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Employee Treatment and Bank Default Risk during the Credit Crisis

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Abstract

We examine whether banks’ interest in the well-being of their workforce, measured by an index of employee relations strengths, explains their default risk during the recent credit crisis. Using a sample of 179 U.S. banks, we find that banks with greater pre-crisis employee relations strengths experience lower default risk and have higher excess returns during the crisis. These banks have lower asset volatility and leverage, suggesting that bank default risk is mitigated through lowering operational and financial risks. Banks’ prudent risk-taking behavior benefits shareholders in times of heightened risk. The results are robust to alternative model specifications and endogeneity issues.

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Notes

  1. The G-index is missing for about half of our sample firms. We follow the approach described in Kim and Lu (2011) to maintain sample size. Specifically, we set missing observations for the G-index to zero and include in the regression a dummy variable equal to one if the governance data are available, and zero otherwise; this dummy variable allows the intercept term to capture the mean of the governance variable for missing values.

  2. As an alternative to the G-index, we consider the CGQ (Corporate Governance Quotient) index, calculated based on data available from the Institutional Shareholder Services as of the end of 2006. The index uses 52 firm attributes in four broad subcategories: board of directors, audit, anti-takeover, and managerial compensation and ownership (See, e.g., Aggarwal et al. 2008; Chung and Zhang 2011). The CGQ index is expressed as a percentage, where satisfying minimally acceptable governance standards for all 52 attributes earns a firm an index of 100%; if an attribute is missing then the index represents the percentage of non-missing attributes that are satisfied. Our main results continue to hold when we add to our main specification the CGQ index either separately or jointly with institutional holding variables.

  3. See http://www.thegreenpapers.com/G04/President-Strength.phtml. Rubin (2008) finds that firms’ CSR rankings are significantly correlated with the political leaning of their headquarter state.

  4. Ideally, in this analysis, we would like to measure the Employee Relations index further back in time. However, data on CEO inside debt are not available before 2006. Therefore, we measure both variables in 2006, one year before the onset of the crisis. Using Employee Relations index measured in 2005 produces even more statistically robust results.

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Acknowledgments

We thank Moody’s KMV for providing us with the data on expected default frequency. We are grateful to Alex Edmans, Isaac Otchere, Carl Shen and the participants at the 26th Conference on the Theories and Practices of Securities and Financial Markets and the seminar of University of Otago for many constructive comments and suggestions. We are equally grateful to the referee and editor for their useful comments which improve the quality of the paper. Any remaining errors are the sole responsibility of the authors.

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Authors and Affiliations

  1. Department of Accountancy and Finance, University of Otago, Dunedin, New Zealand

    Tu Nguyen

  2. School of Accounting, Economics and Finance, University of Wollongong, Wollongong, NSW, 2522, Australia

    Sandy Suardi

  3. Department of Economics and Finance, La Trobe University, Bundoora, Australia

    Jing Zhao

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  1. Tu Nguyen
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Correspondence to Sandy Suardi.

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Nguyen, T., Suardi, S. & Zhao, J. Employee Treatment and Bank Default Risk during the Credit Crisis. J Financ Serv Res 59, 173–208 (2021). https://doi.org/10.1007/s10693-020-00343-8

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