Competition versus agency costs: An analysis of charter values in European banking

It remains an empirical question whether deregulation and consolida- tion in European banking have a tangible eect on bank behavior and bank performance. In this paper, we investigate how competition and e¢ ciency aect the franchise value of European banks. We compute a noise-adjusted bank-speci…c time-varying measure of bank charter value for a large sample of listed European banks for the period 1995-2003, us- ing stochastic frontier analysis and combining accounting data and stock market variables. We investigate the determinants of this noise adjusted Tobin's Q, which correlates very strongly with the shortfall from the mar- ket value frontier. We use our measure to discriminate between Market- Power and E¢ cient-Structure hypotheses. We …nd strong economic and statistical evidence for the Relative Market Power hypothesis and the X- e¢ ciency hypothesis. We also analyze the extent to which leverage limits the potential agency costs if there is separation between bank ownership and bank management. We …nd that more levered banks perform better than less levered banks, but the relationship switches at higher capital ratios. These …ndings are robust when controlling for diversi…cation in bank activities, bank pro…tability, bank risk, institutional features and the macro-economic environment.