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Capital Structure Adjustments of Bank Holding Companies and Subsidiary Failure

A subsidiary failure may deteriorate the bank holding company’s (BHC) financial conditions. BHCs’ managers possess better knowledge than market investors concerning the likelihood of subsidiary failure, which gives rise to information asymmetry. We examine the effects of this information asymmetry on capital structure adjustments of BHCs in the periods surrounding subsidiary failure. We find that subsidiary failure significantly affects financial policies of the parent companies. Specifically, BHCs increase leverage ratio as early as one year prior to the failure of their subsidiaries, and substantially lower leverage after subsidiary failure. These capital structure adjustments are attributable to BHCs’ internal capital risk and most importantly, the information asymmetry between BHCs and the market.