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Abstract:
This paper looks at the role of commercial banks and investment banks as financial advisors. Unlike some areas of investment banking, commercial banks have always been allowed to compete directly with traditional investment banks in this area. In their role as lenders and advisors, banks can be viewed as serving a certification function. However, banks acting as both lenders and advisors face a potential conflict of interest that may mitigate or offset any certification effect. Overall, we find evidence of the certification effect for target firms, but conflicts of interest for acquirers. In particular, the target earns higher abnormal returns when the target's own bank certifies the (more informationally opaque) target's value to the acquirer. In contrast, we find no certification role for acquirers. This may be due to two reasons. First, certification plays less of a role for acquirers because it is the target firm that must be priced in a merger. Second, acquirers predominantly utilize commercial bank advisors in order to obtain access to bank loans that may be used to finance the post-merger transition period. Thus, we find that acquirers tend to choose their own banks (those with prior lending relationships to the acquirer) as advisors in mergers. However, this choice weakens any certification effect and creates a potential conflict of interest because the acquirer's advisor negotiates the terms of both the merger transaction and future loan commitments. Moreover, the advisor's merger advice may be distorted by considerations related to the bank's credit exposure resulting from both past and future lending activity. The market prices these conflicts of interest; we find significantly negative abnormal returns for bank advisors when they advise their own loan customers in acquiring other firms.

Relationship banking, investment bank advisors, commercial bank advisors, certification effect, conflict of interest effect, mergers, acquisitions

Abstract:
This paper looks at the role of commercial banks and investment banks as financial advisors. Unlike some areas of investment banking, commercial banks have always been allowed to compete directly with traditional investment banks in this area. In their role as lenders and advisors, banks can be viewed as serving a certification function. However, banks acting as both lenders and advisors face a potential conflict of interest that may mitigate or offset any certification effect. Overall, it is found that, in their merger and acquisition advisory function,the certification effect of commercial banks dominates the conflict of interest effect and that the certification effect is particularly strong when the target s own bank advises merger targets.

Relationship banking, investment bank advisors, commercial bank advisors, certification effect,, conflict of interest effect, mergers, acquisitions

Abstract:
This paper looks at the role of commercial banks and investment banks as financial advisor's. Unlike some areas of investment banking, commercial banks have always been allowed to compete directly with traditional investment banks in this area. In their role as lenders and advisor's, banks can be viewed as serving a certification function. However, banks acting as both lenders and advisor's face a potential conflict of interest that may mitigate or offset any certification effect. Overall, we find evidence of the certification effect for target firms, butconflicts of interest for acquirers. In particular, the target earns higher abnormal returns when the target s own bank certifies the (more information ally opaque) target s value to the acquirer. In contrast, we find no certification role for acquirers. This may be due to two reasons. First, certification plays less of a role foracquirers because it is the target firm that must be priced in a merger. Second, acquirerspredominantly utilize commercial bank advisor's in order to obtain access to bank loans that may be used to finance the post-merger transition period. Thus, we find that acquirers tend to choose their own banks (those with prior lending relationships to the acquirer) as advisors in mergers.However, this choice weakens any certification effect and creates a potential conflict of interest because the acquirer s advisor negotiates the terms of both the merger transaction and future loan commitments. Moreover, the advisor s merger advice may be distorted by considerations related to the bank s credit exposure resulting from both past and future lending activity. The market prices these conflicts of interest; we find significantly negative abnormal returns for bank advisor's when they advise their own loan customers in acquiring other firms.

Relationship banking, investment bank advisors, commercial bank advisors, commercial bank advisors, conflict of interest effect, mergers, acquisitions

Abstract:
This paper looks at the role of both commercial and investment banks in providing merger advisory services. In this area, unlike some areas of investment banking, commercial banks have always been allowed to compete directly with investment banks. In their dual role as lenders and advisors to firms that are the target or the acquirer in a merger, banks can be viewed as serving a certification function. However, banks acting as both lenders and advisors face a potential conflict of interest that may mitigate or offset any certification effect. Overall, we find evidence supporting the certification effect for target firms. In contrast, conflicts of interest appear to dominate the certification effect when banks are advisors to acquirers.

