Bank Competition and Cost of Equity Capital

Abstract

Using a large panel of U.S. public firms, we exploit the staggered deregulation of interstate bank branching laws to examine whether banking competition affects the implied cost of equity. We hypothesize that banking competition may result in weakened banks’ ability to access borrower firms’ information, and thus a higher cost of equity. Consistent with our prediction, we find that banking competition increases the cost of equity of firms from states with high banking competition. Our findings are robust to several econometric specifications, including controlling for potential endogeneity and a variety of approaches to gauging cost of equity. This effect is more pronounced for firms with higher external finance dependence, weaker corporate governance, and higher firm risk. Overall, these results shed light on the information disadvantage of competition in banking industry, which negatively impacts shareholders’ value via discount rate hikes.

Keywords: Bank Deregulation; Banking Competition; Cost of Equity; Cost of Capital; Risk

JEL Classification: G30; G32.