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Federal Reserve Bank of Chicago
Local Market Consolidation and Bank
Productive Efficiency
Douglas D. Evanoff and Evren Örs
WP 2002-25
Local Market Consolidation and Bank Productive Efficiency
Douglas D. Evanoff
and
Evren Örs1
Abstract
The recent banking literature has evaluated the impact of mergers on the efficiency of the
merging parties [e.g., Rhoades (1993), Shaffer (1993), Fixler and Zieschang (1993)]. Similarly,
there has been analysis of the impact of eliminating bank entry restrictions on the average
performance of banks [Jayaratne and Strahan (1998)]. The evidence suggests that acquiring banks
are typically more efficient than are acquired banks, resulting in the potential for the new combined
organization to be more efficient and, therefore, for the merger to be welfare enhancing. The
evidence also suggests, however, that these potential gains are often not realized. This has led some
to question the benefits resulting from the recent increase in bank merger activity. We take a
somewhat more comprehensive and micro-oriented approach and evaluate the impact of actual and
potential competition resulting from market-entry mergers and reductions in entry barriers on bank
efficiency. In particular, in addition to the efficiency gains realized by the parties involved in a bank
merger, economic theory argues that additional efficiency gains should result from the impact of the
merger on the degree of local market competition. We therefore examine the impact of increased
competition resulting from mergers and acquisitions on the productive efficiency of incumbent
banks. Our findings are consistent with economic theory: as competition increases as a result of
entry or the creation of a more viable local competitor, the incumbent banks respond by increasing
their level of cost efficiency. We find this efficiency increase to be in addition to any efficiency
gains resulting from increases in potential competition occurring with the initial elimination of
certain entry barriers. Thus, consistent with economic theory, new entrants and reductions in entry
barriers lead incumbent firms to increase their productive efficiency to enable them to be viable in
the more competitive environment. Studies evaluating the impact of bank mergers on the efficiency
of the combining parties alone may be overlooking the most significant welfare enhancing aspect of
merger activity. We do not find evidence of profit efficiency gains. In fact, the mergers are
associated with decreases in profit efficiency; perhaps indicating that revenues may also be
competed away from incumbents as a result of mergers.
1
The authors are affiliated with the Federal Reserve Bank of Chicago and Southern Illinois University,
respectively. They acknowledge helpful comments on earlier drafts from Nicola Cetorelli, Bob DeYoung,
Joe Hughes, Frank Skinner and participants in the 2000 International Atlantic Economic Society Meetings in
Charleston, the 2001 Financial Management Association Meetings in Toronto and the 2002 American
Economic Association meetings in Atlanta. Outstanding data and editorial support by Nancy Andrews, Portia
Jackson and Sue Yuska is acknowledged and greatly appreciated. The views expressed are those of the
authors and may not be shared by others including the Federal Reserve Bank of Chicago and the Federal
Reserve System.
Comments can be addressed to the authors at Research Department, 230 South LaSalle Street, Chicago, IL
60690-0834 (312-322-5814) devanoff@frbchi.org, and Department of Finance, MC 4626, Carbondale, IL
62901 (618-453-1422) eors@siu.edu, respectively.
1
Local Market Consolidation and Bank Productive Efficiency
1. Introduction
In the U.S., local banking markets have historically been protected from entry through a
complex set of state and federal regulations. Significant industry consolidation, mostly in the form
of mergers and acquisitions (M&As), has followed the deregulation that took place over the past
two decades. Indeed M&A activity has been substantial over this period with some 350 bank
mergers per year during the 1980s and expanding to over 550 per year during the 1990s. Although
most of these involve smaller banks, interest in the impact of mergers has been significant and has
recently been renewed with the combination of larger banks.
There is significant disagreement as to the effect of these mergers. Economic theory
suggests that mergers can be an efficient means to restructure the industry allowing inefficient
banks to exit the industry and more efficient firms to obtain efficient scale. However, the evidence
on the welfare gains from merger activity has been mixed, at best. Indeed, as the result of studies
finding relatively minor cost savings and adverse effects on the stock value of the acquiring firm,
recent research has often questioned the motives of the management of acquiring banks. For
example, evaluating the relationship between large mergers and executive compensation, Bliss and
Rosen (2001) found evidence of agency problems and empirical support for the contention that
mergers typically increase the wealth of the CEO, often at the expense of shareholders. So there
appears to be little evidence of welfare enhancing benefits resulting from the recent increase in bank
merger activity.
While previous research has evaluated the productive efficiency gains from merging banks,
we take a broader perspective and evaluate potential benefits induced by market structure changes
brought on by bank consolidation. Ours is a more comprehensive, micro-oriented approach that
examines a group of banks that are expected to be indirectly affected by bank M&As: incumbent
2
banks that operate in the same market as the acquired bank. We examine changes in incumbent
banks’ productive efficiency following M&A. Our priors are that external entry into a market via an
M&A or within-market consolidation will give a competitive incentive to other incumbent banks to
improve the efficiency of their operations. While the bank productive efficiency research, and the
bank M&A literature are rather extensive, the effect of entry on the efficiency of incumbent banks
has not received as much attention. If one is interested in the potential welfare implications of bank
merger activity, however, incumbents’ cost reductions and revenue adjustments as a reaction to
consolidation may dominate the impact found from concentrating exclusively on the merging
parties.
In the next section we discuss the bank merger literature and align our work within that
literature. In Section 3 our methodology and data sources are discussed. Our empirical findings are
discussed in Section 4 and the final section summarizes.
2. Background and Motivation
As the bank consolidation trend has increased in recent years there have been a number of
studies to evaluate the potential impact of bank mergers. The issues considered include the
potential impact on market competition [Savage (1993), Thomas (1991), Calem and Nakamura
(1995), Prager and Hannan (1998) and Amel and Liang (1997)]; on market entry [Seelig and
Crutchfield (1999) and Berger, Bonime, Goldberg and White (2000)]; and on credit availability
[Rose (1993), Whalen (1995, 2001), Gunther (1997) and Berger, Demsetz, and Strahan (1999)].
