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Journal of Economics and Business xxx (2007) xxx–xxx

PRESS Journal of Economics and Business xxx (2007) xxx–xxx Mergers and acquisitions and bank performance in

Mergers and acquisitions and bank performance in Europe: The role of strategic similarities

Yener Altunbas¸ a, , David Marques´ b,1

a University of Wales, Bangor, Centre for Banking and Financial Studies, School of Accounting, Banking and Economics, SBARD, Gwynedd, LL57 2DG Bangor, United Kingdom b European Central Bank, Capital Markets and Financial Structure Division, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany

Received 28 January 2005; received in revised form 30 June 2006; accepted 27 February 2007

Abstract

We examine the impact of European Union banks’ strategic similarities on post-merger performance. We find that, on average, bank mergers have resulted in improved performance. We also find that for domestic deals, it can be quite costly to integrate institutions which are dissimilar in terms of their loan, earnings, cost, deposit and size strategies. For cross-border mergers, differences between merging partners in their loan and credit risk strategies are conducive to higher performance, whereas diversity in their capital and cost structure has a negative impact from a performance standpoint. © 2007 Elsevier Inc. All rights reserved.

JEL classification: G21; G34

Keywords: Banks; M&As; Performance

1. Introduction and motivation

At the global level, one of the most notable developments affecting the banking industry over the last 20 years has been the unprecedented level of merger and acquisition (M&A) activity. This trend towards financial consolidation accelerated in the late 1990s in most OECD countries for

The opinions expressed in this paper are those of the authors only and do not necessarily reflect the views or imply any responsibility from the European Central Bank. Corresponding author. Tel.: +44 1248 382191. E-mail addresses: y.altunbas@bangor.ac.uk (Y. Altunbas¸), david.marques@ecb.int (D. Marques).´

1 Tel.: +49 69 13446460; fax: +49 69 13446514.

0148-6195/$ – see front matter © 2007 Elsevier Inc. All rights reserved.

doi:10.1016/j.jeconbus.2007.02.003

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/ Journal of Economics and Business xxx (2007) xxx–xxx Fig. 1. Mergers and acquisitions in the

Fig. 1. Mergers and acquisitions in the EU banking sector.

a number of reasons, such as improvements in information technology, globalisation of real and financial markets, increased shareholder pressure and financial deregulation. 2 Regarding the latter factor, in the United States, most restrictions on intrastate banking were abolished by 1990, and lingering geographical restrictions were abolished with the passing of the Riegle-Neal Interstate Banking and Branch Efficiency Act (1994). Likewise, the barriers in the US financial sector between depository institutions, securities and insurance firms were significantly weakened with the passing of the Financial Services Modernization Act (1999). As a result, from 1980 to 2003 the number of banks in the United States declined from around 16,000 to 8,000, and the share of the ten largest banks rose – in terms of total assets – from 22% to around 45%. 3 The creation of the single market for financial services in the early 1990s and, more recently, the introduction of the euro have helped to accelerate this process of financial consolidation also in Europe. During the late 1990s, the volume and number of M&As increased in the euro area in parallel with the creation of Monetary Union (Fig. 1). According to most bankers and academics, however, the process of banking integration is far from complete and is expected to continue. 4 First, many of the forces underpinning this consolidation process – such as the effect of technological change and financial globalisation – will continue to exist. Second, the number of banks per inhabitant in the European Union (EU) is almost double that in the United States, suggesting that there is room for consolidation in the EU. Third, there is still a considerable degree of heterogeneity across EU countries in terms of banks’ concentration. 5 In terms of the impact of financial consolidation on bank performance, a large number of empirical studies have been devoted to this issue in the United States, but scant evidence is available in the EU. At the same time, empirical results in the United States could also be of interest in Europe, given that the process of financial deregulation began earlier in the United States than in the EU. In terms of methodology, the empirical literature analysing the effects of consolidation on banks’ performance follows two main empirical methods. The majority of studies follow event study-type methodology, often based on changes in stock market prices around the period of

2 See Group of Ten (2001).

3 Piloff (2004).

4 See, for instance, McKinsey (2002) and Morgan Stanley (2003).

5 See, for instance, ECB (2004).

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the announcement of the merger. These studies typically try to ascertain whether the announce- ment of a bank merger creates shareholder value (normally in the form of cumulated abnormal stock market returns) for the shareholders of the target, the bidder and/or the combined entity. The underlying hypothesis of these studies is that excess returns around the announcement day could explain the creation of value associated with the merger. Following this procedure, the majority of US studies find mixed or negative results and show that most bank mergers create shareholder value only for the shareholders of the target institution, normally at the expense of the bidding institution (for a review, see Beitel & Schiereck, 2006; Piloff & Santomero, 1998). 6 Recent US studies have provided an interesting contribution by sub-sampling the population of merging banks according to their product or market-relatedness. The objective of such studies is to establish whether certain shared characteristics between merging institutions could create or destroy shareholder value. These studies build on established evidence from the corporate finance literature which suggests that by focusing on their core business, companies could improve their profitability and market value. Empirical results from the United States show that mergers of banks showing substantial dissimilarities in terms of geographical or product strategies could destroy overall shareholder value (see Amihud, De Long, & Saunders, 2002; Houston & Ryngaert, 1994). DeLong (2001) and Cornett et al. (2003) argue that only bidders that focus both on geography and product-relatedness do not destroy value. Using a unique database, Deng and Elyasiani (2005) find that geographic diversification is associated with insignificant value effects and a significant decline in banks’ risk, thereby providing a rationale for the financial consolidation witnessed in recent years. 7

A second group of studies measure the impact of financial integration on bank performance

via accounting ratios of performance (such as return on assets) or productive efficiency indicators

(such as indicators of scale economies). The potential for scale economies is often one of the mains reasons given by practitioners to justify M&As. However, the majority of US studies find that these potential efficiency gains resulting from size rarely materialise after the merger (see Berger, Demsetz, & Strahan, 1999; Berger, DeYoung, Genay, & Udell, 2000; Piloff, 1996). A possible reason for this is that some efficiency gains may take a long time to accrue. 8 More specifically, while some efficiency gains (such as those derived from risk diversification or the

benefits of brand name) can be accrued in the short run, others, such as the benefits derived from cost reductions or the majority of scope economies, may take longer to materialise. This is probably due to the difficulties of integrating broadly dissimilar institutions (see Vander Vennet,

2002).

