Academic journal article Academy of Banking Studies Journal

Equity Ownership and Thrift Failures during the S&L Crisis

Academic journal article Academy of Banking Studies Journal

Equity Ownership and Thrift Failures during the S&L Crisis

Article excerpt


We explore the role of equity ownership as a mechanism for protecting the interest of shareholders during the crisis within S&L industry. According to Fama (1980) equity owned by corporate insiders helps to alleviate agency problems for shareholders if it aligns the interests of insiders and outside shareholders. However, Gorton & Rosen (1995) and Stulz (1988) suggest that equity owned by insiders may also serve to entrench managers, thereby creating a shield against discipline by outsiders. Outside shareholders interest may also be protected by outside holders of large chunks of a firm's shares. These large shareholders are usually institutional investors who are more sophisticated and have a greater incentive to expend the resources necessary to monitor the managers of a firm. To the extent that shareholders in publicly traded thrifts suffered huge losses during the crisis, an interesting question arise as to whether the heterogeneity of equity ownership within the S&L industry had any impact on the survival of these institutions.

To address this question we focus on the period of turmoil within the S&L industry extending from 1983 through 1994, which represents drastic changes and that provides several events for which we can examine the influence of equity ownership on firm survival. Other factors such as fluctuations in interest rates, deregulation, and the condition of regional economies may have contributed to failures but are beyond the control of managers. However, other factors that may have contributed to the failures such as decisions to expand assets and liabilities, the selection and mix of these assets and liabilities, and the decision to leverage up the firm are well within the bounds of managerial prerogatives. As such, this period provides an exceptional opportunity to investigate the relationship between inside equity ownership and the success or failure of savings and loan associations, which may be attributed to the quality of managerial decisions.

We explore the following questions: How effective was equity ownership in resolving shareholder-manager conflicts? Was the presence of unaffiliated blockholders an effective mechanism for representing outside shareholders' interest? To provide answers to these questions, we analyzed a sample of publicly traded S&Ls that should provide opportunities to trigger the intervention by equity owners to preserve the welfare of the firm.

Our analysis reveals that independent outside directors owned less equity in failed S&Ls than they did in non-failed institutions. Similar comparisons for affiliated outside directors show that affiliated outside directors owned more equity in failed than they did in non-failed institutions. The presence of unaffiliated blockholders among the owners of sample firms appears to be related to the probability that an S&L failed. These findings suggest that the distribution of equity ownership between insiders and outside shareholders should be incorporated among the factors to be addressed before we can be confident that the S&L problems are behind us.

These findings contribute to our understanding of the relationship between equity ownership and firm performance, thereby enriching our knowledge of the dynamics within the S&L industry. The sample consists of firms that are actively traded on national exchanges and, therefore, are exposed to the full range of corporate control mechanisms. In addition, the sample is limited to one industry in order to avoid cross industry differences. However, this restriction in no way limits the value of this study, as the role of equity ownership in resolving agency problems in non-financial firms is already well documented (Himmelberg, Hubbard & Palia, 1999; Agrawal & Knoeber, 1996; McConnell & Servaes, 1990; Morck, Shleifer & Vishny, 1988; Shleifer & Vishny, 1986). Furthermore, the use of S&Ls allows us to examine the role of the equity ownership as an alternate explanation for the failures in that industry. …

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