The Effects of Deregulation on Bank Stock Price-Earnings Ratios

Abstract

Major exogenous events (often legislative) can result in significant (and possibly permanent) structural changes in the price-earnings ratios (P/Es) of companies in a particular sector of the economy. In an era of increasing deregulation, it is important to develop a framework for estimating the impact of deregulation on measures of market capitalization such as P/E. This study addresses these concerns, focusing on the banking sector. Specifically, we (1) estimate the P/Es of banks with more than one billion dollars of total assets during the 1976-85 period and (2) assess the impact of the Depository Institutions Deregulation and Monetary Control Act of 1980 (hereafter DIDMCA) on those P/Es by running full 10-year regressions with dummy variables and by running separate regressions on the pre-DIDMCA and postDIDMCA data and testing for structural changes in the estimators. Theory and previous empirical work suggested that we test approximately 50 different variables as estimators of bank P/E.1 These variables were broadly classified into the following eight categories-(1) growth variables, (2) payout, (3) transitory earnings, (4) lagged P/E ratios, (5) risk variables, (6) interest rates, (7) DIDMCA and (8) miscellaneous financial ratios.