Bank stockholders’ vs bank bondholders’ market discipline during crisis time: an investigation based on supervisory stress test information disclosure

Purpose - This paper aims to investigate how stockholders and bondholders react to the information disclosed on the financial markets during crisis periods. This paper considers the 2011 European Banking Authority’s stress test as it disclosed detailed information about banks. Design/methodology/approach - It was conducted during the European sovereign debt crisis, and this paper uses an event study methodology. This paper analyzes the average cumulative abnormal returns for different subsamples of banks. This paper compares the reactions of stockholders and bondholders to the stress test by considering pre-results announcements (signal generating process) to the publication of the results on the disclosure date, using quantitative data for each individual bank that participated in the stress test (the signal provided to the financial market). Findings - This paper finds that stockholders’ reaction is more sensitive to idiosyncratic components of the disclosed information, whereas bondholders are more influenced by systematic risk. A deeper investigation shows that subordinated bondholders tend to behave quite similarly to stockholders. This specific reaction of stockholders during financial distress may make them more likely than bondholders to impose market discipline during troubled periods. Originality/value - This paper brings several new insights to the behavior of stock and bond holders during times of financial distress and makes recommendations to regulators that may serve to refine communication to markets to reduce the shock of negative news.