Additional Evidence On Insider Ownership and Bank Risk-Taking

Abstract:     
This paper examines the effect of stock ownership by managers and directors (insiders) on risk-taking in a sample of 177 Bank Holding Companies (BHCs), over the period 1995-2002. The banking literature suggests that bank owners are interested in increasing bank risk in order to maximize their value, while managers prefer to take on moderate risks in order to protect their positions and the related benefits. One mechanism that could align managers' interests with those of owners is stock ownership. However, at some levels of stock ownership, managers may become entrenched and value more the private benefits of their positions than the equity gains they would get from an increased risk. We examine the alignment and entrenchment effects of insider ownership by testing for three specifications of insider ownership: a linear, a quadratic and a piecewise linear specification. The linear specification indicates that there is a positive and significant effect of insider ownership on bank risk-taking. The piecewise linear specification reveals that there is a positive and significant effect of insider ownership, only for high levels of ownership (greater than 25%). The quadratic specification also shows some evidence of a U-shaped insider-ownership risk-taking relationship. As a whole, we interpret this as evidence that the alignment of bank managers' interests with those of outside shareholders takes place rather at high levels of ownership.

Keywords: insider stock ownership,, banking, regulation, risk-taking

JEL Classification: G21, G32, J33

Accepted Paper Series