Putting skin in the game

This paper examines the relation between managerial ownership and bank risk exposure for a large sample of international financial institutions. We seek empirical evidence suggested by theories concerning conflicts between managers and owners over risk-taking. We argue that managers holding equity of their bank take less risk because they have fewer opportunities to diversify risk compared with outside shareholders. Our findings are consistent with this idea. We document lower risk levels for banks that employ bank managers with higher equity stakes. Our evidence also suggests that external shareholders affect risk taking via directors representing their interests. We also demonstrate that regulation hardly affects the risk-taking of bank managers holding on their bank's shares. This contrasts with outside shareholders who are more likely to expose their bank to higher risk levels when regulation protects the bank against default. Managerial equity incentives may, therefore, serve as a risk reduction instrument.