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Do Financial Conglomerates Create or Destroy Economic Value?

This paper attempts to ascertain whether or not diversification (revenue and cost economies of scope) is value-enhancing or value-destroying in the financial services sector. The degree of diversification can change either as a financial services firm divests or acquires assets, or as it redirects its business activity into new business segments. Additionally, its portfolio of activities can shift over time due to divergent growth rates in the existing business segments and can assume more or less diverse geographic patterns.

Recent years have seen a burgeoning of mergers and acquisitions in the financial services sector. Of approximately 350,000 M&A transactions in all industries valued at $24.6 trillion during 1985-2005 worldwide, approximately 124,000 transactions valued at $10.1 trillion (41 percent by value) involved the financial services industry - defined as commercial banking, investment banking, insurance, asset management, and financial infrastructure services (clearance, settlement, payments, custody, etc.).

These transactions presumably had as their principal objective increasing the value of the firms involved through some combination of revenue enhancement, improved operating efficiency, or risk reduction. All of the transactions either increased the firm's market share, defined functionally or geographically, or diversified its operations across financial functions or geographies (or both).

Of the aforementioned financial-sector transactions, about 20% by value were "cross-market," involving at least two areas of financial services activity, and about 7% were "cross-border" involving more than one country. At the extreme, both financial conglomerates and global financial firms have emerged as important participants in the market for financial services.

Do Financial Conglomerates Create or Destroy Economic Value?