Modern Banking

[ 518 ]

M O D E R N B A N K I N G

Table 9.6 Number of Mergers and Acquisitions by Country

1 Europe includes: Belgium, France, Germany, Italy, Netherlands, Spain, Sweden, Switzerland, UK.

2 Securities includes investment banks.

Source: OECD (2001), Report on Consolidation in the Financial Sector, Annex 1.

According to an OECD (2001) report (covering 13 key industrialised countries51), during the 1990s, there were over 7600 deals involving the acquisition of one financial firm by another, with a total value of $1.6 trillion.52 Between 1990 and 1999, there was a threefold increase in the number of deals, and the total value of M&As increased more than tenfold. More detailed figures for Europe and the USA appear in Table 9.6.53 This table shows that

51Australia, Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Spain, Sweden, Switzerland, UK and the USA.

52Source: BIS (2000), p. 33, which obtained the data from the Securities Data Corporation.

53The insurance sector is not shown, but the numbers were comparatively small.

[ 520 ]

M O D E R N B A N K I N G

banks’ share of non-financial short-term corporate debt, from about 58% in 1985 to around 48% a decade later (Bliss and Rosen, 2001). However, as was noted in Chapter 1, banks have expanded into new areas (e.g. bancassurance) and increased off-balance sheet activities. Changes in regulation may also be a factor. In the USA, changes to the Bank Holding Company Act in 1970, together with liberalisation of state laws on the treatment of BHCs, increased merger activity. More recently, allowing commercial banks to have section 20 subsidiaries, relaxing the laws on interstate branching, and the repeal of Glass Steagall, so that financial holding companies can have banking, securities and insurance subsidiaries, encouraged greater consolidation and nation-wide banking. In Europe, the Banking and Investment Services Directives, the introduction of the euro, and the Lamfalussy report should have encouraged greater integration of EU markets.54 Another factor is technological change, which (as was seen in an earlier section) has affected cost and profit X-efficiency, both by encouraging more revenue earning financial innovations (e.g. the derivatives markets) and cutting costs, such as the delivery of retail banking services. It is estimated that IT accounts for 15 – 20% of total bank costs, and is growing. Mergers can help control these costs and improve IT systems.

9.5.3. Empirical Studies on Mergers and Acquisitions in the Banking Sector

The literature on bank mergers and acquisitions is vast, much of it based on US data. Researchers have asked different sets of questions. These include the following.

žAnnouncement Effects: Using event study methodology, researchers have asked: how does the announcement of M&As affect the share price performance of the bidding and target firms, that is, do bank shareholders gain or lose?

žPerformance: What are the performance characteristics of the banks before and/or after the merger? The most common performance measures include cost ratios, cost-X- efficiency, scale/scope economies and profits.

žManagerial Motives: Do bank M&As maximise wealth by creating value and benefiting shareholders or are they undertaken by managers to maximise their own utility? The most common reason given for why managers might pursue managerial utility is because compensation has been shown to rise with the size of a firm.

žMarket Power/Competition: How will M&As affect competition in the financial sector? Greater consolidation can increase market power of the remaining banks, causing them to raise prices and/or reduce services.

žSystemic Risk: Will M&As encourage more diversified, and therefore bigger, less risky banks or could bank managers assume more risks because a merger has made them ‘‘too big to fail’’?

Some studies test for the effects of M&As indirectly. They examine whether economies of scale or scope are achieved (and if so, at what asset level), or how concentration affects

54 See Chapter 5 for more detail on the changes in US and EU regulation.

[ 522 ]

M O D E R N B A N K I N G

Cumulative abnormal returns (CAR) for the interval [−t1, t2] is the sum of the mean of the abnormal returns, and defined as:

where

n : number of shares included in the analysis

The dependent variable, abnormal returns, is usually weighted either by total assets of each firm or by stock market value prior to the announcement. Separate estimates are obtained for the acquirer and acquired firms.

