Lobbying, Regulatory Enforcement and Corporate Governance: Theory and Evidence from Regulatory Enforcement Actions against US Banks

We explore protection against enforcement as a motive for lobbying and present evidence for bank holding companies with good corporate governance but a poorly performing portfolio of subsidiaries to be more likely to lobby. A simple theoretical model of lobbying as a means for banks to communicate otherwise private information on their quality rationalizes regulators' responsiveness to lobbying, even though lobbying banks inadvertently expose themselves as violators of the regulation. Using a composite governance indicator as a proxy for a bank's quality, we take the hypotheses from the model to a panel dataset of 173 large bank holding companies and their subsidiaries. In line with the theoretical hypotheses, we find that subsidiaries of lobbying, high-governance parent companies are less likely to receive a regulatory enforcement action, but the reverse is true for poor-governance parent companies. Furthermore, banks whose parent companies have lobbied perform better (worse) after five years if the bank holding has a high (low) governance indicator. On a policy note, our paper highlights a potential benefit of the lobbying system and makes the case for carefully designed incentives and commitment powers of bank regulators in order to make the most of this benefit.