Finance - Theses
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ItemDo bank managers respond to debt-market discipline?( 2014)The 2007/08 financial crisis reignited debates on what is a socially optimal capital structure for banks. One school of thought suggests that debt capital could be beneficial for banks because it provides a disciplinary mechanism over the decisions of bank managers. However, inconclusive empirical evidence of the existence of debt holder discipline creates a gap between the market discipline hypothesis and reality. Given the systemic importance of banks to the financial system and the high amount of debt in banks’ capital structure; it is important to determine if debt can make banks safer through disciplining the decisions of bank managers. The thesis examines the response of bank managers to the Federal Reserve Board’s 2008 clarification of the types of bank debt covenants that are legally enforceable. Unlike the prior empirical literature, which measures market discipline by changes in the price or quantity of debt, I follow the theoretical banking literature and measure market discipline as the ratio of bank debt with legally enforceable covenants to total liabilities. The market discipline that arises from debt covenants comes from the conditionally demandable threat to bank managers and the incentivised monitoring of the debt holders. By examining a sample of bank holding companies in United States between 2005 and 2011, I find evidence of bank managers reducing wealth transfer to equity holders and reducing bank fragility in response to increases in market discipline from the 2008 clarification. I also find that opacity of a bank’s activities reduces the response of bank managers, and that market discipline influences bank managerial actions up to four calendar quarters into the future.