Group Title: analytics of multibank holding company behavior
Title: The analytics of multibank holding company behavior
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Title: The analytics of multibank holding company behavior
Physical Description: xiii, 143 leaves. : ; 28 cm.
Language: English
Creator: Boczar, Gregory Edward, 1943-
Publication Date: 1973
Copyright Date: 1973
Subject: Bank holding companies -- Florida   ( lcsh )
Economics thesis Ph. D
Dissertations, Academic -- Economics -- UF
Genre: bibliography   ( marcgt )
non-fiction   ( marcgt )
Thesis: Thesis -- University of Florida.
Bibliography: Bibliography: leaves 139-143.
General Note: Typescript.
General Note: Vita.
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Bibliographic ID: UF00098367
Volume ID: VID00001
Source Institution: University of Florida
Holding Location: University of Florida
Rights Management: All rights reserved by the source institution and holding location.
Resource Identifier: alephbibnum - 000582563
oclc - 14125030
notis - ADB0940


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Copyright by
Gregory Edward Boczar


There are many individuals who have assisted in the com-

pletion of the dissertation. Speciial mention needs to be made of the

assistance provided by Professor Ralph H. Blodgett, the chairman of

my dissertation committee. He was a steady source-of encouragement,

advice and tolerance. His willingness to smooth over some of the

obstacles to getting an education was essential to my getting this far.

I am appreciative of the support in various forms provided

by the Board of Governors of the Federal System. Thanks go to Bob

Creller and Joe Holmes for very competent programming assistance.

Several of my colleagues were most generous with their time and advice

including Steve Rhoades, Bud Talley, Art Fraas and Bob Lawrence.

Steve Rhoades especially forced me: time and again -to clarify my

thinking and to improve my writing. The Research Library at the

Federal Reserve Board always provided professional service beyond the

call of duty. Both Ann Marie-Martin and Judy Back deserve special

mention. Statistical and clerical assistance were competently provided

by Anita Barley, Gloria Battle, Jackie Rupp, Ronnie Mc~illiams and

Lucy Nelson among others. Typing of numerous drafts was done by

Janet Breen, Ann Marie Cowan and Joan Albamonte.

The person who deserves the most, thanks is my wife Marilyn.

She has helped in every conceivable way assuming family responsibilities

so that I could work, acting as a sounding board- for my ideas, and

encouraging me when I was discouraged.


ACKNOWLEDGMENTS**********-********....... iv

LIST OF TABLES**--***************** ..................... .........v~~,iii

LIST OF FIGURES............,~ .....n ,n x

ABSTRACT***************-**************************........4..~~~~/~ i


1. PURPOSE AND DESIGN OF THE STUDY....................,.....,... 1
Purpose of the Study.............. .,................ ... 1
Design of the Study: A Homogeneous Population. ,......... 1
Design of the Study: The Extreme Instance. ............ 5
Design of the Study: Decisions and Independent.,
Decision Makers...................................., 7
Organization of the Study. ....,......., .,,........... 7
Definitions and Terminology. ...............,,, .......... 8

Historical Review Up to 1956.......................... 11
Regulation of Bank Holding Companies............. ..,,, 14
Banking Act of 1933 ............,............. ..,.,, 14
The Bank Holding Company Act of 1956. ............. ,. 16
The 1966 Amendments................................, 18
The 1970 Amendments.................................. 20
Development of Bank Holding Companies After 1956....... 21

3. A CRITICAL REVIEW OF THE LITERATURE. ..........;............. 28
A Selective and Critical Review: An Aid to
SModel Building............... ........,..,....,....o. 28
Fischer: Bank Holding Companies. ...........,,...... 28
Lawrence: The Performance of Bank Holding Companies.....; 31
McLeary: Bank Holding Companies--Their Growth
and Performance...............................o, 34
Weiss: Bank Holding Companies and Public Policy........., 35
Talley: The Effects of Holding Company Acquisitions
on Bank Performance...,................ .~............. 36
Piper: The Economics of Bank Acquisitions
by Holding Companies. ...............;.............. 38
Possible Efficiencies of the Holding Company Structure.. 41-
Schweitzer: Economies of Scale ald Holding Company
Affiliation................................:.. 42
Upson and Jessup: Returns from Bank Ho'lding Companies... 43
Alhadeffs: Recent Bank Mergers.........................., 44
The Relative Standing of,Banks.........;.,.........o... 45
Summary ..........,...............o.,..... .....~..o~nn, 46

Chapter Page

MAXIMIZERS ........... ,.............................. 48
External Expansion and Profit Maximization. ........... 49
The Alternative Hypothesis: Size Maximization. ........ 50
Profit Maximization Versus Size Maximization. ......... 52
Application of the Profit Maximization Hypothesis..... 53

5. A MIODEL OF LEAD BANK STATUS............................... 55
Definition of Lead Bank Status........................ 55
The Set of Potential Lead Banks.....................;.. 56
Lead Banks and Chains................................. 58
The Time Framework of the Study. .................... 59
A Framework for the Empirical Model...............,, 60
The Regulatory Position. ..........,.................. 61
Individual Bank Characteristics....................... 62
Environment. ............. ............. ............. 67
The Statistical Model. ..........,,.................. 69

6, THE DETERMINANTS OF LEAD BANK STATUS. ................... 78
Interpreting the Probit Statistical Model............. 78
The Likelihood Ratio Test............................. 79
A Stepwise Testing Procedure..........;................ 80
The Results for Single Predictors..................... 81
The Results for Several Predictors.................... 85

7. .A MDDEL OF HOLDING COMPANY ACTIITY....................... 93
The. Profit Maximization Hypothesis and Holding
Company Activity..............,..................... 93
Measures of Holding Company Activity............ ...... 94
The Dependent Variable and Tobit Analysis............. 96
Metropolitan Markets..............................;... 97
The Time Period. ................... ................... 99
A Framework for the Explanatory Variables............. 102
The Regulatory Environment. .......................... 102
Expected Profitability of the Market.................. 103
The Snowball Effect. ................... ............... 106
Alternative Measures of Explanatory Variables......... 108
The Model of Holding Company Activity. ................ 108

Interpreting the Tabit Statistical Model.............. 109
The Results for Single Predictors..................... 111
The Results for Several Predictors. ................. 120

FUTURE RESEARCH. ......... .............. ............. 130
A Sumrmary of the Results................. 130
Conclusions for Cases Analysis........................11

Chapter Page

Directions for Future Research. ................... .... 134

APPENDIX............. ................. .'.................... .... 135

BIBLIOGRAPHY. ............... ................................. 139


Table Page

1.1 Multibank Holding Companies in Florida as of
December 29, 1972...................................... 3

1,2 Deposit-Size Distribution of Banks in Multibank
Holding Companies as of December 29, 1972............ ... 4

1.3 Population, Personal Income, Deposits and Banks in
Florida, 1960-1972................................ ... 7

2.1 Registered Bank Holding Companies: Number, Number of-
Banks and Branches, and National Share of Offices
and Deposits, 1956, 1960, 1965............,........ ........ 22

2.2 Offices and Deposits of Banks Affiliated with
Registered Bank Holding Companies, 1965-1970. ........... 24

:2.3 Percentage of Banking Offices in Each State and
Percentage of Deposits in Each State Held by
Registered Bank Holding Companies, 1965 and 1970......... 25

6.1 Identification of Variables with Means and Standard
Deviations....................................... 82

6.2 ~Probit Model of Lead Bank Status Using Single Predictors... 83

6.3 Probit Model of Lead Bank Status Using Two Predictors...... 86

6.4 Final Equations for the Model of Lead Bank Status.....;..... 88

6.5 Correlations Between Variables in Model of Lead Bank
Status........................................... 90

6.6 The Probability of Lead Bank Status........................ 91

7. 1 Holding Company Proposals Denied or Abandoned, 1963-1972.. 95

7.2 Metropolitan Banking Markets in Florida. ................... 100

7.3 Multibank Holding Company Activity in Florida,
1960-1972........................................ 101

8.1~ Identification of Variables with Means and Standard
Deviations. ............. ..............................112

8.2 Tobit Model of Holding Company Activity Using
Single Predictors................................. .115


Table Page

8.3 Tobit Model of Holding Company Activity Using Two
Predictors.............************************** 121

8.4 Tobit Model of Holding Company Activity Using
Three Predictors...********************************* 124

8.5 Final Equations for the Model of Holding Company
Activity*********************-........,....... ............ 125

8.6 Correlations Between Variables in Model of Holding
Company Activity....,................... ................ 127

8.7 The Probability of Activity and the Expected Value of
Activity. ..........*************************************** 129

A. 1 The Set of Potential Lead Banks..............,,..... ........ 135

A.2 Decisions Mhde by Potential Lead Bank Through
December 31, 1972...................................... 137


Figure Page

5. 1 A Straight Line Fit with Regressian Model. ................ 71

5.2 .Homoskedasticity about the Regression Line................, 71

5.3 Normal Distribution of Dosage Thresholds....... ........... 74

5.4 Cumulative Distribution of Insects Killed.................- 74

5.5 The Probit Line for Lead Bank Status...................... 76

8. 1 The Tobit Line for Holding Company Activity. .............. 110

Abstract of Dissertation Presented to the
Graduate Council of the University of Florida in Partial
Fulfillment of the Requirements for the Degree of Doctor of Philosophy



Gregory Edward Boczar

December, 1973

Chairman: Ralph H. Blodgett
Major Department: Economics

Multibank holding companies have developed rapidly since

1965. The purpose of the study is to explain the behavior of these

companies--their formation and expansion. The study is limited to

formations and acquisitions in Florida for the last decade. By

restricting the study to a single state, it is possible to control for

a number of significant differences among holding companies. Also,

Florida is an especially ideal state for study because it has experi-

enced more growth of holding companies, population, personal income

and bank deposits than any other major state.

By way of introduction to the recent upsurge of holding

contmpany growth, the historical and legal framework of multibank hold-

ing companies is described. A critical review of the scholarly

literature on holding companies is also undertaken. Both the

historical and legal review and the review of the literature provide

information on the motivation and behavior of multibank holding

companies. A profit maximization hypothesis is selected as the

appropriate analytical framework because the hypothesis is more

workable and somewhat more consistent with the facts than its chief

rival, the size maximization hypothesis.

In order to explain empirically the behavior of multibank

holding companies, a model of lead bank status and a model of holding

company activity are developed and tested. The probit statistical

technique rather than the more conventional regression approach was used

-to test the model of lead bank status because the dependent variable

only takes the value of zero or one. The explanatory .variables for

the model of lead bank status fall into three categories: regulatory

position, characteristics of the bank and environment of the bank.

It was not possible to measure the regulatory position of the Board

of Governors of the Federal Reserve System because of the lack of

overt actions by the Board. In terms of an individual bank's

characteristics, the amount of correspondent business done by the bank

and the absolute size of the bank proved to be significant determinants

of lead bank status. No evidence was found to support the idea that

banks with declining market shares tend to anchor holding companies..

Also, lead banks cannot be characterized as either wholesale- or

retail-oriented nor are they especially successful in gaining loans

in general. In terms of the environment of a bank, the relative

importance of a bank's market as a financial center had a favorable

influence on lead bank status. Finally, if relatively few banks in

the recent past have affiliated with holding companies, a bank is

more likely to become a lead bank than if: a substantial portion of the

banks in the market have come under holding company control.


The model of holding company activity was tested using the

tobit statistical method. The tobit method is appropriate because the

dependent variable does not take on negative values, having a lower

limit of zero. The explanatory variables for the model of holding

company activity are divided into three categories: regulatory

environment, expected market profitability and a snowball of ect. The

regulatory attitude of the Federal Reserve Board toward holding company

activity in a market is measured by the level of market concentration.

As postulated, concentration had a dampening effect upon the amount of

activity in a market. In terms of expected market profitability, both

current market profits (income as a proportion of capital of asset) and

deposits per capital or per bank had a significant positive influence on

holding company activity. The level of per, capital personal income was

found to have a positive and highly significant effect on holding

company activity. Neither population per bank nor short term (two-year)

changes in population, personal income or deposits have a systematic

influence on holding company activity. Some evidence was found to

support the contention that holding company activity tends to snowball

over time.




Multibank holding companies have developed rapidly in the

United States since 1965. This activity by bank holding companies has

been concentrated in a dozen unit-banking and limited-branching states.

The most active state has been Florida. In.1965 there were six multi-

bank systems in Florida which controlled 55 banks. By December 1972,

there were 27 bank holding companies which controlled 280 banks. In

terms of number of multibank systems and in terms of number of affiliated

banks, Florida currently ranks first in the nation.

PurPose of the Study

The purpose of the study is to explain the formations of, and

acquisitions by, multibank holding companies. In order~ to understand

the factors which influence holding company formations, a model of lead

bank status is developed and then empirically tested. In order to under-

stand the factors which cause holding companies to be more active in one

market than another, a model of holding company activity is developed

and then empirically tested. Both models are developed within the frame-

work of a profit maximization hypothesis.

Design of the Study: A Homogeneous Population

A recent study of multibank holding companies concluded:

It is almost impossible to make an unqualified statement
concerning the structure, organization, or operation of
holding companies which will fit all situations. Bank
holding companies, as they have developed in this country,
tend to reflect the special circumstances of their

-1 -

- 2-

organization and their location. The' factors which
brought them into existence have differed over time,
as have the financial requirements of the localities
or regions in which they operate. Given a banking system
with striking differences in bank size, operating powers,
management philosophies, supervisory status, and tradi-
tions,' it is not surprising that bank holding companies
are found to differ significantly one from the other.
...It [the above] makes difficult the task of the
analyst who seeks absolutes....1

Because of this wide diversity among bank holding companies, the usual

ceteris Dalibus assumptions are not satisfied in a general study of

these companies.

In order to control for the significant differences among

holding companies, the study is restricted to formations and acquisi-

tions in Florida for the last decade. By limiting the study to one

state, we control for differences in banking traditions and management

philosophies which appear to vary from one state to another and from

one region to another.2 Of course, all holding company banks in the

study will be subject to the same state banking laws.

In addition, there are no striking differences among Florida

holding companies in terms of total deposits controlled nor in terms of

number of banks controlled. .(See Table 1.1.) The size distribution

of affiliated banks is similar among holding companies except for the

billion dollar First :National Bank of Miami, the lead bank for Southeast

Banking Corporation. (See Table 1.2.)

In order to have a more homogeneous population, the study is

limited to the banking activities of multibank holding companies. Thus,

1' Carter H. Golembe and Associates, The Future of Registered Bank
Holding Companies (Washington, D. C.: The Association of Registered
Bank Holding Companies, 1971), pp. 35-36.
2 Ibid., p. 29.


