Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law.
Corporate governance incentives at too-big-to-fail financial firms deserve systematic examination. For industrial conglomerates that have grown too large, internal and external corporate structural pressures push to re-size the firm. External activists press it to restructure to raise its stock market value. Inside the firm, boards and managers see that the too-big firm can be more efficient and more profitable if restructured via spin-offs and sales. But for large, too-big-to-fail financial firms (1) if the value captured by being too-big-to-fail lowers the firms’ financing costs enough and (2) if a resized firm or the spun-off entities would lose that funding benefit, then a major constraint on industrial firm over-expansion breaks down for too-big-to-fail finance.
Propositions (1) and (2) have both been true and, consequently, a major retardant to industrial firm over-expansion has been missing in the large financial firm. Debt cost savings from the implicit subsidy can amount to a good fraction of the big firms’ profits. Directors contemplating spin-offs at a too-big-to-fail financial firm accordingly face the problem that the spun-off, smaller firms would lose access to cheaper too-big-to-fail funding. Hence, they will be relatively more reluctant to push for break-up, for spin-offs, or for slowing expansion. They would get a better managed group of financial firms if their restructuring succeeded, but would lose the too-big-to-fail subsidy embedded in any lowered funding costs. Subtly but pervasively, internal corporate counterpressures that resist excessive bulk, size, and growth degrade.
