Banks with Something to Lose: The Disciplinary Role of Franchise Value

[...]In this article, we explore the relationship betweenfranchise value and risk taking over the 1986-94 period.We extend Keeley’s empirical analysis by estimating theeffect of franchise value on a variety of measures of bankrisk. We find an inverse relationship between franchisevalue and an “all-in” measure of risk based on stock-returnvolatility, which incorporates the risks of a bank’s asset, liability,and off-balance-sheet positions as well as its leverage.We also use information from the balance sheet todetermine how high-franchise-value banks reduce risk. Wefind that banks with more franchise value hold more capitaland have less asset risk than banks with less franchisevalue. Though their tendency to hold risky loans is similarto that of other banks, banks with high franchise valuemaintain better diversified loan portfolios.[...]