Mergers and acquisitions among financial institutions have risen steadily for the past few decades. Both the regulatory changes and international commerce
improvement have paved the way for a continued increase in international mergers and acquisitions for financial institutions. However, international mergers and
acquisitions in banking industry remained relatively rare compare to other industries.
Between 1990 and 2005, only about 15 percent of all bank merger and acquisition deals around the world involved headquarters in two different countries (see Table 1).
Focarelli and Pozzolo (2001) found that in the 1990s, cross-border mergers accounted for only 13 percent of merger activities within the banking industry compared to 35 percent within manufacturing and 24 percent within all sectors on average.
One of most important issues to accelerate the financial consolidation is
regulatory changes. A sequence of laws passed over last two decades in Europe and United States had motivated management of financial institutions to expend its market by either operating across national borders, or getting into other financial fields. In United States, the Riegle-Neal Act of 1994 played an important role to change the way of mergers and acquisitions of financial institutions. The Riegle-Neal Act eliminated most of the restrictions on interstate banking and branching. It allows geographic expansion in the United States. However, U.S. banking laws still prohibit most types of universal banking. More recently, the Gramm-Leach-Bliley Act of 1999 passed to remove many restrictions on combing commercial banking, securities companies, and insurance companies into a consolidated financial organization (Berger et al., 2000).
In Europe, the Single European Act of 1986 created a single economic
marketplace across the EU. When it effected in 1992, it also eliminated all physical,
legal, and technical barriers to cross-border movement of labor, goods, services, and capital. The Second Banking Co-ordination Directive of 1989 introduced the single banking license throughout the EU. Most importantly, it allowed the universal banking system. In 1993 and 1994, the time of the effectiveness of the Second Directive, a series of directives was introduced to achieve a European single securities market and to establish a “single passport” for investment firms (Benink 1993;
Molyneux et al., 1996).
The improvement in international commerce has increased the demand for international financial services. A financial institution, especially a bank, would like to “follow the client ” to provide the services in a foreign country. There are few ways to make it possible, including the foreign direct investment (FDI), the mergers and acquisition of a local bank, etc. These investment activities in a foreign nation not only provide efficient services to the existed customers but also create a new opportunity to expend the market across the border.
Table 1 and Table 2 display aggregate statistics on trends in financial
consolidation, especially the figures about merger and acquisition activities in banking industry. Table 1 shows the number and the percentage of international financial institution mergers and acquisitions of each type of financial institutions from 1990 to 2005. It is clearly showed that insurance companies has the highest percentage (23.7%) to merge with or acquire another financial institution across the border; while international mergers and acquisitions only account for 0.46% of all mergers and acquisitions of saving companies. From another point of view, most financial institutions still merge with or acquire the firm within the same financial fields, but about half of merger and acquisition deals made by investment companies are with
More specifically, Table 2 expresses the number and the percentage of international bank mergers per continent as well as the changes over time.
Worldwide, the number of mergers and acquisitions within banking industry (both parties are commercial banks or BHCs) reached to the peak in 1990s, and started to decrease between 2001 and 2005. However, international mergers and acquisitions did not follow the same direction. The number of international mergers and
acquisitions increased steadily between 1990 and 2005. European nations and North American nations experienced a significant growth in the share of international bank mergers and acquisitions through the three periods. This situation clearly showed the effect of the deregulation of the Second Directive in Europe and the Riegle-Neal Act in United States after 1995. On the other hand, Asia and Pacific nations and Latin America nations experienced a significant downward trend in percentage international mergers and acquisitions in banking industry through three periods.
The decline figure in Asia and Pacific area probably resulted from the financial crises in the late 1990s. It also noticed that international mergers and acquisitions occurred relatively low in North American nations, at the average of 2 percent of the total
merger and acquisition deals although the figures steadily increase through the period.
Table 2 also shows the international mergers and acquisitions within the same
continent. The percentage of intra-continental mergers and acquisitions showed the upward trend in both African nations and European nations; while Asia and Pacific area and Latin America experienced a decline in mergers and acquisitions within same continent. Within this criterion, European countries experienced a significant growth.
