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
JOURNAL OF FINANCE, Vol 50 No 5, December 1995
In the 1980s, U.S. banks became systematically less profitable and riskier as nonbank competition 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 equityholders 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 played a more important role than did the moral hazard associated with deposit insurance in explaining the recent behavior of the banking industry.
JEL Classification: G21Accepted Paper Series
Date posted: July 22, 1998
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