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A ARHUS U NIVERSITY , B USINESS & S OCIAL S CIENCES

Shareholder Value in Banks

A M ASTER T HESIS B Y
Kasper Wittrup, Msc. Finance [282606]
Jesper Agerholm Jensen, Msc. Finance [284012]
1st August, 2012

Supervisor: Christian Schmaltz


Department of Economics and Business

Abstract
The recent turmoil in the global banking system has illustrated that bank performance,
measured as total shareholder return, has a substantial impact on the overall economy.
Therefore, maximization of shareholder value is currently an important management
issue and should be moved to the top of the bank CEOs agenda, not just for the bank
itself but also for the overall economy.
This thesis sets out to investigate whether drivers of value creation can be found and
whether they are implementable. It advances earlier studies of shareholder value creation
in banks on three areas. First, a comprehensive balanced panel data set for 132 banks
from 2001 2011 is constructed, including variables not tested among academia before.
Second, the use of listed banks makes it possible to apply total shareholder return as the
dependent variable and a measure for shareholder value creation. Finally, an operational
part, focusing on actual actions to be taken by bank managers, an area not studied by
academia, makes the thesis a valuable tool in the search for shareholder value
maximization.
The thesis suggests that by implementing a value-based management system and focus
on the most important value drivers such as ROA and revenue growth it will increase
shareholder value significantly. The findings confirm some of the findings in the key
valuation literature (Koller, Goedhart & Wessels 2010) but extents them to banks.

Content
Part I Introduction
1. Introduction.................................................................................................................... 1
1.1 Problem Statement ................................................................................................... 2
1.2 Thesis Structure and Research Design ...................................................................... 2
1.3 Delimitations............................................................................................................. 5
1.4 Theory of Science ...................................................................................................... 5
1.5 Literature Review ..................................................................................................... 6
1.6 Data Sources ............................................................................................................. 7
2. The Importance of Shareholder Value in Banks ............................................................. 8
2.1 Measuring Shareholder Value ................................................................................... 9
2.2 Value-based Management ....................................................................................... 10

Part II Identifying Value Drivers


3. The Business Model of Banks....................................................................................... 14
3.1 The Balance Sheet of a Bank and Implications for Valuation ................................ 15
3.2 The Income Statement and Implications for Valuation .......................................... 16
3.3 The Regulatory Impact ........................................................................................... 17
4. The Principles of Bank Valuation ................................................................................ 19
4.1 Market-based Models .............................................................................................. 20
4.2 Equity-based Models ............................................................................................... 22
5. Value Drivers Discussed by Academia ......................................................................... 25
5.1 Profitability as the Main Value Driver ................................................................... 26
5.2 Risk and Cost-efficiency as the Main Value Drivers ............................................... 28
5.3 Bank Diversification as a Value Driver ................................................................... 29
6. The Value Drivers Discussed by Consulting Companies .............................................. 31
6.1 The Value Drivers Discussed by McKinsey ............................................................ 32
6.2 The Value Drivers Discussed by Boston Consulting Group (BCG) ........................ 34
6.3 The Value Drivers Discussed by PriceWaterhouseCoopers ..................................... 37
7. The Shareholder Value Banks ...................................................................................... 40
7.1 The Value Drivers of Value-based Management Banks .......................................... 41
8. Mapping the Value Drivers .......................................................................................... 43

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Part III Analysis


9. The Data Set ................................................................................................................ 47
9.1 The Conditions ....................................................................................................... 49
9.2 Other Issues ............................................................................................................ 54
10. Analyses...................................................................................................................... 55
10.1 The Academic Approach ....................................................................................... 55
10.2 The Applied Model ............................................................................................... 59
10.3 Robustness Check using Different Model Specification Methods .......................... 61
10.4 The Reduced Model Including Robustness Checks ............................................... 64
10.5 Correcting for Expectations .................................................................................. 65
11. Further Analyses ........................................................................................................ 67
11.1 Investigating TSR Performance of the VBM Banks ............................................. 67
11.2 Investigating the Top Performing Banks .............................................................. 68
11.3 Prioritizing Profitability and Growth.................................................................... 69
11.4 The Relative Importance of Value Drivers Before and During the Crisis ............. 70
11.5 Investigating Differences between US and Europe ................................................ 71
12 Constructions of the Value Driver Map....................................................................... 73

Part IV Operationalizing the Value Drivers


13. Operationalizing Profitability, Growth and Risk Control........................................... 76
13.1 Value Driver 1 ROA .......................................................................................... 77
13.2 Value Driver 2 Revenue Growth ........................................................................ 81
13.3 Value Driver 3 Risk Control .............................................................................. 85
13.4 Summarizing Part IV ............................................................................................ 89

Part V Assessment and Conclusion


14. Critical Review of Results .......................................................................................... 90
14.1 Putting the Results into Perspective..................................................................... 91
15. Conclusion .................................................................................................................. 91
16. Bibliography ............................................................................................................... 94
17. Appendix .................................................................................................................. 101

iii

Exhibit list
Exhibit 1.2.1: Thesis Structure ................................................................................... 3
Exhibit 3.1.1: The Structure of Part II ..................................................................... 13
Exhibit 3.1.2: The Non-interest Income Share ......................................................... 14
Exhibit 3.1.3: Balance Sheet of Banks and Non-banks ............................................ 15
Exhibit 3.2.1: Income Statement of Banks and Non-banks ....................................... 17
Exhibit 4.1.1: The Correlation between ROE and P/B ............................................ 21
Exhibit 4.2.1: Value Drivers Extracted from Bank Valuation Models ...................... 24
Exhibit 5.1.1: The Value Drivers according to (Fiordelisi, Molyneux 2010) ............. 26
Exhibit 5.1.2: The Investigated Value Drivers .......................................................... 27
Exhibit 5.2.1: The Value Drivers Identified by (Gross 2006) .................................... 28
Exhibit 5.2.2: The Investigated Value Drivers .......................................................... 29
Exhibit 5.3.1: The Investigated Value Drivers .......................................................... 30
Exhibit 6.1.1: McKinseys View on Value Drivers in Banking .................................. 33
Exhibit 6.1.2: Performance and Confidence Indicators used by McKinsey ............... 34
Exhibit 6.2.1: The Relationship between CoE and RIR............................................ 36
Exhibit 6.2.2: 40 Variables Considered by BCG ....................................................... 37
Exhibit 6.3.1: PWCs Value Driver Categories ......................................................... 37
Exhibit 6.3.2: CoE and Sector Beta .......................................................................... 39
Exhibit 7.1.1: Selection Process................................................................................. 40
Exhibit 7.1.2: Deutsche Bank Case Study................................................................. 42
Exhibit 7.1.3: The Most Commonly Used KPIs ........................................................ 43
Exhibit 8.1.1: Mapping the Value Drivers ............................................................... 45
Exhibit 9.1.1: Structure of Part III ........................................................................... 47
Exhibit 9.1.2: The conditions of the three estimation techniques ............................. 49
Exhibit 9.1.3: Testing for Endogeneity and Finding Suitable Instruments ............... 50
Exhibit 9.1.4: The Tests for Heteroskedasticity ........................................................ 51
Exhibit 9.1.5: The Durbin-Watson Test for Serial Correlation ................................. 52
Exhibit 9.1.6: The Standardized Residuals ............................................................... 53
Exhibit 10.1.1: The Eight Variable Categories.......................................................... 56
Exhibit 10.1.2: The Investigated Profitability Measures ........................................... 57

iv

Exhibit 10.1.3: The Investigated Growth Measures .................................................. 58


Exhibit 10.2.1: The Applied Model ........................................................................... 60
Exhibit 10.3.1: The Chosen Variables from the Univariate Analysis ........................ 62
Exhibit 10.3.2: The Factor Analysis Categories ........................................................ 63
Exhibit 10.4.1: The Reduced Model with Robustness Checks................................... 64
Exhibit 10.5.1: Controlling for Expectations ............................................................. 66
Exhibit 11.1.1: The Performance VBM Banks .......................................................... 67
Exhibit 11.2.1: Performance of Top, Medium and Low Performers .......................... 68
Exhibit 11.3.1: Prioritizing ROE and Growth........................................................... 69
Exhibit 11.3.2: Investigating Interaction Terms ...................................................... 70
Exhibit 11.4.1: Results from Pre-crisis and Crisis using FE and White Standard
Errors ........................................................................................................................ 71
Exhibit 11.5.1: 10 Year CAGR TSR across the Included Countries ......................... 72
Exhibit 11.5.2: Performance of North American and European Banks ..................... 72
Exhibit 11.5.3: Investigating the Europe Factor ....................................................... 73
Exhibit 12.1.1: The Value Driver Tree ..................................................................... 74
Exhibit 13.1.1: The Structure of Part IV .................................................................. 76
Exhibit 13.1.2: KPIs for Profitability Improvement.................................................. 78
Exhibit 13.1.3: Operational Effectiveness Measures .................................................. 79
Exhibit 13.2.1: KPIs for Achieving Revenue Growth ................................................ 81
Exhibit 13.3.1: KPIs for Enhanced Risk Control ...................................................... 85
Exhibit 13.3.2: 10 steps to cope with Regulatory Changes ....................................... 87
Exhibit 13.4.1: Operational Strategies to Improve Shareholder Value and Their KPIs
.................................................................................................................................. 89

Part I Introduction
1. Introduction
Its only when the tide goes out that you learn whos been swimming naked.
- Warren Buffet
September 15th 2008 the tide went out and large banks lay naked on the beach. Lehman
Brothers filed for Chapter 11 bankruptcy, and this date marks the beginning of the end
of the glory years. The banks had been too leveraged, had filled the financial system with
risk and not considered whether return was captured based on strong business models or
high risk. A decade of deregulation had given the banks endless opportunities to seek
more value and to take on more risk. What followed was a financial crisis which likes
only had been seen during the Great Depression back in 1929 (French et al. 2011). As a
consequence, regulators have now started to tighten the requirements and therefore
totally reshaped the industry (Visali et al. 2011).
Dramatic changes need dramatic actions. In order to increase shareholder value, banks
need to adapt their business models to the changing environment. In the report The
State of Global Banking in Search of a Sustainable Business Model the consulting firm
McKinsey highlights four major trends that will force European and North American
banks to change their business models:

The new tight regulation carried forward by the Basel Comity is the single most
important factor

The squeeze on capital funding leads to pressure on smaller banks and pressure on
deposit margins

A huge gap between established markets and emerging markets opens up for
attractive geographic growth opportunities

Changing consumer behavior increases the importance of delivering a unique


customer experience.

Even though the changes seem dramatic, history has shown that when a sector is
confronted with game-changing regulations there is a will and a necessity to work
through it. In the late 1990s the US government enforced similar game-changing rules in
the telecommunication industry. The changes lead to a total reshaping of their business
models, they reduced costs and staff numbers by 30-50% and improved productivity. The
banks need to be just as bold and find a way to reshape their business models in order to
adjust to the new normal where return on equity above 20% is no longer the industry
standard.

Part I Introduction

With shareholder value creation as the ultimate goal, the trade-off between risk and
return will be brought back on the CEOs agenda. Banks need to question themselves,
what the key focus of the business models should be and how the entire organization can
be aligned to reach this goal. This is what this thesis seeks to find out.

1.1 Problem Statement


In order to get back on track, banks need to align their efforts on creating value and they
need to find out how this is done in the environment they face. Therefore, the key
research question under investigation is stated as follows:

KRQ: How should banks maximize shareholder value?

To answer the key research question the following questions need to be answered:

RQ1: How is the value of a bank determined?

RQ2: What are the potential value drivers of a bank?

RQ3: Which value drivers generate most shareholder value?

RQ4: Do banks with value-based management strategies manage what they


intend to manage?

RQ5: How are the value drivers made manageable?

By answering the five research questions the reader will get an understanding of the full
picture of value creation in banks. Further, it will be possible to identify the value
drivers that banks need to prioritize in order to maximize shareholder value. The aim of
this study is not just to combine these two areas but to take it even further. To the
authors knowledge no academic study has yet been able to both combine theory and
practice with operational strategies on how to increase shareholder value on an
operational level.

1.2 Thesis Structure and Research Design


In order to answer the research questions, the overall structure is inspired by (Rappaport
1998) who recommends a framework that enables managers to monitor the overall value
creation and identify the activities they are to focus on. It follows four steps
1. Identify the value drivers that have the greatest impact on value.
2. Isolate the drivers that management can influence.

Part I Introduction

3. Develop a value driver map of the business


4. The value drivers should be disaggregated in order to operationalize the value
drivers and make it possible for all employees to understand how they create
value.
Exhibit 1.2.1: Thesis Structure
Introduction
Introduction
Why shareholder value?

Research
question
Shareholder
value in banks

Part I

VD

P/B
Research
design

VD

Multiple
analysis

VD

P/E

VD

Value-based
management

Equity DCF

VD
VD

Bank
Valuation

Cash floworiented

Dividend
discount model

Academia

Concept

Part II

Shareholder
value

Consultants

Case study of
VBM banks

VD

Residual
income

Identifying
value drivers

Concept

VD
VD
...

Article 1
...
Article N

VDn

Company 1
...
Company N

VDn

Bank 1
...
Bank N

Concept

VD

RQ1: How is the


value of a bank
determined?
RQ2: What are the
potential value
drivers of a bank?

VD1
...

KPI1
...
KPIn

Part III

Operational strategies

Part IV

Data selection

Analysis

Value drivers
from Part II

Regression
and test

Empirical
findings

Study of case
banks

Making KPIs
operational
Methodology

RQ3: Which value


drivers generate most
shareholder value?
RQ4: Do banks with
VBM strategies
manage what they
intend to manage?
RQ5: How are the
value drivers made
manageable?

Source: Own contribution

Inspired by the thoughts of (Rappaport 1998) the thesis initially starts with discussing
the application of the shareholder value view, and the existing research on shareholder
value in banks.
Shareholder value management has for many years been a dominating management
concept and a performance indicator for companies all over the world. However, more
than twenty years after the groundbreaking book by (Copeland, Koller & Murrin 1991)
still only few articles have discussed shareholder value management in connection to
banks and none of these have had both an internal and an external view. To fill this gap
Part I will be a discussion regarding shareholder value and value-based management.
When applying this approach in banking, the measurement of shareholder value is
necessary and will therefore also be addressed in Part I.
In Part II the objective is to give an overview of the current thinking within shareholder
value in banking and identify the value drivers that are to be included in the regression
models in Part III. It will begin with an assessment of the preferred bank valuation
models. By finding the models that explain how to value banks the hypothesis is that the

Part I Introduction

drivers behind these models will also be possible value drivers for banks. The models
discussed will be both peer group multiples and equity-based models. This chapter will
also provide an answer to RQ1 and knowledge regarding how the value of a bank is
determined.
Following the valuation chapter the focus turns towards identifying the value drivers
found relevant in academia and by practitioners. Starting with academia, a limited
number of articles1 have been written on the subject, the most well-known being
(Fiordelisi, Molyneux 2010) and none of them have used Total Shareholder Return
(TSR) as their dependent variable as done in this thesis. This is followed by an analysis
of the largest management consulting houses and their view towards shareholder value
creation among banks. Finally, 20 case banks who have implemented value-based
management are included in the analysis. The case banks are chosen trough an
investigation of the sample banks and the screening is conducted using some clearly
defined screening rules. Through case studies of shareholder-focused banks and a careful
study of the literature the main goal of Part II is to provide an answer for RQ2.
Part III of the thesis contains a regression analysis with the research objective of finding
the value drivers that maximize shareholder value and thereby answering RQ3. Such an
empirical study aims to give a better understanding of value creating drivers and thereby
provide valuable insights for bank managers on how to manage the bank. For this, a
balanced panel data set is used and through comprehensive analyses that considers and
corrects for elements such as heteroskedasticity, endogeneity etc. the final model will
yield insight into the value drivers that have a significant influence on the dependent
variable. Further, it is examined both whether value-based management banks
outperform non-value-based management banks based on TSR and whether topperforming banks outperform the other banks on the key value drivers. The former is
done to investigate RQ 4. Next, differences between European and North American
banks yield information regarding any unobserved effects in the different regions. In order
to build further knowledge about the value drivers, additional analyses such as
robustness tests and expectation correction tests suggested by (Koller, Goedhart &
Wessels 2010) and (Jiang, Koller 2007) supports the construction of a comprehensive
value driver tree
In Part IV an ending discussion will provide the reader with some operational actions to
be taken in order to affect the main value drivers. This is done through a breakdown of
the value driver tree constructed in Part III, by analyzing identified top-performers and
carefully study the prevailing strategies within management consulting. Part V will
conclude upon the findings and address the KRQ.

A quite large number of German articles have focused on shareholder value in connection to banks, but this study have
only focused on those written in English

Part I Introduction

1.3 Delimitations
The thesis will limit itself to only focus on banks within the European and North
American area. This limitation is made due to the differences that are seen among
developed world banks and emerging market banks (Dayal et al. 2010). Further, it has
been necessary to make limitations on the banking type. Banks that secure less than 30%
of their revenues in the retail banking segment are not considered for this thesis which
allow drawing more consistent conclusions. Next, TSR is seen as the best measure for
shareholder value and therefore only listed banks are considered.
Furthermore, the regulatory requirements are expected to influence the stock price since
capital requirements and restrictions on the calculation of risk-weighted assets directly
influences the profitability of banks. However, since it is not possible for bank managers
to affect the regulatory requirements, it is not within the scope of this study.
Finally, the recent financial crisis has undoubtedly had a huge effect on the shareholder
value generation in the banks. The thesis will however not contain an extensive
discussion on the financial crisis since it has received a large amount of attention in
recent literature (French et al. 2011).

1.4 Theory of Science


Scientific studies and research is affected by the paradigm of the researcher and how the
researcher views the world. Since the paradigm will influence everything in a study from
problem statement to data collection and analysis it is important to clarify the paradigm
applied (Arbnor, Bjerke 1997).
The main paradigm of the thesis is one closely related to the analytical paradigm
described by (Arbnor, Bjerke 1997). This paradigm sees the world objectively and tries to
explain cause-and-effect relationships as they exist in the real world. However, also the
radical structural paradigm inspired by (Bell, Bryman 2003) is applied when analyzing
specific strategies followed by the case banks and in determining whether a bank uses
value-based management or not. This research obviously causes the interpretation to be
influenced by the authors paradigm.
Given the paradigm, the study will use econometric methods that give the best
approximation of the real world. The statistical analysis will show a cause-and-effect
relationship as it exists in the real world and the influence of the researchers is therefore
minimal, which is in accordance with the analytical paradigm.
The analysis of the case banks and their strategies relies heavily on qualitative methods.
The case banks are chosen based on a subjective evaluation of their management system
and here the radical structural paradigm comes into play (Bell, Bryman 2003). The
conclusions drawn from the analysis of the case banks relies on the view of the

Part I Introduction

researchers. Since the qualitative part is included in order to add another dimension to
the analyses it is believed that it will add value to the study.
The results from the quantitative and the qualitative part of the research will in total
lead to results that will shed light on how banks should prioritize their value drivers to
maximize shareholder value.

1.5 Literature Review


The main sources of inspiration are (Koller, Goedhart & Wessels 2010), (Dermine 2008)
and (Rappaport 1998) and their work on the importance of shareholder value and the
value creation process. The shareholder value view that dominates the thesis was
introduced by (Rappaport 1981) as he questioned whether accounting numbers was the
best measures for company performance.
The literature used for the valuation models in Part II is especially focused around
(Koller, Goedhart & Wessels 2010, Damodaran 2009, Dermine 2009) and (Gross 2006)
where the first two are considered gurus within corporate valuation. Turning towards
academia, the literature on shareholder value creation in banks is scarce since most is
still focusing on accounting numbers and banking profitability. Key literature on the
subject includes (Gross 2006), (Fiordelisi, Molyneux 2010) (Baele, De Jonghe & Vander
Vennet 2007) and (Rapp et al. 2011). As seen in Section 1.2 this thesis also takes an
internal view where key literature is found among the management consulting houses.
Especially (Visali et al. 2011, Dayal et al. 2010, Duthoit et al. 2011, Dayal et al. 2011,
Leichtfuss et al. 2010, Maguire et al. 2009) together with numerous annual reports from
the case banks have been applied.
In relation to the statistical analysis in Part III a wide range of key literature is used.
(Wooldridge 2002), the most extensive book on the subject of panel data analysis, has
together with (Baltagi 2001) been used as an important guideline for the statistical
analysis while (Wooldridge 2009) and (Verbeek 2009) have been indispensable in relation
to delivering practical and statistical guidance for the analysis.
Further, (Koller, Goedhart & Wessels 2010), which follows the ground breaking work of
(Copeland, Koller & Murrin 1991) has conducted key research on how value is created in
non-financial companies and is a major source of inspiration to some of the more
thorough analyses.
For Part IV, mainly articles from McKinsey & Company and BCG have been applied
since academia does not discuss their findings on such an operational level.

Part I Introduction

1.6 Data Sources


The thesis relies 100 percent on publicly available information about the banks in the
sample. The primary data sources are Bloomberg, Bank Scope, Datastream and annual
reports. The Bank Scope database was used in the selection of the 132 banks because of
its use of standardized variables but unfortunately the database almost contained no
data before 2005. Therefore the data was primarily drawn from Bloomberg which also
provides standardized data. Datastream was primarily used to get the macroeconomic
data for the analysis.
Also annual reports have been an important data source for several reasons. First of all,
the data provided by Bloomberg was not 100% sufficient. However, the effort put into
gathering data has resulted in a unique balanced panel data set containing data for all
included variables for all banks for the years 2001 to 2011. Secondly, the annual reports
were an important data source in the identification of the value-based management
banks. For a full view of the data selection process see Appendix 17.2.1.

Part I Introduction

2. The Importance of Shareholder Value in Banks


The origins of the shareholder value view can be dated all the way back to economist
Adam Smith. In The Wealth of Nations Adam Smith argued that the individuals pursue
of wealth will create a capitalistic society for everyones benefit. The argument went that
if everyone seeks to maximize his own benefits, capital will be distributed to the best
investments. Even though it may not be in the individuals interest to promote public
interest, he does so anyway through his allocation of capital (Smith 1776). However, the
shareholder value view started gaining significant support during the 1980s and 1990s
and is today considered the dominant corporate objective (Shukla 2009). According to
(Young, O'Byrne 2001) the following major developments have lead to the increasing use
of shareholder value:

Globalization and deregulation

The end of capital and exchange controls

Advances in IT

More liquid securities markets

Improvements in capital market regulation

Generational changes in attitudes towards savings and investments

The expansion of institutional investments

As discussed in the introduction, the lack of focus on both profitability and the cost of
capital have been the key sources to the financial crisis. By introducing shareholder
value-based management, this problem will be avoided. (Koller, Goedhart & Wessels
2010)
Even though the principles of shareholder value have gained ground, some articles argue
that it comes at the cost of the stakeholders. However, in relation to the central
argument of Adam Smith, maximizing shareholder value does not only benefit the
investors, it also creates growth and wealth in the economy through more jobs, employee
benefits, more CSR spending, more focus on environmental issues etc. Hence shareholder
value and stakeholder value are not competing ideas as much of the literature suggests
(Rappaport 1981). Further, (Jensen 2001) is even more radical since it argues that the
whole idea of stakeholder maximization is flawed as it involves maximizing more than
one measure. According to (Jensen 2001) shareholder value maximization is the only
objective that makes sense since it involves maximizing only one measure. Other
complications regarding shareholder value creation have been suggested by (Kay 2010).
(Kay 2010) claims that a key deficiency of shareholder value management is the fact that
it causes managers only to focus on the next earnings announcement. (Koller, Goedhart

Part I Introduction

& Wessels 2010), however, stresses that the argument is flawed due to the fact that value
is determined by the long-run expectations and not short-term earnings.
In the discussion of shareholder value in banks, it is suggested by (Gross 2006) that even
though limited articles have focused on shareholder value in banks, the creation of it is
even more important for banks than for regular companies. Banks are required to secure
growth through equity which is easier gained if investor can see that they are rewarded
(Gross 2006). However, due to the important role of banks in the economy and the
complexity of bank valuation there is still a large skepticism when it comes to
shareholder value maximization in banks, skepticism that after the crisis only has
increased (Gross 2006). This is in line with (Porter, Kramer 2011) that proposes the
creation of shared value as the new main objective of the company. According to (Porter,
Kramer 2011) the central argument in shareholder value is outdated due to the narrow
focus.
Even though the authors acknowledge a few of the deficiencies presented in (Porter,
Kramer 2011) the arguments by (Rappaport 1981) and (Gross 2006) is supported more
strongly and shareholder value will still be the predominant methodology throughout this
thesis.