In particular, the target earns higher abnormal returns when the target's own bank certifies the (more informationally opaque) target's value to the acquirer. In contrast, we do not find a certification role for acquirers. There are two possible reasons for these different outcomes. First, it is the target firm, not the acquirer, that must be priced in a merger. Second, acquirers predominantly use commercial bank advisors to obtain access to bank loans that may be used to finance the merger. Thus, we find that acquirers tend to choose their own banks (those with prior lending relationships to the acquirer) as advisors in mergers. However, this choice weakens any certification effect and creates a potential conflict of interest because the acquirer's advisor negotiates the terms of both the merger transaction and future loan commitments. Moreover, the advising bank's recommendations may be distorted by considerations related to credit exposure incurred in both past and future lending activity. The market prices these conflicts of interest; we find significantly negative abnormal returns for bank advisors when they advise their own loan customers in acquiring other firms.

relationship banking, investment bank advisors, commercial bank advisors, mergers and acquisitions

Abstract:
This study examines both the quantity and price of risk exposure for different segments of financial intermediaries in order to determine whether market segmentation exists in the financial services industry in the United States. We distinguish between depository institutions, securities firms, insurance companies, mutual funds, and other financial firms using each company s SIC code. We find evidence of market segmentation in both market risk levels and market risk premiums. The results provide little evidence of interest rate risk exposure across all types of financial intermediaries, suggesting the prevalence of hedging programs using interest rate derivatives. However, the market prices interest rate risk exposure differentially by type of financial intermediary. We find that as a market segment, insurance companies were exposed to more interest rate risk particularly in the period late 1980 s to early 1990 s. The interest rate risk premium for banks was among the highest of all financial intermediaries. Overall, we find that securities firms, as a group, have the most market risk exposure, followed in order of descending market beta, by banks, other financial firms, insurance companies, and mutual funds, although the order is reversed when examining the market risk premium. Indeed, we find support for an inverse relationship between the quantity and price for market risk, but not for interest rate risk. When we investigate the impact of two regulatory policy changes, we find that (1) the shift in the conduct of monetary policy towards targeting of monetary aggregates induced banks to take on more market risk, probably due to a decline in their charter value; (2) bank market risk-taking increased further with the introduction of riskbased capital requirements which further reduce charter value for banks; and (3) insurance companies are subject to the highest interest rate risk premiums during the 1988-1994 subperiod, following by commercial banks, probably due to interest rate risk subsidy under the risk-based capital requirements. Overall, during the period 1974-1994, banks increased their market risk exposure despite the tightening of regulatory restrictions, insurance companies increased their interest rate risk exposure over the subperiods. We create synthetic universal banks comprised of portfolios of banks, securities firms, and insurance companies. We find that the synthetic universal banks have significantly positive excess returns, with lower market and interest rate risk exposures and higher expected returns than securities firms.

Abstract:
This article examines the primary motivation of the bank merger waves in the 1990s. Our investigation of the factors that determine bid premiums paid for target banks focuses on the importance of the financial characteristics of the targets, composition of their boards of directors, and the regulatory environment. The value of the target bank to the acquiring bank should reflect its present discounted value of future net cash flows. Thus, at a minimum, the bid price should be a combination of the stand-alone value of the net assets of the target bank and the net cash flows from higher-valued deposit insurance as a result of the proposed merger. Finance literature also suggests that in large transactions, such as mergers and acquisitions, the value of independent outside directors can be very important as internal governance mechanisms for protecting the interest of shareholders and help to mitigate shareholder/management agency problems. In addition, regulation could also play an important role in determining the number and type of bank merger transactions. Prior to the Riegle-Neal Act banks were restricted by federal and state laws from expanding across state lines. We examine whether bank merger prices were higher or lower as a
result of these restrictions. We find a variety of interesting and important results. We find that higher performing targets, as measured by return on assets, are offered higher bid premiums. We also find that lower risk targets, as well as those that may provide some diversification benefits, are offered higher prices. We find that changes in the regulatory environment had a significant impact on bank merger activities in general, and bank merger prices in particular. For example, merger bid premiums increased by approximately 35 percent on average from the pre- to the post-Riegle-Neal periods. Finally, consistent with the literature on non-financial firms, our results provide strong support for the proposition that during takeovers independent boards act to increase the wealth of the shareholders of target banks.

