Magazine article American Banker

Study: Market a Weak Cop

Magazine article American Banker

Study: Market a Weak Cop

Article excerpt

When it comes to influencing management decisions, debt and equity markets may not be the disciplinarians that banking company supervisors have heralded. In the past year, regulatory authorities from the Federal Reserve Board to the Basel Committee on Banking Supervision have agreed that as banking companies become more and more complex, the forces of market discipline must be harnessed to help regulate them. The traditional argument goes like this: Stock and bondholders have a vested interest in the safety of the companies they invest in, so they monitor their risk-taking practices very closely. The stock of a company perceived to be too risky will fall in value, and the institution will have to pay more to float its debt. These signals of market displeasure will force management to rein in their risky practices. But a study, commissioned by the National Bureau for Economic Research and making the rounds among academics and regulators, casts doubt on that theory, finding little relationship between the movement of bank holding company debt and equity prices and subsequent managerial action. Federal Reserve Bank of Chicago economic advisor Robert R. Bliss and University of Florida professor Mark J. Flannery tracked the stock and bond prices for 107 bank holding companies from 1986 to 1997, and concluded that while evidence suggests a slight influence on institutional behavior, consistent market influence on managerial actions "remains, for the moment, more a matter of faith than of empirical evidence." The study -- which the authors presented at a Chicago Fed conference this month -- identified various actions managers might take in response to the movement of stock and bond prices, such as reduction in leverage and changes in dividend policies. The authors said they found no evidence that such actions actually were taken when securities prices fell. …

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