Forgive Me All My Sins: How Penalties Imposed on Banks Travel Through Markets

Abstract

From 2005 to 2015, the 25 largest global financial institutions paid more than 285 billion US dollars in legal penalties, corresponding to approximately 20% of their market value. We examine the stock, bond, and CDS market reaction to the announcements of fines and settlements for banks. We document positive stockholder and bondholder valuation effects as well as a tightening of CDS spreads for banks to these resolution announcements. These reactions can be attributed to the resolution of uncertainty surrounding legal proceedings. Moreover, even though monetary penalties are cash-flow-effective, they are not income-effective in the year they are announced, suggesting that banks make adequate provisions for these penalties. In addition, we observe positive spillover effects to other banks facing pending lawsuits with the same plaintiff.