Institutional Ownership and Tail Risk Comovement in Banks

Recent regulatory discussions concentrate on the role institutional investors play in the financial sector. We investigate the determinants and consequences of institutional ownership (IO) in banks. Our findings suggest that institutional owners invest more in banks that have a lower proportion of consumer and real estate loans; are less opaque; have a lower level of insider control; are larger, older, and more capitalized; and have lower stock return volatility. In contrast, banks’ funding characteristics, loan risk appetite, and connectedness with other banks do not seem to be relevant factors in institutional investors’ decisions to hold a bank. We further investigate whether IO is related to tail risk comovement and changes in bank operations. We find robust evidence suggesting that IO is positively associated with a bank’s future tail risk and that the association between IO and tail risk is significantly higher for banks than it is for nonfinancial firms. We also find that this relationship is stronger for banks during economic downturns. Correspondingly, we find that there is a greater reduction in lending growth and greater increases in opacity and risk taking during recessionary periods for banks with higher levels of IO. Our results suggest that institutions with low monitoring incentives in particular play a role in increasing tail risk comovement and in the deleterious real effects of IO. Lastly, we find evidence suggesting that disclosure may play a role in mitigating the relationship between IO and tail risk comovement.

This paper was accepted by Eric So, accounting.

Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.02522.