In line with the results of event studies, the few studies analysing the effect of M&A activity

on actual operating performance do not find a significant impact of financial consolidation on

profitability in the US banking sector (Linder & Crane, 1993; Rhoades, 1994). At the same time, geographical diversification – often measured as interstate banking expansion – seems to lead to higher operating performance and earnings volatility (see Rivard & Thomas, 1997).

In Europe, the handful of cross-country studies conducted to date find that bank mergers and

acquisitions accrue significant stock market valuation and operating performance gains (see Beitel & Schiereck, 2006; Cybo-Ottone & Murgia, 2000; Diaz, Garcia Olalla, & Sanfilippo Azofra,

6 By contrast, Houston et al. (2001) find evidence of some revaluation for certain subsets of banks.

7 This result is also in line with Akhibe and Whyte (2003) and Hughes et al. (1999).

8 See Focarelli and Panetta (2003) and Diaz et al. (2004).

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2004), particularly in the case of product-focused transactions (Beitel, Schiereck, & Wahrenburg, 2004). 9 Overall, then, very little effort has been directed towards understanding how the degree of relatedness between merging firms affects post-merger operating performance, particularly in Europe. We attempt to address this issue by using a wide sample of merging banks, and analyse the factors that are expected to influence the success of M&As by considering whether a merger of firms with similar strategic orientation leads to higher profitability.

2. Strategic fit and performance

The above discussion of the empirical literature on M&As highlights the importance of prod- uct and geographical similarity for post-merger performance. To investigate this issue further, we borrow our model from the strategic management literature. Corporate strategists have long recognised that the “strategic fit” between merging partners is a critical factor in determining the success or failure of a deal. Levine and Aaronovitch (1981) and Lubatkin (1983) were among the first to stress the importance of studying the strategic and organisational aspects of M&A activity. Building on this idea, Markides (1992) analysed this issue with regard to the United States in the 1980s, which was a period in which many firms reduced their diversification by refocusing on their core business. He found that firms announcing a strategic shift towards refocusing on their core activities experienced a significant improvement in their market value. The underlying hypothesis of Markides’ research is that while diversifying has some benefits for corporations, there is a decline in the marginal benefit of diversifying. At the same time, there is also an increase in the marginal costs associated with diversifying. In other words, as firms diversify away from their core business, marginal profits tend to decrease while marginal costs tend to rise (Markides,

1992).

For banks, expanding into new products and geographical areas has a number of advantages. Clearly, it allows financial institutions to diversify both their risks and their sources of revenue, thereby providing a buffer in the event of geographic or product-related shocks. 10 In addition, diversification enables banks to obtain additional benefits derived from a more extensive use of firm-specific assets, such as brand name, consumer loyalty or top-quality managers. In the specific case of large banks involved in both commercial and investment banking activities, the benefits of diversification could also include those derived from scope economies or the ability to quickly mobilise additional financial funds in order to obtain certain investment banking deals. Finally, assuming that banks create effective internal capital markets, diversification would reduce the cost of financing for banks (see Houston, James, & Marcus, 1997). At the same time, as mentioned above, diversification has a number of potential disadvantages. As a financial institution becomes more complex, it is more difficult for managers to control the entity, possibly leading to less efficient internal control procedures and duplicated or overlap- ping expenses. A related issue is that as firms diversify, it is more difficult to create the right

9 Comparing pre- and post-merger performance among European banks, Vander Vennet (1996) finds that domestic mergers of similar-sized partners are profitability-enhancing.

10 Winton (1999) argues that diversification reduces the odds of bank failure and improves performance. At the same time, when banks’ loans have very high downside risks, diversification can actually increase the odds of bank failure, particularly if diversification involves expansion into sectors where the bank lacks expertise. This is confirmed by the empirical results from Acharya et al. (2006), who, using a sample of Italian banks, found that for high-risk banks, diversification produced even riskier banks.

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incentives and to rationalise a workforce. For instance, it might be more complex to create a homogeneous corporate culture for universal banks that are active in both commercial and invest- ment banking activities. In this respect, inefficiencies may be created when managers apply their existing “dominant” logic to newly acquired but strategically dissimilar banks (Prahalad & Bettis, 1986). Similarly, as diversity increases, the internal power struggle between divisions of diversi- fied firms could intensify, leading to a less efficient allocation of resources 11 (see Rajan, Servaes, & Zingales, 2000). In addition, a more diversified financial institution may be more difficult to understand for investors. Thus, it might be difficult for a diversified bank to optimise market value as investors tend to shun opacity. Likewise, managers may choose diversification to reduce risk even when shareholder wealth would be more likely to be maximised by not entering into new lines of business or geographical areas.

