentialmeasuresasinstrumentsfor
ownershipstructureandgovernancechoices.Ourfirst,andprimary,instrumentisanindicator
22
variablecapturingachangeintheidentityofthepresidentofthebank,whichweidentifiedusing
theExaminationReports.Weinvestigatethecausesofmanagerialturnoverbysearchingonline
newspaperandothersourcesforinformationaboutthecircumstancesthatgaverisetothose
changes.Thesecondinstrumentisthelogofthenumberofotherbanks(national,state,savings,
andprivate)operatinginthesamecityasthesubjectbank.Thissecondinstrumentisusedonlyin
somerobustnesstestsdescribedbelow.Weconsidertheexclusionrestrictionforthissecond
instrumentasmorecontroversial,andthuswedonotincludeitinourbaselinespecifications.
AnimportantfeatureofthebankingsystemduringtheNationalBankingErawasthe
systemofinterbankdepositingofreserves.Nationalbankswererequiredtoholdcashand
interbankdepositsagainsttheirowndepositliabilities.Banksoutsidemajorcitiesneedtoholda15
percentreserve,three‐fifthsofwhichcouldbeheldasdepositsatbanksinlarger“Reserve”cities
or,“CentralReserve”cities—NewYork,Chicago,orSt.Louis.BanksinReservecitiesneededtohold
a25percentreserve,halfofwhichcouldconsistofdepositsina“CentralReserve”city.Depositsin
NewYorkplayedakeyroleinthesettlingofinterregionalpayments.Manybankshelddeposits
withbanksinNewYork.Moreover,banksinNewYorkprovidedasubstantialamountofinterbank
loansthroughrediscounting.TocapturethepotentialimportanceofproximitytoNewYorkin
affectingbanks’risksandoperations,weincludethelogofthedistanceofbanksfromNewYorkas
acontrol.Wealsoincludeanindicatorforwhetherthecityinwhichthebankislocatedisareserve
city,tocapturethepossibleeffectsofdifferencesininterbankrelationshipsandreserve
requirementsonbankbehavior.
5.Analysis
Weareinterestedinhowexogenousbankcircumstancesinfluenceownershipand
corporategovernancechoices,andrelatedbankbehavior,asdescribedinourfourHypothesesin
Table1andourtheoreticaldiscussionofthosehypothesesabove.Asthesevariablesareclearly
23
inter‐related,westartbypresentingourapproachtoidentifyingthelinkagesamongownership
structure,governancechoices,rentseeking,andriskmanagement.Wethenreviewourfindings.
5.1.Inter‐relatedownershipandcorporategovernancemeasures
Ourinitialempiricalapproachtoidentifyingtheeffectsofownershipandgovernance
choicesonbankbehavioremploysatwo‐stepprocedure,whichtreatsownershipstructureand
corporategovernancepracticesasendogenous.Formostofthevariablesweanalyze,we
instrumenteithermanagerialownershiporcorporategovernancescoreusingeventsassociated
withmanagerialturnover.23Weexpect(andfindinTable6)thatamanagerialturnoverevent(such
asthedeathofabankpresident)isassociatedwithareductioninthemanagerialownershipshare
ofthebankandanincreaseincorporategovernance.
Toverifythatmanagerialturnoveristraceabletoexogenousevents,weperformedweb‐
basedsearches,andalsosearchedthroughnewspapersavailablethroughthevariousdigitized
searchenginesmaintainedbytheLibraryofCongress,tofindinformationaboutthechangesin
bankpresidentsbetween1882and1892forbanksinoursample.Weusedboththebanknames
andthepresidents’namestoobtaininformationaboutthereasonformanagerialturnover.Because
thesourcescoveredbythesedigitaldatabasestendtobebiasedtowardlargercities’newspapers
andnationalpublications,wewerenotabletofindinformationaboutmanyofthesemanagement
changes.Forthe137relevantturnovereventsinoursample,wefindinformationexplainingthe
reasonforthemanagementchangefor37oftheevents.For65oftheeventsforwhichinformation
waslacking,wewereunabletolocateanynewspapersfortherelevanttimeperiodandlocation.
For35oftheeventsforwhichinformationwaslacking,localnewspapersfortherelevanttime
periodwereavailable,butwewereunabletofindanystoryaboutthechangesinbankpresidents.
23Asweexplainfurtherbelow,forsomevariablesofinterest,managerialturnoverdoesnotsatisfythe
exclusionrestrictionsforavalidinstrument.
24
Managerialturnovergenerallywasassociatedwithclearlyidentifiableexogenousevents.In
the37caseswewereabletotrace,thecausesofturnoverincludeddeathorsevereillness(23
cases),electiontopublicofficeorothernewcareeropportunity(9cases),retirement(2cases),and
otherapparentlyexogenouscircumstances(onedepartureinthewakeofacashierembezzlement,
onebecauseofbusinessproblemsunrelatedtothebank,andonebecausethepresidentdeclined
re‐election).Wealsocheckedfornotablechangesintheconditionofthebanksasindicatedby
changesinthecapitalstockaroundthetimethepresidentchanged.Wefindnoevidencethat
changesincapitalsystematicallypreceded,followed,orwerecoincidentwithturnover.Inour
regressions,theturnoverinstrumentismeasuredasthenumberoftimesthePresidentofthebank
changedbetween1882and1892.InadditiontoreportingIVresults,wealsoreportnon‐
instrumentedOLSorprobitresultsforpurposesofcomparison,whichprovideestimates
interpretableonlyundertheassumptionsthatmanagerialownershipandcorporategovernance
choicesareexogenouslygivenwithrespecttotheotherendogenousvariablesweanalyze.
5.2.Corporategovernance,balancesheetcomposition,andrisktaking
WebeginouranalysisofHypothesis3inTables7and8byfocusingonmeasuresofrisk
fromtheliabilitysideofthebalancesheet.Withrespecttothecompositionofliabilities,we
examinebankrelianceontheuseofborrowedfunds,whichpreviousresearchhasshownisa
forecasterofbankdistress(CalomirisandMason,1997;2003;Carlson,2010).Borrowedfunds
weremoreexpensiveandhadtobesecured;useofthesefundssuggestsagreaterlevelofrisk.Due
todatalimitationsintrackingtheexactamountsofborrowedfunds,weuseaprobitspecificationto
testwhetherourownershiporgovernancevariablesareassociatedwiththeuseofsuchfunds.We
find,inTable7,thatbanksinwhichmanagersaremoresignificantownersarelesslikelytorelyon
borrowedfundsfromotherbanks.ThatresultholdsbothforsimpleprobitandIVspecifications.
Thesimpleprobitresultindicatesthatanincreaseinthemanagementownershipshareof10basis
25
points,roughlyhalfastandarddeviation,wouldhavereducedtheprobabilityofborrowingby0.05,
afairlysubstantialeffect.Theresultsforcorporategovernancehaveoppositesign,asexpected;
exogenousincreasesinformalcorporategovernanceareassociatedwithhigheruseofborrowed
money(heretheIVresultsarestatisticallysignificantbutthesimpleprobitresultsarenot).
Toeconomizeonthereportingofotherresultsrelatingtoriskchoice,oursubsequent
findingsforthreeotherendogenousvariablesmeasuringriskaresummarizedinTable8,which
omitsreportingthevariouscontrolvariablesandfocusesonthekeycoefficientsofinterest(the
relationshipamongmanagerialownership,governancescore,ortheirinstrumentedvalues,andthe
othervariablesofinterest).Theseresultscorroboratetheresultsforborrowedmoney.
Withrespecttousingmeasuresofriskbasedontheassetsideofthebalancesheettotest
Hypothesis3,weconsiderthecompositionofloans.Asnotedearlier,realestateloanswere
generallyconsideredtoberiskierandwereforbiddenbytheNationalBankAct,butbankscould
usemortgagestosecuredebtspreviouslyenteredinto.AsshowninTable8,whenmanagement
ownsmoresharesinthebank,thebanktendstohavefewermortgagesonitsbooks.Thisfindingis
statisticallysignificantbothinasimpleTobitregressionaswellasusingIV.TheTobitcoefficient
indicatesthataonestandarddeviationincreaseinownershipwouldhavedecreasedrealestate
loansasashareoftotalloansby1.2percentagepoints,asizeabledecreasegiventhat,onaverage,
realestateloansonlyaccountedfor3.6percentoflending.Governancescore(whether
instrumentedorotherwise)hastheoppositesign,asexpected,butisnotstatisticallysignificant.
