Institutional ownership and bank failure

Abstract

We study the relationship between bank failure and dedicated institutional ownership (hereafter IO) employing a logit model. We focus on dedicated institutional investors (hereafter IIs) as defined by Bushee (2001) and Bushee and NOE (2000) because they are stable shareholders and have large investments in the investee companies. Four results are obtained. First, based on the instrumental variable approach, a greater proportion of dedicated IO is associated with reduced probability of bank failure. This result is robust to the propensity score matching technique. The rationale is that dedicated IIs collect information on the investee banks by holding stable and concentrated positions in these banks, monitor them, and reduce their ownership in cases of trouble earlier than other IIs do. This effect has a larger magnitude in banks with greater organizational complexity and larger size. Second, after controlling for the sell herding effect of other IIs, we find that the dedicated IO proportion still has a negative and significant coefficient, indicating that dedicated IIs trade on fundamental information rather than herding with other IIs. Third, three potential channels of collecting information, (i) placing representatives on the board as directors, (ii) greater capacity in analyzing financial statements through cross-ownership in other banks, and (iii) higher monitoring incentive due to more stable and concentrated ownership, are investigated. We find evidence in favor of the effect of cross-ownership in the banking industry, ownership stability and concentration. Fourth, the ownership of dedicated IIs is significantly larger in banks acquired by other banks than those filing for Chapter 7 liquidation, ascribing a constructive role for dedicated IIs.