Competition versus Efficiency: What drives franchise values in European banking?
O. DE JONGHE
R. VANDER VENNET
This paper investigates how stock market investors perceive the impact of market structure and efficiency on the long-run performance potential of European banks. To that end, a modified Tobin’s Q ratio is introduced as a measure of bank franchise value. This measure is applied to discriminate between the Market Structure and Efficient-Structure hypotheses in a coherent forward-looking framework, in which differences in banks’ horizontal and vertical differentiation strategies are controlled for. The results show that banks with better management or production technologies possess a long-run competitive advantage. In addition, bank market concentration does not affect all banks equally. Only the banks with a large market share in a concentrated market are able to generate non-competitive rents. The paper further documents that the forward-looking, long-run perspective and the noise adjustment of the performance measure overcome most of the drawbacks associated with testing these hypotheses in a multi-country set-up. Finally, notwithstanding the international expansion of bank activities, the harmonization of regulation and the macroeconomic convergence in the European Union (EU15), we still find that country-specific macroeconomic variables have a significant impact on bank performance. The findings indicate that there is a trade-off between competition and stability that should be taken into account when assessing mergers or acquisitions.
charter value, market power, efficiency, Tobin’s Q, stochastic frontier
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