Working Paper Series
Inside Debt, Bank Default Risk, and
Performance during the Crisis
Rosalind L. Bennett
Federal Deposit Insurance Corporation
Levent G ̈untay
Federal Deposit Insurance Corporation
Haluk Unal
University of Maryland, R.H. School of Business
and FDIC Center for Financial Research
First Version: August 2010
Current Version: February 2014
FDIC CFR WP 2012-03
NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical
comment. The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do
not necessarily reflect the views of the Federal Deposit Insurance Corporation. References in publications
to this paper (other than acknowledgment) should be cleared with the author(s) to protect the tentative
character of these papers.
Inside Debt, Bank Default Risk, and
Performance during the Crisis
Rosalind L. Bennett
Federal Deposit Insurance Corporation
Levent G ̈untay
Federal Deposit Insurance Corporation
Haluk Unal
University of Maryland, R.H. School of Business
and FDIC Center for Financial Research
First Version: August 2010
Current Version: February 2014
FDIC CFR WP 2012-03
NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical
comment. The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do
not necessarily reflect the views of the Federal Deposit Insurance Corporation. References in publications
to this paper (other than acknowledgment) should be cleared with the author(s) to protect the tentative
character of these papers.
1
Inside Debt, Bank Default Risk, and
Performance during the Crisis
Rosalind L. Bennett
Federal Deposit Insurance Corporation
Levent Güntay
Federal Deposit Insurance Corporation
Haluk Unal
University of Maryland, R.H. Smith School of Business
First Draft: August 2010
Current Draft: February 2014
ABSTRACT
In this paper, we examine whether the structure of the chief executive officer’s (CEO)
compensation package can explain default risk and performance in bank holding
companies (BHCs) during the recent credit crisis. Using a sample of 371 BHCs, we show
that in 2006 higher holdings of inside debt relative to inside equity by a CEO after
controlling for firm leverage is associated with lower default risk and better performance
during the crisis period. We present evidence that before the crisis banks with higher
inside debt ratios also have supervisory ratings that indicate stronger capital positions,
better management, stronger earnings, and being in a better position to withstand market
shocks in the future. Such ex ante evidence can explain the observed relationship between
inside debt, default risk, and performance during the crisis.
JEL classification: G01, G21, G28, G32
Keywords: Executive compensation, financial crises, bank risk
Opinions expressed in this paper are those of the authors
and not necessarily those of the FDIC.
Corresponding author: hunal@rhsmith.umd.edu, tel: 301 405 2256. We thank the seminar and conference
participants at the Federal Deposit Insurance Corporation, Pamukkale University, Turkish Central Bank
Financial and Macroeconomic Stability 2012 Conference, Financial Management Association 2012
Meetings, and FDIC-JFSR Annual Bank Research Conference in 2013. Also, we thank Christine Blair,
Robert DeYoung, Michael Faulkender, Paul Kupiec, John Pogach, and Nagpurnanand Prabhala for helpful
comments and suggestions.
Inside Debt, Bank Default Risk, and
Performance during the Crisis
Rosalind L. Bennett
Federal Deposit Insurance Corporation
Levent Güntay
Federal Deposit Insurance Corporation
Haluk Unal
University of Maryland, R.H. Smith School of Business
First Draft: August 2010
Current Draft: February 2014
ABSTRACT
In this paper, we examine whether the structure of the chief executive officer’s (CEO)
compensation package can explain default risk and performance in bank holding
companies (BHCs) during the recent credit crisis. Using a sample of 371 BHCs, we show
that in 2006 higher holdings of inside debt relative to inside equity by a CEO after
controlling for firm leverage is associated with lower default risk and better performance
during the crisis period. We present evidence that before the crisis banks with higher
inside debt ratios also have supervisory ratings that indicate stronger capital positions,
better management, stronger earnings, and being in a better position to withstand market
shocks in the future. Such ex ante evidence can explain the observed relationship between
inside debt, default risk, and performance during the crisis.
JEL classification: G01, G21, G28, G32
Keywords: Executive compensation, financial crises, bank risk
Opinions expressed in this paper are those of the authors
and not necessarily those of the FDIC.
Corresponding author: hunal@rhsmith.umd.edu, tel: 301 405 2256. We thank the seminar and conference
participants at the Federal Deposit Insurance Corporation, Pamukkale University, Turkish Central Bank
Financial and Macroeconomic Stability 2012 Conference, Financial Management Association 2012
Meetings, and FDIC-JFSR Annual Bank Research Conference in 2013. Also, we thank Christine Blair,
Robert DeYoung, Michael Faulkender, Paul Kupiec, John Pogach, and Nagpurnanand Prabhala for helpful
comments and suggestions.