The Carrot and the Stick: Bank Bailouts and the Disciplining Role of Board Appointments

Abstract

We empirically examine the Capital Purchase Program (CPP) used by the US gov- ernment to bail out distressed banks with equity infusions during the Great Recession. We find strong evidence that a feature of the CPP – the government’s ability to ap- point independent directors on the board of an assisted bank that missed six dividend payments to the Treasury – helped attenuate bailout-related moral hazard. Banks were averse to these appointments – the empirical distribution of missed payments exhibits a sharp discontinuity at five. Director appointments by the Treasury led to improved bank performance, lower CEO pay, and higher stock market valuations.

Keywords: Bank Bailout, TARP, Capital Purchase Program, Dividend Payments, Board Appointments, Bank Recapitalization

JEL Classification: G01, G2, G28, G38, H81