This increase could be the result of countries in Eastern Europe opening their markets to their wealthier neighbors (Bush and DeLong, 2004), and the single license of bank through EU introduced in Second Directive in early 1990s. Banks in Europe and in North America would then tend to acquire institutions in their own continents as
Table 1
International mergers & acquisitions by different financial institutions
Acquiring Institutions
Source: Thomson Financial Securities Data (2006), author calculations.
Table 2
International mergers and acquisitions in banking industry by continent between 1990 and 2005
Asia & Pacific Africa Europe Latin America North America Total
Panel A: 1990-2005
Number of bank mergers & acquisitions 649 58 2194 227 3871 6999
International mergers & acquisitions 159 25 740 48 79 1051
Domestic mergers & acquisitions 490 1454 33 3792 179 5948
Source: Thomson Financial Securities Data (2006), author calcula tions.
opposed to traveling across oceans to find a merger partner (Bush and DeLong, 2004).
This could result from different legal systems and imprecise regulations of most developing countries in other continents, even though some countries contain huge market potential. Different languages, cultural backgrounds, transparency, government regulatory systems, and risks are all important factors for banks to consider to merge or to acquire across national border.
III、Literature Review
There are several aspects related to international mergers and acquisitions in previous researches. A number distinct hypotheses have been advanced to explain the motivations inherent in merger and acquisition activities. Different stakeholders of the firm may be interested in one or more than one motives to make the
consolidation decision. Shareholders may engage in cross-border consolidation activities in order to maximize wealth by increasing the financial institution’s market power in setting retail prices and/or by improving the efficiency. Managers may be able to pursue personal objectives in consolidation decisions, particularly in banking corporate control is relatively weak. The governments also play very important roles in cross-border consolidation activities through changing the regulatory, through approval or disapproval decisions for individual mergers and acquisitions, and through providing consolidation assistance during the period of the financial crisis.
The literature review would be divided into two parts: the wealth maximizing motives and consequences and the non-wealth maximizing motives and consequences.
A、The motives for and the consequences of maximizing wealth
The primary goal and motive behind most of merger and acquisition deals in the financial service industry is to achieve the main purpose of maximizing shareholder’s wealth. The increase in the shareholder’s wealth of the acquiring entity either could be a result of value created by the merger and acquisition activity or could result from a wealth transfer from bondholders to shareholders with no change in total market value of both participants. The two main ways to achieve it are improving the efficiency and profitability and increasing the market power in the setting service and retail prices.
A.1 Efficiency and Profitability
Improving efficiency is another major way to create shareholder’s wealth.
Eventually, efficiency gains are made by reducing costs, increasing revenues, and/or reducing risks to increase value for the given set of prices. Mergers and acquisitions may allow the institutions to achieve the economies of scale, scope, or mix of
products, which may reduce operational, marketing, or administrative costs.
According to the synergy hypothesis, mergers create synergetic gains if the production, administrative, or marketing costs of the consolidated firms are smaller than the sum of these costs for the two individual firms before their merger. Everything else being the same, lower costs should mean increased profits and higher stock prices for both acquiring bank shareholders and target bank shareholders. Expected synergistic gains should create positive net aggregate wealth. Reductions in risk may also increase shareholder wealth because of financial distress, bankruptcy, and loss of franchise value.
Both in U.S. and Europe, many studies suggest that mergers and acquisition may
be motivated in part by the potential for efficiency gains. Some studies show that in a substantial proportion of mergers and acquisitions, a large, more efficient institution tends to take over a smaller, less efficient institution. In U.S., acquiring banks appear to be more cost efficient than target banks on average (Berger and Humphrey, 1992; Pilloff and Santomero, 1998). Another study of US banks found that
acquiring banks are more profitable and have smaller nonperforming loan ratio than target banks (Peristiani, 1993). However, one study found that while
poorly-capitalized banks are more likely to be acquired, banks with a high degree of cost inefficiency are less likely to be acquired without government assistance
(Wheelock and Wilson, 1998). O ne European study also found that large, efficient banks tend to acquire small, less efficient banks (Vander Vennet, 1997). Mergers and acquisitions may also improve efficiency if greater diversification improves the
risk-expected return tradeoff. It is consistent with one study which found that U.S.
acquiring banks bid more for targets when the consummation of the M&A activities would lead to significant diversification gains (Benston et al, 1995). Diversifying mergers and acquisitions may also improve efficiency in the long term through expanding the skill set of managers (Milbourn et al., 1999).