The vast majority of work in this area is based on US data. Rhoades (1994) conducted a survey of 21 US studies that used event study methodology and published results in the period 1980 – 93. Seven found the merger announcement had a significantly negative influence on the shareholder returns for the bidding firm, another seven found no effect, three report a positive finding, and four find mixed effects. By contrast, eight of the nine studies that look at targets report positive shareholder returns, and one finds no abnormal returns. Four papers measure the net wealth effects: one finds a positive effect, another finds a negative, and two studies reported net gains for some merger announcements. Recently, some studies have used European data. Below, the key findings from relatively recent work using US and European data are reported.57

Cybo-Ottone and Murgia (2000; cited as COM below) was one of the first major European studies. Over the period 1988 to 1997, COM include European M&As from 14 countries,58 involving 54 buyers and 72 target financial firms. The sample includes banks, securities and insurance firms, but at least one party to the merger must be a bank. For the acquiring banks, when a general market index is used as the benchmark, they find significant and positive abnormal returns in the shorter event periods (e.g. 1 or 2 days on either side of the announcement) of 0.99% and 1.4%. Finding a significantly positive return for the bidding bank contrasts with virtually all US studies, which find a significantly negative effect. Table 9.7 summarises the sample details of the studies cited here. Cornett and Tehranian (1992), Houston and Ryngaert (1994), Zhang (1995), Pilloff, (1996), Siems (1996) and Bliss and Rosen (2001) all report an immediate drop in the share price of the acquiring firm in the region of 1.96% to 3.8%. As Table 9.7 shows, the average size of US banks (measured by total assets) is smaller. Of the US studies, Siems (1996), looking at 19 mega bank mergers, had the highest mean size of $61 billion for the bidder, compared to $136.3 billion in COM. Bliss and Rosen (2001) also looked at mega mergers, and found the net percentage share price change in a 3-day window was, on average, −2.4%.59

57Studies based on M&As in other regions are virtually non-existent, though this will change because in Japan and some Asian countries, M&As have increased in recent years.

58Austria, Belgium, Denmark, Finland, France, Germany, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK.

59A mega merger is defined as one where the target bank is at least 10% the size of the bidder. Bliss and Rosen’s sample consisted of the largest US banks by asset size: a bank was in the sample if it was in the top 30 in any of the

[ 524 ]

M O D E R N B A N K I N G

žThere is evidence of significant excess returns in domestic mergers but not for cross-border deals. Based on this result, COM suggest deals with a large geographical overlap are more likely to improve productive efficiency. The results for cross-border mergers are consistent with Berger and Humphrey (1992) and Rhoades (1993). Mergers with foreign banks do less well.

žThey find the combined value increased for M&As among insurance firms and banks. COM suggest this finding is due to scope economies or revenue efficiencies from cross selling – though there is no explicit test of this explanation.

žThere is no evidence to support gains from M&As between commercial banks and securities firms. This could be due to a clash in cultures between universal banks and investment banks.

DeLong (2003) compared 41 non-US mergers and 397 US mergers between 1988 and 1999. Some findings are similar to Cybo-Ottone and Murgia. Non-US bidders gain, but their US counterparts lose, on average, 2.1% – the difference is significant at the 99% level of confidence. Targets in both groups earn significant, positive abnormal returns but the non-US group earn about 8.6%, less than the US bank group, where the CAR is 15.39%, a difference of 6.8%. DeLong introduces control variables to try and explain these differences. Also, non-US mergers are subdivided into two groups: 18 mergers from ‘‘market based’’ economies, and 23 that are ‘‘bank based’’.60 This split produces returns that are roughly the same for both the US and non-US banks in market based economies, for bidders and targets. However, if the CAR of the US bank group is compared with the non-US group, the differences remain. DeLong (2003) cautions against concluding that the effects of M&As on shareholders are the same for all banks in market based economies. Some of his control variables suggest differences in structure influence the shareholder wealth effects of a merger. For example, strict anti-trust laws in the USA limit the size of the targets, but in other countries the limits are more relaxed. This could mean the overall gain for shareholders outside the USA is greater. In bank based economies shareholders of bidding and target banks stand to gain more.