2.1 Measuring Shareholder Value


Having discussed the importance of shareholder value the next question is how to
determine it. Even though various measures are used in the shareholder value literature
the most direct measure is the TSR measure:
Total Shareholder Return (TSR ) =

Stock Price + Dividend


1
Stock Price

EQ 1

It is however discussed, that one major weakness of TSR as a shareholder value measure
is the stock market expectation affection and some practitioners are therefore reluctant to
use it (Gross 2006). Therefore (Koller, Goedhart & Wessels 2010) examines different
methods to correct for expectations and finds that they become insignificant over a
longer time span.
A greater weakness is however, that while the total shareholder return belongs to the
market measure category, a measure for unlisted companies needs to be found. For this,
the consultancy firms have developed a wide range of residual income measures (Young,
O'Byrne 2001). Economic Value Added (EVA) is such a residual value measure,
developed by the consulting company Stern Stewert & Co and among the most widely
used measures of shareholder value (Young, O'Byrne 2001). According to (Young,
O'Byrne 2001) the major benefit of EVA is that it can be calculated and implemented at
all levels of a company. EVA equals the spread between return on net assets and the cost
of capital, multiplied by invested capital:

Part I Introduction

EVA = (RONA WACC)Invested capital

EQ 2

Another popular measure is the economic profit measure put forward by (Koller,
Goedhart & Wessels 2010) which is very similar to the EVA model
EP = (ROIC - WACC)Invested capital

EQ 3

This model has gained in popularity over the last years because of its close relation to
economic theory and a companys competitive strategy (Koller, Goedhart & Wessels
2010). It highlights whether the company is capable of earning more or less than its cost
of capital. The key issue with the two models is however, that they fail to account for
synergies between the different business units of a company. They therefore have some
limitations when it comes to representing the total value generation in a company
(Young, O'Byrne 2001).
Several studies have found that residual income models are capable of explaining some of
the variance in TSR but the amount is limited. In the studies conducted by (Gross 2006)
Economic Profit is used as the preferred shareholder value measure, since (Gross 2006) is
working with non-listed banks. However, since total shareholder return is preferred and
the data is available, this thesis only uses the Economic Profit variable as an explanatory
variable.

2.2 Value-based Management


As has just been seen, shareholder value is focusing on how much value is generated to
the owners. Such an increasing focus on the owners has compelled bank managers to
adopt new management approaches that are designed to fit this change. Value-based
management is developed exactly with this purpose in mind since it focuses on
shareholder value creating activities throughout the whole organization (Ameels,
Bruggeman & Scheipers 2002). (Dermine 2008) defines value-based management (VBM)
as:
Value-based management refers to the corporate objective of increasing the wealth of
shareholders of a corporation
- (Dermine 2008)
In order to efficiently work on the ultimate goal of creating value for the shareholders a
value-based management system should use the most important value drivers as key
performance indicators (KPIs) and use operational KPIs that supports (Rappaport,
1998).
In accordance with (Rappaport, 1998), this thesis defines value drivers as the main
components of shareholder value and KPIs as the strategic and operational measures
implemented to support the VBM system in ensuring shareholder value maximization.

10

Part I Introduction

When using VBM, managers and employees are encouraged and measured on their
ability to create shareholder value through the use incentive systems and KPIs
(Rappaport 1998). The ideas behind the concept have risen from the agency theory which
focuses on the relationship between the agent and the principal. It is the agents
obligation to fulfill the principals objectives because of the economic relationship they
have. Since agents are moved by their self-interest it is necessary to align the two parties
interests in order to secure that they share a common goal. In theory there are two
problems that can disturb this alignment of interest, the agency problem and the
problem of risk sharing (Ameels, Bruggeman & Scheipers 2002). The first is based upon
the assumption that the agent and the principals interests and goals might conflict and
that it is difficult or too expensive for the principal to monitor the agent (Eisenhardt
1989). Secondly, risk sharing assumes that there is a difference between how the two
parties are affected by different risk structures and therefore differs in the way they act
(Shankman 1999). In summary both of these two issues between management and the
shareholders are the corollary of a lack of goal congruence between the objectives of the
agents and principals. By letting managers think like shareholders, Value-based
management reduces this lack of goal congruence. Therefore, VBM should be
implemented as an overall management tool that enables this. (Pitman 2003)
2.2.1 VBM Implementation
(Rappaport 1998) acknowledges the huge task at hand when a company starts
implementing a VBM system since it requires a complete corporate transformation.
Important implementation lessons can however, be learned by the study of Lloyds bank
who implemented VBM. The CEO, Brian Pitman, identified the following five steps in a
successful VBM implementation (Pitman 2003):
1. Define one objective: The first thing that needs to be done is to reach agreement
in the management of the bank. The management should agree that shareholder
value creation is the priority. A starting point that is also acknowledged by
(Young, O'Byrne 2001).
2. Establish stretch goals: It is important to be very ambitious when setting the
goals. Lloyds set out to be the best shareholder value generator in the financial
sector, and they reached the goal. After this they started benchmarking
themselves against the best shareholder value generator at the time, Coca Cola.
3. Align reward system behind goals: The use of incentive systems is crucial to a
successful VBM implementation. In connection to this (French et al. 2011)
highlights some important issues in relation to the systemic importance in banks.
It is recommended to use long-term reward systems to prohibit inappropriate
short-term maximization. The use of long-term reward systems is also supported
by (Young, O'Byrne 2001).

11

Part I Introduction

4. Cultivate learning and change minds: VBM needs to be a part of the culture at
the bank. This step is supported by both (Rappaport 1998) and (Young, O'Byrne
2001) who confirm the importance of shareholder value understanding and
commitment.
5. Make the difficult choices: If a business segment for several years has delivered
poor shareholder value results then the business segment should be shut down.
However, before a bank is ready for an implementation of VBM, the first task, according
to (Rappaport 1998), is to find those value drivers that have the greatest impact on
shareholder value. Part II will identify these value drivers and Part III will figure out
which of them to focus on.

12

Part II Identifying Value Drivers


The purpose of Part II is to yield an understanding of the banking business model, define
the current thinking on bank valuation and identify the value drivers that are to be tested
in Part III. Exhibit 3.1.1 summarizes the structure of Part II.
Exhibit 3.1.1: The Structure of Part II
Understanding Banks

Chapter 3
The Business Model of Banks

External KPIs

Chapter 4
Bank Valuation

Chapter 5
Academia

Internal KPIs

Chapter 6
Consulting

Chapter 7
VBM Banks

Conclusion

Chapter 8
Mapping the Value Drivers

Source: Own contribution

Focusing on the value drivers from an operational and strategic angle, the objective is to
permeate the bank with a strategy that is centered on shareholder value creation both in
terms of decision making and resource allocation (Gross 2006). However, before
identifying the value drivers of banks a detailed description of the banking business
model and the differences between banks and non-banks will be provided in Chapter 3.
Chapter 4 follows with a discussion regarding which bank valuation models external
analysts apply in the estimation of a fair value of the bank, and the value drivers that
can be derived from these models. Afterwards, a literature review of the academic articles
focusing on creation of shareholder value in banks will be given in Chapter 5. Those two
groups have an outside-in perspective while management consulting companies and
banks, discussed in Chapter 6 and 7 respectively, are able to make internal analyses.
Finally, Chapter 8 will end Part II by addressing whether there is a consensus across the
different types of literature and which value drivers that will be incorporated in Part III.
Identifying these value drivers is an importance step towards making managers capable
of managing the bank with shareholder value as a main goal (Rappaport 1998).

13

Part II Identifying Value Drivers

3. The Business Model of Banks


Banks are very different from non-banks when it comes to the construction of their
business model (Gross 2006). Looking at the products, non-banks in general occurs risk
as a side-effect of doing business while banks has managing, incurring, structuring and
assessing financial market risk as one of their core business activities. By taking this risk,
they provide the service of storing value and extending credit, acting as intermediaries
between parties with funding surpluses and deficits (Koller, Goedhart & Wessels 2010).
This gives banks a very central function in the modern economy but it also makes them
heavily dependent of the overall economy.
However, in the later years this typical model has evolved and todays universal banks
have a whole palette of activities in their portfolio (Koller, Goedhart & Wessels 2010).
Especially proprietary trading activities in well-known products such as equity stocks,
foreign exchange, bonds etc. or more exotic products such as credit default swaps or
asset-backed securities have become a larger part of large banks income (see Exhibit 3.1.2
interest income vs. non-interest income). Also non-banking activities are an increasing
part of banking income, a strategy that has evolved from their focus on increasing
number of customers and income per customer. By creating synergies between different
financial areas such as real estate, insurance, pension products etc. banks have been able
to increase total income. Even though this shifting in the banks business model has
increased its diversification it has also increased the volatility and cyclicality and gains
made over several years can be wiped out in a single year (Koller, Goedhart & Wessels
2010).
Exhibit 3.1.2: The Non-interest Income Share
1600
1400
billion USD

1200
1000
800
600
400
200
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Non interest income
Source: Bloomberg, own contribution

14

Net interest income

Part II Identifying Value Drivers

Despite these great uncertainties in the business model, factors like long-term contracts,
high percentage of existing lending relative to new lending and the law of large numbers
makes analysts capable of giving reliable estimates, and their valuation models an
indicator of which KPIs bank managers are to focus on. (Gross 2006)

3.1 The Balance Sheet of a Bank and Implications for Valuation


One of the core differences between bank and non-bank balance are their balance sheets.
Since the financial risks, that banks occur, affects both assets and liabilities it is
important for them to focus on both sides in order to run their business (Gross 2006).
Exhibit 3.1.3 outlines the key differences.
Exhibit 3.1.3: Balance Sheet of Banks and Non-banks
Assets

Nonbanks

Banks

Nonbanks

Banks

PP&E

25%

1%

Equity capital and reserves

18%

4%

Investments

13%

2%

Provisions

20%

1%

Inventories

23%

N/A

Liabilities

62%

91%

Receivables

33%

74%

- Trade payables

12%

N/A

- From customers

15%

49%

- Liabilities, fin. institution

20%

29%

- From credit institutions

N/A

25%

- Liabilities, non-banks

N/A

38%

- Other receivables

18%

0%

- Securitised loans

N/A

23%

Investment securities

3%

19%

- Other liabilities

31%

5%

Cash and Cash Equiv.

4%

1%

Other assets

0%

2%

Liabilities

Source: (Gross 2006), own contribution

3.1.1 The Assets Side


Where some of the large entries in non-banks are property, plant & equipment and
inventories the asset side in banks are mainly dominated by receivables from either
customers or other credit institutions. Further, the tangible assets and capital
expenditures in banks are of minor importance since human capital and intangibles like
brand and employees are the main cost drivers and therefore booked in the income
statement (Gross 2006). One practical way to deal with such an issue is to estimate
investments in intangibles and then adjust the income statement and balance sheet by
capitalizing these investments (Damodaran 2009). For analysts to estimate working
capital they fall into another type of problem. When working capital is defined as the
difference between current assets and current liabilities a large proportion of the banks
balance sheet falls under one of these two categories. The changes are often both large
and volatile and may have no relationship to reinvestments. If it is not possible to
directly identify capital expenditures and changes in working capital it is not possible to
estimate cash flows either (Damodaran 2009). All in all, when not available, numbers

15

Part II Identifying Value Drivers

have to be estimated by the analyst, making estimated cash flow less reliable (Koller,
Goedhart & Wessels 2010).
Another area to focus on when valuing banks is the fact that assets are traded in the
market and often not held to maturity which is why the marked-to-market principle is
often applied (Damodaran 2009). Besides increasing volatility it creates at least one
problem. Comparison and interpretation of ratios (e.g. P/B or ROE) between banks and
non-banks is almost impossible. If ROE is taken as an example: In non-banks this would
be a measure of the return earned on equity invested in the company but that
information is missed due to the marked-to-market principle. In fact if the assets were
truly marked-to-market ROE would equal the cost of equity (Damodaran 2004).
3.1.2 The Liability Side
Opposite to most industrial companies, banks are capable of earning money on the
liability side as well as the asset side (Damodaran 2009). Normally only assets drive the
value but with the deposit franchise given by the government, banks can issue deposits at
costs lower than the cost of raising an equivalent amount of funds with equal risk in the
open market. This positive spread on the liability side creates value for the shareholders
and is the reason why liability management should be seen as part of a banks business
operations when valuing them. If it was purely financing, the bank would be paying
market rates for the deposits and only through the tax shield would shareholders gain
value (Copeland, Koller & Murrin 2000). This also explains the high leverage that banks
have, with equity capital only making up 4% of the total liability side. As a result of this
structure, banks can only be valued correctly if all financing activities are included in the
valuation model. From an outside-in perspective it is, however, difficult to determine the
function of debt (Gross 2006).
A further note on the equity is its role as liquidity which in banks is not just residuals of
the production process. For a bank, the liquidity kept on its books plays a key role as
input factor into its banking business, making cash flows very volatile and difficult to
forecast (Gross 2006).

3.2 The Income Statement and Implications for Valuation


From a valuation point of view, it is important to understand the main driver of revenue,
interest income. Most banks experience a maturity miss-match on their balance sheet as
a result of short term deposits and long term lending and therefore not all interest
income creates value (Koller, Goedhart & Wessels 2010). In a situation with maturity
miss-match the bank do not earn an excess interest spread due to their value adding
activities but due to being on different parts of the yield curve and therefore taking more
risk, see Appendix 17.1.1 for a more thorough discussion of the value creating income and
how it has evolved in the last decade. From Exhibit 3.2.1 the differences between
banking and non-banking income statements can be seen.

16

Part II Identifying Value Drivers

Exhibit 3.2.1: Income Statement of Banks and Non-banks


Revenues

Nonbanks

Banks

Expenses

Nonbanks

Banks

Sales

93%

N/A

Supplies expense

61%

N/A

Change in inventories

1%

N/A

Staff expense

17%

10%

Interest income

1%

83%

Other adm. expenses

N/A

7%

Inc. from provisions

N/A

7%

Depreciation

4%

7%

Inc. from sec. & inv.

N/A

4%

-Fixed Assets & intangibles 4%

1%

Net inc. financing business N/A

1%

-Provision on receiv. & sec.

N/A

6%

Other income

5%

Interest expense

2%

71%

Tax charges

3%

1%

Other expenses

14%

4%

5%

Source: (Gross 2006), own contribution

Another important income driver is the increased focus on proprietary trading which has
also increased the risk through increased volatility and made it challenging for external
analysts to estimate the internal positions. Finally, a typical banking income is fee and
commissions when the banks are either advising or servicing their customers. Services
that include deposits transport of money, exchange, provision of liquid funds etc. (Gross
2006).
On the expense side a structural characteristic of banks is their high share of fixed costs
due to storage of both human capital and advanced IT systems. Together with variable
costs like interest expenses (similar to COGS in non-banks), and provision for loan losses,
this is what mainly drives expenses (Gross 2006). Especially the loan loss should be
handled with care. The probability of default fluctuates significantly during a business
cycle. However, rather than writing of loans as they default, banks make provisions for
losses and average out the large changes (Damodaran 2009). This of course comes in
handy when making valuation but it is a subjective decisions whether banks are
conservative and set aside a large amount for loan losses or aggressive. In an estimation
of future loan losses there are three ways to go, either analysts use sector wide estimates,
the banks historical provisions (to see whether it is conservative or aggressive) or a
combination of both. (Damodaran 2009)

3.3 The Regulatory Impact


All over the world banks are regulated due to their important role in the economy and
their dependency on economic cycles (Visali et al. 2011). Although the regulations differ
from country to country there are some typical requirements that recur. The typical
forms of bank regulation covers capital requirements put forward by the Basel
Committee on Banking Regulations and Supervisory Practices. Capital ratios are
calculated based on the banks risk-weighted assets and should ensure that neither
claimholders nor depositors are at risk. Besides increasing costs, these capital

17

Part II Identifying Value Drivers

requirements also represent a bottleneck in the banks growth opportunities and therefore
have to be considered both in connection to valuation and in the testing of KPIs (Gross
2006). In the following sections, the two largest regulatory changes will be discussed. For
a more thorough discussion of the regulatory landscape, see Appendix 17.1.2.
3.3.1 The Impact on Liquidity and Capital Risk
After the crisis few industry experts would disagree that tighter capital requirements is
desirable in order to keep a more stable future for both the banking industry and the
overall economy (French et al. 2011). However, since it is a large driver for profitability
both analysts and banks will have to cope with these changes and academia has to
incorporate it in the studies. (Visali et al. 2011)
The impact from the new regulatory constraints on capital will have a triple impact on
the banks: An increase in the core tier 1 capital ratio, stricter rules on how to calculate
the core tier 1 capital ratio and changed weights in the calculation of RWA (Basel
Committee on Banking Supervision 2010). Especially two constraints, that affect RWA,
have been added after it was clear that the capital requirement on trading books where
not high enough to absorb all the trading losses from market fluctuations (Leichtfuss et
al. 2010). These constraints are counterparty- and market risk, and they impact RWA
through increased Value-at-Risk. From these changes the largest banks (263 of the
largest banks European and North American banks) capital ratios are, with no changes
on the balance sheet, expected to fall from 11.1% to 5.7% whereas RWA is expected to
increase by 23 % (Basel Committee on Banking Supervision 2010). Shifting towards a
less capital intensive business model is therefore key in avoiding the increased regulatory
constraints (Visali et al. 2011).
During the crisis, the inefficient allocation of liquidity costs highlighted how ineffective
many banks liquidity risk management systems were. This was mainly due to the low
focus on liquidity risk from a regulatory perspective (Leichtfuss et al. 2010). Basel III,
however, introduces from 2019 two new liquidity requirements that banks need to fulfill,
the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR). (Basel
Committee on Banking Supervision 2010) estimates that global banks will need to raise
an additional 1.7 trillion EUR in liquid assets just to comply with the LCR. Looking at
NSFR, which are to limit the maturity mismatch discussed earlier, it will trigger even
larger fundamental changes. It is expected that global banks with no changes on their
balance sheet would have to add 2.9 trillion EUR2 of additional long term funding to
their balance sheet. In Europe alone the equivalent number is 1.8 trillion EUR due to
their high reliance on wholesale funding3 (Basel Committee on Banking Supervision
2010).

It should however be mentioned that the two numbers are not additive since a shortfall in one of them affects the other
and improvement will likewise affect both numbers
3
Wholesale funding increases the loans to deposit ratio

18

Part II Identifying Value Drivers

4. The Principles of Bank Valuation


Surprisingly few studies have focused on bank valuation and the determinants that drive
market value in banks. Even in one of the most accepted valuation books Valuation
measuring and managing the value of companies by (Koller, Goedhart & Wessels 2010)
only one chapter is devoted to the subject and in the chapter intro it is written Banks
are among the most complex businesses to value, especially from the outside in. Published
accounts give an overview of a banks performance, but the clarity of the picture they
present depends largely on accounting decisions made by management(Koller, Goedhart
& Wessels 2010). Maybe because of this great complexity another author writes There
is still a lack of comprehensive coverage of this subject [bank valuation]. Moreover, the
valuation literature that does focus on banks has rarely been practical and theoretical
satisfactory at the same time (Gross 2006).
In the valuation of banks several factors need to be addressed which might be why
standard literature only focuses on valuating industrial companies (Gross 2006). Banks
have in the recent years started expanding their potential customer base and increased
their business scope. This has increased the complexity greatly, making it necessary to
use different valuation models for their different divisions (Koller, Goedhart & Wessels
2010). Yet, a detailed income and balance sheet that is divided into these different
business units is very rare and subjects such as transfer pricing, capital allocation and
synergies created through cross-selling are difficult to estimate (Koller, Goedhart &
Wessels 2010). Especially if some products are kept due to their synergies even though
income margins are low or negative. Further, due to a very non-transparent balance sheet
and income statement, as discussed in Chapter 3, it is difficult to define entries such as
debt, capital expenditures, working capital etc. which makes the estimation of cash flows
(the core in DCF-valuation) difficult (Damodaran 2004). Also, accounting rules that
apply to banks are often different from those that apply in non-financial companies which
yields the problem, also mentioned by (Koller, Goedhart & Wessels 2010), that
performance largely depends on accounting decisions made by management. Further,
normal bank products are often not patented and difficult to differentiate which makes
forecasting even more difficult than the above mentioned complications suggest. Finally,
banks are due to their economic importance often heavily regulated which is something
that must be incorporated in the models. (Koller, Goedhart & Wessels 2010)
Since the value found in valuation models can be seen as a proxy for the market value
and TSR (Koller, Goedhart & Wessels 2010) this chapter will discuss the value drivers
that affect the valuation models. In Part III it will be tested whether drivers of valuation
models also are capable of explaining TSR.
One of the valuation pioneers, Aswath Damodaran, suggests that banks are best valued
using equity valuation models rather than the usual enterprise valuation models applied
in non-banks valuation (Damodaran 2009). The following methods will be discussed in
order to identify factors that might drive TSR:

19

Part II Identifying Value Drivers

Market-based models

Equity based models

Some of the general assumptions behind almost all of the valuation models are going
concern and that they are valued on a stand-alone basis (without synergies in e.g. M&A
activities), these assumptions will also be applied here. (Koller, Goedhart & Wessels
2010)

4.1 Market-based Models


When using market-oriented approaches, analysts use stock market data to form peer
group multiple analysis in order to compare the value of two banks. The core
assumptions behind peer group valuation based on multiples are the similarity between
the compared banks both on size, risk, type etc. (Koller, Goedhart & Wessels 2010)
In the valuation of non-banks, value multiples such as EV/EBITDA or EV/EBIT are the
preferred multiples. However, these are not applicable in bank valuation due to the
difficulty in estimating both the enterprise value and the operating income. Enterprise
value is difficult to estimate due to the challenges in interpreting the debt while
estimating operating income cause problems in the separation of operating and financing
activities. (Koller, Goedhart & Wessels 2010)
Especially two models are preferred in the literature: P/E and P/B (Koller, Goedhart &
Wessels 2010, Damodaran 2009, Dermine 2009, Gross 2006)(Fernndez 2001).
P/E is one of the most widely used multiples across several industries (Gross 2006) and is
defined as price per share over earnings. The level of P/E is a function of earnings
growth, the payout ratio and the cost of equity. As with non-banks, high growth banks
with high payouts and low cost of equity should trade at high P/E levels (Damodaran
2009).
There are however some disadvantages with this approach when it comes to banks. First
of all, the actual P/E multiple do not take a forward looking perspective, a problem that
to some extent can be taken care of by using forward earnings. A more important
drawback is its dependency of the underlying accounting variables and the subjective
accounting decisions made by the banks that tends to make it very volatile, see Appendix
17.1.3. (Damodaran 2009)
Due to this instability of P/E another equity ratio, the P/B ratio, is preferred. In this
ratio the market value is compared to the value of book assets. This multiple is driven by
earnings growth, payout ratios, cost of equity, business mix (Dermine 2009) and ROE,
where ROE is the variable that has the most impact on P/B (Damodaran 2009).
Mathematically the superiority of P/B over P/E can be seen from the following formula:

20

Part II Identifying Value Drivers

!" #" $%& "


'(() *&+," #" $%& "

!" #" $%& " - . /


'(() *&+," #" $%& " - . /

=
EQ 4

Price per share


EPS
P

= ROE
EPS
Book value per share
E

Since P/B is constructed by P/EROE, it is preferred because it has all the benefits that
the P/E ratio provides but also the current level of ROE. The stock market often uses
ROE in the estimation of a fair price and the high correlation between ROE and P/B
makes it a preferred multiple (Damodaran 2009). This correlation can also be seen from
the data found for this thesis. Exhibit 4.1.1 shows both the ROE and PB of the average
bank in the sample and a correlation of 96% supports this close relationship. If the stock
market e.g. demands 7 % ROE and the banks are capable of delivering 14 % a rule of
thumb is that the bank will trade at P/B close to two. If the bank, however, only
delivers ROE of 3.5% (on a consistent basis) the stock market will trade it at P/B close
to 0.5. (Damodaran 2009)
Exhibit 4.1.1: The Correlation between ROE and P/B
3.0
2.5

13.3% 12.9% 13.8%

Correlation = 96%
12.9%

2.2

2.1

2.1

12%

2.1

1.8

16%
14%

2.4

2.0
1.5

18%

14.7% 15.3% 15.3%

10%
1.7

1.2

1.1

1.1
0.9

1.0

8%
6%

2.1%

0.5

4.7% 0.8%

2.7%

0.0

4%
2%
0%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
P/B

ROE (right axis)

Source: Bloomberg, Own Contribution

The relationship between P/B and ROE is stronger in banks than in non-banks. This is
not a surprise because the book value of equity is much more likely to track the market
value of equity invested in existing assets due to the marked-to-market principles
discussed in Chapter 3 (Damodaran 2009). One of the drawbacks by using the P/B
multiple is, however, that it does not include off balance sheet items such as interest rate
derivatives, loan commitments, loans without recourse where the bank has no
commitment etc. even though these items often account for a significant part of the

21

Part II Identifying Value Drivers

business (Johnson 1996). Finally, P/B suffers from some of the same general drawbacks
as discussed in Appendix 17.1.3, regarding P/E.
4.1.1 Control Variables Derived from Multiples
In connection to this thesis, one general problem with multiples in regards to value-based
management is that management cannot directly influence the multiples since they are
not transparent to managers (Damodaran 2009). It does however, not mean that
multiples are useless because they can give an indication to managers of whether the
business environment is changing (Gross 2006). Further, when the thesis discusses the
different parameters to incorporate into the regression model in Part III, P/B will, due to
its superiority, be used as a control variable for the market expectations instead of P/E
suggested by (Koller, Goedhart & Wessels 2010).

