Exploiting a unique hand-built dataset, this paper finds that CEO educational attainment, both level and quality, matters for bank performance. We offer robust evidence that banks led by CEOs with MBAs outperform their peers. Such CEOs improve performance when compensation structures are geared towards greater risk-taking incentives, and when banks follow riskier or more innovative business models. Our findings suggest management education delivers skills enabling CEOs to manage increasingly larger and complex banking firms and achieve successful performance outcomes.

Manuscript Type: ReviewResearch Question/Issue: Bank governance has become the focus of a flurry of recent research and heated policy debates. However, the literature presents seemingly conflicting evidence on the implications of governance for bank risk-taking. The purpose of this paper is to review prior work and propose directions for future research on the role of governance on bank stability. Research Findings/Insights:We highlight a number of key governance devices and how these shape bank risk-taking: the effectiveness of bank boards, the structure of CEO compensation, and the risk management systems and practices employed by banks.Theoretical/Academic Implications: Prior work primarily views bank governance as a mechanism to protect the interests of bank shareholders only. However, given that taxpayerfunded guarantees protect a substantial share of banks' liabilities and that banks are highlyleveraged, shareholder-focused governance may well subordinate the interests of other stakeholders and exacerbate risk-taking concerns in the banking industry. Our review highlights the need for internal governance mechanisms to mitigate such behavior by reflecting the needs of shareholders, creditors and the taxpayer.Practitioner/Policy Implications: Our review argues that the relationship between governance and risk is central from a financial stability perspective. Future research on issues highlighted in the review offer a footing for reforming bank governance to constrain potentially undesirable risk-taking by banks.

Bank payouts divert cash to shareholders, while leaving behind riskier and less liquid assets to repay debt holders in the future. Bank payouts, therefore, constitute a type of risk-shifting that benefits equity holders at the expense of debt holders. In this paper, we provide insights on how incentives stemming from inside debt impact bank payout policy in a manner that protects debt holder interests. We show that CEOs with higher inside debt relative to inside equity are associated with more conservative bank payout policies. Specifically, CEOs paid with more inside debt are more likely to cut payouts and to cut payouts by a larger amount. Reductions in payouts occur through a decrease in both dividends and repurchases. Our results also hold over a subsample of TARP banks where we expect the link between risk-shifting and payouts to be of particular relevance because it involves wealth transfers from the taxpayer to equity holders. We conclude that inside debt can help in addressing risk-shifting concerns by aligning the interests of CEOs with those of creditors, regulators, and in the case of TARP banks, the taxpayer.JEL Classification: G21, G28, G34, J33 Keywords: banks, inside debt, CEO incentives, payout, dividends 1 IntroductionRecently, there has been considerable interest in what determines banks to pursue risky policies.This interest stems in part from the historic magnitude of the financial crisis of 2007-09 which resulted in substantial losses for bank investors and gave rise to unprecedented levels of government support to the banking sector. In an attempt to prevent financial sector meltdown, the U.S. government bailed out the banking sector by injecting more than $400 billion of taxpayer funds. With taxpayers turned into creditors and exposed to losses resulting from risky bank behavior, there has been a great deal of attention on how to prevent excessive bank risktaking in the future. Specifically, a prominent question now is how to motivate banks to pursue bank policies which protect creditor and taxpayer interests. Our paper looks at this question.When banks engage in high levels of risk-taking, it implies a type of risk-shifting that favors bank equity holders over debt holders. Risk-shifting favors equity investors because equity investors hold convex claims over firm assets which causes their expected payoffs to rise exponentially with bank risk; by contrast, debt holder payoffs are concave due to limited upside potential in the value of their claims (Jensen and Meckling, 1976). For debt holders, high risk taking, therefore, implies a higher probability of losses without the same potential for gains that equity holders benefit from. Consequently, it is important to understand how the risk-shifting behavior of banks can be mitigated. We examine this issue by focusing on the compensation structure of bank CEOs. Specifically, we test whether payments to CEOs of banks that are more like debt (than like equity) is associated with bank policies that favor debt holders over equity holders. ...

Article:Srivastav, A orcid.org/0000-0003-4831-4458, Armitage, S, Hagendorff, J et al.(1 more author) (2018) Better safe than sorry? CEO inside debt and risk-taking in bank acquisitions. Journal of Financial Stability, 36. pp. 208-224. AbstractWidespread bank losses during the financial crisis have raised concerns that equity-based compensation for bank CEOs causes excessive risk-taking. Debt-based compensation, so-called inside debt, aligns the interests of CEOs with those of external creditors. We examine whether inside debt induces CEOs to pursue less risky acquisitions. Consistent with this, we show that acquisitions announced by CEOs with high inside debt incentives are associated with a wealth transfer from equity to debt holders. After the completion of a deal, banks where acquiring CEOs have high inside debt incentives display lower market measures of risk and lower loss exposures for taxpayers. JEL Classification: G21, G34, J33

Using a unique international dataset, we show that the CEOs of large banks exhibit an increased probability of forced turnover when their organizations are more exposed to idiosyncratic tail risks. The importance of idiosyncratic tail risk in CEO dismissals is strengthened when there is more competition in the banking industry and when stakeholders have more to lose in the case of distress. Overall, we document that the exposure to idiosyncratic tail risk offers valuable signals to bank boards on the quality of the choices made by CEOs and these signals are different from those provided by accounting and market measures of bank performance and by idiosyncratic volatility. In contrast, systematic tail risk is usually filtered out from the firing decision, only becoming important for forced CEO turnovers in the presence of a major variation in the costs that the exposure to this risk generates for shareholders and the organization.  We thank John Core (the editor) and Robert Bushman (the reviewer) for their many insightful comments and suggestions.

Using a unique international dataset, we show that the CEOs of large banks exhibit an increased probability of forced turnover when their organizations are more exposed to idiosyncratic tail risks. The importance of idiosyncratic tail risk in CEO dismissals is strengthened when there is more competition in the banking industry and when stakeholders have more to lose in the case of distress. Overall, we document that the exposure to idiosyncratic tail risk offers valuable signals to bank boards on the quality of the choices made by CEOs and these signals are different from those provided by accounting and market measures of bank performance and by idiosyncratic volatility. In contrast, systematic tail risk is usually filtered out from the firing decision, only becoming important for forced CEO turnovers in the presence of a major variation in the costs that the exposure to this risk generates for shareholders and the organization.  We thank John Core (the editor) and Robert Bushman (the reviewer) for their many insightful comments and suggestions.

Article:Srivastav, A orcid.org/0000-0003-4831-4458, Armitage, S, Hagendorff, J et al.(1 more author) (2018) Better safe than sorry? CEO inside debt and risk-taking in bank acquisitions. Journal of Financial Stability, 36. pp. 208-224. AbstractWidespread bank losses during the financial crisis have raised concerns that equity-based compensation for bank CEOs causes excessive risk-taking. Debt-based compensation, so-called inside debt, aligns the interests of CEOs with those of external creditors. We examine whether inside debt induces CEOs to pursue less risky acquisitions. Consistent with this, we show that acquisitions announced by CEOs with high inside debt incentives are associated with a wealth transfer from equity to debt holders. After the completion of a deal, banks where acquiring CEOs have high inside debt incentives display lower market measures of risk and lower loss exposures for taxpayers. JEL Classification: G21, G34, J33

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