International mergers and acquisitions of financial firms

... valuation effects of international mergers an d acquisitions of financial firm s A bnorm al re tu rn s accruing to shareholders of financial firms participating in international m ergers and acquisitions. .. of dom estic m ergers and acquisitions of both corporate and financial firms, it has only begun to investigate international corporate m ergers and is particularly limited for international mergers. .. permission of the copyright owner Further reproduction prohibited without permission INTERNATIONAL MERGERS AND ACQUISITIONS OF FINANCIAL FIRMS A Dissertation by RITA BISWAS Submitted to the Office of

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University M icr ofi lms International

International mergers and acquisitions of financial firms

A Dissertation by

RITA BISWAS

Submitted to the Office of G raduate Studies of

Texas A&M University

in partial fulfillment of the requirements for the degree of

DOCTOR OF PHILOSOPHY

December 1990

Major Subject: Finance

Gary T renndpohl' 'fH ead of Department)

December 1990

International M ergers and Acquisitions of Financial Firms

(December 1990)Rita Biswas, B.A., Calcutta University;

M.A., Calcutta University;

M.S., U niversity of Rochester;

Chair of Advisory Committee: Dr Donald R Fraser

This study investigates the valuation effects of international mergers

shareholders of financial firm s participating in international m ergers and acquisitions are hypothesized to be statistically different from those arising

o ut of domestic acquisitions

Several factors may be responsible: first, the degree o f inform ational asym m etry is higher in international acquisitions vis-a-vis dom estic ones - the differences w ill be m ore pro n o u n ced d ep en d in g on the extent of previous presence of the acquirer in the target country Further, to the extent

m a rk e ts are im p erfect, s h a re h o ld e rs m ay p e rc e iv e b e n e fits from international diversification, w hich causes an u p w ard rev alu atio n of the shares of those financial firms announcing international acquisitions

in herent in obtaining inter-country regulatory approval, as com pared to a dom estic 'intent-to-acquire' announcem ent.

F ourth, since regulations affect the set of participating bidders and targets an d hence the com petitive pressure in the acquisitions m arket, both the division of gains betw een b id d er and target shareholders as well as the prem ia p a id in any p artic u la r acquisition, m ay be different from their dom estic counterparts

U sing a sam ple of 220 international acquisition events, spanning eleven countries, over the time period 1977-1987, this study tests the above

h y p o th ese s u sin g the ev en t stu d y m ethodology an d finds significant differences bew teen domestic and international acquisitions

Finally, the stu d y also identifies a possible set of determ inants of the

include the m ethod of paym ent and the extent of the acquisition

The overall evidence p ro v id es insight into the un d erly in g factors

m otivating these acquisitions It also provides evidence on the degree of com petition and segm entation in the international m arket for bank control

TO DAVAI It's not a recipe after all,

It still surprises m e w h y Dr Fraser continued to ch air my dissertation for it seemed like every time I w arm ed u p to a m eaningful pace I would take off to some remote country for a wild vacation Obviously he is a very patien t man I thank him for his generous help and only h o p e th at I can do justice to his faith and confidence in me.

To Dr Mahajan I ow e special thanks for that extra p ressure and

m otivation he provided w henever I felt discouraged about the dissertation Some of his optim ism rubbed off an d I actually found myself thinking about finishing up!

I w ould like to thank the entire departm ent at Texas A&M for their friendly cooperation Things w ere so m uch sim pler due to the (almost 24-hour) open door policy of all the faculty - in particular I w o u ld like to

m ention D rs A lderson, Dubofsky, K annau, Lum m er an d Dr Z ardkoohi (from the departm ent of Management) for letting me use them as a walking encyclopaedia in Finance For non-academ ic problem s, I w as fortunate to have Charlotte Paton's friendship to bide m e by Thank you, Charlotte

W ords can never express w h at I owe my parents and w hat I

w ould like to thank them for Still, I w ould like to take this o p portunity to tell them th at I could not have come so far if they had not instilled the right

Life as a doctoral student at College Station was m ade tolerable (even bordering on FUN at times) also because of all the friends I had there

To m ention a few, Anu, Deepak, Liz, Ashok, Jim and Shaubhik - I am indeed fortunate to have friends like you

A nd then of course th ere's the other ad v iso r I h av e - my husband, Amit W ithout his h elp /h in d ran ce I could n o t have solved Ito's Lemma, coded in Fortran, hand-gathered daily prices from the microfilm, played D igger for 17 hours continuously, prin ted m y d issertatio n an d com pleted it w hen I did W ithout his h elp /hindrance, I could have learnt TeX, m astered SAS and kept my sanity

