Go figure - even bankers are in the dark

Wednesday, 19 December 2012  Features

Financial services are complex. If you have difficulty understanding what your bank is up to, you're not alone.

New research by Professor Renée Adams at the Australian School of Business suggests that even bank executives at the highest levels don't fully comprehend their firm's operations and plans of action.

"It's quite clear from our evidence that they don't understand exactly what is happening in their banks, nor what impact the strategies their banks are taking will have on their firm's performance," says Professor Adams, Commonwealth Bank Chair in Finance at the Australian School of Business.

"If they did, then they should perform very well when they buy their own bank's shares. But they don't. They may do quite well at selling, which suggests they're good at figuring out when things are going poorly, but not when there's upside potential."

Professor Adams and her colleagues analysed legal insider trades between 2003 and 2009 by the managers and directors of hundreds of US banks. This was compared with insider trades in non-financial firms, including cases where bankers sat on the boards of both types of institution.

"In those cases, the banker always did better in the trading of the non-financial firm's shares than in their own bank's," says Professor Adams

Another counter-intuitive discovery was the lack of market reaction to bankers' insider trades, an activity that in other sectors would be seen as conveying valuable information about a company's prospects.

"We really expected, especially around the period of the global financial crisis, that the market reaction to banks trading in their own shares would be much higher than the market reaction to the insider trades of non-financial firms," Professor Adams says. "But we found exactly the opposite."

The researchers have examined plausible explanations for why bank insider trades are deemed uninformative by the market and also why bank executives are generally not very good at making them.

Their findings will inform present debate about desirable levels of equity-based pay for bank leaders and highlight the need for an internal redesign of banks that gives "all the people all the right incentives".

In the meantime, banks remain "difficult to understand; not only for outsiders but also for insiders", Professor Adams says.

Professor Adams presented her research at the 25th Australasian Finance & Banking Conference at the University of NSW on December 16-18. The annual conference is the Asia-Pacific's leading forum for insights into financial issues.

For more details, or to interview Professor Adams, contact Marie Kelly on 0408 256 381.