Throughout the world, by the end of 2008, many banks had seen most of their equity destroyed by the crisis that started in the US subprime sector in 2007. Yet, not all banks across the world performed equally poorly. In this paper, we investigate how banks that performed better during the crisis, measuring performance by stock returns, differed from other banks before the crisis. Academics, journalists, and policy-makers have argued that lax regulation, insufficient capital, excessive reliance on short-term financing, and poor governance all contributed to making the crisis as serious as it was. If these factors did contribute to making the crisis worse, we would expect that banks that were more exposed to these factors performed more poorly during the crisis. We investigate the relation between these factors and the stock return performance of large banks during the crisis, where large banks are defined as banks with assets in excess of $50 billion in 2006. With our definition of large banks, 32 countries had at least one large bank and our sample includes 164 large banks from these countries.

Many analyses of the crisis emphasize the run on the funding of banks that relied on short-term finance in the capital markets for a substantial fraction of their financing (see, for instance, Adrian and Shin, 2008, Brunnermeier, 2009, Gorton, 2010, and Diamond and Rajan, 2009). We would expect banks that rely on short-term finance before the crisis to perform worse during the crisis. We find that this is the case with two different approaches. First, we find strong evidence that banks that relied more on deposits for their financing in 2006 fared better during the crisis. Second, following Demirg¨ uc–Kunt and Huizinga (2010), we use a measure of short-term funding provided by sources other than customer deposits. We show that performance is strongly negatively related to that mea-sure both for the sample of large banks and the sample extended to include large financial institutions that are not depository banks, such as investment banks. These analyses also emphasize how losses force banks to reduce their leverage, perhaps through fire sales of securities, and how this effect is greater for banks with more leverage. We find that large banks with less leverage in 2006 performed better during the crisis.

An Organization for Economic Co-operation and Development (OECD) report argues that ‘‘the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements’’ (Kirkpatrick, 2008). More recently, the National Commission on the Causes of the Financial and Economic Crisis in the United States concluded that ‘‘dramatic failures of corporate governanceyat many systematically important financial institutions were a key cause of this crisis.’’ (The Financial Crisis Inquiry Report, 2011, pp. xvii). Some academic studies also emphasize that flaws in bank governance played a key role in the performance of banks (Diamond and Rajan, 2009, and Bebchuk and Spamann, 2010). The idea is generally that banks with poor governance engaged in excessive risk taking, causing them to make larger losses during the crisis because they were riskier.

We use two proxies for governance. The first one is the ownership of the controlling shareholder in 2006. The second one is whether the bank had a shareholder-friendly board. To the extent that governance played a role, we would expect banks with better governance to have performed better. It is generally believed that greater ownership by insiders aligns their incentives more closely with the interests of shareholders. However, a powerful controlling shareholder could use control of a bank to benefit o