Multi-Market Interdependence and Local Market Competition in Banking

Abstract

C LEARLY, one of the most significant institutional developments affecting the organization of American industry in recent years has been the trend toward diversification. Many important industries have been restructured as single product firms have been replaced (often by acquisition) by large conglomerates producing scores of diverse products. The rapid emergence of the conglomerate form of business organization has raised fundamental questions regarding the implications of this trend for the market system-a system in which interfirm competition is the basic regulating device.1 There has been a great deal of controversy within the economics and legal professions about the long-run implications of conglomerate firms for economic performance.2 This is due, in large part, to the fact that there is no theoretical framework and no general empirical evidence that is relevant to the intermarket relationships of multi-product firms. The shortcomings of theory arise from the fact that traditional microeconomic theory focuses only on the interrelationships of firms operating in the same market, while the lack of empirical evidence stems from the fact that appropriate micro level data for testing generally are not available. Although the lack of theoretical framework and data generally has precluded systematic analysis of the competitive effects of diversification,3 a number of intuitively appealing and workable hypotheses have been developed in connection with the conglomerate form of business organization. This study tests one of the major hypothesized consequences of conglomerate dominance-the development of mutual forbearance. The hypothesis holds that conglomerate firms that meet in many markets will develop a and let live philosophy since action initiated in any market may induce retaliation in other markets where they are more vulnerable.4 As a consequence, the prevalence of conglomerate firms will mean a reduction in rivalry even in markets with a relatively competitive structure based on traditional measures of market structure. This study uses a multiple regression model to analyze the relationship between market rivalry and intermarket contacts of dominant firms. The study develops a simple model that illustrates the implications of the mutual forbearance hypothesis and discusses the hypothesis in the context of commercial banking. It then sets out the estimating equation and develops a variable that is designed to capture the degree of intermarket contact among dominant firms. Additional variables are developed and used along with the intermarket contact variable in a regression analysis that covers a sample of 187 major banking markets. The study focuses upon the commercial banking industry because it is characterized by firms with relatively homogeneous product mixes that operate in a variety of relatively well defined geographic markets. Furthermore, and of particular importance, the necessary micro level data are available. Finally, the issue is highly relevant in banking today.5 However, by focusing upon the banking industry the results may be subject to question in two respects. First, it may be argued that the diversification subject to investigation in this study is Received for publication December 22, 1976. Revision accepted for publication June 7, 1977. * University of Florida and Board of Governors, Federal Reserve System, respectively. Support from the Center for Public Policy Research at the University of Florida and from the Board of Governors of the Federal Reserve System is gratefully acknowledged. The opinions are those of the authors and do not necessarily reflect the views of their respective institutions. I See Grabowski and Mueller (1970) and Grether (1970). 2 See, for example, Edwards (1955), Stocking (1955), Edwards (1964), Turner (1965), Federal Trade Commission (1969), St. John's Law Review (1970), Steiner (1975). 3 For a test of one consequence of conglomerate firms, see Rhoades (1973) and Rhoades (1974). 4 This hypothesis was first stated by Edwards (1955). In another context, Solomon (1970) suggested it may be important in the banking industry. 5 See, U.S. v. Marine Bancorporation, Inc., et al. (1974) and U.S. v. Connecticut National Bank et al. (1974).

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