Diversification, Organization, and Efficiency: Evidence from Bank Holding Companies

Abstract

We use a portfolio-simulation technique to assess the benefits of diversification by bank holding companies. Using a sample of multi-bank bank holding companies (MBHCs) from 1990 to 1994, we construct pro forma benchmark portfolios for each MBHC composed of shares of single banks, weighted to correspond to the MBHC's distribution of activities across size and state. We then compare the performance and characteristics of the MBHCs with those of their "pure-play" alternatives. We find that diversification within the holding-company structure does bring benefits: the MBHCs hold less capital and do more lending, on average, than their pro forma benchmarks. They also earn enough income to compensate for the administrative costs of internal organization. These findings are consistent with an efficiency explanation for diversification stressing internal-capital-market advantages, rather than an empire-building explanation.

JEL Classification: G21, L22