Size matters: Economies of scale in European payments processing

This paper investigates the existence and extent of economies of scale in the European payment processing industry. It is expected that the creation of a single European payments area (SEPA) will spur consolidations and mergers among European payment processors to more fully realize payment economies of scale. We find evidence for the existence of significant economies of scale using data of eight European payment processors during the years 1990–2005. The analysis also reveals that ownership structure is an important factor to explain cost differences across European processing centers.     

Risk and concentration in payment and securities settlement systems

What drives the intraday patterns of settlement in payment and securities settlement systems? Using a model of the strategic interaction of participants in these systems to capture some stylized facts about the Federal Reserve's Fedwire funds and securities systems, this paper identifies three factors that influence a participant's decision on when to send transactions intraday: cost of intraday liquidity, extent of settlement risk, and system design. With these factors, the model can make predictions regarding the impact of policy on the concentration of transactions, amount of intraday overdrafts, central bank credit exposure, costs to system participants, and other risks.     

Relative Performance Evaluation of Mutual Funds: A Non-Parametric Approach

We propose an alternative mutual fund performance index which addresses the benchmark problem and controls for economies of scale in managing mutual funds. We advance a new concept of 'return-cost' efficiency as another important element in evaluating portfolio management, in addition to the mean-variance efficiency concept. Our index based on a non-parametric estimation is shown to be similar to the Sharpe index with multiple slopes (or factors). We have shown that all fund categories, except income funds, have similar average efficiency scores after controlling for economies of scale. Most funds operate in increasing returns to scale and seem to be successful in holding mean-variance efficient portfolios, but unsuccessful in allocating transaction costs efficiently, evidenced by excessive turnovers and loads.     

Factor price misspecification in bank cost function estimation

Many studies of bank productivity implicitly assume that banks face imperfect factor markets in accessing labor and capital such that, in renting the same factor of production, at the same time, one bank will pay a price that will vary greatly from that of another bank. Usually, this implicit assumption is introduced by researchers’ simple expedience in calculating a factor price by dividing total cost attributable to a factor by the number of units rented. The range of factor prices so obtained, however, exceeds the reasonable bounds commonly observed in integrated factor markets. Our study contends that the wide variety of labor factor prices implicitly assumed is in fact a reflection of a variegated labor market and that the wide variety of financial capital costs is a reflection of incomplete specification of funds’ costs. We contend that, particularly in cross-sectional studies, it would generally be better for researchers to assume that banks faced competitive factor markets, thereby allowing the factor price term of cost functions to be eliminated. Not only would such elimination allow for a better estimate of true economies of scale and efficiency; it would also simplify greatly the estimation of many models. In this paper, we review briefly the significance of specifying factor prices in cost functions. Then we look at some actual factor prices that are reported in studies and used as inputs to cost function estimation. We conduct some simple tests to show what the reported factor prices in banking may actually represent. Having shown that factor prices reported are subject to misspecification, we estimate a set of cost functions with and without factor price specifications. We conclude by demonstrating that the improper specification of factor prices can affect inferences regarding measurement of inefficiency and returns to scale. Finally, we suggest methods by which these misspecifications may be rectified by use of time series, regional and international factor pricing data.     

ECONOMIES OF SCALE IN MUTUAL FUND ADMINISTRATION

Since many mutual fund expenses are fixed costs, asset growth should reduce the ratio of fund expenses to average net assets. A translog cost function is estimated for a sample of 2,610 funds to evaluate the existence and extent of economies of scale in mutual fund administration. The elasticity of fund expenses with respect to fund assets is significantly less than one, indicating there are economies of scale in mutual fund administration. Average costs diminish over the full range of fund assets; however, the rapid decrease in average costs is exhausted by about $3.5 billion in fund assets.     

Determinants of cost efficiencies in the mutual fund industry

We evaluate determinants of cost efficiencies in the U.S. mutual fund industry for 1998-2003. Our empirical results show that cost increases in this industry have been less than proportional to increases in assets. We find that funds without a 12b-1 plan show larger economies of scale than funds with a 12b-1 plan; institutional funds show greater economies of scale than do retail funds; and that fund families that are more focused in their investment objectives reap benefits of lower fund management costs than do fund families that are more diversified in their investment objectives.     

Operational outages and aggregate uncertainty in the federal funds market

This paper uses operational problems at depository institutions in sending Fedwire payments as a proxy for aggregate uncertainty in end-of-day Fed account positions and then examines funds market behavior on those days. The results suggest that increased uncertainty is associated with a deviation of the federal funds rate from the Federal Open Market Committee’s (FOMC’s) target rate; the magnitude depends on the severity of the difficulty, the payment volume of the affected participant, and the time of day. The intraday standard deviation of the federal funds rate is also affected by operational outages. Moreover, extensions to Fedwire are more likely on days with possible outages, and discount window borrowing picks up on these days as well.     

