Ten years ago, a series of bank failures rocked the financial and economic worlds. One of the immediate political consequences of those failures was the creation, by the US government, of a Troubled Asset Relief Program (TARP). This almost immediately morphed into a troubled equity relief program, because as Treasury Secretary Henry Paulson put it at the time, the purchase of the relevant assets "would take time to implement and would not be sufficient given the severity of our problem." The government had to shore up balance sheets of big banks quickly, and it did so by buying their equity.
This action gave a new level of ubiquity to the expression "too big to fail." Those banks had received a bail out because of their TBTF status. Thus, the quality of being TBTF proved to be a crucial asset, one that presumably makes the (still private) equity of some banks more valuable than the equity of other, smaller or less well-connected, banks.
Indeed, much scholarly work in the subsequent decade has taken it for granted that banks deemed TBTF are valued more highly than they would otherwise be, because the presumed safety net beneath them is itself factored by efficient capital markets into their price.
This has raised policy questions. Are banks below this threshold expanding or merging in order to get above the threshold? To get the safety net and the presumed higher valuations? Should such expansions or mergers be discouraged?
The point of reviewing the very familiar history of the above four paragraphs is that it offers background and context for a new Fisher College of Business Working Paper, "Are the Largest Banks Valued More Highly?"
It Didn't Begin in 2008
Generally, the presumption has been that if there is a valuation premium from size, the premium did not begin with the crisis of 2008. After all, the phrase "too big to fail," though it crashed pop culture in a big way only then, had been around among policymakers and the scholars who study them for decades longer than that. Congressman Stewart McKinney may have coined the term in 1984 in connection with a crisis at Continental Illinois.
At any rate, the answer that the authors of the new working paper give to their title question is, "not necessarily." They maintain that the safety net comes with real costs, in terms of "greater regulatory scrutiny, political risk, or regulatory requirements that force them to pursue suboptimal policies."
From the shareholders' point of view, there is another cost: opacity. TBTF status may help shied managements from monitoring, making equity in such banks, ceteris paribus, less valuable than equity in other institutions with more transparent managements. In other words, agency costs are higher.
The authors of the working paper are: Bernadette Minton, Rene Stulz, and Alvaro Taboada. Monton and Stulz are affiliated with Ohio State University, Fisher College of Business, Taboada with Mississippi State.
Minton et al., found, looking at the period 1987 to 2006, that bank valuations were negatively related to size. The year 1987 (three years after the collapse of Continental Illinois) is a good one to begin such sampling, because it was the year of the Black Monday stock market crash.
Testing Against Thresholds
"Throughout our sample period," they write, "acquisitions have negative abnormal returns for bank acquirers. Using all acquisitions by banks in our sample, we can reject the hypothesis that banks benefit from crossing either the $50 billion of assets or the $100 billion of assets TBTF thresholds. In addition, we find evidence that banks that cross a TBTF threshold experience worse abnormal returns than banks that make an acquisition that does not cross a TBTF threshold." That evidence is especially strong for acquisitions that cause the acquirer to cross the $100 billion threshold.
If banks are crossing such thresholds with the idea that they will thereby be making their stock more valuable, they are deluded.
A cynic might add that this study leaves open the possibility that bank managements may count on their stockholders erroneously, believing they'll get something for nothing. That could be a factor in selling a stockholder base on mergers or other expansions that help the imperial ambitions of managers (and help create opacity) but that actually hurt that stockholder base.
Presumably, that hypothesis is a matter for further study.