Too-Big-to-Fail Shareholders

By Yesha Yadav. Full text here.

Abstract: “To build resilience within the financial system, post-2008 Financial Crisis regulation relies heavily on banks to fund themselves more fully by issuing equity. This reserve of value should buttress failing banks by providing a mechanism to pay off creditors and depositors and preserve the health of financial markets. In the process, shareholders are wiped out. Scholars and policymakers, however, have neglected to examine which equity investors, in fact, are purchasing bank equity and taking on the default risk of U.S. banks. This Article addresses that question. First, it shows that five asset managers—BlackRock, Vanguard, State Street Global Advisors, Fidelity, and T. Rowe Price—dominate as repeat holders of block equity stakes across the largest twenty-six U.S. banks. As shareholders of record representing the savings of mutual and other fund holders, these asset managers administer funds that hold a sizable economic stake in the U.S. banking system. Secondly, this Article examines the effectiveness of asset managers in managing the bank default risk taken on by their funds. While theory generally assumes that shareholders face high costs and are risk seeking in bank governance, this Article offers a different perspective. Asset managers are traditionally passive in corporate governance. This passivity can be beneficial for bank regulation by offsetting the risk- chasing tendencies of the paradigmatic bank shareholder. Further, with multiple block equity stakes, asset managers can be efficient absorbers of the informational costs inherent to bank governance. Finally, in light of the default risk being assumed by their funds, this Article examines pathways to bring asset managers more actively into bank oversight. With numerous block holdings at major banks, they can bolster public oversight by offering private “systemic” monitoring across the financial system. Fundamentally, in connecting the aspirations of post-Crisis regulation with the real-world implications of its implementation, this Article highlights the significance of shareholders that cannot now afford to fail in bank governance.”