Dual holding and bank risk

Abstract

Using the 2007–2009 financial crisis as a quasi-natural experiment, we show that banks with investors holding simultaneously both equity and bonds (dual-holders) exhibit lower risk and superior performance. Dual-holders' influence is higher in more opaque banks, indicating that the mechanism of transmission is through a decrease in information asymmetry and a reduction in debtholder–shareholder conflict. This effect translates into higher unconditional and risk-adjusted stock returns. These economically large results show that a market mechanism implemented by outside investors is strongly effective in mitigating excessive risk taking by banks thus providing important normative implications for the stability of financial systems.