A Generalized User-Revenue Model of Financial Firms under Dynamic Uncertainty:Equity Capital, Risk Adjustment, and the Conjectural User-Revenue Model

A generalized user-revenue model is proposed in which the volatility risk of quasi short-run profits and equity capital effects reflecting the risk of bearing the costs of financial distress are taken into consideration. This is achieved by extending the conjectural user-revenue model proposed by Homma and Souma (2005). Specifically, uncertainties are added to endogenous holding-revenue and holding-cost rates, and the utility function of financial firms is formulated in terms of both quasi short-run profits and equity capital. The conjectural user-revenue price is extended as a generalized user-revenue price, and the extended generalized-Lerner index is proposed to incorporate these extensions

Competition on the Cost Frontier and Intertemporal Regular Linkages: Theoretical Implications of the Efficient Structure and Quiet-Life Hypotheses

This paper explores theoretical implications of the efficient structure and quiet-life hypotheses on the basis of the generalized user-revenue model constructed by Homma (2009, 2012). From the perspective of the extended generalized-Lerner index (EGLI) on the cost frontier, the following two points are noteworthy: 1) it is not always possible to justify anti-monopoly and anti-concentration policies using support for the quiet-life hypothesis; and 2) new industrial organization policies are required if support for the efficient structure hypothesis is undesirable. Furthermore, where intertemporal regular linkage of single-period EGLIs on the cost frontier exists, the appropriate industrial organization policies must be determined based on a long-term perspective. If this linkage shows an upward trend caused mainly by an upwardly trending intertemporal regular linkage of single-period Herfindahl indices, then anti-monopoly and anti-concentration policies are justified from a long-term perspective. If the upward trend of the intertemporal regular linkage of single-period EGLIs on the cost frontier is, however, caused mainly by the intertemporal regular linkage of single-period dynamic cost efficiencies or single-period optimal planned financial goods, then other policies are desirable because in this case anti-monopoly and anti-concentration policies cause unnecessary distortion in the economy

A Generalized User-Revenue Model of Financial Firms under Dynamic Uncertainty : An Interdisciplinary Analysis of Producer Theory, Industrial Organization, and Finance

In the present paper, we apply the generalized user-revenue model (GURM) presented by Homma (2009) to Japan’s banking industry and perform an analysis fusing producer theory and industrial organization theory (applied microeconomics) and finance (asset pricing theory). Basically, while basing the approach on the GURM, we derived the generalized user-revenue prices (GURPs) and the extended generalized Lerner indices (EGLIs), organized their theoretical characteristics from an interdisciplinary analytical perspective, applied the GURM to Japanese city banks, and estimated the GURPs and the EGLIs. These efforts provided material for thinking about the necessity of risk-adjustment policies as part of the industrial organization policy in the banking industry. Based on the EGLI estimation results, regarding the components of the EGLIs (in terms of absolute value), the risk-adjustment effects are the largest, followed by the equity capital effects, and the market structure and conduct effects are the smallest. This is the same as the results for the GURPs, so there is pressure to review conventional competition policy, which considers primarily the market structure and conduct effects. It has been pointed out that switching from a competition policy to a risk-adjustment policy is necessary, so specific measures in risk-adjustment policy that have not yet been considered must be taken into account. Furthermore, the injection of public funds dramatically improved (decreased) the risk-adjustment effects of the EGLI for long-term loans and dramatically increased the degree of competition in the long-term loan market

Competitive Pressure and Intertemporal Linkages : A New Definition and Theoretical Expansions

