An Empirical Study of Bank Merger Influence Bank Performance in US

8/15/2019 An Empirical Study of Bank Merger Influence Bank Performance in US

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An empirical study of bank merger influence bank performance in US- a factor analysisapproach


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Introduction

The business environment has undergone unprecedented changes in the recent past

due to the numerous dynamics in the global economic atmosphere. Technological advances

and globalisation have altered the way companies do their business. The financial world is

also expanding at an exponential speed. During the last few decades, there have been many

trade agreements and increase in international trade transactions and volumes globally

(Berger, 199 !. This integration has mar"ets giving rise to various financial activities that

offer even more attractive choices of investment. #very organisation wants to maximi$e its

mar"et share and control its future growth (%e$itis, &'' !. or organisations to grow in the

globalised mar"et place and achieve a competitive advantage, they must remain strong and

dynamic. urthermore, the need specialised and precise information before they venture into

new mar"ets. )ncreased economic reforms and liberalisation in many countries has seen more

ban"s engage in expansionary activities that include mergers (%e$itis, &'' !. *ergers happen

when two businesses in the same industry agree to forge ahead as a +oint or single entity with

a view of en+oying mutual benefits (Berger, 199 !. *ergers play an important role in the

success of organisations in a globalised world. Their role in boosting and increasing the si$e

of start ups and their mar"et capitalisation cannot be ignored. *ergers give organisations

several advantages such as speed to mar"er, speed to positioning and speed to attaining

competitive advantage. *ergers are driven wider economic themes such as the need for

organisations to reconfigure their initiatives and strategies and align them with the macro

events (%e$itis, &'' !. They are also driven by the need by organisations to ad+ust to

externalities that alter their value chain dynamics or their competitive landscape.

urthermore, the need by organisations to achieve economies of scale both from a product

offering and a geographical perspective has led to several mergers. ne of the industries in

the - that has witnessed significant number of mergers is the ban"ing industry. Ban"s play


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a very significant role in the economy of any nation. ne of their main functions is to collect

money from sectors with excess funds and lend the money to sectors with insufficient funds.

Therefore, they act as financial intermediaries, a role that helps them determine the

distribution and amount of credit in an economy. )ncreased ban" credits automatically leads

to increased investment in a country. This in turn leads to increased levels of employment.

Therefore, changes in the lending behaviours of ban"s impacts on a country/s economic

development. Ban"s alter their lending decisions as they respond to the dynamics in the

ban"ing mar"et and its structure (%e$itis, &'' !. 0hanges in the structure of the ban"ing

industry can affect the position, performance and growth of a ban". There are three main

measures that affect the performance of ban"s. These are cost, ris" and revenue. verall

performance of a ban" is a combination of all the three measures (%e$itis, &'' !. The long

term goal of any ban" is to maximi$e the wealth of its shareholders. They do this by

maximising % # which consists of cost, ris" and revenue. 0hanges in these % #

subcomponents can increase or decrease the performance of a ban" (%e$itis, &'' !.

Therefore, to remain competitive and to secure their mar"ets, ban"s that has their

performance altered by dynamics in the mar"et environment resort to mergers. *ergers can

be defined as unification of two entities or players into a single entity. )t is a process whereby

two business entities are combined under common ownership. xford dictionary defines a

merger as the process that combines to business into one (%e$itis, &'' !. ban" merger ta"es

place when two ban"s that were previously distinct get consolidated into one institution. )t

occurs when an independent ban" becomes part of another existing ban" after losing its

charter.

2ressure on ban"s to increase their revenues has increased merger activities in the -

because this is one of the few ways for them to boost their performance (%e$itis, &'' !..

