IDEAS home Printed from https://ideas.repec.org/p/rut/rutres/200401.html
   My bibliography  Save this paper

Managerial Incentives and the Efficiency of Capital Structure in U.S. Commercial Banking

Author

Listed:
  • Joseph P. Hughes

    (Rutgers University)

  • William W. Lang

    (Federal Reserve Bank of Philadelphia)

  • Choon-Geol Moon

    (Hanyang University)

  • Michael S. Pagano

    (Villanova University)

Abstract

We extend the literature on the effects of managerial entrenchment to consider how safety-net subsidies and financial distress costs interact with managerial incentives to influence capital structure in U.S. commercial banking. Using cross-sectional data on publicly traded, highest-level U.S. bank holding companies, we find empirical evidence of Marcus' proposition (1984) that there are dichotomous strategies for value maximization—one involving relatively higher financial leverage and the other, lower financial leverage. We find that a less levered capital structure is associated with higher charter value and vice versa. Moreover, differences in charter value result in dichotomous strategies for managerial entrenchment: under-performing, less levered firms hold too little capital while under-performing, more levered firms hold too much.

Suggested Citation

  • Joseph P. Hughes & William W. Lang & Choon-Geol Moon & Michael S. Pagano, 2004. "Managerial Incentives and the Efficiency of Capital Structure in U.S. Commercial Banking," Departmental Working Papers 200401, Rutgers University, Department of Economics.
  • Handle: RePEc:rut:rutres:200401
    as