The most common justification for bank mergers, however, is that they should result in cost
reductions and superior operating efficiency. For years, the potential benefits resulting from
mergers were evaluated by estimating the potential efficiency gains to be realized from scale
3
economies. Most of the bank cost literature, however, found that scale advantages were exhausted at
relatively low levels of outputs and nearly constant returns to scale were rather common in the
industry [for literature reviews see Berger, Demsetz and Strahan (1999), Berger and Humphrey
(1997), Berger, Hunter and Timme (1993) and Evanoff and Israilevich (1991)].2 More recently
merger studies have evaluated the impact of bank mergers on the potential improvement in
operating efficiency measured with either standard cost accounting ratios or as technical
inefficiency representing production away from the cost frontier. Many of these studies find that
while there appear to be significant potential efficiency gains from mergers [Rhoades (1993) and
Shaffer (1993)] the gains typically are not realized [Berger and Humphrey (1992), Linder and Crane
(1993), Rhoades (1993, 1994, 1998), Peristiani (1997), Shaffer (1993), and Srinivasan and Wall
(1992)].3
One possible response to this literature, however, is to be critical of it and to argue that there
may indeed be efficiency gains with mergers although they cannot be captured using this
methodology. An alternative ‘catch-all’ methodology would be to evaluate how the stock market
appraises the value of bank mergers. It may be that gains from either cost savings or from other
merger benefits such as diversification are realized and viewed favorably by shareholders. This
literature, however, is no more suggestive of merger benefits than is the cost efficiency literature.
Hannan and Wolken (1989) and Houston and Ryngaert (1994) found that the merger
announcements actually lead to a decrease in the value of the acquiring firm’s stock price. While
increases in the acquired firm’s stock price may partially offset this loss, studies of the net benefits
typically suggest either net losses are realized or, at best, the findings are inconclusive [see Rhoades
(1994)].
2
An exception to this finding is the work of Hughes and Mester (1998).
Again, there are exceptions: see Fixler and Zieschang (1993), Berger and Humphrey (1997), and Hughes, Lang,
Mester and Moon (1999).
3
4
We take a different approach to evaluating potential welfare gains resulting from bank
mergers. Our basic contention is, similar to the arguments of DeYoung, Hasan and Kirchhoff
(1998) and Jayaratne and Strahan (1998), that the elimination of entry barriers should result in
efficiency gains as institutions realize that their local market will no longer be protected by
regulation. Similarly, and most importantly, actual entry by a firm into a local market should place
competitive pressure on banks to improve operations to remain a viable competitor. In competitive
markets, banks are also likely to face increased competitive pressure to reduce costs and adjust
revenues as competitors in the local market merge. The potential for these latter effects may be
particularly strong in the banking industry as past research has found acquiring banks to be
relatively efficient, and thus, potentially, relatively aggressive competitors. Therefore, increases in
both potential and actual competition should place pressure on incumbent banks to improve their
operational efficiency. The first effect occurs when entry barriers are eliminated and the latter when
consolidation actually occurs. We differ from previous research in that we are not assessing the
efficiency of the bank actually involved in the merger. Rather we evaluate the parties that will be
affected by the bank that is buying his way into a more viable role in the local market. Since we
evaluate the impact on a larger number of banks the welfare implications could be quite large. Even
small efficiency improvements by a large number of incumbents can lead to substantial industrywide cost savings and revenue effects.
Our work most closely aligns with previous research by DeYoung, Hasan, and Kirchhoff
(1998) who find that following the deregulation of laws that restricted interstate and intrastate
banking, local banks’ productive efficiency initially deteriorated, but then improved over time.
However, it is not clear from this evidence how the incumbent banks in local markets reacted to
5
actual competitive entry.4 It could be that the local banks, following deregulation, increased
efficiency anticipating market entry. It could also be the case that banks waited for the actual
consolidation before investing managerial time and effort to improve their efficiency. We separate
out these potential effects.
3. Methodology and Data Sources
We examine the impact of entry on incumbent banks in both urban (as defined by MSA and
CMSA) and in rural banking markets (as defined by counties). We use X-efficiency measures
generated from the estimation of annual cost frontiers and alternative profit frontiers to conduct the
analysis.5
Below we define the following cost relationship and resulting cost efficiency measures:
(
)
C
C i = f C (w i , y i , z i ) 1 + Ineff i C e vi
1
C i = f C (w i , y i , z i )
C
Eff i
C
viC
e
C
C i = f C ( w i , y i , z i ) e u i e vi
ln C i = F C (w i , y i , z i ) + u iC + viC
C
1
= e uˆi
C
Eff i
C
Eff i C = e −uˆi
⇔
(
where uˆ iC = E u iC ε iC
)
and ε iC = u iC + viC
where w, y, z are vectors of factor prices, output levels, and fixed-netput levels, respectively.
Similarly, we define the following ‘standard’ profit relationship and resulting profit Xefficiency measures:
4
Although DeYoung, Hasan and Kirchhoff do evaluate the change in efficiency as the market share controlled by nonlocal firms changes.
5
We also evaluated a standard profit frontier and found results similar to those using the alternative profit approach.
Additionally, we utilize financial ratios in place of the technical efficiency measures to check the robustness of the
results.
6
Pi = f
StdP
Pi = f
StdP
Pi = f
StdP
(
)
StdP
(w i , p i , z i ) Eff i StdP e vi
1
(w i , p i , z i )
StdP
1 + Ineff i
StdP
( w i , p i , z i ) e −ui
viStdP
e
StdP
e vi
ln Pi = F StdP (w i , p i , z i ) − u iStdP + viStdP
StdP
Eff i StdP = e −uˆi
(
where uˆ iAltP = E u iStdP ε iStdP
)
and
ε iStdP = −u iStdP + viStdP
where w, p, z are vectors of factor prices, output prices, and fixed-netput levels, respectively. We
also define (and report results based on) an ‘alternative’ profit relationship which consists of the
dependent variable and composite error term of the ‘standard’ profit relationship and the
explanatory variables of the cost relationship (where, w, y, z are vectors of factor prices, output
levels and fixed-netput levels, respectively).
