Market Discipline and Incentive Problems in Conglomerate Banks
AbstractThis paper analyses the optimal conglomeration of bank activities. We show that the effectiveness of market discipline for stand-alone activities (divisions) is of crucial importance for the potential benefits of conglomeration. We find that effective market discipline reduces the potential benefits of conglomeration. With ineffective market discipline of stand-alone activities conglomeration would further undermine market discipline, but may nevertheless be beneficial. In particular, when rents are not too high the diversification benefits of conglomeration may dominate the negative incentive effects. A more competitive environment therefore may induce conglomeration. We also show that introducing internal cost of allocation schemes may create ‘internal’ market discipline that complements the weak external market discipline of the conglomerate. In this context we show that these schemes should respond to actual risk choices, rather than be limited to anticipated risk choices.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1949.
Date of creation: Aug 1998
Date of revision:
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Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
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- Andrew Winton, 1999. "Don’t Put All Your Eggs in One Basket? Diversification and Specialization in Lending," Center for Financial Institutions Working Papers 00-16, Wharton School Center for Financial Institutions, University of Pennsylvania.
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