Are private banks the better banks? An insight into the principal-agent structure and risk-taking behavior of German banks

In this study, we hypothesize that the distinguishable principal-agent relationships of German banks significantly influence the risk-taking attitudes of bank managers. In particular, we substantiate the theory that banks owned by dispersed shareholders, or federal state authorities, face a higher relevance of principal-agent problems than other banking sectors due to the lack of monitoring bank managers. Our results show that lack of accountability allows bank managers the liberty to participate in risk-taking behavior. First we present, from the bank owners' viewpoint, a theoretical model to explain three factors of principal-agent relationships used to determine the highest probability of choosing an optimal portfolio of risky assets. The three factors are: the ability to control bank managers, the risk pooling capabilities of bank owners and bank managers, and the incentive of seeking high returns. To support our hypothesis, we apply an empirical study to the distance-to-default of different German banking sectors. This demonstrates that the risk-taking attitudes of banks are closely related to banks' ownership structures. Consequent to our findings, we suggest legislative and regulatory authorities increase vigilance in terms of principal-agent problems within certain sectors of the banking industry.