Table 1.1

Multibank Holding Companies in Florida
as of December 29, 1972

Number Total
Rank Name and Location of Holding Companies of Banks Deposits

1 Southeast Banking Corporation, Miami 18 1,517. 2
2 Barnett Banks, Jacksonville 36 .1,245.9
3 Florida N/B, Jacksonville 31 1,167.0
4 First at Orlando, Orlando 25 1,075. 3
5 Atlantic Bancorporation, Jacksonville' 20 855.9
6 First Financial Corp., Tampa 9 682. 3
7 First Florida Bancorp., Tampa 24 646. 8
8 E11is Banking Corp., Brandenton 15 529.4
9 Consolidated Bankshares, Ft. Lauderdale 8 505.0
10 Exchange Bancorporation, Tampa 10 478.9
11 United Bancshares, Miami 6 493.8
12 City National Bank Corp., Miami 3 441.5
13 Pan American Bancshares, Miami 9 436. 9
14 Charter Bankshares, Jacksonville 9 341. 9
15 Broward Bancshares, Ft. Lauderdale 4 304. 3
16 First State Banking Corp., Miami 5 247.7
17 Florida Commercial Banks, Miami 5 :243.8
18 First Bancshares, Boca Raton 6 224.6
19 American Bancshares, North Miami 6 191.3
20 .Palmer Bank Corp., Sarasota 4 167.3
21 First National Bankshares, Pompano 4 166.7
22 Combanks Corporation, Winter Park 5 131.5
23 Citizens Bancshares, Hollywood 5 113. 6
24 Central Bancorp., Miami 2 107. 1
25 Community Banks, Seminole 5 89. 4
26 Florida Bancorp, Pormpano 3 80.3
27 Jefferson Bancorporation, Miami 3 77. 3

Source: Florida Bankers Association; Board of Governors of the Federal
Reserve System.

a Rank is based on total deposits as of December 29, 1972.

Table 1.2

Deposit-Size Distribution of Banks in Multibank
Holding Companies as of December 29, 1972

Number of Banks in

Each Size Classb

Greater 100 25 .
than 500 to 500 to 100

1 -- 9

than 25



Ranka Name of Holding Company

1 Southeast Banking Corp.
2 Barnett Banks
3 Florida National Banks
4 First at Orlando
5 Atlantic Bancorporation
6 First Financial Corp.
7 First Florida Bancorp.
8 Ellis Banking Corp.
9 Consolidated Bankshares
10 Exchange Bancorporation
11 United Bancshares
12 City National Bank Corp.
13 Pan American Bancshares
14 Charter Bancshares
15 Broward Bancshares
16 First State Banking Corp.
17 Florida Comrmercial Banks
18 First Bancshares
19 American Bancshares
20 Palmer Bank Corp.
21 First National Bankshares
22 Combanks Corporation .
23 Citizens Bancshares
24 Central Bancorp
25 Community Banks
26 Florida Bancorp
27 Jefferson Bancorporation

b Size

Source :

classes are in terms of $millions of deposits.

Florida Bankers Association; Board of Governors of the Federal


one bank holding companies and the nonbanking activities of multibank

holding companies are excluded from the study. Furthermore, no Florida

bank holding company appears to be a purely financial holding company;

that is, a company which acquires and holds bank stock solely for

investment purposes. Also, there are no Florida companies which have

grandfathered banking subsidiaries in other states.

By concentrating on the period from 1963 through- 1972, the

study will cover a period of sustained holding company activity by

newly-formed or newly-active holding companies. During this time

period the statewide bank holding companies were very active with the

exception of the Florida National Banks.1

Design of the Study: The Extreme Instance

As indicated above, Florida has recently experienced more

holding company activity than any other state. In terms of population

growth for the last decade, Florida was the fastest growing major state

in the U.S. and was second only to Nevada among all states. During the

past decade, Florida had the greatest percentage increase in personal

income of any major state and was second only to Nevada among all states.2!

For the period from 1960 to 1972, deposits of Florida banks increased by

406.'4 percent which is the highest percentage increase in total deposits

of any major state. More banks were opened in Florida from 1960 to 1972

1One researcher in studying holding company acquisitions nationwide
found a considerable difference in the results of his model by dividing
the population into growth-oriented and non-growth-oriented bank holding
companies. R. Charles Mayer, A Model of the Determinants of Registered
Bank Holding Company Acquisitions, Doctoral Dissertation, Graduate School
of Business, University of Pittsburgh, 1971, p. 100.

2 Florida Banking and Its Largest Banking Institutions, Allen C. Eving
& Co., Jacksonville, Florida, 1972, pp. 5-6.

- 6-

than in any other state. Finally, Florida is by far the most underbanked-

state in the country.1

What we have is a cluster of events which can be characterized

as an ~ext~reme instance. In an extreme instance, the variables of

interest are subject to major shifts. In this study, there are large

changes in holding company activity, population, personal income, bank

deposits and number of banks in a short period of time. (See -Table 1.3.)

The extreme instance is a way of approximating a controlled

experiment. Even if the cateris 2811MEs assumption cannot be strictly

enforced, nonetheless the cetera will be relatively small when compared

to the large changes in the variables of interest. Thus, the extreme

instance provides the researcher with a nearly perfect situation to


In order to generalize from the extreme instance, the behavior

observed must accurately reflect the properties of the system and not

be pathological.

In general, as long as (1) the system responds in a
systematic and controlled fashion rather than in an
erratic and disorganized manner and (2) the actions
were taken as a result of deliberation rather than
spontaneously without calculated intent, the stress
created by the extreme instance can be assumed to be
producing a characteristic response

1 Florida's population per banking office was 12,738 in 1970. The
next least banked state was Illinois with a figure of 9,216.
2 The entire discussion of extreme instances is taken from Oliver E.
Williamson, The Economics of Discretionary Behavior: Managerial
Objectives in a Theory of the Firm (Englewood Cliffs, N.J.: Prentice-
Hall, Inc., 1964).
3 Ibid pp. 87-88.

Source: Bureau of Economic and Business Research, University of.
Florida; Office of Business Economics, U.S. Department of Commerce;
Board of Governors of the Federal Reserve System; Florida Bankers

Design of the Study: Decisions and Independent Decision Makers

The study is designed to explain the decisions made by bank

holding companies. The decision makers may be top management and/or

the owners of a possible lead bank or of a holding company. It is

assumed that the decision makers are independent, i.e., that with a

population of k banking organizations there are k independent sources

of decision making.

Organization of the Study

Chapter 1 presents the purpose and design of the study. A

number of terms are defined.

- 7-

Table 1.3

Population, Personal Income, Deposits, and Banks
in Florida, 1960-1972

of Banks


Year Population

1960 5,095
1961 5,270
1962 5,458
1963 5,621
1964 5,796
1965 5,974
1966 6,137
1967 6,289
1968 6,492
1969 6,699
1970 6,842
1971 7,025
1972 7,211

Personal Income
($ millions)


Total Deposite
($ millions)

19,780.1 .

Chapter 2 provides a brief history of the growth of multibank

holding companies. The legislation affecting bank holding companies is


Chapter 3 consists of a critical review of recent scholarly

work on bank holding companies.

Chapter 4 considers the profit maximization and size maximi-

sation hypotheses. The profit model is found to provide a useful

framework for analysis.

Chapter 5 presents a model o~f lead bank status. Both an

individual bank's characteristics and a bank's environment are thought

to influence a bank's decision regarding lead bank status. The profit

statistical model is used to. test the model.

Chapter 6 presents the empirical results for the model.of

lead .bank status.

Chapter 7 presents a model of holding company activity. The

regulatory environment, expected market profitability and the snowball

effect are thought to determine the level of holding company activity

in different metropolitan markets. The tobit statistical model is used

to test the model.

Chapter 8 presents the empirical results for the model of

holding company activity.

Chapter 9 summarizes the results of the study and discusses

the implications of the study for case analysis. Areas for future

research are suggested.

Definitions and Terminology

Terms used in the study are defined below.

- 9-

A bank holding company is defined as any company (or trust)

which owns or controls 25 percent or more of-the stock of each of two

or more banks.1 Such companies are regulated by the Federal Reserve

Board and must register with it.

In this paper, the term "bank holding company" always refers

to.a multibank holdiing company which is registered with the federall

Reserve Board.2! The terms "group banking" and "multibank system" are

used as synonyms for the term "bank holding company".

Chain banking refers to the ownership of controlling interest

in two or more banks by an individual or informal group of individuals.3

It is important to distinguish chain banking from bank holding

companies or group banking. Chains are subject to individual control

while groups are subject to corporate rule. A group customarily has

some form of central management while a chain typically does not. Also,

groups are frequently headed by a major metropolitan bank while chains

rarely have such an arrangement.

1 Ordinarily corporations have no inherent power to hold stock in
another corporation. Some state laws permit the acquisition of bank
stock by corporations; other states restrict or prohibit the acquisition
of bank stock. A useful summary of the state laws on this matter are
provided in Bank Holding Company Facts, Association of Registered Bank
Holding Companies, Washington, D.C., 1972.
2 The only exception is Florida National Banks (formerly the DuPont
Trust) which was not required to register with the Federal Reserve
Board until passage of the 1966 Amendments. In this study Florida
National Banks is treated as if it became a registered bank holding
company when the Bank Holding Company Act of 1956 was approved.
The term "controlling interest" is deliberately vague. For a dis-
cussion of the problems involved in defining chain banks see Jerome C.
Darnell, "Chain Banking," National Banking Review, vol. 3 (March,1966),
pp. 308-309.

* 10 -

The lead bank of a holding company is the bank which the

management of a holding company designates as the lead bank. The lead

bank is generally the largest affiliate and it is' usually located in

the same city as the headquarters of the bank holding company. Fre-

quently there are officers and directors common to the lead bank and

the holding company.

Holding company activity refers to decisions favoring holding

company formations and acquisitions. The formation of a bank holding

company requires the appr-oval of the Board of Governors of the Federal

Reserve System under Section 3(a)(1) of the Bank Holding Company Act,

as amended. The acquisition of a bank by a holding company must be approved

by the Board of Governors under Section 3(a)(3) of the Bank Holding Company

Act, as amended.



The Bank Holding Company Act became law in 1956. The statute

did not appear to have much immediate effect upon holding company

activity nationwide or in Florida. However, in 1965 there began a

significant upsurge in bank holding company activity and in 1966 the

Act was amended in a way which encouraged a further surge of interest

in these companies. By way of introduction to these recent events, a

brief historical review is undertaken.

Historical Review Up to 1956

The beginnings of the holding company framework of operation

are to be found in the early history of American banking. During the

first half of the nineteenth century many of the multiple office systems

closely resembled bank holding companies. Examples of institutions which

resembled holding companies would include the First and the Second Bank

of the United States and later several state branching systems in the

Midwest. At the turn: of the century, several bank holding companies were

formally incorporated in` the Northwest.1

Bank holding companies developed rapidly in the decade of the

twenties. Nearly all the major systems which registered as a result of

thie Bank Holding Company Act of 1956 were organized from 1928 to 1930. 2

Gerald C. Fisher, Bank Holding Companies (New York: Columbia University
Press, 1961), pp. 4-8.
W. Ralph Lamb, Group Banking (New Brunswick, N.J,: Rutgers University
Press, 1962), pp.. 82-83.

11 -

--12 -

The rapid expansion of group banking in this. period cannot be attributed

to any single factor but rather to diverse and complex factors.

...One would have to consider: the farm depression
and the failure of small rural banks; the general
consolidation movement in many other industries;
the "snowball effect" as one bank holding company was
formed and banks organized others to maintain their~
competitive position, correspondent business, and
prestige; the restrictions on branch banking and the
belief that the laws would soon change; and the
investor's eagerness tolpurchase stock, including
holding company shares.

Perhaps the most important of these diverse factors was the

restrictions on branch banking. As metropolitan areas grew, the larger

institutions, which usually are located downtown, became less convenient

sources of banking services as compared to suburban banks.

Congestion which existed in all major cities made
banking at a single office, usually located in the
business district, very difficult. In addition,
retail as opposed to wholesale banking was growing-
in importance and many bankers wished to adjust 2
their facilities to meet this new market pattern.

One way for a large unit bank to adjust to a new market pattern was to

organize or to join a holding company.

The economic, regulatory and psychological conditions cited

above had resulted in ninety-seven groups -by 1931. These groups con-

trolled 978 banks and 1,219 branches, and they held 22 percent of the

loans and investments of all commercial banks.3 However, the rapid

Gerald C. Fischer, American Banking Structure (New York: Columbia
University Press, 1968), p. 95.

Fiecher, Bank Holding Companies, pp. 23-24.

U.S., Congress, House, Committee on Banking and Currency, Control and
Regulation of Bank Holding Companies, 84th Cong., 1st sess., 1955, p. 33.

- 13-

growth of bank holding companies ended with the beginnings of the great

depression of the 1930's.

The 1930's constituted a period of retrenchment for bank

holding companies. The depression forced a drastic reorganization of

the banking structure. By the end of 1934 the number of commercial

banks had dropped to about 15,400 as compared to nearly 29,000 in 1920.1

Data released by the Federal Reserve Board for 1936 showed fifty-two

groups operating 479 banks, a decline of roughly 50 percent from the

number of groups and affiliated banks in operation in 1931.

The depressed state of the economy, the relaxation of legisla-

tion restricting branch banking and the general antagonism toward holding

companies in general severely curtailed interest in group banking well

into the next decade. As a result, the position of groups relative to

commercial banks in general showed little change between the mid-1930's

and 1948. In 1937 these firms controlled 7 percent of the banking offices

and 11 percent of the bank deposits of all commercial banks. These figures

were almost unchanged in 1948.2

During the early postwar- period, 1947-1953, the growth of bank

holding companies largely paralleled the expansion of comm~ercial banking

in general. The proportion of U.S. offices and deposits controlled by

bank holding companies remained essentially unchanged.3

1 Comptroller of the Currency, Annual Report (Washington, D.C.:
Government Printing Office, 1964), pp. 7-8.
2Fischer, Bank Holding Companies, pp. 35-37.
Thomas R. Piper, The Economics of Bank Acquisitions by Registered Bank
Holding& Companies (Boston: Federal Reserve Bank of Boston, 1971), pp. 47,49.


There was a marked acceleration in the expansion of bank

holding companies between January 1954 and June 1956. This increase in

the growth rate of group systems was dominated by the acquisitions of

Transamerica (later Western Bancorporation) and the Marine Midland

Company.1 Two major reasons for the spurt in growth for this 2-1/2

year period were: the fear of restrictive federal legislation and the

efforts to rebuild Transamerica following the sale of its interest in

Bank of America.2 .

Regulation of Bank Holding Companies

Commercial banking in the United Stat'es has been subject to

regulation and supervision by federal and state authorities since the

1780's. However., since the bank holding company itself is not a bank,

it did not come under state or federal banking laws. The rapid expan-

sion of bank holding.companies in the 1920's stirred congressional

interest in establishing some degree of federal regulation of group

banking. After extensive hearings by the House and Senate over a three

year period, the Banking Act of 1933 (Glass-Steagal Act) was passed.3

Banking Act of 1933

The Banking.Act of 1933 granted the Federal Reserve Board limited

powers to regulate holding company affiliates. A holding company, affiliate

1 A list of all 340 acquisitions made by holding companies between the
end of World War II and December 31, 1967, is provided in Piper, pp. 18-26.

Fischer, Bank Holding Companies, pp. 39-42.

The full text of the Banking Act of 1933 is contained in the June 1933
issue of the Federal Reserve Bulletin.

- 15

was defined as any organization which controls the majority of the stock

of a Federal Reserve System member bank.1 A firm which fell within this

definition must obtain a voting permit from the Board of Governors to

vote the stock of a subsidiary which is a member bank. Before granting

a voting permit, the Board of Governors considered the financial condi-

tion of the applicant and the general character of its management.2

There were several obvious weaknesses in this Act. First,

registration was not required of systems composed. of only nonmember

state banks and it was possible for some groups to control their banks

without obtaining a voting permit. Second, the statute did not attempt

to regulate the formation or expansion of bank holding companies. Third,

group systems were permitted to continue investing in nonbanking enter-


The banking authorities sought the enactment of regulatory

legislation to supplement the bank holding company provisions of the

1933 Act. Recommendations of the regulatory agencies in the 1940's asked

for a curb on the further expansion or formation of groups. After 1950,

the position taken by the federal supervisory agencies moderated because

in many instances the groups were performing valuable service in upgrading

the management and condition of affiliated banks.4

1"Banking Act of 1933," Federal Reserve- Bu--lleti vol. 19 (June, 1933),

p. 385.
2 "Federal Reserve Act Digest," Encyclopedia of Banking Laws (Hartford,
Conn.: Lamont Cross & Company, 1964), pp. 8-9.
Fischer, American Banking Structure, pp. 103-104.
Lamb; ppt 177-193. Also, refer to Benjamin J. Klebaner, "The Bank
Holding Company Act of 1956," Southern Economic Journal, o.2 Jnay
1958), pp. 313-326.

