Since 1914, bankers have been sitting on the boards of Federal Reserve Banks. Whether this arrangement serves private or public interests is a question that has been publicly debated at least since the 1930s (Bopp, 1937) and probably much earlier. I contribute to this debate by providing the first systematic evidence that banks with Reserve Bank directorships appear to benefit from their positions.
The structure of Reserve Bank boards is determined by the Federal Reserve Act of 1913. Each of the twelve Reserve Banks has a board consisting of nine directors. The Board of Governors appoints three of the directors, the class C directors, to represent the public. Member banks in each district elect the remaining six directors. They elect three directors, the class B directors, to represent the public and three directors, the class A directors, to represent member banks.
This potentially creates a “fox guarding the henhouse” situation, since banks have influence over the governance of the very institutions that supervise them. There are benefits to such an arrangement; for example, it allows the Reserve Banks to gain valuable information about the state of the financial sector. However, this situation could also potentially give rise to private benefits for banks. I do not address the question of whether such private benefits are socially optimal in this paper. Instead, I focus on documenting that they exist.
One potential private benefit for banks is preferential treatment in supervision. Although Reserve Bank boards are generally not directly involved in any supervisory decisions, many questions arose during the financial crisis about the Fed’s treatment of banks that were connected to it through Reserve Bank directorships, most notably Goldman Sachs.
Another potential private benefit for banks could be privileged access to information. Recent evidence documents that cycles in the equity premium are causally tied to policy news that is leaked informally form the Fed to the financial sector and the media. Since Class A directors have direct contact with Fed officials, it is plausible that these directorships represent one such “informal” information transmission channel.
To examine whether banks benefit from Class A directorships, I assemble a wide variety of different data sets on the employers of Reserve Bank directors and the directors themselves. Because member banks have to elect both bankers and non-bankers, the fixed board structure of the Fed provides a nice setting in which to identify differential benefits (or costs) of directorships for bankers and non-bankers. Whenever possible, I benchmark the banks against the non-banks.
Amongst others, I find that Federal Reserve Bank directorships add value, but primarily for banks. The abnormal market reaction to the election of a banker to a Fed board is 0.99%. For non-bankers, the average market reaction is -0.57%. In cross-sectional regressions, I find the market reaction for Class A directors is higher when they are elected to the board of the Federal Reserve Bank of New York and when the election takes place during the financial crisis. In contrast, the market reaction to class B directorships is negative during the crisis.
An analysis of insider trading behavior supports an information advantage story. On average A directors buy more shares in their employers while they sit on the board of a Fed than B or C directors. One notable example of a Class A director buying shares while serving as a Fed director is Jamie Dimon, who during his tenure as director of the Federal Reserve Bank of New York bought more than 860,000 shares in JP Morgan. Dimon bought 500,000 (direct) shares in JP Morgan on January 16, 2009 and 360,000 (direct) shares on July 19 and 20, 2012.
On average A directors also buy more shares on the board than they do off the board. Furthermore, the market reaction to insider purchases of A directors is significantly more positive when they sit on the board of a Fed. In contrast, there is no differential market reaction to purchases by B and C directors when they sit on the board of a Fed. Consistent with the event study results, I find that the market reaction is higher for A directors when they sit on the board of a Fed during the financial crisis and when there is greater uncertainty about financial regulation.
My results are consistent with the idea that private interest representation on Federal Reserve Bank boards may lead to private informational benefits and, possibly, private supervisory benefits for banks. While I explore alternative hypotheses, no other hypothesis fits the pattern of all the results I present as well.
The results of this study may help inform the debate about potential reform to the governance of the Federal Reserve. Senator Dodd’s reform bill of November 10, 2009 proposed to strip banks of their power to select Federal Reserve Bank directors. Although the Dodd-Frank Act of 2010 does not contain such a provision, it does restrict class A directors from having a say in the selection of Fed presidents. In May, 2013 Senators Sanders, Bozer and Begich introduced legislation to remove banking executives from Fed boards. Representative DeFazio introduced a companion measure in the House. However, many oppose changing the structure of the Fed’s boards, as they argue that it would deny the Fed an important source of information about the economy and credit conditions. Thus, to date, the structure of Reserve Bank boards remains substantially the same as it was in 1913.