US bank holding companies: Structure of activities and performance through the cycles

The development of market-based finance has supported a larger involvement of banks in non-banking activities over the last decades. Does diversification beyond “traditional” banking result in actual diversification of earning risks and superior risk-return profile? Existing studies on bank performance address the effect of earnings based on accounting types and for specific time periods. With the exception of proprietary investments and financial leverage, knowledge with regard to underlying activities is scarce and little conclusive to date. Other studies, mainly stemming from central banks, do not focus on activity types or risk-return but evidence a marked influence of economic conditions and financial markets on banks' income.The paper proposes a twofold original contribution by addressing the influence of economic conditions and financial markets on specific activities conducted by banks. Based on granular data from a panel of US Bank Holding Companies (BHC), it first aims at estimating profitabilities related to “traditional” banking services and to (customers) investment services conditional to the environment. The study is then extended by the simulation of multiple scenarios to assess the expected performance of activities (profitability and risk) as well as the extent of uncertainty. Diversification into investment services is found to improve the expected risk-return. Also, well calibrated interest rate mismatch (between assets and liabilities) further supports performance. Deviations from historical volatilities and correlations of influential variables may cause diversification benefits to vary. Results however also suggest that the uncertainty of ROE associated with such diversification is limited compared to banking alone.     

Valuation effects of new capital issues by large bank holding companies

Bank regulators in the United States and other major industrial nations have agreed on a framework for regulating bank capital, proposing that all banking organizations maintain common equity and perpetual preferred capital equal to 4 percent of risk-adjusted assets. This proposal raises important questions about the effect of different capital definitions on banking organizations. This article examines the stock market valuation effects of banks' issuing securities that are considered regulatory capital over the 1982–1986 period. The results are consistent with Myers and Majluf's securities overvaluation hypothesis.     

The effect of capital adequacy guidelines on large bank holding companies

The United States federal bank regulators imposed numerical capital guidelines in 1981. If these guidelines are binding on bank holding companies, then theoretical evidence suggests that banking organizations may be increasing asset risk. This study tests empirically the hypothesis that the guidelines are binding. Two models of changes in bank holding company equity capital to assets ratios are developed and tested using maximum likehood estimation: a regulatory model and a market model. The results indicate that most large bank holding companies are influenced by regulatory forces.     

Dividends and financial health: Evidence from U.S. bank holding companies

Using a large sample of U.S. bank holding companies from 1986 to 2020, we show that there is a positive relationship between banks' dividends lagged by one quarter and their financial health in the current quarter. We also find that this positive relationship is more pronounced for banks with lower capital adequacy and during the 2007–2009 financial crisis, indicating that it is more necessary for banks with these characteristics to use dividends to convey information regarding their financial health. Our additional analyses suggest that total payout is also positively associated with bank financial health, and that the positive relationship between dividends and financial health applies to private banks as well, but that the magnitude is weaker for them than for public banks. Our overall findings primarily complement a risk reduction hypothesis in corporate finance and bank payout policies.     

Bank discrimination, holding bank ownership, and economic consequences: Evidence from China

This paper finds that compared with Chinese state-owned firms, non-state-owned firms have a greater propensity to hold significant ownership in commercial banks. These results are consistent with the notion that because non-state-owned firms are more likely to suffer bank discrimination for political reasons, they tend to address their financing disadvantages by building economic bonds with banks. We also find that among non-state-owned firms, those that hold significant bank ownership have lower interest expenses, and are less likely to increase cash holdings but more likely to obtain short-term loans when the government monetary policy is tight. These results suggest that the firms building economic bonds with banks can enjoy benefits such as lower financial expenses and better lending terms during difficult times. Finally, we find that non-state-owned firms with significant bank ownership have better operating performance. Overall, we find that firms can reduce discrimination through holding bank ownership.     

Corporate governance and earnings management at large U.S. bank holding companies

This paper examines whether corporate governance mechanisms affect earnings and earnings management at the largest publicly traded bank holding companies in the United States. We first find that performance, earnings management, and corporate governance are endogenously determined. Thus, OLS estimation can lead to biased coefficients and a simultaneous equations approach is used. We find that CEO pay-for-performance sensitivity (PPS), board independence, and capital are positively related to earnings and that earnings, board independence, and capital are negatively related to earnings management. We also find that PPS is positively related to earnings management. Finally, PPS and board independence are positively related and the relationship is bidirectional. While both PPS and board independence are associated with higher earnings, our results indicate that more independent boards appear to constrain the earnings management that greater PPS compels.     

Size and earnings volatility of US bank holding companies

We examine whether bank earnings volatility depends on bank size. Using quarterly data for bank holding companies in the United States for the period 1995Q1–2010Q3 and controlling for the quality of management, leverage, and diversification, we find that bank size reduces return volatility. However, the effect is non-linear: when bank size exceeds a certain threshold (about US$5 billion) size is positively related to earnings volatility. The recent financial crisis decreased the threshold beyond which the impact of size on volatility turns positive.     