The Impact of Scale,Complexity, and Service Quality on the Administrative Costs of Pension Funds: A Cross‐Country Comparison

Administrative costs per participant appear to vary widely across pension funds in different countries. Using unique data on 90 pension funds over the period 2004–2008, this article examines the impact of scale, the complexity of pension plans, and service quality on the administrative costs of pension funds, and compares those costs across Australia, Canada, the Netherlands, and the United States. We find that, except for Canada, large unused economies of scale exist. Higher service quality and more complex pension plans significantly raise costs. Administrative costs vary significantly across pension fund types, with differences amounting to 100 percent.     

Performance of the Life Insurance Industry Under Pressure: Efficiency,Competition, and Consolidation

This article investigates efficiency and competition in the Dutch life insurance market by estimating unused scale economies and measuring efficiency‐market share dynamics during 1995–2010. Large unused scale economies exist for small‐ and medium‐sized life insurers, indicating that further consolidation would reduce costs. Over time average scale economies decrease but substantial differences between small and large insurers remain. A direct measure of competition confirms that competitive pressure is lower than in other markets. We do not observe any impact of increased competition from banks, the so‐called investment policy crisis or the credit crisis, apart from lower returns in 2008.     

The structure of the global reinsurance market: An analysis of efficiency,scale, and scope

We estimate economies of scale and scope as well as cost and revenue efficiency to explain the structure of the global reinsurance market, where large reinsurers dominate but both diversified and specialized reinsurers are competitive. The costs and benefits of size and product diversification are particularly relevant to the reinsurance industry, as risk diversification is central to the industry's business model. We find that reinsurers with total assets less than USD 2.9 billion exhibit scale economies, while those with total assets greater than USD 15.5 billion do not. Large reinsurers are characterized by high cost efficiency, while small reinsurers exhibit superior efficiency only when specialized. Large reinsurers also exhibit revenue scope economies when operating both life and nonlife reinsurance. Moreover, the evidence is in line with the efficient structure hypothesis: cost-efficient reinsurers can charge lower prices without sacrificing profitability.     

A Fundamental Approach to Estimating Economies of Scale and Scope of Financial Products: The Case of Mutual Funds

We propose a Fundamental approach to estimate the economies of scale and scope for financial institutions offering multi-product lines. We first estimate pure economies of scale from its fundamental definition, which is the marginal cost reduction that is to be achieved by single product firms of increasing size that offer the same product. Similarly, we estimate the economies of scope from its fundamental definition, as the marginal cost reduction achieved by the addition of a new product line. Operationally, we compare the cost of operating a say, 3 product-line financial institution with the cost of operating a portfolios of companies that are synthetically created from a control sample of financial institutions offering fewer, such as 2 and 1 similar product lines. When this approach is applied to mutual funds data, we find economies of scale for some fund type. The evidence on marginal cost economies due to increasing scope is rather weak. The results have practical implications for potential organizers and current management of investment companies.     

Size effects and economies of scale in European real estate companies

This study investigates scale economies in European real estate companies. We examine the effects of size on revenue, expense, profitability ratios and capital costs using panel data regression. We find that larger real estate companies in Europe are able to generate higher revenue per unit of company size, incur lower costs and produce higher returns. Net Operating Income ratios and return ratios increase while Selling, General and Administrative expense ratios decrease with the size of a company. However, we do not find evidence that larger companies have lower cost of debt or lower weighted average cost of capital. From our analysis, it is evident that particularly small firms can reap substantial economies of scale as they grow. However, the benefits of further growth tend to be much more modest for larger companies. Given REITs are on average larger than comparable non-REITs this may explain why REITs have lower economies of scale in expenses and revenues than Non-REIT real estate companies.     

Branching,scale economies,and banking costs

In this paper, we develop and estimate a model of bank costs based on a theory of the branch cost function. First, we show that convenient branch location is important to banking customers and implies that banks do not necessarily operate branches at minimum average cost. This theoretical result provides a rationale for including branch variables in the bank cost function. Second, we estimate a statistical cost equation derived explicitly from assumptions about the branch cost function and including branch output variables. Our empirical results suggest substantial economies of scale at the branch level, but no economies from expansion by branching. Finally, we show that the resulting cost structure of the banking industry does not imply that a highly concentrated banking structure is necessary for efficiency. Thus, economies of scale would not be expected to force small banks out of the market, even if current restrictions on interstate banking are liberalized.     

Do Excess Funds Make Financially Constrained Firms Better Off? Evidence from IPOs in China

Firms in transition economies often suffer financial constraints. In initial public offerings (IPOs), however, many newly listed Chinese firms raise funds in excess of what is originally planned. This paper examines whether these excess IPO funds are wasted on value-destroying spending or enable firms to take growth opportunities. After controlling for the endogeneity issue, we find that Chinese firms with excess IPO funds have better post-IPO operating performance, especially those with limited financing channels. In revealing the mechanism, we find that excess IPO fundraising alleviates financial constraints and reduces the cost of debt.     

