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    The Stock Market and Bank Risk-Taking
    30 Nov 2016Working Paper Summaries

    The Stock Market and Bank Risk-Taking

    by Antonio Falato and David Scharfstein
    It is clear that risk-taking by financial institutions is one of the main causes of financial crises and severe recessions. Yet we know relatively little about what gives rise to such risk-taking in the first place. This paper presents evidence that a focus on short-term stock prices induces publicly-traded banks to increase risk relative to privately-held banks. The findings provide support for the view that compensation schemes should require management to hold stock for longer periods to mitigate their incentives to pump up short-term earnings and the short-term stock price.
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    Author Abstract

    We present evidence that pressure to maximize short-term stock prices and earnings leads banks to increase risk. We start by showing that banks increase risk when they transition from private to public ownership through a public listing or an acquisition. The increase in risk is greater than for a control group of banks that intended but failed to transition from private to public ownership, a result that is robust to using a plausibly exogenous instrument for failed transitions. The increase in risk is also greater than for a control group of banks that were acquired but did not change their listing status. We establish that pressure to maximize short-term stock prices helps to explain these findings by showing that the increase in risk is larger for newly public banks that are more focused on short-term stock prices and performance.

    Paper Information

    • Full Working Paper Text
    • Working Paper Publication Date: September 2016
    • HBS Working Paper Number: NBER Working Paper Series, No. 22689
    • Faculty Unit(s): Finance
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    David S. Scharfstein
    David S. Scharfstein
    Edmund Cogswell Converse Professor of Finance and Banking
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