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For many years, MBA students were taught that there was no good reason for companies that hedge large currency or commodity price exposures to have lower costs of capital, or trade at higher P/E multiples, than comparable companies that choose not to hedge such financial price risks. Corporate stockholders, just by holding well‐diversified portfolios, were said to neutralize any effects of currency and commodity price risks on corporate values. And corporate efforts to manage such risks were accordingly viewed as redundant, a waste of corporate resources on a function already performed by investors at far lower cost. But as this discussion makes clear, both the theory and the corporate practice of risk management have moved well beyond this perfect markets framework. The academics and practitioners in this roundtable begin by suggesting that the most important reason to hedge financial risks—and risk management's largest potential contribution to firm value—is to ensure a company's ability to carry out its strategic plan and investment policy. As one widely cited example, Merck's use of FX options to hedge the currency risk associated with its overseas revenues is viewed as limiting management's temptation to cut R&D in response to large currency‐related shortfalls in reported earnings. Nevertheless, one of the clear messages of the roundtable is that effective risk management has little to do with earnings management per se, and that companies that view risk management as primarily a tool for smoothing reported earnings have lost sight of its real economic function: maintaining access to low‐cost capital to fund long‐run investment. And a number of the panelists pointed out that a well‐executed risk management policy can be used to increase corporate debt capacity and, in so doing, reduce the cost of capital. Moreover, in making decisions whether to retain or transfer risks, companies should generally be guided by the principle of comparative advantage. If an outside firm or investor is willing to bear a particular risk at a lower price than the cost to the firm of managing that risk internally, then it makes sense to lay off that risk. Along with the greater efficiency and return on capital promised by such an approach, several panelists also pointed to one less tangible benefit of an enterprise‐wide risk management program—a significant improvement in the internal corporate dialogue, leading to a better understanding of all the company's risks and how they are affected by the interactions among its business units.

Consolidation in the banking industry has sparked concern about the survival of small banks, particularly as it relates to the availability of credit to small businesses. However, if small banks have an advantage in processing credit information, compared to large banks, they should continue to survive in a competitive environment. We evaluate risk-adjusted commercial loan yields (gross yields less net charge-offs and the risk-free rate of return) at small and large banks for the period of 1996 through 2001. Our primary finding is that, after controlling for market concentration, cost of funds, and a variety of other factors that might influence yields, smaller banks earn greater risk-adjusted yields than larger banks. This result suggests that small banks make better choices from the available small business loans and is consistent with the notion that these banks have an information advantage in evaluating credit.

A number of studies and banking practitioners have questioned the ability of small banks to survive in a deregulated environment. We consider the hypothesis that small community banks actually have an information advantage in evaluating and monitoring loan quality. We call this the information advantage hypothesis (IAH). We evaluate four loan quality measures for a sample of all Florida banks for the period 1986 to 1996. There is no systematic evidence that loan quality is greater at small banks. Both net chargeoffs and loan loss provisions are lower at small banks in non metropolitan areas than at other banks, which is consistent with the IAH. However, other measures of loan quality—nonperforming loans and other real estate owned—are higher at small banks.

Economics is the mother discipline of both marketing and finance. In recent years, marketing researchers have largely looked to scholars in psychology and sociology for inspiration. The economic roots of marketing are sometimes forgotten. One way to recapture this lost heritage is by turning to the sister discipline of finance, an area of inquiry that has made great strides in terms of applying economic principles to business problems. The purpose of this special issue is to explore the interface between marketing and finance. The following essay provides an introduction to this issue. It also provides a background for thinking about the ways in which the two disciplines diverge and the ways in which they are complementary.

