Categories: Harvey Mudd College (HMC)Term Paper Samples

The Impact of Mergers and Acquisitions – Term Paper

Most bank mergers are pursued at the domestic level rather than the cross-country level. Their limited success rates could explain the limited number of cross-country bank mergers. The bidder banks may be held back by the fear that cross-border bank mergers may end up creating banking organizations without any meaningful competitive advantage in the host country. Berger et al. (2001) indicate that the lower success rates for cross-border mergers can be directly attributed to the many banking efficiency barriers created by different regulatory conditions in the host countries. Some countries may have adverse banking supervision structures that may end up upsetting the operations of cross-border bank mergers. There is also the challenge posed by linguistic and cultural differences as well as increased geographical distance. When a bank in a developing country chooses to enter into a merger with a bank in a developed country, it faces cultural differences such as differences in accommodation, transport infrastructure and the kind of food consumed. 

There are three common ways that banks can rely on to measure the extent of risk and value when considering pursuing strategic mergers. These are changes in systemic risk, changes in total risk, and evidence of abnormal returns for banking organizations. Changes in systemic risk can be measured by conducting event studies and performing beta regressions. Several bank merger studies conducted in the banking industries in developing countries and Europe have helped to highlight the extent of systemic risk involved in the pursuit of bank mergers. They have also demonstrated marked banking differences between different countries; for instance, the U.S. and the developing countries in Africa. There is also marked differences in the banking industry of U.S. and Europe. They have outstanding cultural, economic and legal differences. For instance, it is notable that the U.S. banks do not pursue investment banking, whereas European banks are allowed to conduct investment banking business. Early research in the banking industry in the 1980s supported the position that bank mergers created value for shareholders and resulted in efficiency gains in the banking organizations. Most banks then reacted by pursuing merger and acquisitions, but this also caused a rise in stock price for most banks. 

According to Wagner (2010), the last financial crisis also had a direct effect on these regression results for beta values of the acquirer banks. It reduced the systemic risk for the acquirer banks, especially in the case of bank mergers in the domestic market. Interestingly, this research does not find evidence to ascertain that newly acquired banks that cause a direct shift in income will reduce the beta value. The findings indicate that there was a direct impact on acquirer banks’ systemic risk whenever they announced banking merger deals. This is demonstrated by the marked shift of lower positive beta changes in the pre-crisis period to a much more negative change in the crisis period. Wagner (2010) indicates that banking mergers that happened in Europe, U.S. and other industrialized countries in the last phase reduced the systemic risk for the acquirer banks when assessed using domestic bank indexes. Arguably, banking mergers reduce the systemic risk for bank mergers effected in the domestic market. This information would be useful to bank managers who are considering pursuing the strategy of bank mergers as an approach to risk diversification. 

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DeLong and Saunders (2002) posit that in the advent of bank mergers, the shareholders of the target bank demonstrate both negative and positive reactions to systemic risk. Amihud et al. (2002) also determined that cross-border mergers of financial and banking institutions neither decreased nor increased the risk of banking.

Agmon and Lessard (1977) conducted research on the beta change for stock returns of the U.S. multinational financial corporations after they had pursued mergers. Their data was harmonized using beta indexes for the U.S. and the host countries for the target banks. Their findings indicated the U.S. multinational companies had lower beta returns in the U.S. home market and higher beta index in the world. They also determined that when a domestic bank acquires a foreign bank, there are significant changes witnessed in income shares emanating from domestic and foreign markets. The domestic bank will witness an increase in the share of income earned in foreign markets. On the contrary, it will witness a decline in the share of income emanating from the home market. Amihud et al. (2002) studied this dependence to come up with the findings that, after the execution of banking mergers, the expectations are that the returns by the acquirer bank will have a stronger covariance with the banking indexes of foreign markets, and a weaker covariance with the banking index of the domestic market. These findings highlight the idea that an acquirer bank’s beta increases with respect to the world banking indexes, including that of the home country. However, its beta decreases when assessed with respect to the domestic banking index. The change happens because of decreased return percentages from the domestic market of the acquirer bank and increased return percentages from the foreign markets (Milbourn, Arnoud & Anjan, 1999). 

