Expense Preference and Managerial Control: the Case of the Banking Firm

This article presents a test of the expense-preference theory of the firm as it applies to the banking industry. We use a model which incorporates explicitly the role of control by the firm's owners in determining the level of firm's inputs chosen by managers and yields implications which allow ownership information to be used in a more extensive test of the expense-preference hypothesis than heretofore has been conducted. We test the model by using detailed information on the dispersion of ownership and on other characteristics of a large number of individual banking firms. Consistent with the implications of expense-preference behavior, manager-controlled banks operating in noncompetitive markets are found to spend more on items likely to be preferred by managers than do owner-controlled banks in the same situation. This, along with other results, lends support to the expense-preference model over the more traditional one of profit maximization.