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Evidence on the Objectives of Bank Managers

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  • Joseph Hughes
  • Loretta Mester

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.

Suggested Citation

  • Joseph Hughes & Loretta Mester, 1992. "Evidence on the Objectives of Bank Managers," Center for Financial Institutions Working Papers 94-15, Wharton School Center for Financial Institutions, University of Pennsylvania.
  • Handle: RePEc:wop:pennin:94-15
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    File URL: http://fic.wharton.upenn.edu/fic/papers/94/9415.pdf
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    References listed on IDEAS

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    1. Paul J. Gertler & Donald M. Waldman, 1990. "Quality Adjusted Cost Functions," NBER Working Papers 3567, National Bureau of Economic Research, Inc.
    2. Joseph P. Hughes & Loretta J. Mester, "undated". "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.
    3. Mester, Loretta J., 1991. "Agency costs among savings and loans," Journal of Financial Intermediation, Elsevier, vol. 1(3), pages 257-278, June.
    4. 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 504-525, November.
    5. Mester, Loretta J., 1992. "Traditional and nontraditional banking: An information-theoretic approach," Journal of Banking & Finance, Elsevier, vol. 16(3), pages 545-566, June.
    6. 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.
    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 203-211, May.
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    Cited by:

    1. Delis, Manthos D. & Karavias, Yiannis, 2015. "Optimal versus realized bank credit risk and monetary policy," Journal of Financial Stability, Elsevier, vol. 16(C), pages 13-30.
    2. Li-Gang Liu & Changchun Hua, 2010. "Risk-return Efficiency, Financial Distress Risk, and Bank Financial Strength Ratings," Working Papers id:2944, eSocialSciences.
    3. Changchun Hua & Li-Gang Liu, 2010. "Risk-return Efficiency, Financial Distress Risk, and Bank Financial Strength Ratings," Finance Working Papers 22756, East Asian Bureau of Economic Research.
    4. Bris, Arturo & Cantale, Salvatore, 2004. "Bank capital requirements and managerial self-interest," The Quarterly Review of Economics and Finance, Elsevier, vol. 44(1), pages 77-101, February.

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