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Evidence on the Objectives of Bank Managers

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Author Info
Joseph Hughes
Loretta Mester

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Abstract

The paper attempts to present empirical evidence on the behavior of bank managers - are they risk neutral and act on behalf of shareholders to maximize profits or risk averse and trade-off profits for risk reduction? The paper examines the bank's choice of financial capital since increasing financial capital reduces the risk of insolvency. A multiproduct cost function which incorporates asset quality and the risk faced by uninsured bank depositors is derived from a model of utility maximization.

The authors' interpretation of the model is that it explicitly models a kind of x-efficiency. Because a bank may desire to trade-off risk and return, it may not use the cost minimizing level of financial capital.

The authors extend the model of Hughes and Mester (1993) to allow a bank's choice of financial capital level to reflect its preference for return versus risk. The model consists of the cost function, share equations, and demand for financial capital equation, which are estimated jointly. The authors find evidence that banks in all size categories are acting in a non-risk neutral manner. Estimates of scale and scope economies based on this model show economies of scale at banks in all size categories. The authors also find evidence of product-specific scope econo-mies, cost complementarity between some outputs, and cost non-complementarity between other outputs.

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Publisher Info
Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 94-15.

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Date of creation: Sep 1992
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Handle: RePEc:wop:pennin:94-15

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Mester, Loretta J., 1991. "Agency costs among savings and loans," Journal of Financial Intermediation, Elsevier, vol. 1(3), pages 257-278, June. [Downloadable!] (restricted)
  2. Hunter, William C & Timme, Stephen G & Yang, Won Keun, 1990. "An Examination of Cost Subadditivity and Multiproduct Production in Large U.S. Banks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(4), pages 504-25, November. [Downloadable!] (restricted)
  3. Paul J. Gertler & Donald M. Waldman, 1990. "Quality Adjusted Cost Functions," NBER Working Papers 3567, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Mester, Loretta J., 1992. "Traditional and nontraditional banking: An information-theoretic approach," Journal of Banking & Finance, Elsevier, vol. 16(3), pages 545-566, June. [Downloadable!] (restricted)
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  5. McAllister, Patrick H. & McManus, Douglas, 1993. "Resolving the scale efficiency puzzle in banking," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 389-405, April. [Downloadable!] (restricted)
  6. Joseph P. Hughes & Loretta J. Mester, . "A Quality and Risk-Adjusted Cost Function for Banks: Evidence on the "Too-Big-To-Fail" Doctrine," Rodney L. White Center for Financial Research Working Papers 25-92, Wharton School Rodney L. White Center for Financial Research.
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  7. Hannan, Timothy H & Hanweck, Gerald A, 1988. "Bank Insolvency Risk and the Market for Large Certificates of Deposit," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(2), pages 203-11, May. [Downloadable!] (restricted)
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  1. Antonio Lopes & Luca Giordano, 2006. "Risk Preference and Investments Quality as Determinants of Efficiency in the Italian Banking System," Quaderni DSEMS 12-2006, Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia. [Downloadable!]
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