Wealsoconsidertheexaminer’sassessmentofassetproblems,measuredbytheestimated
lossesonassetsrelativetototalassets.WereportinTable8thatgreaterownershipby
managementisassociatedwithlowervaluesofthatmeasure.Aonestandarddeviationincreasein
ownershipisassociatedwithareductioninestimatedlossestoassetsofabout0.7percentage
points–aconsiderablereductiongiventhatlossesaveragedontheorderof1.2percentofassets.
TheIVspecification,however,isnotstatisticallysignificant.
26
Interestingly,thereisanegativeassociationbetweengovernancescoreandestimatedasset
lossinthenon‐instrumentedspecification.Theexaminerreportsprovideabreakdownofsources
ofexpectedlossesornecessarywrite‐downs(suchasloanlosses,securitylosses,building
valuation,etc.).Weanalyzedthecompositionofexpectedlossesandfindthathigherexpected
losses/write‐downsrelatedtothecategory“fixturesandfurnishings”aretheprimarycontributor
tothegreaterexpectedlossesofbanksthatdisplaylowmanagerialownershipandlowcorporate
governancescore.Thatresultisintuitivelyappealing:excessiveexpendituresonfurnishingsarea
wasteful,value‐destroyinguseoffundsthatwouldnotbechoseninadisciplinedenvironment.
Withrespecttobanksurvival,Table8reportsthatincreasedownershipbymanagementis
associatedwithareducedlikelihoodthatthebankclosesbetweenOctober1892andDecember
1893(thebulkoftheclosuresoccurduringthePanicof1893).Whenmanagershadagreater
ownershipstake,theytooklessriskandwerethuslesslikelytosuccumb.Greateruseofformal
corporategovernancecreatesmoretoleranceforfailurerisk.
Wenowturntothequestionofhowownershipandgovernancestructurearerelatedto
greaterorlesserrelianceonparticulartoolsofriskmanagement(Hypothesis4).Thedefaultriskof
abankismainlydeterminedbythreevariables:theriskinessoftheriskyassets(loansandother
riskyassets),theratioof(riskless)cashassetstototalassets,andtheratioofequitytoassets.Less
riskyloans,ahigherratioofcashassets,orahigherequityratioallcontributetolowerrisk.Banks
cantradeoffamongthesethreemeasurestotargetthedesiredlevelofdefaultriskontheirdebts.
Ofcourse,inestimatingtherelianceoncash,otherfactorsarerelevantandmustbe
controlledfor.Inparticular,thestructureofdepositshasimplicationsforliquidityrisk—abank
thatismorereliantoncheckingaccountsthansavingsaccountsforitsfundingwillprobablyneed
toholdmorecash,ceterisparibus.Thus,weincludeadditionalcontrolsinouranalysisofthe
27
choicesofcashandequity,inparticulartheratioofindividualdepositstototalliabilitiesandthe
ratioofcheckingdepositstoallindividualdeposits.24
Theresults,presentedinTables9and10,showthatbankswithgreatermanagerial
ownershipprefertomakegreateruseofcashandlessuseofequitycapitaltotargettheirdefault
risk.Atbanksthathadmoreboardoversightofmanagement,capitalratiosweregenerallyhigher
andcashratiostendedtobelower,consistentwiththehypothesisabove.Aonestandarddeviation
increaseinmanagementownershipisassociatedwithareductioninthenetworthtoassetratioof
about3.5percentagepoints(themeanratiowas33percentagepoints)andanincreasethecashto
assetratioof0.5percentagepoints(themeanratiowas8percentagepoints).Theseare
economicallymeaningfulmagnitudes.
5.3.Corporategovernanceandinsiderrentseeking
HereweexploreHypothesis2–whethermanagerialownershipandformalgovernanceare
relatedtoinsiderrentseeking.Inparticular,welookatofficersalaries,lendingtoinsiders,and
(lower)dividendpaymentsaswaysthatinsidersmightseektoextractvaluefromthebank.
24Asnotedearlier,banksinReserveCitieswererequiredtoholdmorecashrelativetodepositsthanother
banks.WethereforeincludeanindicatorvariableforwhetherthebankislocatedinaReserveCity.The
resultsindicatethatbeinginaReserveCitydidboostcashholdingsslightly.Findingonlyamodesteffectis
consistentwithCarlson(2015)whofindsthatcashholdingswerenotverydifferentbetweenbanksinlarger
countrycitiesandbanksinthereservecities,asthebuffersheldbythecountrybanksweresubstantial.
Moreover,hefindsthatitwasnotuncommonforbankstoholdlesscashthanrequired,whichsuggeststhat
thereserverequirementswerenotstronglybinding.Forthesereasons,thesimpledummyvariablecontrolin
theregressionislikelysufficient.
28
TheOLSresults,showninTable11,areconsistentwiththatideaandindicatethatwhenthe
managersownmoreshares,theytendtopaythemselveshighersalaries,andwhengovernance
scoreishigh,managersreceivelowersalaries.
WedonotreportIVresultsformanagerialsalariesbecausewedonotbelievethatthe
necessaryexclusionrestrictionsaresatisfiedforusingtheturnoverinstrumentinthesalaries
regression.Turnoverofmanagementislikelytohaveadirectpositiveeffectonmanagerialsalaries,
becausetheneedtohireanewbankpresidentislikelytorequireattractingcandidatestothebank
quickly,sometimesfromadistance.
Anotherwayofextractingrentsfromabankisfortheownerstolendtothemselvesto
financetheiroutsideprojects.Therehasbeenconsiderableprioracademicanalysisofthisissue,
whichindicatesthatinsiderlendingisnotalwaysvalue‐destroyingorrisky(Lamoreaux,1994;
Haber,1995).Welookattwovariablesrelatedtoinsiderlending.Thefirstistheamountofloans
madetoallinsiders(boardmembersandmanagement)relativetoallloans.Thesecondisthe
proportionofallinsiderloansgoingtomanagers.
Interestingly,inregressionsnotreportedhere,wefindthatneithermanagerialownership
norBoardoversightareassociatedwiththetotalproportionofinsiderlending(definedtoinclude
loanstobothmanagersanddirectors).Wedofind,however,thatownershipandgovernance
structurestronglyinfluencewhoreceivesthoseinsiderloans(Table12).Atbanksinwhichthe
managementownedagreaterproportionofthestock,agreaterfractionofinsiderloanswenttothe
management.Aonestandarddeviationincreaseinmanagementownershipincreasedtheinsider
shareofloansgoingtomanagersby7.5percentagepoints.Giventhatofficers,onaverage,received
37percentofinsiderloans,thiseffectofownershipisconsiderable.Whenthereweremore
corporategovernancecontrols,moreoftheinsiderloansweremadetotheoutsidedirectors.
Withrespecttodividends,wefind,intheOLSresultsreportedinTable13,thatwhenmore
sharesareownedbymanagers,dividendpaymentsarehigher.Whilethisfindingisconsistentwith
29
theideathatinstitutionswithhighermanagerialownershipprovidegreaterpayoutstoowners,itis
alsoconsistentwiththeideathattheseinstitutionsaremoreprofitable.WedonotreportIV
resultswithrespecttodividendpaymentbecause,asinthecaseofmanagerialsalaries,wedonot
believethattheexclusionrestrictionsfortheinstrumentaresatisfied.Totheextentthatmanagerial
turnoverhasatemporaryeffectonbankperformance,itmayaffectdividendsdirectly.25
Takentogether,ourresultsregardingsalaries,insiderlending,anddividendpaymentsare
consistentwithHypothesis2.Whenmanagersownagreaterfractionoftheequitysharesofthe
bank,theyextractgreaterrentsfromthebankthroughhighersalariesandmoreloansto
themselves,althoughmanagerspreferhigherdividendpayments,whichthey,asmajor
stockholders,benefitfrom.Similarly,theresultsongovernancescoresshowthatstronger
oversightbytheBoardofDirectorstendstobeassociatedwithlessrentextractionbythemanagers
butsomewhatgreaterextractionbytheoutsidersontheBoard(insiderlendingbecamedirected
moretowardtheoutsidersontheBoard).
5.4.Corroboratinganecdotalinformation
Intheprevioussections,wefindthathighmanagementownershipisassociatedwithsafer
assetportfoliochoices,lowmanagementownershipisassociatedwithriskierportfoliosand
managerrentseeking,andstrongcorporategovernanceappearstoreducerentseeking.These
25TheNationalBankingActprohibitedbanksfrompayingdividendsiftheywereexperiencinglossesthat
exceededtheirundividedprofits(i.e.lossesthatwoulderodethebank’ssurplus).Aswenotedearlierthat
bothbankswithgreatermanagementownershipandwithstrongergovernancehavelowerlosses,wemight
haveexpectedbothownershipandourgovernancemeasuretoincreasethelikelihoodofdividendpayments.
