Three Essays in Banking: Corporate Governance, Internationalization, and Government Bailouts

This dissertation extends a growing literature on banking and finance by investigating bank corporate governance, internationalization, and bailouts. The first essay conducts the first assessment of shareholder activism in banking and its effects on risk and performance. Activism can create value and be an effective monitoring mechanism for banks, but it may also be a destabilizing mechanism, as maximizing shareholder value may cause financial instability. We focus on the conflicts among bank shareholders, managers, and creditors (e.g., regulators, deposit insurers, taxpayers, depositors). We find activism may generally be a destabilizing force, increasing bank risk-taking, but creating market value for shareholders, and leaving operating returns unchanged. This is consistent with the empirical dominance of the Shareholder-Creditor Conflict, which predicts that activist shareholders may induce managers to take higher risk to increase returns at the expense of creditors, given creditors’ difficulty in monitoring and regulatory-induced incentives. However, during financial crises, the increase in risk vanishes, suggesting activism may not be a major cause of risk during such times. From a public perspective, creditors (including the government) may lose during normal times, but not during crises. In the second essay (co-authored with Allen N. Berger, Sadok El Ghoul, and Omrane Guedhami), we document a positive relation between internationalization and bank risk. This is consistent with the empirical dominance of the market risk hypothesis – whereby internationalization increases banks’ risk due to market-specific factors in foreign vii markets – over the diversification hypothesis – whereby internationalization allows banks to reduce risk through diversification of their operations. The results continue to hold following a variety of robustness tests, including endogeneity and sample selection bias. We also find that the magnitude of this effect is more pronounced during financial crises. The results appear to be at least partially explained by agency problems related to poor corporate governance. These findings suggest that authorities might consider internationalization as an additional factor in bank supervision and regulation. In the third essay (co-authored with Allen N. Berger), we investigate whether the U.S. government bailout of banks during the recent financial crisis, the Troubled Assets Relief Program (TARP), gave recipients competitive advantages. Using a difference-indifference (DID) approach, we find that: 1) TARP recipients received competitive advantages and increased both their market shares and market power; 2) results may be driven primarily by the safety channel – TARP banks may be perceived as safer, which is partially offset by the cost disadvantage channel – TARP funds may be relatively expensive; and 3) these competitive advantages are primarily or entirely due to TARP banks that repaid early. The results of this paper may help explain other findings in the literature on TARP and yield important policy implications. The costs of the competitive distortions of bailouts should be weighed against the costs and benefits in terms of lending, risk taking, financial stability, and the overall effects on the economy