Bank Capital and Value in the Cross Section - FEDERAL RESERVE BANK of NEW YORK

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Staff Reports

Bank Capital and Value in the Cross Section

September 2009 Number 390

JEL classification: G21, G24, G34

Authors: Hamid Mehran and Anjan Thakor

We address two questions: (i) Are bank capital structure and value correlated in the cross section, and if so, how? (ii) If bank capital does affect bank value, how are the components of bank value affected by capital? We first develop a dynamic model with a dissipative cost of bank capital that is traded off against the benefits of capital: strengthened incentives for the bank to engage in value-enhancing loan monitoring and a higher probability of avoiding regulatory closure due to loan delinquencies. The model predicts that (i) the total value of the bank and its equity capital are positively correlated in the cross section, and (ii) the various components of bank value—the synergies among the bank’s assets and liabilities and the net present value to the shareholders of investing capital in the bank—are also positively cross-sectionally related to bank capital. When we confront the predictions with the data on bank acquisitions, we find strong support. The results are robust to a variety of alternative explanations—growth prospects, desire to acquire toe-hold positions, desire of capital-starved acquirers to buy capital-rich targets, market timing, pecking order, the effect of banks with binding capital requirements, too-big-to-fail, target profitability, risk, and mechanical effects.

Available only in PDF PDF

74 pages / 350 kb

For a published version of this report, see Hamid Mehran and Anjan Thakor, "Bank Capital and Value in the Cross-Section," Review of Financial Studies 24, no. 4 (April 2011): 1019-67.

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