Abstract:
Commercial bank merger and acquisition (M&A) transactions are especially informative for analyzing the impact of differing corporate governance structures on the balance of corporate control between managers and shareholders. We exploit these special characteristics to investigate the balance of control between top-tier managers and shareholders using data from bank M&A transactions over the period 1990-2004. Unlike research on non-financial firms, the impacts of independent directors, managerial share ownership, and independent blockholders on bank merger purchase premiums in this environment are likely to be measured more consistently because of industry operating standards and regulations. It is also the case that research on banks in this area has not received adequate attention. Our model controls for risk characteristics of the target and the acquiring banks, the deal characteristics, and the economic environment. The results are robust. Our results are consistent with those found for non-financial firms, and are consistent with the hypothesis that independent directors could provide an important internal governance mechanism for protecting shareholders' interests especially in large scale transactions such as mergers and takeovers. We also find results consistent with the conflict of interest argument, where top-tier managers tend to trade potential takeover gains in return for their own personal benefits, such as job security and other employment related perquisites. Our overall findings would support policies that promote independent outside directors on the board of commercial banking firms in order to provide protection for shareholders and investors at large.

Corporate governance, bank merger, merger purchase premium, performance, bank holding companies

Abstract:
This paper estimates the value of the too-big-to-fail (TBTF) subsidy. Using data from the merger boom of 1991-2004, we find that banking organizations were willing to pay an added premium for mergers that would put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. We estimate at least $14 billion in added premiums for the eight merger deals that brought the organizations to over $100 billion in assets. In addition, we find that both the stock and bond markets reacted positively to these deals. Our estimated TBTF subsidy is large enough to create serious concern, since recent assisted mergers have allowed TBTF organizations to become even bigger and for nonbanks to become part of TBTF banking organizations, thus extending the TBTF subsidy beyond banking.

bank merger, too-big-to-fail, TBTF subsidy, systemically important bank

Abstract:
This paper estimates the value of the too-big-to-fail (TBTF) subsidy. Using data from the merger boom of 1991-2004, the authors find that banking organizations were willing to pay an added premium for mergers that would put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. They estimate at least $14 billion in added premiums for the eight merger deals that brought the organizations to over $100 billion in assets. In addition, the authors find that both the stock and bond markets reacted positively to these deals. Their estimated TBTF subsidy is large enough to create serious concern, since recent assisted mergers have allowed TBTF organizations to become even bigger and for nonbanks to become part of TBTF banking organizations, thus extending the TBTF subsidy beyond banking.

bank merger, too-big-to-fail, TBTF subsidy, systemically important bank

Abstract:
This paper examines an important aspect of the "too-big-to-fail" (TBTF) policy employed by regulatory agencies in the United States. How much is it worth to become TBTF? How much has the TBTF status added to bank shareholders' wealth? Using market and accounting data during the merger boom (1991-2004) when larger banks greatly expanded their size through mergers and acquisitions, we find that banking organizations are willing to pay an added premium for mergers that will put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. We estimate at least $14 billion in added premiums for the nine merger deals that brought the organizations over $100 billion in total assets. These added premiums may reflect that perceived benefits of being TBTF and/or other potential benefits associated with size.

