How Important Is Moral Hazard For Distressed Banks?

98 Pages Posted: 15 May 2020 Last revised: 27 Jul 2020

See all articles by Itzhak Ben-David

Itzhak Ben-David

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)

Ajay A. Palvia

FDIC, Division of Insurance and Research

René M. Stulz

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: May 12, 2020

Abstract

The moral hazard incentives of the bank safety net predict that distressed banks take on more risk and higher leverage. Since many factors reduce these incentives, including charter value, regulation, and managerial incentives, the net economic effect of these incentives is an empirical question. We provide evidence on this question using two distinct periods that include financial crises and are subject to different regulatory regimes (1985–1994, 2005–2014). We find that distressed banks reduce their leverage and decrease observable measures of riskiness, which is inconsistent with the view that, on average, moral hazard incentives dominate distressed bank leverage and risk-taking policies.

Keywords: Banks, distress, moral hazard, deleveraging, leverage, risk

JEL Classification: G11, G21, G33

Suggested Citation

Ben-David, Itzhak and Palvia, Ajay A. and Stulz, Rene M., How Important Is Moral Hazard For Distressed Banks? (May 12, 2020). Fisher College of Business Working Paper No. 2020-03-009, Charles A. Dice Center Working Paper No. 2020-09, European Corporate Governance Institute – Finance Working Paper No. 681/2020, Available at SSRN: https://ssrn.com/abstract=3599483 or http://dx.doi.org/10.2139/ssrn.3599483

Itzhak Ben-David

Ohio State University (OSU) - Department of Finance ( email )

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HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/index.htm

National Bureau of Economic Research (NBER) ( email )

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HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/

Ajay A. Palvia

FDIC, Division of Insurance and Research ( email )

550 17th Street NW
Washington, DC 20429
United States

Rene M. Stulz (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

HOME PAGE: http://www.cob.ohio-state.edu/fin/faculty/stulz

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

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1000 Brussels
Belgium

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