Scale economies in pension fund investments: A dissection of investment costs across asset classes

Using a unique dataset of 225 Dutch occupational pension funds with a total of 928 billion euro of assets under management, we provide a comprehensive cross-sectional analysis of the relation between investment costs and pension fund size. Our dataset is free from self-reporting biases and decomposes investment costs for 6 asset classes in management costs and performance fees. We find that a pension fund that has 10 times more assets under management on average reports 7.67 basis points lower annual investment costs. Economies of scale differ per asset class. We find significant economies of scale in fixed income, equity and commodity portfolios, but not in real estate investments, private equity and hedge funds. We also find that large pension funds pay significantly higher performance fees for equity, private equity and hedge fund investments.     

Operating efficiency of Canadian banks

This article assesses Canadian banks' ability to realize scale economies and cost complementarities in joint production. The Canadian banking system, with its 10 or so large banks and 50 smaller ones, offers a good database for a study of efficiency, especially since previous work suggests that the system's concentration has had little impact on system competitiveness. This article estimates a system of cost and cost share equations using Zellner's iterative seemingly unrelated regression technique, then evaluates scale economies and cost complementarities from the estimated cost functions' first and second partial derivatives. The article compares a model that classifies deposits as inputs with another that classifies them as outputs. The empirical findings indicate that deposits are better modelled as outputs than inputs; that Canadian banks organize to exhaust available sources of scale economies and economies in joint production; and that conclusions regarding scale economies and cost complementarities differ importantly according to whether deposits are modelled as inputs or as outputs.     

Einsparpotenziale bei Verwaltungs- und Verfahrenskosten durch die Fusion von gewerblichen Berufsgenossenschaften — eine empirische Analyse für Deutschland

We analyze the cost savings potential with regard to administration and management costs by merging Commercial Employment Accident Insurance Funds (Berufsgenossenschaften) in Germany. We use data from the German Federation of institutions for statutory accident insurance and prevention (HVBG) for 1999 to 2004. Large Berufsgenossenschaften (BGs) have lower administration and management costs per insured person. However, costs per insured person are negatively correlated with insured risk of the BGs which in turn is an important source of administration and management costs.Results of a multivariate regression analysis help to identify cost drivers and the existence of economies of scale. Notifiable accidents, occupational diseases and risk explain administration and management costs. All estimation results are highly significant and allow to conclude that remarkable economies of scale are likely to be present in the organization of the BGs. Our results are robust to alternative specifications. Also, risk turns out to be an important cost driver with regard to management costs.A hypothetical policy reform is considered that reduces the number of BGs from formerly 35 to 18. We come up with an estimate of expected cost savings (without cutting benefits) of 83 million euros, about 10 % of the current management costs of the BGs under consideration.     

Precautionary Demand and Liquidity in Payment Systems

In large‐value real‐time gross settlement payment systems, banks rely heavily on incoming funds to finance outgoing payments. Such reliance necessitates a high degree of coordination and synchronization. We construct a model of a payment system calibrated for the U.S. Fedwire system and examine the impact of realistic disruptions motivated by the recent financial crisis. In such settings, individually cautious behavior can have a significant and detrimental impact on the overall functioning of the payment system through a multiplier effect. Our results quantify the mutually reinforcing nature of greater caution, and allow comparative statics analysis of shifts in key parameters.     

Transaction costs, quality, and economies of scale: examining contracting choices in the hospital industry

This study examines make or buy decisions for 196 hospitals in the United States using transaction costs as the basis for analysis. We examine the potential effects of quality and economies of scale on these decisions. We find evidence to support the view that transaction costs, quality and economies of scale play an important role in the integration decision and that this role depends on whether the transaction is industry-specific or generic in nature. This study examines the contracting choices of many firms across multiple transactions with a significantly larger data set than previous work in the area.     

How Issue Size, Risk, and Complexity are Influencing External Financing Costs: German IPOs Analyzed from an Economies of Scale Perspective

This paper is focused on the cost of raising capital in Germany. A cross-sectional analysis of flotation cost data for 117 IPOs over the years 1993–1998 is presented. We find average flotation costs to be 7.77 percent of gross proceeds, while underwriting fees average 5.01 percent. Our results extend the literature in two important directions. First, contrary to the conventional economies of scale view we find marginal spreads to be rather constant in gross proceeds and to be higher for more risky and more complex offerings. Fixed costs amount to 5 to 9 percent of underwriting fees. Second, by applying a principal component analysis we find issue size, an issuer risk factor, and an offering method complexity factor to have an economicaly meaningful impact on underwriting fees.