3. Methodology and data issues

3.1. Methodology

Normally, each organisation sets its own goals and objectives together with its preferred strat- egy. It is therefore possible to differentiate between firms on the basis of their fundamental choices expressed in terms of long and short-term strategies. Their success is, by and large, dependent on their choice of strategy. We build on the model suggested by Ramaswamy (1997), who anal- ysed the impact of M&As on performance in the US banking sector according to the similarities between target and bidder. The model relates changes in performance before and after a merger to a set of strategic indicators and a set of control variables. Strategy researchers have used resource allocation patterns as indicators of the underlying strategies pursued by organisations (Dess & Davis, 1984; Zajac & Shortell, 1989). For instance, firms which have adopted a cost-efficiency strategy tend to exhibit lower levels of operational expenditure to total assets than other firms. In sum, the concept of strategic similarity used in this paper also assumes that the major aspects of an organisation’s strategy can be seen in the resource allocation decisions that its management takes. Hence we assume that if two firms show similar resource allocation patterns, measured from their balance sheet statements, across a variety of strategically relevant characteristics, they can be broadly considered to be strategically similar (Harrison, Hitt, Hoskisson, & Ireland, 1991). We first identify the financial features of targets and bidders, considering the main charac- teristics regularly used by practitioners to analyse the financial performance of banks. 12 As in Ramaswamy (1997), we measure the strategic similarity of firms involved in M&A activity by using a simple indicator containing the financial characteristics for each strategic variable and individual merger:

SI i,k = (X B,i,k X T,i,k ) 2

(1)

Hence SI i,k is the similarity index for the kth variable for the ith merger, and X B,i,k and X T,i,k are the scores of the target (Tn) and the bidder (Bn) for the kth variable. In terms of sampling, we prefer to examine domestic and cross-border merger results separately. This is because most prac-

11 This is because headquarters have limited power over the divisions of the entity. This is characterised by models of power-seeking (see Shleifer & Vishny, 1989).

12 See McKinsey (2002).

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Table 1 Definition of the strategic variables (in percentages)

Dimension

Symbol

Formula

Performance change Liquidity Efficiency Capitalisation Loan ratio Credit risk Diversity of earnings Off-balance sheet activity Deposit activity Other expenses Bidder performance Relative size Time dummies Country dummies

ROE

Return on equity (post-merger) weighted return on assets (pre-merger) Liquid assets to total deposits Total costs to income Total capital to total assets Loans to total assets Loan loss provisions to net interest revenues Other operational revenues to total assets Off-balance sheet items to total assets Customer loans to customer deposits Other expenses to total assets Return on equity of the bidder (pre-merger) Total assets of target to total assets of bidder Yearly time dummies Country dummies

LIQ

COST/INC

CA/TA

LOAN/TA

BADL/INT INC

OOR/TA

OBS/TA

LOANS/DEP

TECH

PREROE B

RSIZE

TD

CD

Sources: Bankscope and Thomson Financial Deals.

titioners consider the characteristics, motives and performance implications to be very different for domestic and cross-border mergers. 13 Building on the approaches by Datta, Grant, and Rajagopalan (1991), Chatterjee, Lubatkin, Schweiger, and Weber (1992) and Ramaswamy (1997), the dependent variable used is the change in performance, which is measured as the difference between the merged banks’ 2-year average return on equity (ROE) after the acquisition and the weighted average of the ROE of the merged banks 2 years before the acquisition ( ROE). 14 We also use a variety of financial indicators (SI i,k ) to define the strategic features of banks. These indicators include measures of financial perfor- mance, asset and liability composition, capital structure, liquidity, risk exposure, profitability, financial innovation and efficiency (see Table 1). Among the explanatory variables, relative size (RSIZE) and merger performance of the bidder (BID ROE) are included as additional control variables (X i,j ), as these variables are expected to be important determinants of bank performance, as well as country (CD x ) and time dummies (TD l ) 15 :

n

i=1

ROE i =

n

2

i=1 j=1

X i,j +

n

9

i=1 k=1

SI i,k +

14

x=1

CD x +

8

l=1

TD l

(2)

The relationship between changes in performance ( ROE) and efficiency (COST/INC) is expected to depend on whether banks are involved in domestic or cross-border M&As. When domestic consolidation takes place, cost economies related to factors such as overlapping branches and shared technology are probably easier to implement. For cross-border deals, according to most practitioners, potential revenue-enhancing and risk diversification aspects generally prevail over

13 Cross-border mergers are defined as those in which the merging institutions are situated in different EU countries.

14 We consider a 2-year time window for three main reasons. First, it is difficult to single out the impact of a single merger from the others in the sample as a few of the banks in the sample merged several times. Second, when considering a longer time span, the effect of other economic factors could distort the results. Third, when considering a longer time span, the sample size shrinks dramatically, particularly with regard to cross-border mergers. As a robustness check, Appendix A analyses the results for a 4-year window and finds the results broadly unchanged.

15 From a different perspective, Vander Vennet (2002) emphasises the relationship between bank efficiency and size also in Europe.

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cost efficiency-related considerations. This is also because the potential for cost enhancements in cross-border deals is often hampered by greater differences in terms of corporate culture and less overlap in terms of branches and other operational aspects. The relationship between the variables measuring the relative size of target and bidder (RSIZE)

and performance ( ROE) is an ambiguous one (see Amaro de Matos, 2001). It can tentatively be said that for domestic mergers, the smaller the size of the target compared with the bidder (i.e. the lower the RSIZE ratio), the easier it is to impose cost restructuring and realise cost savings. For this reason, a negative relationship between relative size (RSIZE) and performance ( ROE)

is expected.

By contrast, in the case of cross-border mergers, the goal of the bidder is seldom rapidly achieved cost economies but rather revenue-enhancing benefits. As a consequence, for cross- border mergers, a positive relationship between relative size (RSIZE) and performance changes ( ROE) is anticipated. The level of the bidder’s pre-merger performance (PREROE B), measured as its return on

capital, is also likely to influence the post-merger performance of the combined entity ( ROE).