To empirically relate bank performance to actual and potential market entry, in our first
stage procedure we generate bank cost and profit frontiers for each year. We utilize the
intermediation approach, accounting for both interest and noninterest expenses and estimate twooutput, three-input, and two-fixed-netput translog cost and profit frontiers. Outputs are defined as
loans and leases, and securities and are produced using labor, transaction deposits, and purchased
funds. Physical capital and financial (equity) capital are included as fixed netputs as these are
difficult to change in the short-term. The frontiers are estimated using semi-parametric translog
functional forms. Previous research has shown that the standard translog function often does not
provide an adequate representation of the frontier for all banks in the sample. Fourier
transformations have been found to significantly improve the fit and, therefore, is the approach
7
taken in our analysis [see for example, Mitchell and Onvural (1996), McAllister and McManus
(1993)]. Our resulting cost relationship is: 6
C
ln
w3 z 2
2
w 1 2 2
w w
= α + ∑ β i ln i + ∑∑ β ij ln i ln j
i =1
w3 2 i =1 j =1
w3 w3
2
y
+ ∑ χ m ln m
z2
m =1
2
z
z 1
+ δ 1 ln 1 + δ 11 ln 1
z2
z2 2
2
2
wi y m 2
wi z1 2
ym
+ ∑∑ γ im ln ln
+
µ
ln
ln
+
θ
ln
∑
∑
i
m
w z
w
z
1
1
i =1 j =1
i
m
=
=
z2
3 2
3 2
y
1 2 2
+ ∑∑ χ mn ln m
2 m =1 n =1
z2
5
yn
ln
z2
[
+ ∑ θ q cos(Ψq ) + ρ q sin(Ψq )
z1
ln
z2
]
q =1
5
+∑
q =1
∑ [θ
5
r =1
qr
]
cos(Ψq + Ψr ) + ρ qr sin(Ψq + Ψr ) + u C + v C
where7:
C: is the cost of production (including interest and noninterest expenses)
w1: price of labor – salaries and employee benefits divided by the number of full-time equivalent
employees
w2: price of small deposits (core deposits) – interest expense on all deposits except wholesale CDs divided
by the book value of all deposits except wholesale CDs
w3: price of purchased funds – interest expense on wholesale CDs, fed funds, repos, demand notes issued to
the Treasury, other borrowed money, and subordinated notes and debentures divided by the book value
of these liabilities
z1: physical capital – book value of premises and fixed assets
z2: financial (equity) capital – book value of equity
y1: securities – book value of interest bearing balances due from depository institutions, held-to-maturity
and available-for-sale securities, fed funds sold, reverse repos, trading assets
y2: loans and leases – book value of total loans and leases
p1: price of securities
6
See Berger and Mester (1997) for a discussion of our cost specification. We scale total costs by one of the input prices
to insure factor price homogeneity, and by one of the fixed-netputs to avoid heteroskedastic joint-error terms.
7
Bank and time subscripts are omitted here for clarity.
8
p2: price of loans and leases
cos(Ψq) and sin(Ψq) are orthogonal trigonometric Fourier terms that are created based on rescaled
cost function explanatory terms spanning the [0, 2π] interval.8
ui + vi is a composite error term with ui representing the efficiency term and vi the random error term.
Assuming a half-normal distribution for the X-efficiency term, ui, and a normal distribution for the
symmetric error term, vi, around the frontier, the X-efficiency estimate can be obtained as:
εiλ
φ
σ uσ ν σ ε i λ
+
E[u i | ε i ] =
σ εiλ σ
Φ σ
where
σ = σ u2 + σ v2
and
λ=
σu
.
σv
We define the ‘standard’ profit frontier by substituting (1) adjusted-variable profits instead of
variable costs, (2) output prices instead of output levels, and (3) a composite error term that incorporates
one-sided profit inefficiencies (-ui) and symmetric random error (vi). We also derive the ‘alternative” profit
frontier which is defined in terms of adjusted variable profits, output levels, fixed netputs, and a composite
error structure (-ui+vi).
The frontier relationships are estimated using a three-step procedure [see Kim and White (1998)].
First we estimate a cost (profit) function using Ordinary Least Squares (OLS). The function’s coefficient
estimates together with the variance of the predicted error terms are used as starting values in the Maximum
Likelihood Estimation where λ is assumed to be equal to 1. The coefficient estimates obtained from this
second stage are then used as the starting values for the final Maximum Likelihood Estimation of the
8
Where the cost frontier terms are scaled into the [0.1×2π, 0.9×2π] range using the following transformation: Ψq=0.2πµ×Min(ϕ)+µ×ϕ and µ=(0.9×2π-0.1×2π)/[Max(ϕ)-Min(ϕ)]. For additional details, see Berger and Mester (1998).
9
complete model where the initial value of λ is set equal to 1. Two efficiency measures are generated from
this process. An increase in either one is consistent with efficiency improvements. The first is an efficiency
ranking relative to the sample for each year. Using the relative ranking decreases potential problems with
having the efficiency frontier shift through time. However, we also generate X-efficiency measures and
pool them across time and assume if there is a any shift in the frontier it has been a parallel shift across all
banks, i.e., we allow for annual shift binaries in our performance estimation procedure.
We use a two-step procedure to evaluate changes in cost efficiency resulting from actual or
potential mergers. We generate the performance measures from the annual frontier estimates. We
then develop an unbalanced panel data set with over 140,000 bank observations over the 1984-1999
period and analyze the relationship between the performance measures and the increased
competition resulting from potential entry (via the elimination of barriers) and actual consolidation.
That is, the performance measures can then be regressed on alternative measures of merger activity
or entry barrier reductions to capture their impact on performance.
Performancei ,t = a +
4
∑b
j = −2
j
MAi ,t + j + c InterBHCi ,t + d IntraBranchi ,t + e IntraBHCi ,t
+ f AGEi ,t + g BVTAi ,t + h MSAi ,t + k HHI i ,t + l BHCi ,t + m PIGi ,t + Di + Dt + ε i ,t
where
Perfi,t : the performance measure (either the X-efficiency index or accounting ratios. If the
inefficiency index is used it is equal to 0 for the least efficient firm, 100 for the most efficient.)