ABSTRACT iiiDEDICATION v

Acquisitions 62.3 Bank M ergers, Regulation and Interstate

Expansion 12

2.6 International Banking Trends: US Expansion

A b ro a d 292.7 International Banking Trends: Foreign Banking

in the U.S.A 31

3.2 Factors Determ ining the M edium for Foreign

Expansion 433.3 Potential Valuation Effects of International

3.4 Diversification and Risk Reduction as a

Potential M otive 49

3.5 The M ethod of Paym ent 50

IV METHODOLOGY AND ESTIMATION PROCEDURES 53 4.1 Introduction 53

4.2 M easurem ent of Abnorm al Returns 54

4.3 Test Statistics and the N ull Hypothesis 57

4.4 Tests of Differing Effects Between G ro u p s 58 4.5 Wealth Effects and the Division of Gains Analysis 58

4.6 Regression Analysis 60

4.7 Data Sources and Sam ple Selection 61

4.8 Criteria for Qualifying as an International Financial Acquisition 63

4.9 Final Sample Selection Criteria 64

4.10 Data Availability Problems 65

4.11 Sub-sample Data Sources and Description 66 4.12 Sample Statistics 66

V EMPIRICAL RESULTS 71

5.1 Introduction 71

5.2 Overall Valuation Effects 72

5.3 International Versus Domestic Acquisitions 76

5.4 Categories of International Acquisitions -A Comparison 81

5.5 M ultiple Regression Analysis 94

5.6 Wealth Effects and the Division of Gains 97

VI SUMMARY AND CONCLUSIONS 103

REFERENCES 106

SUPPLEMENTARY SOURCES CONSULTED 112

VITA 114

1 Sum m ary of Previous Studies 40

2 Distribution of Bidders and Targets 68

3 Overall Bidder Returns in International Acquisitions 73

4 Overall Target Returns in International Acquisitions 75

5 Overall Bidder Returns in Domestic Acquisitions 77

6 Differences Between Domestic and International Bidders 79

7 Overall Target Returns in Domestic Acquisitions 80

8 Differences Between Domestic and International Targets 82

9 Evidence on Product Diversification : Bidders 84

10 Evidence on Product Diversification : Targets 86

11 Evidence on Method of Paym ent Differences : Bidders 87

12 Evidence on Method of Paym ent Differences : Targets 88

13 Evidence on Old Versus N ew Targets 91

14 Evidence on Controlling Interest: Bidders 92

15 Evidence on Controlling Interest Targets 93

16 W ealth Effects Analysis: Bidders 99

17 W ealth Effects Analysis: Targets 100

18 Division of Gains Analysis 101

19 Division of Gains Analysis (Positives Only) 102

20 Com parison w ith Previous Studies 104

CHAPTER I

INTRODUCTION

In A ugust 1983, M itsubishi Bank Limited, the fourth largest bank in Japan, acquired the Bancal Tristate C orporation from its U.S ow ners The

New York Times (August 15, 1983, Page 18) reported that "banking specialists

say the subsidiaries of Japanese banks have been able to attract business by offering low er interest rates for borrow ers and higher rates for depositors They are aided, in part, by the low er cost of capital to their p aren t banks in Japan that enables them to u ndercut their American com petitors." Is this entirely correct? If so, does it apply to other bank acquisitions too? Does this explain the observed trends in international banking? If not, then w hat are the determ ining factors of the ow nership pattern and structure of the world banking industry?

International banking trends have reversed from the dom inance of U.S banks operating abroad in the 1960’s to the growing influence of foreign banks in the U.S in the 1970's and 1980's Further, mergers and acquisitions

This docum ent is form atted in the style of Journal of Financial Economics.

have em erged as the p o pular m edium for this w ave of foreign expansion, outdoing alternative means such as opening a branch o r subsidiary Does an econom ics-based cost-benefit analysis explain this choice? Or, is it explained

by im perfections such as tax and regulation differentials?

O n the other hand, consider the micro- and macro-economic im pact of this global tren d of foreign expansion in the banking in d u stry Is this a

faire? Or, should the relevant regulatory authorities intervene to foster it?

Perhaps it should be curbed w ith regulatory intervention

The current literature is inadequate for providing accurate answ ers to the above questions From the realm of international trade, one of the theories p u t forw ard to p ro v id e a rationale for the foreign expansion of a

com petitive w orld economy, a b ank locates in the country w hich allows it to

advantage enables it to compete w ith the host-country banks

The m ore traditional reasoning is simple: global com panies need global banks Each bank has a differentiated package of services and its close relatio n sh ip w ith a firm is one differentiated product Therefore, banks follow their domestic customers abroad under the belief that their previously

e sta b lish e d re la tio n sh ip w ill g iv e them an ed g e o v e r th e ir foreign com petitors

If a bank believes it has a firm-specific advantage, such as a particular lending technique developed at hom e, then it has the m otive to expand abroad This strategy w ould w ork so long as the advantage w as not a function of its hom e country’s factor endow m ents; for instance, if the lending technique involved a specific type of skilled labor then this w ould no longer be a m otive for going abroad.

The present study provides an analysis of the financial m arket effects

of foreign acquisitions and attem pts to explain some of the determ inants of these effects

A pproxim ately 220 acquisition events w ere identified over the time period 1977-1987, w here the bidder an d the target belong to tw o different nations Using financial data and event study methodology, the effect of each

of these events on the participating firm s' shareholders is docum ented Next, stratifying the sample in different ways, w ith respect to specific criteria such as the size of the target, the exchange rate betw een the currencies involved, the n atu re of the bid d er or target, the m ethod of p aym ent and others, the valuation effects of each of these is documented

For com parison purposes, the same analysis is conducted on a control

differentials for each subsam ple provides insights into the m otivating factors

of international acquisitions Finally, a regression analysis is done on the

w ealth effects using m easurable proxies of the above stratification criteria as independent variables