If a bidder has a high level of profitability before the merger, it is more likely that the profitability

of the new institution will decrease in the short term. Conversely, it is probable that bidders with

a lower level of performance will manage to increase their profitability. As a consequence, a

negative relationship between bidders’ PREROE B and ROE is expected initially (see Vander Vennet, 2002). To measure the strategic similarities of firms involved in M&A activity, several indicators of the strategic relatedness of the merging firms are obtained. First, the earnings diversification strategy, which is a broad product strategy, refers to the emphasis on other sources of income apart from the traditional net interest revenues. Maximisation of non-interest revenue as a general strategy is measured by the ratio of other operational revenue to total assets (OOR/TA). The focus on or exposure to off-balance sheet activities (OBS) is measured as the ratio of off-balance sheet activity to total assets (OBS/TA). At the outset, dissimilarities in non-interest income sources of revenue (OOR/TA) and in off-balance sheet activities exposure (OBS/TA) are both expected to enhance post-merger performance ( ROE) as they could help to broaden access to financial innovation and new sources of revenue (see Gande, Puri, & Saunders, 1997; Harrison et al., 1991). This positive relationship is expected to be particularly strong in the case of domestic mergers, where homogeneity among merging entities tends to be higher and the difficulties associated with the integration of new products are normally lower than in the case of cross-border mergers (see Harrison et al., 1991). Second, banks’ strategies in relation to their credit risk and loan-to-deposit profiles are exam- ined. The credit risk strategy is measured as the level of loan loss provisions divided by net interest revenues (LLP/IR). Regarding banks’ loan and deposit profiles, the ratio of total loans to total customer deposits (L/D) is included, as it provides a proxy for the use of relatively low-cost deposits in relation to the amount of loans outstanding. In addition, banks’ broad balance sheet loan composition is measured as the ratio of net loans to total assets (NL/TA), which takes into account the prominence of loans in banks’ total assets. In general, post-merger performance can be expected to worsen when banks with very different asset quality and overall portfolio strategies merge. Since economies of scale and the fast integra- tion of the cost base are essential goals of a large number of domestic mergers, conflicts arising from managerial disparities with regard to critical decisions, such as asset quality or the overall portfolio strategy structure, may be an obstacle to creating such synergies. Overall, the greater the difference between merging banks’ strategies, the lower the performance after merging is initially

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expected to be. The opposite may happen in cross-border mergers, as one of the goals of such operations may be to improve revenues derived from the inclusion of new portfolio strategies or to reduce the risk profile of one of the merging partners (see Demsetz & Strahan, 1997). Third, the cost controlling strategy, which shows the emphasis on minimising costs by relating expenditure to revenues, is measured by the cost to total income ratio (CIR). As a result of economies of scale and scope stemming from the combination of similar skills, a firm competing on the basis of low cost and operating efficiency is expected to benefit from merging with another organisation characterised by a set of similar competencies. Firms characterised by different cost controlling strategies, however, may show a drop in performance if they merge (see Altunbas, Molyneux, & Thornton, 1997; Prahalad & Bettis, 1986). As a consequence, the cost to income ratio (CIR) is expected to be negatively correlated with overall performance (ROE). On the other hand, this kind of relationship may not be significant in the long term if a cost-efficient bidder manages to implement its low-cost strategy across the larger merged firm. This may also be the case for cross-border M&As, where cost controlling may not be the main strategic advantage sought by the firms involved (see Berger et al., 2000). Fourth, the capital adequacy level is measured as the ratio of equity to total assets (CA/TA). Practitioners, analysts and regulators have attached increased importance to this variable in recent years. From a prudential regulatory perspective, bank capital has become a focal point of bank regulation (see Vives, 2000). The effect of changes in the capital adequacy level on performance depends on the theory of the banking firm. According to the “signalling hypothesis”, commer- cial banks specialise in lending information to problematic borrowers (Berger, Herring, & Szego, 1995). Since bank managers usually have a stake in the capital of the bank, “it will prove less costly for a ‘good’ bank to signal better quality through increased capital than for a ‘bad’ bank”. 16 There- fore, banks can signal favourable information by merging with banks with larger capital ratios, indicating a positive correlation between capital and earnings, and suggesting a positive relation- ship between capital structure dissimilarities and performance (see Acharya, 1988). Conversely, Ross (1977) argues that lower, rather than higher, capital ratios signal positive information, since signalling good quality through high leverage would be less onerous for a “good” bank than for a “bad” bank. 17 Fifth, the liquidity risk strategy is measured as the ratio of liquid assets to customer and short- term funding (LIQ). As maintaining a generous liquidity ratio is expensive, different liquidity management strategies might imply that one of the merging banks can improve its liquidity management after the merger, thereby improving performance. Finally, the strategy of banks in terms of technology and innovation is measured as other costs (i.e. total costs excluding interest, staff and other overhead payments) to total assets (TECH). Dissimilarities in investment in technology between the bidder and the target are expected to produce better performance as each of the merging partners may benefit from returns to scale and scope derived from the investments made by their merging counterpart. In the case of cross-border mergers, however, where technological incompatibilities are likely to be greater, differences in strategy may lead to a drop in performance (see Harrison, Hall, & Nargundkar, 1993).

16 Berger (1995, p. 436).

17 Another argument regarding changes in the capital structure and performance relates to agency problems between shareholders and managers. Some of the corporate finance literature suggests that increasing financial leverage could reduce this type of agency problem. The reason for this is that leverage may increase pressure on bank managers to become more efficient owing to short-term pressures arising from debt-servicing needs (see Berger et al., 1995; Jensen,

1986).

