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Abstract:
By studying the German universal banking system in the pre-World War I period, in comparison with its American and British counterparts, this paper investigates whether universality (the combination of commercial and investment banking services) influences banking industry concentration, levels of market power, or financial performance of banks. The short answer is "no". First, given that the UK's specialized commercial banking sector was structured very similarly to the German universal industrial banking sector, and that neither system was extremely concentrated in the pre-war era, the paper argues that universality does not necessarily or uniquely propagate concentration. Second, on average, German universal banks behaved no less competitively than their American counterparts in the provision of loan services. Structural price markup models, as well as reduced-form Rosse-Panzar tests, demonstrate little deviation from competitive pricing in either country. The findings therefore indicate that universality does not lead to appreciable market power, in either an absolute or a relative sense. These same results also imply that banking industry concentration, at least up to the moderately high levels found in Germany, does not in itself produce anti-competitive behavior. The empirical results, though contradictory to common wisdom about German universal banking, are easily motivated by the theoretical literature in industrial organization. Finally, estimates of returns on equity and on assets suggest only slight international differences in average returns over extended periods, but large deviations in individual years. Adjusting for prevailing rates on government bonds, commercial loans, or commercial deposits narrows the gaps further. Universality is not linked with superior profitability, whether the hypothesized source is efficiency (economies of scope) or monopoly power. These three sets of findings may assuage fears that deregulation in American banking could lead to excessive concentration and therefore collusive behavior. At the same time, the results may lower hopes of significant efficiency gains from broadening the scope of services.

Financial institutions, universal banking, financial system design, competition, concentration, banking industry atructure, profitability, return on assets

Abstract:
Underpricing of new issues relates negatively to underwriter reputation in studies covering the US during the early 1970s until 1997 but positively in one study of IPOs from 1992-4. This paper investigates whether IPO underpricing depends on the organization of the financial system, whether underwriter reputation is a consistent indicator of firm quality and therefore (negatively) of underpricing, and whether this reputation effect also appears in completely different contexts. The study also looks for truncation in the observed returns distributions that may hint at price support activities on the part of underwriters. To answer these questions, the study presents evidence on new issues of stocks and their one-day returns in the Berlin market of 1882-1892 along with parallel data from the New York markets of 1998-2000.

Despite what appear to be major institutional differences between the US and Germany, underpricing and its correlates are remarkably similar in the two cases: median underpricing is nearly the same in the two samples. Strikingly, the link between underwriter reputation and underpricing is positive both in the U.S. of recent years and in Berlin of the 1880s. This finding is in stark contrast with those for the US in the 1970s and 80s. The trade off between prices and rationing faced by underwriters might result in this instability in the reputation-underpricing link. Finally, the observed distributions of first-day returns for both markets display marked skewness toward positive values ? a pattern that is consistent with left censoring and quite possibly with underwriter price supports.

These results support a number of conclusions: first, either underwriter reputation is a poor signal of firm quality or firm quality is positively related to underpricing in certain circumstances; second, the largest and most prestigious underwriters may exert market power or at least provide more or better service in return for their higher indirect costs; third, the relationship between underwriter reputation or market share and underpricing clearly varies dramatically over time and across countries; and finally, financial system design?in particular, universal and relationship banking?may have little impact on the performance of new issues markets. Given the German results, one should conclude either that significant information asymmetries exist despite universality and formal relationships in the banking system or that information problems are unnecessary for the emergence of underpricing.

IPO, underpricing, underwriter reputation

Abstract:
Financial systems are often described either as bank-based, universal, and relational or as market-based, specialized, and arms-length; and for many years academics and policymakers have debated the relative merits of these different types of systems. This paper inquires into the underlying causes of financial system structure and development. Older theories dictated that financial institutions developed in relationship to the economy's level of development. Newer work has brought political and legal factors to the fore: hypothesizing specific relationships between banking structure and state centralization and between financial development and legal tradition. This study classifies countries by type of financial system, and in doing, indicates that few banking systems fit the extreme paradigms of universal - relationship or specialized - arms length banking. On the other hand, despite several cases of temporary upheaval, and recent widespread movement toward conglomeration, banking system structure has remained remarkable stable over the last 100 to 150 years.

Economic factors in the late nineteenth century provide relatively strong explanatory power for financial system development, market orientation, and banking structure at the eve of World War I and in the present day. Banking specialization and market orientation appear strongly associated with legal tradition, though it seems more likely that the three characteristics are jointly determined or that the legal system variable simply proxies for a close or historical tie to the exporter of many political-economic institutions, England. Legal orientation exerted little impact on financial institution growth at the turn of the century and provides no consistent prediction of real economic growth rates over the past 150 years. Finally, political structure relates significantly to market orientation but not to banking system design or legal tradition. Nonetheless, many individual country histories make it clear that political forces played important roles in shaping regulations that in turn altered the course of financial institutions and markets. The results here simply suggest that these political forces appeared inconsistently and had no traceable, uniform relationship to the overall political system in place in the nineteenth century.