2articularly, small and regional ban"s are loo"ing for new ways of increasing their exposure


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to loans. The ban" industry in the - is being plagued by intense competition in loan

origination. urthermore, community ban"s are merging with a view of managing their

concentration and scaling up their loan business (%e$itis, &'' !. The liberali$ation of

geographic based restrictions on ban"ing institutions in -nited tates that started in the late

3's produced a rapid wave of consolidation in the ban"ing sector. Between 1939 and 1994,

there were more than 56'' mergers in the country where two or more ban"s got consolidated

under one charter. s a result of this wave of mergers, the industry has been in a constant

state of transition. *erger activities were especially strong in the first half of the 9's with

ban" mergers involving over &' 7 of industry assets annually (%e$itis, &'' !.. *ergers and

consolidation in general have lead to a dramatic increase in the si$e of ban"s. The mean si$e

of ban"ing institutions in -nited tates has grown by over percent in from early 's to

mid 9's. The mean si$e of complete ban"ing institutions has grown by 11' percent over the

same period (%e$itis, &'' !. The amount of mergers in the - has fluctuated immensely

since &'''. Between &''' and &''&, the numbers of mergers decreased in almost all sectors

in the - . 8owever, there was an increase in the number of mergers in the - between &''&

and &''3. 8owever, the &''3 financial crisis decreased the number of mergers between &''3

and &''9 (%e$itis, &'' !. *ergers increased slightly in &'1' but the decrease continued

between &'1' and &'15. 8owever, in the ban"ing industry, mergers increased between &'1'

and &'15 but there was a decrease between &''9 and &'1'. This phenomenon indicates that

the ban"ing sector follows a different trend as compared to other sectors.

iven the role played by ban"s in the national economy, it is not surprising that

merger activities among ban"s have received considerable attention from researchers. There

are several potential benefits that ban"ing institutions have accrued from the lifting of

geographical barriers that limited competition in the industry and the associated wave of

mergers (%e$itis, &'' !.. These include increase in geographical diversification, elimination


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of selfserving and inefficient managers of ban"ing institution, reduction of costs and

improved competition among others.

urthermore ban" mergers have significant impact in financial stability because the

lead to alterations in mar"et power, competition and concentration. *any researchers argue

that there is a trade off between competition in the ban"ing industry and stability which may

re:uire the intervention of competition authorities and ban"ing supervisors. 0han et al.

(199;! argues that increased competition in the ban"ing mar"ets means that there is an

erosion of the finances or surplus ban"ing institutions can gain after screening the :uality of

followers. %eduction in incentives for screening leads to deterioration of the :uality of loan

portfolios of many ban"ing institution. *ore theoretical evidence on mar"et power and ban"

ris" trade


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researchers measured merger effect on ban" performance based on accounting data. The

present study aims at analy$ing the impact of mergers on the performance of ban"s. 0hanges

in performance are measured using accounting data by comparing return on e:uity before and

after mergers. dditionally, the study analy$es sources of the changes in performance using

several indicators that include cost efficiency, li:uidity ris" and earning diversification beside

the use of accounting data, the performance of bidder ban"s will be analy$ed through the use

of event study methods that will help in calculation of cumulative abnormal returns of stoc"s

during the window period. There will deeper analysis conducted with a view of examining

the difference between mergers of a bidder and a listed target and a non


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ac:uisitions that increase value. )n most cases, the companies that ac:uire related companies

are received in a better manner by the mar"et. These companies produce the best operating

returns after the mergers than in diversified merger and ac:uisition transaction, though there

are a number of diversifying transactions that are successful. There are other indicators of

mergers and ac:uisitions that increase value. These include transactions that involve e:ual or

smaller targets that are private in nature because the competition for bidding is not as intense

as in standard situations. urthermore, the deals are structured in a better manner, and can be

easily financed using cash instead of using stoc". This ma"es them flexible.