The significance of the stu d y of financial m ergers an d acquisitions across national borders should not be underestim ated Investigating the set

of m otivating m acro and micro factors can provide useful insights, especially

w ith respect to policy prescriptions W hile the prim ary concern underlying

d om estic an d co rp o rate m ergers centers aro u n d the issue of m ark et concentration alone, transnational financial mergers involve socioeconomic and political issues such as reciprocity relations with other governm ents, the need for the enhancem ent of dom estic financial m arkets, the degree of governm ent control, etc., to nam e just a few Therefore, there is m ore to the

m arket for international bank control than m erely view ing it as a m arket in

w hich alternative m anagerial team s com pete for the rights to m anage a bank’s resources

W hile the literature has been prolific in the analysis of dom estic

m ergers and acquisitions of both corporate and financial firms, it has only begun to investigate international corporate m ergers and is particularly lim ited for international mergers of financial firms O ne of the purposes of the present study is to fill this void in the literature

With respect to the methodology, m ost of the recent literature on bank

m ergers has used accounting d ata and various regression techniques to examine the im pact of a m erger on the profitability of the relevant banking firms H ow ever, the efficient-markets and rational-expectations hypothesis posits th at security prices reflect all available inform ation Hence, any unanticipated changes result in a current change in security prices, and the price change is an unbiased estimate of the value of the changes in a firm's

fu tu re cash flows a n d riskiness This hypothesis underlies a variety of

m ethods for estim ating the effects of unanticipated changes on shareholder

w ealth, including the event study m ethodology commonly em ployed in the study of corporate m ergers Thus, the use of financial data rath er than accounting d ata m ay result in a m ore precise evaluation of the effects of a bank merger

In this introductory chapter, w e have presented the objectives and

literature in the broad area of m ergers an d acquisitions w ith respect to the issues raised and analyzed, and the results of these studies C hapter three discusses the issues relevant to the stu d y of transnational m ergers and acquisitions of financial firms and identifies their testable im plications Chapter four describes the methodology and estimation procedures followed

by a description of the data sources and sam ple selection C hapter five reports and analyzes the results and com pares them to the im plications of the hypotheses The final chapter provides a sum m ary of the key findings and conclusions of this study

CHAPTER II

REVIEW OF RELEVANT LITERATURE

2.1 Introduction

M ergers and acquisitions are strategic decisions w hich have received

w id esp read attention in the literature They have been analyzed from a

v ariety of p o in ts of view in clu d in g th e m otives, fin an cial econom ies involved, com petitive effects and w ealth effects (see Jensen and Ruback,

1983, for a com prehensive review, and m ore recently, Jarrell, Brickley and

N etter, 1988, for the empirical evidence since 1980)

W ith regard to the w ealth effects, the general conclusion has been that takeovers generate abnorm al returns for the shareholders of target firms

H ow ever, the evidence on returns to the shareholders of acquiring firm s is less clear (see Roll, 1986, for a review) W hile some have found a positive

w ealth effect for shareholders of acquiring firms (e.g Bradley, 1980, Schipper and Thom pson, 1983, and Dennis and McConnell, 1986), others have found their effect to be negative (Dodd, 1980 and Firth, 1980)

2.2 Com peting Theories o f Mergers and A cquisitions

In an attem p t to resolve the above m entioned contradictory results,

A squith, Bruner an d Mullins (1983), have found that b id d in g firms receive positive cum ulative excess returns thro u g h o u t m erger program s involving

multiple acquisitions (up to four) for the sam e bidding firm They attribute the differences betw een their results an d p rio r w ork to failures by earlier studies to control for target size, success of the m erger b id , an d the time period in which the b id occurred.

H alp ern (1983), in a survey of event studies related to acquisitions, suggested th a t a preferable technique to obtain evidence on the m otivation for m ergers is to blen d the resid u al m ethodology w ith m icroeconom ic

fo u n d atio n s, such as the method of paym ent, found in the in d u stria l

organization literature Carleton et al, (1983) and W ansley, Lane an d Yang (1983a, 1987), have incorporated the p aym ent m ethod into m erger studies and conclude that cash takeovers an d securities exchanges are distinctly different C um ulative average residuals to target firms in cash transactions

w ere found to be approxim ately tw ice the level ob serv ed in securities exchanges (33.54 percent versus 17.47 percent) Even after accounting for firm size and the time pattern of cash and securities acquisitions, the difference is significant

H ansen (1987) presents a theory for the choice of exchange m edium in mergers an d acquisitions The m odel he uses is one of bargaining under asymmetric inform ation W hen a target firm know s its value better than a potential acquirer, the acquirer will prefer to offer stock, w hich has desirable contingent-pricing characteristics, ra th e r th an cash Either tax effects or asymmetric inform ation on the acquiring side can make the acquirer's choice

signalling equilibrium develops, w hereby the target uses bo th exchange

m edium offered and the am ount of any stock offer as signals of the acquiring

Yang, an d Carleton et al, is consistent w ith this payment method signalling

hypothesis.