The results underscore two principal themes: the weight of history in determining the growth and design of financial institutions and markets, and the importance of idiosyncratic forces that buffet institutions over time. Despite obvious connections among political, legal, economic, and financial institutions, robust, long-term, causal relationships often prove to be elusive.

Financial system design, universal banking, economic growth, legal tradition, political centralization

Abstract:
Based on daily prices (amtliche Kurse) we estimate effective spreads of securities traded at the Berlin Stock Exchange in 1880, 1890, 1900 and 1910. Several extensions of the Roll measure are applied. We find surprisingly tight effective spreads for the historical data, comparable with similar measures of the MDAX and DAX at the end of the 20th century.

price discovery, effective spreads, market microstructure

Abstract:
Close bank relationships are thought to ameliorate firms' liquidity constraints--a phenomenon frequently measured by liquidity sensitivity of investment. Using a panel of German firms during the formative years of universal banking (1903-1913), this paper shows that, even controlling for selection bias, investment is more sensitive to internal liquidity for bank-networked firms than unattached firms. The firm exhibiting the greatest liquidity sensitivity, however, faced no apparent liquidity constraints. The findings yield two implications: they support recent research rejecting a linear relationship between liquidity sensitivity and financing constraints, and they suggest that relationship banking provides no consistent lessening of firms' liquidity sensitivity.

Abstract:
Close bank relationships are thought to ameliorate firms' liquidity constraints--a phenomenon frequently measured by liquidity sensitivity of investment. Using a panel of German firms during the formative years of universal banking 1903-1913), this paper shows that, even controlling for selection bias, investment is more sensitive to internal liquidity for bank-networked firms than unattached firms. The firm exhibiting the greatest liquidity sensitivity, however, faced no apparent liquidity constraints. The findings yield two implications: they support recent research rejecting a linear relationship between liquidity sensitivity and financing constraints, and they suggest that relationship banking provides no consistent lessening of firms' liquidity sensitivity.

Abstract:
The historical literature has traditionally paid much attention to the role of universal banking in the industrialization of Germany and has presumed, in line with Gerschenkron (1962), that the system gained preeminence in the late nineteenth century due to the general 'backwardness' of the economy. Some researchers have stressed legal and political factors in the evolution of German financial institutions, placing particular emphasis on the Stock Exchange Law of 1896. The 1896 law, because it restricted the allowable activities of the securities exchanges, is seen as promoting the growth and concentration and possibly also monopoly power in the universal banking sector. Two important tax levies on securities market business, arriving shortly before and after the 1896 law, are also considered as an catalyst for change in the financial system. Despite the many claims made about the impact of regulation and taxation, though, a convincing quantitative analysis of the multiple influences is still lacking.

The current paper begins to fill this gap by examining company law and stock exchange regulations from the 1870s until the onset of World War I and by investigating the measurable effects of this legal framework on the development of the universal banking sector from 1884 to 1913. The analysis covers three hypothesized areas of impact: concentration, overall growth, and volume of business relative to the stock markets. The findings indicate that the size and volume of the German universal banks developed in a strong, but sustained, manner throughout the period considered, and concentration of the sector increased less than the conventional wisdom supposes. None of the three considered indicators reacted significantly to the 1896 stock exchange law, but all three appear to have increased weakly in response to taxes. Comparison with the British deposit banking sector indicates that the two countries followed nearly identical paths towards increasing concentration between 1884 and 1920, and that indeed the greatest push towards concentration came between 1913 and 1920 - long after the regulation and taxation episodes in Germany. Moreover, in spite of the growth of the German universal banking sector during the period, the British deposit banking sector was still markedly larger in 1913 (normalized by GNP). Thus, the evidence suggests that the effects of individual pieces of legislation were small compared to other changes in the economy.

Stock Market, Taxes, Regulation, Universal Banking, Concentration

Abstract:
The historical literature has traditionally paid much attention to the role of universal banking in the industrialization of Germany and has presumed, in line with Gerschenkron (1962), that the system gained preeminence in the late nineteenth century due to the general 'backwardness' of the economy. Some researchers have stressed legal and political factors in the evolution of German financial institutions, placing particular emphasis on the Stock Exchange Law of 1896. The 1896 law, because it restricted the allowable activities of the securities exchanges, is seen as promoting the growth and concentration and possibly also monopoly power in the universal banking sector. Two important tax levies on securities market business, arriving shortly before and after the 1896 law, are also considered as an catalyst for change in the financial system. Despite the many claims made about the impact of regulation and taxation, though, a convincing quantitative analysis of the multiple influences is still lacking.

