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Cost of Capital and Dividend Policies in Commercial Banks

Published online by Cambridge University Press:  19 October 2009

S. D. Magen
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Extract

The purpose of this study is to analyze the behavior of the cost of equity capital in the commercial banks by looking at whether there exists an optimal composition of the bank “fund structure” that would maximize bank earnings through the minimization of its cost of funds. The analysis should give an approximate cut-off point for testing such projects as “checking plus,” checkless payment systems, etc.

Type
Financial Institutions
Information
Journal of Financial and Quantitative Analysis , Volume 6 , Issue 2 , March 1971 , pp. 733 - 746
Copyright
Copyright © School of Business Administration, University of Washington 1971

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References

1 Since deposits constitute a considerable percentage of bank resources, and the term capital structure has been used in the literature to define the combination of owners equity and long-term debt in industrial and mercantile firms, it is more appropriate to use the term fund structure for the banks as a substitute for the term capital structure.

2 Modigliani, Franco and Miller, Merton, “The Cost of Capital Corporation Finance and The Theory of Investment,” American Economic Review (June 1958) pp. 261–297.Google Scholar

Durand, David, “The Cost of Capital Corporation Finance” and the “The Theory of Investment: Comment,” American Economic Review (September 1959) pp. 639–654.Google Scholar

Durand, David, “The Cost of Debt and Equity Funds for Business,” and discussion by Clay J. Anderson and Martin W. Davenport in Conference on Research in Business Finance (New York: National Bureau of Economic Research, 1952) p. 254.Google Scholar

Solomon, Ezra, The Theory of Financial Management (New York: Columbia University Press, 1963).Google Scholar

Weston, J. Fred, “A Test of Cost of Capital Propositions,” The Southern Economic Journal (October 1963) pp. 52–64).Google Scholar

3 Wippern, Ronald, “Financial Structure and the Value of the Firm,” The Journal of Finance (December 1966), p. 619. For definition of i/NOEBIT and i/E–2s, see pp. 9 and 10.Google Scholar

4 By “the same degree of government regulation,” it is meant the extent of supervision by the F.R. System and other regulatory agencies as to safety and reserves requirements. The paper does not consider the matters of branchings and impact on competitiveness, or the variety of regulations governing states versus national banks.

5 The banks were classified into the three categories based on the general knowledge of bankers.

6 Modigliani and Miller, J“The Cost of Capital,” p. 261–97.

7 Barges, Alexander, The Effect of Capital Structure on the Cost of Capital (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1963). p. 22.Google Scholar

8 R. Wippern, “Financial Structure,” p. 619. Wippern included dividends on preferred stock in the numerator of the ratio.

9 Other possible and equally acceptable measurements would have been the dividend yield on either book or market value. To keep the scope of this study within manageable proportions, it was decided to restrict the measurements of the dependent variable to these two estimators.

10 Benishay, Haskel, “Variability in Earnings-Price Ratios of Corporate Equities,” American Economic Review (March 1961). pp. 81–94.Google Scholar

11 Wippern, R., “Financial Structure,” p. 621, and Brigham, E. and Gordon, Myron, “Leverage, Dividend Policy and the Cost of Capital,” Journal of Finance, (March 1968), pp. 98–99.Google Scholar

12 Durand, David, “Bank Stocks and the Analysis of Covariance,” Econometrica, (January 1955), pp. 30–45.CrossRefGoogle Scholar