Corporate Control, Portfolio Choice, and the Decline of Banking
Gary B. Gorton
Yale School of Management; National Bureau of Economic Research (NBER)
Richard J. Rosen
Federal Reserve Bank of Chicago - Economic Research
NBER Working Paper No. w4247
In the last two decades U.S. banks have become systematically less profitable and riskier as nonbank competition has eroded the profitability of banks' traditional activities. Bank failures, insignificant from 1934, the date the Glass-Steagall Act was passed, until 1980, rose exponentially in the 1980s. The leading explanation for the persistence of these trends centers on fixed-rate deposit insurance: the insurance gives bank shareholders an incentive to take on risk when the value of bank charters falls. We propose and test an alternative explanation based on corporate control considerations. We show that managerial entrenchment, more than moral hazard associated with deposit insurance, explains the recent behavior of the banking industry.
Number of Pages in PDF File: 52working papers series
Date posted: December 29, 2006
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