2 2 #heories on $ergers

There are several theories scholars have used to explain why mergers occur. The first

theory is "nown as the mar"et power theory. ccording to this theory, mar"et power is

defined as the potential of one or several mar"et participants to influence the nature of

production, :uality, and price the mar"et (*ontgomery, 19 6!. Therefore, mar"et power can

result in uncompetitive high profits that are ris" free. Based on this theory, mergers reduce the

number of ban"s in the mar"et, thus shrin"ing competition. This leads to higher concentration

in the mar"et in a manner that increases the mar"et power of the ban"ing industry. Therefore,

ban"s are able to increase prices and gain more profit. o mergers are expected to impact

positively on the performance of both bidders and targets. The second theory is "nown as the

synergy theory. This theory postulates that the amount of economic value that comes out of a

merger depends on the resources that the merging firms have, relative to the total amount

within an economy, and the availability of opportunities for the firms to use the said resources

(0hatter+ee, 19 ;!. Based on this theory, mergers are expected to raise a firm/s cash flow and

also increase its value through synergy. ynergy increases firm/s economies of scales and

combined the advantages of two firms. ynergy emanates from the increased revenue as a

result of up selling or cross selling, savings in tax and cost reduction. The theory posits that


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the performance of the two bidders is expected to improve according to 8an"ir et al &'11.

The other theory that explains the reasons why firms merge is the agency theory. gency

theory argues that managers always have incentives to ensure that their organisations grow

beyond their si$e. This growth increases the power of a manager by increasing the amount of

resources they control. urthermore, the growth leads to increased compensation for

managers (>ensen, 19 ;!. ccording to this theory, managers resort to mergers for their own

personal benefit without any consideration of economic reasons. The final theory is the

information asymmetry theory. *oeller et al, &''3 argues that mergers have a negative

impact on stoc" returns because an announcement of mergers gives signals to the mar"et that

the stoc"s of a firm is overvalued. -nder this theory, mergers are li"ely to affect the

performance of bidders negatively.

2 % $otives behind $ergers

8illier et al, &'1' explores several reasons why organisations engage in mergers. 8e

asserts that the first motive is enhancement of revenue. This happens on the realm of strategic

benefits, mar"eting gains and mar"et power. *ar"eting gains always have a significant

positive impact on operating revenues. *ar"et power creates a near monopoly by reducing

competition these increasing profits. 2alepu et al, (&'15! asserts that firms merge to lower

costs. 8e argues that cost reduction has a significant impact on a firms operating efficiency.

perating efficiency comes through economies of technology transfer, economies of scale,

improved management and economies of scale. #conomies of scale ta"e is the result of

hori$ontal mergers that ensures that firms share resources thus decreasing operating costs as

they increase the number of products. 2alepu et al, (&'15! outlines another motive of

mergers. 8e argues that mergers are meant to improve target management, especially if the

bidder assumes that the target has had a series of systematic underperformance in the mar"et.

urthermore, mergers help firms to combine complementary resources. nother motive of


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merger and ac:uisition is to improve target management. This happens if management of

bidder firm assumes that the target has systematically underperformed in the mar"et. 2illoff

and antomero (199;! argue that the main reason for merger is to enhance firm performance.

This can be achieved through various methods. ne of them is transfer of managerial

"nowhow from the bigger firm to the smaller firm which will lift it to the level of the bigger

firm. The second method is through exclusion of unnecessary human resources and facilities

which leads to cost reduction and increased efficiency. Third, the merged firms combine their

mar"et shares and increase their competitive advantage in the mar"et.

2 & 'orms of $ergers

There are two forms of merger. These are merger and consolidation. *erger involves

absorption of one institution by another. The absorbing institution is referred to as the bidder

while the one being absorbed is "nown as the target. ?hen mergers ta"e place, the bidder

assumes ownership of all the assets and liabilities of the target. fter the merger, the target

firm ceases to exist as a separate firm. n the other hand, consolidation involves merging two

e:uivalent firms to create a new firm. irms that engage in consolidation cease to exist as

separate entities and become a whole new entity (%e$itis, &'' !. *ergers are different from

ac:uisition. )n the case of ac:uisition, target forms continue to exist even after the

ac:uisition, because the bidder +ust buys shares in the target firm.

