4. Analysis of Strategic Investment under Maximum Equity Value
4.3 Result and Analysis
institution after acquiring equity stakes I
Vd
such that maximizing the objective
function LId. The first order condition is and the se nd order condition is
)
order condition is negative in sign and means that there exists optim
acquiring equity stakes to maximize stockhol . Without the closed form, we
comp static statistics and the results will be discussed to analyze the risk factor
4.3 Result and Analysis
stment objectives under the restriction of capita
al instantaneous volatility of asset return * in foreign financial institution
will adopt numerical analyses * with different parameters. Furthermore, the
of the portfolio after acquiring equity stakes.
I
Vd
der equity
I
Vd
In this section, we will inspect the inve
l control and pressure for maximizing shareholder value and look into the numerical analyses with optimal asset risk portfolio and its proportion of acquiring equity stakes. By (18), the relative comparative statics will be discussed as follows.
(1) The asset return volatility and increasing foreign financial institution asset value after acquiring equity stakes show negative correlation as shown in Figure 1. With the asset value approach demonstrating an increase of the foreign financial institution’s asset value, the volatility of the asset return would be lower.
Simultaneously, the foreign financial institution must also pay attention on the
‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
s liability have
stake
by eight factors: the asset value of Chinese bank , and liability ; the individual positive correlation after taking equity stakes as shown in Figure 2. The result shows that an increase in the liability ratio to asset causes the asset return volatility to increase when foreign financial institutions invest via borrowing. In other words, the portfolio risk and liability increase simultaneously.
(3) The asset return volatility on foreign financial institution and risk weight has negative correlation, as shown in Figure 3. When the amount of liability is limited with high-risk weight, the foreign financial institution must have more capital and less risk-weighted assets to reduce the portfolio risk and asset return volatility.
Furthermore, we could calculate the corresponding optimal acquiring equity s proportion i when 2* *I is known. This optimal proportion will be affected
Vd
volatility of asset return on invested Chinese bank
Vf Bf
Vf
and foreign financial
institution
Vd
; the volatility of the exchange rate on the home country of foreign financial institution and invested Chinese bank X ; the correlation coefficient of the asset return on a foreign financial institution and invested Chinese bank V ,dVf ; the
institution
correlation coefficient of an asset return and exchange rate of the for ign financial e
X Vd,
, and the correlation coefficient of an asset return and exchange rate
on the invested Chinese bank Vf,X. In what follows, we will discuss the effects of these eight factors on choosing the optimal proportion.
(1) The optimal proportion shows positive correlation (Figure 4) with asset value , and negative correlation (Figure 5) with liability , in proportion with the asset value of the invested Chinese bank. This result can be explained as if the Chinese
Vf
Bf
bank had a higher asset value or lower liability value, then its responding equity will be higher as well. In other words, the foreign financial institution will
‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
Vf
of invested Chinese bank (Figure 6). When foreign financial institution is
higher risk object to reduce the portfolio risk. This conclusion is similar to the argument in the previous part in which, when the invested Chinese bank has better asset quality with stable volatility asset returns, it can help stimulate the foreign financial institution to invest and increase the optimal acquiring equity stakes proportion.
restricted on capital, as guided by risk-weighted asset, it will likely not invest in a
(3) The optimal proportion and asset return volatility
Vd
of foreign financial institution after acquiring equity stakes also shows negative correlation (Figure 7).
and exchange rate volatility
That also illustrates that when the foreign financial institution has good asset quality and high profitability, its asset quality will be more stable with tolerable risk taking and exposure.
(4) The optimal proportion X have negative
ficient of an asset value between the correlation (Figure 8). From this result, we can say that, when the foreign financial institution’s country of origin belongs to a major currency country or the portfolio’s denominated currency has low volatility of exchange rate with RMB, it will help increase the optimal acquiring equity stakes proportion. When economic and trade activities become more frequent and stable between the foreign financial institution and local bank’s country of origin, it will help keep the volatility level and increase its optimal proportion.
(5) The optimal proportion and correlation coef
foreign financial institution and invested Chinese bank
f dV
V , has negative
invested Chinese bank, it will focus on creating more value and developing complementary businesses more than the local bank. These activities are in lieu of reaching economic scales by acquiring equity stakes. Additionally, two institutions that have a low correlation in asset portfolios will help reduce the portfolio risk and meet risk-weighted assets requirements as required by its home country.
correlation (Figure 9). When foreign financial institution acquires equity stakes of
‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
(6) The optimal proportion has both negative correlations with the correlation coefficient of the exchange rate and the foreign financial institution’s asset value
X Vd,
and the correlation coefficient of the exchange rate and the Chinese bank’s asset value V X
f,
(Figures 10 and 11). This indicates that, when the foreign financial institution has diversified its currency portfolio with invested Chinese bank, the optimal proportion will be increased while the foreign financial institution can reduce the risk of exposure to meet the risk-weighted assets requirement.
4.4 Brief Summary
As transnational investment is a trend, this paper has considered exchange rate cross-curren
the minimum BIS ratio requirement for foreign financial institution to take ow
quiring equity stakes proportion. Specifical
cy risk with the capital restrictions of Basel According in analyzing foreign financial institution’s acquisition of Chinese banks. By using the contingent-claim optimization model, we find that the correlation coefficients, including both the individual return of the asset values and exchange rate, would affect the instantaneous standard deviation on both institutions. In addition, if two institutions were complementary or have a low correlation and the overall asset portfolio of the foreign financial institution have a negative correlation or no relation with the RMB currency or the invested Chinese bank as mainly operating locally, then the risk of the foreign financial institution could be reduced by participating in acquiring equity stakes.
Other than meeting
nership stakes of Chinese bank and pursue the goal of maximizing shareholder value, we also found the instantaneous standard deviation of the optimal returns of an asset. With numerical analyses, the results show that the overall portfolio risk of foreign financial institution would be reduced under the circumstances that the asset value increases, the debt ratio decreases, and regulatory risk weight decreases after acquiring equity stakes, if the foreign financial institution is restricted on the risk-weighted asset guided by current regulations.
Finally, we examine the factors that could affect the optimal ac
ly, this proportion would be affected by factors such as the Chinese bank’s asset value, liability, volatility of asset return, and the correlation coefficient between the returns and exchange rate. Other factors include the correlation coefficient of the foreign financial institution’s asset value and exchange
‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
rate and the volatility of an asset return. The result show that other than the asset value of the Chinese bank has a positive direction with optimal proportion, the remaining factors appear to show negative relations. This result could be explained as when foreign financial institutions implement the strategy of acquiring equity stakes, apart from meeting the capital requirement to lower portfolio risk, they could create maximum values and returns by picking local banks with good asset qualities that are locally and financially well-developed. Furthermore, the optimal proportion could be more beneficial if both parties operated complementary business.
Currently there are restrictions on the proportion of acquiring equity stakes not more than 20% by anyone foreign financial institution and 25% for all foreign financial institutions. However, foreign financial institutions can still be beneficial on equity returns by helping the Chinese banks to create a strong earning power, designed business expansion and corporate governance from acquiring equity stakes.
This argument comes with the same conclusion as the model applied in this paper.