A Primer on Market Discipline and Governance of Financial Institutions for Those in a State of Shocked Disbelief

47 Pages Posted: 7 Jun 2012

See all articles by Joseph P. Hughes

Joseph P. Hughes

Rutgers, The State University of New Jersey - Department of Economics

Loretta J. Mester

Federal Reserve Bank of Cleveland; University of Pennsylvania - The Wharton School

Date Written: June 7, 2012

Abstract

Self regulation encouraged by market discipline constitutes a key component of Basel II’s third pillar. But high-risk investment strategies may maximize the expected value of some banks. In these cases, does market discipline encourage risk-taking that undermines bank stability in economic downturns? This paper reviews the literature on corporate control in banking. It reviews the techniques for assessing bank performance, interaction between regulation and the federal safety net with market discipline on risk-taking incentives and stability, and sources of market discipline, including ownership structure, capital market discipline, product market competition, labor market competition, boards of directors, and compensation.

Keywords: Banking, Regulation, Market Discipline

Suggested Citation

Hughes, Joseph P. and Mester, Loretta J., A Primer on Market Discipline and Governance of Financial Institutions for Those in a State of Shocked Disbelief (June 7, 2012). FRB of Philadelphia Working Paper No. 12-13, Available at SSRN: https://ssrn.com/abstract=2079617 or http://dx.doi.org/10.2139/ssrn.2079617

Joseph P. Hughes (Contact Author)

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

Loretta J. Mester

Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

University of Pennsylvania - The Wharton School

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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