Does Geographic Proximity Change the Passiveness of Equity Ownership by Bank Trust?

• DOI: http://doi.org/10.1111/irfi.12216
• Author: Ha‐Chin Yi,Kiyoung Chang,Ying Li
• Date: 01 March 2020
• Published date: 01 March 2020

Does Geographic Proximity Change

the Passiveness of Equity

Ownership by Bank Trust?*

KIYOUNG CHANG

†

,YING LI

‡

AND HA-CHIN YI

§

†

College of Business, University of South Florida Sarasota-Manatee, Sarasota, FL

‡

School of Business, University of Washington, Bothell, WA and

§

College of Business Administration, Texas State University, San Marcos, TX

ABSTRACT

We provide evidence that while concentrated bank trust ownership is passive

with distant firms, it is nonpassive with local firms and reduce their risk-tak-

ing. Concentrated local bank trust ownership is associated with (i) lower

future firm equity beta and (ii) less uncertain corporate policies. The results

cannot be explained by private information alone, are not driven by local

bank trusts as a mixed debt-equity holder, and are robust to various tests for

endogeneity. We also explore channels through which local bank trusts

could exert their influence, including their stabilizing function during crisis

periods and joining force with local independent directors.

JEL Codes: G30; G23; G32

Accepted: 10 June 2018

I. INTRODUCTION

The proportion of US equities owned by institutional investors has increased

substantially, reaching 67% by the end of 2009 (The Conference Board 2010).

The increasing dominance of institutional investors contrasts with our limited

understanding of ownership characteristics that influence the role of the highly

heterogeneous institutional investors. In this paper, we explore the effect of

geographic proximity has on a unique type of institution—bank trust. By com-

paring local and nonlocal concentrated bank trust ownership at the same firm

that differs only in their distance to the firm’s headquarters, we show that geo-

graphic proximity alone leads to more active influence by bank trusts on firm

risk-taking.

Trust is a fiduciary relationship in which the trustee holds legal title to speci-

fied property and manages that property for beneficiaries (Schanzenbach and

Sitkoff 2007). Trust, usually referred to as bank trust, is managed by the trust

* We would like to thank Stephen Brown, Rajib Doogar, Steve Holland, Paul Malatesta, Jim Miller,

PK Sen, and seminar participants at University of Washington Bothell for their helpful comments.

© 2018 International Review of Finance Ltd. 2018

International Review of Finance, 20:1, 2020: pp. 3–43

DOI: 10.1111/irfi.12216

department of a bank, savings and loan associations, and trust companies. The

relevance of bank trust resides in the fact that Americans are bequeathing hun-

dreds of billions of dollars a year for the next half century—the largest wealth

transfer in history (Havens and Schervish 2003). According to the calculation of

Schanzenbach and Sitkoff (2012) based on Federal Deposit Insurance Corpora-

tion (FDIC) annual reports of trust holdings, approximately 65% of the trust

investments reside in stocks during the period 2001–2008. The largest stock

holdings by the trust accounts are then reported in banks’or trust companies’

13F filings to the Securities and Exchange Commission (SEC), also known as

the institutional ownership of the stock by bank trusts or “bank trust owner-

ship”. Compared to other self-identified categories of institutional ownership,

like investment advisors, pension funds, etc., bank trust ownership is subject to

more stringent legal and regulatory environment with respect to their fiduciary

responsibilities (Del Guercio 1996). Because of their stringent requirements,

bank trusts are one of the most conservative institutional investors (Bennett

et al. (2003) and has low turnovers to reduce costs to the beneficiaries

(Schanzenbach and Sitkoff 2007).

While bank trust’s stronger preference for low-risk stocks is well documented

in the literature (Hankins et al. 2008), it is less clear whether bank trust owner-

ship will have an influence on a firm’s risk-taking behavior ex post. Further, the

endogenous nature of ownership structure (Demsetz 1983; Demsetz and Lehn

1985) makes it hard to produce conclusive evidence on the effect of geographic

proximity. We address this concern by comparing large ownerships by bank

trusts that differ only in geographic proximity, for the same firm at the same

time, using a firm fixed effects regression that also controls for year fixed effects,

to achieve identification. Specifically, we identify a differential relation between

concentrated bank trust ownership and corporate risk-taking behavior when

the only factor that changes is their geographic proximity

1

and show that geo-

graphic proximity alone leads bank trust ownership to overcome their passive-

ness and behave differently from their nonlocal peers.