The effect of stock-for-debt swaps on bank holding companies

Twenty-two of the numerous stock-for-debt swaps that have taken place since August 1981 have been by bank holding companies. Although the most oft-quoted reason for making the swap is its positive effect on reported earnings, we argue that the effects of the Bankruptcy Tax Act of 1980 on the tax treatment of early retirement of discount debt often makes stock-for-debt swaps a preferable alternative to cash repurchases of discount debt for sinking fund obligations. Furthermore, for bank holding companies, the swaps allow them to adjust their capital positions to new optimal levels ad dictated by the more stringent capital standards promulgated by the regulatory authorities in 1981. For 99 non-banking firms we found a significant and negative abnormal average return on the swap announcement date of ?0.49 percent. For the 22 bank holding companies, however, we found no significant abnormal average return on the announcement date of the swaps. The results suggest that swaps may be reducing the potential costs of regulatory interference for bank holding companies if they are overlevered, which offsets whatever other force is driving down stock prices on new issue announcement dates.     

Diversification and the cost of debt of bank holding companies

In this study, we investigate the relationship between various dimensions of diversification and the cost of debt for publicly traded bank holding companies (BHCs). We find that both domestic geographic diversification of deposits and diversification of assets lead to a lower bond yield-spread. Diversification of non-traditional banking activities leads to a lower cost of debt only when yield-spread and diversification are estimated simultaneously. In addition, we find that medium-sized BHCs experience a greater reduction in bond yield-spread than small-sized and large-sized BHCs. This is consistent with the too-big-to-fail (TBTF) effects in the banking industry. Furthermore, we document that the association between diversification and yield-spread is bidirectional with higher yield-spreads being associated with greater asset and activity diversification and lower geographic deposit dispersion. The effect of diversification on bond yield-spread is robust after accounting for cross-sectional and serial correlation, and the endogeneity of diversification.     

Cyclicality of liquidity creation: Nonlinear evidence from US bank holding companies

Using a panel smooth transition regression framework on a new proxy of the business cycle (BC) index and quarterly data of US bank holding companies from 1993Q1 to 2020Q1, our results provide empirical support for the theory that the BC has a nonlinear effect on liquidity creation. We find a positive and highly significant nonlinear effect of the BC on liquidity creation, which not only supports the pro-cyclicality of liquidity creation but also improves the liquidity creation estimation compared to previous studies. The results are robust to different proxies of the BC and model specifications. We also document that US bank holding companies create liquidity more during the expansion phase (normal times) than during the recession phase (crisis times) of the BC, suggesting an asymmetrical effect of BC changes on liquidity creation. Our findings have important implications for financial market participants by suggesting that banks should keep alternative sources of funding on hand during the BC recession phase. Insights from our study also provide policy implications for central banks and prudent supervisors to consider when incentivizing banks, for instance, by lowering regulatory requirements, adjusting the policy rate, or implementing any other quantitative easing policy during the BC recession phase to keep the financial system efficient.     

Bank holding company performance,risk, and “busy” board of directors

We examine the association between “busyness” of the board of directors (serving on multiple boards) and bank holding company (BHC) performance and risk. We estimate several simultaneous-equations models employing the 3SLS technique and instrumental variables to account for endogeneity. We obtain four main results. First, BHC performance measures (return on equity, Tobin’s Q and EBIT over total assets) are positively associated with busyness of directors. Second, BHC risk measures (total, market, idiosyncratic, credit and default risks) are inversely related to busyness of directors. Third, performance (risk) benefits of having busy directors strengthened (weakened) during the financial crisis of 2007–2009. Fourth, busy directors are not more likely to become problem directors (fail the 75% attendance standard), and if sitting on boards of both BHC and non-financial firms, they attend more of the BHC board meetings, than those of the non-financials. Our findings partially alleviate concerns that over-boarded directors shirk their responsibilities.     

Blockholder leverage and payout policy: Evidence from French holding companies

This paper focuses on dominant owners’ use of leverage to finance their blockholdings and its relationship to dividend policy. We postulate that blockholder leverage may impact payout policy, in particular when earnings are hit by a negative shock. We use panel data for France where blockholders have tax incentives to structure their leverage in pyramidal holding companies and study the effect of the financial crisis in 2008/2009. We find no difference in payout policy and financial behavior during the 1999 to 2008 period between firms with levered owners and other firms. However, in the years 2009 to 2011 following the crisis, dividend payouts increase in proportion to pyramidal debt of dominant owners. We inspect pyramidal entities individually and find that on average only 60% of dividends are passed through to the ultimate owners, with the rest predominantly used to meet debt service obligations of the pyramidal entities.     