- 16 -

The Bank Holding Company Act of 1956

The Bank Holding Company Act of 1956 was intended to accom-

plish several objectives: (1) to define bank holding companies; (2) to

prevent holding companies from acquiring banks across state lines; (3)

to control the formation and expansion of multibank systems within

their "home"' states; (4) to preserve the historical separation between

the suppliers of money and the users of money.l

A bank holding company was defined in the Act as any company

which owned or controlled 25 percent or more of the stock of two or

more banks or which controlled in any manner the election of a majority

of the directors of two or more banks. Companies falling within the

statutory definition were required to register with the Board.of Governors,

to disclose prescribed information in reports to the Board, and to submit

to examination by the Federal Reserve System.

The Board's consent was required before a bank holding company

could be formed, before a bank holding company could acquire over 5 per-

cent of the voting stock or substantially all the assets of any bank,

or before two bank holding companies could merge. In deciding whether

to.grant approval for these actions, the Board was required to consider

the following factors:

(1) the financial history and condition of company
or companies and the banks concerned;
(2) 'their prospects;
(3) the character of their management;
(4) the convenience, needs, and welfare of the
communities and areas concerned; and
(5) whether or not the effect of the acquisition
or merger or consolidation would be to expand
the size or extent of the bank holding

1 William F. Upshaw, "Antitrust and the New Bank Holding Company Act: Part
II," Monthly Review, Federal Reserve Bank of Richmond (March, 1971), p. 3.

- 17 -

system involved beyond limits consistent
with adequate and sound banking, the public
interest, and preservation of competition
in the field of banking

The first three factor pertained to the organization's solvency,

asset condition, capital and operations, thus continuing the underlying

concern for depositors reflected in the 1933 Act. The last two factors

represent a significant departure from earlier legislation. For the

first time, concern is shown for the competitive health of the banking

industry. It is recognized that the acquisition of a bank involves

important nonsafety-oriented considerations such as the expected effects

on banking competition, the possible introduction of new services at the

acquired bank, and changes in its lending behavior and pricing policies.2

Under the 1956 Act, a registered group was prohibited from

engaging in any business other than banking, managing banks, or providing

certain services to subsidiary banks. The holding company law also deals

with intra-system transactions, restricting lending and credit operations

of groups.3 The restrictions placed on intra-system dealings made it

difficult for bank holding companies to perform the function of facilitating

loan participation and other joint credit transactions. In fact, the

1956 legislation effectively made it easier for correspondent banks than

for holding company affiliates to take joint action.4

"Bank Holding Company Act of 1956," Federal Reserve Bulletin, vol. 42

(May, 1956),. p. 446.
2 nFederal Laws Regulating Bank Mergers and the Acquisition of Banks by
Registered Bank Holding Companies," Economic Review, Federal Reserve Bank
of Cleveland (January, 1971), pp. 20-21.
S"Bank Holding Company Act of 1956," Federal Reserve Bulletin, vol. 42
(May, 1956)-, p. 448.
SGeorge R. Hall, "Bank Holding Company Regulation," Southern Economic
Journal, vol. 31 (April, 1956), p. 344.

- 18 -

The Board of Governors in its annual report to Congress in

1958 discussed the regulation of holding companies. The Board had

encountered substantial difficulty in balancing "convenience and needs"

and "competitive impact" considerations, both of which the Board is

required to consider in passing upon applications. To compound the

problem, the terminology used in connection with the question (of

"competitive impact" was imprecise. Another problem of the 1956 Act

involved the severe restrictions placed on intra-system loan partici-

pations. In order to correct the problem, the Board recommended repeal

of the restrictions. The report also recommended that one bank holding

companies come under regulation and that several exemptions of organiza-

tions from the holding company law be repealed.1

The 1966 Amendments

The enactment of the 1966 Bank Holding Company Act Amendments

satisfied several of the Board's recommendations for changes in the law.

Several categories of exemption from the Act were repealed; nonbusiness

long-term trusts were brought within the coverage of the Act; the stan-

dards and antitrust procedures made applicable to bank mergers by the

Bank Merger Act of 1966 were made applicable also to bank holding company

cases; and the provisions of Section 6 of the Act, which restricted inter-

subsidiary loans and investments, were repealed.2

The Amendments of 1966 clarified Congressional intent with

respect to the relative importance of convenience and needs factors

1 "Report Under the Bank Holding Company Act," Federal Reserve Bulletin,
vol. 44 (July, 1958), pp. 776-796.
2 Amendments to Bank Holding Company Act," Federal Reserve- Buletin.,
vol. 52 (July, 1966), p. 966.

- 19 -

and considerations involving competitive impact. The Board was directed

not to approve:

(1) Any acquisition...which would result in monopoly,
or which would be in furtherance of any combina-
tion or conspiracy to monopolize or attempt to
monopolize the business of banking in any part of
the United States, or

(2) Any other proposed acquisition...whose effect in
any section of the country may be substantially
to lessen competition, or tend to create a monop-
oly, or which in any manner would be in restraint
of trade, unless it finds that the anticompetitive
effects of the proposed transaction are clearly
outweighted in the public interest by the probable
effect of the transaction in meeting the conven-
ience and needs of the community to be served.1

Contrary to the wishes of the Federal Reserve Board, the 1966

legislation continued to exempt one bank holding companies. Beginning

in 1968, a dramatic surge in the growth of one bank holding companies

stirred Congressional interest in bringing these companies within the

purview of the Act. By the end of 1968, seven of the ten largest com-

mercial banks in the United States had formed one bank holding companies.

A year later the list included 43 of the 100 largest banks.2

The most important factor motivating banks to adopt this

form of organization was the fact that one bank holding companies were

not subject to regulation and therefore were able to engage in any non-

banking activity. The increasing costs of funds in 1968 and 1969 and

the competitive disadvantage of the interest ceilings imposed by

Regulation Q encouraged banks -to organize these companies because a

bank holding company could issue commercial paper,.just as any ~other

1 Ii. pp. 967-9 68.
2 nThe 1970 Amendments to the Bank Holding Company Act: One Year Later,"
Business Conditions, Federal Reserve Bank of Chicago (December, 1971)
p. 3.

- 20 -

corporate borrower. Another factor stimulating change was the growing

investment by banks in data processing equipment and personnel. The

one bank holding company structure allows for the establishment of a

subsidiary which may adopt wage and personnel policies needed to

attract specialized personnel and the subsidiary is well suited to

marketing excess machine capacity. Also, the organization of a

holding company is one, and perhaps the only, method owners of banks

may use to insulate themselves against litigation attacking their

right to enter new areas not specifically authorized by statute.1

The 1970 Amendments

The Bank Rolding Company Act Amendments of 1970 expanded the

coverage of the Act to include a company that controls only one bank.

Other provisions of the 1970 legislation include an expansion of the

Board's authority to determine that a company controls a bank and a

prohibition against tie-in arrangements whereby a bank extends services

to a customer upon certain conditions.2

The 1970 Act revised Section 4(c)(8) of the Holding Company .

Act under which bank holding companies may acquire interests in non-

banking activities. The legislation provides that such activities may

be approved if they are determined by the Board to be '' closely

related to banking as to be a proper incident thereto....u3

William F. Upshaw, "Antitrust and the New Bank Holding Company Act:
Part III," Monthly Review, Federal Reserve Bank of Richmond (April,
1971) pp. 4-6.
2 'Bank Holding Company Act Amendments of 1970," Federal Reserve
Bulletin, vol. 57 (January, 1971), p. 29.

3 Ibid., p. 31.

- 21 -

The Board is also authorized to differentiate between an activity

comlmenced de novo and the acquisition of a going concern.1

Development of Bank Holding Companies After 1956

After passage of the 1956 Act, it was expected that holding

companies would expand substantially. The growth of multibank groups,

however, closely paralleled the general development of the banking

system in the period from 1956 to 1965. At the end of 1956 there were

49 separate bank groups registered with the Board pursuant to the~ Act.

For year end 1960, there were 42 distinct registered companies and

five years.1later there were 48 multibank systems. The share of U.S.

total deposits held by subsidiaries was little changed for the period;

7.5 percent ia 1956 compared to 8.3 percent in 1965. Similarly the

ratio of holding company offices to all commercial bank offices changed

by less than 1.0 percent, with groups possessing 6.7 percent of all

banking offices at the end of 1965. (See Table 2.1.)

Since the end of 1965, holding companies have expanded sub-

stantially. Many factors contributed to the increase in holding company

activity. The abolition in 1964 of the 2 percent federal tax penalty

imposed on companies filing a consolidated tax return was one contributing

factor. 2 Another possible consideration was that the holding company

idea had finally come of age. This was suggested by the Board's approval

1 For a good explanation of the 1970 Amendments see Donald L. Kohn and
John F. Zoellner, "The Amended Bank Holding Company Act," Monthly Review,
Federal Reserve Bank of Kansas City (May, 1971) pp. 11-20.
2 Ed Tyng, "New Moves to Form Holding Companies Seem Likely Now that
Tax Penalty is Dead," Journal of Commerce, April 7, 1964, pp. 1, 24.

in April 1966 of three holding company formations by New York


Table 2.1

Registered Bank Holding Companies: Number,
Number of Banks and Branches, and National Share
of Offices and Deposits, 1956i.1960, 1965

December 31 December 31 December 31
1956 1960 1965

Number of holding companies 49 42 48

Number of banks 428 426 468

Number of branches 783 1,037 1,486

Holding company offices as
a percentage of all banking
offices 5.8 6.2 -6. 7

Total deposits (millions of
dollars) 14,843 18,274 27,560

Total deposits of holding
companies as a percentage of
deposits of all banks 7.5 8.0. 8.3

- 2 -

a Numbers are for separate bank groups. There were
bank holding companies, in 1956, for example, but in
holding company controlled another.

53 registered
four cases one

Source: Unpublished Federal Reserve Board data; Federal Reserve
Bulletin, June -1961 and August 1966.

The three companies were BT New York Corporation, Charter New York
Corporation and -Security New York Corporation. The New York groups
had total deposits of over $8.2 billion which is approximately 30
percent of the total deposits figure for all registered companies
at the end of 1965.


- 23-

The 1966 Amendments (enacted in July of 1966) contributed to

the dramatic increase in holding company activity. Repeal of the

restrictions upon loan participation and the sale of loan paper

certainly encouraged the activity. The 1966 amendments also clari-

fied the applicability of the antitrust laws to banks and required

the Department of Justice to challenge the Board's decisions upon

holding company applications within thirty days of approval. The

formation or acquisition is thereafter permanently immune from anti-

trust attack except under the monopolization provisions of Section 2

of the Sherman Act.1 No longer were bank holding companies haunted by

the possibility of future challenges of their past actions by the

Department of Justice.

As shown in Table 2.2, there has been a steady increase in

the number of multibankc holding companies from 1965 to 1970. At the end

of 1970, holding companies controlled .11.8 percent of the banking

offices as compared to 6.7 percent of the offices in 1965. The per-

~centage of deposits controlled by holding companies nearly doubled

during this five-year period, with holding companies possessing 16.2

percent of U.S. deposits at the end of 1970.

Table 2.3 provides a state-by-state summary of the development

of multibank holding companies between 1965 and 1970.2 Unlike the

1"Amendments to Bank Holding Company Act," Federal---. Resere Buleti,

vol. 52 (July, 1966), p. 967.
2For a similar summary which uses the years 1956, 1962 and 1969,
see Golembe, pp. 7-10.

End of Number of Number of Banking Offices Deposits ($ millions)
Year Companiesa Banks Number % of U.S. Total % of U.S.

1965 48 468 1,954 6. 7 27,560 8. 3
1966 58 561 2,363 7.8 41,081 11.6
1967 65 603 2,688 8. 6 49,827 12..6
1968 71 629 2,891 8. 9 57,634 13. 2
1969 86 723 3,397 10. 1 62,574 14. 3
1970 111 895 4,155 11. 8 78,064 16. 2

a Separate bank groups only; if a subsidiary bank is also a registered
bank holding company only one is included in the total.
Source: Federal Reserve Bulletin, August issues from 1966 through 1971.

aggregate data of Table 2.2, which may suggest a broadly based advance

Ln holding company activity, the state data indicate that much of the

growth has taken place in a small number of states. Of the 34 states

and the District of Columbia in which registered bank holding companies

operated in 1970, seven states showed a decline' in holding company

offices as a percentage of total offices between 1965 and 1970, and

19 states noted an increase of less than 10 percent: The only areas

reporting an expansion of 10 percent or more of banking offices were

Alabana (13.7), Colorado (13.6), District of Columbia (12.8), Florida

(25. 7), Maine (42.7), New Jersey (12.2), New York (17.7), Ohio (10.6)

and Virginia (21.1). Florida and Colorado are unit-banking states while

Alabama, New Jersey, New York and Ohio are limited-branching states.

Although Maine and Virginia are classified as statewide-branching states

1 Benton E. Gup, A Study of Banking Structure (Occasional Report Series,
Vol. 2, No. 3; Tulsa, Oklahoma: University of Tulsa, 1970), pp. 38-54.

2A -

Table 2.2

Offices and Deposits of Banks Affiliated with
Registered Bank Holding Companies, 1965-1970


a 0

&$ duddooJdad oddR
Com M A NA
ggg + +++++. +rf+++++....++++v~m ~ ~ ~ m~~
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em M
C MA cllo M hcm 4@Ncv ~ m h~o~-umhlolON@ 0hNl
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a MM O *MO M s a O w a m
ur: 0H HM M NE E BE E


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* 27 *

the statutes do not favor statevide-branching (although it is possible)

and the dominant structure is of the limited-branching variety.1 The

increase for the District of Columbia is due to the registration of

Financial General Corporation pursuant to the Bank Holding Company Act

Amendments of 1966.

In terms of deposits, 10 states showed holding company deposits

declining or remaining constant and in 16 states holding company control

of deposits rose by less than 10 percent from 1965 to 1970. The following

states had an increase of holding company deposits of 10 percent or more:

Alabama (16.0), Colorado (29.2), District of Columbia (11.4), Florida

(38.5), Maine (41.2), Missouri (23.7), New Jersey (16.8), New York (17.7),

Ohio (11.5) and Virginia (21.1). Except for the District of Columbia,

all of these states prohibit or make difficult statewide-branching.

Since the end of 1970, multibank holding companies have rapidly grown

in Texas (unit-banking) and Tennessee (limited-branching).

SFor example, in Virginia an organization can achieve- statewide
branching only by merger. The mergered bank loses its branching priv-
ileges. (Individual banks may branch countywide, more or less.) In
addition, only banks in existence for 5 years or more may be acquired
by merger. Because of these limitations on statewide-branching ,
~Virginia organizations have generally formed holding companies. Affi-
liates of holding companies do not lose- their branching privileges and
affiliates are not required to have been in existence for at least
five years.



