An analysis of bank charter value and its risk-constraining incentives

Valuable bank charters have been hypothesized to provide bank managers self -regulatory incentives to constrain their risk taking. However, this paper presents evidence that charter value itself may derive from high-risk activ ities, indicating that minimizing risk taking also would limit the value of the charter. During economic expansions, bank charter values increase to r eflect growth opportunities. In turn, high-charter-value banks gain easier access to equity capital sources for expansion. The result is a positive re lationship between charter value and capital ratios during expansions. Howe ver, this relationship may invert during economic contractions. Panel regre ssions demonstrate that the charter value and bank leverage relationship is sensitive to market conditions.