Thatwefindgreaterinsiderownershipincreasesthelikelihoodofdividendpayoutsbutmoreformal
governancedoesnotsuggeststhatourresultsmainlyreflectmanagerialbehavioraldifferencesratherthan
exogenousdifferencesinprofitability.
30
findingareconsistentwithanecdotalinformationintheexaminerreports.Forexample,inone
bankwithhighownershipandstronggovernance,theexaminerreportedthat:“Thisisavery
conservativebankandloansanddiscountsonlywheretheybelievethattheyareperfectlysafe.I
candiscernnopoorpaperinthebank.26”
Moreover,wefindexamplesofexaminerexpressionsofconcernaboutbankswithlow
managerownershipandlowgovernancescores:
Itscapitalisbadlyimpaired…Itisshamefulandwickedthatsomuchmoneyshould
befooledawayinsoshortatimeandprovethefollyofhavingrealestate
speculatorsasmanagersofbankinginstitutions.27
and
Thegeneralconditionofthebankisgoodexceptingthattheofficersareusingtoo
muchofthebank’smoneywithoutsecurity,loaningtoomuchtotheBankofEverett
andusingtoomanydevicestomakeagoodshowing.28
Theseareparticularlyaptexamplesofthesortsofbehaviorsweidentifyinthe
empiricalanalysis.Moregenerally,inreviewingtheanecdotalinformation,wefindthat
theretendedtobemoreconcernsaboutbankswithlowmanagementownershipandlow
governanceandfewconcernsaboutbankswithhighownershiporgovernance.
6.Robustnessandextensions
Herewediscussavarietyofrobustnesschecksandextensionsofthebaselineanalysis.
6.1.Consideringinteractionsbetweenownershipandgovernancechoice
Ourfirstextensionistore‐runourregressions,allowingbothstockownershipstructure
andcorporategovernancetoenterasendogenousvariablesinthesameregressions.TheIVresults
26ExaminerreportofJanuary7,1893fortheLumberman’sNationalBank,Stillwater,MN,charter1783.
27ExaminerreportofDecember28,1892fortheWashingtonNationalBankofTacoma,WA,charter4018.
28ExaminerreportofMarch1,1893fortheColumbiaNationalBank,Tacoma,WA,charter4623.
31
reportedthusfartreatthetwoendogenousvariablesasalternativemeasures,reflectingourview
thatconcentratedownershipandformalgovernancearealternativemeansofensuringgood
management,andthattheyarenegativelycorrelatedchoices.Toconsiderpossibleinteractions
betweentheownershipconcentrationandformalgovernancerequirestheidentificationofa
secondinstrument.Onecandidateisthedegreeofcompetitivepressurefacedbythebank,which
wecapturewiththenumberofotherbanks(national,state,savings,andprivate)operatinginthe
samecityasthesubjectbank.Althoughusingbothmanagerialturnoverandcompetitivepressure
resultedinqualitativelyencouragingfirst‐andsecond‐stageresults,theinstrumentswerenot
powerfulenoughtoyieldstatisticallysignificanteffectsinsecond‐stageregressionsthatincluded
bothownershipconcentrationandformalgovernancechoiceasendogenousvariables,andwedo
notreportthoseregressionresultshere.
Asasimplerapproachtoinvestigatingtheinteractionsofownershipconcentrationand
governancechoice,wedividebanksintofourgroups,usingatwo‐by‐twomatrixthatmeasures
eachbank’scombinationofmanagerialownershipandformalcorporategovernancescore.Thefour
groupsaredefinedas(1)high‐managerialownershipandhigh‐formalgovernancescorebanks,(2)
high‐managerialownershipandlow‐formalgovernancescorebanks,(3)low‐managerialownership
andhigh‐formalgovernancebanks,and(4)low‐managerialownershipandlow‐formalgovernance
banks.Thisapproachalsohelpsassureusthatourearlierresultswerenotdrivenbyoutliersinour
concentrationmeasure.OurfindingsforthesegroupsarereportedinTable14.
Asexpected,thefourthgroup(whichlackseitherahighdegreeofmanagerialownershipor
formalgovernance)isriskierthantheotherthree.Thisgroupwasmorelikelytouseborrowed
funds,moreheavilyinvestedinrealestateloans,andhadgreaterexpectedlossesthantheother
groups.Furthermore,thesebanksdisplayhigheroperatingcosts,whichamoregranularanalysis
showsistheresultofunusuallyhighspendingonbankfurnishings(aformofmanagerial
perquisities).
32
Severalotherfindingsarealsoconsistentwithourearlierresults.Forinstance,theratiosof
managerialsalariestoassetsandofloanstomanagersrelativetoallinsiderloansaresignificantly
greateratbanksinwhichmanagementownershipishigherandformalcorporategovernanceis
lowercomparedtobankswithlowmanagerialownershipandhighformalgovernance.The
averageratioofcashtoliabilitiesishigherwhenformalgovernanceislow.Networthtoasset
ratiosarelowerforthetwogroupswithhighmanagementownershipthantheothertwogroups.
6.2.Differentcomponentsofgovernancescore
Wealsoexaminedtheseparateroleofeachofthecomponentsofthegovernancescoreused
above.Specifically,wetestedwhetherourresultsrelatingtothecorporategovernancescoreare
drivenbyoneortwoofthefiveindividualindicatorsbyrepeatingtheregressions,replacingthe
scorevariablewitheachcomponentinturn.Inmanycases,wefindthatthecoefficientsonthe
individualcomponentstendtopointinthesamedirection,whichsuggeststhattheoverallresults
areindeeddrivenbythesummationofthesedifferentmeasures.Forexample,wefindthatthe
reductioninlossesrelativetoassetsismoststronglyassociatedwithhavinganactivediscount
committeeandwithhavingabondedcashier;therelationshipwiththeothergovernancemeasures
alsopointinthatdirectionbuttheeffectsaresmaller.Mostothervariablesbehavesimilarly.
Forafewmeasures,therelationshipbetweenoversightandoutcomesismorecomplicated.
Fortheuseofborrowedfunds,havingtheboardmeetmonthlyormorefrequently,havinga
relativelyhighportionoftheBoardconsistingofoutsidedirectors,andrequiringabondfromthe
cashierareallassociatedwithanincreasedlikelihoodofusingborrowedfunds.Bycontrast,having
anactivediscountcommitteeandrequiringabondfromthepresidentarebothassociatedwitha
lowerlikelihoodofusingborrowedmoney.Thus,thereissomeindicationthatthedifferent
oversightmeasurestriggereddifferentresponsesonthepartofmanagersinsomecases.
33
6.3.Examiningexecutivecompensationschemes
Managerswerepaidsalaries,andthereisnoevidenceofstock‐based,option‐based,orcash
bonusesinmanagerialcompensation.Nevertheless,weareabletoconsiderhowmanagerial
incentivesmayhavebeeninfluencedbytheextenttowhichtheincomeofthemanagercovaried
withthebank’sincome.Themanagerreceivedasalaryaswellasdividendpayoutsbyvirtueofhis
ownershipofshares.Anumberofrecentstudiesfindthatcompensationsensitivitytofirm
performancemattersforrisktakingandthatwhentheexecutive’ssalaryismoresensitivetorisk–
inourcase,whenitismoredependentondividends–thebank’sinvestmentstendtoberiskier(Bai
andElyasiani2013;Cheng,HongandScheinkman2013).Forthisanalysis,wefocusontheincome
ofthepresident.
Wefindthathavingahigherproportionofthepresident’scompensationintheformof
salary(ratherthandividends)isassociatedwithhavingahigherproportionofloansrelatedtoreal
estateandhavinglargerforecastedlosses.Theseresultspointtogreaterrisktakingwhen
compensationislessduetoprofits.Ofcourse,theseresultsaresubjecttoconcernsabout
endogeneity;havinglargerexpectedlossespresumablyreducesprofitsanddividends,which
increasestheproportionofcompensationduetosalary.
6.4.Alternativemeasuresofoutsidedirectorinfluence
Ourmeasureofoutsidedirectorownershipconsidersalloutsidedirectorstogether.
