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Measuring Agency Costs and the Value of Investment Opportunities of U.S. Bank Holding Companies with Stochastic Frontier Estimation

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Listed:
  • Joseph P. Hughes

    () (Rutgers University)

  • Loretta J. Mester

    () (Federal Reserve Bank of Cleveland)

  • Choon-Geol Moon

    () (Hanyang University)

Abstract

By eliminating the influence of statistical noise, stochastic frontier techniques permit the estimation of the best-practice value of a firm’s investment opportunities and the magnitude of a firm’s systematic failure to achieve its best-practice market value – a gauge of the magnitude of agency costs. These frontiers are estimated from the performance of all firms in the industry and, thus, capture best-practice performance that is, unlike Tobin’s q ratio, independent of the managerial decisions of any particular firm. Using the frontier measure of performance applied to 2007 data on top-tier, publicly traded U. S. bank holding companies, we obtain evidence on market discipline: we find that higher managerial ownership at most banks tends to align the interests of insiders with those of outside owners and to be associated with improved financial performance; at most banks, higher blockholder ownership is associated with improved financial performance obtained from blockholders’ monitoring; and, at most banks, higher product-market concentration is associated with poorer financial performance and the so-called managerial quiet life. Using the frontier measure of investment opportunities, we find evidence that banks with relatively higher-valued investment opportunities achieve less of their potential market value, while banks with lower-valued opportunities achieve more of their potential value. In spite of their lower-valued opportunities, these banks, on average, achieve the same Tobin’s q ratio and, thus, appear better able to exploit their less valuable investment opportunities. Our results suggest that higher-valued opportunities may reduce managers’ performance pressure and provide a stronger incentive to consume agency goods.

Suggested Citation

  • Joseph P. Hughes & Loretta J. Mester & Choon-Geol Moon, 2016. "Measuring Agency Costs and the Value of Investment Opportunities of U.S. Bank Holding Companies with Stochastic Frontier Estimation," Departmental Working Papers 201605, Rutgers University, Department of Economics.
  • Handle: RePEc:rut:rutres:201605
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    References listed on IDEAS

    as
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    Keywords

    banking; efficiency; ownership structure; competition;

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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