The Determinants of Operational Risk in U.S. Financial Institutions

Abstract

We examine the incidence of operational losses among U.S. financial institutions using publicly reported loss data from 1980 to 2005. We show that most operational losses can be traced to a breakdown of internal control, and that firms suffering from these losses tend to be younger and more complex, and have higher credit risk, more antitakeover provisions, and chief executive officers (CEOs) with higher stock option holdings and bonuses relative to salary. These findings highlight the correlation between operational risk and credit risk, as well as the role of corporate governance and proper managerial incentives in mitigating operational risk.