Presentation at Auckland Finance Meeting 18-20.12.2014

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Crisis performance of European banks –
does management ownership matter?
Auckland Finance Meeting, 18-20 December 2014
Dr.Sc.(Econ.), Senior Economist Hanna Westman

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Overview of my presentation
(the work and views are my own and does not necessary reflect the opinions of the Bank of Finland)
• Motivation
– Weaknesses identified in the banking sector as the financial
sector unravelled
– Identified gap in the academic literature
• Methodology
– Hypothesis to be explored
– Data set
– Variables
– Specification of regressions
• Main findings
• Policy implications
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Motivation
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European banking sector weaknesses
revealed during the financial crisis
• Banks had grown ever bigger in size.
• Banks had grown in scope and their organisational
complexity and opacity had increased.
• Banks became difficult to monitor, supervise and
manage.
• Leverage had strongly increased and the average
maturity of funding had shortened.
• Excessive risks had been taken across business lines
and in the shadow banking sector.
• The implicit government guarantee grew larger and
the too-big-to-fail problem was aggravated.
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Source: The Final Report of the High-level Expert Group on the structure of the EU banking sector, i.e.
the Liikanen Report.

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Evidence of impact of managerial
incentives on US data inconclusive
→ Weaker performance
• Greater drop in stock price
performance and lower
profitability in banks with CEO
ownership (Fahlenbrach &
Stulz, 2011).
• Shareholder friendly boards
weakened crisis performance
(Beltratti & Stulz, 2012)
→ Stronger performance
• CEO ownership does not have
an impact on default risk,
whereas lower level manager
ownership increases default
risk (Berger et al., 2014).
• Insider ownership mitigates
risk-taking (Cheng et al.,
2010).
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• Managers are more risk averse than shareholders
(Gropp & Köhler, 2010)
• Ownership align interests with shareholders; induce
excessive risk-taking or superior performance?

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The impact of management ownership
might vary with the strategy of the bank
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Most likely in
Traditional
bank
Large
diversified
bank
Small
diversified
bank
Non-
traditional
bank
X X (X)
(X) (X) X
X
Safety net
Incentives to monitor
Incentives to take risk
Opacity
Ability to monitor
Ability to take risk
Complexity
Ability to monitor
Ability to take risk

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Hence also the joint impact of
ownership and strategy is assessed
• As proposed in the survey on corporate governance of
banks by de Haan & Vlahu (2015, forthcoming), drawing
on Westman (2011) done on a pre-crisis data set of
European banks.
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Impact of bank
strategy
Impact of
management
ownership
Joint
impact
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Assessment in period of severe stress
provides new insights
• Risks taken in normal times are only realised much later
or in times of severe stress.
→ Assessing impact of management ownership on pre-crisis
performance only as done in Westman (2011) is not sufficient.
• Distinguishing between the early crisis period
(2007-2009) and later crisis period (2010-2012/13) gives
additional insights on potential impact on recovery.
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The expected impact of management
ownership on bank crisis performance
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Methodology
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Data is available for 200 European banks
• Listed and unlisted Bank Holding Companies,
commercial and investment European banks.
• Pre-crisis ownership data available on the BankScope
DVDs from 2004, 2005 and 2006.
• Consolidated financial data for at least 2005 to 2012 is
available in BankScope as of May 2014.
– Banks majority owned by other European bank dropped.
• Outlier observations dropped
– Outside the 5% and 95% percentile in the profitability (risk-
adjusted profitability and default risk) variables.
– Interest income to total operating income or loans to total
earning assets is not within the range of 0 to 100%
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Hand-collected data on management
ownership pre-crisis
• Management remuneration schemes include various
components, of which stock ownership is one.
– Ownership generally seen as promoting long-run objectives,
whereas bonuses induce short-termism.
• Ownership data collected from the BankScope database
DVDs from 2004, 2005 and 2006.
• “Management and employees” or “Individuals and
families” owners cross-checked and recoded.
• MGT is a dummy variable taking the value 1 if any of the
eight owners listed in the BankScope database was a
member of the management team.
• 21 banks with management ownership in the sample.
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Banks are categorised in four groups
according to their strategy
1. Banks are categorised into traditional, non-traditional
banks or diversified banks.
2. Diversified banks are categorised into small and large.
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Traditional banks
(41 banks)
Diversified banks
(77 banks)
Non-traditional
banks (40 banks)
Small diversified
banks (42 banks)
Non-interest income / Other assets than loans / Off-balance sheet items
Size

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Two model specifications are used in
the main analysis
1. Impact of management ownership on bank crisis
performance
2. Impact of management ownership on bank crisis
performance, while accounting for bank strategy
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[ ] [ ] 11111 −−−− ++++= tititititi BANKSTRATEGYMGTPERF ,,,,, *** εβββα
PERFi,t =α + β1 * MGTi,t−1
" →" +β2 * MGTi,t−1 *SMALLDIVi,t−1 + β3 * MGTi,t−1 * LARGEDIVi,t−1
" →" +β4 * MGTi,t−1 * NONTRADi,t−1
" →" +β * STRATEGYi,t−1
$% &'+ β * BANKi,t−1
$% &'+εi,t−1

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Main findings
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Main findings
• Some indication of support for Hypothesis 1 and 2.
– The drop in performance appear to be more dramatic in banks
with management ownership.
– Still the performance appear to remain on a superior level and
appear to improve in the latter period.
• Strong support for Hypothesis 3 and 4
– There is a negative impact of management ownership on the
crisis performance of traditional and large diversified banks
i.e. banks benefiting from a safety net.
– There is a positive impact of management ownership on the
crisis performance of non-traditional and small diversified
banks i.e. opaque banks not benefiting from a safety net.
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Weak results, which need further
assessment
• Results does not support for Hypothesis 5.
– Large diversified banks do not perform worse than traditional
banks.
– Further examination to ensure that it is the safety net that drives
the negative impact of management ownership rather than
complexity or opacity.
• Shift in performance from early crisis period to latter
crisis period to be added, to better assess the impact on
recovery in performance (hypothesis 6).
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Impact of management ownership on
performance in early crisis period
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(2007-2009)
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Impact of management ownership on
performance in latter crisis period
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1

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Joint impact of management ownership
and strategy on 2007-2009 performance
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Joint impact of management ownership
and strategy on 2010-2012 performance
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2

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A number of robustness checks are
made
• The management ownership variable is refined.
– The bank is categorised as a bank without management
ownership if the management received ownership only in 2005.
– If there was management ownership before the year 2005, but
not in the later years, the bank is categorised as having
management ownership.
• Blockholder ownership used as an indication of inside
control.
• Banks that switch strategy during the crisis dropped.
• The continuous variables underlying the strategy
variables rather than the strategy variables used.
• The results are in line with the main findings.
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Policy implications
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Policy implications
• Important to tailor regulation in the domain of corporate
governance to bank characteristics.
• Alternatively, measures to reduce the safety net to a
minimum could be imposed.
– Higher and better quality capital requirements are implemented.
– New recovery and resolution regimes are implemented.
– Structural reforms have been implemented in the US and the
UK. Negotiation on the European Commission proposal ongoing.
• Discussion needed of whether aligning incentives to
shareholder interest only is good corporate governance,
particularly if safety net sizable.
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Thank you!
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