However,itispossiblethattheeffectsofboardoversightdependontheamountofsharesthat
particularboardmembersown.Toinvestigatethatpossibility,wecreateadummyvariable
indicatingwhenthereisanoutsidedirectorwithmoresharesthananyofthetopthreemanagers
(individually,notcollectively).Suchanoutsidedirectorexistsforabout20percentofthebanksin
oursample.
34
WhenadirectorwithalargenumberofsharesisontheBoard,wefindthatthepresenceof
suchanindividualtendstomagnifythepriorresultofgreaterrisktaking.Forinstance,thebank
tendstohavegreatersharesofloansrelatedtorealestate.Thetendencyforgreaterrisktaking
appearstobeconsequentialasbankswithlarge‐shareholdingdirectorsalsoaremorelikelytoclose
duringthepanic.
6.5.Additionalcontrolvariables
Wealsotriedincludingavarietyofothervariablesascontrols.Onesuchvariablewasthe
averagescoreforbanksinthesamecity,whichmightreflectthebestpracticeoftheneighboring
banks.Thisvariabletendedtohavethesamecoefficientasthebank’sownscorevariable.
Includingitdidnotaffecttheresultsaboutwhichwearemostinterested.
Asanalternativetocontrollingforspecificfactors,wealsoreplacedourcontrolswithstate
fixedeffects,whichprovideamoregeneralcontrolforthingsthatmightbelessobservable(suchas
differencesintheabilityofstatebankstoofferservicesprohibitedtoNationalbanks).Usingfixed
effectsalsohaslittleeffectontheownershipstructureorcorporategovernanceregressions.
Wealsotriedincludingthesquareoftheownershipbythetopthreemanagersincasethere
werediminishingreturnstoownershipconcentration.Thisvariablealsodidnotaffectourmain
resultsandwaslargelyinsignificant.
7.Conclusion
Ourresultshaveinteresting,important,andnovelimplicationsforhowgovernance
differenceshelpbankstoattractoutsidefundingsourcesinanenvironmentinwhichconflictsof
interestareimportant.Wefindthatmanagerialownershipandformalgovernancetoolsare
alternativemeanstoresolveconflicts.Eachofthesealternativeshasimportantandsomewhat
differentimplicationsforrentseeking,thetargetingofdefaultrisk,andthetoolsused(cashvs.
35
equity)toachievethetargetedlevelofdefaultrisk.Moreconcentrationofownershipleadstoless
formalstructuresofgovernance,moreinsiderbenefitsthroughloansandsalaries,moredividend
paying,lessrisktaking(presumablyduetoriskaversionofmanagerstockholders),andmore
relianceoncash(toresolveasset‐substitutionandadverse‐selectionproblems).Ourfindingson
howmanagerialownershipaffectsrisktakingareausefulcomplementtotherecentliteratureon
theimpactofmanagerialincentives.Endogenouslychosenformalgovernancestructuresproduce
greaterrisk,andmorerelativerelianceoncapitalforriskmanagement,butlowermanagerial
salaries.
Theselatterfindingsaregenerallyconsistentwiththeliteratureonthevalueofcorporate
boardscurrently(JohnandSenbet,1998,HermalinandWeisbach,2003).Someofourotherresults
contrastwithcurrentexperience.Theexpansionofthesafetynetandtoo‐big‐to‐failprotectionhas
beenassociatedwithadramaticdeclineinbanks’holdingsofcashassetsasaproportionoftotal
assets.Furthermore,recentexperiencesuggeststhatthedisciplineofoutsidestockholders
(institutionalblockholders)ofbankstockhasbeenassociatedwithgreaterrisktakingbyprotected
banks,whichhasbeeninterpretedasameansofmaximizingtheputoptionvalueofgovernment
protection(LaevenandLevine,2009).Thedeclineofcashandincreasedtoleranceforriskby
blockholdersofbanksthatenjoysafetynetprotectioncontrastwiththebehaviorofhistorical
banks,whichemployedcashaspartofacrediblestrategytosignaleffectiveriskmanagement,and
whichweresubjecttobothdepositordisciplineandeffectiveoversightbyoutsidestockholders
whousedcorporategovernancetoolsasameansoflimitingbankrisk.
Insummary,therearetwokeycorporategovernanceproblemsthatariseinbanking:
managerialrentextractionthroughsimpletransfers(highsalariesandsubsidizedloansto
managers)andthepossibilityofmanagers’undertakingexcessiverisk.Highmanagerialownership
withoutformalcorporategovernanceaddressesthesecondoftheseproblems,butpermitsgreater
managerialrentextractionthanwouldoccurundermoreformalcorporategovernancepractices.
36
Thatoutcomemaybepreferredbythemanagerswhoorganizebanks(i.e.,ifthepotentialrents
fromexpandingthesizeofthebankarelimited).If,however,managerswishtoexpandtheir
enterprisestoascalethatislargerelativetotheirmanagerialstakesinthebank,thenformal
corporategovernanceislikelytobecomenecessary.Theformalapproachtogovernanceresultsin
highertoleranceforrisk(reflectingthegreaterdiversificationofholdingsofbankstock)anda
reductionintherentsthatbankmanagersareabletoextractthoughhighsalariessubsidized
lending.Inthepresenceofformalgovernance,managerssharetheirprivilegedaccesstobankloans
withoutsidedirectors.
37
Appendix
A.1.AModelofEndogenousAsymmetricInformationandCorporateGovernance
Webeginwiththesimplestpossiblemodelofcorporategovernancechoice,inwhichthe
assetsofthebankconsistentirelyofloansandthefinancingofthebankconsistsonlyofstock.We
relaxtheseassumptionssubsequently,andshowthatthecentralimplicationsofthemodel–thatis,
thathighermanagerialwealthtendstoreducetherelianceonformalcorporategovernance–also
holdwhenweallowfordepositfinancingandtheholdingofcashassets.
Abankerisendowedwithwealth(E)andlendingopportunities(agivennumberof
profitablepotentialloansthathemightundertake).Eachloanisnormalizedtobeofidentical,
unitarysize.Thenumberandamountofloansmade,X,isbetween0andXmax.Forsimplicity,we
assumethatthebankholdsonlyloansandisfinancedentirelybyequityprovidedbythebanker
andoutsideinvestors(thereisnobankdebt).Themanager’sequityshareofthebank,m,is
thereforeE/X.Whenweadddepositliabilitiesandcashassetstothemodel–asinCalomiris,
Heider,andHoerova(2014)–themainconclusionsofthemodelarethesame,butadditional
conclusionsfollowwithrespecttotheroleofcashinincentivizinggoodriskmanagement.
Interestingly,inthisframework,cashplaysanimportantroleinincentivizinggoodrisk
managementwhetherornotoutsiderfinancingisintheformofdebtorequity.Thiswarrants
emphasis:unlikethediscussionofJensenandMeckling(1976),theproblemofriskshiftinginthis
modelisaconflictbetweentheinsider/managerandalloutsidefundingsources,notjustdebt
holders.29Inthesimplifiedmodel,bankmanagersfaceincentivestoincreaseriskinvalue‐
29Inthemodelpresentedinthisappendix,theoutsideequityinvestoreitherbecomesaninsiderbybeing
invitedtoparticipateingovernance,orremainsuninvolvedingovernanceknowingthatthebankerwill
investinriskmanagementduetoasufficientlyhighlevelofm(thebanker’sproportionofownership).
Calomiris,Heider,andHoerova(2014)showthat,intheirmodel,theoptimalcontractforinvestorswho
remainoutsiders(andthereforearenotabletocontrolriskmanagement)wouldbeseniordepositsinabank
38
destroyingways(so‐called“assetsubstitution”or“riskshifting”)eventhoughdebtfinanceis
absent.Minorityshareholders,likecreditors,haveaninterestinensuringproperriskmanagement
bybankmanagers,whichcaneitherbeachievedthroughhighermanagerialstakesinthebankor
formalcorporategovernance.
Outsideequityisprovidedbyasingleoutsideinvestor.Theoutsideinvestorandthebanker
arerisk‐neutralandhaveidenticalreservationreturnsofR,whichrepresentsthegrossreturnthey
couldearnonanalternativetolending.Theloanopportunitiesofthebankerareworthpursuing,
butonlyifthebankerinvestshisowneffortinriskmanagement.Onecanthinkofthisinvestmentin
riskmanagementasthebanker’scontinuingperformanceofduediligence,monitoring,and
enforcementofloancovenants.Riskmanagementeffortisprivatelycostlytothebanker;itentails
disutilityequaltoBX.Withriskmanagement,loansearnacertainreturnofY>R.Withoutrisk
management,loansearnYwithprobabilitypand0withprobability(1‐p).Withoutrisk
management,loansarenotworthwhileinvestmentsbecausepY<R.