The current paper begins to fill this gap by examining company law and stock exchange regulations from the 1870s until the onset of World War I and by investigating the measurable effects of this legal framework on the development of the universal banking sector from 1884 to 1913. The analysis covers three hypothesized areas of impact: concentration, overall growth, and volume of business relative to the stock markets. The findings indicate that the size and volume of the German universal banks developed in a strong, but sustained, manner throughout the period considered, and concentration of the sector increased less than the conventional wisdom supposes. None of the three considered indicators reacted significantly to the 1896 stock exchange law, but all three appear to have increased weakly in response to taxes. Comparison with the British deposit banking sector indicates that the two countries followed nearly identical paths towards increasing concentration between 1884 and 1920, and that indeed the greatest push towards concentration came between 1913 and 1920 - long after the regulation and taxation episodes in Germany. Moreover, in spite of the growth of the German universal banking sector during the period, the British deposit banking sector was still markedly larger in 1913 (normalized by GNP). Thus, the evidence suggests that the effects of individual pieces of legislation were small compared to other changes in the economy.

Stock market, taxes, regulation, universal banking, concentration

Abstract:
The cross-section of average annual returns on German common stock in the period of 1881-1913 exhibits several of the patterns that have been observed in more recent U.S. data. Market beta is hardly important, and its explanatory power is swamped by size and the ratio of book value to market value. A book-to-market risk measure (covariance with a portfolio long in high book-to-market firms and short in low book-to-market firms) has no effect on the explanatory power of the book-to-market characteristic. But the size effect appears to be caused by selection bias in the sample. And the book-to-market effect is opposite that of the recent U.S. experience (and, hence, can certainly not be attributed to selection bias). Finally, a momentum portfolio constructed on the basis of the error of the basic 3-characteristic model (market beta, size and book-to-market) does not generate significant returns. These findings highlight the variability in the power of certain characteristics in explaining the cross section of average returns.

Common stock returns, beta, momentum portfolio, selection bias

Abstract:
A firm's investment-cash flow sensitivity is often considered evidence of financial constraints, but such sensitivity may also stem from agency problems of free cash flows (managers overinvest). Close banking relationships are thought to ameliorate financing constraints and possibly agency problems, while ownership concentration mostly serves to prevent the latter. In Spain, a civil-law (French) system, where banks play a prominent role and where capital markets remain underdeveloped, these effects could be magnified. We find that bank relationships (via equity ownership or via debt) have little effect on firms' investment-cash flow sensitivity. In contrast, we find significantly lower cash-flow sensitivity among firms with high ownership concentration. The findings bolster the managerial overinvestment interpretation of cash-flow sensitivity and suggest that bank relationships provide imperfect substitutes for the oversight of large stakeholders.

investment, cash-flow sensitivity, financing constraints, managerial overinvestment, bank relationships, ownership concentration, civil law tradition

Abstract:
Despite reputedly widespread market manipulation and insider trading, we find surprisingly high liquidity and low transactions costs for actively traded securities on the NYSE between 1890 and 1910, decades before SEC regulation. Moreover, market makers behave largely as predicted in theory: stocks with liquid markets and competitive market makers (cross-trading at the rival Consolidated Exchange) trade with substantially lower quoted bid-ask spreads and with less anti-competitive behavior (price discreteness). Effective spreads, illiquidity, and volume all improve monotonically over time. Notably, the asymmetric information component of effective spreads increases in relative and absolute terms from 1900 to 1910.

Abstract:
Using a new set of monthly stock price data for a random sample of German companies, we investigate the pattern of common stock returns on the Berlin Stock Exchange between 1904 and 1910, when it ranked among the very top markets worldwide. We find that the CAPM performs poorly in this context: beta does not relate significantly to returns, while additional factors do. However, the anomalies we uncover differ substantially from those found in the United States more recently. Specifically, we find that book-to-market ratios relate negatively to returns, while size relates positively (but weakly) to returns. Also at odds with U.S. experience, earnings ratios are insignificant (though positive) in predicting returns, and a momentum portfolio earns returns not different from zero, on average. In addition, we explore the impact of bank directors sitting in company boards, since these bankers are thought to have wielded influence over firms and possibly over the price-setting process at the exchanges. Controlling for selection bias, however, we find that bankers had no consistent effect on common stock returns.

CAPM, size, value, momentum effects, stock market anomalies, relationship banking, Germany

Abstract:
Based on daily prices (amtliche Kurse) we estimate effective spreads of securities traded at the Berlin Stock Exchange in 1880, 1890, 1900 and 1910. Several extensions of the Roll measure are applied. We find surprisingly tight effective spreads for the historical data, comparable with similar measures of the MDAX and DAX at the end of the 20th century.

Price discovery, effective spreads, market microstructure

Abstract:
This article poses three main questions: Does the civil-law tradition favor large, concentrated, universal banking systems? Does this sort of legal system work against the development of active securities markets? Do powerful universal banks (whether or not legal tradition lies at the root of bank power) replace securities markets or prevent them from operating efficiently? Based on evidence from Pre-World War I Germany, this paper argues that the answer to all three questions is no.