    Download full text from publisher

    File URL: http://www.sas.rutgers.edu/virtual/snde/wp/2004-01.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Smith, Clifford Jr. & Watts, Ross L., 1992. "The investment opportunity set and corporate financing, dividend, and compensation policies," Journal of Financial Economics, Elsevier, vol. 32(3), pages 263-292, December.
    2. Bhattacharya Sudipto & Thakor Anjan V., 1993. "Contemporary Banking Theory," Journal of Financial Intermediation, Elsevier, vol. 3(1), pages 2-50, October.
    3. Joseph P. Hughes & William W. Lang & Loretta J. Mester & Choon-Geol Moon, 1996. "Efficient banking under interstate branching," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 1045-1075.
    4. Galloway, Tina M. & Lee, Winson B. & Roden, Dianne M., 1997. "Banks' changing incentives and opportunities for risk taking," Journal of Banking & Finance, Elsevier, vol. 21(4), pages 509-527, April.
    5. Saunders, Anthony & Strock, Elizabeth & Travlos, Nickolaos G, 1990. "Ownership Structure, Deregulation, and Bank Risk Taking," Journal of Finance, American Finance Association, vol. 45(2), pages 643-654, June.
    6. Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, vol. 26(1), pages 3-27, July.
    7. Sanford J. Grossman & Oliver D. Hart, 1982. "Corporate Financial Structure and Managerial Incentives," NBER Chapters, in: The Economics of Information and Uncertainty, pages 107-140, National Bureau of Economic Research, Inc.
    8. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    9. Walter Novaes, 2003. "Capital Structure Choice When Managers Are in Control: Entrenchment versus Efficiency," The Journal of Business, University of Chicago Press, vol. 76(1), pages 49-82, January.
    10. McConnell, John J. & Servaes, Henri, 1990. "Additional evidence on equity ownership and corporate value," Journal of Financial Economics, Elsevier, vol. 27(2), pages 595-612, October.
    11. Gerald T. Garvey & Gordon Hanka, 1999. "Capital Structure and Corporate Control: The Effect of Antitakeover Statutes on Firm Leverage," Journal of Finance, American Finance Association, vol. 54(2), pages 519-546, April.
    12. Zwiebel, Jeffrey, 1996. "Dynamic Capital Structure under Managerial Entrenchment," American Economic Review, American Economic Association, vol. 86(5), pages 1197-1215, December.
    13. Brian J. Hall & Jeffrey B. Liebman, 1998. "Are CEOs Really Paid Like Bureaucrats?," The Quarterly Journal of Economics, Oxford University Press, vol. 113(3), pages 653-691.
    14. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
    15. Yaron Brook & Robert Hendershott & Darrell Lee, 1998. "The Gains from Takeover Deregulation: Evidence from the End of Interstate Banking Restrictions," Journal of Finance, American Finance Association, vol. 53(6), pages 2185-2204, December.
    16. Barclay, Michael J. & Holderness, Clifford G. & Pontiff, Jeffrey, 1993. "Private benefits from block ownership and discounts on closed-end funds," Journal of Financial Economics, Elsevier, vol. 33(3), pages 263-291, June.
    17. Rebecca Demsetz & Marc R. Saidenberg & Philip E. Strahan, 1996. "Banks with something to lose: the disciplinary role of franchise value," Economic Policy Review, Federal Reserve Bank of New York, vol. 2(Oct), pages 1-14.
    18. Clifford G. Holderness & Randall S. Kroszner & Dennis P. Sheehan, 1999. "Were the Good Old Days That Good? Changes in Managerial Stock Ownership Since the Great Depression," Journal of Finance, American Finance Association, vol. 54(2), pages 435-469, April.
    19. Harris, Milton & Raviv, Artur, 1990. "Capital Structure and the Informational Role of Debt," Journal of Finance, American Finance Association, vol. 45(2), pages 321-349, June.
    20. Bauer, Paul W., 1990. "Recent developments in the econometric estimation of frontiers," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 39-56.
    21. Kane, Edward J & Unal, Haluk, 1990. "Modeling Structural and Temporal Variation in the Market's Valuation of Banking Firms," Journal of Finance, American Finance Association, vol. 45(1), pages 113-136, March.
    22. Flannery, Mark J, 1994. "Debt Maturity and the Deadweight Cost of Leverage: Optimally Financing Banking Firms," American Economic Review, American Economic Association, vol. 84(1), pages 320-331, March.
    23. Stulz, ReneM., 1988. "Managerial control of voting rights : Financing policies and the market for corporate control," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 25-54, January.
    24. Berger, Philip G & Ofek, Eli & Yermack, David L, 1997. "Managerial Entrenchment and Capital Structure Decisions," Journal of Finance, American Finance Association, vol. 52(4), pages 1411-1438, September.
    25. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    26. Morck, Randall & Shleifer, Andrei & Vishny, Robert W., 1988. "Management ownership and market valuation," Scholarly Articles 29407535, Harvard University Department of Economics.
    27. Guay, Wayne R., 1999. "The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and determinants," Journal of Financial Economics, Elsevier, vol. 53(1), pages 43-71, July.
    28. Saxonhouse, Gary R, 1976. "Estimated Parameters as Dependent Variables," American Economic Review, American Economic Association, vol. 66(1), pages 178-183, March.
    29. Jondrow, James & Knox Lovell, C. A. & Materov, Ivan S. & Schmidt, Peter, 1982. "On the estimation of technical inefficiency in the stochastic frontier production function model," Journal of Econometrics, Elsevier, vol. 19(2-3), pages 233-238, August.
    30. Israel, Ronen, 1991. "Capital Structure and the Market for Corporate Control: The Defensive Role of Debt Financing," Journal of Finance, American Finance Association, vol. 46(4), pages 1391-1409, September.
    31. Hughes, Joseph P. & Lang, William W. & Mester, Loretta J. & Moon, Choon-Geol, 1999. "The dollars and sense of bank consolidation," Journal of Banking & Finance, Elsevier, vol. 23(2-4), pages 291-324, February.
    32. Assem Safieddine & Sheridan Titman, 1999. "Leverage and Corporate Performance: Evidence from Unsuccessful Takeovers," Journal of Finance, American Finance Association, vol. 54(2), pages 547-580, April.