Theobservabilityofriskmanagementdependsonthecorporategovernanceenvironment
chosen.Ifthebankerchoosestoincludetheoutsideinvestorinthegovernanceofthebank,then
riskmanagementisobservableandcontractible.Ifthebankerchoosesnottoincludetheoutside
investorinthegovernanceofthebank,thenriskmanagementisamatterofprivateinformation
onlyobservedbythebanker.
withcashreservesaswellasloans.Thekeydifferencesinassumptionsbetweenthatmodelandthe
simplifiedonepresentedherearetheavailabilityofasinglelargeoutsideinvestor(assumedhere)andthe
possibilityofestablishingoversightofriskmanagementbythatoutsideinvestor.Calomiris,Heider,and
Hoerova(2014)assumethatoutsideinvestorsarefragmented.Theirsolutiontoincentive‐compatiblerisk
managemententailstheuseofdepositsandcashreserveholdings.Inasmallbank,withasinglelargeoutside
investor,andthepossibilityofdirectmonitoringofthebankerbythatoutsideinvestor,depositorwithdrawal
threatsandidlecashholdingsarenotnecessarytoachieveefficientriskmanagement.
39
Thebanker’s“salary”(S)isaformofrentextraction,whichisendogenoustothecorporate
governancechoiceofthebanker.Ifthebankerdoesnotincludetheoutsideinvestorinthe
governanceofthebank,thenhewillsethissalarysuchthattheoutsideinvestorreceivesonlythe
reservationreturnR.Ifthebankerincludestheoutsideinvestorinthegovernanceofthefirm,then
hemustsharetherentsfromlendingaboveRwiththeoutsideinvestor.Theprecisedegreeofthat
sharingshouldreflect,inamorerealisticmodelofthemarketforoutsidefunding,thecompetition
amongoutsideinvestorstosupplyfundstothebank.Inourmodel,wesimplyassume,withoutloss
ofgenerality,thatthebankerandoutsideinvestorsplittherentsevenlywhentheoutsideinvestor
isincludedincorporategovernance.
Aswewillshow,inequilibrium,becauseriskmanagementisprivatelycostlytothebanker,
withoutoutsideinvestorinvolvementincorporategovernance,thebankerwillhavetolimitthe
sizeofthebanktoX*.Withoutsiderinvolvementincorporategovernance,thebankercansetthe
sizeofthebanktoXmax.Thus,thebankertradesoffthebenefitofgreaterrentsthatcomewith
largerbanksize(whichisonlyfeasibleifheincludestheoutsideinvestorinthegovernanceofthe
bank,andsharestherentsfromlendingwiththeoutsideinvestor)againstthecostofsharingthe
rentsoflendingwiththeoutsideinvestor.
X*isdeterminedbytheincentive‐compatibilityconstraintforthebankertoinvestinrisk
managementintheabsenceoftheinvolvementoftheoutsideinvestoringovernance.Without
outsiderinvolvement,thebankerwillchoosetoinvestinriskmanagementonlyifthepayofftohim
fromdoingsoexceedsthepayofffromnotdoingso.Thisiscapturedbytheexpression:
SX+m(YX–SX)–BX>p[SX+m(YX–SX)].
(1)
Recallthatm=E/X.X*isthemaximumfeasiblelevelofXatwhichthisequationissatisfied
(thatis,wheretheequationissatisfiedasanequality,inwhichthebankerisindifferenttoinvesting
inriskmanagement).X*alsoimpliesauniqueminimumvalueofm*.
m*=E/X*={[B/(1‐p)]–S}/(Y–S). 40
(2)
Asthisexpressionshows,thecriticalvaluesofm*andX*dependonS.Swillbechosento
transferallrenttothebanker,leavingtheoutsideinvestorearningonlythereservationlevelof
return,R.Inotherwords,Sischosenbythebankertosatisfythefollowingexpression,whichisthe
participationconstraintfortheoutsideinvestor:
(X–E)R=(1–m)(YX–SX).
(3)
(4)
ThisexpressionreducestoS=Y–R.
Thus,theconditiondeterminingthecriticalvalueofm*canberewrittenas:
m*={[B/(1‐p)]–(Y–R)}/R. Thisexpressioncanbeusedtoperformcomparativestaticanalysisofm*withrespecttodifferent
valuesofp,Y,andR.Inparticular,itcanbeshownthatahigherYimpliesalowervalueofm*.
Intuitively,whenrentsarehigher,thebankerisabletocrediblypledgetoinvestinrisk
management,withoutoversight,withalowerminimummanagerialstakem*.
Whetherthebankerwillchoosenottoincludetheoutsideinvestoringovernance(and
operatethebankatthelevelofX*)ortoincludetheoutsideinvestoringovernance(andoperate
thebankatXmax)dependsonhowmuchthebankerreceivesundereachofthosealternatives.Recall
that,iftheoutsideinvestorisincludedincorporategovernance,hewillsplittherentswiththe
banker,andtherefore,boththebankerandtheoutsideinvestor/directorwilleachearnanidentical
“salary”ofS=(Y–R)/2.
Ifthefollowingconditionissatisfied,thebankerwillearnmorebychoosingtoincludethe
outsideinvestoringovernanceandoperatethebankatXmax:
ER+Xmax(Y–R)/2>ER+X*(Y–R). (5)
SolongasXmax>2X*,thisconditionissatisfied.Notethat,inanycomparativestaticcalculation,Y
affectsthegovernancedecisiononlyindirectlythroughthepositiveeffectofYonX*(i.e.,dX*/dY>0,
implyingthat,ceterisparibus,higherYmakesitlesslikelythatoutsideinvestor’swillbeinvitedto
participateingovernance).
41
Theabovemodelhasclearimplicationsforcorporategovernancedecisionsandtheir
consequences.Dependingonthesizeofrentsperloan,andthenumberofloansavailabletothe
banker,hewilldecidewhethertorunthebankwithnooutsideoversightortoincludetheoutside
investorinoversight.Iftheoutsideinvestorisincludedinoversight,then“asymmetricinformation”
and“assetsubstitutionrisk”willbeeliminated,andthebanker’ssalarywillbelower,asheisforced
tosharerentwiththeoutsideinvestor.
A.2.Addingcashassetsanddepositstothemodel
Themodelcanbeextendedtoallowbankerstochoosetoholdcashinacredibleand
observableform.Ifcashassetsareaddedtothemodelwithoutalsoallowingforseniordeposit
claims,cashholdingswouldservenopurpose.Toseewhy,considertheeffectonequation(1)of
bankcashholdings,C.Becausecashisriskless,thebankerwillreceive,inadditiontothepayoffs
describedinequation(1),anamountmCirrespectiveofwhetherthebankerundertakesrisk
management.Thus,cashhasnoeffectonthebanker’sriskmanagementeffort.
AsCalomiris,Heider,andHoerova(2014)pointout,however,outsiderfinancingviaequity
isnotgenerallytheoptimalcontractunderthesecircumstances.Bygivingoutsidersaseniorclaim
onthecashflowsofthebank,thebankerensuresthatwhenriskisnotmanagedproperly,and
whenlowpayoffsoccur,outsiderswillreceiveallofthecash,notjust(1‐m)C.Thuswhenoutsider
financingispartlyintheformofdeposits,andbankersareabletoholdcash,bankersareableto
committoproperriskmanagementbyholdingasufficientamountofcashassets.Depositsandcash
affectriskmanagementbecause,unlikeoutsideequityfinancing,depositfinancingdoesnotdilute
theupsideofthebanker’sprofit,andunlikeoutsideequityholders,depositsreceiveallofthe
bank’scashassetswhenthebankerchoosesnottoinvestinriskmanagementandthebadoutcome
occurs(withprobability1‐p).
42
Amorerealisticmodel(whichwouldhavetobemuchmorecomplicatedthateitherthe
frameworkpresentedhere,orthatofCalomiris,Heider,andHoerova,2014)couldallowforboth
depositsandoutsideequitysourcesoffunding.AsCalomiris,Heider,andHoerovaconjecture,such
amodelcouldsolveforaninteriorsolutionfortheoptimalmixofoutsidefunding.Insuchamodel,
themarginalcostofrelyingmoreonoutsideequityisthemarginalcostofcorporategovernance
improvementstomakeriskmanagementdecisionsobservabletothemarginaloutsideequity
holders,whilethecostofrelyingmoreonseniordepositsistheopportunitycostofcashholdings.