MAi,t+j = 1 if entry occurs in bank i’s market in year t+j (j∈{-2,-1,…,+4}), and 0 otherwise.
InterBHCi,t = 1 for all years following the year in which interstate BHC deregulation took place in
bank i’s state, 0 otherwise.
IntraBranchi,t =1 for all years following the year in which intrastate branching deregulation took
place, 0 otherwise.
IntraBHCi,t =1 for all years following intrastate BHC expansion deregulation in bank i’s state, 0
otherwise.
10
AGE i,t = Bank i’s age in year t.
BVTA i,t = Book value of total assets (in 1999-dollars).
MSAi,t =1 if bank i is located in a MSA or CMSA, 0 otherwise.
BHCi,t =1 if bank i is the affiliate of a BHC, 0 otherwise.
HHIi,t is the Herfindahl Index for the local market.
IGi,t is percentage annual personal income growth in bank i’s market.
Di is the bank fixed-effect for bank i.
Dt is the year fixed-effect for year t (excluded when the X-efficiency rankings are used as the
performance measure).
3.1 Data
Bank level financial data are obtained from the Report of Condition and Report of Income
Statements (Call Reports) for the 1984-1999 period. Merger and acquisition information is from the
Board of Governors Merger and Acquisition database. Summary statistics of the merger data are
presented in Tables 1 and 2. In our analysis we also control for additional factors that may explain
changes in bank performance such as banking market concentration, regional economic conditions,
and the timing of deregulation. Regional personal income growth is used to control for local
economic conditions at the county or MSA level. Personal income data are obtained from the BEA.
Concerning our deregulation information, we define intrastate branching deregulation as
occurring when a state moves from unit or some form of limited statewide branching to unlimited
statewide branching. Our intrastate branching indicator variable is set equal to one starting with
the year in which unrestricted statewide branching legislation became effective, zero otherwise. In
1986 (the starting year of our sample) all states except Illinois, Kansas, North Dakota, and Texas
allowed some form of statewide branching. We define intrastate multi-bank holding company
(MBHC) deregulation as passage from limited to unrestricted operations for MBHCs within the
state. Our indicator variable is set equal to one for the year the restriction is liberalized and
11
thereafter. Interstate MBHC deregulation occurs when legislation allows out-of-state BHC entry
based on regional reciprocal, national reciprocal, or national non-reciprocal (whichever comes
first). The indicator variable is set equal to one starting with the year the deregulation took place
and thereafter, and zero otherwise. The sources of information for deregulation include Amel
(2000) and Berger, Kashyap, and Scalise (1995, Table B6).
4. Empirical Results
Our estimates of the performance equation using the cost X-efficiency ratings for the entire
sample are presented in the first column of Table 3. Over 140,000 observations are used in the
estimation. We are interested in determining whether cost efficiency improves (i.e., b > 0}
following mergers in the local market. However, it is possible that banks in markets where mergers
occur are simply more efficient banks and would have been improving whether entry had occurred
or not. To allow for this we also include measures, MA-, to capture changes in performance in the
two years prior to the mergers. The results presented in column 1 of Table 3 do not indicate any
efficiency improvement prior to entry. However, we do see improvements after entry, MA+, and
the findings are consistent with our earlier discussion of banks attempting to improve their
efficiency when they are confronted with actual competition via a merger in the local market. For
the first three years following a merger in the market the cost efficiency (X-efficiency) of
incumbent banks improves relative to banks in markets without entry. The coefficients for the
merger variable in the year of the merger and four years afterwards are also positive, but are
insignificant. The results are somewhat mixed for the influence of eliminating potential entry
barrier, i.e., statewide branching barriers and intra- and inter-state restrictions on BHC expansion.
Elimination of barriers to intra-state BHC expansion results in banks responding by improving cost
X-efficiency (i.e., e > 0). We do not get this type of response for the other two entry barriers. The
12
deterioration in efficiency following inter-state BHC expansion is somewhat consistent with
DeYoung, Hasan and Kirchhoff (1988) who found efficiency deteriorated immediately following
the elimination of entry barriers, but eventually (after 6 years) delivered gains in efficiency. The
deterioration can be characterized as an adjustment period. It may be that a substantial portion of
our bank observations do not have sufficient time for recovery during our sample period and a more
complex binary structure may be needed to capture delayed improvements. Efficiency gains were
not found to be realized by banks when statewide branching laws were relaxed; in fact the
regulatory change was associated with deterioration in cost X-efficiency. Banks may have rapidly
expanded their branch network and increased their costs during the transition period to the new
environment. The results in column 1 also suggest that improvements in cost X-efficiency were also
greater, ceterus paribus, for banks that were members of a holding company and were located in
non-metropolitan areas. To summarize the findings, they are generally consistent with welfare
enhancing effects from mergers, and less so with potential entry from new competitors.
For robustness checks we also conducted analyses using subsamples of the data. These
results are also presented in columns 2-4 of Table 3. Using the efficiency rankings we analyze the
largest quartile of banks, the highest quartile of banks ranked by the Market’s HHI, and the
subsample of mature banks, defined as those in existence over nine years. The latter subsample is
included because previous work has shown newly chartered banks to have substantially different
efficiency ratings [see DeYoung and Hasan (1998)].
The results are similar to those found using the overall sample. Efficiency was not
improving prior to merger activity but did following the merger. In fact, the efficiency gains
following mergers were greater in the subsamples. This is generally consistent with our priors:
13
larger banks may be more responsive to new or larger competitors and banks in highly concentrated
markets potentially have the most room for efficiency gains from perceived increased competition.9
We get rather similar results using the efficiency measures instead of the rankings. Across
the four samples, (columns 4-7 of Table 3) the banks did not appear to be increasing their efficiency
prior to the merger activity, but did see advances following mergers (although the impact appears
weaker in the large bank and mature bank subsamples). Again, however, using this efficiency
measure across time requires some rather strong assumptions about changes in bank efficiency
estimates across annual samples. Concerning influences from potential competition resulting from
the elimination of entry barriers, our results are similar to those found with the efficiency rankings.