In a widely cited 1986 article in the American Economic Review, Michael Jensen gave the concept of free cash flow (FCF) a new twist by redefining it as cash flow in excess of that required to fund all projects with positive net present values. Put another way, FCF represents funds available in the firm that managers may choose to hold as idle cash, return to shareholders, or invest in projects with returns below the firm's cost of capital. In redefining FCF in this way, Jensen converted FCF from a measure of economic income and value into a measure of corporate assets available for discretionary, and potentially value-destroying, use by firm managers. And, as he argued in his important article, managers in mature businesses with substantial free cash flow have a tendency to destroy value by plowing too much capital back into those businesses or, often worse, making ill-advised acquisitions in unrelated businesses. Several methods have been developed in financial markets and internal corporate governance systems to discourage managers from wasting FCF. Better monitoring by boards of directors, large ownership blocks, and properly aligned management compensation contracts are all parts of the solution. And the extraordinary increase in stock repurchases in recent years, invariably applauded by investors, is another illustration of the market's success in encouraging companies to address their free cash flow problems. But if the “FCF problem” of the private sector has attracted considerable attention from finance scholars, the problem is even more acute in the public sector, where FCF can be thought of as tax revenue in excess of what is required to finance well-defined and generally accepted levels of public services. Unlike the private sector, in the public sector there are neither measures nor mechanisms by which to monitor and constrain wasteful spending by elected officials. In this article, the authors attempt to measure the costs to taxpayers of government FCF using the case of Alaska, which since 1969 has received a huge windfall of tax revenue from North Slope oil leases. After examining the state's public finances from 1968 through 1993, the authors offer $25 billion as a conservative estimate of the social losses from Alaska's waste of free cash flow during that 25-year period.

Whether pure contagion is more likely to occur when a federal deposit insurer is severely undercapitalized is an unanswered question. This paper provides evidence on this issue by examining the stock market reaction of savings and loans (S&Ls) to the crisis of Financial Corporation of America (FCA) in 1984, when the Federal Savings and Loan Insurance Corporation was fiscally unsound. Consistent with a contingent insurance guarantee hypothesis, the results show large, significant negative abnormal returns (ARs) for a portfolio of high insured deposit S&Ls during FCA's crisis.

This article examines failure rates in de novo S&Ls that initiated operations during the 1980–1986 period. Overall failure rates are similar to those for existing institutions but are found to vary significantly by location, time of charter, and organizational form. Both univariate tests and results from a probability-of-failure model indicate that inadequate capital, economic stress, poor management of higher risk lending allowed by broader powers, and operating inefficiencies contributed significantly to the likelihood of failure. Use of brokered funds and rapid asset growth are also significantly related to failure likelihood. Interestingly, for those S&Ls which eventually failed, rapid asset growth and high proportions of nonperforming assets actually delayed the timing of their failure. We interpret this to be the result of regulatory forbearance. We also find significant differences between the financial characteristics of de novo and non-de novo S&Ls.

This study examines efforts being made by commercial banks to satisfy their obligations under the Community Reinvestment Act while at the same time responding to changes in their economic and competitive environments. Banks are being directly and indirectly mandated by outside forces to find ways to serve all segments of their markets. What one could consider the banks' choices or prerogatives, such as served markets, selection and pursuit of desired market niches, differentiation strategies, and positioning alternatives, are all being affected by outside regulatory forces. In an effort to identify the marketing-related factors that differentiate the two groups, this study compares the policies and characteristics of those institutions that are satisfying their regulatory obligations to those institutions that are not satisfying their obligations. © 1995 John Wiley & Sons, Inc.

This paper examines the savings and loan (S&L) equity market reaction to the 1985 Ohio S&L Crisis. In contrast to the expectation of negative abnormal returns associated with contagion, the authors find, during the crisis period, significant positive abnormal returns that are larger for a portfolio of less solvent S&Ls, and a significant decline in systematic risk. The results are consistent with an insurance subsidy hypothesis whereby news of the FSLIC's inadequacy in conjunction with the crisis signaled greater future reluctance by regulators to close large federally-insured S&Ls.

This paper develops a simultaneous equation model to investigate the investment policies, financing policies, and risk/return characteristics of de novo thrift institutions. A model to explain state entry rates for de novo institutions is also presented. Entry dates are significantly influenced by investment powers as the numbers of de novo charters are found to be significantly higher in states with the most liberal set of permissible activities. Economic growth and the demand for financial services also contributed to higher entry rates. Utilization of the liberal powers did not, however, contribute positively to returns. Firms with riskier asset portfolios were found to have lower realized returns. Efficiency in operations and strong capitalization were found to be positively associated with higher returns.