In the preceding chapter the history of the bank holding

company movement was reviewed. In this chapter the scholarly litera-

ture on bank holding companies is reviewed.

A Selective and Critical Review: An Aid to Model Building

The review of literature will cover empirical studies of multi-

bankr holding companies since 1960.1 In the course of the review, we will

attempt to determine the characteristic operating policies of bank

holding companies. In order to determine if the results of the empirical

studies are reliable, the review of literature will be critical as well

as descriptive. The entire review of literature is designed to assist

in subsequent model building.

Fischer: Bank Holding Companies

An obvious starting point is Fischer's monograph on bank

holding companies. -Fischer- surveyed holding companies by means of

questionnaires and interviews to determine their organizational and

operational practices. .He found that most multibank systems employed

legal counsel and accounting and tax specialists. The headquarters of

the holding company did some, central purchasing and advertising;

SThe one exception is the Alhadeffs' study of bank mergers which was
published in 1955.

- Z8 -

- 29 -

operations specialists were made available to subsidiary banks; and

there was a considerable amount of committee activity.1

The lead bank of the holding company encouraged the less

active subsidiary banks to modernize by adopting the practices of the

lead bank. Almost without exception, the lead banks encouraged the

affiliated banks to emphasize consumer credit. (Consumer loans yield

a considerably higher rate of return than other types of loans and they

are subject to a number of cost savings if uniform systems and proce-

dures can be followed by all members of the bank holding company.)2

In the course of his interviews, Fischer found multibank

systems fully involved in the supervision of portfolios with special

assistance provided to affiliates in managing their cash positions.

The bank holding company actually participated in very little personnel

coordination or development despite claims to the .contrary.3

In unit-banking and limited-branching states, correspondent

banking is an important source of interbank service flows. Many of the

ways in which a depository bank aide its correspondents are very similar

to the services provided by a bank holding company. Because of the

similarity of services, many multibank holding companies have consolidated

correspondent accounts while having the lead bank or the holding company

itself provide subsidiary banks with specialized services.4

Fischer, Bank Holding Companies, pp. 86-87.
Ibid., pp. 87-92.
SIbid., pp. 94-98.
hid., p. 105.

- 30 -

Fischer observed that entry of a .bank holding company into a

rural community had .no effect on the general level of interest rates

although the new affiliate often stirred the competitive spirits in the

community as one bank remodeled or provided a drive-in facility and

other banks countered with innovations of their own.1

The research by Fischer is subject to several critidisms.

The review of operating policies of multibank systems is based upon

questionnaires and interviews. Information gathered by these means is

exposed to the problem of respondents giving good reasons as opposed to

the real reasons for operating policies. Also, there are difficulties

in classifying, and generalizing from, the information obtained from

questionnaires and interviews.

In Fischer's 1961 study, most of the holding companies surveyed

had been in existence since the late 1920's. One may wonder whether the

results of the study reflect the operating policies of the newly formed

or newly active multibank holding companies of the late 1960s.

As Fischer is well aware, he may be criticized for attempting

to generalize from a very diverse sample.2 His sample of holding com-

panies includes old and new groups, large and small .groups, groups which

operate in unit-banking, limited-branching, and unlimited-branching

states. The' sample includes states where the holding company movement

is in an advanced stage (Minnesota) and states where holding company

activity had yet (in 1961) to begin a sustained movement (Ohio).

Ibid., p. 130
2This criticism may be applied in varying degrees to all the works
surveyed in this chapter. Of course, there are multivariate statistical
methods (not used by Fischer) which would control for some of the
different characteristics of bank holding companies.

- 31 -

Because of these extreme differences, the behavior of the bank holding

companies sampled is very diverse. As a consequence, Fischer is unable

to make strong statements concerning holding company behavior because

of the wide differences in behavior observed.

Lawrence: The Performance of Bank holding Companies

The first rigorous study of bank holding company behavior was

done by Lawrence. In the study he employed the before-and-after method

of analysis in order to isolate the impact of holding company affilia-

tion upon certain performance variables. This method of analysis was

applied ~to the acquired bank and a comparable nonaffiliated bank. The

use of paired bank comparisons permitted Lawrence to hold constant all

relevant local market conditions.1

The acquired banks were essentially similar to the paired

independent--banks in terms of pre-affiliation performance variables with

the only exception being due to balances as a proportion of total deposits.

A possible explanation for this difference is that banks with relatively

large due to balances are reluctant to affiliate with a holding company

from fear of losing correspondent business upon affiliation.2 Additional

reasons for a reluctance to affiliate may be a lesser need on the part

of the bank for correspondent-type services, from a holding company and

the ability of the bank to possibly anchor a holding company itself.

1 For a good discussion of the paired bank methodology, see Piper,
pp. 166-168.
2 Robert J. Lawrence, The Performance of Bank Holding Companies
(Washington, D.C.: Board of Governors of the Federal Reserve System,
1967), pp. 15-16.

As for post-affiliation performance, acquired banks were much

more active than the paired independent banks in making loans. The

difference in the proportion of assets devoted to both statis-

tically significant and quantitatively significant. Lawrence reported

that "the result for the loans-to-assets ratio is one of the strongest in

the entire study--the subsidiaries of bank holding companies have on the

average a loans-to-assets ratio that is more than 5 percentage points

higher than the ratio for the independent banks."' Lawrence also found

that holding company banks had a higher percentage of their assets in

the obligations of states and political subdivisions and lower percentages

of their assets in U.S. Government securities and cash plus due from

balances.2 After affiliation, subsidiary banks were found to be much

more aggressive than the independent banks in seeking out consumer

instalment loans. The subsidiaries' ratio of instalment loans to assets

was 3.15 percentage points higher than the ratio of paired independent

banks .

In the Lawrence study, holding company banks do not

have any competitive advantage over nonaffiliated banks. The average

growth rates of affiliates were not superior to the growth rates of

the independent banks. The earnings of subsidiary banks were not signi-

ficantly different from the earnings of the independent banks. Also,

there was no evidence of operating efficiencies as measured by the

operating ratio (operating expenses divided by operating revenue).4

Ib d., p. 17.

SThis result is confirmed by other studies which employ less rigorous
measurement techniques. See, for example, Golembe, p. 49.
SLawrence, pp. 21-25.

No one to date has substantially improved upon the Lawrence

research although it is subject to some criticism. The paired bank

approach used in the study assumes that the actions of the paired bank

are independent of the operating changes of the acquired bank. One may

question this assumption since the banks are in the same market.

Both a strength and a weakness of the study is the sharp

differences among the banks in the study:

The selected banks include large and small banks,
banks in standard metropolitan statistical areas
and small towns, banks in all sections of the
nation, subsidiaries of large and small holding
companies, lead and on nead banks, and unit and
limited-branch banks.

From such a diverse sample, Lawrence may be justified in making general

statements about holding company behavior. However, it can be argued

that the univariate statistical method (t-test on difference of means)

employed by Lawrence did not adequately control for the sharp differences

in the banks sampled. It is possible that the extreme' differences among

the banks actually reduced the significance of some of the statistical

tests. Instead, if Lawrence had controlled for the differences in, say,

the size, location, length of affiliation and branching characteristics

of the banks sampled by using a multivariate statistical method, he may

have found that holding companies affiliates were, say, more efficient

or more profitable than independent banks,2

Ibjid., p. 12.
SLawrence did divide the sample into two groups on the bases of
location, size of holding company, size of bank, and length of .acquisi-
tion. These divisions did not yield more significant results. However,.
the sample was divided on the basis of one- characteristic at a time.
Also, the divisions were very rough; e. g., a bank was either a large
bank or a small one.

- 34 -

McLeary: Bank Holding Companies--Their Growth and Performance

Bank holding companies in the Sixth Federal Reserve District

(Atlanta) were studied by Mc~eary. His study was a replication of the

Lawrence research, with the sample consisting of holding company affil-

iates in Florida, Georgia, and eastern Tennessee. McLeary employed a

paired bank method in analyzing performance variables- after affiliation. 1

Four performance variables of affiliated banks were found to be signifi-

cantly different (in the statistical sense). Subsidiary banks .generally

charged lower interest rates on loans, carried fewer U.S. Government

securities and more state and local obligations relative to assets, and

had a higher percent of their deposits in demand accounts than did

independent banks.2

The McLeary study has several serious deficiencies. There

is no economic justification for excluding western Tennessee which is

not in the Sixth Federal Reserve District. McLeary failed to take

account of differences among the three states included in the study.

Florida is a unit-banking state while Georgia and.'Tennessee permit

limited-branching. In 1960 Georgia prohibited the formation of bank

holding companies or the further expansion of existing holding companies.

Florida and Tennessee place no restrictions on holding company activity.

Also, bankers in Florida and Tennessee have reacted differently to the

possibility of adopting the holding company structure. The beginning

of sustained holding company activity in Florida occurred in 1966. The

SMcLeary realized that a before-and-after study is needed to determine
rigorously whether operating differences observed are due to changes
following affiliation or are due to the fact that 'holding companies
acquired banks with certain performance characteristics.
2 Joe W. McLeary, "Bank Holding Companies: Their Growth and Performance,"
Monthly Review, Federal Reserve Bank of Atlanta .(October, 1968), p. 137.

- 35 -

take off for holding company activity in Tennessee occurred at least

three years later.1 The McLeary study covered holding company subsid-

iaries in existence at the end of 1966.

Weiss: Bank Holding Companies and Public Poliev

Weiss studied holding company structure and performance in

the New England states of Maine, Massachusetts and New Hampshire. He

found that the holding companies expected to be consulted by affiliated

banks on matters such as changes in dividend policy, establishment of

branches, or other factors that affect earnings. Most holding companies

in the study discouraged correspondent relationships with banks outside

the system in order to minimize the non-earning assets of subsidiaries. 2

In general, the acquired banks' loan to deposit ratio increased

in the post-acquisition period. Also substantial shifts occurred in the

composition of the acquired banks' non-loan assets in the post-acquisi-

tion period. The acquired banks generally reduced their holdings of

U.S. Government securities and their holdings of currency plus due from

balances -relative to total assets. The affiliated banks increased their

holdings of state and 1ocal government obligations. In the majority of

holding company acquisitions studied, Weiss found a decrease in consumer

instalment loans as a .proportion of total loans~. Earnings performance

and the growth of capital accounts for the acquired banks seemed unaffected

In Florida, holding companies' share of total deposits of the state
went from 22.4 percent in 1965 to 38.4 percent in 1969. The comparable
figures for Tennessee are 2.6 percent and 8.2 percent.
2Steven J. Weiss, "Bank Holding Companies and Public Policy," New
England Business Review, Federal Reserve Bank of Boston (January/February,
1969), pp. 18-19.

- 6 -

by holding company affiliation.1 None of Weiss' results were subjected

to statistical tests because the number of banks in the study was

extremely small.

Weiss discussed several factors which appeared to influence

holding company behavior. He contended that the holding company struc-

ture was particularly attractive to center city banks that lacked the

legal power to branch into growing suburban areas... Also, he suggested

that adoption of a holding company organization may be motivated in

part by a desire to increase the size of a single banking organization.

In the case of Maine, Weiss found that the aggressive activity of one

holding company had been an important factor contributing to an upsurge

of interest in holding companies by other Maine bankers.2

Talley: The Effects of Holding Company Acquisitions on Bank Performance

The Lawrence research was updated by Talley using a larger and

different sample of acquired banks for the period from 1966 through 1969.

In reviewing the portfolios of the banks in the study, Talley found that

the acquired banks tended to switch out of governments and into.state

and local obligations and loans, particularly consumer loads. *In com-

paring the mean difference of affiliated banks versus independent banks

before affiliation with the mean difference after affiliation, Talley

1 Ibid., pp. 21-22.
2 Ibid., pp. 9-15. Situations similar to the one in Maine have occurred
in other states. For example, in New Mlexico "the obvious success and
Lapressive growth record of Bank Securities has apparently triggered
action on the part of four or five bank groups that are reported in the
process of forming bank holding companies." "Bank Breakthrough in New
Mlexico," Burroughs Clearing House, vol. 54 (September, 1970), p. 25.

observed an increase in the subsidiaries' ratio of loans to assets of

3.85 percentage points.1 As measured by the mean change in the differ-

ence method, the subsidiaries' ratio of consumer loans to total assets

increased by 1.60 percentage points.2 Both results are statistically

significant at the .01 level.3

Talley suggested that the portfolio changes found may be due

to the holding company structure which permits affiliates to be located

in diverse locations thereby lowering risk to the system as a whole.

Also, acquired banks can expect assistance from other affiliates or the

holding company in the event of liquidity problems. In addition, the

portfolio changes may be due to headquarters replacing conservative

management with more aggressive~, profit-oriented management.4

Bank holding company affiliation did not result in statistically

significant changes in the capital, prices, expenses or profitability of

acquired banks with one exception. Other operating expenses as a per-

centage of total assets was significantly higher for acquired banks.

One plausible explanation for this higher expenses ratio is that the

acquired banks paid significant management fees to their holding companies.

The only major difference from the Lawrence study was that Talley did not

SThis result is observed in other research. For example, Piper, p. 129.
Also see Irving Schweiger, "Reply to Chicago Banking: A Critical Review,"
Journal of Finance, vol. 17 (October, 1962), p. 424.
2 Lawrence in his study excludes single payment loans from the consumer
instalment loan category. Talley includes single payment loans in his
consumer loan category.
Samuel H. Talley, The Effect of Holding Company Acquisitions on Bank
Performance (Washington, D.C.: Board of Governore of the Federal Reserve
System, 1972), pp. 8-9, 16.
SIbid., pp.' 9-10.

- 38

find that banks acquired by holding companies increased their service


Talley's study is subject to the criticisms applied to the

Lawrence paper; namely, the assumption of independence implicit in the

paired bank method and inadequate controls for a very diverse sample.

It is possible that Talley's conclusion that holding company affiliation

did not have a broad impact on the performance of acquired banks is

invalid because his univariate method of analysis did not adequately

adjust for differences among the banks studied.

Piper: The Economics of Bank Acquisitions by Holding Companies

Recently, Piper has done extensive research on the profit-

ability of bank acquisitions by holding companies. He found that

affiliation with a holding company was not associated, on average, with

any important increase in bank profitability over and above that exper-

ienced by banks generally. Furthermore, there was little evidence of

superior growth by the acquired banks.2

Piper also considered the question of whether the acquisition

programs of holding companies are profitable.3 An acquisition was judged

profitable if earnings per share of the holding company were higher in

1967 as a result of the acquisition. Piper .omitted from the analysis of

profitability any favorable impact on the holding company's stock resulting

1Ibid., pp. 10-13.
Piper, p. 161.
3 It is quite possible that a bank may not be exceptionally profitable
either before or after acquisition and still be a profitable addition to
the holding company. Such would be the case if a bank were acquired by
a holding company at a bargain price.

- 39 -

from the acquisition activity itself. Also omitted were any increases

in the earnings of the parent company resulting from fees paid to it

by the acquired bank.1 Piper found that the 102 acquisitions studied

.were breakeven investments, on average, and they did not result in higher

earnings per share for the holding companies involved.2 There was a

definite tendency for acquisitions during the period 1946-1958 to be

less profitable than those completed during the period 1957-1967.. In

the second period from 1957 to 1967, holding companies acquired -banks

that had excess capital that either could support further bank expansion

or could be reallocated to other, more productive uses in the system.