The only barrier reduction that tends to be followed by efficiency gains is the elimination of the
restriction to intra-state BHC expansion.
We also evaluate profit efficiency changes in markets following merger activity. We again
use efficiency rankings to evaluate changes in the relative position of banks. Results for the full
sample and alternative subsamples are presented in columns 9-12 in Table 3. Profit efficiency was
either deteriorating or remaining relatively unchanged following market merger activity. This could
result from increased (price) competition having significant effects on ‘revenue’ efficiency as banks
may suddenly be required to charge more competitive loan rates or transaction fees than were
previously charged. Combined with the cost efficiency finding, these results suggest that the
adverse revenue effects were quite significant.
Finally, we also analyzed the impact of potential and actual entry on bank performance
measured with accounting ratios. There are a number of potential reservations to keep in mind with
this analysis. First, past studies have shown that simple accounting ratios may significantly
misrepresent cost efficiency [DeYoung (1997, 1998)]. Second, while in the current analysis we are
9
However most of the potential apparently lies in the tails of the distribution as the HHI entered with a negative
14
accounting for time effects, we are not controlling for an array of additional influences, which may
affect the ratios. Therefore the results using the accounting ratios should be viewed and interpreted
cautiously. However the trends in these ratios following mergers may help explain the sources of
efficiency gains or losses.
With the preceding caveat in mind, using various cost ratios as performance measures we
relate these to the same measures of entry barrier reduction and entry via mergers as before. These
results are presented in Table 4.10 First we find that non-interest expenses relative to total assets
decreases following market merger activity (column 1) although the change is not statistically
significant. We also find that as merger entry occurs banks respond by controlling both labor costs
and the cost of premises-and-fixed-assets (columns 2 and 4). The ratio of each of these expenses
relative to total non-interest expense decreases with mergers. Again, this most likely occurs because
these are items over which management has control in an attempt to become efficient in response to
additional competition. However, these results should be interpreted with caution for the reasons
discussed above.
5. Summary and Conclusions
Much of the recent banking literature has evaluated the impact of mergers on the efficiency
of the merging parties. The evidence suggests that while acquiring banks are typically more
efficient than acquired banks, creating the potential for the new combined organization to be more
efficient, these potential gains appear to often not be realized. This has led some to question the
benefits resulting from the recent bank merger activity. We take a somewhat more comprehensive
approach and evaluate the impact of actual and potential competition resulting from market-entry
mergers and reductions in entry barriers on bank cost and profit efficiency. We consider both the
coefficient in the full sample.
15
efficiency gains realized by incumbent banks in the affected banking market. Our findings are
consistent with economic theory: as mergers occur, the incumbent banks respond to the increased
competition by decreasing their costs and increasing their level of efficiency. We find this
efficiency increase to be in addition to efficiency changes resulting from increases in potential
competition occurring with the initial elimination of entry barriers. However, there are
inconsistencies in our findings concerning efficiency gains around decreases in competitive barriers.
While there are generally cost efficiency gains following the liberalization of restrictions on intrastate BHC expansion, these are insignificant or perverse when intrastate branching or inter-state
BHC restrictions are eliminated. However, consistent with economic theory, new entrants via
mergers lead incumbent firms to increase their productive efficiency to enable them to be viable in
the more competitive environment. Thus, studies evaluating the impact of bank mergers on the
efficiency of the combining parties alone may be overlooking the most significant welfare
enhancing aspect of merger activity.
There are a number of potential extensions of the analysis. For example, the analysis could
be integrated into the literature on strategic responses to takeovers [see Hughes, et al. (2001)]. This
literature argues that as the threat of takeovers increase, the potential target firms will respond by
increasing leverage to reduce the potential gains from acquisition. This should make them less
attractive targets. Thus there may be a relationship between attempts to improve efficiency and
incumbent bank capital ratios. The sample could be bifurcated into subsamples based on capital
levels to see if the efficiency response differs.
10
Coefficients for the time dummies are again excluded from the table to save space.
16
REFERENCES
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unpublished manuscript, Board of Governors of the Federal Reserve System.
Ackermann C. and H. Servaes (1999) “How Industry Rivals Respond to Control Threats,”
IFA Working Paper, London.
Amel, D. and J.N. Liang (1997) “Determinants of entry and profits in local banking markets,”
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17
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20
Number of
M&As
4,411
2,438
5,622
2,309
Within-Market M&As
Out-of-Market M&As
Within-State M&As
Out-of-State M&As
21
The market is defined as a CMSA, MSA, or county. An institution's market is defined as the largest-holder's market (CMSA, MSA, or
county for the highest-BHC if any exists, for the institution itself oherwise). Note that some of the largest markets,i.e. MSAs and
CMSAs, span multiple states. The number of observations in this table may not necessarily add up to 7,931, as we could not match some
of the market definitions across (i) Board's M&A dataset which spans the whole calender year, (ii) the Federal Deposit Insurance
Corporation's Summary of Deposits dataset which are collected each June, and (iii) the Call Reports which are end-of-year reports.
7,931
Number of M&As
3,570
3,378
78
68
837
B: Breakdown of Mergers & Acquisitions by Entry Type
Total
Within-BHC M&As
Across-BHC M&As
Independent Bank M&As
BHC acquiring Independent Bank
Independent Bank Acquiring a BHC unit
A: Breakdown of Mergers & Acquisitions by Organizational Structure Type
Sample information covers the 1984-1999. The Merger & Acquisition (M&A) information comes from the Board of Governors of the
Federal Reserve System’s M&A dataset. The sample excludes Government assisted M&As (i.e., excluding observation for which code=5
and/or merge_cd=50).