    33. Hart, Oliver & Moore, John, 1995. "Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management," American Economic Review, American Economic Association, vol. 85(3), pages 567-585, June.
    34. Billett, Matthew T, 1996. "Targeting Capital Structure: The Relationship between Risky Debt and the Firm's Likelihood of Being Acquired," The Journal of Business, University of Chicago Press, vol. 69(2), pages 173-192, April.
    35. Fama, Eugene F & Jensen, Michael C, 1983. "Separation of Ownership and Control," Journal of Law and Economics, University of Chicago Press, vol. 26(2), pages 301-325, June.
    36. Hadlock, Charles & Houston, Joel & Ryngaert, Michael, 1999. "The role of managerial incentives in bank acquisitions," Journal of Banking & Finance, Elsevier, vol. 23(2-4), pages 221-249, February.
    37. Morck, Randall & Shleifer, Andrei & Vishny, Robert W., 1988. "Management ownership and market valuation : An empirical analysis," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 293-315, January.
    38. McConnell, John J. & Servaes, Henri, 1995. "Equity ownership and the two faces of debt," Journal of Financial Economics, Elsevier, vol. 39(1), pages 131-157, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Fiordelisi, Franco, 2007. "Shareholder value efficiency in European banking," Journal of Banking & Finance, Elsevier, vol. 31(7), pages 2151-2171, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Joseph P. Hughes & Choon-Geol Moon & William W. Lang & Michael S. Pagano, 2001. "Managerial Incentives and the Efficiency of Capital Structure," Departmental Working Papers 200102, Rutgers University, Department of Economics.
    2. Hughes, Joseph P. & Lang, William W. & Mester, Loretta J. & Moon, Choon-Geol & Pagano, Michael S., 2003. "Do bankers sacrifice value to build empires? Managerial incentives, industry consolidation, and financial performance," Journal of Banking & Finance, Elsevier, vol. 27(3), pages 417-447, March.
    3. Alexander Radygin & Revold Entov & Marina Turuntseva & Alena Gontmakher & Harry Swain & Jeff Carruthers & Karen Minden & Cheryl Urban, 2002. "The problems of corporate governance in Russia and its regions," Published Papers 12, Gaidar Institute for Economic Policy, revised 2002.
    4. Ruben Arrondo & Silvia Gomez-Anson, 2003. "A study of Spanish firms' security issue decision under asymmetric information and agency costs," Applied Financial Economics, Taylor & Francis Journals, vol. 13(10), pages 771-782.
    5. de Jong, A., 2001. "The Disciplining Role of Leverage in Dutch Firms," Other publications TiSEM 940ddf9b-7e19-460c-be52-d, Tilburg University, School of Economics and Management.
    6. de Jong, A., 2001. "The Disciplining Role of Leverage in Dutch Firms," Discussion Paper 2001-48, Tilburg University, Center for Economic Research.
    7. James, Hui & Benson, Bradley W. & Wu, Chen (Ken), 2017. "Does CEO ownership affect payout policy? Evidence from using CEO scaled wealth-performance sensitivity," The Quarterly Review of Economics and Finance, Elsevier, vol. 65(C), pages 328-345.
    8. Jayati Sarkar & Subrata Sarkar, 2005. "Debt and corporate governance in emerging economies: Evidence from India," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2005-007, Indira Gandhi Institute of Development Research, Mumbai, India.
    9. 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.
    10. Pablo de Andres Alonso & Felix J. Lopez Iturriaga & Juan A. Rodriguez Sanz, 2005. "Financial decisions and growth opportunities: a Spanish firm's panel data analysis," Applied Financial Economics, Taylor & Francis Journals, vol. 15(6), pages 391-407.
    11. Howell, Jann C. & Stover, Roger D., 2002. "How much do governance and managerial behavior matter in investment decisions? Evidence from failed thrift auctions," Journal of Corporate Finance, Elsevier, vol. 8(3), pages 195-211, July.
    12. Bradley W. Benson & Wallace N. Davidson III & Hongxia Wang & Dan L. Worrell, 2011. "Deviations from Expected Stakeholder Management, Firm Value, and Corporate Governance," Financial Management, Financial Management Association International, vol. 40(1), pages 39-81, March.
    13. Harvey, Campbell R. & Lins, Karl V. & Roper, Andrew H., 2004. "The effect of capital structure when expected agency costs are extreme," Journal of Financial Economics, Elsevier, vol. 74(1), pages 3-30, October.
    14. Gorton, Gary & Rosen, Richard, 1995. "Corporate Control, Portfolio Choice, and the Decline of Banking," Journal of Finance, American Finance Association, vol. 50(5), pages 1377-1420, December.
    15. Pablo de Andrés-Alonso & Valentín Azofra-Palenzuela & Juan A. Rodríguez-Sanz, 2000. "Endeudamiento, oportunidades de crecimiento y estructura contractual: un contraste empírico para el caso español," Investigaciones Economicas, Fundación SEPI, vol. 24(3), pages 641-679, September.
    16. Benson, Bradley W. & Chen, Yu & James, Hui L. & Park, Jung Chul, 2020. "So far away from me: Firm location and the managerial ownership effect on firm value," Journal of Corporate Finance, Elsevier, vol. 64(C).
    17. Isagawa, Nobuyuki, 2002. "Callable convertible debt under managerial entrenchment," Journal of Corporate Finance, Elsevier, vol. 8(3), pages 255-270, July.
    18. Doukas, John A. & Pantzalis, Christos, 2003. "Geographic diversification and agency costs of debt of multinational firms," Journal of Corporate Finance, Elsevier, vol. 9(1), pages 59-92, January.
    19. Aloke Ghosh & Doocheol Moon & Kishore Tandon, 2007. "CEO Ownership and Discretionary Investments," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(5‐6), pages 819-839, June.
    20. Walter Novaes, 2002. "Managerial Turnover and Leverage under a Takeover Threat," Journal of Finance, American Finance Association, vol. 57(6), pages 2619-2650, December.

    More about this item

    Keywords

    capital allocation; efficiency; agency problems; corporate control; charter value;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:rut:rutres:200401. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/derutus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.