Bank consolidation is a global phenomenon. In the U.S. alone, over 8,000 bank mergers occurred from 1980 through 1998, while the largest acquisitions, accounting for one-half of the total consolidated assets for the 19-year period, occurred from 1995 through 1998 (Rhoades, 2000). Countries in Europe and elsewhere have experienced consolidation as well.
A recent study by the Group of Ten found a high level of merger and acquisition activity in the 1990s among financial firms in 13 countries studied (Australia, Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Spain, Sweden, Switzerland, U.K., and the U.S.), with a noticeable acceleration in consolidation activity from 1997 through 1999. Of the 7,304 financial mergers documented in the study, nearly 61 percent involved banks. This consolidation activity created a number of large, complex financial institutions, and the number of banking firms declined in almost every country during the decade (Group of Ten Report, 2001).
Recent studies have shown that such consolidation may enhance the value of banks in the industry since there appear to be strong scale economies (Stiroh, 2000; Hughes, Lang, Mester, and Moon, 2000; and Hughes, Mester, and Moon, 2001). The potential for scope economies between various product lines, although not supported by strong empirical evidence in the literature, could also drive value-enhancing consolidation.
Skeptics, on the other hand, often accuse bankers of sacrificing value to build increasingly larger institutions, or financial empires. Some bank mergers have been criticized for not producing the cost savings or increased revenues that were touted when the mergers were announced, and some academic studies of the effects of consolidation on cost efficiency confirm the critics’ assessment (Peristiani, 1997). Other studies find it difficult to make a general statement about the efficiency of mergers (Shaffer, 1993). Studies of the effects of bank acquisitions on bank market value have generally been negative. In critical reviews of this literature, Pilloff and Santomero (1996) and Calomiris and Karceski (1998) note that, while some event studies find that acquirers increase their market value, more studies find that acquirers destroy value.
The weight of the evidence raises the question of whether the value-enhancing incentives to merge are being subordinated to the incentives to build a larger institution from which the managers could more easily take greater financial compensation and consume more agency goods, such as perquisites, reduced effort, and risk avoidance. Presumably, the ability of managers to act on these value-destroying incentives to merge depends on their ability to resist market discipline that is, on the level of their entrenchment.
This paper seeks evidence on these incentives from data on publicly traded bank holding companies operating in the U.S. from 1992 through 1994. We proceed by characterizing managerial entrenchment and by looking for evidence of entrenchment in the association of ownership structure and investment opportunities with financial performance. We use two measures of financial performance: (1) a proxy for Tobin’s q ratio and (2) a measure of lost market value, the shortfall of the actual market value of a bank’s assets from their highest potential market value. We estimate the highest potential market value of a bank’s investment in its assets by fitting a stochastic frontier of banks’ market values to their investments in assets.
The stochastic frontier yields a “best-practice” market value of each bank’s investment in assets as well as the short-fall between this potential value and the bank’s achieved market value. We then examine the relationship between financial performance and ownership structure to identify those structures that are associated with poorer performance. We term such structures “entrenched.” Ownership structure is given by the proportion of the bank owned by insiders, an indication of their ability to resist market discipline, and by the proportion of the bank owned by outside block-holders, an indication of the incentive of these stakeholders to monitor management.