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3.2. Data sources

9

Our data cover registered mergers and acquisitions that took place in the EU banking sector between 1992 and 2001. Two hundred and sixty-two such M&As took place, of which 207 were domestic and 55 were cross-border. To be included in the sample, both the target and the bidder banks had to be independent commercial banks based in an EU Member State at the time of the merger, and the bidder must not have been involved in any other merger in the 3 years prior to the merger. Individual deal-by-deal data on the M&A activity of financial firms were obtained using the SDC Platinum database from Thomson Financial. The accompanying individual accounting data for each of the merged companies were taken from the Bank Scope database of Bureau Van Dyck.

4. Results

The descriptive statistics (see Table 2) indicate that, in terms of size, as measured by total assets, the bidders are on average around seven times larger than the targets. Bidders are also more cost- efficient than targets, particularly in the case of domestic mergers. On the other hand, targets have larger loan and non-interest income to total assets ratios. Targets also have substantially less capital leverage than bidders. Comparing domestic and cross-border M&As, domestic targets tend to have a better credit risk profile than the bidders, whereas in cross-border M&As the level of loan loss provisions is broadly similar for targets and bidders. The main differences relate to the size and quality of assets, suggesting that cross-border mergers are mainly to be expected from larger institutions which, probably as a result of greater information asymmetries, take over institutions with better credit quality and capital ratios. The overall picture, then, is of large and generally more efficient banks taking over relatively less risky, smaller institutions with more diversified sources of income. In many respects, the financial features of bidders and targets engaged in domestic consolidation are similar to the features of those involved in cross-border deals. Following a cross-border merger, the performance ( ROE) of the new joint entity increases by around 2.5%, in terms of the return on capital (see Table 3). The improvement in performance is also confirmed by the median increase in returns of around 1.5%. Banks entering into domestic mergers experience, on average, an improvement in performance of 1.2%. Owing to the scarcity of European studies, this finding is interesting in itself, but it is also striking because most US empirical literature finds no abnormal stock market returns or improved post-merger efficiencies. The finding, however, is broadly consistent with results by Houston, James, and Ryngaert (2001) for the United States and Diaz et al. (2004) for Europe. In terms of size, the relative size of targets compared with bidders tends to be smaller in domestic than in cross-border deals. The median figures for the relative size indicator (RSIZE) show that targets are around 21% of the size of bidders for cross-border mergers and 19% for domestic mergers. The main strategic differences among variables are shown in detail in Table 3. The median and mean in Table 3 could be directly interpreted as a measure of dispersion between merging partners in the units of the underlying variable expressed as percentages. 18 Concerning the differences

18 For instance, a mean in the relatedness index of 22.5 for a specific variable would indicate an average absolute difference among merging partners of 22.5% on that given variable.

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Table 2 Descriptive statistics of the main ratios of the merging institutions

Variables a

Cross-border

Domestic

Mean

Median

S.D.

Mean

Median

S.D.

Target Total assets b Liquid assets to total deposits Total costs to income Total capital to total assets Loans to total assets Loan loss provisions to net interest revenues Other operational revenues to total assets Off-balance sheet items to total assets Customer loans to customer deposits Other expenses to total assets

Bidder pre-merger Total assets b Total assets b Liquid assets to total deposits Total costs to income Total capital to total assets Loans to total assets Loan loss provisions to net interest revenues Other operational revenues to total assets Off-balance sheet items to total assets Customer loans to customer deposits

58,667

24,629

65,373

18,202

2,554

40,211

30.7

28.2

18.2

30.3

27.7

23.4

68.7

69.8

17.0

71.5

72.0

19.1

6.9

5.0

8.6

6.9

5.7

6.3

48.7

49.1

19.3

51.8

49.7

26.3

24.1

16.9

24.9

27.9

18.7

39.3

1.2

1.1

0.7

1.3

1.1

1.2

24.9

15.8

29.0

18.9

12.6

24.4

70.1

65.0

45.7

71.8

60.4

46.0

0.9

0.9

0.4

1.3

1.2

0.9

208,597

166,548

183,144

61,437

19,296

93,762

29.9

25.7

18.0

28.2

26.0

17.2

66.9

69.1

13.4

68.1

69.5

12.9

4.5

3.8

2.1

5.7

5.1

3.3

45.9

47.9

13.3

49.0

49.6

15.3

24.4

19.0

23.2

19.5

17.1

12.0

1.1

1.1

0.6

1.1

1.0

0.9

28.7

19.0

49.9

28.3

16.6

136.0

68.9

64.9

35.4

67.5

62.7

48.2

0.8

0.8

0.4

1.1

1.0

0.7

Bidder post-merger Total assets b Total assets b Liquid assets to total deposits Total costs to income Total capital to total assets Loans to total assets Loan loss provisions to net interest revenues Other operational revenues to total assets Off-balance sheet items to total assets Customer loans to customer deposits

267,694

201,665

233,659

81,609

25,054

129,460

24.9

23.3

15.1

29.3

29.6

14.7

67.1

68.5

14.1

68.1

68.4

16.2

4.5

3.9

2.1

5.9

5.5

3.2

45.6

44.5

14.1

50.9

51.8

15.0

23.0

14.0

36.8

16.6

15.6

11.6

1.4

1.5

0.7

1.2

1.2

0.8

27.0

23.5

23.8

20.6

15.5

18.9

63.9

61.1

22.8

71.5

68.2

38.7

0.8

0.8

0.4

1.0

0.9

0.6

a See Table 1 for a definition of the variables.

b Total assets in US dollars (millions). Since the standard deviations could be substantial for some of the ratios, Appendix B also considers whether the differences between bidders and targets are statistically significant.

between domestic and cross-border deals in the indices of relatedness, targets and bidders are quite different in terms of their credit risk, off-balance sheet and liquidity strategic positions. They also differ in capital structure, albeit to a lesser extent. Appendix C considers the correlations among the different variables. As expected, we find some correlation between those ratios that share the same balance sheet item on their numerator or denominator (such as LOAN/TA and OOR/TA). This suggests the possibility of some multi- collinearity between some of the variables. Hence, we employ – stepwise – maximum likelihood estimation to single out the model and take into account that some of the variables might show

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Table 3 Descriptive statistics of the main determinants of performance

 

Variables

Cross-border

 

Domestic

 

Mean

Median

S.D.

