Monopoly and Expense Preference Behavior: An Empirical Investigation of a Behavioralist Hypothesis

One of the most interesting developments in the theory of the firm has been the ad hoc extensions by behavioralists intent on introducing a more complete and realistic utility function for the firm.' Within the behavioralist framework, the notion of expense-preference behavior is of particular interest because, in addition to having implications for theory, it has implications for empirical work that estimates the welfare loss due to monopoly2 and tests the structure-performance relationship. At present, empirical evidence on the notion of expense-preference behavior is dreadfully limited. This is most unfortunate since, as Williamson noted [34, 1034], this is an empirical question and such evidence would have important implications for both theoretical and empirical work. Moreover, the evidence that does exist, [34; 5] and even the theoretical work, seems based on the assumption that expense-preference behavior will be manifested solely through excess salary or staff.3 This seems unlikely, and ironically, unrealistic. This paper expands the scope of expenses through which expense-preference behavior may be manifested and conducts a detailed test of the expense-preference hypothesis. In order to give empirical content to the expanded scope of expenses, it is necessary to focus on the banking industry because a unique set of data on expenses exists for that industry. There is another good reason for conducting a test of the expense-preference hypothesis on the banking industry. In particular, the structure-performance studies in banking generally indicate, like their counterparts in the industrial sector, that market structure has a statistically significant effect on prices and rates of return.4 However, in contrast to findings in the industrial sector, those for banking reveal that the quantitative effect of structure is very small. This suggests the possibility that expense-preference behavior in banking may be important