A squith an d Kim (1982) have investigated the possibility that the positive abnormal returns earned by the acquired firms' stockholders come at the expense of other claimants That is, mergers may im pose a loss on some claim ants of the m erging firms, an d the stockholders' positive abnorm al retu rn s m ay sim ply reflect neg ativ e abnorm al re tu rn s to these other claimants Since a m erger is a corporate investm ent, the stockholders may earn positive abnorm al retu rn s (even if there is no real synergy) at the expense of bondholders by increasing the firm's risk through the merger

Asquith and Kim's results, however, show that w hile the stockholders

of target firms gain from a m erger bid, no other securityholders either gain or

lose To provide direct evidence on the existence of diversification effects

and incentive effects, they test w h eth er the b o n d h o ld e rs’ retu rn s are

dep en d en t upon the correlation betw een the returns of the m erging firms and w h eth er the size of the b o n dholders' and stockholders’ retu rn s in individual mergers are correlated Their results are consistent w ith a capital

m arket that efficiently resolves conflicts of interest betw een stockholders and bondholders

W hile trading on nonpublic inform ation is illegal, the enforcem ent of this law has been erratic, particularly in the area of trading in advance of

m erger announcements Keown and Pinkerton (1981) and Keown et al (1985)

p ro v id e e v id e n c e c o n firm in g sta tistic a lly th a t im p e n d in g m erger announcem ents are poorly held secrets, and trad in g on this nonpublic

in fo rm atio n ab ounds Specifically, leakage of inside information is a

pervasive problem occurring at a significant level up to twelve trading days prior to the first public announcem ent of a proposed merger

M ore recently, Lloyd, H and a n d M odani (1987) have pro v id ed evidence that m anager-controlled firms do not pursue the same objectives as

ow ner-controlled firms In particular, they found that m anager-controlled com panies have a significantly greater tendency to engage in conglomerate

m ergers than do firms w ith strong owner control They m easure the degree

of ow ner control versus m anager control of a firm by the percent of stock held by a single interest For instance, a single interest w ith a significant percentage of stock has substantial stake in the firm ’s results and will

m onitor the firm 's m anagers closely Further, a large holder will have a relatively easy tim e rem oving unsatisfactory m anagem ent If the stock is scattered am ong m any holders of insignificant percentage, m anagers have little fear of them and are free to pursue their own interests

Synergism is defined as the incremental wealth to the shareholders of both m erging firms due to the merger - net of any potential gains achievable

th rough investors' personal diversification over the com m on stocks of the

m erging firms Choi an d Philippatos (1983) and m ore recently, Davidson,

G arrison and H enderson (1987) m easure the synergistic effects of mergers on

the stockholders of the acquiring and acquired firms The evidence suggests operational a n d /o r financial synergy, w ith nonconglomerate mergers being

m ore frequently synergistic

H earth and Zaim a (1986) point out that, w hile earlier studies have

co n cen trated on price m ovem ents aro u n d the d ate of the first public announcem ent of the im pending m erger, their approach is different In their opinion, the announcem ent date constitutes only one of two im portant

events d u rin g the m erger process The other is the resolution date, the date

the merger is either called off or completed Considering a selloff as a reverse

m erger, H earth an d Zaima look at the w ealth effects of voluntary selloffs on the shareholders of both divesting a n d acquiring firm s a n d find that the

m arket reaction to a selloff occurs throughout the entire divestiture process

an d is n o t lim ited to th e p re-an n o u n ce m e n t p erio d As u n certain ty concerning the selloff appears closer to resolution, the m ark et reaction continues

W ith respect to m ergers and m arket concentration, Eckbo's (1985) results im ply that the levels of concentration and m arket shares found in the

D epartm ent of Justice’s m erger guidelines are unlikely to identify truly anti­com petitive mergers His empirical evidence fails to su p p o rt the prediction

of the market concentration doctrine w hich is th at a horizontal m erger is

more likely to have collusive, anti-competitive effects the greater the merger- induced change in industry concentration

So far, the tw o m ain thrusts of enquiry in m any stu d ies on takeovers and m ergers have been to provide an economic rationale for such activity

w ithin the context of a theoretical m odel, and to in vestigate ex post the

economic benefits (either in total or to various parties), an d the implications for pricing efficiency According to D avidson (1985), a second theoretical line

of enquiry which deserves attention is as follows: if gains do exist, then first,

is the m ethod of reporting offers efficient in the sense th at this should result

in a takeover /m e rg e r offer being attractive to all parties, a n d second, how

w ould these gains rationally be split between the various groups, and to w hat extent w ould this split be a Pareto im provem ent or be allocatively efficient

In this context, Davidson studies the efficiency of the bidding m echanism in

takeovers and the im plied apportionment of value gains, given th at there

m ay be inform ation asym m etry betw een the shareholder groups or their agents, th e m anagers (taking the agency theory view of th e ow ner- shareholder as the principal and the m anager as the agent) H e finds that

w here debt securities are in issue, protection should be given to bondholders,

if the takeover is to result in Pareto im provem ent The extent of value transference depends crucially on the state of the bidder, post-takeover

Finally, Smirlock, Beatty and Majd (1985) provide an excellent survey

opportunities for reducing the taxes paid by the two involved parties Also, the role of increasing debt capacity is essentially a tax-induced motive because

of the deductability of interest paym ents The gains to m erger are from increasing the portion or total am ount of profits available to shareholders How ever, taxation can only be a m otivation for a merger if consum m ation of the m erger is either required to obtain the tax benefits or the tax gains exceed the total costs of the merger or there are no low er cost alternatives The stu d y concludes that tax code provisions are a significant influence on

m erger activity

2.3 Bank Mergers, Regulation and Interstate Expansion

All the above studies hav e d ealt w ith the issue w hen b o th the acquiring and the acquired firms are based w ithin the same country and the entities in question are prim arily non-financial firms