Bankersthatchoosemoreinformalcorporategovernancewilltendtorelymoreonoutsideequity
fortheiroutsidefinancing,andwillholdasmallerfractionoftheirassetsincash.Inourempirical
results,wetest,andconfirm,thosepredictions.
43
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48
Table1
Summaryofanalysis
Hypothesis1
Exogenousinfluencesthatincreasemanagerialownership=>Reducerelianceonformal
governance
Explanation:Whenmanagerialstakesarehigher,thereislessneedforformalgovernanceto
constrainmanagerialbehaviortowardrisk.
Dataanalysis:Managementownershipisinstrumented(hereandthroughout)byexogenous
turnoverevents.Formalgovernanceismeasuredbythefrequencyofboardmeetings,thenumber
ofoutsidedirectorappointments,theexistenceofanactivediscountcommittee,andthebondingof
bankofficers.
Hypothesis2
More(exogenous)managerialownership=>Highermanagers’salaries,moreloanstomanagers,
higherdividends
Explanation:Whenmanagershavemoreownership,thereislessformalgovernanceandtherefore
managersenjoygreatercontrol.Theypaythemselvesmoreandgivethemselvesgreateraccessto
loans.Whentheyarelargestockholders,managersalsohavestrongincentivestopaydividends.
Dataanalysis:Managers’salaries,thefractionofloansthatwerelenttomanagers,andtheratioof
dividendstopaidincapitalareanalyzedasdependentvariables.
Hypothesis3
More(exogenous)managerialownership=>Lessrisktakingbythebank
Explanation:Whenmanagerialstakesarehigher,managerswillbemorerisk‐aversebecausethey
areundiversifiedjuniorclaimantsonthebank.
Dataanalysis:Risktakingismeasuredbytheuseofhigh‐cost“borrowedmoney”tofinancethe
bank,aswellasbythefractionofrealestateloanstototalloans,theexaminer’sestimatesoflosses
relativetoassets,andbytheriskofbankclosure.
Hypothesis4
More(exogenous)managerialownership=>Moreuseofcashratherthanequitytoreducedefault
risk
Explanation:Cashisusefultoensuremanagerialeffortinriskmanagement.Morecashreduces
managerialincentivestoshirkinriskmanagementandtherebyprotectsdepositorsandoutside
shareholdersfromriskshiftinginbadstates.Thisprotection,however,islessnecessarywhenrisk
managementissubjecttooversightduetothepresenceofformalgovernance.
Dataanalysis:Bankschoicesofcash‐to‐assetsratioandequity‐to‐assetsratioareanalyzedas
dependentvariables.
49
Variable
Management
ownership
Source
Boardmeetsmonth
Examreport
Examreport
Outsidedirectorson
Examreport
board
Activediscount
Examreport
committee
Table2
Listofvariables
Description
Theshareofstockownedbythetop3bankmanagers
–thepresident,vicepresident,andcashier
Indicatorvariablefortheboardofdirectorsmeeting
monthlyormorefrequently
Theshareoftheboardofdirectorsthatconsistedof
individualsthatwerenotmanagers
Indicatorvariableforhavinganactiveindependent
discountcommittee
Presidentbonded
Examreport
Presidentpostedasuretybond
Cashierbonded
ExamReport
Cashierpostedasuretybond
Score
Derived
Sumofgovernanceindicators
Turnover
Examreports&
bankersmagazine
Numberofchangesinthepresidentbetween1882
callreportand1892callreport
Logassets
CallReport
Logofassets.
Logage
Comptroller&
RandMcNally
Logofthedifferencebetween1892andthetimethe
bankwasestablished.
Salariestoassets
Examreport
Ratioofsalariesof3officerstoassets
Officersloansto
insiderloans
Examreport
Dividendstoshares
Examreport
Usedborrowed
funds
Realestateloansto
totalloans
Otherrealestate
ownedtoassets
Troubledloansto
totalloans
Examreport&call
report
Ratioofloansmadetotop3officerstoloanstoall
insiders(managersandboardmembers)
Ratioofdividendspaidatlastpayouttoshares
outstanding(dollarspershare)
Indicatorthatthebankborrowedusinginterbank
certificatesofdeposit,rediscounts,orbillspayable
Examreport
Ratioofloanssecuredbyrealestatetototalloans
Callreport
Ratioofotherrealestateownedtoassets
Lossestoassets
Examreport
Examreport
Loanlossestoassets Examreport
Otherlossesto
Examreport
assets
Losseson
Examreport
furnishingstoassets
Individualdeposits
Callreport
tototalliabilities
Ratioof“troubled”loans– thosepastdueor
suspended–tototalloans
Ratiooftotallossesonallbalancesheetitemsas
estimatedbytheexaminerrelativetoassets
Ratiooflossesonbadloans,otheroverduepaper,
otherloansandoverdraftstoassets
Ratiooflossesonsecurities,bankhouse,furnitureand
fixtures,otherrealestate,cash,andothertoassets
Ratioofrequiredwrite‐downsonfurnitureand
fixturestoassets
Shareofliabilitiesconsistingofdepositsby
individuals
50
Checkingdepositsto
Examreport
individualdeposits
Shareofindividualdepositsconsistingofchecking
deposits
Ratioofcapital,surplus,andundividedprofitsto
assets
Networthtoassets
Examreport
Cashtoassets
Examreport
Cashandlegaltendertoassets
Closed
Comptroller
reports
Indicatorthatthebanksuspended,failed,voluntarily
liquidatedafterfilingtheSept.1892callreportbut
beforeJan1,1894.
Reservecity
Comptroller
reports
Indicatorthatthecityisareservecity
Logcitypopulation
1890Census
Logofcitypopulation(citypopulationisnotavailable
forElPaso,TXsocountypopulationisused)
LogdistanceinmilestoNY
LogdistancetoNew
York
Fractioncounty
incomefrom
agriculture
Mininginstate
StatisticalAbstract
oftheUSfor1892
Valueofagriculturalproductsinthecountydividedby
thesumofthevalueofagriculturalproductsandthe
valueofmanufacturing
Thestateminedmorethan$1millioningoldand/or
silverin1891.
OldState
Statehoodoccurredpriorto1851
1890Census
51
Table3
Summarystatistics
Variable
Mean Median
Std.
