Expense-Preference Behavior in Banking: A Reexamination

Abstract

In a recent issue of this Journal, Franklin Edwards develops a test designed to distinguish between expense-preference and profitmaximizing behavior and applies it to the banking industry. Using a pooled time series of aggregate SMSA data, he finds that both the number of banking employees and bank wage and salary expenditures are greater in banking markets exhibiting monopoly power, indicating "that an expense-preference model may be a more useful framework for describing and predicting bank behavior than is the traditional profit-maximization model" (Edwards 1977, p. 158). This finding is suggested to have relevance to regulated firms in general. The present paper reports a further empirical test of expensepreference behavior in banking-one based on different and in many respects superior data. Reported estimates are found to be consistent with predictions of the expense-preference hypothesis as derived from Edwards's model and in fact conform reasonably well to estimates reported by Edwards. Two empirical findings, however, bring some of the assumptions underlying Edwards's model into question. The data employed in this study describe 49 different local banking markets and the behavior of 367 individual banks in the state of Pennsylvania during 1970. This data set differs from that used by Edwards in a number of respects. Most important, it allows observation of the behavior of individual banks rather than the SMSA aggre-