Date of Award

Spring 1-1-2011

Document Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Finance

First Advisor

Sanjai Bhagat

Second Advisor

Michael Stutzer

Third Advisor

Martin Boileau

Abstract

We investigate the link between firm size and risk-taking among financial institutions during the period of 1998—2008 and make four contributions. First, size is positively correlated with risk-taking measures even when controlling for other observable firm characteristics, such as market-to-book asset ratio, corporate governance, and ownership structure. This is consistent with the notion that “too-big-to-fail” policies distort the risk incentives of financial institutions. Second, a simple decomposition of the risk measure, the Z-score, reveals that financial firms engage in excessive risk-taking mainly through leverage. Third, we find that the recently developed governance variable, measured as the median director dollar stockholding, has a substantial impact on reducing firms’ risk-taking. Lastly, investment banks are generally riskier than commercial banks. These findings suggest that rather than capping the firm size, it is more effective for policymakers to control a financial firm’s risk-taking by strengthening regulations on capital requirement; they also provide justification for the functional separation of investment banking from wholesale financial services. In terms of corporate risk management policy, these findings suggest that the excessive risk-taking problem can potentially be attenuated by focusing on the governance structure.

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