H o w ever, follow ing the 1970 am en d m en t to the Bank H olding Com pany (BHC) Act of 1956, the grow th of bank holding companies and their expansion into nonbank activities has produced striking structural changes

in the banking industry BHC's found equity participation and acquisitions

as a m ore attractive means of financing business activity relative to lending This gave rise to an increase in acquisitions by BHC's and it also increased both the bank's risk and return

A num ber of studies have investigated BHC acquisitions One of the earliest ones is that by Frieder and A pilado (1983) Their stu d y addresses

m anagerial m otivation, stockholder m otivation, organizational effects of affiliation and the proper analytical approach to study BHC's They em ploy a

co n so lid a te d e n tity v iew p o in t, d ev elo p a v a lu a tio n m o d el a n d in

im plem enting it em pirically using accounting data, they consider factors such as intra-organizational effects, service fees, expanded debt capacity and equity adjustm ents Using a variable post-acquisition interval length, they find th a t b an k acquisitions h av e a positive im pact o n the accounting profitability of acquiring BHC's

O n the other hand, Swary (1983) uses stock price d ata to examine certain aspects of the Federal Reserve Boards' ad m inistrative decisions

re g a rd in g nonbank acquisitions by BHC's His resu lts su g g est th at stockholders of BHC's w hose acquisition p lan s w ere ap p ro v ed realized positive abnorm al returns following the announcem ent of the acquisition of

a nonbank firm This result is consistent w ith the synergy interpretation of nonbank acquisitions by BHC's Further, Swary found that stockholders that

w ere denied perm ission to acquire nonbank firms sustained significant losses during the five weeks following the Board's decision These abnorm al losses can be interpreted as forgone synergy rents or as a m arket reaction to the Board's signal that the BHC in question is excessively risky W hen looking at BHC acquisitions of m ortgage firm s in particular, Swary (1981) finds th at stockholders of acquiring BHC's do not realize abnormal returns following

unregulated industries: any economic rent w hich is generated by such an acquisition is captured by the acquired mortgage firm This implies that there exist BHC's, other than the acquiring one, that could also affect a profitable merger w ith the mortgage firm

M ore recently, Sushka and Bendeck (1988) analyze bank shareholder returns at the time of Federal Reserve approval of mergers to assess whether regulation reduces differential inform ation betw een b ank m anagers and outsiders o r reduces m anagers' ability to take advantage of differential information Their empirical tests indicate that there are negative returns to acquiring banks for external m ergers (targets in which the acquirer had no

p rem erg er eq u ity interest) b u t norm al re tu rn s for in te rn a l m ergers;

e m e rg e n c y m e rg e rs g e n e ra te p o sitiv e re tu rn s b e fo re a n d u p o n

announcem ent; m ore neg ativ e results occur in states w ith b ranching restrictions and in cases w hen equity financing is used.

O ther studies which have em ployed the event stu d y m ethodology to explore the w ealth effects of BHC acquisitions and bank m ergers conclude that bid d er shareholder announcem ent day returns are insignificant while target shareholders gain, (Neely, 1987) However, as Trifts an d Scanlon (1987) point out, there is evidence that the acquiring banks cannot be considered a

acquisitions earn positive an d statistically significant abnorm al returns and significantly outperform those involved in relatively sm aller m ergers Based

on their results, Trifts an d Scanlon conclude that there are differential

opportunities for gain from interstate m ergers, dependent u p o n the relative

size of the acquisition and the degree to which it expands the geographic

m arket served by the bank

W hile the Bank H olding C om pany Act of 1956 lim ited in terstate

ow nership of banks b y companies ow ning m ore than one bank and restricted the range of their perm issible nonbanking activities, one-bank holding companies were not subject to the 1956 Act Thus the latter were unrestricted

in the types or geographic locations of their n o n b an k in g subsidiaries

A ccordingly, beginning in mid-1968, several m ajor m oney center banks began to organize them selves into one-bank h o lding com panies an d to acquire a w ide range of subsidiaries engaging in activities not perm itted to either banks or subsidiaries of m ulti-bank holding com panies Eisenbeis,

H arris and Lakonishok (1984) specifically investigated w hether shareholders

of banks and BHC's perceive diversification benefits through exam ining the

form atio n of one-bank holding companies an d changes in reg u latio n

announcem ents of one-bank holding com pany form ations after the 1970

am endm ents w ere not associated w ith positive abnorm al retu rn s since the

am en d m en ts re d u ce d the scope of th e one-bank h o ld in g com panies' activities

Unlike Eisenbeis et al's results, A harony and Swary (1981) investigated the stock m arket's response to the passage of the 1970 am endm ents and concluded that they had no differential effect on the risk and return to one- bank h o lding com panies, m ulti-bank h o lding com panies an d in d ep en d en t banks Eisenbeis et al attribute the inconsistency in the findings to Aharony and Swary's m isspedfication of event dates

Going back to the issue of hom ogeneous groups of banks, Lobue (1983- 84) categorized holding companies by stock exchange listing, relative sizes of sellers an d of buyers, an d state branching lav/s and found som e differences betw een groups In particular, she found that a New York Stock Exchange listing and a relatively high seller-to-buyer asset ratio both positively im pact acquisition returns, whereas location in lim ited banking states suppresses returns