Mean

Median

S.D.

Dependent variable

Performance change

2.44

1.68

5.44

1.22

1.05

5.37

Control variables

Relative size

0.79

0.21

1.62

0.75

0.19

2.16

Bidder performance

9.41

8.94

5.88

8.11

8.02

6.20

Strategic relatedness Liquidity Efficiency Capitalisation Loan ratio Credit risk Diversity of earnings Off-balance sheet activity Deposits activity Other expenses

21.01

18.74

17.60

12.94

8.82

13.28

15.70

10.82

14.03

16.49

11.83

15.89

4.00

1.95

8.48

3.47

1.75

6.13

18.06

14.08

15.31

18.16

10.88

24.03

22.50

13.94

27.78

18.22

7.05

36.11

0.72

0.52

0.60

0.81

0.48

1.15

27.47

12.96

50.83

22.10

7.10

128.96

37.10

25.05

42.01

35.59

17.19

56.21

0.56

0.32

0.38

0.63

0.43

0.80

Note: The strategic variables show the values of the similarity index for each variable.

multi-collinearity. 19 Possible idiosyncratic heterogeneity effects are taken into account through the use of country and time dummies. These dummies are particularly important to filter out macroeconomic and regulatory factors. 20 Table 4 illustrates the responsiveness of banks’ post-merger performance to a set of main control variables (model 1) and an additional set of variables measuring strategic similarity. Model 1 shows the impact of the control variables on post-merger performance, whereas model 2 also includes the strategic variables. The results are given separately for cross-border and domestic mergers to take into account the distinct differences between the two types of merger. As expected, the results indicate that size differences between merging partners play a major role in influencing performance, but the impact differs markedly for domestic and cross-border mergers. For domestic mergers, the larger the target bank is by comparison with the bidder, the lower the post-merger performance, which reflects the difficulty of assimilating larger institutions. By contrast, for cross- border mergers, the larger the target is by comparison with the bidder, the better the post-merger performance is on average. This is probably because in cross-border mergers, the goal of the bidder is generally not to achieve rapid cost economies but rather to gain benefits deriving from other synergies. The results for pre-merger bidder return on capital (PREROE B) suggest that a relatively high level of performance on the part of the bidder tends to negatively affect the level of performance of the new entity after the merger. These results are in line with the “floor/ceiling effect” of

19 In the case of cross-border mergers, we consider the country of the bidder. The regression weights the impact on the

parameters of the size of the bidder institution. As a robustness check, we also ran the ridge regression method – to account for the possible distortion on the coefficients derived from linear dependencies among variables – and this showed broadly similar results.

20 Since M&As normally come in waves (see Shleifer & Vishny, 2003), the use of time dummies is also helpful to filter out the effect on changes in performance of years of particularly high M&A activity.

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Table 4 Results of hierarchical regression analysis of the impact on change in performance of strategic and other control variables

Variables

Domestic

Cross-border

Model 1

Model 2

Model 1

Model 2

Relative size Bidder performance level Efficiency Capitalisation Loan ratio

0.443* (0.0516)

0.335* (0.0495)

0.325* (0.0607)

0.327* (0.0587)

0.538* (0.0153)

0.540* (0.0148)

0.468* (0.0358)

0.494* (0.0358)

0.057* (0.0057)

0.044** (0.0149)

0.070* (0.0148)

0.202* (0.0218)

0.026* (0.0052)

0.095* (0.0145)

Credit risk Diversity of earnings Other expenses

0.001 (0.0025)

0.013 § (0.0078) 0.318 (0.3531) 4.150* (0.5808)

0.589* (0.0843)

0.827* (0.1513)

Off-balance sheet activity Liquidity

0.003* (0.0006)

0.007 § (0.0037) 0.033* (0.0102)

0.001 (0.0069)

Deposit activity Intercept R 2 -adj F-value

5.133* (0.2603)

0.003 § (0.0017) 6.474* (0.2827)

7.152* (0.4776)

0.009 + (0.0041) 9.573* (0.5327)

0.425

0.488

0.404

0.537

217.080

123.120

62.740

47.230

Note: * ,+,§ Significant at the 1%, 5% and 10% levels, respectively. Model 1 includes the control variables only. Model 2 is the complete model, which includes both the control and strategy variables. The standard errors of the coefficients are in parenthesis.

the empirical literature (see Ramaswamy, 1997). In other words, as bidders tend to have higher performance levels than targets, a certain balancing of performance between bidders and targets is likely to take place after the merger. 21 Differences in efficiency levels, measured as the cost-to-income ratio, are disadvantageous from a performance perspective. This could be due to the difficulty of integrating banks with very different cost structures, particularly in the short term. As indicated, firms characterised by different cost controlling strategies could experience a drop in performance if they merge (see Altunbas et al., 1997). This finding may be related to US evidence showing that there is generally very little improvement in cost efficiencies after a merger (see DeYoung, 1997; Rhoades, 1994). Concerning the differences in capital structure, in the case of domestic mergers, capital level differences are performance-enhancing. For cross-border M&As, however, dissimilarities in the capital structures tend to result in lower performance. Since capital is often used by banks to signal favourable asset quality, it seems to be more difficult for cross-border mergers (where asymmetries of information between merging partners are larger than for domestic mergers) to integrate institutions with different capital structures. The results for the diversity of earnings, credit risk and loan-to-asset ratio variables show that, for domestic deals, it can be quite costly to integrate institutions which are heterogeneous in terms of their earnings and loan strategies. In other words, the more the bidder’s type of business differs from that of the target in a domestic merger, the worse the post-merger performance will be. The cost-cutting focus of the bulk of domestic operations coupled with the usual conflicts arising from managerial disparities with regard to critical decisions could account for this effect. This is in line with the bulk of the US literature, which suggests that the corporate focus tends to be on enhancing performance.