Consolidation in the banking industry has sparked concern about the survival of small banks. However, if small banks are better at processing credit information than large banks, they should continue to survive in a competitive environment. We evaluate risk-adjusted commercial loan yields (gross yields less net charge-offs and the risk-free rate) at small and large banks for 1996 through 1999. We find that risk-adjusted yields fall as the proportion of small business loans (i.e., original amounts less than $1 million) increase. However, smaller banks earn greater risk-adjusted yields than larger banks. Our results suggest that small banks make better choices from the available small business loans. This finding is consistent with the notion that these banks have an information advantage in evaluating credit and adds to our understanding of the intermediation process.

This study investigates scale economies in the savings and loan (S&L) industry prior to deregulation. Use of the translog cost function permits the estimation of U-shaped cost curves and of separate scale and branch size eonomies. The model also allows the cost elasticities to vary by size of financial institution. The model is estimated on a large nationwide sample of savings and loan associations. The results indicate significant economies of scale over a wide range of output for institutions that engage in traditional specialized activities.

NEOCLASSICAL MICROECONOMIC THEORY traditionally has assumed that the decision process in the firm is guided by the objective of profit maximization. A number of economists have suggested, however, that managers may pursue goals which maximize personal utility rather than firm profitability [1, 10, 11, 23, 24]. Conditions under which managerial discretion may be substituted for profit maximization include weak competition in the product or service market, a high degree of regulation, and the separation of ownership and control. Under these conditions, managers have greater opportunity to indulge in discretionary expenditures and the pursuit of managerial emoluments. That is, managers may seek to achieve a higher level of personal utility via higher salaries, additional staff, and other perquisites for which they have positive preferences. In general, this results in an expansion of expenditures beyond the profit-maximizing level and a suboptimal (X-inefficient) use of resources within the firm. The expense-preference theory of the firm recently received considerable support by the work of Edwards [3] in which he developed a test to distinguish between expense-preference and profit maximizing behavior. Upon application of this test to the banking industry, Edwards found that the number of employees and bank expenditures on wages and salaries are higher in noncompetitive banking markets

In this paper, stock prices for savings institutions that have converted to the stock form of organization are examined. Event-study methodology is used to focus on the returns to initial shareholders in the period immediately following initial trading. The results of the study indicate significant positive returns in savings institution conversions in the first several trading days, suggesting a one-time wealth transfer from depositors not exercising their rights to initial shareholders. The results also provide support for the efficiency of the market as the market price adjusts quickly in the first two days of trading after the public offering. Given the FHLBB's objectives, there appears to be little cause for regulatory concern although initial returns are significant.

The purpose of this study is to investigate the determinants of savings and loan profitability. Although considerable discussion has been devoted to studying the cyclical behavior of thrift institution profitability, there is a void with respect to the determinants of individual association profitability. This paper investigates whether performance variations are more determined by differences in the individual association's financial characteristics than by the external factors of the market in which they operate, such as state usury laws, market structure, and other economic characteristics of market areas.

A MULTIVARIATE ANALYSIS OF STOCK VERSUS MUTUAL PERFORMANCE IN THE SAVINGS AND LOAN INDUSTRY

the effects of the money supply and interest rates on sub-aggregates of investment expenditure. General theoretical agreement exists that the monetary transmission process involves portfolio adjustments by various spending units in response to Federal Reserve actions. After a series of portfolio substitutions, the effects of monetary policy are ultimately felt on income and employment. Important differences remain, however, between the monetarist and neo-Keynesian versions with respect to the key variables in the transmission mechanism. Monetarists emphasize that spending units respond to discrepancies between desired and actual money balances by changing their rate of spending. Thus the major variable in the monetary mechanism is the money supply which ultimately affects expenditures on the