Targeting Return on Equity: Banks' Controlling Ownership and Risk

39 Pages Posted: 4 Nov 2018 Last revised: 3 Aug 2020

See all articles by Caren Yinxia Nielsen

Caren Yinxia Nielsen

Copenhagen Business School - Center for Corporate Governance; Knut Wicksell Centre for Financial Studies--Lund University

Lars Christian Ohnemus

Copenhagen Business School

Date Written: June 24, 2020

Abstract

Since the 2008-09 global financial crisis, banks are criticized for levering up their balance sheets to reach for return on equity (ROE) target. We conduct the first systematic study on banks' actual practice of targeting ROE, based on a unique hand-collected data for 188 publicly listed commercial banks in Europe from 2000 to 2018. The results show that the increasing holding of large controlling owners is positively and significantly linked to the propensity of targeting ROE. This finding is in line with the agency theory that these owners monitor the management to reduce the principle-agent conflicts. Differently we also find that, stock-based compensation is positively linked to managers' tendency to publish the explicit target numbers. However, contradict to the criticism on banks' excessive risk taking, the higher the probability of targeting ROE is, the marginally lower the probability of default is in the following year. Furthermore, this risk reduction is mainly driven by the significant increase of regulatory capital reserve rather than return on assets or equity ratio. Our study contributes to the understanding of not only the targeting itself, but also the implicit linkage between bank ownership and risk taking. In addition, it offers insights to policy makers in terms of bank regulation.

Keywords: Banks; targeting return on equity; agency theory; controlling ownership; default risk; regulatory capital

JEL Classification: G21; G28; G32; G34

Suggested Citation

Nielsen, Caren Yinxia and Ohnemus, Lars Christian, Targeting Return on Equity: Banks' Controlling Ownership and Risk (June 24, 2020). Available at SSRN: https://ssrn.com/abstract=3265180 or http://dx.doi.org/10.2139/ssrn.3265180

Caren Yinxia Nielsen (Contact Author)

Copenhagen Business School - Center for Corporate Governance ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+4538152694 (Phone)

HOME PAGE: http://https://sites.google.com/site/carensprofhome/

Knut Wicksell Centre for Financial Studies--Lund University ( email )

Box 7082
Lund, S220 07
Sweden

Lars Christian Ohnemus

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

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