4.2 Equity-based Models


The equity based models are based on discounting future cash flow to equity (CFE) by
the cost of equity in order to find the company value (Koller, Goedhart & Wessels
2010)(Damodaran 2009)(Dermine 2009). In the estimation of CFE it is however necessary
to look at the income statement and balance sheet of a bank. Since the simplest bank to
value is a pure retail bank, this banking type will work as an example.
Starting from the top of the income statement, the overall revenue driver in retail
banking is net interest income and is calculated as the difference between interest income
and interest expense. From this, operating expenses and taxes are subtracted in order to
arrive at the net income which is the amount left to equity holders when all expenses and
obligations to debt holders have been paid, for a detailed description of the income
statement and balance sheet see Appendix 17.1.4.
Even though net income is the earnings that theoretically are left to the equity holders, it
does not equal the CFE. As discussed in Chapter 3 banks need equity to grow if it is to
meet regulatory demands, increasing equity means less cash to equity holders. Finally,
other types of non-operational income or expenses also have to be included in the
calculation of CFE. Therefore, CFE is calculated as net income subtracted changes in
equity book value plus other comprehensive income after debt obligations have been met
which can be seen in the following formula (Koller, Goedhart & Wessels 2010).
CFEt = NIt - Et +OCIt

EQ 5

The value of the company is then calculated as the value of future cash flows (CFE)
discounted with the proper cost of capital. Since WACC is not applicable cost of equity
is applied as the discount factor and the equity value of a bank is calculated as
V" = =

22

89.:
( ;)< ):

EQ 6

Part II Identifying Value Drivers

Another way to calculate CFE is by summing all expected cash paid to or received by
equity holders and discounting it at the cost of equity. Since both calculations will arrive
at the same number a thorough discussion of this method can be found in Appendix
17.1.5.
Turning towards the cost of equity, it is the return a firm theoretically pay investors to
compensate for the risk they undertake (Brealey, Myers & Marcus 2012). Quantification
of this tradeoff between risk and return is one of the important problems in modern
financial economics (Campbell, Lo & MacKinlay 1998). (Markowitz 1959) laid the
groundwork for this quantification and (Sharpe 1964) and (Lintner 1965) build upon it in
the development of the capital asset pricing model (CAPM) where the cost of equity is
determined by the following equation
CoE = Rf +Bank (Rm - Rf)

EQ 7

In this model it is assumed that investors can lend and borrow at the risk free rate Rf
and that the CoE is calculated as the risk free rate plus the banks beta multiplied with
the market return subtracted the risk free rate. This shows that taking on more risk
(increasing the beta) will increase the CoE.
The equity cash flow method is straightforward and theoretically correct, however, in
connection to value-based management it yields a serious pitfall because it is impossible
to track where and when profit is created. Therefore, some further analyses are required
in order to show investors and bank managers how and where value is created. Such an
analysis is the residual income model. (Dermine 2009)
4.2.1 Residual Income
By construction, residual income models are able to give a detailed description of the
value created by a company over a certain period because it calculates the difference
between return and the cost of capital of an activity. Since the methods are derived
directly from the DCF approach any valuation based on the residual income method will
be identical to the DCF approach (Koller, Goedhart & Wessels 2010). The general
residual income formula is stated as
Residual Income = Invested Capital (ROIC - WACC)

EQ 8

However, since bank valuation differs from normal valuation by its focus on equity the
general residual income model for banks should be adjusted to the following (Damodaran
2009):
Residual income = Equity (ROE - Cost of equity)

EQ 9

From the formula it can be seen, that it is a measurement tool that are able to determine
both whether the bank earns more than their cost of capital and how much the bank

23

Part II Identifying Value Drivers

earns more. It is applicable in each business unit and also takes into account the
corresponding risk of a given activity.
Besides being a multiyear VBM tool that focuses on shareholder maximization, Stern
Stewart also suggests residual income models as a tool to motivate managers because it
makes them think like owners (Stewart 1998), thereby avoiding some of the agency
theory problems discussed in Chapter 2.
4.2.2 The Value Drivers
To summarize the value drivers in the valuation models a value driver tree for a simple
retail bank has been constructed, see Exhibit 4.2.2. Following the trees branches it is
possible to analyze how value is increased in the valuation models.
Exhibit 4.2.1: Value Drivers Extracted from Bank Valuation Models
Value driver tree

Value drivers
Interest
rate
liabilities1
Interest
rate assets1
Net interest
income

Value
creation

Cost of
equity

Interest rates on products

Volumes: Book values of


assets and liabilities
outstanding

Cost-to-income ratio:
Operating costs of business
relative to net interest
income

Capital ratio: Equity


requirements for assets
outstanding

COE: Cost of equity based


on asset liability mix

Growth: Growth of assets


and liabilities

Loan losses: Expected future


losses on loans outstanding

Liabilities

Operating
expenses1

Additions
to loan loss
provisions1

3 Cost/income

Return on
equity

Assets

4
6

Growth

Equity

Capital
ratio

1After taxes

Source: (Koller, Goedhart & Wessels 2010)

It is clear from the model, that the cost-income ratio is an important driver and
calculated as operating expenses divided by net interest income. Further, subtracting
taxes, operating expenses and loan loss provisions from the net interest income makes it
possible to derive the net income and thereby calculate return on equity, which is, as
described in the residual income model, a key driver in bank valuation models. (Koller,
Goedhart & Wessels 2010)

24

Part II Identifying Value Drivers

5. Value Drivers Discussed by Academia


Since the mid-2007 where the financial crisis started, it has been illustrated that bank
performance has a substantial influence on efficient capital allocation and the overall
economy (French et al. 2011). Academia has for some time had this in mind, and quite a
few papers have focused on how banks are able to increase their profitability. Studies like
(Athanasoglou, Brissimis & Delis 2008)(Brissimis, Delis & Papanikolaou 2008)(Lepetit et
al. 2008)(Berger et al. 2004)(Berger, Mester 2003)(Salas, Saurina 2003) are considering a
wide range of factors that they believe affect banking profitability. These factors include
bank specific, industry specific and macro specific variables. Most studies have some kind
of geographical area that they focus on. (Athanasoglou, Brissimis & Delis 2008) looks at
the Greek banking sector from 1985 to 2001 in order to test whether bank-specific,
industry-specific and sector-specific variables have an impact on profitability while
(Dietrich, Wanzenried 2011) focused on the same variables in the Swizz banking sector.
The study finds that all the bank specific factors (except for size) affect profitability.
Similar, (Brissimis, Delis & Papanikolaou 2008) examines the relationship between
individual bank performance with the banking sector reform-4, competition- and risk
variables. In their study, which they have conducted between 1994 and 2005, they find
that increased competition increases the efficiency and that increased risk has a negative
impact on the bank profitability. As discussed earlier, risk has always been an important
part of bank profitability. In connection to that (Lepetit et al. 2008) investigate the
relationship between risk and product diversification and find, that banks with a higher
non-interest income ratio display higher risk than pure retail banks. Other aspects of risk
are the degree of leverage and the impact on profit and efficiency. Both (Berger,
Bonaccorsi di Patti 2006) and (Margaritis, Psillaki 2010)(Cummins, Lewis & Wei 2006)
have analyzed this relationship and find that, controlled for everything else, higher
leverage (e.g. a lower tier 1 ratio) increases the bank efficiency and therefore bank
profitability. Further, in relation to changes in the leverage ratio, (Kwan, Eisenbeis 1997)
and (Demirg-Kunt, Huizinga 2004) recognize that a positive loan and deposit growth
affects profitability positively. Finally, studies have also focused on different source of
profits like e.g. (Cummins, Lewis & Wei 2006) or (Gillet, Hbner & Plunus 2010) who
both investigate the relationship between operational risk and the corresponding reaction
on the stock market.
As it has just been described, there is a large amount of literature focusing on how
profitability might be affected by various factors. However, the empirical literature on
how shareholder value can (Marshall 1891)be affected by various factors is somehow
limited. Only a few studies have tried to find a relationship between bank productivity,
bank efficiency and shareholder value but they generally come up with positive results.
(Fiordelisi 2007) defines a measure called shareholder value efficiency where banks
producing the highest economic value add are described as the value-efficient banks.

By using the European Bank for Reconstruction and Development Index of banking sector reforms

25

Part II Identifying Value Drivers

(Beccalli, Casu & Girardone 2006) tests the stock return on various efficiency measures
and generally find a positive correlation between the two. However, the studies are
limited to only focusing on the relationship between a single factor and shareholder value
creation instead of testing a larger set of factors that might affect shareholder value (like
cost of equity, growth, risk etc.). The articles discussed in Section 5.1, 5.2 and 5.3 are
considered the main literature within the area of shareholder value creation.

5.1 Profitability as the Main Value Driver


(Fiordelisi, Molyneux 2010) tries to cover some of the gaps within the shareholder value
in banks literature. First, a broad range of factors that impact shareholder value in
European banks are analyzed. This is followed by a causality test of the factors where
there is controlled for the trade-off between various value determinants (Fiordelisi,
Molyneux 2010).
The shareholder value creation measure used by (Fiordelisi, Molyneux 2010) is the
economic value added (EVA) which is defined as a banks net operating profits
subtracted its capital charge over the same period. In order to affect the EVA banks have
three bottoms to push: Net operating profit, opportunity cost of capital and invested
capital. The value drivers suggested by (Fiordelisi, Molyneux 2010) can be observed in
Exhibit 5.1.1.
Exhibit 5.1.1: The Value Drivers according to (Fiordelisi, Molyneux 2010)
Interest
income
Income
structure
Net
operating
profit

Fee income
Security
investment
returns
Interest cost
and exp.
credit loss

EVA

Cost
structure
Risk
exposure

Opportunity
cost of
capital

Level of risk
management

Invested
capital

Fee cost
Capital
losses
Operating
costs

Leverage

Source: (Fiordelisi, Molyneux 2010), own contribution

26

Part II Identifying Value Drivers

From this value driver tree different KPIs are evaluated. (Fiordelisi, Molyneux 2010)
suggests that, based on earlier profitability literature such as (Berger, Mester 2003)
(Lepetit et al. 2008) and (Beccalli, Casu & Girardone 2006), cost efficiency, revenue
efficiency and income diversification is expected to have an impact on the income
structure of the bank. Also loan and deposits growth is considered valuable KPIs
(Demirg-Kunt, Huizinga 2004) and are seen as proxy for both bank performance and
soundness. Other authors such as (Stan Davis, Tom Albright 2004) also suggest it as a
proxy for customer satisfaction. Turning toward risk exposure and risk costs, a suggested
KPI is loan loss provisions to total loans (Brissimis, Delis & Papanikolaou
2008)(Athanasoglou, Brissimis & Delis 2008). The industry specific factors are testing
whether the market structure has any impact on the performance (Berger et al. 2004).
For this, the Herfindahl index is included since it measures the domestic banking
industry concentration. The last measure is the macroeconomic factor GDP per capita
which are included as a control variable according to (Salas, Saurina 2003) and
(Brissimis, Delis & Papanikolaou 2008).
Exhibit 5.1.2 illustrates the various factors and shows the results from the article. The
most important finding in the article is that cost-efficiency and revenue-efficiency are
confirmed to have a positive relationship on shareholder value (measured by the
shareholder value efficiency measure). Furthermore, the use of generalized method of
moments allows the test of lagged effects of the independent variables because it is
suggested that the total payoff might not come right away. Both cost and revenueefficiency is confirmed to have a lagged effect on the value generation. Finally, it is
emphasized that the value factors often have both positive and negative side effects and
it is a trade-off between those that measures the net effect.
Exhibit 5.1.2: The Investigated Value Drivers
Variable

Result

Profitability

"Cost-efficiency"
"Revenue efficiency"
"Profit efficiency"

Positive relationship and a lagged effect ***


Positive relationship and a lagged effect **
Positive relationship and a lagged effect ***

Credit risk,
liquidity
and
leverage

Provision to loan-loss reserves


Security investments/assets
Avg. loans/Avg. deposits
Liabilities/equity

Positive relationship **
Negative
Negative
Positive

Control
variables

Net non-interest inc./Net oper. inc.


Adj. loan growth rate
Adj. deposit growth rate
Total assets
Herfindahl index
GDP pro capita

Positive relationship ***


Positive
Negative relationship *
Negative
Negative
Negative

* Significant at 10%

** Significant at 5%

*** Significant at 1%

Source: (Fiordelisi, Molyneux 2010), own contribution

27

Part II Identifying Value Drivers

5.2 Risk and Cost-efficiency as the Main Value Drivers


(Gross 2006) states that shareholder value has become the pre-eminent performance
measure in many industrial companies and it has significantly affected how some banks
in recent years have tried to optimize their business. The objective of the paper by
(Gross 2006) is to find the metrics that are able to quantify the story behind shareholder
value and to understand the fundamental drivers of value. Also in this thesis it is
emphasized that not many articles have so far been written on the subject and it
therefore contributes to the mapping of the value drivers in banks. The analysis is based
upon a regression analysis of 139 retail banks in Germany in the period 1998-2003. Since
the analysis is based on non-traded banks it is not possible to get TSR data and a
residual income value is used to approximate it. Besides not being available, (Gross 2006)
believes that TSR is affected by short-term market reactions and this potential over- or
under valuation makes residual income more reliable. The rationale behind this decision
is to be found in earlier literature by (Stephen H Penman, Theodore Sougiannis 1998)
where evidence for residual income as a superior measure for shareholder value creation
in companies has been provided. Further, residual income is directly linked to the
operational value drivers that (Gross 2006) looks at. Finally residual income can easily be
estimated with the data required in a banks annual reports. The relationship between
residual income and the different drivers can be seen in Exhibit 5.2.1.
Exhibit 5.2.1: The Value Drivers Identified by (Gross 2006)
Intrinsic value

Financial indicators

Operational value drivers

Income/Equity
RoE (After tax)

Business mix:
Diversification of income

RIOE

Cost/Equity

Risk capabilities:
LLP/Interest income

Economic equity

LLP/Equity

Branch structure:
Customers/Branch

Taxes/Equity

Cost efficiency:
Total cost/Employees

Residual income
Cost of Equity

Source: (Gross 2006), own contribution

The drivers that are tested in the study and that can be seen in Exhibit 5.2.1 above are
the strategic and operational value drivers that affect the residual income on equity
(RIOE). The first driver is business mix, also suggested by (Baele, De Jonghe & Vander
Vennet 2007)(Dayal et al. 2011) and (Leichtfuss et al. 2010), where income diversification
is used as a measure. Low diversification is seen as a measure for the traditional lendingoriented business model where a high measure characterizes the diversified banks and
those that are more depended on fees and advisory-based income. The second driver is
branch structure, measured as customer per branch. It has been widely argued whether
there is such a thing as an optimal branch structure but it is potentially a value driver.
Cost efficiency is the third driver that is tested and measured as total cost per employee.
Due to recently introduced cost programs it is expected to be a value driver that affects

28

Part II Identifying Value Drivers

TSR, this is supported by (Dermine 2008) and (Fiordelisi, Molyneux 2010). Finally, risk
capabilities are included since it is expected to be still more important for banks in the
future. The LLP/Interest income provides important information regarding the risk
capabilities of a bank and is thus expected to influence bank value significantly.
The findings in (Gross 2006) suggest that only the cost efficiency and the risk capabilities
are relevant drivers for shareholder value in banks. Whereas, both the business mix and
the branch structure driver is difficult to make any reliable conclusions on, due to their
ambiguity. The regression results for the business mix suggest that an increased income
diversification is value destroying in the short-term. Results for the underlying income
cost and risk structure for the bank is somewhat controversial as well. Looking at the
branch structure there is no empirical evidence for the value impact of changes in the
branch structure and it is therefore concluded that it has no direct impact on value.
Potential value implications are instead driven by the interdependence of the branch
structure and the different value drivers (Gross 2006). Exhibit 5.2.2 summarizes the
different value drivers and the key results of the study.
Exhibit 5.2.2: The Investigated Value Drivers
Variable

Category

Result

Interest income / Total income


LLP / Interest income
Customers / Branch
Total cost / employee

"Business mix"
"Risk"
"Branch structure"
"Cost efficiency"

No clear relationship
Positive relationship
No clear relationship
Positive relationship

Interest rate
Ln(assets)
Universal bank dummy

"Control variable"
"Control variable"
"Control variable"

Source: (Gross 2006), own contribution

5.3 Bank Diversification as a Value Driver


Following the second banking directive 1989, European banks has been allowed to pursue
functional diversification across different financial activities like investment banking,
commercial banking, insurance etc. This law has increased the diversification among
some banks (Baele, De Jonghe & Vander Vennet 2007). The aim of both (Walter 1997)
and (Baele, De Jonghe & Vander Vennet 2007) is to test whether these conglomerate
banks have a comparative advantage in terms of long-term shareholder value, compared
to the more specialized competitors. From a regulatory perspective, a bank is considered
a conglomerate by (Baele, De Jonghe & Vander Vennet 2007) when its product portfolio
consists of two out of three of the following: banking, insurance or securities-related
activities. In order to test for diversification in practice, researchers look toward noninterest income in order to measure the diversification. Non-interest income effectively
captures all those income streams that are not bank related which makes it suitable for
these kinds of tests (Dermine 2009).

29

Part II Identifying Value Drivers

When a bank chooses to diversify itself it yields both some advantages and disadvantages
that affects the shareholder value (Baele, De Jonghe & Vander Vennet 2007). The
advantages are first of all created through increased cost effectiveness or increased
revenue effectiveness (synergies) of combining the different kind of financial activities.
Further, both the bank and e.g. the insurance part possess information from their
activities that facilitate the efficient provision of each others financial services. Hence, a
banking conglomerate is able to exploit the information it has collected on different
activities and thereby secure increased performance and market valuation. Finally, when
cross-activity is allowed, managers of the financial firms incur a higher degree of
monitoring by the acquiring market (Saunders 1994) which might decrease some of the
agency problems. Taking a look at the disadvantages, a more diversified company may
also mean a more complex business which decreases shareholder value. Further, agency
problems in the form of conflict of interest might be increased both between insiders and
outsider but also between each division. Also more person-specific disadvantages may
arise since managers can seek private benefits by a merger or by taking in a new business
unit even though it is at the cost of shareholder value. Finally, conglomerate discount is
a widely used term and also tested by (Schmid, Walter 2009) in terms of banking. It is
here found that banking conglomerates normally trade at a discount. Theoretically it is
unclear when dealing with non-banks and banks whether the advantages weigh stronger
than the disadvantages in terms of shareholder value. However, (DeLong 2001) have
obtained that shareholder value is created through M&A activities only when they are
based on activity and geography whereas more functional mergers are value destroying.
As it is clearly seen, the literature is divided in the question whether increased
diversification increases or decreases shareholder value. In the studies (Baele, De Jonghe
& Vander Vennet 2007) finds strongly positive correlations between shareholder value
and the degree of diversification, measured as non-interest income to total revenue,
meaning that the stock market anticipate the advantages to have a greater weight than
the disadvantages. In Exhibit 5.3.1 some of the other variables that (Baele, De Jonghe &
Vander Vennet 2007) tests in order to decide whether diversification affects performance
can be seen.
Exhibit 5.3.1: The Investigated Value Drivers
Variable

Category

Result

Revenue diversity
Equity to assets
Equity to assets squared
Cost-income
Loan loss provisions
Ln (assets)

"Business mix"
"Leverage"
"Leverage"
"Cost efficiency"
"Risk"
"Size"

Positive impact on value creation ***


Negative (Not significant)
Positive impact on value creation ***
Negative impact on value creation ***
Positive (Not significant)
Negative (Not significant)

* Significant at 10%

** Significant at 5%

*** Significant at 1%

Source: (Baele, De Jonghe & Vander Vennet 2007), own contribution

Another way of looking at diversification is by discussing whether large banks outperform


small banks because only the very large banks have the capabilities of having several

30

Part II Identifying Value Drivers

financing activities (Walter 1997). An issue that has received a very large amount of
attention is the existence or lack of economies of scale and scope. Where economies of
scale refer to size being able to create a competitive advantage, economies of scope refer
to the fact that joint offerings create competitive advantages (Dermine 2008). (Walter
1997) addresses the problem through a discussion about the two phenomena. In an
intensive sector with high information, many distribution challenges and high fixed costs
it might be suggested that there is an economic rationale behind economies of scale.
Economies of scope are discussed by looking at supply and demand side. On the supply
side, scope economies are related to the sharing of costs through joint production of
similar products. However, banks might also be exposed to diseconomies of scope on the
supply side due to inertia and lack of responsiveness and creativity through increased
bureaucratization and increased complexity. Further, (Calomiris 1995) have found that
there was a negative supply side economy of scope among universal banks, meaning that
the more products the bank had in its portfolio the higher were the cost on each product
compared to the specialized companies. Turning towards the demand side, economies of
scope arises if the bank succeeds in lowering the total cost compared to if the customer
needs to buy each financial product at separate companies. Diseconomies of scope on the
demand side could be experienced through agency costs if the multibank employees act
against the interest of the customers in order to facilitate a sale to another part of the
bank. Even though (Walter 1997) only discusses the different issues without testing
them, they will be included as variables in the analysis in Part III.

6. The Value Drivers Discussed by Consulting Companies


Having discussed value drivers from an outside-in perspective the following chapters will
focus on the value drivers that are found through an internal view by consulting
companies and the banks. Consulting can deliver an internal view because they are hired
by the bank management to optimize the bank and therefore gain access to internal data.
This data is collected in information pools and used in their industry analyses. (Visali et
al. 2011, Duthoit et al. 2011)
Operational excellence is becoming a still increasing focus of bank managers, but
relatively few of them understand the steps they must take to raise their operational level
(Duthoit et al. 2011). According to the consulting industry, the maximization of
shareholder value is therefore a strong performance measure where managers are forced
to make value creating decisions. In the following part the results of a literature review of
the articles concerning the subject shareholder value in banks will be presented. The
objective of the part is to give both an overview of the different methodologies and a
more operational view than what is often seen within academia. Finally, the findings will
be applied as input factors in Part III.
Before discussing the findings from management consulting companies, it is important to
understand the major drawback in using consulting literature. The key focus in these
31

Part II Identifying Value Drivers

firms is to earn money meaning that the more companies implement shareholder valueapproaches the more training is needed, training that consulting companies offer (Young,
O'Byrne 2001).(Myers 1996) discusses this greed driven war between the consulting
companies. However, keeping this drawback in mind it can also be suggested that they
are forced to provide the readers with some strong analyses in order to secure their
business, and therefore lessons can still be learned from analyzing the findings of
consulting companies.
In the procedure of selecting the consultancy companies there was a requirement
regarding available reports on the subject. The chosen companies that lay ground to this
were Booz & Company, Bain & Company, Boston Consulting Group (BCG), McKinsey
& Company, Deloitte, KPMG, Ernst & Young and PriceWaterouseCoopers (PWC). Of
these companies only McKinsey & Company, BCG and PWC had available publications
on shareholder value in banks. Measured by the number of available articles BCG is the
consultancy company with most focus on the subject, however, McKinsey also have
contributed with a great deal of insight. A more extensive description of the consulting
companies and the selection process see Appendix 17.1.6. The following will focus on key
drivers discussed by the consulting firms while the more thorough operational changes
that need to be made in order to affect the drivers will be discussed in Part IV.

6.1 The Value Drivers Discussed by McKinsey


Each year McKinsey analyses the banking sector in the article series "The State of Global
Banking" where the core drivers for bank valuation are discussed. As is the case with
McKinseys general view on shareholder value creation, the core driver in banks is the
economic profit. However, the economic profit is calculated differently from banks to
non-banks, where ROE and cost of equity are the main drivers (Visali et al. 2011)5.
Exhibit 6.1.1 shows how McKinsey sees value creation in banks.