Holding companies that were active in acquisitions during the 1957-1967

period were also more aggressive in theirluse of long term notes and


In considering the motivations for holding company behavior,

Piper stated:

Organizers and managements of bank holding companies
seemed motivated by two primary considerations: (1)
the prestige and increased lending capacity of a
large regional banking group and (2) beliefs, un-
substantiated by a substantial accumulation of
research, that scale economies and improved manage-
nent would offset premium prices paid for banks and
would permit profitable expansion by acquisitions

Piper, pp. 216-219. The omission of management fees paid to the
parent company is questionable. Both Lawrene and' Talley report signi-
ficant increases in other expenses for acquired banks. These other
expenses are very likely management fees.
2Piper has assumed that the growth prospects- of the bank and the
holding company were equal beyond 1967. He also assumed that the holding
company's policies with respect to the existing system were unaffected
by a change in its acquisition activity.
Piper, pp. 224-225.
Ibid., p. 252.

- 40 -

With regard to the considerations of prestige and large

lending limits, none of Piper's own research provides support for such

a contention.- The fact that the acquisitions studied by Piper were

at best a breakeven proposition for the holding companies involved

does not lead to the conclusion, which is implicit in the consideration

of prestige, that holding companies are not profit maximizers. One

may propose that for acquisitions made during the 1946-1956 period the

holding companies involved were overly optimistic; i.e., they incorrectly

estimated the future stream of earnings from their acquisitions. For

the 1957-1967 period, Piper actually found that holding company acquisi-

tions were, on balance, profitable.2

With respect to the unsubstantiated belief in scale economies,

Piper states that in almost all acquis-itions by holding companies, scale

economies were probably negligible since the size of the firm was in-

creased but plant size was not increased. Piper cites research by Bell

and Murphy which shows that the greater labor requirements of branching

offset the economies of acale which permit specialization in many

banking functions.3 comparing a holding company system to a

branching system which seems inappropriate. A more appropriate basis

Piper appears to be strongly influenced by Reid's study of mergers
involving large banks. See Samuel R. Reid, Mergers, Managers and the
ESSESSI, @iew York: McGraw-Hill Book Co., 1968), Chapter 10.
2The sixty-seven acquisitions analyzed during the second eleven-year
period had a mean profitability index of 1.07. The breakeven point was
1.0. See Piper, p. 224.
3 Ibid., p. 256. The reference is to Frederick W. Bell and Neil B.
Murphy, Costs in Commercial Banking: A Quantitative Analysis of Bank
Behavior and Its Relation to Bank Regulation (Boston: Federal Reserve
Bank of Boston, 1968).

- 41-

(if one proposes to test the arguments for efficiencies as expressed by

advocates of the holding company structure) is to compare unit banks

operating independently with unit banks operating within a holding

company framework.

Possible Efficiencies of the Holding Company Structure

Conceptually, returns to scale refer to the percentage change

in physical output resulting from simultaneous and equal percentage

changes in the employment of each input. Thus, the advocates of

holding company efficiencies are not really claiming economies of

scale as this term is strictly defined. Rather, the emphasis is on

economies of vertical integration for the multibank holding company

(the multiplant firm).1 The Bell and Murphy research does not test

this claim. The use of the operating ratio by Lawrence and Talley as

a rough-and-ready measure of operating efficiencies is very rough.

It must be said that the case for economies of vertical

integration accruing to the multibank holding company is most convincing,

a 211211. Holding companies .have a greater ability to tap major money

markets than do individual banks. The credit of the parent organization

is usually stronger than that of individual units, so the parent can nego-

tiate better terms. A large organization can recruit better talent because

of the fringe benefits, salary structure and additional possibilities of

advancement. The holding company vehicle permits pension and profit

sharing plans, as well as other fringe benefits, to be uniformly applied

to all units in an efficient program. Coordinated advertising programs

1 The formation of a multibank holding company may be viewed as the
positioning of a layer of management on top of a group of semiautonomous
banks .

42 -

may be applied to all units. The bond portfolio of all units can be

administered more expertly by a central department. Centralized uniform

accounting can provide vital help in efficient operations and assist in

financial planning and budgeting. A centralized auditing program can

be beneficial to subsidiary banks both as a management tool and as a

means of supplementing director's examinations.1 Note that these argu-

ments for group efficiencies are based upon a fundamental economic

principle. Large markets promote the increased division of labor and

the increased division of labor makes possible a more efficient use of


Schweitzer: Economies of Scale and Holding Company Affiliation

Schweitzer has conducted the only research to date which

directly examines the question of efficiencies in m~ultibank systems.

In the research, he specified and estimated a cost function for banks

which stressed their dual function as intermediaries and payments

clearinghouses. The results of the study suggest that there are economies

of holding company affiliation. Schweitzer concluded:-

On the holding company question, it appears that .-
there are cost savings to be achieved through
affiliation with a holding company group, and
particularly with one of the two large Ninth
District groups. But these savings accrue prin-
cipally to banks in the intermediate size ranges.

1 Eugene H. Adams, "Economy, System Changes Require States to Modernize
Bank Structure," American Banker, etme ,17,p 1
2 Although Adam Smith used the pin factory to explain this principle,
nonetheless the principle may be extended to the modern multiplant firm.
It should also be noted that the problems of a limited supply of manage-
ment services are less press-ing for registered bank holding companies
because federal statutes require relatively homogeneous components for
the company.

- 43 -

from $3.5 to $10.0 million and from $10.0 to $25.0
million total assets.1

These conclusions can only be termed suggestive. One may

question~ whether Schweitzer's use of only two independent production

functions adequately reflects the variety of output produced by banks.

Also, data on the factor ptices for labor and for demand deposits were

not available for estimating the cost function.2

Upson and Jessup: Returns from Bank Holding Companies

Research by Upson and Jessup bears upon the question of the

profit orientation of holding companies. (Recall that Piper stated

that holding companies have a prestige and size orientation.) They found

that the earnings of multibank holding companies and the valuation of

these earnings were very favorable. The researchers created a price

index of holding company stocks for the period from 1957 to 1971 for

companies with over $500 million in group deposits after -1960. Share

prices between 1957 and 1971 increased almost 200 percent ~(about 8 per-

cent, compounded annually). For the same period, Moody's common stock

price index for banks outside New York City increased about -117 percent

The behavior of the holding company indez is attributed to

the management policies of these companies which have resulted in divi-

dends growing more rapidly for holding companies than for individual

banks. This greater growth of dividends basically reflects real growth

1 Stuart A. Schweitzer, Cost and Production in Banking: The Case of the
Ninth Federal Reserve District, Doctoral Dissertation, Department of
Economics, University of Minnesota, 1970. Cited in Golembe, p. 59.
Stuart A. Schweitzer, "Economies of Scale and Holding Company Affilia-
tion in Banking," Southern. Economic Journal~, vol. 38 (October, 1972),
pp. 259-263.
SRoger B. Upson and Paul F. Jessup, "Returns from Bank Holding Companies,"
The Bankers Magazine, vol. 155 (Spring, 1972), pp. 60-61.


in earnings per share because the holding companies have typically

not increased their dividend payout ratios over the time period.1

Upson and Jessup also developed a more comprehensive. measure

of performance than the price index of holding company stock by com-

bining price and dividend information into total rates of return. This

measure includes both dividend income and capital gain or loss and

allows for the timing of receipts and outlays. Using this measure of

performance, a complete matrix of returns for the shares of holding

companies was calculated. For the period from 1957 to 1971, the average

return for all holding periods was 11.2 percent, compounded annually.2

The results of the research by Upson and Jessup demonstrate that holding

company profits, on average, have been very favorable. The results also

imply that holding .companies are profit oriented.3

Alhadeffs: Recent Bank Mergers

Research by the Alhadeffs is relevant t'o the study of holding

company behavior. In analyzing bank mergers, which occurred in the

early 1950s, the researchers hypothesized that uneven rates of growth

among banks were a major reason for the observed increase in bank mergers.

The Alhadeffs wrote: "The very rapid growth of the past decade has created

stresses and maladjustments owing to uneven rates of growth of different

Ibid., pp. 61-62.
2 Ibid., p. 62. The returns are approximately symmetrical around the
overall mean of 11.2 percent. There are relatively few negative returns
and no negative, returns appear ~for holding periods of longer than two
Note that Piper looked at holding company profitability in terms of
earnings per share for a selected set of acquisitions while Upson and
Jessup considered the returns to the entire holding company system in
terms of share prices and in terms of their comprehensive measure of
per formance.


banks."1 If a merger is not an acceptable solution to a lagging growth

rate--which is usually the case in unit-banking states and often the case

in limited-branching states--then a bank may decide to organize or to

join a holding company in order to remedy a record of poor growth.

In the same study, the Alhadeffs reported that mergers oc-

curred in clusters and gave two reasons for the merger clusters:

Banks which have not yet begun to acquire other
banks begin to do so in simple imitation of the
initiators. A pattern of acquisitions which is
desirable for the initiators can be equally
desirable for the imitators. The clustering is
also explained by the defensive reaction of non-
participating banks to the acquisition activities .
of the initiating banks. Once mergers have begun
in an area, the relative standing of the, other
banks is either actually or imminently threatened
and a retalitary merger is the surest way to
maintain a threatened position.2

The merger clusters cited by the Alhadeffs appear to have an analogue

Ln the snowballing of holding company; activityy which was observed in

several states.3

The Relative Standing of Banks .

In explaining the clustering of~nergers, the Alhadeffs

mentioned a' bank's concern for its relative standing in the market.

A bank's concern for its relative standing is quite understandable if

its relative position declines because of a movement of customers to.

other banks. The Alhadeffs pointed to an indirect effect of a decline

in market standing. A decline in market standing is accompanied by a

1 Charlotte P. Alhadeff and David A. Alhadeff, "Recent Bank Mergers,"
Quarterly Journal of Economics, vol. 55 (November, 1955),- p. 512.
2- Ibid., p. 518.
See Chapter 2, p.12 and this chapter, p. 36,


relative (and possibly an absolute) loss of deposits which often causes

an increase in the capital to deposit ratio which reduces the leverage

on the bank's earnings.1

Related to the question of relative standing is the. fact

that a bank possesses a supply of highly specialized resources, namely,

banking knowledge and experience. These specialized resources are

relatively fixed in the near term so these resources may be viewed as

involving a type .of fixed cost.2 It is advantageous for the bank to

attempt to spread these fixed costs (of specialized resources) over

additional units of output because, other things being equal, average

costs decline as fixed costs are stretched over added output. Of course,

the ability of a bank to spread out fixed costs is a function of its

ability .to expand. It should also be noted that a bank's knowledge and

experience increases over time, thereby augmenting the bank's capacity

for production. With the passage of time, lacklustre growth can result

in a serious underutilization of resources.3

The empirical studies consistently found that holdihg company

affiliates have altered their portfolios in a manner that should increase

returns. Cash, due from balances and' U.S. Governments have been reduced

and a larger part of the portfolio has been devoted to local and state

1Alhadeff, p. 516.
Note that if a bank forsakes its accumulated knowledge and experience
and seeks to acquire a completely different kind of knowledge and exper-
ience, the opportunity costs will be high.
3 The emphasis here is upon the human resources of the bank. Since the
provision of banking services is labor intensive, this emphasis seems

- 47 -

obligations and to loans, especially consumer loans. Many holding

companies provided correspondent-type services such as portfolio

analyses, accounting services and guidance on operational matters.1

The parent often charged the subsidiaries .fees for the services provided.

Also, banks were thought to be very sensitive to their relative position

in a market. Those banks whose relative positions were threatened--

for example, downtown banks in a unit-banking state--may be attracted

to the holding company structure as a way to improve their market

standing. Holding company growth has occurred in .spurts perhaps because

independent banks have frequently reacted to the aggressive actions of

holding companies by organizing or joining a holding company. The evi-

dence is inconclusive on the question of whether holding company affil-

Lates are more efficient than comparable independent banks. Holding

companies appear to have operated very profitably, especially in the

last decade or so.2

For a recent discussion of the range of services provided by holding
companies see Robert J. Lawrence, OperatinR Policies of Bank Holding
Companies--P-art 1 (Washington, D.C.: Board of Governors of the Federal
Reserve System, 1971).
2 A recent study of holding company performance was conducted by Golembe
and Associates. The study was not reviewed because the empirical work
is poorly done. A paired bank method is used on an after-acquisition
basis only in an attempt to analyze holding company behavior. The before-
acquisition analysis was never done using rigorous statistical tests..
There are only 16 and 22 group banks for the two post-acquisition dates.
The tests applied for the post-acquisition dates are biased since some
group-banks were paired with more than one independent bank. To confirm
the results of the paired bank approach, Golembe analyzed national data
for all insured banks and all affiliated banks as of December 31, 1968.
This use of aggregated data for a single point in time without the
benefit of any statistical tests is unacceptable. See Golembe, Chapter 3.



Neither the history of holding companies covered in Chapter 2

nor the review of the literature presented in Chapter 3 have provided

clear evidence as to the underlying motivation behind the actions of

bank holding companies.

On the one hand, the changes observed in the portfolios of

affiliated banks suggest that holding companies are profit oriented.

Also, if one accepts the arguments in favor of efficiencies for the

holding company structure, then the adoption and use of this structure

by a banking organization may indicate that the organization is profit

conscious. Furthermore, holding companies have operated quite profit-

ably, at least in the last decade or so. Of course, profitable opera-

tions are supportive of a profit maximization hypothesis.

On the other hand, the very rapid external expansion of some

holding companies may imply that they are size maximizers. Also, the

very high prices paid for unaffiliated banks by holding companies suggest

that they are size oriented.l

1 Unpublished tabulations of the Federal Reserve Board show the premiums
paid by holding companies in Florida, Missouri, New Jersey and Ohio for
1970 and 1971. (The premium represents the difference between the market
value of the shares offered and the book value of the shares acquired,
expressed as a percent of book value.) The median premium ranged from
a low of 52.2 percent in Ohio to a high of 131.6 percent in Florida.

- 48 -

- 49 -

This chapter will discuss briefly profit maximization and

size maximization as alternative bases for .explaining holding company

behavior. Before model building can begin, it is necessary to decide

upon the underlying motivation of holding companies.

External Expansion and Profit Maximization

Most holding company affiliates are acquired by means of a

share exchange. In a share exchange, the holding companies with high

price-earnings multiples can pay a higher price for a bank than holding

companies with low multiples, other things being held equal.1 Also,

the highly valued company is able to pay the high acquisition prices

frequently demanded by independent banks without adversely affecting

per share earnings.

Accordingly, it seems necessary for the holding company that

dishes to undertake an aggressive program of external expansion to have

a relatively favorable price-earnings ratio. If a holding company with

a relatively unfavorable price-earnings ratio undertakes an active

program of expansion, the company will likely experience a dilution in

per share earnings and per share assets. The holding company will soon

be forced to curtail its expansion program since each additional

acquisition will increase the amount of dilution suffered by the

Southeast Banking .Corporation and United Bancshares, both Miami-
based holding companies, made a bid to acquire Lon Worth Crow, a
mortgage banking company with close ties to United Bancshares. South-
east Banking acquired the company because it was able to pay a higher
price than United. At the time, Southeast's P/E ratio was about
double the P/E ratio of United.

- 50 -

original stockholders.1

The primary determinants of the price-earnings multiple

appear to be the growth of earnings per share and the growth of the

associated dividends per share. There is a "growing consensus of

belief in a definite relationship (through the interaction between

the stock market, dividend policy and the reinvestment rate) between

the maximum obtainable growth rate of the supply of capital...and the

rate of profit earned on existing assets."2 If one accepts the argument

for a relationship between earnings growth, the P/E ratio and expansion,

then it follows that a holding company which intends to expand externally

nust be profit conscious.

