Do Markets React to Bank Examination Ratings? Evidence of Indirect Disclosure of Management
Quality Through BHCs' Applications to Convert to FHCs
October 2000
Linda Allen, Julapa Jagtiani, and James Moser
ABSTRACT
Certain nonrecurring circumstances associated with the passage of the Financial Services Modernization Act of 1999
have created a unique opportunity for the market to obtain bank examination ratings of management quality. We utilize
this natural experiment in order to determine how the market views this heretofore private information. We find
that the stock market utilizes bank examination ratings in order to reveal regulatory intent, rather than simply
as information about management quality. Revelation of unsatisfactory M ratings (denoted “bad news”) causes BHC
stock returns and market risk betas to increase, whereas revelation of acceptable M ratings (“good news”) causes
BHC stock returns and market risk betas to decrease. The market thrives on “bad news” because unsatisfactory M
ratings indicate that regulatory intervention is likely to occur, possibly benefiting both shareholders and creditors.
On the other hand, revelation of acceptable M ratings (“good news”) indicates that bank regulators are unprepared
to intervene in the near future. Moreover, we find lower bond spreads for a subsample of FHCs with satisfactory
M ratings revealed upon conversion.
Subject: Corporate Finance/M&A
Linda Allen
Institution: Zicklin School of Business, Baruch College, CUNY
Julapa Jagtiani
Institution: Supervision and Regulation, Federal Reserve Bank of Chicago
Email: Jagtiani@Chi.Frb.Org
Telephone: (312) 322-5894
James Moser
Institution: Research Department, Federal Reserve Bank of Chicago
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