This follows what was discussed in the section regarding bank valuation models

32

Part II Identifying Value Drivers

Exhibit 6.1.1: McKinseys View on Value Drivers in Banking


Revenues
before PLL

Net interest
margin
Fee Margin

Annual PLL

Net income
Cost-income
ratio

ROE

Other incl.
taxes

Intangible
assets

Total Assets
RWA

Tangible
common
equity

RWA/Total
assets

TCE Ratio
Source: McKinsey: (Visali et al. 2011)

6.1.1 The Value Drivers


In order to have a successful VBM system, bank managers need to take into
consideration the future challenges that lie ahead of them (Visali et al. 2011). The world
is consistently evolving, and with it the environment that banks operate in. At the
moment, especially four trends will have an impact on the core value drivers going
forward.
First, the increasing regulation is the single most important driver when it comes to
profitability. Due to the heavy capital constraints, equity capital and funding costs will
increase which is expensive for banks as discussed in Chapter 3. These increased
regulatory constraints will impact the key drivers through a set of underlying value
drivers. ROE will be affected both in the numerator and the denominator. Return will be
negatively impacted due to the increasing cost of holding equity and higher operational
costs whereas the common equity in the denominator will increase. This expected
decrease in ROE is also the main reason for the negative TSR in the years after the crisis
(Daruvala, Malik & Nauck 2012). Looking at the other driver, cost of equity, it is
expected to decrease due to a more secure sector. However, the decrease is not expected
to make up for the lower ROE.
Second, the squeeze on capital and funding driven by new investment opportunities and
the increasing demand for capital in banks all over the world increases the funding costs.
An underlying value driver that is affected by this change is the net interest margin. This
development is especially seen in Spain where the increasing demand for capital have
more than doubled the interest rate on customer deposits compared to treasury bills, and
therefore puts pressure on the net interest margin. (Visali et al. 2011)

33

Part II Identifying Value Drivers

Third, revenue growth is still seen as a value driver by McKinsey. In the recent years it
has however been difficult to grow organically within the Western European and
American region. The arguments for this driver are therefore to be found in the emerging
markets. Banking TSR have been significantly higher in those countries that have
experienced growth compared to those where a flat development have been seen. This
indicates that those banks, capable of capturing revenue growth will be able to increase
shareholder value. (Visali et al. 2011)
Finally, the shift in consumer behaviour to a more technology-driven behaviour will
affect the cost driven value driver. By closing branches or making them smaller bank
managers will be able to decrease the cost-income ratio which is also expected to affect
shareholder value positively. However, as is always the case with change, only the banks
capable of adapting to the changing environment will benefit from it. Those banks not
capable of delivering superior customer experience to a new generation of self-helped
customers will have a hard time competing. (Visali et al. 2011)
6.1.2 Macro Variables
When testing the value drivers, bank managers are not solely responsible for the
development of a banks performance; some factors are to be controlled for in order to
isolate the internal value drivers. One of these is the domicile countrys credit rating. If
the country has a low credit rating it will affect the banks credit rating, higher the
lending costs and thereby make it difficult to compete across borders and be more
vulnerable to foreign competitors with higher credit ratings. A proxy for this credit rating
is the CDS spread which McKinsey uses to control for the different funding costs (Visali
et al. 2011). In Exhibit 6.1.2 all the value drivers that McKinsey focus on can be seen.
Exhibit 6.1.2: Performance and Confidence Indicators used by McKinsey
Performance indicators
Financial depth
Banking revenue growth
Net interest and fee margins
Annual provisions for loan losses
Non-performing loans
Cost-income ratio
Banking profit growth
ROE
Capital ratios
Loan-to-deposit ratio

Confidence indicators
Cross-border capital flows
Short-term cross-border loans
LIBOR-OIS spreads
Bank Credit Default Swap (CDS) spreads
Bank market capitalization
Bank price-to-book multiples

Source: (Visali et al. 2011), own contribution

6.2 The Value Drivers Discussed by Boston Consulting Group (BCG)


In order to explore what drives bank valuation and which value drivers to focus on, BCG
has conducted several analyses on the issue. The analyses are based on the largest banks

34

Part II Identifying Value Drivers

in the world where they compare top performers with the underperformers on some key
value drivers. Key findings from these studies are that even among large universal banks
there are several factors that can increase performance (Duthoit et al. 2011).
6.2.1 The Focus Areas
In general, BCG focuses on some operational drivers such as sales- and service
effectiveness, process- automation and industrialization in order to affect key value
drivers like CIR, ROE, ROA, revenue growth etc. Where McKinsey focused on four
trends that the banking business models need to adapt to, BCG see two major trends
that challenge these numbers. First of all, an intensifying competition due to
deregulation, that opens the international markets and increases the number of global
banks, the introduction of both direct and online banking and increasing customer
demands. This change in the competitive landscape is expected to put an increasing
pressure on the banks earnings margins. Secondly, BCG also emphasizes the importance
of adapting to the capital requirements and uses the Risk-to-income ratio as a measure
on how capable the bank is of controlling for the increasing risk (Dayal et al. 2011).
Starting with the competitive landscape, the question is now where the new margin
equilibrium on the cost-income ratio and ROA will be and how bank managers can
increase it to an absolute maximum. As stated BCG has looked at how some banks
historically have been able to outperform and are giving two suggestions on what bank
managers can do in the future and which value drivers to focus at. In order to become a
winning bank BCG suggest that bank managers focus on ROA and CIR since they are
the two accounting numbers that are able to grow value the most (Duthoit et al. 2011).
Further, revenue growth is also an important value driver and can be achieved either by
organic growth or through M&A activities. Like McKinsey, BCG supports their
arguments for revenue growth being an important value driver, based on the
development in emerging market. (Dayal et al. 2010)
Achieving revenue growth is however very difficult. The reason for this low growth in
developed economies is not due to a decreasing focus from the top management but more
because of the challenges in increasing revenue per customer. As can be seen in the next
section a strong customer focus is needed thereby building the growth upon a long lasting
customer relationship. (Dayal et al. 2010)
6.2.2 The Value Drivers
Even though it is suggested that revenue growth is a value driver, being large is not a
synonym for sector outperformance. BCG has, just as (Walter 1997) and (Baele, De
Jonghe & Vander Vennet 2007) looked at whether large banks outperform smaller banks.
In these studies they have spotted what they call domestic champions which are those
banks that have been able to focus on creating superior sales and service by knowing
their customers preferences. This focus on a small market might conflict with the revenue
growth value driver, but being really good in a small area can make up for the missing

35

Part II Identifying Value Drivers

size (Leichtfuss et al. 2010). In Appendix 17.1.7 an example of a domestic champion can
be found. However, BCG also highlights some advantages from being a large bank. Often
diversification is larger in global banks making them more resilient. Further, by
spreading portfolios across different regions the great dependency to the overall economy
is also diversified across several regions (Leichtfuss et al. 2010).
The second large factor that BCG sees as a KPI is the Risk-to-income ratio (RIR), a
ratio that helps the bank manager balance between risk and growth. The fact that some
banks, during the crisis, came close to failure while others collapsed or became dependent
of government support has highlighted the importance of strong risk management skills
(Leichtfuss et al. 2010). Further, risk cost has been the main driver of negative value
creation since the start of the crisis and is expected to remain high for the coming years
(Dayal et al. 2011). In Exhibit 6.2.1 it is clear to see how the RIR has evolved as an
effect of increasing cost of equity and provision for loan losses.
Exhibit 6.2.1: The Relationship between CoE and RIR
800
700

192%
200%

Billion USD

600

82% 258
65% 66% 62%

200

150%

411

400

100

145%

135% 312

500

300

250%

136%

65
50

80
60

88
53

51%

335

60% 62%
216

160
249
104 135
103
43 50 60

400
258

100%
50%

199
0%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Provision for loan loss

Cost of equity

RIR (Right axis)

Source: Bloomberg, own analysis


Looking across the BCG studies included in this review a total of 40 variables affecting
the shareholder value has been identified, see Exhibit 6.2.2.

36

Part II Identifying Value Drivers

Exhibit 6.2.2: 40 Variables Considered by BCG


Dayal et. al. (2010)
Dayal et. al. (2011)

Leichtfuss et. al. (2010)

ROE

Risk to income ratio (RIR)

CIR

Trading revenue growth

Operating costs

ROA

Operating profit margin

Risk weighted assets

Revenue

Risk cost

Loan to deposit ratio

Cost

Tier 1 ratio

Growth in Long term assets

LLP

RWA growth

Deposit growth

Retail banking revenue

Economic recovery (macro)

Cost to income ratio

Regulation criteria

Refinancing costs

Duthoit, et. al. (2011)

Olsen et. al. (2010)

Cost-income-ratio

Branch wait time

Profit growth

Customer/FTE

Call wait time

Multiple change

Sales&Service FTE/Total FTE

Call resolution time

Dividend yield

New Accounts/ Sales FTE

Time until new account ready to use

Net debt charge

New current account/operations FTE

Time from application to fund available

Revenue growth

Existing curr. accounts/operations FTE

Time from application to condition app.

Sales growth

Sales conversion/inbound call

% of FTE with Customer facing sales

Margin change

Customer attrition rate

Cycle times

Profitable growth*

Level of automation (Q)

Call centre metrics

Sources: Dayal et. al. (2010), Dayal et. al. (2011), Leichtfuss, et. al. (2010), Dutohoit et. al. (2010), Olsen et. al. (2010),
own contribution

6.3 The Value Drivers Discussed by PriceWaterhouseCoopers


Although PWC have not published many articles on how to create shareholder value in
banks, (Black, Wright & Bachman 1998) presents a set of drivers that PWC focus on
when they evaluate banks. Besides macro economic factors, they group banking value
drivers into three overall categories growth, returns and risk. These three overall
drivers are then broken down into ten value drivers (Black, Wright & Bachman 1998).
Again, residual income is used as the dependent variable. Exhibit 6.3.1 shows the value
drivers.
Exhibit 6.3.1: PWCs Value Driver Categories
Category
Growth

Returns

Risk

Value Driver
Competitive advantage period
Capital expenditures
Growth in operating assets
Net interest margin
Non-interest income growth
Cost-income ratio
Loan loss rate
Cash tax rate
Regulatory requirements
Cost of equity

Source: (Black, Wright & Bachman 1998), own contribution

37

Part II Identifying Value Drivers

6.3.1 The Growth Drivers


The first driver that bank managers should focus on is increasing the banks growth by
gaining competitive advantages. In PWCs models, the competitive advantage period that
the bank has is measured as the period where the bank is capable of earning a higher
operating return than their cost of capital (positive residual income). In the calculation of
this period it is discussed that the sustainability of the banks competitive advantages
needs to be taken into account because most banking products are easy to duplicate.
This makes these periods with positive residual incomes short unless the bank is capable
of renewing their portfolio all the time. An example from the Danish market of this ease
of duplication was Danske Banks launch of an iPhone app. It only took the competitors
six month to invent their own app making the period of competitive advantages
extremely short. Further, although it was argued in an earlier chapter that capital
expenditures are a minor part of a banks balance sheet, PWC believes it is capable of
explaining how value is created. Finally, growth in operating assets which is made up of
loans and other earnings assets (short term assets, long term positions in investments,
loans to banks etc.) is the final growth driver. Even though the last driver does not
directly affect the cash flow it is assumed that every loan creates deposits and thereby
creates value (given that net interest margin is positive). (Black, Wright & Bachman
1998)
6.3.2 The Return Drivers
The first return driver that PWC focus on is the net interest margin, since it can be
approximated to work as a cash flow measure which is what creates value in their
banking model. Further, non-interest income, which is made up of fees, commissions and
trading income (this is other operating income in the data) is expected to drive value.
Having covered the two main income drivers PWC turn towards the cost side of the
return. Like many other studies it is again the cost-income ratio that is included since it
is expected to be the best cost driver. Other cost measures are the loan loss provisions
that are used as a proxy for the implications of non-performing assets on the equity
holders cash flow. The last driver is the cash tax rate which is a measure that (Black,
Wright & Bachman 1998) suggest to control for. It has a great impact on the bottom line
and cash flow to investors but it is something that the banks cannot control themselves.
6.3.3 The Risk Drivers
The last two drivers is concentrated around risk since this, as discussed before, is an
important part of the bank. The first driver is connected to the regulatory requirements
and is therefore focused on the amount of equity that is needed to maintain capital
adequacy. PWC focus both on tier 1 and total capital ratios in order to determine the
effect that it will have on the cash flow to shareholders. The final driver is the cost of
equity that (Black, Wright & Bachman 1998) calculates through the CAPM framework
and therefore is affected by the risk free rate, the market risk premium and the beta as
discussed in Chapter 4. In the later years there has been a dramatic increase in the cost
38

Part II Identifying Value Drivers

of equity which is both driven by an increasing market risk premium but also through a
higher beta. This development in both beta and cost of equity can be seen from Exhibit
6.3.26.
Exhibit 6.3.2: CoE and Sector Beta
18%
16%

0.77

0.75 0.74
0.71

0.75

0.67 0.67

14%

16.3%

0.63

0.62
0.59

12%

0.55

12.7% 12.6%

0.53
10%

12.9%

11.1%

8%

9.7% 9.6%

9.2%
8.2%

6%

8.3%

0.70
0.65
0.60
0.55
0.50
0.45

7.9%

0.40

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Cost of equity

Sector beta

Source: Damodaran, Own data

0.80

The beta is only from American bank stocks, but is used as a proxy for the bank beta in this thesis.

39

Part II Identifying Value Drivers

7. The Shareholder Value Banks


Having discussed the external views that both valuation models and academia have and
the internal view from consulting houses it is now time to take the last group, the banks.
It is assumed that banks must be the ones that know themselves the best, and the
identified case banks therefore play an important role in the determination of value
drivers. The shareholder value banks in this study are banks who have implemented
value-based-management, or in other words banks that have oriented all key processes
and systems towards the creation of shareholder value (Young, O'Byrne 2001).
In order to determine whether a bank has introduced value-based management a method
inspired by (Rapp et al. 2011) is used. (Rapp et al. 2011) examines annual reports for all
the banks in the sample and lists some clearly defined criteria. According to the criteria
of (Rapp et al. 2011) a company has implemented a VBM system in a particular year, if
an internal control system with an integrated VBM metric is described and this measure
is used as a target or controlling mechanism.
This means that one of the following three criteria has to be satisfied before the bank is
identified as a shareholder value bank:

The direct mentioning of an implemented value-based management system

The banks vision involves creating shareholder value

The banks mission or ultimate goal is to create shareholder value

The selection process can be seen in Exhibit 7.1.1.


Exhibit 7.1.1: Selection Process
1. Screening

2. Screening

3. Screening

2011 Annual Reports


for 132 sample banks

Mission and vision

Annual Report 2001 or


earliest one available for
20 remaining banks

Mission and vision

Company information

Company website

Search key words

Search key words

Articles

Approved VBM bank

Summarize data on the key performance indicators


Summarize data for the cases

Source: Own contribution

40

Part II Identifying Value Drivers

The careful study of the annual reports resulted in the identification of the shareholder
value banks. Both annual reports from the beginning and the end of the sample period
were analyzed. If traces of VBM were found both in the beginning and the end of the
period it is assumed that the bank has been committed to shareholder value in the entire
sample period. A total of 20 banks were found and Appendix 17.1.8 lists the identified
banks and the key arguments behind the title as shareholder value bank.
A major weakness of the procedure is that the analysis is performed outside-in and it is
almost impossible to determine whether or not the bank actually is managed according to
the principles of value-based management (Rapp et al. 2011). An extensive research on
VBM, conducted by (Boulos, Haspeslagh & Noda 2001) revealed that it takes more than
words to outperform competitors with a VBM system. It might therefore be difficult to
assess whether a bank only states that it has implemented VBM or if it actually manage
the entire bank according to the VBM principles. With this in mind it is still found
valuable to discuss which value drivers the banks consider. In the following, Deutsche
Bank will be presented further in Exhibit 7.1.2 since it is one of the banks that are
committed to shareholder value creation. The motivation for including case studies is
that the full understanding of the focus of the shareholder value banks is important. An
analysis of the remaining 19 case banks can be found in Appendix 17.1.9.

7.1 The Value Drivers of Value-based Management Banks


Deutsche Bank directly states that they have followed the guiding principles of valuebased management (See Section 2.2) and uses TSR as their shareholder value measure:
"Based on a TSR-model which identifies the determinants of our value development
empirically, key metrics for internal steering were derived and connected with businessspecific value drivers."
- (Deutsche Bank, annual report 2010)
Since Deutsche Bank has declared its objective regarding total shareholder return it is
safe to assume that the bank in some way has identified the drivers of shareholder value
and incorporated the most important ones as KPIs in their management control systems.

41

Part II Identifying Value Drivers

Exhibit 7.1.2: Deutsche Bank Case Study


Deutsche Bank is the largest bank in Germany, and headquartered in the Twin
Towers in Frankfurt. The bank is also on a global scale one of the largest banks as
it employs more than 100.000 people. It offers a full range of financial products such
as retail banking, private banking, investment banking, fund management etc.
Shareholder Value Focus
In the annual report from 2010 Deutsche Bank, as the only sample bank, explains
their value-based management system in detail. The description of the value-based
management system yields valuable insights about their key value drivers. Deutsche
Bank has conducted a large-scale internal analysis of their shareholder value
Thegeneration.
evidence from
Deutsche
Bankofis the
the movements
most direct in
statement
about
the use
valueThrough
analyses
key value
drivers
theyof have
based management. In Europe the value-based management systems are also
identified the following KPIs:
implemented.
KPIs
1. Return on equity
8. Economic profit growth
2. IBIT
9. Core Tier 1 ratio
3. CI-ratio
10. Leverage Ratio
4. Economic Profit
11. Liquidity
5. Revenue growth
12. Economic Capital Usage
6. IBIT growth
13. Share of classic banking
7. Asset growth
14. Revenue from growth regions
Another important feature of their VBM system is that the KPIs are evaluated each
year based on internal analysis and benchmarking. The annual review of the VBM
system is recommended by (Rappaport 1998). Deutsche bank also remunerates their
employees based on their contribution to shareholder value generation which was
recommended by (Pitman 2003).
Measured on TSR, DB has not been able to outperform the market:
70%
20%
-30%
-80%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
TSR DB

TSR MSC Fin.

42

Part II Identifying Value Drivers

In Exhibit 7.1.3 the identified KPIs from the banks with value-based management have
been summed up. Only KPIs used by at least 5 of the case banks are included in the
Exhibit.
Exhibit 7.1.3: The Most Commonly Used KPIs
Variable
ROE
Tier 1 ratio
Cost-income ratio
IBIT growth
ROA or RORWA

Count
15
15
12
11
10

Variable
EPS
Revenue growth
Business Mix
Geography mix
NIM

Count
9
8
5
5
5

Source: Annual Reports of the 20 VBM banks, Own contribution

From Exhibit 7.1.3 it is seen that the most popular KPIs used by the banks are ROE
and the tier 1 ratio. ROE is reported in 15 out of 20 banks. The cost-income ratio is
reported by 12 of the 20 shareholder value banks.
When it comes to growth measures IBIT growth is reported by 11 of the 20 banks and
revenue growth is reported by 8 of the banks. 5 of the banks reported business mix,
geography mix and net interest margin as one of their KPIs.
From the scheme it is seen that the drivers suggested by the VBM banks are very similar
to the drivers found in Chapter 4. This close connection might stem from the stock
markets request for standardized numbers that fit into the valuation models and make
them capable of comparing performance. It might also be that revealing sensitive
information might hurt the bank in the competition against other banks and therefore
only standard accounting numbers are revealed.

8. Mapping the Value Drivers


Exhibit 8.1.1 summarizes the value drivers identified in academia, consulting literature
and in the study of the VBM banks. One question to answer is whether there are
similarities across the internal and external literature and in that case where they are. A
discussion of these results will lead to the identification of the value drivers to be
included in the analysis in Part III.
Especially within the profitability measures are there some similarities between the
internal and external literature. Variables like ROE, Cost-income ratio, IBIT growth,
ROA and NIM are all mentioned across literature and are therefore expected to
significantly influence TSR.
Turning towards risk, both groups acknowledge the importance and prefer variables like
the loan loss rate and tier 1 ratio. A somehow similar measure is the loan loss coverage
that is also widely used and therefore investigated in the study.

43

Part II Identifying Value Drivers

Finally, macro factors are the last group of variables that is discussed across all literature
except from the VBM banks and therefore included in the analysis as control variables.
As discussed in Chapter 3 the economy is central to bank performance and the literature
mention variables like the interest rate, the growth in GDP, market competition and
whether the stock market is bullish or bearish. The reason for the VBM banks lacking
focus on macro variables might be due to the fact that they cannot affect them, rather
than not acknowledging their importance.
Turning towards the differences, especially the consulting literature diverges from the
others due to their generally strong focus on efficiency measures as value creators. An
example is (Duthoit et al. 2011) that has a very operational focus and contains 17
operational factors that influence value creation. However, also six VBM reports
operational measures like number of employees and customer satisfaction scores. This
focus from internal specialists on such efficiency measures indicates that there are more
to shareholder value creation than just pure accounting numbers.
Next, a measure that is discussed across different VBM banks and consultancy reports
but not even elaborated in academia is geography mix, meaning how much of the revenue
is secured outside the domestic market. Deutsche Bank e.g. considers emerging markets
percentage a key value driver (see (Deutsche Bank 2010)). This variable seems reasonable
since the emerging markets have outperformed the developed markets and the expected
growth and earnings are higher (Dayal et al. 2010). One reason why academia has not
touched upon it might be due to low data availability. If the data had been available a
measure like percentage of income from home country would have been interesting as
well as percentage of revenue from emerging markets. For this analysis it has
unfortunately not been possible to collect the data either.
Some other hard-to-measure drivers are also acknowledged by academia and consulting.
The competitive advantage period and the financial innovation are qualitative measures
almost impossible to include in a quantitative study. Finally, EPS is not investigated by
consulting or academia but reported by 11 of the VBM banks. Since it is heavily
influenced by the stock market and expectations it is not tested in this analysis. In the
following Exhibit 8.1.1 a full scheme of the value drivers can be seen.

44

Part II Identifying Value Drivers


Exhibit 8.1.1: Mapping the Value Drivers
Valuation

Consulting

x
x
x

Source: Own contribution

45

x x

Total

US Bancorp

x
x

Brookline

x
x

CVB Financial

x
x

x
x

BOK Financial

Bank of Hawaii

Standard Chartered

First National Bankcorp

Pinnacle Financial

Toronto Dominion

Canadian Western

x
x x
x
x
x
x x x x
x
x
x
x x x x
x
x x
x
x
x
x
x x
x x x
x x
x
x x
x x

x
x
x
x

x x
x
x x x
x

x x

x
x

x
x

Royal Bank of Canada

x x
x
x x x
x
x x

x x

National Bank of Canada

x x
x

CIBC

x x x x
x
x x
x x x x
x x
x x x
x x x
x
x
x
x

x
x
x x

Bank of Montreal

Lloyds

x x x x
x x x x
x x
x
x x x
x x
x x
x x
x x x
x
x x

UBS

x
x

Nordea

SEB

x
x
x

Barclays

Deutsche Bank

Black et. al. (1998)

x
x x x

Deelder (2008)

Visali (2011)

x x

Case Banks

x
x
x
x

x x x
x
x

Olsen et. al. (2010)

x
x x x

Duthoit, et. al. (2011)

x
x

Leichtfuss et. al. (2010)

Dayal et. al. (2010)

Dayal et. al. (2011)

Baele (2007)

Gross (2006)

x
x
x
x

Fiordelisi (2010)

x
x
x
x

Equity-based models

Multiples

x
x
x
x

Damodaran (2009)

Dermine (2008)

Koller (2010)

Tier 1 ratio
ROE
Cost-income ratio
LLR or LLP
IBIT growth
EPS
Business Mix
ROA or RORWA
Revenue growth
Operational
Assets, loans or deposits
NIM
Geography mix
Cost efficiency
COE
Regulatory
Interest rate on products
Loan Loss Coverage
Tax
GDP
Stock Market
SCA period
CapEx
Interest rates
Revenue efficiency
Competition
Financial innovation

Academia

21
20
20
16
13
11
11
10
10
9
8
7
5
5
5
3
3
2
2
2
2
1
1
1
1
1
1

Part II Identifying Value Drivers

In conclusion, the tier 1 ratio (risk measure), ROA (profitability measure), cost-income
ratio (efficiency measure), LLR (risk measure), business mix (diversification measure)
and revenue growth (growth measure) are some of the most reported measures across
academia, consulting literature and annual reports of VBM banks, for the full list of
variables included see Appendix 17.1.10. This also means that there is a common
knowledge regarding which value drivers that creates value, with a few exceptions. The
banks tend to focus on very intuitive and classical firm-specific measures, similar to those
applied in equity valuation-based literature whereas both consulting and academia also
seem to favour macro variables. The reason for this is that VBM banks KPIs need to be
understood by both employees and shareholders. Whereas academic articles are written
to a limited number of economic experts and the consulting reports are written to bank
managers. (Rappaport 1998)
It is clear that only small differences appear between the internal and external literature
and those found seems to occur due to low data availability. These small differences are
expected since all groups impact each others thinking.

