Be careful what you wish for: the stock market reactions to bailing out large financial institutions

Abstract

PurposeThe purpose of this paper is to examine the implicit subsidies received, in the form of stock market returns, from the perception that large banking organizations are too big to fail, and implications for financial regulation.Design/methodology/approachThe empirical analysis focuses on the responses of stock prices of various size groups of banking organizations to announcement of government capital injections to banks (troubled assets relief program) during the 2008 financial crisis, and summarizes responses of regulatory authorities to the crisis.FindingsThe paper finds positive and statistically significant stock return reactions both for a portfolio of the large banking organizations that are part of the initial capital injection plan and a portfolio of the large banking organizations that are not part of the initial capital injection plan, implying a too‐big‐to‐fail (TBTF) effect, especially for the latter group of institutions.Research limitations/implicationsThe paper focuses on a short time frame of stock price reactions to specific events, for the largest US banks. Further examination of longer‐term stock price effects on US as well as foreign banks may be of interest.Practical implicationsThe results have implications for the manner and scope of financial regulatory actions and changes in regulators' approaches to systemic risk and individual bank regulation.Originality/valueThe paper examines TBTF bank subsidy effects in response to a rapidly unfolding financial crisis. These have implications for longer term responses, particularly in the regulatory sphere.