Why Are Bad Loans Originated for Securitization? The Impact of Shareholder Rights in the Banking Industry

• In Event: Shareholder Rights, Corporate Boards and Compensation

Abstract

This paper investigates why and how bank-level shareholder rights affect the quality of loans originated for securitization. Using a sample of bank holding companies, I find that banks with large shareholder rights experience poor securitized loan performance, especially for banks which suffer large information asymmetry or have extreme risk-seeking shareholders. In addition, the negative impact of shareholder rights on quality of securitized loans is mitigated if banks provide less securitization recourse. Lastly, banks with the highest shareholder rights pre-crisis are found to suffer the largest losses in securitized loans during the financial crisis. Overall, the evidence supports the view that securitized loan risk is mostly kept by banks and impelled by shareholders. Hence, there could be a potential negative consequence of having powerful shareholders in banks. These findings should provide insights into the ongoing regulatory reform with regard to rebuilding governance mechanisms for financial institutions.

Author

• Jing Zhang, McGill University