Bank merger, too-big-to-fail, TBTF subsidy, large bank subsidy

Abstract:
Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles. This finding satisfies a necessary condition for regulatory proposals which would mandate increased reliance on sub-debt in the bank capital structure to discipline banks' risk taking. Such proposals, however, have not been implemented, partially because there are still concerns about the quality of the signal generated in current debt markets. We argue that previous studies evaluating the potential usefulness of sub-debt proposals have evaluated spreads in an environment that is very different from the one that will characterize a fully implemented sub-debt program. With a fully implemented program, the market will become deeper, issuance will be more frequent, debt will be viewed as a more viable means to raise capital, bond dealers will be less reluctant to publicly disclose more details on debt transactions, and generally, the market will be more closely followed. As a test to see how the quality of the signal may change, we evaluate the risk-spread relationship, accounting for the enhanced market transparency surrounding new debt issues. Our empirical results indicate a superior risk-spread relationship surrounding the period of new debt issuance due, we posit, to greater liquidity and transparency. Our results overall suggest that the degree of market discipline would likely be enhanced by a mandatory sub-debt program requiring banks to regularly approach the market to issue sub-debt.

Financial regulation, market discipline, subordinated debt, bank capital

Abstract:
Certain nonrecurring circumstances associated with the passage of the Financial ServicesModernization Act of 1999 have created a unique opportunity for the market to obtainbank examination ratings of management quality. We utilize this natural experiment in order to determine how the market views this heretofore private information. We findthat the stock market utilizes bank examination ratings in order to reveal regulatory intent, rather than simply as information about management quality. Revelation of unsatisfactory M ratings (denoted â¬Sbad newsâ¬?) causes BHC stock returns and market risk betas to increase, whereas revelation of acceptable M ratings (â¬Sgood newsâ¬?) causes BHC stock returns and market risk betas to decrease. The market thrives on â¬Sbad newsâ¬? because unsatisfactory M ratings indicate that regulatory intervention is likely to occur, possibly benefiting both shareholders and creditors. On the other hand, revelation of acceptable M ratings (â¬Sgood newsâ¬?) indicates that bank regulators are unprepared to intervene in the near future. Moreover, we find lower bond spreads for a subsample of FHCs with satisfactory M ratings revealed upon conversion.

Abstract:
Certain nonrecurring circumstances associated with the passage of the Financial Services Modernization Act of 1999 have created a unique opportunity for the market to obtain bank examination ratings of management quality. We utilize this natural experiment in order to determine how the market views this heretofore private information. We find that the stock market utilizes bank examination ratings in order to reveal regulatory intent, rather than simply as information about management quality. Revelation of unsatisfactory M ratings (denoted â¬Sbad newsâ¬?) causes BHC stock returns and market risk betas to increase, whereas revelation of acceptable M ratings (â¬Sgood newsâ¬?) causes BHC stock returns and market risk betas to decrease. The market thrives on â¬Sbad newsâ¬? because unsatisfactory M ratings indicate that regulatory intervention is likely to occur, possibly benefiting both shareholders and creditors. On the other hand, revelation of acceptable M ratings (â¬Sgood newsâ¬?) indicates that bank regulators are unprepared to intervene in the near future. Moreover, we find lower bond spreads for a subsample of FHCs with satisfactory M ratings revealed upon conversion.

Abstract:
The recent mortgage crisis has resulted in several bank failures as the number of mortgage defaults increased. The current Basel I capital framework does not require banks to hold sufficient amounts of capital to support their mortgage lending activities. The new Basel II capital rules are intended to correct this problem. However, Basel II models could become too complex and too costly to implement, often resulting in a trade-off between complexity and model accuracy. In addition, the variation of the model, particularly how mortgage portfolios are segmented, could have a significant impact on the default and loss estimated and, thus, could affect the amount of capital that banks are required to hold. This paper finds that the calculated Basel II capital varies considerably across the default prediction model and segmentation schemes, thus providing banks with an incentive to choose an approach that results in the least required capital for them. We also find that a more granular segmentation model produces smaller required capital, regardless of the economic environment. In addition, while borrowers’ credit risk factors are consistently superior, economic factors have also played a role in mortgage default during the financial crisis.