One of the most mentioned sources of the potential efficiency gains from mergers and acquisitions is the economies of scale. According to the hypothesis of economies of scale, the combination of two or more firms will yield an increase in overall effectiveness. A firm is subject to economies of scale when its long run cost decreases as its output increases. In fact, most of the research on bank scale
economies found that the average cost curve had a relatively flat U-shape with
medium-sized banks being slightly more cost scale efficient than either large or small banks. The location of the scale-efficient point differed among studies, but was
usually between about $100 million and $10 billion in assets (Ferrier and Lovell, 1990;
Hunter, et al., 1990; Noulas, et al. 1990; Berger and Humphrey, 1991; Bauer, et al., 1993; Clark, 1996). Most of findings suggested that there were no cost scale
efficiency gains and possibly cost scale efficiency losses from further consolidation of the type of large institutions typically involved in international activity. A recent study, which is consistent with it, found that simulated pro forma mergers and acquisitions between large banks in different nations in the EU found that these mergers and acquisitions were more likely to increase costs than to decrease them (Altunbas, et al., 1997).
Despite most of the empirical evidences suggested that efficiency gains from the exploitation of scale economies disappear once a certain size is reached and that there might be diseconomies of scale above some threshold, most of these research used data on financial institution from the 1980s. There is another factor may have increased scale economies in improving efficiency to increase wealth, which is the technological progress. The large financial institutions may more efficiently exploit new tools of financial engineering, including derivative contracts, off-balance-sheet guarantees, and risk management. In addition, some new delivery methods for customer services, such as ATMs, Internet banking, and phone banking, may also exhibit greater economies of scale than traditional branching network (Radecki, et al., 1997). Moreover, advances in payments technology may have created scale
economies in back-office operations and network economies that may be more easily exploited by large institutions (Bauer and Hancock, 1995; Bauer and Ferrier, 1996;
Hancock, et al., 1999).
Economies of scope and product mix may also provide efficiency gain by
reducing the cost. Financial institutions may provide multiple products within firms
in order to lower down the overall costs. Scope efficiencies were measured by comparing the predicted costs of an institution producing multiple financial services and a set of institutions that each specialize in producing a subset of these services.
However, it is difficult to measure the existence and extent of scope and product mix efficiencies since the benchmark should consist of single-product firms. As the result, the empirical results and implications for consolidation of scope and product mix efficiencies were qualitatively similar to those for scale efficiency studies— very few cost savings were implied from consolidating the outputs of different banks (Hunter, et al., 1990; Noulas, et al., 1990; Pulley and Humphrey, 1993; Ferrier, et al., 1993).
Scope and product mix efficiencies are being focused in 1990s since more and more international mergers and acquisitions and cross- industry consolidation occurred.
However, most of studies of scope and product mix efficiencies focused on cross industry consolidation, especially the universal bank and financial conglomerates, the combination among commercial banks, insurance companies, security companies, and even the non financial firms. Cost economies may result from sharing physical inputs, reusing information, or reusing managerial expertise. Information reusability (Greenbaum, et al., 1989) may reduce costs when a universal bank acting as an underwriter conducts due diligence on a customer with whom it has had a lending or other relationship (Rajan, 1996). One study of European universal banking found very scope economies (Allen and Rai, 1996); while one study found mostly
diseconomies of producing loans and investment services within German universal banks (Lang and Welzel, 1998). Moreover, cost scope and product mix
diseconomies may arise because of coordination and administration costs from
offering a broad range of products, often outside the senior management’s area of core
competence (Winton, 1999).
Some studies found that there is little change in cost efficiency but an
improvement in profit efficiency of large U.S. banks after mergers and acquisitions, especially if both target and acquiring banks were relatively inefficient prior to the merger (Berger, et al., 1996; Berger and Mester, 1997; Clark and Siems, 1997;
Akhavein, et al., 1997).
