How does ownership structure and manager wealth influence risk? : a look at ownership structure, manager wealth, and risk in commercial banks

Bank managers, stockholders, and directors must work closely together in deciding what risks their bank will assume and how to control the bank's overall risk exposure. Each decision-maker will have to understand the risk preferences of others in order to make mutually acceptable decisions and develop policies that reflect all of their concerns. To the extent that weak risk control is tied to management and ownership structure, bank examiners must also understand the basic components of a sound management and ownership structure if the examiner is to suggest corrective steps for a problem institution. ; This study looks at a sample of Tenth Federal Reserve District banks to investigate the relationship between bank risk, ownership of the bank by managers, and the degree to which managers and owners have their wealth concentrated in their bank stockholdings. Data for 270 randomly selected banks reveal that ownership and wealth diversification of bank owners and managers do influence bank risk. These effects extend not only to the overall risk of the bank, but are also reflected uniquely in asset quality measures, bank leverage, and other parts of a bank's risk exposure. ; Major findings highlight connections between bank risk, ownership structure, and manager wealth. Banks are less risky when bank managers have a higher concentration of wealth in their bank and, thus, have more to lose from taking on additional risk. Possibly seeking to avoid large loan losses that could threaten their employment, hired managers typically operate their banks with lower credit risk than banks with owner managers. Using capital as a buffer against risk, owner-manager banks tend to have higher capitalization than banks with hired managers. Stock ownership by hired managers provides incentives to operate their bank more in line with the risk preferences of owners. Finally, a hired-manager bank will be less risky when a major owner monitoring the bank has much of his or her wealth concentrated in the bank's stock. ; Thus, ownership structure and concentration of wealth in bank equity have a significant influence on bank risk. Understanding how risk preferences depend on ownership and wealth diversification can be valuable information to managers and owners as they grapple with the level and type of risk to take in their banks.