Bank Capital Structure: Charter Value and Diversification Effects
Stern Working Paper Series S-96-52
Posted: 29 Jul 1997
Date Written: December 1996
Recent profitability and recapitalization trends in the banking industry appear to be consistent with a hypothesis advanced by Keeley (1990), Marcus (1984), Demsetz and Strahan (1996), and Demsetz, Saidenberg and Strahan (1996) termed the "charter value" hypothesis. Under this hypothesis banks with greater charter value voluntarily hold higher capital ratios to self-insure against charter loss under regulatory-enforced closure. Alternatively, increased branching and other forms of diversification may actually serve to reduce the capital required by banks to protect against adverse economic shocks, while increasing their expected survival rates. We term this alternative scenario the "diversification hypothesis". This paper tests these hypotheses using a sample of bank-specific market and accounting data covering the period 1893-1992. Our results indicate weak support for the charter value hypothesis during the post-WW II period. By contrast, pre-WW II the results of our analysis offer some support for the diversification hypothesis.
JEL Classification: G21
Suggested Citation: Suggested Citation