Why Do Banks Hide Losses?
54 Pages Posted: 27 Feb 2019 Last revised: 11 Jun 2023
Date Written: February 6, 2019
Despite plenty of anecdotal evidence of hidden losses in banks, there is no systematic study analyzing its economic drivers: we simply do not get to observe what banks are hiding. Using a regulatory change in India that forced banks to reveal their hidden losses, we show that banks with higher shareholding by passive foreign investors hide more. These effects are stronger for banks where CEOs get highly compensated for reported profits. Our findings caution against using high-powered compensation contracts as a substitute for active shareholder monitoring. Instead of solving the agency problem, it can result in perverse misreporting incentives.
Keywords: foreign institutional investor, underreporting, monitoring, incentives
JEL Classification: G21, G28
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