46

Part III - Analysis


The overall purpose of Part III is to provide an answer to RQ3 and RQ4. In order to
answer RQ3 a multiple regression analysis is performed on the data set. The value
drivers found to be most significant are considered the key value drivers of retail banking.
To make the results reliable, extensive robustness checks are performed. Exhibit 9.1.1
summarizes the structure of Part III.
Exhibit 9.1.1: Structure of Part III
The dataset

9.1 The conditions

Testing for heteroskedasticity,


autocorrelation and endogeneity

9.2 Other issues

The model

10.1 The academia approach

Estimation procedures:
FD, FE, RE, 2SLS, GLS

10.2 The applied model

10.3 Robustness checks

Univariate approach
Factor approach

Robustness

Estimation procedures:
FD, FE, RE, 2SLS, GLS

10.4 Reduced model including robustness checks


10.5 Correcting for expectations
11.1 Investigating VBM banks
11.2 Investigating top-performing banks
Further analyses

11.3 Prioritizing Profitability and Growth

Split-sampling procedures that


gives further understanding of
value drivers

11.4 Pre-crisis and crisis


11.5 North America and Europe

Value driver map

12. Construction of the value driver map

Summarizing results using the


guidance of Rappaport (1998)

Source: Own contribution

9. The Data Set


The data collected for this thesis is organized as a balanced panel data set containing
yearly observations for 132 banks from 2001 to 2011. The data has been gathered
following a strict process, ensuring that it only contains banks that have been listed since
2001 and are headquartered in either North America or Europe. For a detailed
presentation of the data selection process, see Appendix 13.2.1.
The general model used in the analysis contains indexed variables with subscript i for the
individual bank (i = 1,,N) and t for all time periods (t = 1,,T):
yit= 0 + x'it+ it

47

EQ 10

Part III Analysis

The availability of repeated observations of the same unit allows for a more specific
model and makes the estimators more accurate than both cross sectional and time series
data (Verbeek 2009). (Baltagi 2001) lists numerous of other important advantages of
panel data:

Panel data controls for individual heterogeneity and does therefore not run the
risk of obtaining biased results like time series or cross section might do.

Panel data gives more informative data, more variability, less co linearity among
the variables, more degrees of freedom and more efficiency.

Panel data is better able to study the dynamics of adjustment.

Panel data is better able to identify and measure effects that are simply not
detectable in pure cross-section or pure time-series data. An example of this is
given by (Ben-Porath 1973).

Panel data models make it possible to construct and test more complicated
behavioural models than purely cross-section or time-series data.

Panel data gathered on micro units are more accurately measured and results in
less bias.

The complications when using panel data is more of a practical nature because it is no
longer appropriate to assume independence between the different observations. This
means that a time-constant unobserved effect, ai, is left in the error-term creating
endogeneity. An example of such an unobserved variable could be the cultural differences
between the banks or if some banks are better at attracting the most skilled employees.
However, several techniques are able to account for this (Wooldridge 2009).
There are three general techniques when estimating panel data (Wooldridge 2002). The
first two estimation techniques, first differencing (FD) and fixed effects (FE), are used if
the data shows sign of unobserved time constant effects. FD is build upon the difference
between two time periods. By subtracting one period from the other the time constant
unobserved effects, that by nature are identical in all periods, will be removed. Under the
assumption of E[uit-uit-1xit-xit-1 ] = 0 the FD estimator is unbiased and consistent. The
second technique, FE estimation, is based on the same principle as first differencing, and
also uses a transformation to remove the unobserved effect ai before the estimation. Each
cross-section is averaged over time and by subtracting the averaged model from the
initial model the time-constant unobserved effect is removed.
The last technique is the random effects estimation (RE). This estimation assumes that
the model does not suffer from time-constant unobserved effects. If the correlation
between the explanatory variables and the unobserved time-constant effects is expected
to be zero (cov(xij,ai )=0) then removing the unobserved effects, as is done in the other
approaches, would result in inefficient estimates which is why the RE model has its

48

Part III Analysis

relevance (Wooldridge 2002). For further description of the different estimation methods
see Appendix 17.2.2.

9.1 The Conditions


For the three estimators to produce valid and reliable estimates the data needs to satisfy
a number of conditions. The full list of conditions can be seen in Exhibit 9.1.2. The task
at hand is to identify the most efficient estimator.
Exhibit 9.1.2: The conditions of the three estimation techniques
First differencing (FD)

Fixed effects (FE)

Random effects (RE)

1. yit = 0 + xit + ait + uit


2. Random sample
3. Variable change over time
4. Strictly exogenous
5. Homoskedasticity
6. Differences in errors are
uncorrelated, No SC
7. Normally distributed

yit = 0+xit + ait + uit


Random sample
Variables change over time
No endogeneity
Homoskedasticity
Errors are uncorrelated,
No serial correlation
Normally distributed

yit = 0 + xit + ait + uit


Random sample
No perfect linear relationships
No endogeneity
Homoskedasticity
Unobserved effects, uncorrelated with explanatory variable

Source: (Wooldridge 2002), own contribution

Under their first four assumptions the FD and FE estimators are both unbiased and
satisfying the six first assumptions makes FD the best linear unbiased estimator (BLUE).
However, when choosing between the two estimation procedures it is found that when
the errors are serially uncorrelated the FE estimator is more efficient than the FD
estimator. However, when the serial correlation is negative the FE estimator is the most
efficient. Focusing on the RE estimator it is both consistent and asymptotically normally
distributed under the first six assumptions (Wooldridge 2002). Depending on which
conditions that are satisfied the preferred estimation procedure can be identified.
In the following sections tests upon condition 4-7 will only be performed on the preferred
model, described in Chapter 10. Condition tests on the other models can be found in
Appendices 16.2.3, 16.2.4 and 16.2.5.
9.1.1 No Endogeneity
Having looked at the time-constant unobserved effects in the start, this section discusses
the consequences of time-varying unobserved effects which can lead to an omitted
variable problem. When an omitted variable is correlated with the explanatory variables
it leads to endogeneity in the variables causing a violation of assumption 4, making all
estimators biased. An example of this has been seen on the Danish market, were Danske
Bank was the first bank to introduce mobile banking. It gave them a competitive
advantage, which impacted their profitability positively and created endogenous variables
(Wooldridge 2009). It was, however, only for a short period since the application was
easily copied by the competitors. As it is not possible to measure such competitive

49

Part III Analysis

advantage the model suffers from omitted variable problems. Since including the omitted
variable is not a solution other methods have to be considered. Most studies choose to
ignore the presence of endogeneity and they therefore either ignore the problem and
suffer the consequence of biased and inconsistent estimators or they assume that the
omitted variables does not change over time and therefore is removed by the use of FE or
FD.(Wooldridge 2009)
However, due to the non-transparent balance sheets of banks, the difficulty for external
analysts to estimate leverage variables and the very subjective way of announcing loan
loss provisions, as discussed in Chapter 3, it is suggested by the authors that the model
might suffer from omitted variables. It is suggested that these omitted variables are to be
found in the method of calculating capital and the bank leverage. Further, it is expected
that the stock markets view towards such variables differs across time (higher weight in
crisis periods) and the impact they have on the variables therefore differs. A combined
test for endogeneity inspired by (Wooldridge 2002) is carried out in Appendix 17.2.3. In
this analysis it is found that the FE model show signs of endogeneity in some of the
independent variables seen in Exhibit 9.1.3.
Exhibit 9.1.3: Testing for Endogeneity and Finding Suitable Instruments
Estimator F-test

FE

0.000

Endogenous variable

Instrument

ROA

ROE

Contingency

Deposits to assets

Ln assets

Risk cost

TSR(-1)

MSCI Finance(-1)

Source: Bloomberg, own contribution

Since ROA is dependent of the leverage, it is suggested that the omitted variables
causing ROA to be endogenous might be found in this particular area. From Chapter 4 it
was seen that ROE is correlated with ROA but independent of the banks leverage level
and is therefore applied as an instrument variable for ROA. Contingency is also found to
be endogenous which might be due to some kind of banking type problem. If the bank
has a certain structure or a culture for holding high amounts of liquid assets, this
banking type variable will be correlated with Contingency. As an instrument variable
deposits to total assets is applied since it correlates with contingency but is expected to
correlate less with the omitted variable. Also, Ln assets is found to be endogenous. As
discussed by (Khorana 2011) conglomerate discounts are often seen among large
corporations and this might cause the variable to be endogenous. Instead, risk cost is
tested as a suitable endogenous variable since it is expected to correlate less with the
conglomerate variable that is omitted but still correlate with the size of the bank.
Finally, TSR (-1) is by construction endogenous and MSCI Finance (-1) is used as an
instrument variable due to the high correlation between those variables.

50

Part III Analysis

Having discussed the variables, each endogenous variable is regressed on the instrument
variable and all are found to be significant explanatory variables, and therefore tried as
instrumental variable. See Appendix 17.2.3 for output data.
In order to handle the endogenous variables Two-Stage Least Squares (2SLS) is
conducted using suitable instrumental variables that are correlated with the endogenous
variable but uncorrelated with the error term (Wooldridge 2002).
Having identified the instrumental variables, it is necessary to test whether the
endogeneity problem is solved. This is done in the following way:

Estimate the structural equation by 2SLS and obtain the 2SLS residuals, i

Regress i on all exogenous variables. Obtain the R-squared

Under the null hypothesis that all IVs are uncorrelated with ui, R12 ~ a q2, where
q is number of instrument variables minus the number of endogenous independent
variables.

With 1320 observations and R12 = 0.00064 the test-statistic is 0.8448 meaning that the
null hypothesis cannot be rejected and the instruments are exogenous in the fixed effects
model.
9.1.2 Homoskedasticity
The standard errors have to be homoskedastic in order for the estimators to produce
unbiased test-statistics. Under the homoskedasticity assumption it is stated that the
variance of the unobserved error, conditional on the explanatory variables, is constant.
Without this assumption the model suffers from heteroskedasticity, making the estimator
of the variances and the t-test biased (Wooldridge 2009). To test for the presence of
heteroskedasticity both the Breusch-Pagan test and a study of the residual plots is
applied. The results can be seen in Exhibit 9.1.4 where it is confirmed that the standard
errors suffer from heteroskedasticity. For a more detailed discussion on heteroskedasticity
and the tests see Appendix 17.2.4.
Exhibit 9.1.4: The Tests for Heteroskedasticity
Test
Breusch-Pagan

FE
F-test

5.148

P-value

0.000

Plot

Clear sign

Source: Bloomberg, Own Contribution

As both the residual plot and the Breusch-Pagan test shows signs of heteroskedasticity,
robust standard errors are applied throughout the analysis. This is in accordance with
(White 1980).

51

Part III Analysis

9.1.3 No Serial Correlation


Serial correlation in linear panel data models biases the standard errors and causes the
results to be less efficient meaning that it is neither a best linear unbiased estimator nor
are the test-statistics asymptotically valid. For further information on autocorrelation see
Appendix 17.2.5.
A test, designed specifically for testing autocorrelation in fixed effects models and
recommended by (Bhargava, Franzini & Narendranathan 1982) and (Verbeek 2009) is
conducted. The test makes a correction for the classical Durbin-Watson in order to apply
it on panel data because it allow the upper and lower limits of the Durbin-Watson Test
to depend on time (T), number of companies (N) and number of variables (K). The
upper and lower bounds used in the analysis are found in (Bhargava, Franzini &
Narendranathan 1982). The most suitable option was to apply N=100, T=10 and K=9
which yields the results illustrated in Exhibit 9.1.5.
Exhibit 9.1.5: The Durbin-Watson Test for Serial Correlation
Positive serial correlation
Negative serial correlation

DW
2.15
1.85

Lower Bound
1.878
1.878

Upper Bound
1.916
1.916

Conclusion
Reject
Accept

Source: Bloomberg, own contribution

The test shows that the model suffers from negative autocorrelation at a 5% significance
level while the test for positive autocorrelation was rejected. In order to cope with the
problems arising from heteroskedasticity and serial correlation robust standard errors will
be used in the reminder of the analysis, a procedure recommended by (Wooldridge 2002)
and (White 1980). With the substantial negative autocorrelation, FE estimator is
suggested to be more efficient than the FD estimator (Wooldridge 2009). However,
(Wooldridge 2009) recommends that both models are applied in order to yield further
insights. For further guidance on the Durbin-Watson Test for panel data, see (Verbeek
2009) and (Bhargava, Franzini & Narendranathan 1982).
9.1.4Normally Distributed Errors
The last assumption check tests for normally distributed errors. In order to confirm
whether or not the errors of the model have the skewness and kurtosis matching a normal
distribution, the Jarque-Bera Test is performed. Exhibit 9.1.6 shows a plot of the
standardized residuals.

52

Part III Analysis

Exhibit 9.1.6: The Standardized Residuals


300

Series: Standardized Residuals


Sample 2002 2011
Observations 1320

250

200

150

100

50

Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis

3.57e-19
-0.013352
0.992496
-1.407938
0.219789
0.311823
5.804015

Jarque-Bera
Probability

453.8287
0.000000

0
-1.5

-1.0

-0.5

0.0

0.5

1.0

Source: Bloomberg, Eviews output

The normal distribution has a skewness of zero and a kurtosis equal to three while errors
have a skewness of 0.311 and a kurtosis of 5.804. This yields the following test statistic:
n
1
1320
1
@0.311823A + (5.804015 3)A E = 453.83 EQ 11
JB = @S A + (K 3)A E =
6
4
6
4
Even though the data, just by looking at it, suggest normally distributed errors, the test
rejects that the sample has the skewness and kurtosis matching a normal distribution.
However, the fact that the sample does not match the normal distribution is not a
problem due to the large sample size (Wooldridge 2009, Verbeek 2009).

9.1.5 Summing up the Assumptions Check


The conclusion to these assumptions tests is that there are problems with all four main
assumptions. As was discussed there are however methods that can be applied in order to
deal with this. To sum up the findings:

Key explanatory variables are endogenous and 2SLS, with the identified
instrumental variables, is necessary in order to produce unbiased results. The
instrumental variables have been identified following the guidance of (Wooldridge
2009).

The models suffer from heteroskedasticity and serial correlation. To cope with this
robust standard errors, recommended by (White 1980), (Verbeek 2009) and
(Wooldridge 2009) are used.

53

Part III Analysis

The standard errors are not normally distributed but with a large sample size this
assumption does not yield any major issues (Wooldridge 2009).

This means that the preferred estimator is the FE estimator with 2SLS implemented to
take care of the endogeneity problem.

9.2 Other Issues


Having investigated the assumptions, some issues still need to be addressed in order to
secure the best possible model. The thesis focuses on making a comprehensive study of
both practitioners such as equity analysts, management consulting houses, the banks and
academia. These findings have resulted in numerous potential value drivers of bank
value. The large number of variables poses an issue that needs to be considered before
the different model building procedures are applied.
Since the model in this thesis initially has many explanatory variables, some of them are
almost bound to be correlated (Wooldridge 2009). Correlation among the dependent
variables leads to multicollinearity which produces unreliable estimates through large
variance in the beta estimates (Wooldridge 2009) which is just as severe as having a
small sample size. Since it is not a direct violation of any of the model assumptions the
literature argues that it is not a problem (Goldberger 1991). Although the problem of
multicollinearity is not clearly defined one thing is clear, all else being equal less
correlation is better (Wooldridge 2009) and some tests are able to give hints on whether
to draw attention to the multicollinearity problem or not. Even though it is not possible
to specify an acceptable amount of correlation (Brooks 2003) suggests four different
solutions for problems regarding multicollinearity:

Ignore it

Drop one of the collinear variables

Transform the highly correlated variables into a ratio

Collect more data increase sample period or frequency

(Wooldridge 2009) suggests that most analysis should not consider multicollinearity,
however, this study has to consider it due to the mathematical connection between many
of the variables. The multicollinearity is assessed in each of the models but only in order
to understand the dynamics of the variables. Only in extreme cases will correlating
variables be excluded. For further discussion on the matter, see Appendix 17.2.6.
9.2.1 Robustness
Another issue is the robustness of the findings. A common exercise in econometric
analysis, and recommended by (White, Lu 2010), is to test the core regression coefficients
by adding and removing regressors. If the coefficients are plausible and robust throughout

54

Part III Analysis

the procedure they are considered valid (White, Lu 2010). In the study this exercise has
been performed throughout all the analyses with a focus on the sign and the level of the
core variables. The method for making robustness checks applied in this thesis is
suggested by (Fiordelisi, Molyneux 2010, Gross 2006) where the data is applied on a wide
variety of models to see how they differ in their findings. For this univariate and two
types of factor analysis is applied.
Further, using robust standard errors can result in efficiency loss when the
heteroskedasticity is weak. (Wooldridge 2009) recommends using generalized least
squares weights in the estimation when this is expected. As a consequence, generalized
least squares (GLS) estimation will be added as a robustness check.

10. Analyses
Having found the value drivers to test, the estimation procedures to use and examined
the conditions, the next step is to perform the estimation. Since 47 variables are too
many to include in a single multiple regression model due to their mathematical nature
as discussed in Chapter 9, different ways of bringing this number down is applied. The
standard approach among academic literature is to discuss the potential variables from
an economic perspective and then choose those that make most sense, see (Fiordelisi,
Molyneux 2010, Rapp et al. 2011, Fiordelisi 2007). This approach is the preferred method
for this thesis, but will be accompanied by some more statistical methods as discussed in
Chapter 9.

10.1 The Academic Approach


In the light of articles like (Fiordelisi, Molyneux 2010, Rapp et al. 2011, Fiordelisi 2007)
the preferred approach, called the academia approach, for this thesis is to discuss each
variable from an economic view and through the knowledge gained about the banking
sector in Chapter 3 combined with a view towards the value driver scheme seen in
Exhibit 8.1.1. By looking at both what the different groups suggest and combine it with
economic sense, it is believed that the best suited model can be constructed.
However, before choosing the variables they will be classified into eight groups
constructed by the authors. The grouping is done in order to avoid a high correlation
among the variables (Hair 2009). They are named profitability, growth, risk cost,
liquidity, efficiency, bank type and two control variables that consist of macro variables
and market variables. In Exhibit 10.1.1 the different groups can be seen, a thorough
description of each variable can be found in Appendix 17.1.10.

55

Part III Analysis

Exhibit 10.1.1: The Eight Variable Categories


Profitability

Growth

Risk cost

Efficiency

ROE

G_REV

NPL_ASSETS

CI_RATIO

NIM

G_LOAN

NPL_LOANS

EXP_ASSETS

ROA

G_DEP

LLR

LN_ASSETS_EMP

RORWA

G_ASSETS

LLC

LN_LOANS_EMP

IBIT_MARGIN

NPL_COV

LN_NET_REV_EMP

ECO_PROF

LLP_INT_INC

G_IBIT

RWA_ASSETS

Deposit int rate

R_E
RISK_COST
RISK_INCOME
WACC
TIER1
EQ_ASSETS

Liquidity

Bank specific

Control (Macro)

Control (Stock Market)

LOANS_ASSETS

Ln assets

TAX_RATE

PE_RATIO

CONTINGENCY

Business mix

10 year

PB_RATIO

DEP_ASSETS

5 year

MSCI_FINANCE

LOANS_DEP

2 year
HH_INDEX
G_GDP
ASSET_GDP
EUROPE

Source: Own contribution

Before looking at the value drivers the control variables first of all need to be identified.
Studies like (Fiordelisi, Molyneux 2010) and (Gross 2006) includes variables to control for
the macro environment. In this study it is also necessary to control for the stock market
and expectations because of the use of TSR as the dependent variable (Koller, Goedhart
& Wessels 2010). From the market control variable PB ratio is, based on the discussion
in Chapter 4, chosen over PE ratio as the preferred expectation variable which is in line
with what (Damodaran 2009) and (Fama, French 1992) suggests. Further, research has
found that industry structures affect the performance of the individual company (Porter
1980). In order to correct for this the sector return, MSCI Finance, is applied as a proxy
variable (Koller, Goedhart & Wessels 2010). Finally, (Rapp et al. 2011, Dey 2008) and
(Wooldridge 2009) suggest including a lagged dependent variable which is why TSR -1 is
incorporated throughout all the analyses.

56

Part III Analysis

10.1.1 Profitability
The procedure for finding the most suitable profitability measure is influenced by (Rapp
et al. 2011). In this method each profitability measure is used as an independent variable
together with the variables from the other groups. The preferred variable is the variable
producing the test with the highest R squared. In Exhibit 10.1.2 this method can be seen.
Exhibit 10.1.2: The Investigated Profitability Measures
y = TSR
ROA

y = TSR

y = TSR

y = TSR

y = TSR

y = TSR

y = TSR

y = TSR

7.317***
[2.347]

ROE

0.361***
[0.120]

IBIT growth

0.0356***
[0.008]

Economic Profit

3.96*10^-8***
[9.37*10^-9]

Net interest margin

0.435
[1.92]

RORWA

0.015
[0.017]

IBIT margin

0.554***
[0.104]

Deposit interest rate

-0.246
[0.217]

Revenue growth
Cost-income ratio

0.230***

0.189***

0.180***

0.283***

0.288***

0.288***

0.267***

0.280***

[0.039]

[0.043]

[0.047]

[0.044]

[0.044]

[0.044]

[0.048]

[0.046]

-0.126*

-0.149

-0.148

-0.135

-0.164*

-0.165*

0.303***

-0.168*

[0.073]

[0.110]

[0.107]

[0.089]

[0.090]

[0.089]

[0.091]

[0.091]

LLC

0.0020***

0.0015***

0.0012***

0.0013***

0.0014***

0.0014***

0.0022***

0.0014***

[0.0002]

[0.0002]

[0.0002]

[0.0002]

[0.0002]

[0.0002]

[0.0003]

[0.0002]

Contingency

0.108***

0.134***

0.142***

0.103***

0.106***

0.105***

0.100***

0.114***

[0.036]

[0.041]

[0.039]

[0.036]

[0.038]

[0.037]

[0.035]

[0.03]

Tier 1 Ratio

0.759

0.734

0.846*

1.225***

1.105**

1.094**

1.079**

1.050**

[0.479]

[0.483]

[0.467]

[0.473]

[0.476]

[0.476]

[0.496]

[0.478]

Price-book ratio

0.109**

0.110**

0.125**

0.125**

0.126**

0.126**

0.104**

0.126**

[0.054]

[0.055]

[0.059]

[0.060]

[0.060]

[0.060]

[0.052]

[0.060]

Ln assets

-0.134***

-0.144***

-0.147***

-0.135***

-0.139***

-0.141***

-0.132***

-0.141***

[0.034]

[0.035]

[0.037]

[0.037]

[0.036]

[0.037]

[0.033]

[0.037]

2 year

-6.39***

-6.16***

-5.14***

-5.86***

-5.75***

-5.76***

-6.72***

-5.63***

[0.748]

[0.725]

[0.745]

[0.753]

[0.770]

[0.759]

[0.781]

[0.766]

MSCI Finance

0.530***

0.533***

0.515***

0.525***

0.528***

0.528***

0.556***

0.522***

[0.056]

[0.056]

[0.057]

[0.058]

[0.058]

[0.058]

[0.055]

[0.059]

GDP growth

2.713***

2.903***

2.49***

3.30***

3.35***

3.36***

2.29***

3.32***

[0.650]

[0.648]

[0.718]

[0.706]

[0.710]

[0.710]

[0.654]

[0.713]

TSR(-1)

-0.302***

-0.295**

-0.275***

-0.271***

-0.270***

-0.271***

-0.315***

-0.272***

R squared

[0.028]

[0.028]

[0.033]

[0.031]

[0.031]

[0.031]

[0.027]

[0.031]

0.556

0.545

0.549

0.530

0.527

0.527

0.558

0.527

Source: Own contribution. * = Significant at 10%, ** = Significant at 5%, *** = Significant at 1%

Even though IBIT margin actually has a slightly higher R squared than ROA, it is
rejected as the best profitability measure due to the unnatural positive sign of Costincome-ratio. From an economic view it is not possible to argue why higher cost-income
ratio should increase TSR. It might be suggested that ROE should be included as the
preferred profitability variable due to its high number of appearances across all types of
literature (mentioned in 18 of the studies). However, ROA is besides being a better
estimator from a statistical point of view also a better variable from an economic
perspective. This is seen from the following formula
ROA = ROEEquity/Assets

57

EQ 12

Part III Analysis

It is clear that the information from ROA both tell the stock market something about
ROE but it also yields information regarding the leverage. As discussed in Chapter 3 the
leverage has had an increasing focus since the start of the crisis and ROA is therefore the
preferred profitability variable.
10.1.2 Growth
The preferred growth measure is identified using the same procedure as applied in the
profitability group. It is found that revenue growth is the preferred variable both based
on Exhibit 10.1.3 where it is the variable that produces the model with the highest R
squared but also based on the value driver scheme from Chapter 8 where it is the most
suggested growth variable. Further, (Dermine 2008) supports it as being an important
value driver.
Exhibit 10.1.3: The Investigated Growth Measures
y = TSR
Revenue growth

y = TSR

y = TSR

y = TSR

0.230***
[0.039]

Asset growth

0.134***
[0.048]

Deposit growth

0.087*
[0.048]

Loan growth

0.142***
[0.046]

ROA
Cost-income ratio

7.317***

8.000***

8.389***

7.988***

[2.347]

[2.459]

[2.459]

[2.438]

-0.126*

-0.169**

-0.167**

-0.177**

[0.073]

[0.077]

[0.077]

[0.099]

LLC

0.0020***

0.0016***

0.0016***

0.0016***

[0.0002]

[0.0002]

[0.0002]

[0.0002]

Contingency

0.108***

0.071

0.084*

0.083*

[0.036]

[0.045]

[0.044]

[0.045]

Tier 1 Ratio

0.759

0.877*

0.775

0.890*

[0.479]

[0.494]

[0.498]

[0.493]

Price-book ratio

0.109**

0.112**

0.113**

0.110**

[0.054]

[0.056]

[0.056]

[0.056]

Ln assets

-0.134***

-0.134***

-0.131***

-0.136***

[0.034]

[0.036]

[0.036]

[0.036]

2 year

-6.394***

-6.522***

-6.567***

-6.656***

[0.748]

[0.757]

[0.752]

[0.758]

MSCI Finance

0.530***

0.558***

0.554***

0.561***

[0.056]

[0.058]

[0.059]

[0.058]

GDP growth

2.713***

2.209***

2.349***

2.282***

[0.650]

[0.641]

[0.651]

[0.638]

TSR(-1)

-0.302***

-0.311***

-0.308***

-0.312***

R squared

[0.028]

[0.029]

[0.029]

[0.029]

0.556

0.541

0.539

0.543

Source: Own contribution. Explanation: * = Significant at 10%, ** = Significant at 5%, *** = Significant at 1%

10.1.3 Risk cost


The risk cost group is further broken down into two groups: cost variables that are
directly connected to the cost of defaulted loans and cost variables that are connected to
the cost of holding equity. For the latter group Tier 1 is chosen since it is the most
discussed variable across all types of literature and the authors cannot find any economic

58

Part III Analysis

reasons that favorise the other variables. From the former group, loan loss coverage is
picked. This is done from an economic point of view because it focuses on both this years
loss and future expected losses, as opposed to pure provisions for loan loss. Further it
seems as good proxy for risk control.
10.1.4 Efficiency
Even though efficiency might be correlated with profitability, the cost-income ratio is
included because of its wide application among the different types of literature as the
second most preferred value driver from Exhibit 8.1.1. Further, the variable has seen an
increase during the crisis and as the consulting literature emphasizes it is a key area to
focus on in order to increase shareholder value.
10.1.5 Liquidity
As discussed in Chapter 3, liquidity will have a large impact on the banking sector in the
coming years due to the regulators fear of bank runs (Basel Committee on Banking
Supervision 2010). Therefore, the variable chosen is the one called contingency since it by
its construction, can be seen as a bank run defence variable. As described in Appendix
17.1.10 it is constructed by taking liquid assets divided by customer deposits. It is
therefore a strong measure for how large a portion of the customers that can withdraw
their money before the bank dries out. It is preferred above the other variables since they
do not have this focus on the banks liquidity.
10.1.6 Bank Type
Ln assets is included as a proxy for size, the intuition behind is influenced by (Rapp et
al. 2011) and (Fama, French 1992). Further, even though business mix is suggested by
the literature all the analyses conducted in this thesis find it extremely insignificant and
it is therefore not applied in the model. Further, as discussed in Chapter 3, (Walter 1997)
finds that mainly the large banks have a diversified portfolio and it may be argued that
business mix is therefore covered by Ln assets.

