Banks with something to lose: the disciplinary role of franchise value

Rebecca Demsetz, Marc R. Saidenberg and Philip E. Strahan

Economic Policy Review, 1996, vol. 2, issue Oct, 14 pages

Abstract: As protectors of the safety and soundness of the banking system, banking supervisors are responsible for keeping banks' risk taking in check. The authors explain that franchise value--the present value of the stream of profits that a firm is expected to earn as a going concern--makes the supervisor's job easier by reducing banks' incentives to take risks. The authors explore the relationship between franchise value and risk taking from 1986 to 1994 using both balance-sheet data and stock returns. They find that banks with high franchise value operate more safely than those with low franchise value. In particular, high-franchise-value banks hold more capital and take on less portfolio risk, primarily by diversifying their lending activities.

Keywords: Bank management; Bank holding companies; Retail trade (search for similar items in EconPapers)
Date: 1996
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