2 ( )ategories of $ergers

There are three categories of mergers. These are hori$ontal mergers, vertical mergers

and conglomerate mergers. 8ori$ontal mergers ta"e place when both the bidder and the target

are in the same industry. or example, if a ban" merges with another ban", that would be

considered as a hori$ontal merger (%e$itis, &'' !. @ertical mergers ta"e place when firms in

different parts of the value chain or production process merge. or example, if a ban" merges

with one of its suppliers or technological companies that ma"e its software that would be


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considered as a vertical merger. The third form of merger is "nown as conglomerate mergers.

This happens when bidders and the target companies do not have any industry relationship.

or example, if a ban" merges with an insurance company, that would be referred to as a

conglomerate merger. urthermore, mergers can be categori$ed using a geographical

perspective. -sing this mode of categori$ation, there are two types of mergers. These are

domestic mergers and cross border mergers. Domestic mergers ta"e place when the bidder

and the target firm belong to the same country. n the other hand, cross border mergers ta"e

place when the target and the bidder firms are from different countries.

2 * Impact of $ergers on +ank ,erformance

2 * ! Impact of mergers on efficiency on profitability and efficiency

There are numerous studies that have been conducted to investigate the impact of

mergers on efficiency and profitability of ban"s. These studies can be classified into twoA ex

ante and ex


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indicates the value of the ban" at the present and the gains expected in future as a result of the

merger.

ridolfsson = tenne" (&''6! argue that for a clear report about the impact of mergers

on ban" performance to be gotten, both approaches must be used together because they are

complementary and cannot substitute each other. They assert that the stoc" price approach

may not be able to detect the occurrence of an unprofitable merger while the accounting

approach cannot detect the reason an unprofitable merger occurs. Tsangara"is, et al. (&'15!

studies a sample of 13& #uropean ban"s between &''' and &'';. 8e found that bidders in

most cases experiences abnormal returns that are statistically insignificant. urther, the

research indicates that bidders that engage in large deals worth over '.6 billion experience

increase in returns around the date of announcement while bidders in smaller deals only

experience increased returns on the day of announcement. The result of this study indicates

that the mar"et perception of the value of a deal in mergers is influenced mainly by the si$e

of the deal. The study indicates that bidders of listed targets normally earn negative abnormal

returns of between


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activity diversifying mergers produced less returns than concentrating mergers but produce

more returns than geographically diversifying mergers. Therefore, the research maintained

that mergers amplify significantly the sector


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performance of ban"s after mergers generally find significantly different results. oddard et

al (&'1&! investigated a sample of 15& mergers that involved ban"s in Catin merica and sia

over the period between 199 and &''9. This study found that bidder ban"s benefit when

they ac:uire unprofitable targets because the assets of unprofitable targets are cheap. l<

hasawneh and #ssaddam (&'1&! investigated a sample of 5'9 mergers in the merican

ban"ing industry using date from between 199& and &''5. The research found that a merger

between a target and a low efficiency bidder creates considerable mar"et returns after the

merger. n the other hand, a merger between a target that is moderately efficient and a bidder

that is least efficient diminishes the value of the bidder. urthermore, the study reports that

cross


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systematically in practice. Therefore, the consensus is that ban" mergers lead to little

efficiency improvements

@ennet (199;! investigated the effect of mergers on efficiency in #uropean ban"ing

industry using a stochastic frontier analysis and a number of crucial financial ratios for the

period between 19 and 1994. 8e found that mergers improve the participating ban"/s

efficiency. "havein et al. 1993 investigated the efficiency effect of megaban" mergers in the

