Volume 18, Number 7
Michael King helps policy makers find a balance between financial innovation and investor protection.
The recent economic crisis has underlined the need for policy makers to take a more active role in supervising international financial systems. Over the past ten years Ivey professor Michael King has been at the heart of this changing environment. As a lead researcher and analyst for the Bank of Canada and then the Bank for International Settlements in Basel, Switzerland, he helped shape key policy decisions.
King's research with the Bank of Canada focused on Canadian markets - how they function, and how they relate to international markets. In one study he looked at why Canadian firms are valued lower than similar American firms. He found that the difference can be explained by ownership differences and share structure. Canadian firms are more likely than U.S. firms to be family owned, and more Canadian firms use dual class shares with different voting rights.
Lower valuations give Canadian firms an incentive to list on U.S. exchanges. King found that this practice tended to close the valuation gap with American firms. "U.S. markets are larger and more liquid, and provide more information and greater transparency," he says. "This makes investors feel more comfortable and better informed about the risks they are taking." He cautions, however, that Canadian firms that list on U.S. exchanges do not see benefits unless they actively develop an American investor base.
King also looked at information leakage and insider trading in takeovers of Canadian firms. He found a clear run up in the price of Canadian companies prior to the announcement of a takeover, suggestive of information leakage and possibly illegal insider trading. His findings support the general view that Canadian capital markets are more prone to insider trading than other countries. "This partly explains why Canadian firms seem to pay a risk premium, which contributes to a lower valuation relative to similar U.S. firms," he says.
Income trusts became a concern to policy makers in the early 2000s. Intended for mature businesses with stable cash payouts, income trusts became a way for companies to distribute income without paying corporate tax. When King investigated income trusts, he found that trust law did not require the same transparency or investor protection provided under corporate law. "The promise of high dividends attracted retail investors who were not aware of the risks they were taking," he says. Faced with a steep increase in the number of companies announcing their intention to convert to income trusts, the government decided to close the tax loophole.
King joined the Bank for International Settlements in 2008 to expand his research on the international financial system. He arrived in Basel at a dramatic time, when the turmoil in the global financial system became a full-blown panic. King's research focused on the aftermath of the collapse of Lehman Brothers, when governments intervened to stabilize their banks and economies. He also worked on the regulatory response.
King studied bank bailouts in the U.S. and five European countries. He found that U.S. bailouts were the most generous to bank shareholders while the U.K. bailouts were the most punitive. As a result U.S. government support provided its banks with a competitive advantage, with U.S. bank stocks dramatically outperforming those of their U.K. rivals. King acknowledges that it's difficult to second guess the success of U.S. policy, but he is concerned that the country may have undermined market discipline and increased the problem of too-big-to-fail banks.
King then looked at how a country's public policies and interventions affected its economic performance following the crisis. In a study of 46 industrial and emerging economies, he found that a country's performance following the crisis was dependent on a combination of good policies and good luck. Good policies included a floating exchange rate, a better capitalized banking sector, a current account surplus, and a low private sector credit as percentage of GDP. Good luck included greater financial openness of the economy, less exposure to funding in the U.S., and less reliance on the export of manufactured goods.
Finally, King worked on the new Basel III banking regulations to address the structural problems that led to the crisis. He was part of the team that looked at proposals for higher bank capital and expanded liquidity requirements. He examined the trade-offs between more stringent capital and liquidity requirements and bank profitability. "Lower bank ROEs," he says, "are outweighed by the overall benefit of a safer financial system with fewer financial crises."
Policy makers are aware that financial markets need more supervision, but they are also concerned that regulations can sometimes lead to unintended consequences. Says King: "Regulators must maintain an important balance, allowing markets to innovate but at the same time protecting investors."