The Alternative Hypothesis: Size Maximization

As noted above, a size maximization hypothesis and a profit

maximization hypothesis appear to provide a satisfactory framework for

explaining holding company behavior. As Lanzilotti has observed:

For example, compare First BancGroup and Huntington Bancshares.
Both Ohio companies have embarked on an aggressive expansion program.
First BancGroup with an especially high P/E multiple has been able to
nake acquisitions on terms that maintain or enhance its own per share
equity and earnings. tHuntington Bancshares with a much lower multiple
has diluted both its earnings and its book value in the course of
acquiring other banks.~ In 1972, Huntington Bancshares has acquired two
small banks whose deposits total $37.2 million, which is about one-fourth
of the deposits acquired in 1970 and in 1971. This reduced amount of
expansion is presumably due to the substantial dilution experienced by
Huntington Bancsharea. See Herbert F. Thomson and Jerry A. Meadows,
"The Expansion of Registered Bank Holding Companies in Ohio," Bulletin
of Business Research., Ohio State University, vol. 46 (July, 1971), p. 3.
2 R.L. Marris, "Review of E.T. Penrose: The Theory of the Growth of
the Firm," Economic Journal, vol. 71 (March, 1971), p. 147.
M Eultibank holding companies apparently believe in a relationship
between profits and multiples and expansion. See Paul S. Nadler,
"Craze for Raising Multiples Spreads with Multi-BHC Craze," American
Banker, October 31, 1972, p. 4.

- 51 -

"Given empirical findings are likely to be consistent with, or at

least partially reconcilable with, many hypotheses. The essential

question is: which hypotheses are likely to yield the most useful

and reliable short-run and long-run predictions."1

The key empirical finding favoring the size maximization

hypothesis is the fact that a number of bank holding companies have

expanded very rapidly. In addition, the fact that holding companies

frequently pay high acquisition premiums for banks is consistent with

this hypothesis. By paying especially high acquisition prices, the

holding company becomes larger at the expense oficarnings per share.

Another possible consideration in favor of this hypothesis

is that the decision-making power in a holding company usually rests

with management. The argument for management control of the holding

company is based upon the fact that the stock of a holding company is

usually widely held. It is often assumed that the management-dominated

firm will opt for some goal (such as size maximization) other than

profit maximization.

Vernon has tested this assumption for banking firms. He


We uncover no evidence to suggest that control
status has exerted a significant influence on
profit. rates of large commercial banks during
recent' years. ...Owner-controlled banks did not
realize higher rates of return on invested capital
than management-controlled banks.2

1 Robert F. Lanzilotti, "Pricing Objectives in Large Companies: Reply,"
American Economic Review, vol. 49 (September, 1959), p. 685.
2Jack R. Vernon, "Separation of Ownership and Control and Profit Rates,
~the Evidence from Banking: Comment," Journal of Financial and Quantita-
tive Analysis, vol. 2 (January, 1971), p. 624.

- 52 -

If one is willing to extend Vernon's results to management-controlled

holding companies, then one cannot argue that holding companies are

not profit maximizers because these companies tend to be management


Profit Maximization Versus Size Maximization

In practice, it is very difficult to distinguish between the

size maximizing firm and the profit maximizing firm. For instance, the

rapid expansion of holding companies and the payment of high acquisition'

premiums may be rationalized in terms of a longrun profit maximization


Under certain conditions a size maximizing firm and a profit

maximizing may behave the same way. It was argued above, thiat a holding

company which wishes to expand rapidly must be profit conscious. Con-

sequently, some size maximizing companies may be forced to maximize

profits in order to pursue an aggressive program of external expansion.

Of course, a size-maximizing company subject to a profit maximization

constraint will behave in exactly the same way as a profit-maximising


Although the evidence is mixed, it appears preferable to use

the traditional model, of profit maximization. The concept of size

maximization is difficult to apply empirically because the notion of a

satisfactory level of profits, which is associated with the size maximi-

zation hypothesis, is difficult to use in empirical work.1

Of course, the size maximizing firm cannot completely ignore its level
of profits. For a discussion of the concept of a satisfactory level of
proits se wilia J.BauolBusiness Behavior, Value and Grawth (e
York: Macmillan Company, 1959), p. 49. For a discussion of the problems
in applying this-concept, see Bevars D. Mabry and David L. Siders, "An
Empirical Test of the Sales Maximization Hypothesis," Southern Economic
Journal, vol. 28 (January, 1967), pp. 367-377.

- 53 -

'By way of contrast, the profit maximization model greatly

simplifies the analysis. Professor Machlup wrote that "the substitution

of~ money profits for a composite of pecuniary [satisfactory profits] and

non-pecuniary rewards [size and prestige] simplifies the analysis so

much that the gain in expediency far exceeds the loss in a~pplicability."1

A statement by Penrose indicates what the profit model must

accomplish in order to explain holding company behavior.

In an analysis of the expansion of individual firms
the profit-seeking assumption is useful so long as
it is possible to set forth in reasonably objective
economic terms the considerations that will determine
the probability that certain specified directions of
expansion will be more profitable than others.

Applications of the Profit Maximization Hypothesis

Models of lead bank status and of holding company activity

will be developed within the framework of the profit maximization

hypothes is. In the model of lead bank status, it is assumed that a

potential lead bank considers its characteristics and the characteristics

of its environment -in deciding whether to lead a holding company. The

profit maximization hypothesis predicts that the bank will lead a holding

company if this is the most profitable opportunity- available. For the

model of holding company activity, it is assumed that holding companies

as a group consider the expected profitability of different markets and

the regulatory position of the Federal Reserve Board in deciding where

to acquire affiliates.' The profit maximization hypothesis predicts

1 Fritz Machlup, "Theories of the Firm: Marginalist, Behavioral,
Managerial," American Economic Reviewvl57(ac 16)p..Th
size maximization model usually carries the suggestion that the firm
values highly the prestige associated with size.
2Edith Penrose, The Theory of the Growth of the Firm (New York: John
Wiley &r Sons, 1959), p. 185.


that holding companies will be most active in the most attractive

markets (in terms of expected returns),- provided the regulatory

position is permissive.

It is important to note that the profit maximization hypothesis

is employed because the hypothesis provides us with a useful and con-

sistent framework for analysis. The historical evidence and scholarly

research suggest, but do not demonstrate, that holding companies are

profit maximizers. The reader should not be misled into thinking that

the study is designed to determine whether or not holding companies

are profit maximizers. Rather, the study is built upon the convenient

and well-known assumption of profit maximization.



Within the framework of the profit maximization hypothesis,

we will develop a model to analyze the factors which cause a bank to

become a lead bank of a'multibank holding company. Alternatively,

the model may be viewed as analyzing the factors which influence the

formation of a multibank holding company. For most cases, the decision

to lead a holding company and the decision to form a holding company

are different views of the same phenomenon.1 That is, a holding company

is generally formed by a bank which assumes lead bank status upon formation.

Definition of Lead Bank Status

In Chapter 1, the lead bank of a holding company is defined

as the bank which the management of a holding company designates as the

lead bank. The Federal Reserve -Bank of Atlanta asks each multibank

holding company to designate a bank as its lead bank in those instances

where it is not obvious which bank is the lead bank, so as a practical

matter it is not difficult to know which bank is the lead bank.

There are a few exceptions. For example, the McNulty Group.of Banks,
which consisted of eleven small banks in Central Florida, became a holding
company in 1967 with the title of First Florida Bancorporation. In 1969,
First Florida "acquired" Marine Bank and Trust Company, Tampa, which bank
became the lead bank of the holding company. See "First Florida Bancor-
poration, Haines City, Florida," Federal Reserve Bulletin, vol. 52 (November,
1966), pp. 1632-1635. "First Florida Bancorporation, Haines City, Florida,"
Federal Reserve Bulletin., vol. 55 (February, 1969), pp. 165-168.

* 55 -

- 56 -

Although it is the case that all multibank holding companies

have lead banks as defined above, nonetheless for a few holding com-

panies no bank has assumed lead bank status.'- The idea of lead bank

status is not easy to spell out, although it is usually evident

whether or not a bank has assumed lead bank status. A bank in taking

lead bank status will provide the top officers of the holding company.

The bank with lead bank status will set the tone for the entire system

in terms of management philosophy, operating procedures, policy guide-

lines and long range planning. The bank with lead bank status will

help the other bank subsidiaries solve problems of management and opera-

tions as well as providing these banks with specialized services.2

The Set of Potential Lead Banks

The set of potential lead banks is defined as the largest 75

banks (in terms of total deposits) in Florida as of December 31, 1971.

Although it is most unrealistic to consider all banks as potential lead

banks, the decision to use the top 75 banks may appear arbitrary. It

was reasoned that Dnly large banks have the opportunity of becoming a

lead bank because only large banks have the financial and human resources

needed to lead a multibank organization.3 A large bank by Florida

1 This appears to be the case with Ellis Banking Corporation of Bradenton,
Florida. Although the First National Bank of Bradenton was designated by
management as the lead bank (and it is used in the study), management of
Ellis Banking Corporation has indicated in discussions with the staff of
the Federal Reserve Board that the holding company "really" does not have
a lead bank.
2 As holding companies grow and diversify, the bank holding company
often takes on an existence distinct from that of the lead bank.
3 All lead banks of multibank holding companies are substantially larger
than the median size bank. The median size bank had total deposits of
$17.0 million as of December 31, 1971.

-57 -

standards was judged to be a bank with approximately $50 million in deposits

or more. The largest 75 banks satisfy this criterion.1

Three of the 75 largest banks were excluded from the set of

potential lead banks because they had been actual lead banks~ since

the 1920's.2. Fourteen of the 75 largest banks were excluded because

they were not independent decision makers. In every case bui one,3

the excluded bank was closely tied to a much larger bank which was

assumed to make the decisions. So, of the largest 75 banks, only 58

banks were judged to be both potential lead banks and independent

decision makers. (See. Table A.1 in the appendix.)~ Of the 58 potential

lead banks used in the study, 21 banks have become lead banks and of

the remaining 37 banks, ten banks have been acquired by holding companies

and 27 banks have made no decision regarding lead bank status. (See

Table A.2 in the appendix.)

It should be noted that three multibank holding companies are

led by banks which are not among the 75 largest banks. These three

lead banks are ranked 89th, 96th and 152nd among Florida's 540 banks on

the basis of total deposits as of December 31, 1971. Only one of the

three holding companies--American Bancshares (152nd)--has subsidiary

banks in more than one metropolitan market.4 The other two holding

1 The 75th largest bank as of year end 1971 had total deposits of
$48.9 million.
2The three banks are Atlantic National Bank, Florida National Bank
and Barnett First National Bank. All three banks are located in
Jacksonville. For a history of these groups see J.E. Dovell, Histor1
of Banking in Florida (Orlando: Florida Bankers Association, 1955),
pp. 183-189.
The .one~exception is Ellis Banking Corporation. The affiliated
Sarasota Bank and Trust Company is substantially larger than the
designated lead bank, First National Bank of Bradenton..
For, a discussion of metropolitan markets, see Chapter 7, pp. 97-99.

- 58 -

companies have subsidiary banks ini only one metropolitan market and are

among the smallest multibank holding companies in the state. The model

of lead bank status is not designed to explain the decisions ~by a few

medium size banks to anchor small local or regional holding companies.

Lead Banks and Chains

Before becoming the lead bank of a registered multibank

system, a bank may have anchored a chain.2 There are two main teasons

why a chain would form a holding company. First, the holding company

structure formalizes and makes permanent the relationships within the

chain.3 Second, the holding company structure allows a former chain

to rapidly expand its banking activities because the- holding company

can obtain outside funds to finance acquisitions.

Chain banking may be viewed as a substitute for the holding

company form of banking. Given this view, we should then hold constant

the influence of chain banking so that we can isolate the influence of

other factors upon lead bank status. Unfortunately, reliable data on

chain banks are not available for all years included in the study. The

SFor the distinction between chain banking and bank holding companies,
see Chapter 1, p. 9.
This was the case with the First National ~Bank at Orlando, Broward
National Bank and First National Bank of Fort Lauderdale. See "First
at Orlando Corporation, Orlando, Florida," Federal Reserve_ Bulletin,
vol. 53 (February, 1967), p. 236. "Broward Bancshares, Inc., Fort
Lauderdale, Florida," Federal Reserve Bulletin, vol. 56 (January, 1970),
p.. 85. "Consolidated Bancshares of Florida, Inc., Fort Lauderdale,"
Federal Reserve Bulletin, vol. 57 (February, 1971), p. 137.
3--- ---------
A chain may be dissolved. This did happen in t~he case of the First
National Group of Southeast Florida. See J.E. Dovell, History of Banking
in Florida: First Supplement (Or~lando: Florida Bankers Association, 1964),
p. 42.

- 59 -

omission of a variable to control for chain banking activity may not be

serious. Darnell, in studying chain banking, did not find a significant

relationship between chain banking and bank holding companies.1

The Time Framework of the Study

In deciding upon lead bank status the potential lead bank has

three options: (1) become a lead bank of a holding company, (2) become

a subsidiary bank of a holding company, or (3) remain unaffiliated.

There is a substantial time lag between the time a bank decides

to become a lead bank (or to be acquired by a holding company) and the

time. this decision is consummated. After a decision is made, time is

expended in finalizing negotiations with the proposed affiliates (or

with the acquiring holding company) and in preparing an application for

the Federal Reserve Board. After the application is filed with the

Federal Reserve Bank, it will take at least 105 calendar days for the

application to be processed by the Federal Reserve System and for the

Board of Governors to act on the proposal.2 An approval by the Board

may not be consummated for .thirty calendar days in order to permit the.

Department of Justice time to challenge the Board's decision. In all,

it appears that anywhere from six months to eighteen months will elapse

between the decision .date of the potential lead bank and the consummation


Jerome C. Darnell, "Determinants of Chain Banking," National Bank
Review, Vol. 4 (June, 1967), pp. 459-468.
Current guidelines state that the Reserve Bank should attempt to
formally accept an application within ten business days after receipt.
The Federal Reserve System (i.e., the Reserve Bank and the Federal
Reserve Board) tries to bring the proposal before the Board of Governors
within ninety calendar days after formal acceptance.

- 60 -

All of the explanatory variables in the model are lagged one

year because of the considerable delay in consumrmating a decision.

The year a decision on lead bank status is consurmmated is determined

from Board documents. The previous year is assumed to be the decision

year and all explanatory variables are measured as of the ~decision year.

The variables are as of the decision year because it is necessary to

measure the characteristics of the bank at the time that the decision

was made. If a potential lead bank has not become a lead bank or been

acquired by a holding company by the end of 1972, which is the terminal

point of the study, then it is assumed that the bank has decided not

to become a lead bank for the time being.

From 1956, when the Bank Holding Company Act was passed, until

1964 no potential lead bank became a lead bank. In 1964, the First

National Bank of Tampa, a potential lead bank, became the lead bank of

a registered holding company. The decision to become a lead bank is

assumed to have been made in 1963. So the study of lead bank status

will cover the period from 1963 through 1971 in terms of decision years

or from 1964 through 1972 in terms of consummation years.

A Framework for the Empirical Model

The variables which affect lead bank status may be divided

into three groups: (1) variables which reflect the regulatory position

toward potential lead banks; (2) variables which measure the economic

characteristics of the potential lead bank; and.(3) variables which

reflect the environment in which a potential lead bank operates. The

relationship of the three types of variables to lead bank status is

summarized in equation (1).

