Why Do Banks Hide Losses?

58 Pages Posted: 27 Feb 2019 Last revised: 9 Sep 2022

See all articles by Thomas Flanagan

Thomas Flanagan

University of Michigan, Stephen M. Ross School of Business

Amiyatosh Purnanandam

University of Michigan, Stephen M. Ross School of Business

Date Written: February 6, 2019

Abstract

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

Suggested Citation

Flanagan, Thomas and Purnanandam, Amiyatosh, Why Do Banks Hide Losses? (February 6, 2019). Available at SSRN: https://ssrn.com/abstract=3329953 or http://dx.doi.org/10.2139/ssrn.3329953

Thomas Flanagan

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Amiyatosh Purnanandam (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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