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

Joseph Hughes, Loretta Mester and Choon-Geol Moon ()
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Choon-Geol Moon: Hanyang University

Departmental Working Papers from Rutgers University, Department of Economics

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.

Keywords: banking; efficiency; ownership structure; competition (search for similar items in EconPapers)
JEL-codes: C58 G21 G28 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2016-06-24
New Economics Papers: this item is included in nep-ban, nep-bec, nep-cfn and nep-eff
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Citations: View citations in EconPapers (1)

Published Posted at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2800299

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Chapter: Measuring agency costs and the value of investment opportunities of US bank holding companies with stochastic frontier estimation (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:rut:rutres:201605

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