Dev
Min
25th
percentile
75th
percentile
Max
Management
ownership
0.24
0.17
0.23
0.01
0.08
0.37
0.97
Boardmeetsmonth
0.63
1
0.48
0
0
1
1
0.69
0.71
0.13
0.20
0.60
0.78
0.94
0.60
1
0.49
0
0
1
1
Presidentbonded
0.33
0
0.47
0
0
1
1
Cashierbonded
0.57
1
0.50
0
0
1
1
Score
2.69
3
1.56
0
1
4
5
Turnover
0.67
0
0.81
0
0
1
3
Logassets
14.1
14.1
0.8
12.0
13.5
14.7
15.9
Logage
2.42
2.40
0.74
0.69
1.79
3.14
3.43
0.59
0.46
0.45
0.02
0.33
0.69
3.61
36.7
34.4
29.4
0
8.1
56.2
100
Dividendstoshares
4.7
4
6.2
0
3
5
50
Usedborrowedfunds
0.31
0
0.46
0
0
1
1
3.6
1.1
6.1
0
0
1.2
11.2
0.9
.1
1.6
0
0
1.2
11.2
9.1
5.9
9.9
0
2.5
12.4
71.8
1.2
.2
3.8
0
0
1.1
32.1
.95
.10
3.05
0
0
.85
28.6
0.27
0
0.96
0
0
0.15
11.3
Outsidedirectorson
board
Activediscount
committee
Salariestoassets
(percent)
Officersloansto
insiderloans
(percent)
Realestateloansto
totalloans(percent)
Otherrealestate
ownedtoassets
(percent)
Troubledloanstototal
loans(percent)
Lossestoassets
(percent)
Loanlossestoassets
(percent)
Otherlossestoassets
(percent)
52
Individualdepositsto
totalliabilities
Checkingdepositsto
individualdeposits
Networthtoassets
(percent)
Cashtoassets
(percent)
0.70
0.72
0.17
0.20
0.57
0.85
0.97
0.74
0.77
0.20
0.18
0.61
0.91
1
32.9
30.7
12.7
8.5
24.1
39.9
76.1
7.9
7.6
3.6
0.3
5.0
9.8
20.3
Closed
0.29
0
0.45
0
0
1
1
Reservecity
0.37
0
0.48
0
0
1
1
Logcitypopulation
11.0
10.8
0.45
8.2
10.3
11.9
12.6
7.07
7.05
0.45
6.35
6.76
7.40
7.81
0.25
0.12
0.27
0.02
0.07
0.36
0.96
Mininginstate
0.21
0
0.41
0
0
1
1
Oldstate
0.55
1
0.50
0
0
1
1
LogdistancetoNew
York
Fractioncounty
incomefrom
agriculture
Note.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
53
Table4
Correlationofmeasuresofownershipandofcontrol
Management
ownership
Boardmeets
atleast
monthly
High%
Outsiderson
Board
Active
discount
committee
President
bonded
Cashier
bonded
‐0.23
‐0.44
‐0.25
‐0.15
‐0.22
0.20
0.33
0.08
0.15
0.25
0.22
0.20
0.24
0.43
Boardmeetsat
leastmonthly
High%Outsiders
onBoard
Activediscount
committee
Presidentbonded
Note.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
54
0.50
Table5
Determinantsofthecorporategovernancescore
Score
‐1.88***
Managementownership
(0.44)
‐0.35***
Logage
(0.13)
.30
Reservecity
(0.33)
0.001
Logcitypopulation
(0.18)
‐1.04***
LogdistancetoNYC
(0.33)
‐0.06
Fractioncountyincome
fromagriculture
(0.51)
.35
Mininginstate
(.31)
.63**
Oldstate
(.24)
11.65***
Intercept
(3.03)
206
Observations
AdjR2
0.30
F‐statistic
12.2
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Estimatedusingordinaryleastsquares.Standarderrorsinparenthesesand
italics.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
55
Table6
FirststageforIVregressions
Management
Score
ownership
0.38***
‐0.06***
Turnover
(0.12)
(0.02)
‐0.49***
0.05***
Logage
(0.14)
(0.02)
.20
‐0.01
Reservecity
(0.34)
(0.05)
0.18
‐0.06*
Logcitypopulation
(0.19)
(0.03)
‐1.15***
0.09*
LogdistancetoNYC
(0.33)
(0.05)
Fractioncounty
0.21
‐0.11
incomefrom
(0.08)
(0.52)
agriculture
.05
.17
Mininginstate
(.05)
(.32)
‐.04
.71***
Oldstate
.04
(.25)
9.20
.19
Intercept
(3.68)
(0.57)
206
206
Observations
2
.28
AdjR 0.18
10.9
F‐statistic
6.53
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Estimatedusingordinaryleastsquares.Standarderrorsinparenthesesand
italics.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
56
Table7
Factorsassociatedwiththeuseofborrowedmoney
Probit
Probit
IV
Managementownership
‐0.51***
(0.15)
‐3.76***
1.24
0.02
(0.2)
‐0.08*
(0.04)
0.23**
(0.12)
‐0.19***
(0.07)
0.15
(0.11)
‐0.58***
(0.20)
0.01
(0.10)
0.04
(0.08)
3.04
(3.78)
Score
Logage
Reservecity
Logcitypopulation
LogdistancetoNY
Fractioncountyincome
fromagriculture
Mininginstate
Oldstate
Intercept
IV
‐0.06
(0.04)
0.23**
(0.12)
‐0.21***
(0.07)
0.17*
(0.10)
‐0.65***
(0.20)
0.02
(0.10)
0.03
(0.08)
4.24
(3.83)
‐.08
(0.17)
0.60
(0.40)
‐0.72***
(0.22)
.74**
(0.33)
‐2.10***
(0.67)
‐0.11
(0.31)
‐.01
(0.25)
3.54
(3.69)
.51***
(.17)
‐0.003
(0.17)
0.43
(0.39)
‐0.50**
(0.21)
0.95***
(0.34)
‐1.48**
(0.65)
‐0.13
(0.30)
‐.22
(0.27)
‐2.67
(4.14)
Observations
200
200
200
200
PseudoR2
0.13
0.09
LRχ2(probit)/
30.95
21.13
39.0
42.8
Waldχ2(IV)
Notes:Wereportmarginaleffectsevaluatedatthemean.Thesymbols(***),(**),and(*)indicate
statisticalsignificanceatthe1,5,and10percentlevel,respectively.Specifications1and2
estimatedusingprobitanalysis;specifications3and4estimatedusinganordinaryleastsquares
firststageandaprobitsecondstage.Standarderrorsinparenthesesanditalics.Standarderrors
inspecifications3and4havebeenadjustedtoreflecttheuseofgeneratedregressors.Sample
includesallNationalbanksin37citiesasdescribedinSection4.1exceptwheretheexaminerdid
notdiscussuseofcertificatesofdepositforthepurposeofborrowingmoney.
57
Table8
Associationofothermeasuresofbankriskwithmanagementownershipandbankgovernance
Realestateloansto
Estimatedlossesto
Bankcloseditsdoors
totalloans
assets
Tobit
IV
Tobit
IV
Probit
IV
‐3.3**
‐6.1
‐0.27*
‐2.9**
(1.6)
(6.4)
(.15)
(1.34)
‐.49**
1.02
.03
.45**
Score
(.24)
(1.2)
(.02)
(.20)
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Tobitregressionsincolumns1and3aretruncatedbelowatzero.Forcolumns
5and6,wereportmarginaleffects.IVregressionsareestimatedusingatwo‐stepprocedure.
Standarderrorsinparenthesesanditalics.Standarderrorsincolumns2,4,and6havebeen
adjustedtoreflecttheuseofgeneratedregressors.Allregressionsincludethecontrolsusedinthe
previousregressions(suchasthoseshownintheprecedingtable).SampleincludesallNational
banksin37citiesasdescribedinSection4.1.
Management
ownership
‐.055**
(.026)
.001
(0.004)
‐.19*
(.11)
.031
(0.020)
58
Managementownership
Score
Individualdepositsto
totalliabilities
Checkingdepositsto
individualdeposits
Logage
Reservecity
Logcitypopulation
LogdistancetoNY
Fractioncountyincome
fromagriculture
Mininginstate
Oldstate
Intercept
Table9
Determinantsoftheratioofnetworthtoassets
OLS
OLS
IV
‐15.6***
(3.45)
‐16.9***
(4.9)
14.9***
(4.8)
‐6.1***
(1.09)
‐7.07***
(2.63)
‐1.57
(1.61)
.55
(2.55)
2.02
(4.09)
‐3.75
(2.43)
‐4.40**
(2.13)
70.8**
(28.5)
1.08**
(0.55)
‐17.5***
(5.1)
12.2**
(5.0)
‐6.38***
(1.15)
‐7.2***
(2.74)
‐.69
(1.67)
0.42
(2.72)
3.92
(4.23)
‐4.38*
(2.53)
‐4.01*
(2.23)
58.0*
(30.3)
‐29.9**
(13.9)
‐16.4***
(5.01)
17.2***
(5.31)
‐5.36***
(1.29)
‐7.31***
(2.68)
‐2.43
(1.83)
1.31
(2.88)
.18
(4.50)
‐3.45
(2.48)
‐5.42**
(2.37)
71.4
(28.9)
IV
5.19*
(2.72)
‐17.4***
(5.6)
11.4**
(5.5)
‐4.6***
(1.7)
‐8.8***
(3.2)
‐.89
(1.84)
5.53
(4.45)
3.57
(4.45)
‐5.59**
(2.90)
‐6.74**
(3.03)
11.8
(44.7)
Observations
206
206
206
206
AdjR2
0.37
0.31
F‐stat(OLS)/Waldχ2(IV)
12.9
10.4
110.0
86.2
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Specifications1and2estimatedusingordinaryleastsquares;specifications3
and4estimatedusingtwo‐stageleastsquares.Standarderrorsinparenthesesanditalics.