Based on the generalized user-revenue model constructed by Homma (2009, 2012, 2018, 2021), this paper clarifies the relation between competitive pressure and the efficient structure and quiet-life hypotheses, and examines the intertemporal linkages and long-term competitive pressure when the sufficient condition for competitive pressure holds for the long term. Given that the source of this competitive pressure is the possibility of a decrease in quasi-short-run profits, the essence of the pressure is the increase in dynamic cost efficiency driven by that possibility. Competitive pressure defined from this point of view comes into existence when the efficient structure and quiet-life hypotheses are accepted and the two hypotheses have opposing implications with respect to industrial organization policy. From this perspective, the existence of such pressure is desirable insofar as the extended generalized-Lerner index (EGLI) on the cost frontier decreases (i.e., the degree of competition on the cost frontier increases). Indeed, if no competitive pressure exists, then there is the possibility that accepting the efficient structure hypothesis is undesirable with regard to industrial organization policy. Furthermore, when the derived sufficient condition for competitive pressure holds for the long term, there are a linkage between current and future improvements in the dynamic cost efficiencies, a linkage between current and future decreases in the EGLIs on the cost frontier, and long-term competitive pressure (i.e., a linkage between a previous decrease in the EGLI on the cost frontier and future improvements in dynamic cost efficiency)

Competition and Efficiency in the Regional Banking Industry: Empirical Implications of the Quiet-Life Hypothesis

Based on the generalized user-revenue model constructed by Homma (2009, 2012, 2018), this paper clarifies the empirical implications of the quiet-life hypothesis in the Japanese regional banking industry. The quiet-life hypothesis is accepted here but the efficient structure hypothesis is not. Moreover, the extended generalized-Lerner index (EGLI) on the cost frontier increases with the Herfindahl index in the previous period if and only if the quiet-life hypothesis is accepted, so it is possible to justify anti-monopoly and anti-concentration policies using support for the quiet-life hypothesis. Furthermore, intertemporal regular linkages (i.e., cyclical linkages) exist because the average loans are not large and only the quiet-life hypothesis is accepted. However, the linkage of the single-period EGLIs of the long-term loans on the cost frontier leads to convergence and is fixed at the very large values in the initial periods; thus, the linkage is judged to be undesirable to Japanese regional banks, similar to the linkages of single-period dynamic cost efficiencies and single-period optimal financial goods

Firm Growth and Efficiency in the Banking Industry : A New Test of the Efficient Structure Hypothesis

In this paper we propose a new test of the efficient structure (ES) hypothesis, which predicts that efficient firms come out ahead in competition and grow as a result. Our test has significant advantages over existing ones, because it is more direct, and can jointly test the so-called quiet-life hypothesis, which predicts that in a concentrated market firms do not minimize costs. We then apply this test to large banks in Japan. Consistent with the ES hypothesis, we find that more efficient banks become larger. We also find that market concentration reduces banks’ efficiency, which supports the quiet-life hypothesis. These findings imply that there is an intriguing growth-efficiency dynamic throughout banks’ life cycle, although our findings also suggest that the ES hypothesis dominates the quiet-life hypothesis in terms of economic impact

Firm Growth and Efficiency in the Banking Industry : A New Test of the Efficient Structure Hypothesis

This paper proposes a new test of the efficient structure hypothesis by directly examining the relation between firm efficiency and firm growth. This is also a test of the so-called quiet-life hypothesis.Applying this test to large banks in Japan, we find that more efficient banks become larger, which is consistent with the efficient structure hypothesis. We also find that market concentration reduces banks’ cost efficiency, which is consistent with the quiet-life hypothesis. These findings imply that there is an intriguing growth-efficiency dynamic throughout the life cycle of banks, although yet another finding suggests that the economic impact of the quiet-life hypothesis is less significant than that of the efficient structure hypothesis

A Conjectural User-Revenue Model of Financial Firms under Dynamic Uncertainty: A Theoretical Approach

This paper extends the user-cost approach of Hancock (1985, 1991) in two ways. First, our model allows financial firms to behave strategically as well as competitively. Second, we do not assume that financial firms are risk-neutral.Our main object is to derive the index of the degree of competition under dynamic uncertainty using this extended model. In our model, the classification of financial goods into inputs and outputs is always consistent with the classification based on the sign of each of the partial derivatives of the variable cost function with respect to financial goods