Bank Opacity and Crash Risk

Abstract

Banks are considered more opaque than non-bank firms because bank loans are privately negotiated between a bank and its customers. Information about the creditworthiness of the customers and the terms of the contracts are generally not available to outside investors. In addition, the trading assets of banks are intrinsically difficult to value given their complexity. Although it is required that a bank reports its trading assets periodically, it is difficult to impossible to determine how trading assets change between two reporting dates. Furthermore, bank managers have as strong a motivation to conceal negative news as their non-bank counterparts do. When the upper limit on how much negative news can be accumulated is reached, all negative news will be uncovered all at once, possibly leading to a stock price crash. We examine how bank assets opacity affects bank crash risk, using loans and trading assets (both measured as a percentage of total assets) as proxies for opacity. We find that opacity of assets is positively related to bank crash risk. In addition, we look at how CEO compensation affects bank crash risk since equity-based pay is blamed for motivating CEOs to engage in opportunistic behaviors such as news hoarding. However, we do not find evidence supporting the view that CEO equity-based pay is associated with higher crash risk. Our results are robust to different specifications and measures of crash risk.