21 It is useful to include time dummy variables to account for idiosyncratic heterogeneity.

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By contrast, in cross-border M&As, the greater the difference is in credit risk and the loan-to- total assets position, the better the average improvement in performance. This supports the theory that enhanced revenues derived from scope economies and broad complementarities between merging institutions are one of the major drivers of cross-border M&As. In addition, it also signals banks’ concern with becoming large international players, as size is perceived to be a major requirement for significant participation in investment banking activities (see Cabral et al., 2002). The results on technology and innovation strategies suggest that differences in terms of innova- tion investment between bidders and targets impact post-merger performance. The more dissimilar banks’ strategies are, the better on average their post-merger performance, as merging partners benefit from the investments in financial innovation and technology made by their counterpart. However, dissimilarities in strategy may create problems in cross-border M&As because the strategies of the merging partners may be incompatible. Finally, in terms of the deposit strategies of merging partners, increased relatedness contributes to enhanced performance for both domestic and cross-border mergers, with the effects being stronger for cross-country mergers, which normally involve greater integration difficulties.

5. Conclusion

The aim of this paper was to shed light on the process of financial consolidation in the EU by assessing whether strategic and organisational fit between financial institutions involved in merg- ers and acquisitions plays an important role in improving post-merger financial performance. We used a relatively simple approach, taking a strategic management and resource-based view of the firms by accepting that financial decisions are, to some reasonable extent, a reflection of the main underlying strategies of banks. The empirical analysis was carried out on an extensive sample of individual European banks’ M&As, which was linked to individual bank accounting information. Results from the descriptive analysis show that the overall statistical picture is of large, generally more efficient banks merging with relatively smaller and better capitalised institutions with more diversified sources of income. By contrast with the results of most of the US literature, we found that there are improvements in performance after a merger has taken place, particularly in the case of cross-border M&As. In terms of the impact of strategic relatedness on performance, the overall results show that broad similarities between merging partners are conducive to improved perfor- mance, although there are significant differences between domestic and cross-border M&As and those involving different strategies. On average, we found that consistency in the efficiency and deposit strategies of merging partners is performance-enhancing, both for domestic and for cross-border M&As. For domestic mergers, we found that dissimilarities in earnings, loan and deposit strategies can have a deleterious effect on performance, whereas differences in capitalisation, technology and innovation strategies were found to improve performance. By contrast, for cross-border M&As, differences in loan and credit risk strategies are performance-enhancing, whereas a lack of coherence in capitalisation, technology and financial innovation strategies has a negative effect on performance. This lends support to the widespread view that difficulties often arise when integrating institutions with widely different strategic orientation.

Acknowledgements

We are very grateful for the useful comments received from an anonymous referee as well as

Phil Molyneux, Rudy Vander Vennet, Rebecca Young, and Jukka

from Hans-Joachim Klockers,¨

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Vesala. We would also like to warmly thank Jean-Paul Genot for his help in pointing us towards the right sources of information.

Appendix A

Table 4 Results of hierarchical regression analysis of the impact on change in performance of strategic and other control variables

Variables

Domestic

Cross-border

Model 1

Model 2

Model 1

Model 2

Relative size Bidder performance level Efficiency Capitalisation Loan ratio Credit risk Diversity earnings Other expenses Off-balance sheet act Liquidity

0.985* (0.137)

0.591* (0.1293)

0.193 (0.1209)

0.112 (0.1312) 0.147 + (0.069) 0.002 (0.10) 0.820* (0.145) 0.033* (0.007) 0.0260 + (0.0122) 3.072 (0.600) 6.231* (1.401) 0.036* (0.007) 0.027* (0.0100)

1.198* (0.0274)

1.216* (0.0252)

0.264* (0.0534)

0.076* (0.009)

0.059* (0.0216)

0.067* (0.010)

0.017 (0.0068)

0.636* (0.155)

2.396* (0.301)

0.005* (0.0008)

0.067* (0.0143)

Deposit activity Intercept R 2 -adj F-value

0.004 § (0.0014) 13.541* (2.053)

 

0.0205* (0.0024)

20.523* (1.621)

49.579* (3.739)

10.169* (0.400)

0.745

0.791

0.845

0.537

451.44

254.55

256.36

47.230

Note: * ,+,§ Significant at the 1%, 5% and 10% levels, respectively. Model 1 includes the control variables only. Model 2 is the complete model, which includes both the control and strategy variables. The standard errors of the coefficients are in parenthesis.

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Appendix B

Table 4 Domestic mergers: descriptive statistics and statistical differences of financial features of target and bidder banks

Variables a

Bidders

 

Targets

 

Mean

S.D.

Mean

S.D.

Target Total assets b Liquid-assets-to-deposits ratio Cost-to-income ratio Capital-to-total assets ratio Loans to total assets Loan provisions-to-int. ratio Other operating inc. to total assets Off-balance sheet to total assets Customer loans-to-deposits ratio Return on equity

61436 *

 

93761

1820 *

 

40210

 

28.1

17.2

30.2

23.3

68.0

*

12.8

71.5

*

19.1

5.6

*

3.2

6.9

*

6.3

49.0

15.3

51.8

26.2

19.4

*

12.0

27.9

*

39.3

1.1

0.8

1.3

1.1

28.2

135.9

18.9

24.4

67.4

48.2

71.7

45.9

7.8

*

9.0

0.4

*

27.2

Return on assets

0.5

*

0.4

0.2

*

1.2

Other expenses to total assets

2.8 *

1.4

3.5 *

1.9

a See Table 1 for a definition of the variables.

b Total assets in US dollars (millions).

