Competition versus efficiency: What drives franchise values in European banking?

This paper investigates how stock market investors perceive the impact of market structure and efficiency on the long-run performance potential of European banks. To that end, a modified Tobin’s Q ratio is introduced as a measure of bank franchise value. This measure is applied to discriminate between the Market Structure and Efficient-Structure hypotheses in a coherent forward-looking framework, in which differences in banks’ horizontal and vertical differentiation strategies are controlled for. The results show that banks with better management or production technologies possess a long-run competitive advantage. In addition, bank market concentration does not affect all banks equally. Only the banks with a large market share in a concentrated market are able to generate non-competitive rents. The paper further documents that the forward-looking, long-run perspective and the noise adjustment of the performance measure overcome most of the drawbacks associated with testing these hypotheses in a multi-country set-up. Finally, notwithstanding the international expansion of bank activities, the harmonization of regulation and the macroeconomic convergence in the European Union (EU15), we still find that country-specific macroeconomic variables have a significant impact on bank performance. The findings indicate that there is a trade-off between competition and stability that should be taken into account when assessing mergers or acquisitions.(This abstract was borrowed from another version of this item.)