WEALTH EFFECTS OF ENFORCEMENT ACTIONS AGAINST FINANCIALLY DISTRESSED BANKS

We examine the stock price reaction for a sample of commercial banks to the signing of cease‐and‐desist orders, written agreements, and formal agreements with bank regulators. These agreements restrict financially distressed institutions from certain activities that may be perceived by the capital markets as favorable or unfavorable. Our finding of a significantly negative mean signing‐day abnormal return suggests that these enforcement actions are not fully anticipated by the market and that, on average, these enforcement actions are perceived as being unfavorable for bank shareholders. Our cross‐sectional analysis suggests that at least part of the negative market reaction is caused by a reduction in the moral hazard problem associated with financially distressed federally insured commercial banks. Although these actions are beneficial to both the federal deposit insurer and ultimately taxpayers, we interpret the cross‐sectional findings as implying that regulators are not acting in a timely fashion to restore the financial health of these distressed “banks. Even though equity values fall, on average, when banks are faced with an enforcement action, our findings do not support the pre‐FIRREA policy not to publicly disclose the signing of enforcement actions because the enforcement action itself is not the source but is merely a reflection of the bank's problems.