Table 1: Mergers & Acquisition Sample Statistics
353
350
95
70
165
305
2,166
2,471
M&As
Affected
Counties
Affected
MSAs
Affected
Markets,
Total
Incumbent
Banks in
Affected
Counties
Incumbent
Banks in
Affected
MSAs
Incumbent
Banks,
Total
2,690
2,428
262
163
79
84
11,349
11,222
Bank
Observations
(excludes the
banks
involved in
the M&As)
1985
1984
Number of
3,022
2,673
349
176
77
99
323
11,065
1986
3,142
2,816
326
201
103
98
533
10,579
1987
3,234
2,607
627
249
95
154
599
10,175
1988
2,836
2,250
586
239
81
158
410
9,918
1989
2,744
2,257
487
218
84
134
381
9,776
1990
2,838
2,437
401
206
92
114
422
9,537
1991
2,943
2,443
500
223
85
138
458
9,288
1992
3,125
2,657
468
246
112
134
594
8,964
1993
3,112
2,520
592
300
113
187
593
8,585
1994
3,089
2,455
634
339
129
210
659
8,142
1995
2,550
2,024
526
276
107
169
588
7,529
1996
2,632
2,132
500
315
131
184
646
7,330
1997
2,480
2,009
471
302
129
173
589
6,908
1998
1,956
1,545
411
228
86
142
463
6,552
1999
22
44,864
37,419
7,445
3,846
1,573
2,273
7,931
146,919
Total
Information on the number of M&As (row 2) is from the Fed’s M&A database and includes some M&As involving non-banks. Information on the
number of affected banks and markets is from the Call Reports and excludes non-commercial banks (non-commercial banks are not analyzed in the
study). Banks with negative book value of total assets (BVTA) or book value of equity are also deleted from the sample.
Table 2: M&A-Affected Market and Bank Statistics
Table 3: Descriptive Statistics
X-efficiency estimates are obtained from cross-sectional translog-Fourier semi-parametric cost, standard profit,
and alternative profit frontier estimates assuming half-normal - normal composite error term. Financial ratios
are truncated at the 1% and 99% of their distributions to dampen the influence of outliers.
Cost X-Efficiency
Mean
85.55%
Std. Dev.
8.34%
Median
87.56%
Max.
99.05%
Min.
12.07%
Standard-Profit X-Efficiency
46.99%
16.50%
48.17%
90.37%
0.01% 146,919
Alternative-Profit X-Efficiency
47.74%
16.06%
49.03%
90.94%
0.01% 146,919
Total Costs / TA
7.50%
1.50%
7.43%
12.17%
4.51% 143,979
Non-Interest Expenses / TA
3.17%
0.96%
3.00%
7.22%
1.44% 143,979
Labor Expenses / Non-Interest Expenses
50.75%
7.28%
50.96
70.30%
Fixed Asset Expenses / Non-Interest Exp.
13.67%
4.25%
13.40%
26.81%
3.88% 143,979
Fixed Assets / TA
1.62%
1.03%
1.41%
5.57%
0.11% 143,979
Interest Expenses / TA
4.31%
1.29%
4.34%
7.44%
1.71% 143,979
Interest Revenue / TA
8.35%
1.29%
8.32%
11.64%
5.47% 143,979
Non-Interest Revenue / TA
0.73%
0.44%
0.62%
2.99%
0.12% 143,979
Transaction Deposits / TA
25.43%
7.31%
24.53%
49.29%
10.55%
143,979
Non-Transaction. Deposits / TA
62.79%
7.82%
63.57%
78.86%
37.78%
143,979
Total Loans / TA
52.71%
13.42%
54.00%
80.42%
16.81%
143,979
ROA
0.93%
0.70%
1.02%
2.41%
−3.25%
143,979
ROE
9.94%
9.72%
11.31%
27.95%
−73.46%
143,979
Equity / TA
8.95%
2.63%
8.47%
19.09%
InterBHC
0.77
0.42
1
1
0
146,919
IntraBHC
0.47
0.50
0
1
0
146,919
IntraBranch
0.41
0.49
0
1
0
146,919
Age
64.34
33.91
72
197
6
146,919
BVTA (millions of 1999 $s)
122.19
318.65
60.31
18,939.00
2.00
146,919
MSA
0.62
0.49
1
1
0
146,919
BHC
0.72
0.45
1
1
0
146,919
HHI
0.2588
0.1706
0.2193
1.0000
0.0273
146,919
IG
5.31%
4.94%
5.12%
112.38
−49.93%
138,774
28.91%
Obs.
146,919
143,979
0.01% 145,449
23
j = −2
∑b
4
j
MAi ,t + j + c InterBHCi ,t + d IntraBranchi ,t + e IntraBHCi ,t
-.0067454
.139509
-.0841756
.1397598
-.0074875
.1465984
.3732874
.1437712
MA-1
MA0
MA+1
51.13801
.3935224
Cost X-Efficiency Rankings:
Full Sample
MA-2
Constant
Cost X-Efficiency Rankings:
Non Local Entry
1.061158
.5186515
1.322327
.5054066
.1093367
.5106717
.9679921
.5003731
49.90154
.9852559
Cost X-Efficiency Rankings:
High Concentration Markets
.3271655
.1650187
.4243353
.2003557
-.0279923
.157244
-.077857
.1558268
52.02252
.4194639
Cost X-Efficiency Rankings:
Largest Bank Quartile
.44255
.2629468
-.1659537
.2760745
.0092469
.2522746
.3827389
.2526015
56.65084
1.001804
Cost X-Efficiency Estimates:
Full Sample
.0703613
.040799
-.0241953
.041341
-.0542833
.0399384
-.0098481
.0401914
87.37568
.1152727
Cost X-Efficiency Estimates:
High Concentration Markets
Cost X-Efficiency Estimates:
Non-Local Entry
.3943617
.1421023
.3065684
.138562
-.0049126
.1400408
.3011207
.1371728
.0796475
.0459193
.1053931
.0556919
-.0421096
.0442977
-.0463717
.0441815
87.58877
87.69419
(.1211758)
(.2815677)
Alt.-Profit X-Eff. Rankings:
Non-Local entry
Alt.-Profit X-Eff. Rankings:
Full Sample
Cost X-Efficiency Estimates:
Largest Bank Quartile
.0022055
.0717633
-.0715322
.0741018
-.0239355
.0692204
.0438597
.0701403
-.2984393
.0919139
.1535411
.0937213
.3739468
.0893494
.525928
.089189
.2698775
.3291544
.3139432
.3207487
.0428771
.3240901
.224537
.3175542
.0774095
(.1058813)
-.2164146
(.1285547)
.3546815
(.1008928)
.4579369
(.0999835)
24
.1351032
(.1441347)
.2367202
(.1513306)
.7102183
(.1382847)
.6035185
(.1384639)
88.25834
53.01796
54.78098
52.92981
17.94136
(.2744501) (.2515815)
(.6252778)
(.2691415)
(.5491401)
Alt.-Profit X-Eff. Rankings:
High Concentration Markets
X-efficiency estimates are in percentages: a coefficient estimate of 1.0 corresponds to a 1.0% increase in the dependent variable given a unit change in the
explanatory variable. X-efficiency rankings range between 0 for the least X-efficient bank and 100 for the most efficient bank in each year. Models are estimated
over the 1984-1998 period. MAt+j dummy variable is equal to 1 in year t if a M&A takes place in year t+j in bank i’s market (j∈{−2, …,+4}), and 0 otherwise.