Beitel, Schiereck, and Wahrenburg’s (2003) sample consists of 98 M&As between large financial institutions61 in the EU states plus Switzerland and Norway. They find the CAR of both bidders and targets in general rise. The CAR [−20, −2] for targets was 3.68% and 0.36% for bidders. For the event window [−1, +1] it was 12.4% and 0.01% for targets and bidders, respectively. The combined CAR of target and bidder is significantly positive for the majority of the 98 transactions. The net welfare gain of the 98 transactions is estimated to be $6.5 billion on the announcement day. These results are similar to those of Cybo-Ottone and Murgia and DeLong. Using each financial institution’s CAR as the dependent variable, Beitel et al. employ regression analysis to identify which variables explain the success of

60DeLong (2003) used the definitions of market and bank based economies developed by Demirguc-Kunt and Levine (1999). The USA and UK are in the market based category because they have well-developed stock markets and securities markets, which means firms can raise finance from several sources, not just banks. Countries such as Germany and Switzerland are more bank based, with large universal banks that can offer customers both onand off-balance sheet banking services.

61Their study included all large financial service providers, for example, insurance and securities firms, and banks.

[ 526 ]

M O D E R N B A N K I N G

and Humphrey (1992), in a study of 60 large US commercial bank ‘‘mega’’ mergers in the 1980s, found no evidence of an increase in cost efficiency. Even though there might have been gains from combining back operations, sharing technology, etc., these were offset by problems such as ‘‘culture’’ differences or the inability of management to run larger banks. Likewise, Berger et al. (1999) surveyed a large number of studies and report little evidence in the way of scale, scope or cost X-efficiencies.

Wheelock and Wilson (2000) include all US commercial banks with assets of at least $50 million,63 using quarterly data from 1984(3) to 1993(4). They look at both bank failures and mergers. The part of the paper relevant to this section is the variables which influence the probability of acquisition. A stochastic frontier model was used to test for cost inefficiency. Input and output technical efficiency were measured using DEA. They find that the likelihood of a bank being acquired declines with cost inefficiency, i.e. the more cost inefficient a bank, the less likely it will be acquired, which is consistent with other studies that have found little in the way of gains in cost efficiency as a result of bank acquisitions. Wheelock and Wilson also found the probability of acquisition declines the higher the return on assets, and the higher a bank’s capitalisation (measured by equity to assets).64

Resti (1998) uses data envelope analysis (therefore non-parametric) to study the impact of 67 Italian mergers (1986 – 95) on cost efficiency. She measures the efficiency of the bidder and target banks in each of the three years before and after the deal. Banks taking part in a merger had their cost X-efficiency measured against a benchmark. Resti found:

žBidders were significantly less efficient than their targets, which suggests achieving greater market discipline does not appear to be a motive.

žOn average, merged banks increased their cost X-efficiency in the post-merger years, though efficiency scores tended to decline in the third year after the merger.

žMergers of large banks did not increase efficiency. Resti suggests this may be due to Italy’s strict labour laws on dismissing employees, making it difficult to achieve cost savings.

žThere was a marked increase in cost X-efficiency for mergers between geographically adjacent banks.

žNo significant change in efficiency was observed if the banks were separated. So there is no support for the idea that the well-known inefficiencies of banks in the south could be improved by mergers with more efficient banks located elsewhere.

Haynes and Thompson (1997) examine mergers between UK building societies in the period 1981 – 93, when the number of mutuals fell from 200 to 80. All but one was due to intra-sector mergers. Data constraints left a final sample of 95 societies, of which there were 79 mergers.65 Using an augmented production function, they report significant productivity gains from the mergers, rising from 3% a year after a merger to 5.5% five years later. They argue their findings are consistent with acquirers being more efficient than targets, so the

63This gives them a bank sample of roughly 4000 banks, depending on the year.

64Wheelock and Wilson also found acquisition is more likely in states where branching is permitted.

65Of the 79 mergers, 47 took place prior to major reforms that took effect in January 1987 (see Chapter 5) and 31 in the post-reform period.