The Impact of TARP's Capital Purchase Program on the Stock Market Valuation of Participating Banks

Abstract:     
We examine the impact of the Capital Purchase Program (CPP), under the Troubled Assets Relief Program (TARP) initiated by the U.S. Treasury, on the equity market valuation of participating bank holding companies (CPP banks). Despite the Treasury’s emphasis that the CPP’s capital infusions were not a bailout of poorly performing banks, CPP banks were subject to low investor sentiment when the program was initiated. We find that CPP banks experienced significantly lower stock returns relative to non-participating bank holding companies (non-CPP banks) during the CPP initiation period, and that the equity market adjusted the valuation of the CPP banks upward in the quarters following the program’s initiation. In contrast to their relatively lower equity market valuation when the program was initiated, we show that CPP banks had stronger fundamentals compared to non-CPP banks both prior to and during the program’s initiation period. We also find evidence that negative media coverage exerted substantial downward pressure on banks’ stock returns and was associated with the significantly lower returns for the CPP banks relative to the non-CPP banks. Our results suggest that the investor sentiment significantly affected the CPP banks’ stock market valuation, contributing to the initial stock market undervaluation and subsequent correction.

Number of Pages in PDF File: 49

Keywords: Capital Purchase Program, Capital Infusion, Bank Performance, Valuation, Investor Sentiment

JEL Classification: E61, E63, G12, G14, G18, G21, M48

working papers series