Creating Shareholder Value for Merger and Acquisitions

What factors determine whether mergers and acquisitions create value for shareholders in the banking industry?

Introduction-Background

There is a significant amount of debate around whether mergers and acquisitions do create value for bank shareholders, with Houston et al (2001, p. 1) arguing that “traditional studies fail to find conclusive evidence that bank mergers create value.” However, several other studies have revealed that bank mergers may create value in certain contexts, depending on how appropriate they are for each company and how they are managed and approached. As such, this dissertation will attempt to identify the various factors which determine whether mergers and acquisitions create value, and how these can be managed to ensure that bank mergers both create and maximise shareholder value.

Literature Review

Houston et al’s (2001) argument around the lack of value creation from bank mergers is based on a study of major bank mergers which occurred between 1985 and 1996. Their results showed that the prospect of a merger tended to result in positive revaluations of the share prices of both companies, with the result being that any benefits post merger were not reflected in share price movements after the merger completed. In addition, the majority of the value created was due to cost savings, instead of any increase in revenue, which meant that the merged bank would not show any significant revenue growth. In addition, the Bank of England (2007) examined a study which showed that whilst an announcement of an acquisition tended to have a positive impact on the share price of the target, it tended to have a negative impact on the market value of the acquirer, although this was only a short term phenomenon.

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As such, and as Glenn (2007) demonstrated, many acquisitions involving banks led to a significant premium being paid by the acquiring firm over the market value of the target. This was found to be a function of the workings of the financial markets, rather than actual expectations of synergies or revenue growth, implying that the valuations of the target firms would tend to be inflated, and destroy any economic value the merger might create. However, Delong and Deyoung (2007) claim that the reason many studies fail to find any evidence of value creation in bank mergers is that large bank mergers are a relatively recent phenomenon, hence there is no best practice available to help managers manage them. This is supported by an investigation of over two hundred bank mergers in the US from 1987 to 1999, which shows that bank mergers performed better the more previous experience and knowledge there was to support them.

Tetsuya (2005) also found that some investors expected mergers to have an adverse impact on a firm which had to borrow to fund them. This could imply that borrowing to fund bank mergers can cause firms to take on an unsustainable level of debt. However, Tetsuya (2005) also found that bank mergers could boost the value of financially distressed banks, by helping support their balance sheet and increase their capital. This is supported by Gupta and Misra (2007) who found that mergers between similar sized banks tended to create more value that those where the target bank is smaller than the buyer. In addition, Banal-Estañol and Ottaviani (2007) found that banks could create value by using a merger for diversification purposes, to reduce their dependence on any single market share and hence increase the welfare of their borrowers and depositors. However, Smith and O’Neill (2003) claim that any diversification in a merger needs to be related diversification in order to generate valuable synergies.

Hagendorff et al (2007) also argues that the role that corporate governance plays in mergers and acquisitions in the banking sector is very important in determining the value of any merger or acquisition, particularly with regards to ensuring that shareholder interests are safeguarded. Hagendorff et al (2008) further claim that levels of investor protection are important factors in determining the investor reactions to any major corporate event, with high levels of investor protection for the shareholders of the acquiring bank increasing the premium that the buyer will need to pay, and hence reducing the value of the merger. This is supported by Dos Santos et al (2008) who found that acquisitions of banks at fair value would not generate value, whilst making a diversified acquisition could create a significant diversification discount for the acquirer. However, De Jonghe and Vennet (2008) found that there is a need to trade off the benefits of diversification and stability when considering any bank merger. Finally, Beitel et al (2004) showed that, much like in other industries, managerial objectives can play an important role in the creation of shareholder value during a merger.

Research Objectives and Research Questions

The main research objective for this piece is to find out what the main factors are in determining whether or not a bank merger or acquisition will create shareholder value. Within this objective, it will be necessary to distinguish between the types of transaction and the relative benefits for both the shareholders of the acquiring firm and the acquired firm, or both sets of shareholders in the case of a merger. This objective will be fulfilled by the creation of a matrix style typology of the various factors identified as important. This matrix will identify each factor, the types of transactions to which it refers, and the impact on the shareholder value generated for both sets of shareholders.