The market structure and performance literature in the area of bank

m ergers have exam ined the im pact of bank mergers in term s of economies of scale an d m arket pow er These studies, exhaustively review ed by Gilbert (1984), find m odest support for a m arket pow er hypothesis and economies of

m etropolitan m arkets of statew ide branching states to find how de novo branches and facilities and mergers affect a 10-year change in concentration Using a series of linear regression models, he investigates the issue of which

m erger size category has a significant correlation with the 10-year change in concentration His test results indicate th at de novo branches an d facilities reduce concentration, m ergers sm aller than 15% of the m arket decrease concentration, an d mergers larger than 15% increase concentration

Beatty, Reirn and Schapperle (1985-86) have looked a t the related issue

of barriers to en try in the banking industry Their stu d y proposes two theories of the effects of barriers to entry on the prem ium over book value

paid in bank m ergers In the excess demand theory, an elim ination of

geographic barriers to entry is hypothesized to be related to an increase in

m erger prem ium w ith an elimination of geographic barriers to entry Their empirical results are consistent w ith the latter theory

W ith respect to interstate U.S bank mergers, H aw aw ini an d Swary

(1989) found that they do not create net aggregate w ealth for shareholders, unlike intrastate mergers On the basis of a comprehensive study, Haw aw ini and Sw ary attribute this result to the lack of synergy-benefits in interstate

m ergers W hile these results are su pported by Baradwaj, D ubofsky and Fraser (1990), C ornett and De (1989) find both bidders and targets to gain significantly from interstate bank mergers

A few studies have considered the issue of acquisitions of failed banks

Pettw ay an d Trifts (1985) have m easured the effects of the purchase and

assum ption (P&A) policies of the FDIC that m erge failed banks into healthy banks Their findings w ere th at although the potential and actual mergers

w ere view ed w ith favor in itially, the actual m ergers w ere considered unfavorable as evidenced by the decline in the abnorm al returns in the post­

m erger period In other w ords, the acquiring banks' w inning bids were considered by the m arket to be in excess of the present value of the expected gains from the mergers; therefore, acquiring banks appeared to overbid for failed banks and the m arket for failed banks is competitive More recently, James an d W ier (1987a) exam ine w hether the sales m echanism u sed by the FDIC in failed bank auctions results in wealth transfers from the FDIC to the acquiring banks They find positive abnormal returns to the w inning bidders

in the FDIC auctions M ore im portantly, they find a negative and significant relation betw een the returns to w inning bidders and the num ber of bidders participating in the auction They conclude that their evidence suggests that the FDIC's auction procedures d o indeed generate wealth transfers

In a sim ilar study, Jam es an d W ier (1987b) exam ine w hether the

existence of potential bidders and alternative target firms affect the division

of gains in bank acquisitions The unique regulatory environm ent in the

banking industry perm its them to identify potential bidders and alternative targets in a particular acquisition fairly simply They find a positive relation betw een the target firm 's share of the acquisition related gains and the num ber of potential bidders an d a negative relation betw een the target's share and the num ber of alternative target firms Their results are consistent

w ith the hypothesis that potential bidders as well as alternative target firms are substitutable for one another at the time an acquisition is announced

Beatty, Santom ero an d Sm irlock (1987) describe the altern ativ e techniques th a t can be used to stru ctu re bank m ergers an d som e of the relevant reg u latio n of bank m ergers an d how stru ctu rin g a m erger in a certain m anner can circum vent or m inim ize regulatory pitfalls They also

em pirically analyze the determ inants of merger premiums In their opinion,

the purchase price of a bank will be prim arily related to four factors: the bank- specific financial characteristics, the operating m ark et en vironm ent, the regulatory environm ent and the w ay the m erger is structured, i.e w hether it

is taxable or nontaxable Additionally, the m erger prem ium m ay be affected

u n d e rs ta n d in g how these v ariab les in te ra c t in d e te rm in in g m erger prem ium s, a bank can determ ine an appropriate bid or ask price in a merger situation U sing accounting data an d regression analysis, Smirlock et al estim ate a m erger prem ium m odel which indicates that acquiring banks pay

a higher p rem ium for well m anaged banks; that banks in noncom petitive environm ents com m and a higher prem ium ; and that acquiring banks intend

to change the portfolio composition of target banks

Fraser and Kolari (1988) extend this study by looking a t small banks in particular and the pricing of their acquisitions Using accounting data and

regression analysis, their evidence indicates the presence of m erger prem ium differentials Specifically, high p rem ium banks ap p ear to have high net profits, a large am ount of dem and deposits (relative to tim e deposits) and low loan losses In contrast, they found m arket characteristics to be less significant for sm all banks Further, their results imply that the m anagers of small banks can influence the m erger value by the decisions th at affect

portfolio com position, pricing an d profitability For instance, banks w ith portfolios that are structured b y m anagem ent to achieve above average risk adjusted returns do appear to com m and higher merger prices.