- 61 -

(1) LBSt = f(FRBty IBCt-1, EEt-1)


LBSt = lead bank status in year t. LBS=1 if the
bank is a lead bank; LBS=0 otherwise.

FRBtpl = regulatory position of the Federal Reserve
Board in year t-1.

IBCt-1 = individual bank characteristics in year

EEt-1 = environment of the bank in year t-1.

The Regulatory Position

TFor the period 1963-1972, the Federal Reserve Board has

approved all proposed formations.1 One cannot conclude from these

approvals that the Board has been completely permissive. The Federal

Reserve Board has certainly exerted an influence upon the decisions of

potential lead banks by means of its decisions on non-Florida cases and

by means of informal staff discussions with these banks. However, it

is an impossible task to measure this influence empirical-ly because of

the absence of any overt actions by the Board. Consequently, it has

been assumed that the Board's influence upon the decisions of potential

lead banks has not been significant and no variable reflecting Board

influence will be included in the model.

1 In 1962, the Board did disapprove the application by four of the eight
largest banks in Florida to form a holding company. Today the four banks
lead the first, second, fourth and tenth largest holding companies in
Florida. "First Bancorporation of Florida, Inc., Orlando, Florida,"
Federal Reserve Bulletin, vol. 48 (August, 1962), pp. 978-984. In 1971,
the Board disapproved a formation which involved a potential lead bank,
the Cormmercial Bank at Winter Park. The formation, however, was .contin-
gent upon the approval of an application by Southeast Banking-Corporation
to acquire all five banks of the proposed multibank holding companies.
"Combanks Corporation, Winter Park, Florida," Federal Reserve Bulletin,
vol. 58 (January, 1972), pp. 55-56.

- 62 -

Individual Bank Characteristics

In looking at individual bank characteristics, six character-

istics are thought to be important determinants of a bank's status and

they are shown in equation (2).

(2) IBCt = g (SZt, CBt, Lt/A C~L/Ag, CL /At, MSt)

IBCt = individual bank characteristics in year t.

SZt = size in terms of total deposits in year t.

CBt = correspondent business measured by due to
balances in year t.

Le/At = loan to asset ratio in year t.

CLt At = consumer loan to asset ratio in year t.

CLt/At = commercial and industrial loan to asset
ratio in year t.

MSt = change in market share for the period from
year t-5 to year t.

The most obvious characteristic of any bank is its size. It

is generally assumed that large banks are more likely to become lead

banks than small ones. The presumption is partly based on empirical

evidence--nine of the ten largest banks in Florida are lead banks.

Partly, it is assumed that the larger banks have the human-and financial

resources needed to lead a multibank system. .In terms of human resources,

the larger is the bank (in absolute terms) the more likely it is to have

specialized services such as investment guidance and data processing

services which can be offered to other banks. In terms of financial

resources, the larger is the lead bank (in absolute terms) the more

- 63 -

marketable will be the holding company stock and the more acceptable

will be the stock in ~share exchanges. In addition, the larger organ-

izations have easier access to financial markets when they publicly

offer additional stock or senior securities. This entire discussion

is intended to suggest that the larger is the bank the better will be

its ability to exhaust any efficiencies associated with the holding

company structure.

The size of a potential lead bank is measured by its total

deposits as of December 31 of the decision year. Total deposits are

deflated using the aggregate GNP deflator in order to remove price

changes in the deposit data for the time period of the study.

A second bank characteristic which is thought to affect the

decision on lead bank status is the size of the bank's correspondent

business. It is hypothesized that the greater is the bank's involve-

ment in correspondent banking the greater is the likelihood that the

bank will become a lead bank.

The hypothesis concerning correspondent business is based on

three considerations.2 First, the larger is the bank's correspondent

business, the more able is the bank to provide future subsidiary banks

Since the study is restricted to the state of Florida, we need not
control for inter-state differences in bank size. As an example of
state differences a $100 million bank, which is a very large bank in
New Mexico, may provide services which are inadequate by Texas standards.
2The three considerations have the same direction of influence and are
to some extent reenforcing. It is not necessary to specify which consid-
eration, if only one, is paramount to a particular bank.

- 64 -

with specialized services. In other words, the bank has expertise that

is useful to a holding company organization. Second, the larger the

correspondent business' the more likely the bank is to have a close

working relationship with other banks. The correspondent bank and its

family of closely-related client banks can easily adopt the holding

company structure and formalize the "family". Third, a bank with a

large amount of correspondent business may organize a holding company

in order to preserve its business from the encroachment of expanding

holding companies. .One sure way to suffer a decline in correspondent

business is for a bank to permit rival organizations to acquire respond-

ent banks.1

Due to balances are used as a measure of the correspondent

business done by a bank because such balances are the usual means of

payment for correspondent services. Due to balances are measured as of

year-end of the decision year and they are deflated with the aggregate

GNP deflator in order to adjust for inflation over time.

In isolating key characteristics of a potential lead-bank,

three portfolio ratios appear useful. These are the total loan to

asset ratio, the consumer loan to asset ratio, and the commercial and

industrial loan to asset ratio.

Both Lawrence and Talley, in studying holding company perform-

ance, found that affiliated banks had a substantially higher proportion

of their assets in loans, particularly consumer loans. In fact the

changes in the loan to asset ratio and the consumer loan to asset ratio

1. See Chapter 2, p. 12, and Chapter 3, pp. 29, 31. Also, Lawrence,
Operating Policies, p. 25.

- 65-

were among the most significant findings, both statistically and quanti-

tatively, in the two studies.1

The assumption is made that the changes in the operating

policies of subsidiary banks reflect the existing practices of the

lead bank. Accordingly, it is hypothesized that the higher the bank's

loan to asset ratio and the higher its consumer loan to asset ratio,

the more likely it is that the bank will become a lead bank. The loan

to asset ratio is measured by a bank's total loans and discounts

divided by its total assets.2 The consumer loan to asset ratio is

defined as total consumer loans divided by total assets.3 .

The third portfolio ratio considered in analyzing lead bank

status was the ratio of commercial and industrial loans to assets. This

ratio was used to indicate the extent to which a bank was wholesale-

or business-oriented. It is hypothesized that wholesale banks will be

likely to form holding companies in order to attract the business of,

and in order to better serve the banking needs of,; multi-establishment

firms. This portfolio ratio is defined as total commercial and industrial

loans divided by total assets.4

It should be noted that there is something of a contradiction

between the business loan ratio hypothesis and the consumer loan ratio

hypothesis. A bank cannot be wholesale-oriented and retail-oriented at

1See Chapter 3, pp. 32, 36-37.
2 In terms of the format of the Report of Condition, total loans and
discounts are item 8 of schedule A; total assets are item 14 of the
front page.
In terms of the Report of Condition format, total consumer loans
are the sum of items 6(a) through 6(f) of Schedule A.
Commercial and industrial loans are items 5 of Schedule A of the
Report of Condition.

- 66 -

the same time.1 The empirical results should determine which ratio,

if either, is a significant determinant .of lead bank status.

It is necessary to control for differences in market condi-

tions in using these portfolio ratios. Differences in market condi-

tions exist because potential lead banks are located in different

geographic markets and because potential lead banks in the same market

have different decision years. In order to control for market differ-

ences a bank's portfolio ratio is divided by the comparable ratio for

the entire market. Accordingly,.the market adjusted variable for, say,

the loan to asset ratio is equal to the loan to asset ratio of the bank

divided by the ratio of total loans to total assets for the market. If

this adjusted variable is above 1.00 then the bank's ratio exceeds the

market's ratio and conversely. The adjusted portfolio variables are used

in empirical tests of the model.

A bank's relative rate of growth is thought to influence a

bank's decision on lead bank status. It is proposed that the poorer a

bank's relative growth (i.e., the greater the decline in a bank's market

share) the more likely is the bank to become a lead bank in an attempt

to recover its relative position and to improve its profit performance.2

The relative rate of growth is measured by a bank's change in market

1 From an accounting point of view, a bank could conceivably have an
above-average business loan ratio and an above-average consumer loan
ratio. This might occur if the bank made relatively few real estate
loans, security loans, loans to financial institutions, and miscellaneous
loans. Such a loan portfolio does not seem probable, however.
2 The stresses caused by uneven rates of growth and the importance of
a bank's relative position were discussed in Chapter 3, pp. 44~46.

- 67 -

share.1 The change in market share is calculated for the period from

year t-5 to year t, where t is the decision year, using the formula in

equation (3).

t=0 t=-3
(3) MSt 1\ Bankr's Deposits)t 1\ Bank's Depositsy
3 Mrket Deposits)t 3 Mrket Deposits)t
t=- t=

It should be noted that a potential lead bank's market standing may

change drastically. This is due to Florida's unit-banking statutes

and its very rapid growth.


In considering the environment of a potential lead bank, three

variables are proposed as significant predictors of lead bank status.2

(4) EEt = h (ENC/BKt, ENC/TDt, MIt)


EEt = environment of bank's market in year t.

ENC/BKt = encroachment as measured by the change in
holding companies' share of banks in the
market from year t-2 to year t.

ENC/TDt = encroachment as measured by the change in
holding companies' share of market deposits
from year t-2 to year t.

MIt = market's importance as a financial center
in year t.

1 An attempt was made to measure market position over time by regressing
market share upon time for the set of potential lead banks. For about
one-quarter of the banks the coefficient of determination (R2), which is
a measure of the explanatory power of the regression equation, was rather
low so this method was not used. The low R2 was usually caused by market
share being very atypical for one year.
2 Other factors affecting the environment of a bank include market growth
and market concentration. However, these factors do not appear, a priori,
to influence a bank's decision regarding lead bank status. For example,
there is no clear reason to think that the likelihood of a bank selecting
lead bank status is.related to the rate of growth of its market.

- 68 -

The amount of recent holding company activity in a market is

thought to be an influence upon lead bank status. It is hypothesized that

encroachment by holding companies on a bank's local market, thereby

threatening its base of operations, will often result in a defensive

reaction by the bank.1 If the independent bank believes it is at a

disadvantage in competing with holding company affiliates, it can form

a holding company or join a holding company. However, which course of

action, if either, the bank will pursue cannot be decided a priori.

Despite the inability to predict the direction of influence,

it seems important to consider the encroachment effect. Much of the

snowballing of holding company activity observed in Florida and else-

where is probably due to the defensive response of banks to encroach-

ment by holding companies on their home markets.2 Given that the en-

croachment effect has a substantial impact upon the amount of holding

company activity, it is of interest to determine empirically whether or

not encroachment has a systematic effect upon a bank's decision regarding

lead bank status.

The encroachment effect is measured in two ways. The variable

ENC/BK measures encroachment in terms of the change in holding company

control of banks in a~ market. The variable ENC/TD measures encroachment

on the basis of the change in holding company control of market deposits.

For example, "the proposal of the Central National Bank of Cleveland
to acquire American Bank of Commerce in Akron was announced as a response
by Cleveland Banks to the encroachment on their traditional territory
by BancOhio Corporation, in its merger with Akron National Bank and
Trust Company." Thomson and Meadows, p. 3.
2 For a discussion of the snowballing of holding company activity, see
Chapter 2, pp. 24-27 and Chapter 3, p. 35.

___ __

- 69 -

Lead bank status is thought to be affected by a market's

importance as a financial center. It is proposed that, cateris

~agibus, the more important is the market as a financial center, the

more likely will be a bank in the market to become a lead bank. The

reason is that the more important a market is as a financial center,

the more likely it is that some banks in the market are informed about

the holding company structure and its possible benefits. The informed

banks are expected to have an influence upon the thinking of other

banks in the market. In other words, important financial centers

possess a stimulating environment which encourages banks to assume

leadership roles in multibank organizations.

A market's standing as a financial center is measured by the

market's share of total deposits in the state in the decision year. One

would expect some correlation between a market's share of deposits and

potential lead banks' deposit size and correspondent business. Nonethe-

less, a market's importance is considered to be a distinct determinant

of lead bank status.

The Statistical Modell

The model of lead bank status is intended to determine the

probability that a bank will opt for lead bank status. The probability

of lead bank status is thought to be a function of a bank's individual

characteristics (IBC) and its environment (EE). Clearly, the object of

prime interest is a probability.

T he discussion is intended to provide the reader with an intuitive
appreciation for why regression analysis is an inappropriate 'statistical
model for this study and why probit analysis is an appropriate statis-
tical model for this study.

- 70 -

The regression model is not a suitable statistical model for

determining the probability of lead bank status. In both ordinary and

generalized least squares regression models, the estimated value for

lead bank status may fall outside the interval from 0 to 1, because

regression models fit straight lines to the data points. .(See Figure

5.1.) An estimated value (probability) for lead bank status of less

than 0 or greater than 1 is inconsistent with interpreting the value

of the dependent variable as a probability.1

Another shortcoming of the regression model is the fact that

it is unable to handle a dichotomous dependent variable. It should be

realized that the actual value of the dependent variable lead bank

status is either, say, O or 1, this is to say, a bank either is or is

not a lead bank.2 Because the dependent variable is dichotomous, the

assumption of homoskedasticity, which is a basic assumption of the

regression model, is not satisfied The assumption of homoskedasticity

means that the expected variance of the error terms is equal for all

observations. In other words, the scatter of data points (the observed

values of the variables) about the estimated regression line is approxi-

mately uniform. (See Figure 5.2.)

1 It makes no sense to say that the probability of a bank selecting
lead bank status is -10 percent or +120 percent.
For example, the expected probability of getting heads from flipping
a coin may be 0.5. Nonetheless, for an actual flip of the coin, the
result is either heads (1) or tails (0).
SIn practice, generalized least squares regression, a technique for
adjusting for heterskedasticity, is unworkable because the calculated
values of the dependent variable are frequently very close to 0 or 1.
As a consequence, the inverse of the estimated disturbance covariance
matrix cannot be calculated (the inverse is singular or nearly singular).

- 71 -

1 agagagemano

of Lead
Bank Status

Figure 5.1

A Straight Line Fit with Regression Model

Figure 5.2

Homoskedasticity about the Regression Line

- 72 -

The variance of the error term is defined as the square of

the difference between the estimated value of the dependent variable

(the probability of lead bank status) and the actual value of the

dependent variable (either 0 or 1). The variance is weighted by the

probability of "success" (the bank is a lead bank) as "failure" (the

bank is not a lead bank).1 Applying the definition of the vari~ance of
the error term and letting "P" equal the probability of lead bank

status, we have:

(4) Variance of error term =(1-P)2(P)+(0-P)2(1-P)
= P-P2

From (4), it is evident that the variance of the error term

depends on P, the probability of lead bank status;2 and P in turn

depends on the individual bank characteristics (IBC) and on the environ-

ment (EE). Consequently, the variance of the error term varies systema-

tically with the explanatory variables. Thus, the assumption of homo-

skredasticity, which is a basic assumption of the regression model, is

not satisfied.

In view of the problem with the regression model, an alterna-

tive statistical approach is needed to handle a dichotomous dependent

1 Probabilities are used for the theoretical distribution while frequen-
cies are used for the actual (sample) distribution.
2For example, if the expected value of lead bank status equals .9,
this means a probability of, 79 that the value will deviate from expectation
by +. 1 and a probability of .1 that the deviation will be -.9, while an
expected value of .4 means deviations of +.6 with probability .4 and
deviations of -.4 with probability .6. Using equation (4), the variance
equals .09 when P=.9, while the variance is .24 when P=.4.

