Managerial Protections, Capital Requirements, and Bank Lending

Abstract

We introduce a model to illustrate how the effect of capital requirements on bank lending can qualitatively depend on the extent of managerial protections against shareholder actions. Protections encourage managers to pursue unprofitable projects. Protected managers can still be disciplined by debt. If debt is constrained by capital requirements, then a higher level of investment can serve as a partial substitute. Capital requirements can therefore spur increased investment for firms with managerial protections. Empirically, bank stress-testing after the 2008 financial crisis led to an increase in lending for banks with strong protections compared to banks with weak protections.

Keywords: Managerial protections, Stress testing, Capital structure, Ownership structure, Investment, Banking

JEL Classification: D24, G32