Variables descriptivas y equilibrio

The largest ever government intervention in the US banking system has prompted researchers to evaluate the effectiveness of emergency capital injections on financial performance of recipient institutions. Yet, there is no consensus in the literature on how efficiently bank recapitalisation works. In general, stability of a TARP recipient is likely to be affected by three key factors: initial financial health, market perception towards TARP investment, and recipient’s reinvestment strategies ex post.

Theoretically, it is argued that the effectiveness of equity capital infusions predominantly depends upon financial health of recipient banks ex ante. Diamond and Rajan (2005, 2011) point out that capital infusions to impaired banks with highly illiquid asset portfolios are not only of no use to help these banks survive and avoid under-priced fire sales but also may destroy their healthier counterparts. Empirical evidence by Bayazitova and Shivdasani (2012) indicates that, compared to non- recipients, TARP recipients tended to be larger, with less stable funding resources, weaker capital ratios, greater derivative exposures, and better performing loan portfolios. Furthermore, several studies point out the key role that political and

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regulatory connections played in distribution of TARP funds (see Duchin and Sosyura, 2012; Li, 2013). These studies suggest that some recipient banks were not healthy at all, while TARP was notionally designed for healthy and viable institutions. Accordingly, Cornett et al. (2013) account for heterogeneity in financial health of TARP recipients and show that performance of recipient banks greatly differs with respect to their pre- crisis health: healthier and larger banks are significantly more likely to repay their TARP funds and less likely to miss their dividend payments.

Another important factor that affects the stability of recipient banks is market perception and sentiment towards recipients, which can greatly affect their stock price performance as well as their access to external funding and liquidity. Indeed, the existing literature provides two divergent views on the relationship between receiving bailout funds and stability of recipient banks in the short-run. On the one hand, some authors support ‘bailout-stability’ view and argue that capital assistance enhances stability of recipient banks in the short-run by improving their capital and liquidity position during adverse financial conditions (see Mehran and Thakor, 2011; Bayazitova and Shivdasani, 2012). Furthermore, capital infusions may be considered as a positive signal about financial health of bailout recipients, particularly considering that TARP funds were designed for viable banks only. Also, investors may assume that TARP recipients are under government’s protection and will be bailed out again by the government, in case of future distress (see Duchin and Sosyura, 2014).

By contrast, advocates of ‘bailout-fragility’ view argue that capital infusions may serve as a distress signal about financial health of a recipient bank. Hoshi and Kashyap (2010) argue that applying for government funds may reduce the value of a bank’s existing equity by indicating that the bank is either unable to raise external funds elsewhere or its potential future loss is likely to be higher than the previously disclosed amount. Furthermore, capital infusions may induce debt overhang problem as government securities have priority over common shares in terms of claim on earnings and dividend payments. This can further undermine the current market value of a recipient’s existing equity. In general, previous studies have provided conflicting empirical evidence on how investors reacted to capital injections; Elyasiani et al. (2014) reveal that investors reacted positively to TARP injections, while others, including

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Farruggio et al. (2013) and Fratianni and Marchionne (2013), find a significantly negative market response to capital infusions.

The impact of capital infusions on long-run stability of a recipient bank mainly depends upon the bank’s risk-taking behaviour and reinvestment strategy ex post. On the one hand, increased capitalisation of supported banks may reduce their risk-taking incentives, which, in turn, enhances their likelihood of survival and long-run stability (Duchin and Sosyura, 2014). Equally important, liquid capital infusions when financial markets are highly illiquid distorts market conditions and gives bailout recipients the advantage to better seize profitable investment opportunities at deep discounts. Thus, skilful managers can use this cheap source of financing to reduce the bank’s risk level via diversification of asset portfolios, thereby promoting the bank stability (Farruggio et al., 2013).

On the other hand, advocates of ‘bailout-fragility’ view argue that bailout recipients may be more fragile in the long run. In particular, capital injections may induce higher risk-taking by a protected bank due to increasing moral hazard incentives on the part of the bank’s managers (see, e.g., Dam and Koetter, 2012; Duchin and Sosyura, 2014). Moreover, one of the primary purposes of TARP was to promote lending activities through TARP recipients. Lending cash liquid to risky borrowers during a period of financial distress can largely deteriorate the quality of loan portfolios in protected banks (Black and Hazelwood, 2013; Elyasiani, 2014).

Building up on the existing literature, the empirical hypotheses about the impact of governmental capital assistance on bank stability are formulated as follows.

Hypothesis 1: Although government bailout is not effective in preventing recipient banks from technical insolvency, larger recipients may avoid regulatory closure.

Several reasons can be provided for this hypothesis. First, in the presence of political and regulatory connections, some unhealthy and highly illiquid banks may receive government funds. This, in turn, may question and stigmatise financial health of other recipients, and hence limit their access to external financing, reduce their share prices, and trigger deposit outflows. Furthermore, having no clear guidance and

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restrictions as to how the government funds should be used may generate ex ante moral hazard incentives on the part of bank managers, particularly if participating in bailout program restricts managers’ compensation. More importantly, when facing financial distress, larger banks are more likely to avoid regulatory closure due to better political and regulatory connections as well as having ‘too-big-too-fail’ status, which ease their access to liquidity and external funding.

Hypothesis 2: Bailout recipients are attractive acquisition targets, regardless of their size and financial health, particularly before the repayment of the bailout funds.

There are three main reasons why the bailout recipients are more likely to be acquired before capital repayments. Over time, many TARP recipients struggled with (i) public stigma and pressure attached to the TARP investment, (ii) reduced share prices due to market uncertainty and stigma, (iii) potential debt overhang problems, and (iv) various restrictions on executive compensations. This may incentivise managers of recipient banks to trade some of their subsidiaries to repay government funds and exit TARP. Furthermore, some recipients that used TARP money to acquire other banks with great bargains during liquidity crisis may sell their less efficient subsidiaries to other banking institutions. Finally, recipients that are expected to face imminent failures may be acquired by other banks under regulatory pressures as well as possibilities of renegotiating TARP terms for acquiring institutions.