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Do Bankers Sacrifice Value to Build Empires? Managerial Incentives, Industry Consolidation, and Financial Performance

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Author Info

  • William Lang

    ()
    (Office of the Comptroller of the Currency)

  • Choon-Geol Moon

    ()
    (Hanyang University)

  • Loretta Mester

    ()
    (Federal Reserve Bank of Philadelphia)

  • Joseph Hughes

    ()
    (Rutgers University)

  • Michael Pagano

    ()
    (Villanova University)

Abstract

Bank consolidation is a global phenomenon. It may enhance the value of firms in the industry if, for example, it is driven by scale and scope economies, but skeptics often accuse bankers of sacrificing value to build empires. Using data on bank holding companies in the U.S., we find strong evidence of managerial entrenchment that influences how asset acquisitions and sales affect financial performance. We measure bank financial performance both by Tobin's q ratio and by its failure to achieve its highest potential market value, which we estimate using a stochastic frontier technique. We find evidence of entrenchment at banks with higher levels of managerial ownership, better growth opportunities, poorer financial performance, and smaller asset size. However, when managers are faced with better growth opportunities, they generally appear to have an elastic demand for agency goods (perquisites, shirking, risk avoidance, etc.). With regard to empire building, we find that an increase in asset size achieved by internal growth is associated with better performance at most banks, but an increase in acquired assets is associated with worse performance at banks with entrenched managers. In contrast, a larger amount of sold assets by banks with entrenched management is related to improved performance. We do not obtain this asymmetry between the effect of sales and acquisitions at banks not exhibiting entrenchment: larger sales and larger acquisitions both improve performance, a result predicted by Shleifer and Vishny (1989). Our evidence is consistent with the often cited role of scale economies as a driver of bank consolidation, but it also suggests that the benefits of asset acquisitions are not obtained by entrenched managers, who may be able to resist market discipline to build empires.

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Bibliographic Info

Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 200117.

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Date of creation: 08 Dec 2001
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Handle: RePEc:rut:rutres:200117

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Keywords: consolidation;

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References

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Cited by:
  1. De Jonghe, Olivier & Vennet, Rudi Vander, 2008. "Competition versus efficiency: What drives franchise values in European banking?," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1820-1835, September.
  2. Koetter, Michael & Wedow, Michael, 2010. "Finance and growth in a bank-based economy: Is it quantity or quality that matters?," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1529-1545, December.
  3. Joseph P. Hughes & Loretta J. Mester, 2012. "A primer on market discipline and governance of financial institutions for those in a state of shocked disbelief," Working Papers 12-13, Federal Reserve Bank of Philadelphia.
  4. M. Koetter, 2004. "The stability of efficiency rankings when risk-preference are different," Working Papers 04-08, Utrecht School of Economics.
  5. Stafano Caiazza & Alberto Franco Pozzolo & Giovanni Trovato, 2011. "Do domestic and cross-border M&As differ? Cross-country evidence from the banking sector," Mo.Fi.R. Working Papers 52, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  6. Wim Fonteyne, 2007. "Cooperative Banks in Europe," IMF Working Papers 07/159, International Monetary Fund.
  7. Christoph Walkner & Jean-Pierre Raes, 2005. "Integration and consolidation in EU banking - an unfinished business," European Economy - Economic Papers 226, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  8. Joseph P. Hughes & Loretta J. Mester, 2013. "Measuring the performance of banks: theory, practice, evidence, and some policy implications," Working Papers 13-31, Federal Reserve Bank of Philadelphia.
  9. Loretta J. Mester, 2003. "Applying efficiency measurement techniques to central banks," Working Papers 03-13, Federal Reserve Bank of Philadelphia.
  10. Jeungbo Shim, 2011. "Mergers & Acquisitions, Diversification and Performance in the U.S. Property-Liability Insurance Industry," Journal of Financial Services Research, Springer, vol. 39(3), pages 119-144, June.
  11. Carow, Kenneth A. & Cox, Steven R. & Roden, Dianne M., 2009. "Demutualization: Determinants and consequences of the mutual holding company choice," Journal of Banking & Finance, Elsevier, vol. 33(8), pages 1454-1463, August.
  12. Atul Gupta & Bently Lalatendu Misra, . "Deal size, bid premium, and gains in bank mergers: The impact of managerial motivations," Working Papers 0004, College of Business, University of Texas at San Antonio.
  13. Williams, Jonathan, 2012. "Efficiency and market power in Latin American banking," Journal of Financial Stability, Elsevier, vol. 8(4), pages 263-276.
  14. Amel, Dean & Barnes, Colleen & Panetta, Fabio & Salleo, Carmelo, 2004. "Consolidation and efficiency in the financial sector: A review of the international evidence," Journal of Banking & Finance, Elsevier, vol. 28(10), pages 2493-2519, October.
  15. Fatma Cebenoyan & Donal Byard, 2003. "Firms’ Relative Operational Efficiency and Analysts’ Earnings Forecasts," Hunter College Department of Economics Working Papers 302, Hunter College: Department of Economics.
  16. Koetter, Michael, 2006. "The stability of efficiency rankings when risk-preferences and objectives are different," Discussion Paper Series 2: Banking and Financial Studies 2006,08, Deutsche Bundesbank, Research Centre.
  17. Fiordelisi, Franco, 2007. "Shareholder value efficiency in European banking," Journal of Banking & Finance, Elsevier, vol. 31(7), pages 2151-2171, July.
  18. Turk Ariss, Rima, 2010. "On the implications of market power in banking: Evidence from developing countries," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 765-775, April.
  19. Ghosh, Chinmoy & Harding, John & Phani, B.V., 2008. "Does liberalization reduce agency costs? Evidence from the Indian banking sector," Journal of Banking & Finance, Elsevier, vol. 32(3), pages 405-419, March.
  20. Rötheli, Tobias F., 2010. "Causes of the financial crisis: Risk misperception, policy mistakes, and banks' bounded rationality," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 39(2), pages 119-126, April.

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