10.2 The Applied Model


Having included all the proposed variables in a regression model some interesting findings
can be seen both in regards to the significant variables but also the insignificant variables
yield some interesting information. The academia approach tests the following model:
TSRt = ROAt + gRevt + LLCt + PB ratiot + 2year + MSCI_Financet +
gGDP + TSRt-1 + it

59

EQ 13

Part III Analysis

Exhibit 10.2.1 shows the results of the academia approach. The results from fixed effects
(FE), first differencing (FD), random effects (RE), two-stage least squares (2SLS) and
generalized least squares (GLS) are all reported.
Exhibit 10.2.1: The Applied Model
FE
FD

RE

FE (2SLS)

FE (GLS)

ROA
Revenue growth
Cost-income ratio
LLC
Contingency
Tier 1 Ratio
Price-book ratio
Ln assets

7.317***

5.680**

6.818***

8.314***

7.388***

[2.347]

[2.595]

[1.929]

[2.504]

[1.205]

0.230***

0.172***

0.258***

0.217***

0.203***

[0.039]

[0.037]

[0.036]

[0.043]

[0.027]

-0.126*

MSCI Finance
GDP growth
TSR(-1)

R squared

-0.078***

-0.116*

-0.131**

[0.073]

[0.070]

[0.033]

[0.070]

[0.058]

0.0020***

0.0007***

0.0020***

0.0019***

0.0018***

[0.0002]

[0.0002]

[0.0002]

[0.0002]

[0.0001]

0.108***

0.039

0.047***

0.102

0.057**

[0.036]

[0.050]

[0.016]

[0.113]

[0.027]

0.759

1.582***

-0.052

0.631

0.957***

[0.479]

[0.565]

[0.317]

[0.513]

[0.350]

0.109**

0.136

0.072***

0.118*

0.162***

[0.054]

[0.089]

[0.021]

[0.068]

[0.021]

-0.002

-0.059

[0.005]

[0.149]

-0.134***
[0.034]

2 year

-0.111

-6.394***

-0.152***
[0.034]
-6.51***

-5.22***

-6.51***

-0.074***
[0.023]
-6.72***

[0.748]

[0.843]

[0.543]

[0.752]

[0.559]

0.530***

0.508***

0.582***

0.544***

0.435***

[0.056]

[0.061]

[0.045]

[0.060]

[0.030]

2.713***

4.807***

2.653***

2.804***

2.548***

[0.650]

[0.736]

[0.548]

[0.639]

[0.413]

-0.302***

-0.558***

-0.180***

-0.300***

-0.317***

[0.028]

[0.022]

[0.028]

[0.029]

[0.021]

0.556

0.594

0.438

0.550

0.438

Source: Own contribution. * = Significant at 10%, ** = Significant at 5%, *** = Significant at 1%

Since the insignificant variables are included in this model, it is not possible to give a full
interpretation of the coefficient (this will be done in Section 10.4). However the sign and
the significance level are important and do not differ from the reduced model. First of all,
an overall look at the model yields not many surprises regarding the sign of the variables.
ROA, revenue growth, CIR and LLC all have the right sign from an economical point
of view, with ROA being the most significant variable. Further, contingency also have a
positive sign which is in line with Chapter 3 that emphasize the great focus this number

60

Part III Analysis

has received since the introduction of new liquidity requirements. Most remarkable is Ln
assets which state that increasing size will have a negative impact on TSR. Literature
such as (Goodhart 2011) and others have argued that bank managers would increase the
assets making the banks to-big-to-fail and thereby increase shareholder value and their
own bonuses. Even though the argument sounds plausible it cannot be supported by the
data in this study. Instead, the negative sign on Ln assets follows the findings from
(Fiordelisi, Molyneux 2010). The conclusion therefore might be that the disadvantages
suggested by (Walter 1997) and (Baele, De Jonghe & Vander Vennet 2007) in relation to
size, weigh more than the advantages. Another interesting variable is the Tier 1 ratio
that is found to be insignificant. The reason might be that even though controlling for
the capital ratio is important, most banks in the study already have tier 1 ratio above
the requested rate (only few have across the eleven years had Tier 1 ratio lower than 6
%) and therefore further increasing the ratio does not add extra value.
Looking at the control variables it is clear to see by their significance level that, as
discussed in Chapter 3, bank performance is very dependent of the overall economy and a
large part of the variance in TSR is also explained by external factors. It might be worth
noticing the negative sign on the interest rate. The reason for this might be found in the
maturity mismatch between assets and liabilities discussed in Chapter 3. When banks are
borrowing at the short interest rate and lending at the long interest rate, an increase in
the short rate will increase costs.
An argument for expecting a positive sign might however be connected to floor risk
which is the interest rate risk on those deposits, loans and advances whose interest rates
depend on the central banks leading interest rate. Since it is not possible for the bank to
lower some of those entries at the same pace as the central bank, it will have a negative
effect on the banks performance (Danske Bank 2012). The results, however, indicates the
net effect being negative.

10.3 Robustness Check using Different Model Specification Methods


Having found the variables for the preferred model this section will take a more
statistical way of finding those variables that best describe TSR. The first method is
called the univariate method and the last two are the Factor analysis model Factor
and Factor analysis model Surrogate, the former testing whether the different overall
groups picked in the preferred model can be justified and the latter testing the robustness
of the variables found.
10.3.1 Univariate Analysis
Univariate is the simplest form of quantitative analysis as it describes the dependent
variable based on a single variable (Babbie 2010). In the univariate method TSR is
regressed on each of the 46 variables by applying the univariate approach. The variables
with a significant impact on TSR on a 5% significance level are kept and sorted by their

61

Part III Analysis

impact on TSR. From each overall group the variable with the highest impact from each
group is chosen as the preferred variable. By applying a standard multiple regression
analysis, following the guidance of (Wooldridge 2002, Wooldridge 2009), the total
number of variables are reduced to the 11 variables listed in Exhibit 10.3.1.
Exhibit 10.3.1: The Chosen Variables from the Univariate Analysis
Coefficient
(univariate)

Prob.
(univariate)

R squared
(univariate)

Category

ROA

11.497

0.000

0.168

Profitability

Revenue Growth

0.231

0.007

0.112

Growth

CI ratio

-0.382

0.000

0.0979

Efficiency

Loans-to-deposits

-0.134

0.005

0.079

Liquidity

NPL-to-assets

-6.222

0.000

0.136

Risk

Ln assets

-0.243

0.000

0.152

Bank specific

PB ratio

0.167

0.000

0.217

Control: Expectations

HH INDEX

0.000

0.005

0.0778

Control: Competition

MSCI FINANCE

0.600

0.000

0.283

Control: Stock market

5 Year

3.334

0.001

0.0821

Control: interest rate

GDP growth

2.261

0.000

0.0871

Control: Economy

Source: Bloomberg, own contribution

The full univariate analysis can be found in Appendix 17.2.7. The analysis reveals that
many of the variables are similar to what was found in the academia model. This means
that the purely analytical univariate approach confirms the results of the less analytical
academia approach.
10.3.2 Factor Analysis
Compared to previous studies on shareholder value in banks this thesis studies a
significantly higher number of variables, see (Fiordelisi, Molyneux 2010, Gross 2006), etc.
Therefore an increased knowledge of the structure and the interrelationships between the
explanatory variables is needed. A factor analysis is suitable for testing some of these
multidimensional relationships and examine whether the information can be summarized
in a smaller number of factors (Hair 2009).
In Exhibit 10.3.2 the findings from the factor analysis can be seen. For a full discussion
on how the factor analysis is conducted see Appendix 17.2.8.

62

Part III Analysis

Exhibit 10.3.2: The Factor Analysis Categories


Component
1
ROA

-.730

LLR

.909

LLP_int_inc

.933

IBIT_margin

-.719

Component name

Profitability

Ln_assets_emp

.886

Ln_loans_emp

.954

Ln_net_rev_emp

.709

Cost efficiency

Business_mix

-.897

Contingency

.708

Ln_assets

.734

Bank type

g_rev

.788

g_loan

.944

g_dep

.915

g_assets

.899

Growth

exp_assets

.716

Loans_assets

.864

RWA_assets

.891

Liquidity

10_year

.703

5_year

.922

2_year

.858

Macro

Source: Bloomberg, Own contribution

The factor analysis investigates the 47 variables and identifies six factors which support
the overall groups chosen by the authors, see Section 10.1. The only variable in the
analysis that is somehow hard to explain is contingency. It was suggested by the authors
that it should have been part of the liquidity group, but the factor analysis specify it as a
bank type variable. It should be noted that it is not possible to compare the sign of the
variables due to the construction of a factor analysis. E.g. profitability have a negative
sign when including it in a regression but as can be seen from Exhibit 10.3.2, ROA and
IBIT margin have negative factor loadings whereas LLR and LLP have positive factor
loadings.
Having tested the robustness of the overall groups the next step is to identify the
appropriate variables since this is the main objective of the study. This is done by
selecting one variable from each group to work as a surrogate variable for the whole
factor. Since all of the variables have a high loading on each factor it is suggested by
(Hair 2009) to choose the surrogate variable based on priori economic knowledge.
However, the preferred model is based on economic knowledge, therefore the surrogate

63

Part III Analysis

variables will be chosen based on the univariate analysis from before. For a more
thorough description of the approach and a description of the final factor model see
Appendix 17.2.8.

10.4 The Reduced Model Including Robustness Checks


In this section, the results of the previous discussed analyses are collected in order to
answer RQ3 and the economic meaning of the findings is discussed. Exhibit 10.4.1 shows
all the different analyses and the corresponding findings at a 5% significance level. Since
the preferred model is the academia FE 2SLS approach that both take heteroskedasticity
and endogeneity into account, the findings in this model are the most interesting.
However, the other models work as robustness checks, and the range and the median
yields information regarding the quality of the findings.
Exhibit 10.4.1: The Reduced Model with Robustness Checks
ROA

FE
ACADEMIA

UNIVARIATE

7.778

Revenue Contin-

PB

2 year

MSCI

GDP

LLC

-0.296

0.002

gency

assets

ratio

0.241

0.120

-0.130

0.105

-6.817
-6.061

0.575

5.743

-0.561

0.001

0.124

-6.952

0.563

3.029

-0.289

0.002

-0.074

0.162

-6.718

0.435

2.548

-0.317

0.002

-0.157

0.080

6.063

0.209

2SLS

8.440

0.200

GLS

7.388

0.203

FE

6.074

0.130

-0.180

0.057

Finance growth

TSR(-1)

growth

FD

FD

Ln

0.548

2.754

0.538

0.194

0.691

5 year

CI

HH

Business

Expenses

Assets

ratio

ratio

index

mix

to assets

0.957
-6.298

3.247

Ln Net
Revenue
Emp

-0.131
-0.143

0.000

-0.175

0.000

-9.481

7.288

0.173

0.058

0.480

-2.928

GLS

4.950

0.137

-0.115

0.106

0.492

-6.225

FE

7.440

0.226

-0.150

0.106

FD

6.087

0.215

-0.337

2SLS

8.271

0.211

GLS

7.237

0.179

Average

7.002

0.193

Low

4.950

Median

7.288

High

8.440

FACTOR

Tier 1

1.395

2SLS

-7.268

NPL

0.559

2.934

-0.290

0.683

5.956

-0.559

-1.425
0.168
-3.303

-10.795

-5.599

0.126

-6.980

0.572

3.098

-0.289

-0.109

0.156

-7.461

0.454

2.844

-0.319

0.088

-0.156

0.114

-6.894

0.549

3.573

-0.365

0.002

-7.145

-1.425

1.176

-0.150

0.000

0.130

0.057

-0.337

0.058

-7.461

0.435

2.548

-0.561

0.001

-10.795

-1.425

0.957

-0.175

0.202

0.088

-0.140

0.106

-6.952

0.553

3.029

-0.306

0.002

-6.298

-1.425

1.176

-0.143

0.241

0.120

-0.074

0.162

-6.061

0.691

5.956

-0.289

0.002

-2.928

-1.425

1.395

-0.131

-4.336

0.086

0.168

-4.413

0.086

0.000

0.168

-5.599

0.086

0.000

0.168

-4.336

0.086

0.000

0.168

-3.303

0.086

*All variables are significant at a 5% significance level

Source: Bloomberg, Own contribution

Looking at the preferred model (Academia FE 2SLS), findings suggest that a one
percentage point increase in ROA will increase TSR with 8.44 percentage points. Even
though the sign is supported by (Fiordelisi, Molyneux 2010, Fiordelisi 2007) and the level
is backed up by all the other models, the level might seem low from an economic point of
view. Putting it into contents with ROE, JP Morgan reported a ROA of 0.84% and a
corresponding ROE of 10.6% in their 2011 annual report. Therefore, holding everything
else constant, an increase in ROA by 1 percentage point would mean more than doubling
JP Morgans ROE to approximately 22.6%. In Chapter 4 it was further discussed that as
a rule of thumb, the stock market calculates the PB ratio as the normalized ROE divided
by the ROE that the stock market requires. This indicates that the coefficient in front of
ROA is too low. Further, the valuation model constructed in Appendix 17.2.9 indicates
that the fair price would increase by 100% for the constructed Bank ABC if the return of

64

Part III Analysis

equity was doubled. An explanation to this might be that one years increase in ROA
does not have full effect on the share price. The stock market wants steady numbers over
a period of time before it is fully accounted for in the stock price (Koller, Goedhart &
Wessels 2010). Further, a 1% point increase in ROA is very extreme and the data might
not be able to capture the full effect at these extreme points (Wooldridge 2009).
Revenue growth is the only variable included in all
coefficient of 0.20 it indicates that TSR will increase
percentage point increase in revenue growth. This is in
Wessels 2010) and also very close to the median of all the

the different models. With a


0.2 percentage points for a 1
line with (Koller, Goedhart &
models.

Since both ROA and revenue growth are significant in almost all of the models and that
they are the most significant variables within each model it supports the findings in
(Koller, Goedhart & Wessels 2010) regarding ROIC and growth as the main value drivers
and these conclusions can therefore be transferred to the banking industry.
Further, this reduced model emphasizes the importance of the external control variables.
The price-book ratio which has the main objective of controlling for expectations is
significant with a coefficient of 0.125. The interpretation of the coefficient is straight
forward. When the price-book ratio increases 1 percentage point TSR is raised by 0.125
percentage points. According to (Koller, Goedhart & Wessels 2010, Dermine 2009, Gross
2006) banks are very sensitive to the world economy and this is confirmed by the results.
The 2 year interest rate variable has a coefficient of 6.952 and is therefore a very
significant value destroyer. When the 2 year interest rate appreciates 1 percentage point
the total shareholder return decreases 6.952 percentage points. As expected GDP growth
have a positive impact on TSR. The coefficient of 3.092 suggests that 1 percentage point
growth in the domestic economy affects TSR positively by 3.092 percentage points. The
stock market is controlled for using the MSCI Finance index. As expected an increase in
the index has a positive effect on the value creation. For guidance on interpretation of
the coefficient see (Wooldridge 2009). One last robustness check is, however, necessary
according to (Koller, Goedhart & Wessels 2010). This is performed in the following
section.

10.5 Correcting for Expectations


As can be seen from the analysis conducted in Section 10.4 expectations have a large
impact on shareholder value creation. In connection to this (Koller, Goedhart & Wessels
2010) argues that TSR in the short run is determined by performance against
expectations and not only absolute performance. (Rappaport 1998) also states that
expectations play an important part in determining the stock price. An example from the
sample is US Bancorp who in 2011 demonstrated financial strength with a return on
assets of 1.43% and a revenue growth of 4.73% but the total return for shareholders in
2011 was still -27.17%. Future expectations simply weighed more even though median
ROA and revenue growth across the sector were 0.64% and 0.19% respectively in 2011.

65

Part III Analysis

According to (Koller, Goedhart & Wessels 2010) realized TSR has the following shortterm key drivers:

Initial expectations

Realized return on capital and growth

Changes in expectations

Over longer time spans TSR is not as strongly influenced by changes in expectations
(Koller, Goedhart & Wessels 2010). In order to control for expectations over the longterm and test whether the main drivers are significant four different analyses have been
conducted. In the following Exhibit 10.5.1 the 1, 3, 5 and 10 year analysis can be seen.
Exhibit 10.5.1: Controlling for Expectations
TSR 1 year

TSR 3 year

TSR 5 year

TSR 10 year

Coefficient

P-value

Coefficient

P-value

Coefficient

P-value

Coefficient

P-value

ROA

6.733

0.001

8.704

0.000

9.516

0.000

15.131

0.000

G_Rev

0.147

0.000

0.115

0.078

0.346

0.000

0.608

0.000

G_IBIT

0.032

0.000

0.003

0.152

0.015

0.000

-0.002

0.310

Contingency

0.151

0.000

0.114

0.002

0.033

0.001

0.038

0.009

PB_Ratio

0.107

0.017

0.031

0.038

0.016

0.022

-0.019

0.200

LNAssets

-0.138

0.000

-0.259

0.000

-0.004

0.037

-0.016

0.006

_2_YEAR

-6.126

0.000

-8.493

0.000

-6.239

0.000

3.457

0.079

G_GDP

2.096

0.001

-0.617

0.317

2.337

0.000

5.075

0.008

MSCI Finance

0.535

0.000

0.750

0.000

1.006

0.000

12.363

0.045

Source: Bloomberg, Own contribution

It is clear that over a 10 year period (long term) TSR is more linked to the fundamental
drivers than it is to expectations. Especially between TSR and ROA is there a very
significant causal relationship, but also revenue growth is significant throughout most of
the periods. Another interesting finding is the fact that the coefficient on the price-book
ratio becomes smaller and smaller as the time span increases. This result confirms the
findings of (Koller, Goedhart & Wessels 2010) since changes in expectations tend to
matter less as the time span, over which TSR is measured, increases. The results confirm
that the findings from Section 10.2 are robust even when correcting more efficiently for
expectations.

66

Part III Analysis

11. Further Analyses


In the following analyses several related questions will be analyzed in order to get a
greater insight into shareholder value creation and the value drivers. First, it will be
tested whether the VBM banks identified in Chapter 7 outperform the other banks in the
sample when it comes to TSR generation. Second, as a validity check of the analyses
already conducted it will be tested whether top performing banks, measured on TSR, do
actually outperform low performing banks on the suggested key value drivers. Thirdly,
the question raised by (Koller, Goedhart & Wessels 2010) concerning prioritization of
profitability and growth in non-banks will in this analysis be answered with regards to
the banking sector. In relation to this, the question regarding whether some value drivers
should be preferred in crisis vs. non-crisis periods is also answered. Finally, the data
contains banks across North America and Europe and it will be tested whether there is a
difference in their performance.

11.1 Investigating TSR Performance of the VBM Banks


In this section the goal is to analyze whether the VBM banks outperform the banks that
are not officially committed to generating shareholder value. The VBM banks are
identified in Chapter 7.
In the analysis the sample is divided into two parts. One part includes the 20 VBM
banks in the sample while the other part consists of the banks that have made no official
statements about managing towards shareholder value creation. Tests on the difference in
mean values of TSR, ROA, revenue growth, ROE and IBIT-margin are conducted.
Exhibit 11.1.1: The Performance VBM Banks
Shareholder value
focused banks

Other banks

p-value

TSR (CAGR)

5.9% *

-1.4%

0.001

ROA

0.8%

0.7%

0.258

Revenue growth (CAGR)

8.1%

6.8%

0.280

ROE

13.1% *

9.3%

0.000

IBIT-margin

28.2%

27.6%

0.432

Source: Bloomberg, Own Contribution. * = Significant difference at a 1% significance level

In Exhibit 11.1.1 it is seen that the shareholder value banks are capable of securing
significantly higher return to their shareholders than non-shareholder banks. A result
that confirms the findings of (Rapp et al. 2011) that open commitment to value-based
management increases the share price. Another interesting finding is that the shareholder
value banks are actually able to have a significantly higher ROE than the other banks.
However, it is just as interesting that ROA does not differ significantly. The case banks
studied in section 7.1 revealed that ROE is preferred above ROA as the banks main

67

Part III Analysis

profitability ratio which might be the reason for this difference. However, it also supports
that banks can increase performance by focusing on the right value drivers.
As a final conclusion it should be mentioned that there might be a very large bias in
these results. It is noted that banks often highlight their share performance in good
times. During crises they then stop commenting on share performance and remove the
shareholder value objective from the mission statements (Rapp et al. 2011). This bias is
minimized by looking at annual reports for the entire time span.
In total it is, however, safe to say that the banks that have openly committed themselves
to shareholder value outperform the banks that havent. Therefore, RQ4 can be
answered. VBM banks manage what they intend to manage: shareholder value. In
connection to the overall analysis in Chapter 10 VBM banks might increase shareholder
value performance further by focusing on ROA instead of ROE.

11.2 Investigating the Top Performing Banks


In order to fully understand the dynamics of the value drivers of banking further analyses
are needed. Inspired by (Frigo et al. 2010) and (Stadler 2007) the sample banks are
divided into quartiles sorted after their TSR performance over the sample period. To
confirm the results of the regression the top banks (the top 25% in the sample) should
outperform the other banks in the sample measured on the key value drivers found in
Chapter 10 and other profitability measures that are highly correlated with ROA. The
ranked banks can be seen in Appendix 17.2.10.
Exhibit 11.2.1: Performance of Top, Medium and Low Performers
Top
Performance
Banks

Medium
Performance
Banks

Low
Performance
Banks

Total

TSR (CAGR)

11.3% **

1.20%

-15.1%

-0.33%

ROA

0.99% **

0.87%

0.30%

0.76%

Revenue growth (CAGR)

11.2% **

6.41%

3.91%

6.97%

ROE

12.1% *

11.5%

4.41%

9.86%

IBIT-margin

34.4% *

30.5%

15.4%

27.7%

Source: Bloomberg. The top-performing banks are the 25% highest TSR generators in the sample over the
sample period. The medium performers are the banks with a TSR ranging from -6.9% to 7.6%. The low
performance
banks
are the
banks
with
a
TSR
below
-6.9%
during
the
period.
*Significant
difference
between
Top
performance
banks
and
Low
Performance
banks
** Significant difference between Top performance banks and Medium Performance banks

From Exhibit 11.2.1 it is confirmed that top performing banks have significantly
outperformed the low performing banks on all the tested value drivers. It is, however,
especially notable that the top performers outperform the other banks when it comes to
the key value drivers ROA and growth.

