Abstract

: In the 1980s, U.S. banks became systematically less profitable and riskier as nonbank competition eroded the profitability of banks' traditional activities. Bank failures, insignificant from 1934, the date the Glass-Steagall Act was passed, until 1980, rose exponentially in the 1980s. The leading explanation for the persistence of these trends centers on fixed rate deposit insurance: the insurance gives bank equity holders an incentive to take on risk when the value of bank charters falls. We propose and test an alternative explanation based on corporate control considerations. We show that managerial entrenchment, more than moral hazard associated with deposit insurance, explains the recent behavior of the banking industry. I. Introduction During the 1980s bank profit, whether measured by accounting return on equity, return on assets, or by market value, declined steadily. Figure 1 shows the accounting return on assets. 1 Not only did banking become less profitable, it ...

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