Academic journal article Federal Reserve Bank of New York Economic Policy Review

Risk and Return of Publicly Held versus Privately Owned Banks

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Risk and Return of Publicly Held versus Privately Owned Banks

Article excerpt


In their seminal work, Berle and Means (1932) point out that the separation of ownership and control in the modern corporation creates a condition whereby the interests of owner and manager may diverge and many of the checks that once operated to limit the use of power have disappeared. The agency theory, formalized by Jensen and Meckling (1976), posits that the agency costs of deviation from value maximization increase as managers' stakes decrease and ownership becomes more disperse.

Countering the incentive problems in the separation of ownership and control are the disciplining forces exerted by the managerial labor market and the capital market. Fama (1980) notes that the signals provided by an efficient capital market about the value of a firm's securities are likely to be important for revaluations of the firm's management. Public ownership also facilitates the market for corporate control. Thus, the signals from publicly traded securities in the capital market could discipline managers and resolve potential agency problems. Hence, whether there is a significant difference in the performance of publicly owned and privately held companies remains an empirical question.

While previous empirical studies have found evidence that management ownership appears to play a significant role in firm performance, their samples often include firms from a cross section of industries. (1) To the extent that ownership structure may depend on industrial characteristics, as argued by Jensen and Warner (1988), Demsetz (1983), and Fama and Jensen (1983), disentangling the relationship between performance and ownership becomes difficult. Moreover, many papers rely on certain corporate events--such as initial public offerings (IPOs) or leveraged buyouts, which are also likely to be endogenous to firm performance--to discern the effects of changes in ownership structure. (2)

In this paper, we employ a different empirical strategy to study the effects of ownership structure on firm performance that is free from any corporate events in the rather homogenous banking industry. In essence, the performance of publicly traded bank holding companies (BHCs) is compared with that of privately held BHCs. (3,4) By focusing on a single industry--banking--we control more precisely the effects of industrial organization on ownership structure. Within the banking industry, different firms may choose to organize themselves differently. To the extent that these firms all operate in the same industry with presumably very similar production functions, it seems plausible to view ownership structure as exogenous in this setting, especially after controlling for firm size. (5) Thus, by focusing on a single industry, controlling for within industry variations, and avoiding corporate events that may be associated with unusual performance (such as de novo banking or IPOs) and bank failures, this study contributes to the field by isolating the ownership effect more accurately.

In addition, while other studies emphasize profitability in their performance comparisons, this paper also examines how ownership structure affects risk taking. According to the agency theory, managers with nondiversifiable human capital may take less risk than is optimal for shareholders. Although this agency problem could be mitigated by structuring the labor contract to induce the manager to move closer to optimal risk taking, such as by tying compensation to the stock price or including stock options as part of the manager's compensation, it is an empirical question whether publicly traded BHCs take less risk than privately held ones. (6)

A larger question about the effects of ownership structure on bank risk taking is whether market discipline is capable of constraining bank risk taking. (7) In recent years, policymakers and bank regulators have warmed to the idea of harnessing market forces to enhance banking supervision. …

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