Cultures of Risk: How Organizational Logics Affect Decision-Making at Commercial Banks

It is well known that the failure of U.S. commercial banks, which became major participants in global financial markets at the end of the 20^th century, was a key mechanism through which risk spread through the global financial system during the 2007-09 financial crisis. However, less is known about why these banks began to take on more market risk in the first place. In order to understand what motivated commercial banks to take on market risk, we must pay attention to the institutional logics—sets of formal and informal rules that provide assumptions about how actors within an organization should achieve goals (Thornton and Ocasio 1999)—used by commercial banks when determining the level of risk they chose to face in financial markets. I examine the impact of two distinct institutional logics, both of which became prominent as commercial banks turned towards investment-banking activities, on banks' attitudes towards market risk. One, an “agency logic”, suggests that banks should orient their actions towards maximizing shareholder value. Another, a “smartness logic”, suggests that the viability of banks is tied to the ability of their securities traders to create and manage new financial innovations. These logics suggest that shareholders and traders, respectively, should have more say over decisions concerning market risk. Using fixed-effect regressions, I test for the effect of the prevalence of these logics on banks’ exposure to market risk using a panel data set of major commercial banks from 1998-2014. Though preliminary results show no robust evidence that either logic has a significant effect on exposure to market risk, further analysis of 10-K forms and annual reports to shareholders allow for a more nuanced understanding of how commercial banks make decisions about risk.