For example, banks with more shareholder-friendly boards invested more aggressively in subprime securitizations that were rated highly secure before the crisis. Although these moves did not look dangerous in 2006 according to traditional risk measures, they turned out to be extremely poor investments once the downturn hit.
The authors also note that the banks that performed better during the crisis operated in much more tightly regulated countries, such as Denmark and Switzerland, with more powerful supervisors, more restrictions on banking activities, and more private monitoring. In addition, banks with less exposure to the U.S. real estate market fared better, whereas banks from countries such as Ireland and Italy, with financial systems more intertwined with the U.S. system, performed worse.
“Banks with more restrictions on their activities could have had higher returns because they did not have the opportunity to diversify into activities that unexpectedly performed poorly during the crisis,” the authors conclude.
Banks with more shareholder-friendly boards, which conventional wisdom suggests would be less risky in their investment decisions, entered the Great Recession with portfolios filled with toxic subprime instruments and were heavily punished by investors as the financial crisis unfolded. Conversely, banks in countries with high levels of regulation, on average, performed better during the crisis.