Relationships, Competition and the Structure of Investment Banking Markets

Abstract

It is well known that competition can destroy incentives to invest in firmspecific relationships. This paper examines how the tension between relationships and competition is resolved in the investment banking market, which for decades has been characterized by both relationships and competition. The model studies the impact on relationships of four different dimensions of competition: non-exclusive relationships, competition from arm's-length intermediaries, non-price competition, and endogenous entry. The analysis shows how market equilibrium adjusts so that relationships are sustained in the face of such competition. Banks are shown to establish relationships without either local or aggregate monopoly power. The model rationalizes two distinct empirical regularities of market structure: the invariance of market concentration to market size; and a pyramidal market structure with an oligopoly comprising similar-sized players at the top and a large number of small banks at the bottom. The analysis may also shed light on the industrial organization of other professional service industries.

Does Trade Credit Facilitate Access to Bank Finance? An Empirical Evidence from Portuguese and Spanish Small Medium Size Enterprises

“…Small business firms may be particularly affected by these changes because of their dependency of financial institutions for external finance (Berger and Udell, 1995;. Large banking institutions devote lesser proportions of their assets to SME, suggesting that consolidation in the financial system reduce the availability of credit to SME (Anand and Galetovic, 2006;Berger et al, 2005;Berger et al, 2007;Berger and Udell, 2002;Degryse and Ongena, 2007;Graig and Hardee, 2007). The financial distress in the banking industry may also impact lending to SME.…”

Price Competition, Efficiency and Riskiness in Investment Banking

“…It should not surprise then if one of the distinctive features that has characterized the industry for decades has been the stability of the level of concentration against increases in the market's relative size. As explained in Hayes et al (1983) and Anand and Galetovic (2006), for decades a pyramidal structure has prevailed,with an oligopoly of large similar-sized 'bulge bracket' firms at the apex. A second layer of the pyramid, on the other hand,is composed by afew medium-sized banks and a large number of small banks.In this study we focus on one specific form of competition, which is the price competition because of the difficulties in measuring client-firm relationships.…”

“…A second layer of the pyramid, on the other hand,is composed by afew medium-sized banks and a large number of small banks.In this study we focus on one specific form of competition, which is the price competition because of the difficulties in measuring client-firm relationships. Anand and Galetovic (2006) observe that these latter are typically embodied in human capital that can move between firms taking these relationships with them.…”

The Choice Between Arm's-Length and Relationship Debt: Evidence from eLoans

“…For instance, Petersen and Rajan (2002) argue that local banks who collect "soft" proprietary information on small firms over time have an informational advantage over more remote competitors who might not enjoy the same degree of access to local information. 2 Several empirical predictions follow.…”

“…In purely transactional credit markets symmetrically informed lenders bid less aggressively because more competition wors-1 For a recent survey on relationship banking see Boot (2000). 2 Agarwal and Hauswald (2006) provide strong evidence for this conjecture. See also Berger, Frame and Miller (2005) on the role of soft information in lending decisions and the ability of smaller banks that presumably have a more local focus to collect and process such intelligence.…”