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A primer on market discipline and governance of financial institutions for those in a state of shocked disbelief

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  • Joseph P. Hughes
  • Loretta J. Mester

Abstract

Self regulation encouraged by market discipline constitutes a key component of Basel II?s third pillar. But high-risk investment strategies may maximize the expected value of some banks. In these cases, does market discipline encourage risk-taking that undermines bank stability in economic downturns? This paper reviews the literature on corporate control in banking. It reviews the techniques for assessing bank performance, interaction between regulation and the federal safety net with market discipline on risk-taking incentives and stability, and sources of market discipline, including ownership structure, capital market discipline, product market competition, labor market competition, boards of directors, and compensation.

Suggested Citation

  • Joseph P. Hughes & Loretta J. Mester, 2012. "A primer on market discipline and governance of financial institutions for those in a state of shocked disbelief," Working Papers 12-13, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:12-13
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    References listed on IDEAS

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    Cited by:

    1. Arnold, Eva A. & Größl, Ingrid & Koziol, Philipp, 2016. "Market discipline across bank governance models: Empirical evidence from German depositors," The Quarterly Review of Economics and Finance, Elsevier, vol. 61(C), pages 126-138.
    2. Hughes, Joseph P. & Mester, Loretta J., 2013. "Measuring the Performance of Banks: Theory, Practice, Evidence, and Some Policy Implications," Working Papers 13-28, University of Pennsylvania, Wharton School, Weiss Center.

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    Keywords

    Regulation; Banks and banking;

    JEL classification:

    • D20 - Microeconomics - - Production and Organizations - - - General

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