InterBHC is an indicator variable that is equal to 1 following the deregulation of out-of-state Bank Holding Company entry into bank i’s host state, and 0
otherwise. IntraBHC is an indicator variable that is equal to 1 following the deregulation of within state BHC expansion in bank i’s host state, and 0 otherwise.
And IntraBranch is an indicator variable that is equal to 1 following the deregulation of within-state branching restrictions and 0 otherwise. MSA is an indicator
variable that is equal to 1 if the bank is located in a Metropolitan Statistical Area and 0 otherwise. BHC is an indicator variable that is equal to 1 if bank i is a
member of a BHC, 0 otherwise. HHI is the Herfindahl-Hirshman Index for banking market (county or MSA) concentration calculated using deposits. Yeareffects (Dt) are added when the dependent variable is the X-efficiency estimates. Standard errors are presented below the coefficient estimates.
+ f MSAi ,t + g HHI i ,t + h BHCi ,t + Di + ε i ,t
Performancei ,t = a +
Table 4: Fixed Bank-Effect Models Using X-Efficiency Estimates
Alt.-Profit X-Eff. Rankings:
Largest Bank Quartile
-2.241786
.5205306
1.354095
.2038919
1.766578
.9124996
146,919
14,607
10.1
MSA
BHC
HHI
Bank-years
Num.of
Banks
Ave. Obs. per
Bank
R2
.58%
59.81
-3.404531
.1523199
IntraBranch
F Statistic
1.502678
.3485717
IntraBHC
.5980584
.1609307
MA+4
-1.093454
.1440754
.6597956
.1560323
MA+3
InterBHC
.5157765
.1488913
MA+2
1.20%
26.08
7.8
4,148
32,458
5.481053
1.572402
1.084239
.4258997
-1.762583
1.793461
-4.451171
.3348396
-.7423617
1.382474
-1.556757
.280353
.8750122
.6238533
1.616009
.5946723
1.636647
.5585496
.64%
55.63
8.8
14,357
126,702
2.69891
.9732049
1.25033
.2192393
-2.089626
.5765987
-3.320927
.1628224
-.1565492
.4250944
-1.264052
.1529561
.6537067
.1830717
.7284296
.1769672
.4386099
.169045
1.1%
26.07
6.8
5,380
36,729
8.292748
2.005306
-.6982564
.4706249
-1.478665
1.117105
-5.000174
.3143132
1.131526
.5781077
-.4353412
.3272047
.626805
.2900931
.8744246
.2826693
.4094847
.2712531
8.10%
414.20
10.1
14,607
146,919
-.4246577
.2664852
.7348785
.0587141
-.4881411
.1463586
-.5810094
.0493874
.6583583
.0988413
-.0308641
.054105
.1356205
.0461913
.1865341
.044348
.1084121
.0421315
10.5%
118.54
7.8
4,148
32,458
.6954644
.4429454
.6573614
.1201226
-.6556636
.492626
-.9178507
.102367
.1308328
.3791694
-.0273276
.1001712
.3580932
.170869
.4345818
.1628157
.4837166
.1530295
8.6%
377.87
8.8
14,357
126,702
-.2985291
.2806909
.7087707
.062264
-.4697526
.1598916
-.575424
.0519609
.3278571
.1186372
.0092239
.0573515
.229892
.0516426
.2454697
.0494382
.1058959
.0470991
9.8%
121.33
6.8
5,380
36,729
.8001882
.555106
.1966594
.1277872
.1143778
.298323
-.5884603
.0986203
.5407665
.1553946
-.5122992
.1152567
.1149502
.0813332
.1351903
.0776946
-.0250129
.0736721
.50%
50.11
10.1
14,607
.67%
14.69
7.8
4,148
32,458
-4.654366
.9979011
-.7712375
.5833671
146,919
.2592253
.2702909
-2.232926
1.138193
.6570461
.2125009
-2.596324
.8773662
1.633844
.1779218
.5457083
.3959191
-.0854656
.3773998
-.6358517
.3544751
-.6152419
.1303495
-1.94914
.3327788
-.3350524
.0973791
-2.2786
.2228442
1.171524
.0921084
-.6754814
.1028841
-.6426959
.0997525
-.6159159
.0951872
.35%
30.66
8.8
14,357
126,702
-1.202534
.6244395
-.4625105
.140671
-1.848085
.3699642
-.4087215
.1044721
-1.094729
.2727542
1.340455
.0981415
-.6778373
.1174647
-.6300672
.1135478
-.5119965
.1084647
25
.55%
13.21
6.8
5,380
36,729
.1091123
1.099211
.3910114
.2579737
.6582419
.6123427
1.334655
.1722913
-1.540121
.3168906
.1256522
.1793578
-.6969612
.159015
-.1838778
.1549456
-.0067016
.1486878
j = −2
∑b
4
j
MAi ,t + j + c InterBHCi ,t + d IntraBranchi ,t + e IntraBHCi ,t
3.030366
.0115072
.0065675
.0040296
-.0036836
.0040053
-.0002204
.0041379
-.0121681
.0040883
MA-2
MA-1
MA0
MA+1
| -.0029161
.0032222
-.015463
.00326
-.0227674
.0031554
-.016624
.003179
6.41782
.0092079
1
Non-Interest
Expenses
BVTA
Constant
2
Interest Expenses
Total Assets
-.0681516
.013828
-.043416 8
.0138548
-.0473147
.013557
-.0248952
.0136712
9.869467
.0379735
Expenses of Premises
& Fixed Assets
BVTA
3
4
-.0185935
.012847
-.0150372
.0133259
.1580999
.012478
.1292664
.0125909
6.31795
.0449873
26
All performance variables are in percentages: a coefficient estimate of 1.0 corresponds to a 1.0% increase in the dependent variable given a unit change in the
explanatory variable. To avoid the effects of the outliers for financial ratios, we truncate financial ratios at 1st and 99th percentiles of their distributions. BVTA
represents the Book Value of Total Assets. Non-interest expenses include salaries and employee benefits (labor expenses) and expenses of premises and fixed
assets (fixed asset expenses), and other non-interest expenses. To generate levels of capitalization the sample is divided into highly capitalized (highest 2/3 of the
sample) and lowely capitalized banks (lowest 1/3 of the sample). Capital ratios are based on book values. MAt+j dummy variable is equal to 1 in year t if a M&A
takes place in year t+j in bank i’s market (j∈{−2, …,+4}), and 0 otherwise. InterBHC is an indicator variable that is equal to 1 following the deregulation of outof-state BHC entry into bank i’s host state, and 0 otherwise. IntraBHC is an indicator variable that is equal to 1 following the deregulation of within state BHC
