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Efficiency of Banks in the Third Federal Reserve District

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  • Loretta J. Mester

Abstract

Over the years, scholars from several different fields, including corporate finance, transaction cost economics, and law, have challenged the famous Modigliani & Miller Irrelevance Hypothesis. Under what conditions, they have inquired, does the choice between debt and equity finance affect the firm’s average cost of capital? Although these scholars have made substantial progress in selected areas, no unified theory of corporate finance has yet emerged. This paper proposes a new theory based on what Oliver Williamson has described as the "measurement branch" of transaction cost economics. The valuation hypothesis, as I characterize it, asserts that debt and equity finance reflect the value of the corporate enterprise in various alternative uses. By defining property rights -- and residual claimancy -- to these value flows, corporate financial claims provide their holders with the incentive to specialize in gathering accurate information about the value of the firm’s intangible assets and thus to avoid the pricing errors that can distort ex ante investment. The resulting improvement in resource allocation maximizes the net value of the firm, or, what amounts to the same thing, minimizes its average cost of capital. According to the valuation hypothesis, moreover, the corporation’s hierarchy of financial claims identifies an overall quasi-rent structure that serves as a real-world proxy for asset specificity that promises to operationalize the specific assets hypothesis. As thus conceived, the valuation hypothesis resolves a number of anomalies in the literature on security, bankruptcy, and corporate reorganizations, and sheds considerable light on the optimal choice of business form.

Suggested Citation

  • Loretta J. Mester, "undated". "Efficiency of Banks in the Third Federal Reserve District," Rodney L. White Center for Financial Research Working Papers 2-94, Wharton School Rodney L. White Center for Financial Research.
  • Handle: RePEc:fth:pennfi:2-94
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    References listed on IDEAS

    as
    1. Loretta J. Mester, 1987. "Efficient production of financial services: scale and scope economies," Business Review, Federal Reserve Bank of Philadelphia, issue Jan, pages 15-25.
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    Cited by:

    1. Hadi Ghafoorian & NikIntan Norhan & Mohammed Ndaliman Abubakar & Fazel Mohammadi Nodeh, 2013. "Efficiency Considering Credit Risk in Banking Industry, Using Two-stage DEA," Journal of Social and Development Sciences, AMH International, vol. 4(8), pages 356-360.
    2. Chris Heerden & Riaan Rossouw, 2014. "Resource utilisation Efficiency: A South African Provincial Evaluation," South African Journal of Economics, Economic Society of South Africa, vol. 82(4), pages 475-492, December.
    3. Maudos, Joaquin & Pastor, Jose M. & Perez, Francisco & Quesada, Javier, 2002. "Cost and profit efficiency in European banks," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 12(1), pages 33-58, February.
    4. Mariani Abdul-Majid & David Saal & Giuliana Battisti, 2011. "The impact of Islamic banking on the cost efficiency and productivity change of Malaysian commercial banks," Applied Economics, Taylor & Francis Journals, vol. 43(16), pages 2033-2054.
    5. Alicia Fourie & Chris van Heerden & Engelina du Plessis, 2022. "Improving destination competitiveness in South Africa: A DEA approach," Tourism Economics, , vol. 28(4), pages 1080-1100, June.
    6. Robert DeYoung & Gary Whalen, 1994. "Banking Industry Consolidation: Efficiency Issues," Economics Working Paper Archive wp_110, Levy Economics Institute.
    7. repec:ebl:ecbull:v:17:y:2005:i:9:p:1-11 is not listed on IDEAS
    8. Dwight Steward, 1998. "A note: Bootstrap standard errors and confidence intervals for weak axiom of cost minimization (WACM) based bank managerial efficiency estimates," Applied Economics Letters, Taylor & Francis Journals, vol. 5(10), pages 617-621.
    9. Imed Limam, 2001. "A Comparative Study of GCC Banks Technical Efficiency," Working Papers 0119, Economic Research Forum, revised 07 May 2001.
    10. Jose Pastor & Lorenzo Serrano, 2005. "Efficiency, endogenous and exogenous credit risk in the banking systems of the Euro area," Applied Financial Economics, Taylor & Francis Journals, vol. 15(9), pages 631-649.
    11. Imed Limam, "undated". "Measuring Technical Efficiency of Kuwait Banks," API-Working Paper Series 0101, Arab Planning Institute - Kuwait, Information Center.
    12. José Manuel Pastor Monsálvez, 1999. "- Credit Risk And Efficiency In The European Banking Systems: A Three-Stage Analysis," Working Papers. Serie EC 1999-18, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    13. Chris van Heerden & Melville Saayman, 2018. "Sustainability of a national arts festival," Tourism Economics, , vol. 24(5), pages 576-592, August.
    14. Jose Pastor, 1999. "Efficiency and risk management in Spanish banking: a method to decompose risk," Applied Financial Economics, Taylor & Francis Journals, vol. 9(4), pages 371-384.
    15. Haslem, John A. & Scheraga, Carl A. & Bedingfield, James P., 1999. "DEA efficiency profiles of U.S. banks operating internationally," International Review of Economics & Finance, Elsevier, vol. 8(2), pages 165-182, June.
    16. Robert DeYoung & Gary Whalen, 1999. "Banking Industry Consolidation: Efficiency Issues," Macroeconomics 9906011, University Library of Munich, Germany.
    17. Chun Liu, 2005. "Measuring the relative efficiency and reorganization-The example of CDFAs of the NAN-TOU County in Taiwan," Economics Bulletin, AccessEcon, vol. 17(9), pages 1-11.

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