Dividend payouts: Evidence from U.S. bank holding companies in the context of the financial crisis

We study dividend payouts of 462 U.S. bank holding companies before and during the 2007–09 financial crisis. Fama and French (2001) characteristics (size, profitability and growth opportunities) explain dividend payouts before and during the financial crisis. The agency cost hypothesis explains dividend payouts before and during (more pronouncedly) the financial crisis. The signaling hypothesis explains dividend payouts during the financial crisis. Regulatory pressure was ineffective in limiting dividend payouts by undercapitalized banks before the financial crisis. Our findings have implications for corporate finance and governance theories, and also for the regulatory reforms that are being discussed among policymakers.     

Bank holding company affiliation and market share performance

This study examines the effect of bank holding company affiliation on the market share performance of banks acquired from 1968–1978. The principal focus of the analysis is on banks acquired in markets without other representation by the parent holding company. Among such banks, holding company affiliation appears to have increased the market share of ‘foothold’ banks (i.e., those with relatively small market share) but reduced the market share of large banks. In both cases, however, the quantitative effect of affiliation is estimated to be very small. Thus, bank regulators may not wish to distinguish on the basis of expected market share performance between ‘foothold’ entry and acquisition of a dominant bank when ruling on market-extension acquisition/merger cases.     

Scale economies,X-efficiency,and convergence of productivity among bank holding companies

Are the less productive banks catching up to the more productive ones and, if so, how quickly and by what means? The objective of this study is to answer these questions by looking for convergence in productivity among bank holding companies (BHCs) in the US Past research has identified two major factors governing productivity in the banking sector – scale economies and X-efficiency. If the gains from scale economies decline with firm size and if the only difference between BHCs lies in their initial size, then the initially smaller BHCs should eventually catch up to the initially larger ones because the former tend to grow more quickly. However, the findings from this study do not support this hypothesis of “absolute convergence”. Indeed, the findings show strong evidence for “conditional convergence”, which means that the steady-state productivity to which a BHC is converging is conditional on the BHCs own level of X-efficiency. Conditional convergence implies that initial differences in X-efficiency among BHCs can, between them, create permanent differences in steady-state productivity.     

Mutual holding companies: Evidence of conflicts of interest through disparate dividends

The mutual holding company (MHC) structure establishes a dual-class stock that creates a unique opportunity to transfer wealth from thrift depositor–owners to new minority shareholders through the disparate payment of dividends. We show that MHCs are priced higher than comparable non-MHCs and dividend policy is a significant component of this valuation. We also show that MHC thrifts pay significantly higher dividends than non-MHC thrifts and that an Office of Thrift Supervision (OTS) ruling reducing the potential for disparate dividends between the two classes of shareholders resulted in lower dividends. These results have policy implications of special significance given that the OTS reversed its position in 2000 and because of the current controversy over the use of the MHC structure in the financial service industry.     

Controlling shareholders,board structure,and firm performance: Evidence from India

We examine the prevalence and performance impact of controlling shareholders and study corporate board structures and ownership structures in 1796 Indian firms. Families (founders) are present on the boards in 63.2 (65.5) percent of the sample firms. On average, founders own over 50% of outstanding shares. In contrast to the findings of Anderson and Reeb (2003) in the U.S. context, we find that controlling shareholder board membership in Indian firms has a statistically significant negative association with Tobin's Q. Higher proportion of independent directors, higher institutional ownership or larger firm size does not appear to mitigate this relationship. Overall, board membership of controlling shareholders appears to be costly for minority shareholders.     

Shareholding structure and corporate performance of partially privatized firms: Evidence from listed Chinese companies

Equity ownership in a listed Chinese firm can have as many as five different classes: state-owned shares, legal-person (LP) shares, tradable A-shares, employee shares, and shares only available to foreign investors, a phenomenon that is unique to the Chinese equity market. In this paper, we investigate whether and how the corporate performance of listed Chinese firms is affected by their shareholding structure. The sample consists of all firms listed in the Shanghai Stock Exchange (SHSE) from 1991 to 1996. It is found that firm performance is positively related to the proportion of LP shares but negatively related to the proportion of shares owned by the state. Additional analyses indicate that firm performance increases with the degree of relative dominance of LP shares over state shares. Moreover, for the subsample of firms that do not have both state and LP shares, the return on equity (ROE) of firms with LP shares but no state shares is higher than that of firms with state shares but no LP shares by 3.84%, and this difference is statistically significant. On the other hand, there is little evidence in support of a positive correlation between corporate performance and the proportion of tradable shares owned by either domestic or foreign investors. These findings suggest that the ownership structure composition and relative dominance by various classes of shareholders can affect the performance of state-owned enterprise (SOE)-transformed and listed firms.     

Bank ownership reform and bank performance in China

Using a panel of Chinese banks over the 1997–2004 period, we assess the effect of bank ownership on performance. Specifically, we conduct a joint analysis of the static, selection, and dynamic effects of (domestic) private, foreign and state ownership. We find that the “Big Four” state-owned commercial banks are less profitable, are less efficient, and have worse asset quality than other types of banks except the “policy” banks (static effect). Further, the banks undergoing a foreign acquisition or public listing record better pre-event performance (selection effect); however, we find little performance change in either the short or the long term.