Institutional Shareholders and Bank Capital

Abstract

While the benefits of higher bank capital for financial stability are largely uncontested, there is a strong disagreement on how bank capital affects shareholder value (i.e., whether higher capital is privately optimal from the perspective of bank shareholders). In this paper, we explore institutional investors’ preferences for bank capital for a sample of U.S. listed banks. We show that institutional ownership is positively (negatively) associated with bank capital (leverage). This association is robust to controlling for asset risk, executive compensation structure, and proxies for shareholder-friendly governance. Additional tests reflect that the association is not primarily due to a selection effect but rather reflects a direct influence of institutional shareholders. Further analyses show that the relationship between bank capital and institutional investors is stronger for investors that are likely to place a higher weight on the stability benefits of bank capital (long-term investors and block-holders). Institutional ownership tends to be lower in banks than in non-banks and complementary tests show that this explains a significant fraction of the difference in leverage ratios between banks and non-banks. Our results suggest that institutional shareholders view bank capital as privately optimal and complement banking regulation in increasing bank capital.