Research Design

The first part of the research will consist of a detailed and structured review of the secondary literature on the subject, which will be used to create a list of the most widely cited and significant factors. From the initial review above, it is expected that the size of each firm, the level of corporate governance and the relatedness of the two businesses. The literature review will aim to find at least three more factors which have been identified by existing studies, as well as expand on the proposed relationships from other studies.

Following this, a questionnaire will be carried out with a sample of major banks from the UK, and potentially further afield, who have completed a merger or acquisition in the past ten years. These questionnaires will focus on determining the relative importance of each factor in the merging process, based on how the companies approached the merger. To support this analysis, measures such as market capitalisation, share price, profitability, the type of transaction, the price paid for the merger, and the return on investment will be taken for each of the mergers; both immediately before and for two years after the transaction. This will help reveal whether the merger was profitable. A multiple regression analysis can then be used for each merger to determine what the critical factors were supporting each merger, and which factors were behind the most successful mergers. This can be used to determine which factors are the key value drivers of mergers in the banking sector, and hence to create the typology of factors and types of transactions.

References

1. Banal-Estañol, A. and Ottaviani, M. (2007) Bank Mergers and Diversification: Implications for Competition Policy. European Financial Management; Vol. 13, Issue 3, p. 578-590.
2. Bank of England (2007) Do announcements of bank acquisitions in emerging markets create value? Bank of England Quarterly Bulletin; Vol. 47, Issue 1, p. 86.
3. Beitel, P. Schiereck, D. and Wahrenburg, M. (2004) Explaining M&A Success in European Banks. European Financial Management; Vol. 10, Issue 1, p. 109-139.
4. De Jonghe, O. and Vennet, R. V. (2008) Competition versus efficiency: What drives franchise values in European banking? Journal of Banking & Finance; Vol. 32, Issue 9, p. 1820-1835.
5. Delong, G. and Deyoung, R. (2007) Learning by Observing: Information Spillovers in the Execution and Valuation of Commercial Bank M&As. Journal of Finance; Vol. 62, Issue 1, p. 181-216.
6. Dos Santos, M. B. Errunza, V. R. and Miller, D. P. (2008) Does corporate international diversification destroy value? Evidence from cross-border mergers and acquisitions. Journal of Banking & Finance; Vol. 32, Issue 12, p. 2716-2724.
7. Glenn, J. (2007) Determinants of Premiums to Book Value Paid in Banking Mergers. International Advances in Economic Research; Vol. 13, Issue 2, p. 245-246.
8. Gupta, A. and Misra, L. (2007) Deal Size, Bid Premium, and Gains in Bank Mergers: The Impact of Managerial Motivations. Financial Review; Vol. 42, Issue 3, p. 373-400.
9. Hagendorff, J. Collins, M. and Keasey, K. (2008) Investor protection and the value effects of bank merger announcements in Europe and the US. Journal of Banking & Finance; Vol. 32, Issue 7, p. 1333-1348.
10. Hagendorff, J. Collins, M. and Keasey, K. (2007) Bank Governance and Acquisition Performance. Corporate Governance: An International Review; Vol. 15, Issue 5, p. 957-968.
11. Houston, J. F. James, C. M. and Ryngaert, M. D. (2001) Where do merger gains come from? Bank mergers from the perspective of insiders and outsiders? Journal of Financial Economics; Vol. 60, Issue 2/3, p. 285-331.
12. Smith, K. and O’Neil, E. (2003) Bank-to-bank deals seldom add value. ABA Banking Journal; Vol. 95, Issue 12, p. 7-10.
13. Tetsuya, K. (2005) Client Firms and Bank Mergers:: Positive Wealth Effect of Bank Mergers on Distressed Firms. Review of Pacific Basin Financial Markets & Policies; Vol. 8, Issue 1, p. 113-130.