W ith respect to regulation changes and the impact on bank m ergers, a

few studies have looked at the issue but from different viewpoints Dubofsky and Fraser (1989) examine the differential im pact of two significant court decisions concerning banking consolidation d u rin g 1981 These tw o court rulings effectively rem oved the possibility th at federal regulatory agencies could ap p ly the theory of probable future competition to block future bank

m ergers and takeovers Based on stock price data, their results show that the

im p a c t of th is re g u la to ry ch ange, w h ic h o cc u rre d w ith o u t an y contem poraneous public press coverage, led to a significant decline in the

w ealth of the shareholders of banks that had been active acquirers This seem s to be consistent w ith the tw o hypotheses which p red ic t negative

m axim ization hypothesis of M ueller (1969), the managers of acquiring banks are m ore interested in size m axim ization than value m axim ization and

a cq u isitio n s could be n egative NPV investm ents; u n d e r th e h u b ris hypothesis of Roll (1986), acquirers over-estim ate the value of targets, and hence overbid in their acquisition attem pts

In a related study, Dubofsky and Fraser (1988) focus on the change in the m arket for bank acquisitions th at occurred, following the above two court decisions in 1981 Since then, the num ber of bank mergers and acquisitions increased dramatically, particularly am ong large banks These court decisions affecting the bank takeover m arket are expected to have h ad a significant

im pact o n how the market reacts to acquisition announcem ents Since the relaxed regulatory standards have increased the num ber of potential bidders for a given target, it is hypothesized th at this will result in a target's price reflecting a higher probability of being acquired Further, acquirers will have

to bid higher prices in order to minimize the probability th a t the attem pt will either lead to other bids from the enlarged set of potential acquirers, or cause the target to seek a "white knight" from this set Thus, the new standards are hypothesized to lead to higher prices p aid for a given am ount of expected profit, thereby lowering the net present value of the acquisition from the acquirers' view points, all else being equal Using residual analysis, their results strongly support the hypothesis that the m arket for bank acquisitions

h as changed after mid-1981 W hereas before mid-1981, shareholders of acquiring banks gained w hen an acquisition announcem ent was m ade, after mid-1981 they lost

Finally, Desai and Stover (1985) investigate the issue of the returns accruing to BHC shareholders w hen an acquisition is initiated by the BHC

given th a t the regulatory environm ent introduces uncertainty about the

eventual outcom e of the review process Consequently, w hen the Federal

R eserve Board approves or tu rn s dow n the p ro p o sal, th ere is some resolution of uncertainty and finally the eventual m erger date resolves all uncertainty regarding the occurrence of the merger Using stock price data,

D esai and Stover find a significant positive abnormal retu rn s accruing to the shareholders of acquiring BHC's w hen the initial announcem ent is m ade

a n d upon approval from the Fed these shareholders earn an additional,

significantly positive abnormal return They also find th at the m agnitudes of these returns are independent of the relative size of the acquired firm.

2.4 Foreign Mergers and Acquisitions

W e n o w exam ine the in tern atio n al aspects of the literatu re, w ith respect to m ergers and acquisitions of both financial and non-financial firms

A central issue exam ined in the literature w ithin this specific area of foreign acquisitions is as follows: If the expected gains in m ultinational

m erg ers a re n o t different from those in dom estic m ergers, th e n the prem ium s p aid o r the abnorm al returns, to the owners of the acquired firms

in m ultinational mergers should not be different either

U n d er the assum ption th at bid prem ium s are proxies for expected gains th ro u g h m ergers, Wansley, Lane an d Yang (1983b) p resen t indirect evidence against the existence of additional perceived benefits available to acquiring firm s through foreign acquisitions in the USA They fin d that although foreign acquirers appear to rew ard shareholders of USA acquired com panies w ith larger cum ulative average residuals, their p aram etric and nonparam etric tests reveal that the differences are not statistically significant Based on the absolute m agnitude of the CAR, however, it appears th at larger prem ium s are associated with foreign mergers On the other hand, Wansley, Lane an d Yang point out that their results could at least partially be d u e to the h ig h deg ree of allocational efficiency associated w ith U.S security exchanges

In a (somewhat) related study, Yang, W ansley and Lane (1985), use residual analysis to evaluate the m arket recognition of the m ultinationality

of a firm In other w ords, they indirectly test and fin d s u p p o rt of the

diversification service hypothesis of foreign direct investm ent, w hich states

that to the extent international capital m arkets (especially stock m arkets) are seg m en ted , m u ltin atio n al co rporations m ay p ro v id e an in te rn a tio n a l diversification service to their shareholders

A n analogy can be draw n in the context of foreign acquisitions: a firm can perform the task of international diversification by acquiring another unit abroad instead of opening a branch or division and if diversification benefits exist then the m arket should recognize and react to the foreign acquisition in the same way it w ould to the m ultinationality of a corporation, all else equal Setting up a branch is a m ethod of foreign direct investm ent, while acquiring a firm is a m ethod of portfolio investm ent, b u t both achieve certain levels of diversification

In a study in a sense opposite to the one by Wansley, Lane an d Yang, Fatemi and Furtado (1987), exam ine the effect of foreign acquisitions on the returns to shareholders of U.S.-based acquiring firms Their hypothesis is that the w ealth effects of foreign acquisitions w ould not differ from those of the dom estic ones if the financial m arkets in the foreign country are as competitive and as efficient as the domestic m arkets, and if there are no net

a d v a n ta g e s (d isad v an tag es) asso ciated w ith co rp o rate in te rn a tio n a l diveiiification On the other hand, existing evidence suggests th at at least some foreign m arkets are n o t as com petitive or as efficient as the U.S

financial m arkets, and th a t there m ay be net benefits associated with corporate international diversification Therefore, it is possible th at the

w ealth effects of foreign acquisitions differ from those associated w ith the dom estic ones Fatemi and Furtado do not find significant abnorm al returns

a t announcem ent, although they do find significant negative cum ulative abnorm al retu rn s for a 59-day period leading to the announcem ent, which again disappear w hen they consider a non-contam inated sam ple over a 24 day period surrounding the announcem ent day

