Franchise Value, Competition and Insurer Risk Taking

Abstract

Existing theory holds that high franchise value (HFV) firms are more prudent than low franchise value (LFV) firms because franchise value cannot be fully liquidated in the event of insolvency. This theory, however, does not consider the opportunity cost to HFV firms of being prudent, especially when confronted with intense competition. We develop a theoretical model in which the risk-constraining effect of franchise value is affected by the degree of competition, and then test it empirically using a sample of publicly traded stock property-casualty insurers. The results suggest that when competition is intense, HFV firms may have sufficient incentive to overcome the risk-constraining effects of franchise value.

Keywords: Franchise Value, Competition, Risk Taking

JEL Classification: G22