Our results based on a sample over 1995–2009 show that an increase in own-

ership by geographically proximate bank trusts is associated with (i) lower future

firm equity beta and (ii) less uncertain future corporate policies. The findings are

also in agreement with the literature, which documents institutional investors’

pursuit of their unique interests other than maximizing shareholder value

(Romano 1993; Faleye et al. 2006). Our findings are robust to definitions of geo-

graphic proximity, and various tests for endogeneity, including firm fixed

effects specifications, firm fixed effects instrumental variable (IV) regression

with the help of a geography-based instrument, and propensity score matching

analysis. After matching for observable firm characteristics including size,

Tobin’s Q, R&D intensity, industry, relative volatility in the previous

1 We use concentrated bank trust ownership in the empirical setting for a study of potential

monitoring because concentrated holdings are documented to be another factor that reduces

monitoring costs so that monitoring behavior is more likely (Chen et al. 2007).

© 2018 International Review of Finance Ltd. 20184

International Review of Finance

24 months, etc., the difference in mean future equity beta between the firms

with high (greater than and equal to 3%) and low (less than 3%) geographically

proximate bank trusts ownership is −0.069, significant at a 1% level, and

amounts to a reduction of about 7.3% of a standard deviation in an average

firm’s beta. The reduction in a firm’s beta that is associated with local bank trust

ownership is even larger in magnitude, at −0.105 during crisis periods.

The finding that geographic proximity alone changes the passive role of con-

centrated bank trust ownership is, to the best of our knowledge, new. We next

explore whether information alone can explain our finding. Headquarters are

the center of information exchange between the firm and its investors (Davis

and Vernon Henderson 2008), it is possible that bank trusts have private infor-

mation about local firms’future risk and corporate decisions (Ivashina and Sun

2011). If informational advantage alone drives the negative relation, we would

also expect to observe lower local bank ownership to be associated with higher

future equity beta. This explanation, however, does not seem to be sufficient as

we find that the negative relation between local bank trust ownership and equity

beta is (i) only driven by the increase of such ownership and (ii) only during cri-

sis periods. Crises are hard to predict and represent a relatively exogenous shock

(Lemmon and Lins 2003; Lin et al. 2011). If a bank trust’s impact on local firms’

risk-taking could be fully attributed to its informational advantage, it should dis-

play the ability to predict lower future risk and select stocks accordingly both in

and out of crisis periods. Further, we find the bank trust’s impact on local firm’s

risk-taking is stronger for large firms, inconsistent with the pure information

story. Another possibility is that local bank trusts can obtain private information

from loan relationships as a joint debt-equity holder. We, however, do not find

support for this explanation either as there is no relation between high local

bank trust ownership and outstanding local loans. Therefore, informational

advantage alone cannot fully explain the differential relation between bank trust

ownership and future firm risk due to geographic proximity.

We suggest a segmentation-based explanation: geographically proximate

bank trust ownership that has a large stake in local firms (concentrated local

bank trust ownership, CLBTO) plays a nonpassive role with corporate risk-

taking because doing so is cost-efficient. We find empirical evidence that sup-

ports the segmentation-based explanation. First, local holding bias is present

for most of the institution types, but is most pronounced for the bank trusts,

especially the largest bank trusts. Among the top 10 largest holdings, a bank

trust’s average local holding size is about double that of a nonlocal holding.

Such concentrated investment in local firms creates incentives for CLBTO’s

nonpassive role. Second, most local bank trusts have a long-term investment

horizon, which makes it more effective if they choose to play a nonpassive role

(Kroszner and Strahan 2001; Gaspar et al. 2005; Chen et al. 2007; Dittmann

et al. 2009).

2

Third, we investigate CLBTO’s trading behavior for local and

2 Our calculation shows that about 93% of local bank trust ownership has a long-term invest-

ment horizon.

© 2018 International Review of Finance Ltd. 2018 5

Local Bank Trust Ownership and Risk Taking