The increase in scale associated with consolidation may create revenue scale economies because some customers prefer the services of larger institutions. It is noticed that part of revenue efficiency comes from financial institutions following the existing customers across international borders, maintaining the benefits of existing relationship. For instance, some analyses found that many foreign banks initially entered the U.S. to help service home country clients that were starting U.S.
operations (Budzeika, 1991; Gross and Goldberg, 1991; Seth and Quijano, 1993;
Terrell, 1993). There are some empirical evidence examined the effects on profit efficiency on scale efficiency, and the result is ambiguous. Some evidence of mild ray scale efficiencies in terms of joint consumption benefits for customers (Berger, et al., 1996), and profit efficiency sometimes being highest for large institutions (Berger, et al., 1993), sometimes being highest for small institutions (Berger and Mester, 1997), and sometimes about equal for large and small institutions (Clark and Siems, 1997).
The consolidation may lead banks to hold a more diversified loan portfolio, which may exploit revenue scope and product mix economies. One is that
consumers may be willing to pay more for the convenience of one-stop shopping of their purchase of financial products. One is the reputation and strong brand name that customers could recognize or even prefer. However, it may also create revenue
scope diseconomies by appearance of conflicts of interest among different product division, etc. One stud y about scope of product mix efficiencies found little or no revenue scope efficiency between deposits and loans in terms of charging customers for joint consumption benefits (Berger, et al., 1996). Studies of profit scope
efficiencies within banking found that joint production is more efficient for some firms and specialization is more efficient for others (Berger, et al., 1993; Berger, et al., 1999).
Mergers and acquisitions may also improve efficiency if greater diversification improves the risk-expected return tradeoff. According to the diversification
hypothesis, the consolidated firms may reduce their combined risk if the mergers create diversification gains. This will be the case if the risk of the combined firms is less than the weighted average of the risks of the two individual firms prior to the consolidation. Consistent with this, one study found that U.S. acquiring banks bid more for targets when the consummation of the merger and acquisition would lead to significant diversification gains (Benston, et al., 1995). Some studies have found that bank managers act in a risk adverse fashion, trading off between risk and expected return, and therefore may tolerate additional costs expended to keep risk under control (Hughes, et al., 1996, 1997).
Taking the risk-expected return tradeoff into account also allows for possible scale, scope, and product mix efficiencies in managing risk. One study found scale efficiency from diversification of loan risk,4 which is presumably because of
diversification benefits. This does not necessarily mean that the institutions would have lower risk, but they may still choose a higher risk-higher expected return point on the improved frontier.
There are still some research suggested that at least some types of cross-border consolidation would improve risk-expected return tradeoff. The literature on
commercial banks in U.S. generally found that larger, more geographically diversified institutions tend to have better risk-expected return tradeoffs (McAllister and
McManus, 1993; Hughes, et al., 1996, 1997; Hughes and Mester, 1998; Demsetz and Strahan, 1997). Similarly, one study which examined the improvement of
diversification gains in the risk-expected return tradeoff found that when organizations are larger in a way that geographically diversifies, especially via interstate banking that diversifies macroeconomic risk, efficiency tends to be higher and insolvency risk tens to be lower (Hughes, et al., 1999). Moreover, one study suggested strong diversification possibilities and opportunities to improve the
institutions’ risk-expected return tradeoffs through cross-border consolidation (Berger, et al., 2000). However, Amihud et al. (2002) examined the effect of 214
cross-border mergers on the acquiring firm’s risk and returns. They find no change in firm risk, on average, but a decline in return on equity for the acquiring firm.
For the international mergers and acquisitions, there are several factors that may cause the efficiency consequences to be different than those for domestic mergers and acquisition. First, there may be some barriers that inhibit foreign financial
institutions from operating efficiency and competing against domestic financial institutions, especially culture and regulatory structures. In addition, the market conditions and policies of the home nation may also affect cross-border efficiency.
Studies of cross border efficiency usually have found that domestic banks are significantly ore efficient than foreign owned banks (DeYoung and Nolle, 1996;
Mahajan, et al., 1996; Berger and DeYoung, 2000; Berger, et al., 2001).
A.2 Market Power
Most of research on market power effect of the merger and acquisition in
financial service industry focuses within one single nation. Particularly, the focus is
financial service industry focuses within one single nation. Particularly, the focus is