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

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

Journal Article

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

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;