expansion in bank i’s host state, and 0 otherwise. And IntraBranch is an indicator variable that is equal to 1 following the deregulation of within-state branching
restrictions, and 0 otherwise. BVTA is the book value of bank’s total assets in millions of 1999 dollars at year-end t. MSA is an indicator variable that is equal to
1 if bank is located in a Metropolitan Statistical Area, and 0 otherwise. BHC is an indicator variable that is equal to 1 if bank i is a member of a BHC, 0
otherwise. HHI is the Herfindahl-Hirshman Index for banking market (county or MSA) concentration calculated using deposits. Year-effect (Dt) coefficient
estimates are not reported to conserve space. Models are estimated over the 1984-1998 period. Standard errors are presented below the coefficient estimates.
+ f MSAi ,t + g HHI i ,t + h BHCi ,t + Di + Dt + ε i ,t
Performancei ,t = a +
Table 5: Fixed Bank- & Year-Effect Models Using Accounting Ratios
Interest Expenses
Total Assets
-.0245283
.004634
.0012547
.0054074
-.0046115
.0098804
.0574765
.0049382
.0824664
.0146203
-.014992
.0058935
.016144
.0266902
138,009
MA+4
InterBHC
IntraBHC
IntraBranch
MSA
BHC
HHI
Total Bank-years
R2
F Statistic
Average Bank-years
3.44%
164.1
9.9
14,520
| -.0219864
.0044443
MA+3
Number
of Banks
| -.0190556
.0042232
MA+2
90%
41,635
10.0
14,465
143,979
-.0829465
.0211444
.0403241
.0046688
-.042802
.011578
-.041574
.003903
.0692137
.0078593
-.0157051
.0042602
.0404194
.0036478
.0396052
.0034984
.0198853
.0033255
11.36%
388.93
8.10
11,973
96,966
-.1907816
.0886222
-.4563021
.0193679
.0228014
.0486701
.0100766
.0169854
.2008434
.0352343
.0276459
.0185631
-.0707842
.015375
-.0522017
.0147695
-.0659936
.014214
5.9%
85.53
4.81
10,028
48,483
.0349888
.0973863
.184335 2
.022492
-.1205616
.0571255
-.1993408
.016812
.1768953
.030895
-.1161628
.017534
-.0156985
.0152206
.0296648
.0143289
.0220927
.0133101
27
Working Paper Series
A series of research studies on regional economic issues relating to the Seventh Federal
Reserve District, and on financial and economic topics.
Extracting Market Expectations from Option Prices:
Case Studies in Japanese Option Markets
Hisashi Nakamura and Shigenori Shiratsuka
WP-99-1
Measurement Errors in Japanese Consumer Price Index
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Taylor Rules in a Limited Participation Model
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Maximum Likelihood in the Frequency Domain: A Time to Build Example
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Labor Market Policies in an Equilibrium Search Model
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Hedging and Financial Fragility in Fixed Exchange Rate Regimes
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Habit Persistence, Asset Returns and the Business Cycle
Michele Boldrin, Lawrence J. Christiano, and Jonas D.M Fisher
WP-99-14
Does Commodity Money Eliminate the Indeterminacy of Equilibria?
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WP-99-16
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Craig Burnside, Martin Eichenbaum and Jonas D.M. Fisher
WP-99-18
Fiscal Shocks in an Efficiency Wage Model
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WP-99-19
Thoughts on Financial Derivatives, Systematic Risk, and Central
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Robert R. Bliss and Nikolaos Panigirtzoglou
WP-99-21
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Michael A. Kouparitsas
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A Note on the Benefits of Homeownership
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The Earned Income Credit and Durable Goods Purchases
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Jonathan Hao, William C. Hunter and Won Keun Yang
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Louis Jacobson, Robert LaLonde and Daniel Sullivan
WP-99-28
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Paula R. Worthington
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WP-99-30
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Drew Dahl, Douglas D. Evanoff and Michael F. Spivey
WP-00-4
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Working Paper Series (continued)
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6
Working Paper Series (continued)
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Bank Procyclicality, Credit Crunches, and Asymmetric Monetary Policy Effects:
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WP-02-19
The Value of Banking Relationships During a Financial Crisis:
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WP-02-20
On the Distribution and Dynamics of Health Costs
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WP-02-21
The Effects of Progressive Taxation on Labor Supply when Hours and Wages are
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7
Working Paper Series (continued)
State-Contingent Bank Regulation With Unobserved Action and
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Local Market Consolidation and Bank Productive Efficiency
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WP-02-25
8
@FedFRASER