Market Discipline in the Governance of U.S. Bank Holding Companies: Monitoring vs. Influencing

Abstract

Market discipline is an article of faith among financial economists, and the use of market discipline as a regulatory tool is gaining credibility. Effective market discipline involves two distinct components: security holders' ability to accurately assess the condition of a firm ("monitoring") and their ability to cause subsequent managerial actions to reflect those assessments ("influence"). Substantial evidence supports the existence of market monitoring. However, little evidence exists on market influence, and then only for stockholders and for rare events such as management turnover. This paper seeks evidence that U.S. bank holding companies' security price changes reliably influence subsequent managerial actions. Although we identify some patterns consistent with beneficial market influences, we have not found strong evidence that stock or (especially) bond investors regularly influence managerial actions. Market influence remains, for the moment, more a matter of faith than of empirical evidence.

Ownership structure, risk and performance in the European banking industry

“…3 2 We refer to the definition of direct market discipline proposed by Flannery (2001), as the process whereby the market discipline signals affect the economic and financial position of a firm. 3 As pointed out by Bliss and Flannery (2000), to be effective direct market discipline requires a firm's expected cost of funds to be a direct function of its risk profile. This in turn requires that the firm's management responds to market signals.…”

Monitoring Matters: Debt Seniority, Market Discipline and Bank Conduct

“…The opinions regarding the preventative influence of market discipline also diverge. Bliss and Flannery (2000) argue that evidence for the influencing dimension of market discipline is virtually absent. This view finds empirical support in research by Billet, Garfinkel, and O'Neal (1998), and Krishnan, Ritchken, and Thomson (2005).…”

Market Discipline and Bank Risk Taking: Evidence from the East Asian Banking Sector

“…Market discipline involves monitoring and influencing by investors (Bliss and Flannery, 2002). Monitoring refers to the investors' capability of assessing a firm's actual situation and sending market signals to the managers.…”

“…1 As highlighted by Berger (1991), Flannery (2001) and Hamalainen et al (2001), most of the earlier literature has been mainly focused on identifying whether stakeholders discipline banks using the two approaches. However, Bliss and Flannery (2002) assert the effectiveness of market discipline need to be assessed based on its ability in influencing banks' risk taking behavior. In line with this, studies by Cordella and Levy Yeyati (1998) and Blum (2002) show that the ability of market in inducing prudential behavior among bank mangers depends on the visibility of banks risk choices and the amount of uninsured deposits.…”