In order to study the value of foreign acquisitions as a m edium for

in ternationai diversification, Fatem i an d F urtado sp lit their sam ple into those in w hich the acquiring com pany has an established presence in the country in w hich the target is located and those w ith no prior experience in the country involved They find that foreign acquisitions are associated with positive w ealth effects w hen they are the means for an initial entry into a foreign m arket No significant w ealth effects are present otherw ise They also fin d th a t conglom erate-type acquisitions are associated w ith non­negative w ealth effects w hich m ay be d u e to a presence of n et benefits associated w ith corporate international diversification

M ore recently, D oukas and Travlos (1988) investigate U.S acquiring firm s ' s h a re p ric e ch a n g e s a sso c ia te d w ith fo re ig n -a c q u is itio n announcem ents The effect of international acquisitions is used to provide

d ire ct evidence on the effect of corporate m u ltinational expansion on

m u ltin a tio n a l n etw o rk are view ed by in v esto rs as v alu ab le options exercisable only w hen the m ultinational corporation is ex p an d in g into

geographical areas that are less related and developed relative to the U.S economy This is one of their points of d eparture from the Fatem i and

F urtado study, w ho also subdivided their overall sam ple by geographical location, b u t n o t explicitly in to d ev eloped and less dev elo p ed areas

H ow ever, like Fatemi and Furtado, Doukas and Travlos find th at there are significant an d positive valuation effects to acquisition announcem ents by

m u ltin atio n a l firm s n o t already operating in the target firm 's country, confirm ing the positive-m ultinational-netw ork hypothesis

W ith respect to evidence on international diversification, Hisey and Caves (1985) m odel a m ultinational conglom erate, diversified across both geographic an d pro d u ct boundaries and use probit analysis to classify diversifying foreign acquisitions of such organizations, based in the U.S They conclude that the choice betw een related and unrelated acquisitions bears little relation to the acquirer’s base activity in the U.S., b u t it is som ew hat affected by transaction costs and the firm's previous experience in

overseas acquisitions

W atson (1978) has identified the conditions u n d er which there m ight

exam ined the inter-tem poral behavior of the correlation coeffidents between

m arket indices (adjusted for exchange rate fluctuations) for eight countries

an d possible implications for international investm ent He concludes that, provided the returns from various national stock exchanges are not perfectly positively correlated, then international diversification can reduce portfolio variance H ow ever, there is some controversy as to the stationarity of these

correlation coefficients over time (Yallup, 1982, an d W atson, 1982) The resu lts show that using a M arkow itz-type strategy, su b stan tially larger benefits w ere available to the investor w ho could perfectly predict future inter-country correlation coefficients, and estimates of these are likely to be

m ore accurate if the stochastic process underlying the ex post returns can be identified

2.5 Evidence from the ILKV Japan and Canada

W ith respect to the p ro fitab ility and w ealth effects of corporate dom estic m ergers in countries other than the U.S., there is some evidence from the U.K., Japan and Canada

Franks, Broyles and Hecht (1977) provide evidence on the profitability

of m ergers of quoted companies w ithin the Breweries and Distilleries sector

in the U.K for the period 1955-72 They used a two-factor m arket model and found that, on average, the m arket w as anticipating a takeover bid three

m onths p rio r to the announcem ent A lthough this was consistent w ith

F irth's (1976) findings, unlike Firth, they found price increases in the acquirers’ shares at least for the first five months after the merger In marked contrast, Barnes (1978) found, from a sample over the perio d 1974-76, that there w as a sharp drop in the price immediately after the merger In a follow

u p study, however, utilizing the same sample and em ploying a methodology sim ilar to th at used by Franks e t al, Barnes (1985) found there w ere slight share price gains initially followed by substantial decreases as time elapsed Firth (1980), in a study of quoted mergers over the time period 1969-75, found evidence consistent w ith the original Barnes' study but w ith a refinement

He reported that the share price of the successful acquirers experienced a drop

considered th at the costs in adm inistering the m erger (e.g the prem ium p aid and th e u n certain ty involved in the m erger) m ore than o u tw eighed the benefits derived (the profitability) The unsuccessful bidders, on the other hand, outperform ed the m arket index in the 12 months following the failed bid The stock m arket had regarded the latter as good news an d hence the superior share price performance For the target firms, their shareholders experienced an increased return (of some 30%) regardless of w hether it w as successful or not

D odds and Quek (1985), provide additional evidence in this context Their stu d y covers a relatively slack period (1974-76) of m erger activity an d their overall results contradict, to some extent, those found by the U.K studies review ed above Firstly, based on the post-merger CAR's, they found the adjustm ent process of the m arket to the newly available inform ation to

be slow and cautious Second, by standardizing the residuals, the effect of the firms' size was to reduce the dispersions of the residuals about their average value Finally, the average residuals for the bid announcem ent m onth w as found to be m ore negative in the case of m erger-active firm s than for the non-m erger active firms Also, it w as fo u n d that the m arket view ed those

m ergers th at w ere financed by cash, and w hich occurred in 1974-76, as less desirable com pared to those offering equity exchange

M ore recently, Franks and H arris (1989) examine the effects of over 1,800 U.K takeovers on shareholder w ealth in the period 1955-85 Their study, based on m onthly data, shows that around the m erger announcem ent