Basel II, Bank Capital, Bank Regulation, Mortgage Default, Retail Credit Risk

Abstract:
Few transactions have the potential to generate revelations about the market value of corporate assets and liabilities as mergers and acquisitions (M&A). Corporate governance and control mechanisms such as independent directors, independent blockholders, and managerial share ownership are usually important predictors of the size and distribution of the incremental wealth generated by M&A transactions. The authors add to this literature by investigating these relationships using a sample of banking organization M&A transactions over the period 1990-2004. Unlike research on non-financial firms, the impact of independent directors, share ownership of the top five managers, and independent block holders on bank merger purchase premiums in this environment is likely to be measured more consistently because of industry operating standards and regulations. It is also the case that research on banks in this area has not received adequate attention. The authors model controls for risk characteristics of the target banks, the deal characteristics, and the economic environment. Their results are robust. They support the hypothesis that independent directors may provide an important internal governance mechanism for protecting shareholders' interests, especially in large-scale transactions such as mergers and takeovers. The authors also find the results to be consistent with the hypothesis that independent blockholders play an important role in the market for corporate control as does managerial share ownership. But these effects dampen the impact of independent directors on target shareholders' merger prices. Their overall findings would support policies that promote independent outside directors on the board of banking firms in order to provide protection for shareholders and investors at large.

Corporate Governance, Bank Merger, Merger Purchase Premium, Performance, Bank Holding Companies

Abstract:
An argument for refusing to publicly disclose supervisory ratings of the safety and soundness of banks rests on the claim that such disclosure will reduce supervisory effectiveness. Specifically, some argue that public disclosure of supervisory ratings will reduce the likelihood that bank supervisors take adverse, but deserved, actions against a bank such as a rating downgrade. This argument has not been subject to an empirical investigation. We provide the first test of this claim by examining if and how rating downgrades and upgrades changed when supervisors altered their policies and began disclosing ratings to bank management. If supervisors were more reluctant to alter ratings because of this change in disclosure policy, then it is reasonable to believe that disclosing ratings to the public—the ultimate goal of many proposals--would have as large or a larger effect. After controlling for bank-specific and standard economic factors, we find that more expansive disclosure did not make downgrades less likely. While such results are insufficient by themselves to justify release of bank supervisory data to the public, they are a necessary condition for enacting such a policy.

Supervisory Ratings, Supervisory Disclosure, CAMEL, BOPEC, Rating Downgrade

Abstract:
This paper discusses the role of risk management and corporate governance as causal factors in the onset of the financial crisis. The downturn in the housing and mortgage markets precipitated the first phase of the financial crisis in August 2007 when the solvency of a number of large financial firms was threatened by huge losses in complex structured financial securities. Why did these firms have such high concentrations in mortgage-related securities? Given the information available to firms at the time, these high concentrations in mortgage-related securities violated basic principles of modern risk management. We argue that this failure was a result of principal-agent problems internal to the firms and to breakdowns of corporate governance systems designed to overcome these principal-agent problems.

Financial Crisis, Risk Management, Corporate Governance, Subprime Crisis

Abstract:
In this article we examine whether the federal safety net is viewed by the market as being extended beyond de-jure deposits to other bank debt and even the debt of bank holding companies (BHCs). We extend previous research by focusing on the post-FDICIA period and by also examining the risk-return relation of bonds issued directly by banks, not BHCs. Our results provide evidence that both bank and BHC bonds are priced by the secondary market in relation to their underlying credit risk, particularly for less capitalized issuers, suggesting that proposals requiring banks to issue subordinated debt may enhance market monitoring and discipline and be useful in supplementing regulatory discipline.

Abstract:
Bank off-balance-sheet (OBS) activities have grown dramatically and have become significantly important, especially at large banks. We investigate whether failure to incorporate OBS products may lead to a misspecification problem. Models that exclude deposits from the output specification suggest economies of scale, which vanish when deposits are included. We find that an inclusion of OBS products has little or no significant effect on the scale economies measures. With only a few exceptions, the results provide no evidence of cost complementarities in joint production. The tremendous growth of bank OBS activities in the 1980s may be explained by the very small (approximately zero) pecuniary cost of these activities.