WASHINGTON - When it comes to influencing management decisions, debt and equity markets may not be the disciplinarians that banking company supervisors have heralded.
In the past year, regulatory authorities from the Federal Reserve Board to the Basel Committee on Banking Supervision have agreed that as banking companies become more and more complex, the forces of market discipline must be harnessed to help regulate them.
The traditional argument goes like this: Stock and bondholders have a vested interest in the safety of the companies they invest in, so they monitor their risk-taking practices very closely. The stock of a company perceived to be too risky will fall in value, and the institution will have to pay more to float its debt. These signals of market displeasure will force management to rein in their risky practices.
But a study, commissioned by the National Bureau for Economic Research and making the rounds among academics and regulators, casts doubt on that theory, finding little relationship between the movement of bank holding company debt and equity prices and subsequent managerial action.
Federal Reserve Bank of Chicago economic advisor Robert R. Bliss and University of Florida professor Mark J. Flannery tracked the stock and bond prices for 107 bank holding companies from 1986 to 1997, and concluded that while evidence suggests a slight influence on institutional behavior, consistent market influence on managerial actions "remains, for the moment, more a matter of faith than of empirical evidence."
The study - which the authors presented at a Chicago Fed conference this month - identified various actions managers might take in response to the movement of stock and bond prices, such as reduction in leverage and changes in dividend policies. The authors said they found no evidence that such actions actually were taken when securities prices fell.
"We find no prima facie support for the hypothesis that bondholders or stockholders consistently influence day-to-day [quarter-to-quarter] managerial actions in a prominent manner," according to the paper.
The authors cautioned that the results do not detract from the importance of market discipline in regulating some aspects of bank company behavior, and in developing useful signals for regulators.
Nor do they deny that market discipline is effective in extreme circumstances - such as when the cost of debt issues becomes too prohibitive to raise capital.
"However," they conclude, "in the absence of specific evidence that bank holding company stock and bondholders can effectively influence managerial actions under normal operating conditions, supervisors would be unwise to rely on investors - including subordinated debenture holders - to constrain bank holding company risk-taking."
Other academics, particularly those who have championed market discipline as an adjunct - or replacement - for regulation, challenged the study's methods and conclusions.
"I thought there were a lot of loose ends in terms of whether the factual conclusions would stand up to further scrutiny," said Charles W. Calomiris, a professor at Columbia University's Graduate School of Business. "Assuming the conclusions are correct, I would argue that what they mean is that we need to work harder to have our regulatory system connect market perceptions of bank risk with behavioral responses by banks."