Review of Quantitative Finance and Accounting, 23: 191–206, 2004
2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
The Impact of Capital Requirements and Managerial
Compensation on Bank Charter Value
Department of Finance and Economics, Rutgers Business School-Newark and New Brunswick, 94 Rockafeller
Road, Piscataway, NJ 08854-8054, USA, Tel: (732) 445-2306
Quinnipiac University, School of Business, 275 Mount Carmel Avenue, Hamden, CT 06518, Tel: (203) 582-3647
Abstract. This paper examines the joint impact of capital requirements and managerial incentive compensation
on bank charter value and bank risk. Most of the previous literature in the area of banking and agency theory
has focused on asymmetric information between either banks and regulators, (and therefore on the role of bank
capital), or between bank shareholders and bank managers, (and therefore on the role of managerial ownership).
In this paper we unify these issues and present empirical results from the regression of capital requirements jointly
with measures of incentive compensation on Tobin’s Q, our proxy for bank charter value, and on the standard
deviation of total return, our proxy for bank risk. In a sample of 102 bank holding companies we ﬁnd that capital
levels are consistently a signiﬁcant positive factor in determining bank charter value and a signiﬁcant negative
factor in determining risk. On the other hand, we ﬁnd our six measures of incentive compensation to be generally
insigniﬁcant relative to charter value but do provide some evidence consistent with a theory relating types of
incentive compensation with risk.
Keywords: banking, capital requirements, incentive compensation
JEL Classiﬁcation: G21, G32
In banking literature the term “charter value” is the term most often used to refer to the
intrinsic value of the ﬁrm. A bank’s charter value is the present value of its future economic
proﬁts as a going concern. It is the bank’s future proﬁt-generating potential arising from such
things as efﬁciency, market power and customer relationships. As in the general corporate
ﬁnance literature it is often proxied by Tobin’s Q. The term “charter value” arises out of
the value created when a bank obtains the ability (i.e. receives a charter) to operate in a
regulated environment. Banking legislation that limits competition provides market power
to approved banking organizations and thereby creates value.
Charter value has been extensively reviewed for its impact on bank risk-taking. Marcus
(1984) argued that research in banking that focuses on exploitation of the federal safety
We thank an anonymous referee for helpful comments.