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Part III Analysis

11.3 Prioritizing Profitability and Growth


(Koller, Goedhart & Wessels 2010) stresses the importance of prioritizing profitability
and growth when trying to increase shareholder value. E.g. in companies with high
profitability, managers should focus on increasing growth while low profitability
companies need to focus on increasing their profitability. This is also discussed in the
paper by (Jiang, Koller 2007) where non-financial firms should prioritize ROIC when it is
below WACC and prioritize growth when ROIC is above WACC.
In this analysis ROE and cost of capital are used instead of ROIC and WACC since it
yields the same interpretation for banks (Gross 2006). Otherwise, the analysis is inspired
by (Jiang, Koller 2007) and therefore the companies compounded average annual TSR
over the period 2001 2011 is calculated for four groups of companies. Those banks with
ROE higher or lower than their cost of equity combined with their respective revenue
growth compared to the sample average of 6%, in Exhibit 11.3.1 this analysis can be
seen. The arrows show which strategy to pursue.
Exhibit 11.3.1: Prioritizing ROE and Growth
2.3%

6.8%

-9.6%

-0.9%

ROE> CoE

ROE< CoE

Below

Above

Source: Bloomberg, Own contribution

From Exhibit 11.3.1 it is found that the worst performing banks are those with average
ROE during the period that is lower than the CoE and a revenue growth below the
market growth. It is furthermore clear that these banks should try to increase ROE
above the CoE before starting to focus on growth. This result is in accordance with the
findings of (Koller, Goedhart & Wessels 2010). For banks positioned in the upper left
corner, the right strategy should be to increase their revenue growth instead of increasing
the ROE further. However, it should not be by taking in activities where ROE is below
CoE. Finally, high growth banks with ROE below CoE should focus on increasing their

69

Part III Analysis

ROE even at the cost of more growth. All in all it supports the findings by (Koller,
Goedhart & Wessels 2010).
Testing this through a more statistical procedure yields the results found in Exhibit
11.3.2.
Exhibit 11.3.2: Investigating Interaction Terms
G_REV*EP_NEG
G_REV*EP_POS
ROE*EP_NEG
ROE*EP_POS
LN_ASSETS

Coefficient

Std. error

t-statistic

P-value

0.574
0.793
1.101
1.064
-0.015

0.085
0.141
0.256
0.174
0.002

6.785
5.611
4.303
6.107
-7.577

0.000
0.000
0.000
0.000
0.000

Source: Bloomberg, Own contribution

The results are not as clear as the findings of (Jiang, Koller 2007) but this might be due
to the fact that prioritization of profitability and growth is not as simple when it comes
to banks because of the fact that banks need equity to grow. (Gross 2006)
Revenue growth over a 10 year period has a positive influence on total shareholder return
both when ROE is above and below the cost of equity. This is due to the positive
coefficient of G_REV*EP_NEG and G_REV*EP_POS.
Finally, improved profitability adds value both when ROE is above the cost of equity
and when it is below. The coefficients of ROE*EP_NEG and ROE*EP_POS are positive
which indicates that increasing ROE creates most value both when ROE is above and
below the cost of equity.
Looking at the size of the coefficients both ROE*EP_NEG and ROE*EP_POS are
higher than the corresponding alternatives. This somehow supports the findings by
(Jiang, Koller 2007) since it appears more valuable to increase ROE when it is below
CoE than when it is above and it also adds more value to grow the bank when economic
profit is positive compared to when it is negative.

11.4 The Relative Importance of Value Drivers Before and During the
Crisis
The cyclical nature of the economy makes it is important for bank managers to know
whether the value drivers differentiate in crisis periods compared to growth periods. In
order to investigate whether this is the case, the sample is divided into two time periods.
The pre-crisis years are the years from 2001 to 2006 and the crisis years are from 2007 to
2011 (French et al. 2011) and (Sorkin 2009)

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Part III Analysis

Exhibit 11.4.1: Results from Pre-crisis and Crisis using FE and White Standard Errors
Pre-crisis
Crisis
Coefficient

Prob.

Coefficient

Prob.

ROA

15.069

0.004

3.656

0.007

Revenue growth

0.095

0.003

0.155

0.002

Contingency

0.210

0.000

-0.050

0.529

Ln assets

-0.147

0.002

-0.039

0.281

PB ratio

0.038

0.264

0.411

0.000

2 year

-3.751

0.000

-11.425

0.000

MSCI Finance

0.604

0.000

0.495

0.000

GDP growth

-4.168

0.001

0.232

0.741

Source: Bloomberg, own contribution.

Some interesting insight can be gained from the analysis in Exhibit 11.4.1. First of all it
is seen that increases in ROA impacts TSR with almost 5 times as much in pre-crisis
years compared to the crisis years. The reason for this might be that increases in ROA
through a down-turn period are, by the market, seen as a one-time effect and not
expected to be persistent whereas increases in ROA in up-turn periods are interpreted as
a more valid sign of profitability (Dermine 2009). Further, the negative coefficient on the
2 year interest rate is in crisis years three times as large compared to the pre-crisis years.
This indicates that during crisis years the negative macro value drivers become more
important factors. Furthermore, the GDP growth seems to be fully explained by the 2
year rate in the crisis years.
Growth in revenue becomes more significant during the crisis. This is counterintuitive
when looking at the results in Section 11.3 where it was seen that when ROE is lower
than CoE revenue growth does not create any value. During the crisis period many banks
experienced levels of ROE that were lower than their corresponding CoE (Visali et al.
2011) and therefore growth was expected to be less value-adding during the crisis. Even
though this conflicts with the findings from Section 11.1 there might be an explanation
for this. Only the strongest banks are capable of securing growth through a down-turn
period, either through acquisitions of struggling banks or by stealing value-creating
customers. The relation between being well-capitalized and delivering positive TSR will
result in the findings seen in Exhibit 11.4.1. Finally, the analysis confirms that ROA and
revenue growth are key value drivers both when the economic climate is good and bad.

11.5 Investigating Differences between US and Europe


It confirmed in Section 10.2 that bank performance is affected by external factors. In this
study some of these external factors are discussed by investigating the shareholder value
generation across the different countries in the sample.

71

Part III Analysis

Exhibit 11.5.1: 10 Year CAGR TSR across the Included Countries


Greece

-24%

Belgium

-22%

Portugal

-19%
-16%

Germany

-10%

Switzerland

-8%

Englan

-7%

Italy

-6%

France

-3%

Spain

1%

US

3%

Sweden

3%

Austria

10%

Denmark

-30%

-25%

-20%

-15%

-10%

Canada

12%

Norway

12%

-5%

0%

5%

10%

15%

Source: Bloomberg, Own contribution

Exhibit 11.5.1 shows clear evidence of shareholder value destruction in the banks
headquartered in the European countries. Only Scandinavian banks seem to be
performing well and the Canadian banks perform extremely well. To investigate the
difference in value generation between the European and the American banks a test is
conducted on the differences in average TSR, ROA and growth.
Exhibit 11.5.2: Performance of North American and European Banks
EU

North America

t-statistic

p-value

TSR (CAGR)

-5.03%

2.07%

-3.859

0.010

ROA

0.54%

0.86%

-5.941

0.000

Growth

5.74%

7.59%

-2.512

0.080

Source: Bloomberg, Own contribution

The analysis supports all previous analyses as the North American banks outperform the
European banks significantly on the key value drivers. The reason for the poor
performance in profitability and growth in the European banks is not only due to bank
managers having a wrong management focus but also the European debt crisis has its
impact. Banks from Greece, Spain and Portugal all contribute with negative TSR as can
be seen in Exhibit 11.5.2.
Some of the differences could, however, be explained by unobserved underlying factor
shared by the European banks. In order to investigate whether such factors appears a
European dummy variable is included in the analysis. The dummy variable equals 1 for
all the European banks and 0 for the US and Canadian banks.

72

Part III Analysis

Since the Europe-dummy do not change over time it is necessary to rely on random
effects estimation in this analysis (Wooldridge 2002). Exhibit 11.5.3 shows the results of
the random effects estimation with the included dummy variable.
Exhibit 11.5.3: Investigating the Europe Factor
Coefficient

p-value

ROA

5.818

0.000

G_REV

0.127

0.000

G_IBIT

0.034

0.000

CONTINGENCY

0.039

0.011

PB_RATIO

0.075

0.000

LN_ASSETS

-0.018

0.000

_2_YEAR

-3.738

0.000

MSCI_FINANCE

0.521

0.000

EUROPE

0.074

0.001

Source: Bloomberg, Own contribution

At first hand, it is surprising to see that the European dummy variable have a positive
and significant sign. However, having controlled for variables such as ROA, growth etc. it
indicates that there is some unknown Euro-factor (or a negative US factor) that has a
positive effect on TSR in European banks. One such variable could be the too-big-to-fail
suggested by (Brewer, Jagtiani 2009), which seems to be more present in the European
banks than in the North-American banks. If European banks are more likely to be saved
when they come into financial distress than US banks, this might explain the positive
sign. It is important to notice that the endogeneity detected in Chapter 9 makes the RE
estimator biased and therefore the coefficient cannot be fully trusted.

12 Constructions of the Value Driver Map


Having conducted the analyses regarding which drivers create shareholder value this
chapter will map those into a value driver tree in order to understand the connection
between the variables. The value driver tree constructed in this thesis is based on both
the findings from the conducted analyses and an economic knowledge gained through
Part II. The key value drivers identified in the FE 2SLS regression based on the
academia approach all play an important role in the map. A value driver tree breaks the
overall drivers down into underlying categories and is a method for visually and
systematically linking a business value drivers to the financial numbers that creates
shareholder value. The main source of inspiration for this is found in (Rappaport 1998)
and the steps described in Chapter 2. This way of mapping value drivers, also shares
some elements with the balanced scorecard constructed by (Kaplan, Norton 1996) since it
illustrates how performance of one driver affects other drivers. In Part IV these drivers

73

Part III Analysis

will be broken down further into operational KPIs which yields several advantages and is
also the premise of (Kaplan, Norton 1996). First of all, it let managers know the relative
impact on the banks value drivers and they can make tradeoffs between pursuing a
critical driver vs. letting a less critical driver deteriorate. Further, managers are capable
of prioritizing activities so that the most value-creating activities are focused on first.
The value driver is illustrated in Exhibit 12.1.1. (Koller, Goedhart & Wessels 2010)
Exhibit 12.1.1: The Value Driver Tree
Value driver tree

Key value drivers


Product
development

Revenue per
client

Market
penetration

Fee cost

Revenue growth

GDP growth

Interest cost

Market
development

Number of
clients

Provision for
loan loss

Profit

ROA
Financial
leverage

TSR

Risk free int.


rate

Income

Other operating
costs

Fee income

Non interest
income

Other operating
income

Non operating
income

Trading income

Interest Income

Risk cost

Loan loss coverage

Market expectations

Risk free rate

GDP growth

MSCI Finance

Deposits

Market risk
premium

Regulatory
changes

Tier 1

Equity

RWA/ Total
assets
Short term
assets

RWA

P/E
Valuation multiples

Revenue growth

Interest rate
Deposits

Beta

ROA

Loans

Nonoperating
expense

Cost

Interest rate
Loans

Total assets

4
P/B

MSCI Finance

Long term
assets

Source: own contribution

According to (Rappaport 1998) the next important step is to differentiate between the
value drivers that managers actually can influence and those who are beyond the control
of the bank. First of all the bank cannot influence the interest rates, the growth in GDP
or the return on the MSCI Finance index. Further, even though the stock markets
expectations are influenced by the performance of the bank it is still difficult to control.
This leaves ROA, revenue growth and loan loss coverage as the main controllable value
drivers of a bank. Inspired by (Dietrich, Wanzenried 2011) and (Athanasoglou, Brissimis
& Delis 2008) a further break-down of the profitability measure has been performed.
Especially the loan loss rate affected the profitability (for further information see
Appendix 17.2.11). The growth variable has been operationalized by looking at the
classical growth strategies from (Ansoff 1965), and risk cost is broken down using
(Sharpe 1964) and (Lintner 1965) as discussed in Chapter 4.
The tree can be seen as a great help for bank managers since it lets them, through a
structured approach, evaluate the performance of each business unit. Even though data
for the full value driver tree is not available for external analyses, bank managers can

74

Part III Analysis

month by month or year by year, track the development of each variable making them
capable of finding the weak spots. In Exhibit 12.1.2 the first step in such an analysis for
Deutsche Bank can be found.
Exhibit 12.1.2: First Step in the Assessment of the Value Driver Tree
87%

100%
10%

7%

7%

2010

2011

0.14%

0.20%

2010

2011

0%
-100%
2007

-51%
2008

2009

Revenue growth

0.50%

0.36%

0.27%

0.00%
-0.18%

-0.50%
79%

100%

2007

2008

0%
-100%

2009
ROA

-9%
2007

-67%
2008

2009

-12%

-23%

2010

2011

40%
20%

TSR

23%
12%

13%

12%

2007

2008

2009

16%

0%
2010

2011

Cost of equity

2.00

1.21

1.00

0.52

0.84

0.74

2009

2010

0.50

0.00
2007

2008

2011

P/B ratio

Source: Deutsche Bank annual reports, own contribution

The 2007 numbers at first hand looks difficult to interpret, however the analysis hide the
fact that Deutsche Bank experienced a significantly drop in their price book value
compared to 2006. Even though the numbers from 2007 looked fine, the stock market
expected it to get worse and TSR therefore experienced a 9% drop. 2008 does also yield
some interesting results. Even though the PB ratio dropped significantly and ROA also
showed a negative development, the large TSR drop of 67% was mainly driven by a 51%
decrease in net revenue growth! Breaking Net revenue growth down even further would
have revealed that almost 10 billion EUR was lost on Net gains on financial assets and
liabilities. In 2009 Deutsche Bank was able to turn these numbers around and therefore
experienced a positive TSR of 79%.
It is interesting to see that Deutsche Bank in 2011 performed well in ROA and growth
but still experienced a negative TSR. The reason for the poor performance seems to be
that the stock market has lowered its expectation for the future performance. The bank
needs to restore the markets confidents by outperforming expectations. Part IV will
identify the operational strategies necessary to increase performance and thereby
shareholder
value.

75

Part IV Operationalizing the Value Drivers


The purpose of Part IV is to give the reader a deeper understanding of the value drivers
mapped in Exhibit 12.1.1 through a further break down into operational strategies. It will
discuss how to increase the drivers through increasing profit, decreasing costs and
keeping control of the risk. The structure can be seen in Exhibit 13.1.1.
Exhibit 13.1.1: The Structure of Part IV
13.1 ROA

13.2 Revenue growth

13.3 Risk control

13.4 VBM KPIs

Identify operational
strategies for improvement
of profitability

KPI 1

KPI 2

KPI 3

KPI 4

Identify operational
strategies for increasing
revenue

KPI 1

KPI 2

KPI 3

KPI 4

Identify operational
strategies for better risk
control

KPI 1

KPI 2

KPI 3

KPI 4

Summarize the identified KPIs

Source: Own contribution

13. Operationalizing Profitability, Growth and Risk


Control
Having derived a detailed value driver tree constructed by the input from both academia
and practitioners Part IV identifies operational strategies and seeks to show how to
increase shareholder value (Rappaport 1998). As before mentioned academia has so far
stopped with the derivation of the most important KPIs. In order to take this thesis
further Part IV will identify which operational actions bank managers can take in order
to maximize shareholder value. Since academia only has an external view to shareholder
value, the articles used are found in the management consulting literature as these
companies have the internal sight that is important for such a study. (Duthoit et al.
2011)
The key value drivers identified in Part III were:

Profitability (ROA)

Revenue Growth

Loan loss coverage (Risk Control)

76

Part IV Operationalizing the Value Drivers

Market expectations

Risk-free interest rate

GDP growth

MSCI Finance

(Rappaport 1998) argues that only value drivers that the company can manage should be
included in the VBM system. Part IV will therefore only operationalize profitability,
revenue growth and loan loss coverage (risk control). Key criteria for a successful
operationalization are that the employees have clear performance measures that focus on
the right value adding activities, that the measures are transparent and aggressive but
achievable (Duthoit et al. 2011). Therefore the operational strategies presented in Part
IV will all have clear KPIs that help the employees track their value generating
performance.
The results so far have shown that it is important to perform well in all the key value
drivers if the banks consistently want to create shareholder value. If a bank only grows
by taking in risky customers the risk control value driver will suffer and thereby hurt
performance.
Discussing a successful application of the value driver tree, bank managers need to
evaluate the current performance in each of the value drivers (as seen in Chapter 12).
When the performance in each value driver has been assessed and evaluated, based on
benchmarking with the top-performing banks and historical numbers, the identification of
weak spots can begin. If the bank performs well in profitability, growth and valuation
multiples but fails to perform well in the risk control value driver then focus should be on
implementing the operationalizing strategies that optimize risk control. (Rappaport 1998)

13.1 Value Driver 1 ROA


With no exceptions, all banks need to lower their costs but still keeping in mind that it
should not be at the cost of customer relationship. It is not strategically wise just to cut
costs; it has to be done in an intelligent manner (Duthoit et al. 2011)
The most significant variable in the analysis in Part III (apart from some control
variables) was throughout all the models ROA. It is a strong performance driver and
therefore also a measure for the banks operational excellence. There are many underlying
measures that affect profitability (see (Dietrich, Wanzenried 2011) and (Athanasoglou,
Brissimis & Delis 2008). Exhibit 13.1.2 illustrates the underlying measures identified in
Part III and Appendix 17.2.11 and the KPIs found in the following section.

77

Part IV Operationalizing the Value Drivers

Exhibit 13.1.2: KPIs for Profitability Improvement


Value driver tree

KPIs
Fee cost

Interest cost
Cost
Nonoperating
expense

Branch wait time

Call wait time

Call resolution time

Online Banking share

Interest rate
Loans

Loans

Provision for
loan loss
Profit
ROA
Financial
leverage

Income

Other operating
costs

Fee income

Customers pr. branch

Non interest
income

Other operating
income

Customer % time

Trading income

Non operating
income

Complexity score

Interest rate
Deposits
Interest Income
Deposits

Source: Own contribution

The following part will go into detail with how managers can affect the profitability of
their bank. The key to successfully maximizing profitability is reached through improved
sales and service effectiveness, followed by an automation of the processes in order to
improve cost effectiveness. Finally, these suggestions should be incorporated in a
streamlined organization that focuses on reduced business complexity (Duthoit et al.
2011) and (Visali et al. 2011). Bank managers, however, need to keep in mind that there
is not a common framework that works for all banks, each bank needs to consider all the
operational advices and choose the strategies based on the banks starting position.
(Rappaport 1998)
13.1.1 Action 1: Sales and Service Effectiveness
In the analysis in Part III, three different operational effectiveness measures were
included. Even though neither of them showed any sign of significance impact on TSR
(as it is seen from the value driver tree their impact is probably described by other
factors) the development in them, shows that the banks have had a focus on increasing
their efficiency, see Exhibit 13.1.3.

78

Part IV Operationalizing the Value Drivers

Exhibit 13.1.3: Operational Effectiveness Measures

Million USD

6
4.48

5
4
3

3.65
0.16

2
1

2.17

3.94
0.20

4.92

5.10

0.21

0.22

5.40
0.23

5.59
0.24

0.18

2.33

2.60

2.96

3.11

3.42

3.70

5.97

6.27

6.06

5.98

0.30
0.25

0.26
0.22
3.77

3.71

0.24

3.51

0.25
0.20
3.81

0.15
0.10

Million USD

0.05

0.00
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Loans pr employee

Assets pr employee

Revenue pr employee (right axis)

Source: Own analysis, own contribution

In order to improve the ratios in Exhibit 13.1.3, (Duthoit et al. 2011) suggests actions
that give sales employees incentives to accentuate products that help tie the customers
more closely to the bank. Since, it is more costly to get a new customer than to retain an
old one (Heskett 1994), keeping customers and increase their engagements automatically
lowers unit cost and increase the effectiveness of the employees. Next, letting customers
interact with the bank through multiple channels (mobile, internet, call centres etc.)
depending on their inquiry, customer questions can be generated to those most suitable
to answer. If clients have questions that call centre can handle (opening hours, questions
regarding different standard products etc. e.g. by the use of interactive voice response
systems) the expensive specialists can then focus on the more complex questions.
(Duthoit et al. 2011)
A requirement for this is the implementation of a customer relationship management
(CRM) system that can handle these easy-to-answer questions. Besides, the CRM
system should also be able to provide the necessary information to these call centres
because efficient contact across all channels is then created. Since customers are divided
into customer groups based on their profitability it is important that low value customers
only receive service that is equal to what competitors are offering. In order to succeed on
those aspects the bank need the CRM system to be able to monitor and differentiate the
customers into different service levels. (Duthoit et al. 2011)
Besides affecting sales effectiveness, the fact that customers are served more quickly also
increase service effectiveness. In general, the top performing banks in (Duthoit et al.
2011) outperform the low performing banks on three KPIs: Branch wait time, call wait
time and call resolution time, measures that will help the banks track and increase their
sales and service effectiveness. (Duthoit et al. 2011)

79

Part IV Operationalizing the Value Drivers

13.1.2 Action 2: Process Automation


Another way to improve the productivity is by developing efficient and effective
processes through process automation (Duthoit et al. 2011). Process automation builds
upon avoiding a large number of manual processes in e.g. sales, service and fulfilment.
This could be by automating new-accounts openings, making standard loan procedures or
other processes that enable efficient data gathering and automated decision making
(Duthoit et al. 2011). The internet has shown its worth in this area since many
customers have accepted to use it for their banking businesses. It is therefore suggested
that banks increase their online activities and cut their costs by closing some of the
costly branches, an opportunity that has only grown bigger by the introduction of mobile
banking (Visali et al. 2011). The Swedish VBM bank Nordea is an example of a bank
that has the closing of branches as an important part of their strategy to improve
shareholder value (Nordea, Annual Report 2011).
KPIs for the process automation are the percentage of clients using online banking and
the number of customers per branch (Visali et al. 2011). The online banking KPI is a
strong measure for automation since it increases the number of tasks that clients can
handle. This will free up capacity and would make it possible for each branch to serve a
larger number of clients with the same number of employees.
13.1.3 Action 3: Organizational Streamlining and Reduced Business
Complexity
Streamlining of the organization is the third strategic lever that banks could use in order
to increase productivity. This means investing in a more lean overhead, reducing
complexity and maximizing the time employees spent with the customers. It is necessary
both to centralize the processes so that they are not carried out in each branch, thereby
experiencing scale benefits and outsource those activities applicable of doing so. (Duthoit
et al. 2011)
Finally, the goal of establishing underlying capabilities and thereby create winning
conditions is achieved through two capabilities. The first is to reduce business complexity
in order to reduce the time to market and facilitate the sales force training. By doing
this, the bank will succeed in simplifying the offerings that are easily integrated across
business units and distribution channels. Further it helps streamlining the product
portfolio and keeps it up to date with the most value-adding activities. Appendix 17.3.1
explains how LEAN initiatives can successfully streamline banks. Second, the best
performing banks outperform through an implementation of a high-productivity culture
where there are clear expectations, where performance monitoring is transparent and
continuous and where incentive schemes are constructed so that they are highly
motivating and easy to understand. This is complemented by training and coaching the
employees on how value is created. (Duthoit et al. 2011)

80

Part IV Operationalizing the Value Drivers

(Duthoit et al. 2011) recommends measuring the percentage of employees facing


customers as a key performance indicator of how streamlined the bank is. Furthermore, a
degree of complexity score should be introduced to track the improvements on this
area (Duthoit et al. 2011). Increased face time with customers means fewer resources
spent on non-value adding activities.

