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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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