Investment Strategies and Market Structure: An Empirical Analysis of Bank Branching Decisions

This paper analyzes the relationship between the competitive environment faced by depository institutions and the decisions these institutions make regarding the size of their branch networks. Specifically, we consider branches as a sunk investment that potentially increases utility for consumers and examine how local competition and product differentiation affect firms’ decisions regarding whether to make such investments. We account for endogenous market structure using an equilibrium structural model, which corrects for bias caused by correlation in the unobservables associated with market structure and branching activity. We estimate the model using data from 1,882 concentrated rural markets. Our results demonstrate the importance of accounting for market structure and product differentiation, and are consistent with a potential entry-deterring effect of bank branch investments.