Bank Valuation in New EU Member Countries

Abstract

This paper studies the role of institutional reforms in affecting bank valuation in new European Union (EU) member countries. It takes advantage of the dynamic nature of institutional reforms in transition economies and explores the causal effects of those reforms on banks’ Tobin's Q over the period of 1997–2008. Using a difference-in-difference approach, the paper shows that Tobin's Q increases substantially after these countries reform their legal institutions and liberalize banking. However, it decreases after stock market reforms. After further examination of the interactive relationships between different reforms and bank valuation, it is observed that when the banking reform is well implemented, legal reform can have a stronger impact on banks’ Tobin's Q. On the other hand, banking reform and security market reform has a substitutive relationship. The analysis also suggests that foreign ownership, market power, and asset diversification significantly affect Tobin's Q. These results are robust even after simultaneously controlling for equity risk.

Keywords: Bank charter value, Foreign ownership, Diversification, Institutional development, Market power, Transition economies

JEL Classification: G21, P30, P34, P52