- 73 -

variable and to restrict the value of the dependent variable to the

interval from 0 to 1. One alternative is the probit analysis model.1

Since probit analysis was developed with reference to the

field of biology, an example from this field may be most helpful in

explaining this statistical method. In biological assay, probit

analysis is used to determine the relationship between the pr ability

that organisms will be killed to the strength of the dose of poison

administered to them. The dependent variable for each organism in the

sample is dichotomous: killed or not killed. Each organism is assumed

to have a dosage threshold, such that a stronger dose will: kill that

organism and a weaker dose will not. Over the population of organisms

of a given kind, these dosage thresholds are assumed to be normally

distributed with a few organisms having very high or very low dosage,

thresholds.vhile most of the organism have intermediate-valued dosage

thresholds. (See Figure 5.3.) A graph of the percentage of insects

killed as the dose of poison increases will give a steadily rising

curve. The curve has an S-shape because the dosage thresholds are

assumed to be normally distributed. In other words, the rate of change

in the percentage killed per unit increase in dose is low in the region

of very small or very large doses of poison but is higher in the inter-

mediate region. (See Figure 5.4.)

SThe basic reference on probity analysis is D.J. Finney, Probit
Analysis (3rd ed.; Cambridge, England: The University Press, 1971).

U' -- -p
Dose of Poison

Figure 5.4

Cumulative Distribution of Insects Killed

- 74 *


Dose of Poison

Figure 5.3

Normal Distribution of Dosage Thresholds

of Insects

- 75 -

The above ,example may be put into the following mnthe-

matical terms. Suppose the Ath organism has an actual value of the

dose T which is a linear function of the concentration of the

poison (CON) and the time .of; exposure to the poison (EXP) to which

the ith organism is subjected.

(5) Ti = Bo ICON +B2EXPi

Assume that Ti is the threshold value of the dose for the Ath

organism. If the actual value of the dose Ti is greater than or equal

to the threshold value of the dose Ti then the ith organism is

killed. If T is less than Ti then the ith organism is not

killed. The coefficients in equation (5)--i.e., Bo, B1 and B2--are

estimated within the maximum likelihood technique.1 Because the maxi-

man' likelihood I(rathetr- th'an :least squares) technique is used, it is

not necessary to assume homoskedasticity (equal variance in the error


The above discussion may not have convinced the reader that

the probit statistical model is appropriate for the study of lead bank

status. Figure 5.5 is designed to erase any lingering doubts. On the

horizontal axis of Figure 5.5 is measured bank size and on the verti-

cal axis is measured whether or not the bank has chosen lead bank

1 In order to find the maximum likelihood coefficients, it is neces-
sary to solve a set of rather complicated non-linear equations. The
solutions (the maximum likelihood estimates) are calculated using the
Newton-Raphson method of iteration. An exposition of the maximum
likelihood solution and a sample calculation of the solution are con-
tained in James Tobin, "The Application of ~Multivariate Probit Analysis
to Economic Survey Data," Cowles' Foundation Discussion Paper No. 1,
1955 (unpublished).


Size of Bank

- 76 -

Bank Is a
Lead Bank 1

Bank Is Not
a Lead Bank 0


Figure 5.5

The Probit Line for Lead Bank Status

77 -

status.` As bank size increases, it' is thought that the chances of a

bank choosing lead bank status increase. Some hypothetical data

points are shown as dots on the figure. Essentially what the probit

technique does is to fit an S-shaped curve to the data points as

shown on the figure.



Using the probit statistical model, the model of lead bank

status was tested on the set of 58 potential lead banks listed in

Table A.2. The time period treated by the model is from 1963 through

1971 in terms of decision years or from 1964 through 1972 in terms of

decision years.

Interpreting the Probit Statistical Model

In order to assist one in interpreting the statistical

results, the probit model- is compared with the regression model.

Just as in regression analysis, the probit model assumes that the

dependent variable, lead bank status (LBS), may be expressed linearly

in terms of the explanatory variables, individual bank characteristics

(IBC) and environment (EE); i.e.,' LBS == BO+B IBC+B EE. In probit

analysis the parameters B B1 and B2 are estimated by the maximum

likelihood method while regression analysis uses the method of least

squares. There is no need to consider the maximum likelihood method

in detail. Suffice it to say that the method of maximum likelihood

gives estimators which have desirable properties and the estimators

are easy to find. For large samples, the maximum likelihood esti-

mates are approximately normally distributed. Because of this

approximate normality it is possible to estimate the standard error

for each coefficient and to calculate t-values for each

- 78 -

* 79 -


The_ Likelihood Ratio Test

In addition to the t-test, the likelihood ratio test may

be used to test hypotheses about the independent variables both

singly (say, IBC = 0) and in combination (say, IBC = 0 and EE = 0).

The likelihood ratio test is closely related to maximum likelihood

estimation and it is easily applied to the probit model which employs

the maximum likelihood technique.

The likelihood ratio is equal to the maximum of the likeli-

hood function when a parameter is not allowed to vary freely

(say, EE = 0) divided by the maximum of the likelihood function when

a parameter freely varies (say, EE # 0).

(1) Likelihood Ratio = A = max L, (EE 0)
max L (EE #~ 0)

Note that max L(EE = 0) will be smaller than or at most equal to

max L(EE # 0) because there is less freedom in maximizing the likeli-

hood function when the hypothesis requires that EE equal zero.

The likelihood ratio test is based on the fact that -21o81

is approximately distributed like chi square with the number of

The probability that a bank will become a lead bank is equal to
the probability that the bank s value for LBS exceeds its threshold
value for LBS. A key portion of the probit model is the assumption
that the threshold values for LBS are normally distributed. In
symbols, Y
Pr(LBS) = 2 e~ _2d
where Y = B0+B1B 2BEE.

- 80

degrees of freedom equal to the number of restrictions on the

parameters. If the likelihood ratio (i.e., -210gly is greater

than the tabled value of the chi-square distribution at some~chosen

level of significance, then the hypothesis of no relationship is

rejected.1 For example, if the likelihood ratio is greater than 2.71,

which is the value of chi .square at a .10 level of significance for

one degree of freedom, then one can reject the hypothesis that EE

equals zero and expect to be right nine out of ten times.

A Stepwise Testing Procedure

A kind of stepwise procedure was employed in testing the

model in order to avoid problems of multicallinearity2 and to con-

serve degrees of freedom. All of the independent variables were

tested one at a time. The more significant variables were then

tested using varying combinations of two variables and so on. In

addition, the initially significant variables were combined with all

other predictors in an attempt to detennine if initially unimportant

variables gained significance when combined with initially significant

In other words, the- critical region for -21ogX is the right-hand
tail of the chi-square distribution. For.a rigorous treatment of
this method, see Alexander Mood, Introduction to the Theory of
Statistics (New York: McGraw-Hill Book Co., 1950), pp. 257-259.
The problem of multicollinearity relates to the high covariance
between two estimators (say, Bl and B2). A principal cause of the
high covarianre is high correlation between the corresponding in-
dependent variables (say, X~ and X,). When multicollinearity exist
among the variables, it is difficult or even impossible to determine
the separate influences of the independent variables. As a result,
the estimated coefficients tend to be unstable and they are not overly

- 81


Table 6.1 enumerates the variables used and reports the

mean and standard deviation of each variable. The relatively large

standard deviation for the correspondent business variable is due to

the rather pronounced bimodal distribution of the variable. In

addition, the values of the CB variable are positively skewed. It

should also be noted that consumer loans include single payment loans

while instalment loans exclude single payment loans.

The Results for Single Predictors

The results of the model when the independent variables

were tested one at~ a time are shown in Table 6.2. Not unexpectedly,

the SZ variable proved to ~be a significant predictors of lead bank

status. Another significant predictor of lead bank status was the

variable for correspondent business. The coefficient had a positive

sign as hypothesized.

None of the loan portfolio measures appeared to be good

predictors of lead bank status.3 The very low likelihood ratio values

As an example of this procedure, see Tong Itun Lee, "Alternative
Interest Rates and the Demand for Money: The Empirical Evidence,"
American Economic Review, vol. 57 (December, 1967), pp. 1168-1181.
2---- --- ---
Throughout the discussion, the term "significant" is used to denote
statistical significance. In Table 6.2, both the t-value and the
likelihood ratio test the same hypothesis; namely, that the estimated
coefficient is not significantly different from zero. It is gratify-
ing to note that the two statistical tests produce consistent results.
The ratio of instalment loans to assets was also tried in place of
the consumer loan to asset ratio. (Recall that Lawrence had used the
former ratio and Talley the latter in studying the performance of
holding company affiliates.) The instalment loan to asset ratio was
not significant and had a negative sign whereas a positive sign had
been hypothesized.

- 82 -

Table 6.1

Identification of Variables with Means and Standard Deviations

Variables Mean Deviation

LBS. Lead bank status. LBS = 1 if
the bank is a lead bank;
LBS = 0 otherwise. .362 .485

SZ. Size of bank in terms of deflated
total deposits ($100 millions). .670 .593

CB. Correspondent business measured
by deflated due to balances
($10 millions). .468 1.298

L/A. Loan to asset ratio of bank
relative to loan to asset fatio
of market. 1.046 .159

CL/A. Consumer loan to asset ratio of
bank relative to consumer loan
to asset ratio of market. .984 .475

IL/A. Instalment loan to asset ratio
of bank relative to instalment
loan to asset ratio of market. .933 .422

CI/A. Commercial and industrial loan
to asset ratio of bank relative
to this ratio for the market. 1.037 .463

MS. Change in market share ~of the
bank over a five-year period. -.0098 .0202

ACT/BK. Holding company activity as
unasured by the change in holding
company control of banks in the
market over a two-year period. .123 .114

ACT/TD. Holding company activity as measured
by the change in holding company
control of total deposits in the
market over a two-year period. .134 .151

MI. Market importance as a financial
center as measured by the market's
share of total deposits in the
state. .102 .073

- 83 -

Table 6.2

Probit Model of Lead Bank Status Using Single Predictors

Ratio Value'






















Independent .

+ 2.122 SE

+ 2.649 CB

+ 0.297 L/A

+ 0.0086 CL/A

-0.605 IL/A

0.105 CI/A

+ 1.123 MS

-3.896 ACT/BK

-1.362 ACT/TD

+ 5.463 MI






== +0.200



=+0. 089



the hypothesis that the independent
effect upon holding company activ-

aThe likelihood ratio value tests

variable does not

have a systematic

** Significant at .05 level.
*** Significant at .01 level.

Note: The figures in parentheses are t-values for each estimated co-

- 84 -

and t-values for the variables L/A, CL/A and CI/A indicates that

they have no systematic influence upon lead bank status. One may

conclude, at least for Florida banks, that lead banks are not espec-

ially aggressive in seeking loan business. Furthermore, one cannot

characterize lead banks as either wholesale-oriented or retail-

oriented .

The market share variable is not a significant predictor.

Given the very low likelihood ratio value, one may conclude that

changes in a bank's relative standing in its local market do not

influence the bank's decision regarding lead bank status.

The variable ACT/BK, which is used to test the encroachment

hypothesis, is significant with a negative sign.1 The variable

ACT/TD, which measures encroachment in terms of holding company

control of deposits, has a negative sign but it is not statistically

significant. These results imply that encroachment by holding

companies does not provoke a bank to form a holding company. It is

possible that encroachment influences banks to join holding companies

rather than form them.

Some care must be exercised in interpreting this result

because only ten out of the thirty-seven banks which were not lead

banks at the end of 1972 had made the decision to become subsidiaries

of holding companies. Of the twenty-seven banks that have not made

1Racall that it was not possible to determine a priori the sign for
the variable ACT/BK but it was felt that an encroachment variable
could help explain the snowballing of multibank holding company
af filiations .

- 85-

an overt decision it appears probable that most of these banks will

join existing holding companies. A few of these banks, especially the

one bank holding companies associated with large non-bank organiza-

tions, will likely remain independent.

The variable for market importance was statistically signifi-

cant at the .05 level of confidence. The variable has a positive

direction of influence as was originally postulated.2

The Results for Several Predictors

All of the significant predictors3 were paired with each

other and with each initially non-significant predictor. None of the

initially non-significant predictors gained significance when combined

with initially significant predictors.

The results from pairing the significant variables are pre-

sented in Table 6.3. Because of the high correlation between size and

correspondent business (0.93) the coefficients for the two variables

are not overly reliable. It is possible, however, to compare the

relative significance of the two variables. Given that the variable

SE is already present in the equation, the addition of the variable CB

1It may be that a potential lead bank has made the decision to remain
unaffiliated. However, there is no way to distinguish such a bank from
a bank that has made no decision one way or the other. Of course, the
decision to remain unaffiliated is revocable while the decision to be-
come affiliated, once consummated, is not revocable.
2 The reader should not suspect a spurious relationship because of the
fact that the largest banks come from the most important financial
centers. The most important financial centers also supplied the great-
est number of medium-large banks. For example, Dade County, which is
the most important financial center in Florida with 22.6 percent of
state deposits, supplied 13 of the potential lead banks, which is 22.4
percent of the total number of 58 banks.
SThe significant predictors from Table 6.2 are SZ, CB, ACT/BK and MI.

The likelihood ratio value tests the hypothesis that the two
variables jointly do not have a systematic effect upon holding company
** Significant ~at .05 level.
*** Significant at .01 level.

Note: The figures in parentheses are t-values for each estimated

-' 86 -

Table 6.3

Probit Model of Lead Bank Status Using Two Predictors


Ratio Valuea

Independent Variables


LBS = -1.224 + 0.697 SZ

LBS = -1.239 + -2.212 SZ

LBS = -2.351 + 2.236 SZ

LBS = -0.394 + 3.592 CB

LBS = -1.633 + 2.991 CB

+ 2.362 CB

-4.147 ACT/BK

+ 5.806 MI

-5.542 ACT/BK

+ 6.442 MI






LBS =-0.482

4.139 ACT/BK +

5.750 MI 11.57***~k

- 87 -

increases the likelihood ratio by 6.47, which is significant at the

.05 level of confidence so one can reject the null hypothesis that

CB = 0, given that SZ is already included in the equation. When the

variable CB is entered first, the addition of the size variable in-

creases the likelihood ratio by only 1.02, which is not significant

at the .05 level of confidence. It is possible to conclude that both

variables supply much of the same information but that the correspond-

ent business variable provides information over and above the informa-

tion contained in the size variable while the reverse is not true.2

The two variables ACT/BK and MI appear to provide added

information. Whether combined with each other or when paired with the

variables SZ or CB, these variables increase the likelihood ratio by a

significant amount.

The final equations for the model of lead bank status are

listed in Table 6,4.3 The two equations are highly significant and

the signs of all the coefficients are correct. One may conclude that

the larger is a bank's size and correspondent business, the higher will

be the probability that the bank chooses lead bank status. If the

bank's market is an important financial center, this will increase the

1With the SZ variable in the equation, the likelihood ratio value is
13.87 (see Table 6.1). With the addition of the CB variable, the
ratio rises to 20.34, an increase of 6.47.
2The t-values for the two variables confirm the finding that the CB
variable is relatively more significant than the SZ variable.
The equations are final in the sense that the addition of a fourth
variable does not increase the likelihood ratio by a statistically
significant amount, with one exception. The sole exception is when the
variable CB is added to the first equation of Table 6.4. However, the
high collinearity between the SZ variable and the CB variable makes it
inappropriate to include both variables in the same final equation.

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