Do Stock Markets Discipline US Bank Holding Companies: Just Monitoring, or also Influencing?

Abstract

This paper offers evidence that bank managers adjust key strategic variables following a risk and/or valuation signal. Banks receive a risk signal when they have a substantially higher volatility compared to the best performing bank(s) with similar business model characteristics, and a valuation signal when they are undervalued relative to the average bank with similar characteristics (using respectively a stochastic frontier and multiplicative heteroscedasticity model). We show that the likelihood that banks receive a risk and/or valuation signal increases with opaqueness, managerial discretion and specialization. Next, we show, using a partial adjustment model, that bank managers adjust the long-term target value of key strategic variables and the speed of adjustment towards those targets following a risk and/or negative valuation signal. We interpret this as evidence of stock market influencing. Finally, we show that our results are unlikely to be driven by indirect influencing by regulators, subordinated debtholders, or wholesale depositors.

Keywords: monitoring, influencing, stochastic frontier, multiplicative heteroscedasticity regression, partial adjustment, opaqueness, earnings forecast dispersion, bank risk

JEL Classification: G21, G28, L25