Review of Industrial Organization 12: 23–35, 1997.
1997 Kluwer Academic Publishers. Printed in the Netherlands.
Market Share Inequality, the Number of
Competitors, and the HHI: An Examination of Bank
TIMOTHY H. HANNAN
Stop 149, Federal Reserve Board, Washington DC 20551, U.S.A.
Abstract. This paper seeks to determine whether the Herﬁndahl–Hirschman index (HHI) adequately
accounts for the roles of market share inequality and the number of competitors in explaining bank
deposit and loan rates. This is been done by estimating deposit-rate and loan-rate equations in which
the HHI is decomposed into components that reﬂect share inequality and number of competitors and,
alternatively, by adding measures of share inequality and the number of competitors as additional
explanatory variables. Results are inconclusive in the case of deposit rates but suggest that the HHI
does not give sufﬁcient weight to the number of competitors in explaining loan rates.
Key words: Banking, competition, antitrust.
The Herﬁndahl–Hirschman Index (HHI) is the most frequently used measure of
market concentration both in research focusing on the relationship between market
structure and ﬁrm performance and, particularly, in the assessment of the com-
petitive impacts of proposed mergers. Since 1982, it has played a central role in
the Justice Department’s merger guidelines, and the Federal Reserve Board uses it
as a screen to determine which proposed banking mergers should be investigated
further in assessing the merger’s competitive impact.
Deﬁned as the summation of squared market shares of all ﬁrms in a market,
the index increases in value as the shares of ﬁrms in the market become more
unequal or as the number of ﬁrms in the market decreases.
Thus, the index reﬂects
differences in share inequality and numbers of competitors, but the question arises
as to whether it does so in an appropriate manner.
As noted recently by Rhoades (1995), there exists substantial cross-market vari-
ation in market share inequality among markets with similar HHI’s. Using a large
Federal Reserve Board. The viewsexpressed herein are those of the author and do not necessarily
reﬂect the views of the Federal Reserve Board or its staff.
For a description of the Federal Reserve Board’s use of the HHI, see Rhoades (1993, 188–189)
or any published Board order on a bank merger application since 1982.
The index can vary from near zero to 10,000 if shares are expressed as percentages and from
near zero to one if shares are expressed in decimal form.