De Nicollo et al. (2003) studied the existent relationship between financial consolidations and risk by looking at various management decisions pursued by large banks and other financial institutions between 1995 and 2000. Their findings indicate that large banks get motivation from incentives modeled on moral hazards. This allows them to develop an increased tendency for risk-taking as compared to smaller banks (Rhoades, 1998). In this regard, the big financial institutions prioritize moral hazard incentives in making investment decisions as opposed to the pursuit of risk reduction brought by increased economies of scale, product diversification or geographical diversification (Wagner, 2010). These large banks have a tendency to take increased risk without much worry out of the assurance that they would be bailed out by government safety nets designed to protect them. This principle is known as the Too-Big-To-Fail ideology. This is akin to the trend of increased risk-taking witnessed when banks enter into a merger. Kane (2000) looks at banking megamergers conducted between 1998 and 1998 in the U.S. His findings show that most shareholders in the U.S. merged banks gain increased shareholder value due to the increased organizational size of the bank.

Research Gap/Significance of the Research Study

Most research studies on mergers in the banking industry such as those conducted by Berger et al. (2001), Wagner (2010), and Kane (2000) focus much on the extent of total risk that accrues to an acquirer bank that chooses to pursue bank mergers. Very limited studies focus on specific systemic risks that often face an acquirer bank that enters into mergers; some of these research studies include those conducted by Wagner (2010), DeLong and Saunders (2002), De Nicollo et al. (2003), and Amihud et al. (2002). This research study will rely on both quantitative statistical findings and qualitative data drawn from past related studies on the topic to determine the relationship between bank M&As and systemic risk. 

Methodology

The research will use both qualitative and quantitative research methods. Qualitative methods would review secondary research/review of past studies on the risk events surrounding banking mergers. Online research for scholarly articles and academic databases on bank mergers would be conducted to provide existing insights on the systemic risk for bank mergers. The study will present an overview of past data and research findings on the impact of banking mergers. For the qualitative analysis, available databases on the existing bank mergers conducted in developing countries, US and Europe will be used for the study, particularly information that touches on domestic bank mergers. The systemic risk for banks will be evaluated statistically using beta regression. 

For quantitative analysis, a regression model would be used. It will rely on independent data variables of the host and domestic banking indexes as well as the foreign country’s performance index to determine the systematic risks for the acquirer bank. It will include a step to subtract the effect of the Foreign Bank Index by regressing the host country banking index and the home banking index against the particular foreign banking index. Thereafter, the residual values of the regression will then be taken to assess the systemic risk by looking the beta values obtained before the bank announced their decision to enter into a merger, and the beta values after the merger announcement. The change in beta is evaluated by subtracting the beta value for the acquirer bank before the merger announcement from the beta value obtained before the announcement of the merger (Shaffer, 1993, p.427). 

The source of data used in the regression analysis will include data from the Datastream public database that lists all mergers for commercial banks that trade in public stock exchange and have some history of stock price recorded over the years. After conducting the regression analysis, the average change of beta coefficients would be reliable indicators of the systemic risk faced by the acquirer banks.

The regression analysis for home and foreign banks’ returns and their beta changes in foreign countries and at home will give systemic insights on the earnings and risks involved in the domestic and foreign markets. Any disparities in the regression values attained would be used as a reliable predictor of the point that little evidence may exist to accurately determine that acquirer banks have increased systemic risk when assessed in European banking indexes or banking indexes of foreign host countries (developing countries), while it reduces when assessed using banking index for the domestic market. 

Data analysis will involve both qualitative analyses of merger events from academic online databases on bank mergers as captured in varied research studies as well as quantitative statistical analysis of changes in beta value for acquirer banks before and after their merger announcement. Qualitative analysis will be used to evaluate qualitative research information collected through reviews of past research studies on systemic risk for acquirer banks in merger deals. The objective, in this case, will be to establish the extent of research in this dimension and identify new research gaps that should be pursued. 

For statistical analysis, the focus would be on conducting regression analysis for home and foreign banks’ returns and their beta changes in (for banks in developing countries and Europe) to determine and compare their R-squared values. This will make it possible to estimate the parameters of the regression model and test the level of significance. The research study would use tables and frequency distributions to present the findings and new resultant research information from the qualitative analysis. 

Timeline/Research Planning

The research is expected to last over a period of three years. The researcher will spend the first one year reviewing online databases that discuss bank mergers and the potential systemic risk. This would be aimed at harmonizing the qualitative information found by earlier researchers and gaining knowledge on the present state of research in the area. The next year would be spent in conducting qualitative regression analysis for change in beta values for acquirer banks that enter into mergers – both in Europe and in developing countries across Africa and Asia. The third year would be spent in writing up the research study processes, methodology, findings and conclusion.  

Norman Wade

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Norman Wade
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