Who Disciplines Bank Managers?*

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. We bring to bear a hand-collected dataset of executive turnovers in U.S. banks to test the efficacy of market discipline in a 'laboratory setting' by analyzing banks that are less likely to be subject to government support. Specifically, we focus on a new face of market discipline: stakeholders' ability to fire an executive. Using conditional logit regressions to examine the roles of debtholders, shareholders, and regulators in removing executives, we present novel evidence that executives are more likely to be dismissed if their bank is risky, incurs losses, cuts dividends, has a high charter value, and holds high levels of subordinated debt. We only find limited evidence that forced turnovers improve bank performance.

Do all new brooms sweep clean? Evidence for outside bank appointments

“…Only after seven years do we no longer observe a significant performance differential between bank-years with and without outside appointments. We regard these negative performance effects as being in line with the findings of Schaeck et al (2012), who document that executive turnovers at US banks correlate with lower profitability and greater losses over a post-turnover period of three years. (1)- (5), the dependent variable is RROE, and in Column (6) it is RROA.…”

“…We extend the literature on post-turnover performance effects (Schaeck et al, 2012) by showing that executives with low managerial abilities, which we call bad outsiders, underperform with their new banks in the post-appointment period whereas executives with high managerial abilities, called good outsiders, only did so at the very beginning of the post-appointment period. These different performance paths indicate that not all executive directors appointed from outside are equally capable of improving bank performance.…”

“…In line with this, several studies document that operating performance of non-financial firms improves following senior executive turnover events (Denis and Denis, 1995;Huson et al, 2004). However, Schaeck et al (2012), who are among the first to examine post-turnover effects in the banking industry, find negative post-turnover performance effects. They argue that turnovers incurred costs (by the turnover itself or by the ongoing restructuring process) that may contribute to greater losses and reduced profitability in the post-turnover period.…”

“…In line with the latter reason, a large number of studies show that executive turnovers are often preceded by poor performance (e.g. Barro and Barro, 1990;Houston and James, 1995;Webb, 2008;Palvia, 2011) and high risk (Schaeck, Cihak, Maechler, and Stolz, 2012). In times of financial difficulties, the incoming executive from the outside is expected to catch up, revise the strategy and restructure the organization.…”

“…In other words, the performance differential between banks appointing good and bad outsiders might be driven by the managerial ability of the good outsiders or, alternatively, by their self-selection into better banks. Not all executive directors will accept job offers at high-risk banks because these positions may come with a higher likelihood of failure (Bushman, Zhonglan, and Wang, 2010;Schaeck et al, 2012) and executive directors care about their market value and reputation in the job market for bank managers. One potential source of selection is that good outsiders (who may receive many job offers because of their managerial ability) select low-risk banks while for bad outsiders (who may receive few job offers) high-risk banks may be the only viable employment option.…”