- ban"ing industry. They found that most ban"s experience efficiency improvements and

increase in profits after mergers. 8owever, Berger et al. (199 ! did not find any significant

improvement in efficiency for mergers in the case of both small and large ban"s. ourlay et

al. (&'';! investigated the efficiency gains from mergers in the )ndian ban"ing industry for

the period between 1991 and &''6. They observed that mergers led to efficiency

improvements for the participating ban"s. Bain and 0y (&'''! examined the shareholder

value and its development for 6' of the biggest ban" mergers of the 199's. The investigation

covered a number of event windows that ranged from three days before merger

announcement to the final completion, and also investigated the mergers a year, two years

and three years after the completion. The study found a mar"ed improvement in performance

for the merged ban"s immediately after the mergers but the performance stagnates after

several years. @al"anov and leimeir (&''3! used a sample of ban" mergers from the - and

#uropean mar"et to investigate the impact of mergers on shareholder value. #vidence from

the - suggested that ban" mergers only provide value for the targeted ban"s and destroy

value for the bidder ban"s. )n the #uropean mar"et, they found that mergers create value for

the target ban"s but do not have any significant value destroying effect on the bidder ban".

*ar"s (&'';! reported that three :uarters of all mergers do not reali$e their strategic and

financial goals. This corroborates the findings of rinivasan (199&! who concluded that

mergers do not necessarily cut cost on the non interest expenses of ban"s


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2 * 2 Impact of mergers on risk

tudies that present evidence on the relationship between consolidation and the

attitude of ban"s to ris" argue that mergers cab reduce ban" ris". 0raig and antos (1993!

examined the ris" effects emanating from mergers. -sing a sample of mergers from between

19 6 and 1991, they found that the ris" of the newly formed firm after a merger is lower than

that of the two firms before the merger. This finding indicates that ban" mergers produce

organisations that are less ris"y meaning that diversification of gains could be one of the

motives for ban"s to merge. Boyd and raham (199 ! examined potential of ris" reduction of

mergers between ban"s and other financial institution through a simulation of cross


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significant ris" reduction for merged ban"s. They argue that ris" reduction happens because

of diversification of ris"s that are idiosyncratic in nature. 8owever, there is another group of

studies that presents evidence that ban"s tend to be ris"ier after mergers than before mergers.

0hong (1991! found that interstate ban" mergers in the - normally increase the volatility of

their stoc" returns. mihud, DeCong and aunders (&''&! investigated cross


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hope to benefit from the systemic ris" exemption offered by the government. dditionally as

also indicated by hull and 8anwec" (&''1!, TB policy automatically provides an incentive

for mergers especially by big ban"s.

2 * % Impact of mergers product provision and standards of service

The number of financial products that ban"s offer to their customers has increased over the

last two decades. The increase can be attributed to several related developments. ne of these

developments is the increased competition between providers of financial service (Berger,

199 !. The second is changes in regulation that have made it possible and easier for financial

companies to enter into new product and geographical mar"ets (%e$itis, &'' !. Therefore, the

merican financial services mar"et has become increasingly complex and divided (Berger,

199 !. 8owever, there is little evidence on the impact of mergers on the products that ban"s

provide to their customers. There are several studies that have investigated the impact of

changes in product provision as a result of mergers on the post merger performance of ban"s.

Boyd and raham (199 ! assert that mergers often lead to disappearance of products. fter

bidder mergers with a target, some of the products that the target was offering its customers

get discontinued. ?hen products that were offered previously by a ban" disappear, the

customers that were signed to that product are also li"ely to disappear (%e$itis, &'' !.

Therefore, he argues that disappearance of some of the products that were on offer before the

merger leads to loss of customers, which can impact negatively on the post merger

performance of some ban"s. Di Eicolo et al. (&''5! argue that mergers often affect customer

loyalty. 8e argues that mergers often lead to closure of some branches meaning that

customers can no longer get services they used to get from closed branches (Berger, 199 !.

uch customers are li"ely to shift to other ban"s in their neighbourhoods rather than follow

their former ban" (Berger, 199 !. The changes that ta"e place after mergers are also li"ely to

how customers perceive a ban". This might force them to loo" for alternative ban"s as a way


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of expressing their dissatisfaction with the new developments. ne of the motivations of ban"

mergers is to improve efficiency and increase profits. ne of the ways of achieving this is

minimising the number of branches and re


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applies in the ban"ing industry. Cisted ban"s give more information than ban"s that have not

been listed. This reduces instances of informational asymmetry. Therefore merging with

targets that have not been listed destroys value for bidders. n the other hand, mergers with

listed targets increases value for the bidders, which positively impacts on their performance.