13.2 Value Driver 2 Revenue Growth


With expected market growth equal to zero and a changing regulatory environment, it
will not be possible to grow the bank based on either increased GDP, through increased
leverage or by increasing risk. Instead growth should be captured from strong
outperformance through tighter customer relationships and a better tailoring of the value
proposition to each customer (Visali et al. 2011). This means that instead of looking at
number of customers, banks need to focus on increasing revenue per customer and
thereby secure revenue growth. A successful implementation of the revenue growth
strategies is also closely correlated to performance of the CRM system. Success requires
that the bank knows its customers needs through detailed and easy accessible
information (Visali et al. 2011). Exhibit 13.2.1 summarizes the growth drivers and the
KPIs to be identified through Section 13.2.
Exhibit 13.2.1: KPIs for Achieving Revenue Growth
Value driver tree

KPIs

Revenue per
client

Revenue growth

Product
development
Market
penetration

Segment mix

Share of wallet

New customer share

Profit per customer

Customer retention

Customer satisfaction

GDP growth

Number of
clients

Market
development

Source: Own contribution

(Maguire et al. 2009) discusses some of the steps that managers can take in order to
drive the bank closer to perfection and positively affect shareholder value through
revenue growth. It is build upon a study of some of the largest banks in the world were
the best performing banks are compared to the worst. The general conclusion is in line
with (Visali et al. 2011) saying that focus is suggested to be on increasing customer
relations through better segmentation, streamlining the product portfolio, increase
customer satisfaction and a have a management capable of pushing the strategy all
through the bank to the front line employees. In short version, the following part will
help managers segment and secure the right customers, find them the right products

81

Part IV Operationalizing the Value Drivers

through a streamlined product portfolio, secure them and finally create shareholder value
and revenue growth from them through long-term relationships.
13.2.1 Action 1: Segmentation of Customers
Looking at the identity of a bank a common phrase goes, perception is reality. Not being
able to clearly tell the customers what the banks identity is, is just as bad as failing to
align the organization and making sure that all business units are behind this identity. In
order to secure this identity perception among customers, consistent marketing
campaigns that help customers associate the banks name and logo with the desired
identity need to be carried out. However, before marketing the banks identity, a careful
segmentation will help securing that the preferred customer groups are easier found and
tied to the banks identity and to the banks core offerings. In general, customers are
either segmented by geography, by their possible product group or through a
combination (Kotler, Keller 2008). Such a process should enable both increased
effectiveness within product development but also through more targeted marketing
campaigns (Kotler, Keller 2008). As was stated in the beginning, revenue growth is not
just about increasing sales per customer but also about securing long-term sales. This is
related to both the customer satisfaction but just as much to the streamlining and
innovation of the product portfolio. Creating the right products for the right customers is
one way to secure long term sales effectiveness (Maguire et al. 2009). Rinkjbing
Landbobank, the number one TSR performer in the data set, is a true segmentation
expert. One of the segments targeted by the bank is medical practices, a segment known
to have low-risk and high profitability (Theil 2012).
A KPI for the segmentation is the segment mix measure. The goal is to increase the
share of revenue in the most attractive segments and thereby secure profitable growth
like Rinkjbing Landbobank has.
13.2.2 Action 2: Streamline Product Portfolio
The second step to take in order to secure increased revenue, is streamlining of the
product portfolio. Banks that perform the best often have a relatively narrow product
portfolio measured by category (Maguire et al. 2009). This focus helps all employees
gaining deep knowledge regarding the products they sell which ultimately affects the
conversion rate and cross-selling opportunities and thereby the revenue growth (Duthoit
et al. 2011).
One way to achieve a streamlined product portfolio is to make sure that the bank knows
its customers needs. In step one, the right customers were found, step two is then to
collect the right information. It is done through detailed information systems that help
the bank only having relevant products in their portfolio, meaning that they offer the
right products to the right customers. However, having a narrow and focused product
portfolio does not mean that no changes are made. What the best practice banks are
good at is not just keeping the portfolio narrow but they also monitor and adjust it to

82

Part IV Operationalizing the Value Drivers

their customers needs. An example of innovative marketing initiatives among some


banks is the new focus on women. Working and wealthy single and married women have
increased their interest in their own financial well being, making it an attractive segment
for most banks (Silverstein, Sayre 2009). However, this second step is closely connected
with the segmentations made in step one because a development of the most dynamic
products depends upon the accuracy of their segmentation and customer insight (Kotler,
Keller 2008). (Maguire et al. 2009) suggests that one way to create this very narrow and
focused strategy is to set up a team that is specialized in developing products for the
most profitable segments. A strong customer insight should then be gained through both
quantitative and qualitative analysis, pilot testing and thereafter fine tuning of the
products before developing a business case for the new product and communicate it
clearly both internally and externally.
A KPI proposed by (Kaplan, Norton 1996) is the Share of wallet measure. Each
customer should have his personal share of wallet measure and the job is for the
employees to maximize this measure. (Kaplan, Norton 1996)
13.2.3 Action 3: Attract and Secure the Profitable Customers
In the third step focus is on the sales people, both in their approach towards new
customers and their effectiveness. First of all, analyses have shown that the best
performing banks have sales people that day by day are working towards increased face
time with value creating customers. Further, creating long term relationships by making
a strong first impression will help the bank secure the customer. Therefore, the six
elements illustrated in Exhibit 13.2.2 are what the banks should focus on in their first
meeting with the customer. (Visali et al. 2011)
Exhibit 13.2.2: The Six Critical Success Factors in the First Client Meeting
1 Effective use of greeters in the sales
4 Compelling simple documentation provided
process

at sale including a clear professional


account opening guidebook and a lucid
explanation of which documents are
required to fulfil the banks needs

Efficient capturing of information,


including and ask once policy that
prevents customers from having to give
basic information repeatedly

5 Detailed explanation of the channel setup,

Physical branch formats that are geared to


sales, with private areas available to help
with account opening, a time when
customer needs must be systematically
assessed; hard cross selling efforts should
be scrupulously avoided

6 Clear description of all fees and charges,

including potential hands on


demonstrations of web site navigation

the concept of full transparency must be


driven home at first contact

Source: (Maguire et al. 2009), own contribution

83

Part IV Operationalizing the Value Drivers

In general the first month of a client relationship should be flawless, the bank should
commit itself to avoid errors and make the client feel valued in order to secure the
customer on a long term basis. However, the banks are still in it for the business and as
described in the start, increasing revenue per customer is a key objective. Therefore, after
the first period focus should shift to cross-selling activities that are tailored to each
customer. (Maguire et al. 2009)
Further, banks should incorporate a comprehensive approach that monitors and
differentiates the service level to different clients thereby helping employees to keep focus
on the value creating customers.
In order to measure the performance in this action the ratio of revenues from new
customers to total revenue should be traced. Furthermore the profit per customer could
be a useful measure. (Kaplan, Norton 1996)
13.2.4 Action 4: Focus on Retaining Customers
Having secured all value creating customers, the last step regards increasing shareholder
value through customer satisfactory and customer relation, meaning keeping the
customer a happy and profitable customer. Where customer satisfactory might be
increased through physical impressions (Maguire et al. 2009), a customer relationship is
achieved by exploiting customer data. Not just to make centralized campaigns that drive
sales of a specific product but instead use the data to reposition the service model so that
it fits each customer segment. E.g. the collection of data on the first day is valuable
information in such a CRM system. By having such a focus, bank managers can better
align the marketing campaigns, product development and the frontline staff around an
offer that suits each customer the best. An example of a successful customer relationship
focus that is able to boost the revenue is seen within online banking. The benefits of
optimizing such a multichannel strategy have been significant for those who have
adapted to it. (Badi et al. 2012)
Finally, the operational actions that effects revenue growth can only be carried out if the
organization is geared towards it. The most successful banks are often characterized by
having a strong leadership, a performance schedule that are build upon value creating
activities in all layers of the company, a wide span of control, less than seven
organizational layers and a clear understanding on how the different teams need to
interact in order to create synergies. (Visali et al. 2011)
In order to measure the progress in retaining the customers, three KPIs are suggested.
(Kaplan, Norton 1996) recommends measuring the customer satisfaction in annual
surveys. An increase in this will imply that the bank has been able to increase the
customer retention. (Kaplan, Norton 1996) also recommends tracing the customer
retention directly. Finally, (Duthoit et al. 2011) recommends tracing the percentage of
time each employee spends facing customers.

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Part IV Operationalizing the Value Drivers

13.3 Value Driver 3 Risk Control


In Chapter 3 it was discussed how the banks business model is centered on managing
risk and the crisis have highlighted the importance of both credit policies but also risk
management skills. What is earned during an up-turn can easily be lost during a downturn if the bank is not capable of managing their risk. The stock market knows this and
therefore rewards the banks with strong risk management skills by decreasing the cost of
capital and thereby increasing TSR which was confirmed in Part III. It is all about
striking a balance between growth and risk and the following part will be a guideline on
how to balance operational risk management. (Visali et al. 2011)
Upcoming regulatory changes make it necessary for banks to cope with risk on an
operational level. The regulatory changes consist of risk measures that are designed to
increase the transparency and stability in the banking sector (Basel Committee on
Banking Supervision 2010). This means that most banks have already tried to upgrade
their risk management skills in order to handle the increasing number of defaults and a
far more stressful and demanding environment, but improvements can still be made.
(Leichtfuss et al. 2010)
Risk management skills are all about the culture of the bank. The banks capable of
creating this culture will also manage risk more efficiently and precisely. It is therefore
important that all employees understand risk in connection to return (Dayal et al. 2011).
Exhibit 13.3.1 shows the components of Risk Control and the KPIs necessary for a
successful implementation of risk reducing strategies.
Exhibit 13.3.1: KPIs for Enhanced Risk Control
Value driver tree

KPIs
Risk free int.
rate

Risk understanding
coverage ratio

Percentage of
revenue from risk
segments

Liquidity adjusted
profit

IT coverage ratio

Beta
Risk cost
Market risk
premium

Tier 1

Equity

Regulatory
changes
RWA/ Total
assets
Short term
assets

RWA
Total assets

Long term
assets

Source: Own analysis, Own contribution

As it is seen from the figure some fundamental operational activities are able to have a
great impact on the TSR. Even though many banks already do something, few do
enough. By taking a more comprehensive view of risk those banks that move first are

85

Part IV Operationalizing the Value Drivers

presented with a window of opportunities that give them competitive advantages (Dayal
et al. 2011).
13.3.1 Action 1: Understanding the Implications of Risk
As was discussed in Chapter 3 the new regulatory environment will lead to changes in
both the banks balance sheets, profitability, funding strategies etc. For bank managers
to be able to develop a strategy that can cope with the changes, (Dayal et al. 2011)
suggests that the following operational actions need to be taken. First it is important for
the managers to get a clear understanding of how and where the changes will impact the
business. It is necessary both to map the pending and the proposed rules in order to
make a coherent strategy. This both help the bank minimize the risk of failing some of
the regulatory variables, which will have a negative effect on the value, and it might
make the bank aware of less regulated opportunities. After that, the bank should
calculate the risk/return on each product with the new regulatory changes implemented
in order to accurately reflect the costs imposed by the reforms. Going forward from this,
it should be clear which products to avoid and which to go for in order to get an
integrated understanding of the economic implications of risk (Dayal et al. 2011). It is
important not just to focus on key ratios such as tier 1 but also to know how and where
risk is created. It is then possible to track both the deployment of capital and the
regulatory and economic implications of this. Such an integrated view of risk will help
banks optimize their funding and capacity resources, an area were many banks are still
able to increase shareholder value. In line with this, increased focus on optimal capital
deployment will also make the bank able to price risk more correctly. The information
needs to reach the sales people in the front line so they are able to perform price
differentiation, making all customers value-creating. It is however important to state that
even though price differentiation among segments is beneficial a high degree of
discrimination within the same segment might be problematic (Kotler, Keller 2008).
Further, the crisis has shown that models are only as good as the input they are provided
with meaning that the accuracy of the input data is of high importance. (Maguire et al.
2009)
In creation of an integrated view on risk, the employees need to fully understand the risk
of their own portfolio (Dayal et al. 2011). To gain further understanding training is
needed and the risk understanding coverage KPI is a suitable measure. Further, KPIs
that favour high quality loans with an acceptable risk profile will help decrease future
loan losses and affect shareholder value positively. The segmentation suggested earlier in
this chapter will make it possible to track the exact exposure to risky segments and the
risk segment percentage could be a suitable KPI for this.
13.3.2 Action 2: Focus on Liquidity and Risk Reduction
Chapter 3 highlighted the importance of regulatory changes on liquidity and risk. In
general, banks need to begin developing a fundamental framework on how to assess the
regulatory changes that affect the riskiness of their assets. Building up capital ratios is

86

Part IV Operationalizing the Value Drivers

only a start. Despite their efforts to cope with the changes and keep up to date with
regulations, only few have fundamentally transformed how they look at risk as a result of
the changes. In order to do this, banks need to develop a comprehensive plan. In (Dayal
et al. 2011) ten steps that bank managers should take in order to cope with the changes
and make sure that cost of equity is kept at a reasonable level are explained. In Exhibit
13.3.2 these ten ideas are summarized.
Exhibit 13.3.2: 10 steps to cope with Regulatory Changes
Aim to comply with - and potentially
1 Establish integrated bank wide steering
6
mechanisms that account for balance
sheet, P&L, capital, liquidity and leverage
effects.

exceed - the new Basel III ratios by 2013


to keep pace with top-tier banks.

Highlight and reassess risk-return


considerations at the group, segment and
product levels.

Plan for continued deleveraging and, in


Europe, greater disintermediation as more
companies shift toward capital markets.

Develop a plan for adjusting prices that


takes into account competitors' reactions
(game theory considerations)

Develop sustainable funding and


refinancing strategies that take into
account the liquidity challenges lying
ahead.

Map the regulatory landscape to cut


through the complexity, facilitate
compliance, and identify potential
arbitrage opportunities.

Identify unexploited risk weighted assets


(RWA) reductions by upgrading the
bank's risk models and improving the
quality of data management.

Understand that Basel III is the global


blueprint and that local requirements (for
example, Dodd-Frank and the Vickers
report) will add challenges on top.

10 Foster the development of a bank-wide risk


culture on the basis of a regulatory and
economic view of the new requirements.

Source: (Dayal et al. 2011), own contribution

As it is seen, strong risk management is centered on a necessity to get a clear and


accurate perspective of risk throughout the whole organization and thereby get an
understanding of where value is actually created. Those banks capable of doing that will
use financial resources more efficiently and thereby be able to pursue those opportunities
that might arise in the wake of the crisis. (Dayal et al. 2011)
In order to measure the employees on the basis of their liquidity and risk reduction
performance new measures needs to be introduced. The employees need to assess the
liquidity drain from each customer in their portfolio and make sure that the profit from
each customer exceeds this liquidity drain. (Dayal et al. 2011)

87

Part IV Operationalizing the Value Drivers

13.3.3 Action 3: Integrate Effective IT Systems


As IT systems are central in managing risk, the regulatory changes will put pressure on
the banks IT capabilities. The systems should be capable of both measuring and
managing risk but it should also help carrying out day to day activities (Bohmayr et al.
2011). It is expected that, as the new regulatory requirements are being implemented,
those banks capable of managing these three areas effectively will gain competitive
advantages. Looking at Exhibit 13.3.1, this means that the good banks will effectively
manage and calculate RWA due to better risk assessment with the positive side effect of
increasing profits through lower loan loss provisions.
In order to gain competitive advantages, bank managers must first of all know where
their IT systems will be put under pressure. On the technological front the bank will
most certainly be pressured within three areas. The first is data gathering that due to a
greater demand of data availability need to ensure consistency in data collection and
interpretation. Further banks will need to strengthen their data calculation and model
setup since the new regulatory changes will require both a larger set of metrics but also
more frequent updates. Finally, the reporting capabilities need to be enhanced in order to
help the employees extract more detailed information on each customer, thereby helping
them make better risk estimates of each customer (Bohmayr et al. 2011). Finally, most
banks will have to upgrade their IT systems in order to cope with the changes. Banks
with systems capable of measuring and monitoring their customers better are able to
build their own credit models instead of applying the standard models. This secures more
efficient capital deployment and risk allocation (Dayal et al. 2011).
Important measures of the IT performance include the IT coverage ratio. The IT
coverage ratio is difficult for the lower level employees to influence and it is more
regarded as the key measure for the IT department.
In Appendix 17.3.2 a description of how the Danish bank Jyske Bank has taken steps
towards both improving the IT infrastructure and decrease costs can be seen.

88

Part IV Operationalizing the Value Drivers

13.4 Summarizing Part IV


The operational strategies needed to maximize shareholder value in banks have been
identified through a careful study of the prevailing strategies proposed by the consulting
companies. Benchmarking against top-performers in each value driver category will show
where the bank should focus in order to maximize shareholder value (Rappaport 1998).
Exhibit 13.4.1 summarizes the actions identified to operationalize the strategies and the
KPIs crucial for the implementation.
Exhibit 13.4.1: Operational Strategies to Improve Shareholder Value and Their KPIs
Symptom

Actions

Key performance indicators

Low
profitability

1. Improve sales and


service effectiveness

*
*
*
*
*
*
*

2. Process automation
and industrialization
3. Reduce complexity

Low growth

1. Effective segmentation
2. Streamline product
portfolio
3. Attract profitable
customers
4. Focus on customer
satisfaction

Poor Risk
control

1. Create risk
management culture
2. Focus on liquidity and
risk reduction
3. Integrate effective IT
systems

Branch wait time


Call wait time
Call resolution time
Percentage of customers using online bank
Customers pr. branch
Percentage of employees facing customers
Complexity score (survey)

* Segment mix
!,$ (M" "NO&O"M"N
* Share of wallet =
( &+ P N&N! &+ N""Q$
* New share =

S"*N," T (M N"U !,$ (M" $


V( &+ "*"N,"

* Profit per customer


* Customer retention
* Customer satisfaction (survey)

* Risk understanding coverage ratio


* Percentage of revenue from risk segments
* Liquidity adj. proPit = ProPit liquidity cost

* IT coverage ratio

Source: Own analysis, own contribution

89

Part V Assessment and Conclusion


14. Critical Review of Results
An empirical study always has its boundaries and areas where it could be expanded. In
this thesis these boundaries are first of all connected to the omitted variable problems
discussed in Part III. Variables that might be valuable to include are e.g. the much
discussed geographical dummy that is able to track revenue and profitability secured by
the bank in different regions. Further, also the more operational KPIs would be
interesting to test in order to see whether some of them are capable of explaining the
variance in TSR. However, a common factor for most of the omitted variables is lack of
data availability. Such tests can therefore only be conducted by analysts in companies
such as management consulting houses that have internal knowledge about a large pool
of banks. Also risk variables that are able to cope with some of the difficulties discussed
in Chapter 3 regarding the complexity of risk cost calculations might yield a better
knowledge regarding the risk variables. Finally, from an economic view such
implementation of new regulatory changes should have a significant impact on TSR, even
though (Schfer, Schnabel & Weder di Mauro 2012) finds no evidence of it. This might
be due to the problems discussed in Chapter 3, because the stock market incorporates
new regulatory requirements as soon as they expect them to be implemented and not
when they are actually implemented. A dummy capable of capturing these expectations
would probably yield insight into the understanding of the regulatory impact.
Further, the methodology applied for identifying VBM banks in this study, inspired by
(Rapp et al. 2011), might also be improved. It was discussed by (Boulos, Haspeslagh &
Noda 2001) that it takes more than words to implement VBM successfully. An even more
valid method would therefore be to conduct internal data in order to get more accurate
perception of the VBM usage. Analyses based on such a study would be more
comprehensive and RQ3 would be answered through a more thorough discussion. Also
further robustness tests might add value. In the thesis FE 2SLS was applied as a way to
correct for endogeneity problems. Another method for doing this suggested by (Fiordelisi,
Molyneux 2010) and (Verbeek 2009) is GMM which also let the author consider the
dynamic panel data models.
Finally, an increased time-span would add value to the thesis. Even though the study
uses an 11 year times-span, which is among the longest time-spans in shareholder value
literature, it would still add value and robustness to the study if the time-span was
increased. However, data availability sets a natural boundary for this possibility

90

Part V Assessment and Conclusion

14.1 Putting the Results into Perspective


For this thesis to be applicable it is important that bank managers start by stating its
current situation both from an external and internal view. From an external perspective,
the current environment with banks being more unpopular than ever, might not favour
implementation of a VBM system. Instead, softer issues such as the stakeholder value
perspective might be easier to implement. However, with stricter requirements, banks
need to adapt to the new environment, making VBM a suitable tool. Following
(Rappaport 1998), when the bank consistently delivers shareholder value it is possible to
focus on the local community and other aspects in the centre of the stakeholder
perspective.
From an internal view, the banks should value each business activity through the
constructed value driver tree, as discussed in Chapter 12. The limitation of this study
regarding internal data availability is not seen inside the bank and by applying monthly
data on the constructed value driver tree, bank managers is able to identify where value
is created and destroyed. This enables the bank to select the suggested KPIs from
Chapter 13 that affect the weak spots in the value driver tree (Rappaport 1998).

15. Conclusion
This thesis investigated the internal and external value drivers most compatible with
shareholder value maximization in banks. Even though there are a growing number of
articles surrounding the concept of shareholder value maximization, the evidence
surrounding this in connection to banks is limited. In order to assess the preferred value
drivers, five guiding research questions were posed. Answering each of these questions
was necessary in determining an answer to the key research question.
Before determining the value drivers that maximize shareholder value in banks, an
understanding of the complex banking business model is a necessary first step. Besides
revealing the differences between banks and non-banks income statements and balance
sheets, Chapter 3 also covered the great interdependence between bank performance and
the overall economy and the regulators impact on the banking environment.
In Part II, RQ1 and RQ2 were answered. To provide an answer to RQ1 the valuation
models applied by external equity analysts and the use of these models was discussed.
Following the external equity analysts view towards value creating drivers, an academic
literature review was conducted. Both groups were seen as having an outside-in view
towards value drivers and therefore expected to focus on overall accounting variables.
Further, management consulting reports and annual reports from 20 value based
management (VBM) banks were expected to provide the thesis with more internal
focused variables. Even though many of the 47 possible value creating drivers appeared

91

Part V Assessment and Conclusion

across the different types of literature, differences were seen. Especially the operational
drivers were only covered by the two latter groups.
In order to determine the significant value creating drivers and answer RQ3, an extensive
dataset was gathered and analyzed. Data on the 47 variables was collected for 132 listed,
North American and European banks from 2001 to 2011. Such a study is unique among
academic literature, both in terms of number of variables, the time period that were able
to include both pre crisis and crisis and in terms of information that many of the
variables provide.
In the specification of the preferred model, economic theory was applied in the
construction of eight overall groups that each of the 47 variables were divided into.
Several estimation techniques were considered for the preferred model. By carefully
analyzing the conditions it was found that the fixed effects two-stage least squares (FE
2SLS) estimator was the most efficient choice. The FE 2SLS model yielded the following
results:
TSRt = -0.02 + 8.44ROAt + 0.2gRevt + 0.002LLCt + 0.124PB ratiot 6.9522year + 0.563MSCI_Financet + 3.029gGDP - 0.289TSRt-1 + it
The findings indicate that return on assets (ROA), revenue growth and loan loss
coverage (LLC) are the main drivers of value creation, when total shareholder return
(TSR) is applied as the dependent variable. The results are in line with similar findings
conducted on non-banks, where return on invested capital (ROIC) and revenue growth
are also the main drivers (Koller, Goedhart & Wessels 2010).
A wide range of robustness checks were conducted. First of all two alternative model
specification procedures were applied. The univariate and factor approaches confirmed
the main findings of the preferred model since ROA and revenue growth also in these
tests ended up being the main value creating drivers. Inspired by (Koller, Goedhart &
Wessels 2010), an analysis correcting for expectations also revealed that when applying a
longer time span ROA and revenue growth are still significant value drivers.
To answer RQ4 and gain insight regarding VBM banks and their performance, it was
tested whether these banks had outperformed the other banks in the sample period. It
was found that VBM banks had generated significantly higher TSR, indicating that
implementing a VBM system will lead to increased shareholder value.
In order to fully grasp the dynamics of shareholder value creation, further analyses were
conducted. Inspired by (Jiang, Koller 2007) the prioritization and timing of pursuing
improved profitability or growth was analyzed. It is difficult to both grow the bank and
increase profitability along the way, therefore finding the right strategy between growth
and return, yields valuable insight. The findings suggested that the optimal strategy
depends on whether or not the banks return on equity (ROE) is above the cost of equity
(CoE). When ROE is below CoE it is suggested that banks focus on increasing

92

Part V Assessment and Conclusion

profitability whereas the opposite is true when ROE is above CoE. The results also
indicate that different economic periods might have different value drivers. To test this,
the sample was split into a pre-crisis and a crisis period. The results from these analyses
indicate that bank-specific value drivers are more value adding in economic up-turns
while the macro-specific drivers tend to dominate during a crisis. However, ROA and
revenue growth were significant value drivers throughout both periods, a result that adds
further robustness to the main findings. Finally, Part III ended with the construction of a
comprehensive value driver tree inspired by (Rappaport 1998).
Providing an answer to RQ5 it is required to follow the last step of (Rappaport 1998) by
operationalizing the identified value drivers. (Rappaport 1998) recommends the
identification of KPIs, enabling both managers and employee to gain stronger insight into
the value creating activities. Since this operating approach is unique among academic
literature, the operational strategies and KPIs were identified by studying management
consulting literature. From the literature it was found that the changing environment
that banks face, as discussed in the introduction, requires them to shift strategy from
increasing number of customers through fierce price competition to increasing revenue
per customer through stronger customer relationships and cross selling activities.
Having answered each of the research questions it is clear how banks should maximize
shareholder value. They should focus on the three main value drivers, implement a VBM
system and execute operational strategies that affect the key value drivers. Finally, by
choosing clearly defined KPIs for both the managers and employees that are in line with
the overall strategy, the banks are ready for the challenging future.

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Part V Assessment and Conclusion

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17. Appendix

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