Standarderrorsinspecifications3and4havebeenadjustedtoreflecttheuseofgenerated
regressors.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1
59
Managementownership
Score
Individualdepositsto
totalliabilities
Checkingdepositsto
individualdeposits
Logage
Reservecity
Logcitypopulation
LogdistancetoNY
Fractioncountyincome
fromagriculture
Mininginstate
Oldstate
Intercept
Table10
Determinantsoftheratioofcashtoassets
OLS
OLS
IV
2.36**
(1.07)
4.54***
(1.52)
0.45
(1.49)
1.14***
(0.34)
0.25
(0.82)
1.45***
(0.50)
1.64**
(0.79)
‐0.96
(1.27)
.35
(0.75)
.37
(.66)
‐26.4***
(8.6)
‐0.26
(0.17)
4.62***
(1.53)
.88
(1.49)
1.15***
(0.34)
0.31
(0.82)
1.32***
(0.50)
1.54*
(0.81)
‐1.24
(1.27)
.48
(0.76)
.37
(.67)
‐23.5***
(9.08)
8.12*
(4.42)
4.31***
(1.60)
‐.47
(1.69)
0.86**
(0.41)
0.34
(0.85)
1.79***
(0.58)
1.09
(.92)
‐.22
(1.43)
0.24
(0.79)
.78
(.75)
‐26.7
(9.2)
IV
‐1.40*
(.80)
4.59***
(1.67)
1.11
(1.62)
.66
(0.50)
0.74
(0.94)
1.37***
(0.54)
.11
(1.32)
‐1.14
(1.38)
.82
(0.86)
1.14
(.90)
‐10.5
(13.2)
Observations
206
206
206
206
AdjR2
0.25
0.24
F‐stat(OLS)/Waldχ2(IV)
8.75
8.36
71.5
65.04
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Specifications1and2estimatedusingordinaryleastsquares;specifications3
and4estimatedusingtwo‐stageleastsquares.Standarderrorsinparenthesesanditalics.
Standarderrorsinspecifications3and4havebeenadjustedtoreflecttheuseofgenerated
regressors.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1
60
Table11
Determinantsofmanagersalariesrelativetoassets
OLS
OLS
0.34**
Managementownership
(0.18)
‐0.01
Score
(0.03)
‐0.20***
‐0.18***
Logage
(0.05)
(0.05)
0.06
0.05
Reservecity
(0.12)
(0.13)
‐0.05
‐0.06
Logcitypopulation
(0.08)
(0.08)
0.14
0.16
LogdistancetoNY
(0.12)
(0.13)
0.11
0.09
Fractioncountyincome
fromagriculture
(0.19)
(0.20)
.004
‐0.003
Mininginstate
(0.12)
(0.13)
0.13
0.12
Oldstate
(0.09)
(0.19)
.40
.53
Intercept
(1.40)
(1.46)
Observations
172
172
AdjR2
0.12
0.10
F‐stat
4.19
3.46
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Specifications1and2estimatedusingordinaryleastsquares;specifications3
and4estimatedusingtwo‐stageleastsquares.Standarderrorsinparenthesesanditalics.
Standarderrorsinspecifications3and4havebeenadjustedtoreflecttheuseofgenerated
regressors.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1wherethe
managersalarieswerereported.
61
Table12
Determinantsofloanstomanagementasashareofinsiderloans
OLS
OLS
IV
IV
Managementownership
Score
Logage
Reservecity
Logcitypopulation
LogdistancetoNY
Fractioncountyincome
fromagriculture
Mininginstate
Oldstate
Intercept
33.38***
(8.89)
.53
(2.69)
2.45
(6.67)
‐.62
(3.81)
8.39
(6.58)
21.1**
(10.3)
1.07
(6.29)
‐2.10
(4.91)
‐31.4
(72.1)
‐5.08***
(1.38)
‐.16
(2.73)
3.18
(6.69)
‐1.55
(3.81)
5.59
(6.73)
18.56*
(10.28)
3.47
(6.30)
.09
(4.99)
20.6
(73.8)
62.6*
(36.8)
‐.80
(3.15)
3.41
(6.80)
.53
(4.09)
5.34
(7.58)
23.9**
(10.9)
.31
(6.38)
‐.89
(5.14)
‐28.0
(72.5)
‐10.5*
(6.23)
‐2.49
(3.82)
5.12
(7.13)
‐1.15
(3.89)
‐1.08
(10.1)
19.2*
(10.5)
5.08
(6.65)
3.89
(6.63)
80.1
(100.5)
Observations
206
206
206
206
2
AdjR 0.18
0.14
2
F‐stat(OLS)/Waldχ (IV)
5.32
5.25
31.1
30.4
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Specifications1and2estimatedusingordinaryleastsquares;specifications3
and4estimatedusingtwo‐stageleastsquares.Standarderrorsinparenthesesanditalics.
Standarderrorsinspecifications3and4havebeenadjustedtoreflecttheuseofgenerated
regressors.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
62
Table13
Determinantsoftheratioofdividendstoshares
OLS
OLS
Managementownership
Score
Logage
Reservecity
Logcitypopulation
LogdistancetoNY
Fractioncountyincome
fromagriculture
Mininginstate
Oldstate
Intercept
6.59***
(1.97)
1.85***
(0.60)
‐0.21
(1.45)
0.43
(0.83)
3.84***
(1.43)
5.21**
(2.23)
‐1.73
(1.36)
.75
(1.08)
‐34.5
(15.6)
‐0.55*
(0.31)
1.98***
(0.62)
‐0.24
(1.48)
.21
(0.84)
3.87***
(1.50)
4.72**
(2.27)
‐1.40
(1.39)
.93
(1.11)
‐29.6
(16.3)
Observations
201
201
2
AdjR 0.15
0.11
F‐stat
5.29
4.14
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Specifications1and2estimatedusingordinaryleastsquares;specifications3
and4estimatedusingtwo‐stageleastsquares.Standarderrorsinparenthesesanditalics.
Standarderrorsinspecifications3and4havebeenadjustedtoreflecttheuseofgenerated
regressors.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1exceptthose
toonewtobeeligibletopaydividends.
63
Table14
Meanbankcharacteristicsbymanagementownershipandgovernancescore
High
ownership
high
governance
High
ownership
low
governance
Low
ownership
high
governance
Low
ownership
low
governance
[1]
[2]
[3]
[4]
0.67
(0.55)
0.75
(0.49)
0.51
(0.45)
0.54
(0.20)
1vs
4
36.3
(26.2)
53.3
(32.2)
24.7
(22.8)
33.9
(28.3)
4.4
(3.4)
7.0
(10.4)
3.3
(1.5)
4.1
(2.9)
20.9
(41.2)
27.1
(44.8)
33.8
(47.6)
3.2
(4.4)
3.5
(4.3)
0.7
(1.5)
Loanlosses
toassets
Otherlosses
toassets
Testfordifferences
inmeans
2vs
4
*
***
3vs
4
*
45.8
(50.9)
**
*
2.5
(4.8)
7.3
(11.7)
**
**
***
1.1
(4.1)
0.8
(1.3)
3.6
(7.6)
**
**
***
0.58
(1.28)
0.90
(3.72)
0.58
(1.00)
2.73
(5.66)
**
*
***
0.10
(0.28)
0.21
(0.60)
0.21
(0.52)
0.86
(2.24)
**
**
**
Closed
30.2
(46.5)
28.3
(45.4)
25.0
(43.6)
33.3
(48.0)
Cashto
liabilities
7.9
(4.3)
8.3
(3.8)
7.6
(3.3)
8.1
(3.1)
Salaryto
assets
Officerloans
toinsider
loans
Dividendsper
share
Used
borrowed
funds
Realestate
loanstoall
loans
Lossesto
assets
*
30.4
30.2
35.8
34.8
Networthto
assets
(11.2)
(11.4)
(13.1)
(15.5)
Notes:Thesymbols(***),(**),and(*)indicatestatisticalsignificanceatthe1,5,and10percent
level,respectively.Standarderrorsinparenthesesanditalics.SampleincludesallNationalbanks
in37citiesasdescribedinSection4.1.
64
Figure1
Distributionofownershipbytopthreemanagers
Shareofsample(percent)
14
12
10
8
6
4
2
0
Ownershipshareoftopthreemanagers(percent)
Note.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
Figure2
Distributionofownershipbyoutsidedirectors
Shareofsample(percent)
30
25
20
15
10
5
0
Ownershipshareofoutsidedirectors(percent)
Note.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
65
Figure3
Distributionofownershipbynon‐managers,non‐boardmembers
Shareofsmple(percent)
12
10
8
6
4
2
0‐2
4‐6
8‐10
12‐14
16‐18
20‐22
24‐26
28‐30
32‐34
36‐38
40‐42
44‐46
48‐50
52‐54
56‐58
60‐62
64‐66
68‐70
72‐74
76‐78
80‐82
84‐86
88‐90
92‐94
96‐98
0
Ownershipshareofnon‐managers/non‐boardmembers
(percent)
Portionofsharesownedbytopthree
managers
Note.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
Figure4
Managerownershipandboardcomposition
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
0
0.2
0.4
0.6
0.8
1
Portionofboardconsistingofoutsidedirectors
Note.SampleincludesallNationalbanksin37citiesasdescribedinSection4.1.
66