Bank Risk and Bank Rents: The Franchise Value Hypothesis Reconsidered

34 Pages Posted: 6 Nov 2020

See all articles by Gianni De Nicolo

Gianni De Nicolo

Johns Hopkins University - Carey Business School; CESifo (Center for Economic Studies and Ifo Institute)

Viktoriya Zotova

University of Maryland - Robert H. Smith School of Business

Date Written: October 10, 2020

Abstract

The predictive relationship between franchise value, measured by Tobin Q, and a theory-based measure of bank risk of insolvency is highly non-linear. Using large samples of publicly quoted banks in the US, Europe, and Asia during 1985-2017, we find that higher values of Q predict lower bank risk of insolvency up to values of Q close to 1, but this prediction is reverted when franchise value is priced and Q exceeds unity, as higher values of Q predict higher bank risk of insolvency. We then construct proxy measures of bank efficiency rents, loan and deposit pricing power rents, and rents due to government guarantees, and show that an increase in these rents is associated with higher market valuation and higher franchise value. Thus, an increase of any of these rents predicts a higher bank risk of insolvency. The franchise value hypothesis is thus rejected in our samples. An interpretation of these findings in light of existing theories is discussed.

Keywords: Tobin Q, Bank Risk of Insolvency, Bank Rents

JEL Classification: C21, E44, G21

Suggested Citation

De Nicolo, Gianni and Zotova, Viktoriya, Bank Risk and Bank Rents: The Franchise Value Hypothesis Reconsidered (October 10, 2020). Available at SSRN: https://ssrn.com/abstract=3708927 or http://dx.doi.org/10.2139/ssrn.3708927

Gianni De Nicolo (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States
(410) 234-4507 (Phone)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Viktoriya Zotova

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

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