Essays in Banking and Production

Author:

Kumar, Pradeep

Graduate Program:

Economics

Degree:

Doctor of Philosophy

Document Type:

Dissertation

Date of Defense:

May 07, 2013

Committee Members:

Mark John Roberts, Dissertation Advisor/Co-Advisor
Mark John Roberts, Committee Chair/Co-Chair
Paul L E Grieco, Committee Member
James R. Tybout, Committee Member
Keith John Crocker, Special Member

Keywords:

Banking
Mergers
Market Power
Cost Efficiencies
Networks
Moment inequalities
Production function
Demand shocks
Inventories

Abstract:

Chapter 1 "Market Power and Cost Efficiencies in Banking" A merger wave during the last 20 years has led to a decrease in the number of commercial banks from 12,343 in 1990 to 6,222 in 2012. For anti-trust and regulatory agencies, evaluating the relative importance of market power and cost efficiencies that result from a horizontal merger is important. To quantify these two effects, I develop an empirical model of banking which includes a demand model for differentiated products that allows market power effects to be calculated and a cost model that quantifies cost efficiencies from a merger. Since most of these banks operate in more than one market, incorporating the network structure of branches in the analysis is important. Cost parameters related to the network structure are estimated using moment inequality methods. Using the estimated parameters, I simulate mergers between banks of various sizes. I find that for a merger between 2 small banks (less than 500 branches), cost efficiencies play an important role in profitability. While for mergers involving a large bank (more than 500 branches) and a small bank or two large banks, the benefits accruing from market power are far more than the cost savings if there is substantial overlap in the networks of the merging banks. Although mergers involving large banks generate more market power, overall consumer welfare increases as the price effect of market power gets dominated by the consumer's preference for a larger bank. Chapter 2 "Market Structure and Growth of Banking in Rural Markets" The passage of the Riegle-Neal act in 1994 enabled banks to expand their network of branches across the United States. Since rural markets are often seen as unattractive destinations for banks due to the lack of commercial activities, this could possibly lead to a lower branch density in rural markets relative to the larger metropolitan markets. Hence it is important to understand the underlying dynamics governing the market structure in these rural areas. In this paper, we study the incentive structure governing branching growth in rural banking markets in the United States. We develop and estimate a dynamic oligopoly model with a rich state space. We find that one-branch banks have a very different incentive structure than other banks in that they generate most of the revenue from non-interest income such as fund-management fees, loan-arrangement fees and by selling insurance. Banks with more than one branch generate revenue using the traditional method of collecting deposits and investing in loans. There is a large adjustment cost involved in opening a second branch which results in few banks making that transition. Chapter 3 "Unraveling Effects of Demand Shocks on Production Function Estimation and Firm Behavior" The traditional productivity measures estimated using revenue-based firm-level data have both demand side and production side shocks embedded in them. In order to separate these two shocks, a small literature has exploited output price data but this data is typically not available in firm-level production data sets. In this paper, we use inventory data to disentangle and separately identify demand and productivity shocks without using any price data. Introducing a demand shock into the model also addresses the multi-collinearity bias pointed out by Ackerberg, Caves and Fraser (2006). Finally, we use our estimates to explain entry/exit dynamics and find that demand shocks are a more important driver of firm-turnover than productivity shocks.