* Indicates that bidders’ and targets’ means of each variable are statistically different at 5% (paired t-test).

Table 4 Cross-border mergers: descriptive statistics and statistical differences of financial features of target and bidder banks

Variables a

Bidders

Targets

Mean

S.D.

Mean

S.D.

Target Total assets b Liquid-assets-to-deposits ratio Cost-to-income ratio Capital-to-total assets ratio Loans to total assets Loan provisions-to-int. ratio Other operating inc. to total assets Off-balance sheet to total assets Customer loans-to-deposits ratio Return on equity

208597.4

*

183144.1

58666.87 *

65372.9

29.9

18.0

30.6

18.2

66.8

1.8

68.7

2.2

4.5

2.1

6.9

8.6

45.9

13.3

48.7

19.3

24.3

23.1

24.1

25.0

1.1

0.1

1.2

0.1

28.7

49.8

24.9

29.0

68.8

35.4

70.1

45.7

9.0

9.1

6.7

16.4

Return on assets

0.3

1.1

0.5

1.1

Other expenses to total assets

2.1 *

0.1

2.6 *

0.2

a See Table 1 for a definition of the variables.

b Total assets in US dollars (millions).

* Indicates that bidders’ and targets’ means of each variable are statistically different at 5% (paired t-test).

16

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Please cite this article in press as: Altunbas¸, Y., Marques, D., Mergers and acquisitions and bank per-´ formance in Europe: The role of strategic similarities, Journal of Economics and Business (2007),

doi:10.1016/j.jeconbus.2007.02.003

Appendix C

Table 4 Correlation matrix of the variables

 

ROE

RSIZE

BID ROE

LIQ

COST/INC

CA/TA

LOAN/TA

BADL/INT I

OOR/TA

OBS/TA

LOAN/DEP

TECH

Cross-border

ROE

1

RSIZE

0.43*

1

BID ROE

0.51*

0.51*

1

LIQ

0.19

0.00

0.08

1

COST/INC

0.25*

0.12

0.06

0.21

1

CA/TA

0.32*

0.00

0.17

0.17

0.49*

1

LOAN/TA

0.13

0.01

0.19

0.28**

0.31*

0.39*

1

BADL/INT INC

0.17

0.47*

0.33*

0.11

0.42*

0.08

0.17

1

OOR/TA

0.13

0.37*

0.30*

0.12

0.13

0.06

0.21

0.25*

1

OBS/TA

0.19

0.02

0.16

0.01

0.05

0.08

0.01

0.11

0.11

1

LOANS/DEP

0.14

0.08

0.08

0.04

0.22

0.28*

0.53*

0.09

0.15

0.08

1

TECH

0.7

0.26*

0.22

0.11

0.14

0.02

0.31*

0.16

0.54

0.12

0.08

1

Domestic

ROE

1

RSIZE

010

1

BID ROE

0.61*

0.04

1

LIQ

0.09

0.04

0.10

1

COST/INC

0.17*

0.07

0.01

0.01

1

CA/TA

0.11

0.11

0.05

0.16*

0.09

1

LOAN/TA

0.13*

0.12

0.01

0.21*

0.32*

0.03

1

BADL/INT INC

0.08

0.05

0.02

0.00

0.12*

0.05

0.19*

1

OOR/TA

0.19

0.06

0.13*

0.13*

0.05

0.22*

0.15*

0.12*

1

OBS/TA

0.03

0.03

0.10

0.02

0.02

0.00

0.01

0.01

0.01

1

LOANS/DEP

0.09

0.08

0.5

0.9

0.16*

0.08

0.42*

0.17*

0.1*

0.03

1

TECH

0.05

0.09

0.02

0.09

0.46*

0.17*

0.57*

0.09

0.34*

0.01

0.06

1

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Please cite this article in press as: Altunbas¸, Y., Marques, D., Mergers and acquisitions and bank per-´ formance in Europe: The role of strategic similarities, Journal of Economics and Business (2007),

doi:10.1016/j.jeconbus.2007.02.003

Appendix D

Table 4 Mergers and acquisitions in the EU banking sector from 1992 to 2001 (value of transactions in millions of US dollars)

Country of target

Country of bidder

 

Austria

Belgium

Denmark

Finland

France

Germany

Greece

Ireland

Italy

Lux.

Netherlands

Portugal

Spain

Sweden

UK

Austria

6,850

0

8,427

20

96

0

0

Belgium

0

19,405

2,022

694

41

0

12,250

0

Denmark

0

8,259

4,426 363

24

0

1

373

Finland

0

2,724

0

0

0

5,141

France

7,970

109,246

1,875

640

517

0

0

408

0

12,001

Germany

0

0

438

64,091

0

186

358

0

1,323

1,703 281

 

Greece

267

445

17,399

0

432

0

Ireland

358

23

0

4,430

147

312

Italy

0

0

644

2,198

152,683

18

857

26

907

181

Luxembourg

131

0

0

0

1,135

2

2,591

Netherlands

2,704

19

469

20

73

6,413

221

0

0

78

Portugal

126

0

0

0

26,050

3,992

83

Spain

25

1,404

881

0

1,372 370

814

1,208

53,271

0

952

Sweden

397

150

20

0

124

20,819

United Kingdom

0

392

0

25

1,302

5,245

0

1,155

0

40

80

0

2,758

42

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