2 Summary of Literature

*ost studies that have tried to capture the impact of ban" mergers on post merger

performance show that there is negligible payoffs or fewer loses and considerable negative

returns some time after. )t appears that most bidders usually outperform the mar"ets before

the event, implying that their position becomes worse after the merger. 8owever the returns

to shareholders of the target ban"s are seen to be positive. This implies that mergers create

wealth. tudies that have investigated the effects of mergers on profitability and efficiency

indicate that mergers improve efficiency and profitability of ban"s. 8owever deeper analysis

indicates that performance of bidder ban"s declines if its value is higher than the average of

the ban"ing sector. This happens because there is increase in cost inefficiency, decreased

revenue enhancement, increased li:uidity ris" and increased asset impairment. nalysis of

stoc"s shows that there is a negative but not so significant impact of mergers on performance

of bidder ban"s. 8owever, accounting analysis show a significant negative performance of

bidder ban" after an ac:uisition. The debate on the performance of bidder ban"s after mergers

is continuous. clear understanding of this issue can be gotten if more studies are conducted

at the country level to investigate whether the impact is the same in different countries. The

performance of bidder ban"s after mergers could be as a result of external factors such as

regulations and macroeconomic elements. uture research should examine the impact of

mergers on other indicators such as the value of bondholders and overall performance of the

entire ban"ing industry.


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List of References

"havein, >.D., .E. Berger. and 8umphrey, D. B (1993!. The #ffects of *egamergers on

#fficiency and 2ricesF #vidence from a Ban" 2rofit unction, Review of Industrial

Organization , 1& (&!, pp 96. ., and #ssaddam, E. (&'1&!. *ar"et reaction to the merger

announcements of - ban"sF non


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- and #urope price efficiency gains from ban" *= sH Journal of Financial

Services Research# 45(5!, &45. >. and Tehranian, 8. (&'';!. 2erformance changes around ban"

mergersF revenue enhancement versus cost reduction $ Journal of "one%# &redit# and

Ban ing# 5 (4!, pp. 1'15., *c illop, D. and ?ilson, >. . . (&''9!. ?hich credit unions are ac:uiredH

Journal of Financial Services Research , 5;, pp. &51J&6&.

oddard, >., *olyneux, 2.and Khou, T. (&'1&!. Ban" mergers and ac:uisitions in emerging

mar"etsF evidence from sia and Catin merica. (he European Journal of Finance ,

1 (6!, 419., 0ollins, *. and easey, . (&'' !. )nvestor protection and the value effects

of ban" merger announcements in #urope and the - . Journal of Ban ing and

Finance# 5&, pp. 1555ensen, *.0. (19 !. Ta"eoversF Their 0auses and 0onse:uences, Journal of Economic

)erspectives , & (1!, pp &1


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*ueller, D 0. (19 '!. (he *eterminants and Effects of "ergers$ 'n International &omparison .

0ambridge, * F elgeschlager, unn = 8ain.

*ylona"is, >. (&'';!. The )mpact of Ban"s *ergers = c:uisitions on their taff‟

#mployment = #ffectiveness. )nternational %esearch Journal of Finance and

Economics , )ssue(5!. ) E 146'. (&'11!. The impact of #uropean ban" mergers on bidder

default ris". Journal of Ban ing ! Finance , 56, pp. 9'&. (1993! Ban" mergers, ban"ing efficiency, and economies of scale and


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An Empirical Study of Bank Merger Influence Bank Performance in US

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