The impact of European bank mergers on bidder default risk

We analyze the implications of European bank consolidation on the default risk of acquiring banks. For a sample of 134 bidding banks, we employ the Merton distance to default model to show that, on average, bank mergers are risk neutral. However, for relatively safe banks, mergers generate a significant increase in default risk. This result is particularly pronounced for cross-border and activity-diversifying deals as well as for deals completed under weak bank regulatory regimes. Also, large deals, which pose organizational and procedural hurdles, experience a merger-related increase in default risk. Our results cast doubt on the ability of bank merger activity to exert a risk-reducing and stabilizing effect on the European banking industry.     

Accounting for distress in bank mergers

Most bank merger studies do not control for hidden bailouts, which may lead to biased results. In this study we employ a unique data set of approximately 1000 mergers to analyze the determinants of bank mergers. We use undisclosed information on banks’ regulatory intervention history to distinguish between distressed and non-distressed mergers. Among merging banks, we find that improving financial profiles lower the likelihood of distressed mergers more than the likelihood of non-distressed mergers. The likelihood to acquire a bank is also reduced but less than the probability to be acquired. Both distressed and non-distressed mergers have worse CAMEL profiles than non-merging banks. Hence, non-distressed mergers may be motivated by the desire to forestall serious future financial distress and prevent regulatory intervention.     

The anatomy of bank diversification

We use panel data from nine countries over the period 1996–2008 to test how revenue diversification affects bank value. Relying on a comprehensive framework for bank performance measurement, we find robust evidence against a conglomerate discount, unlike studies concerned with industrial firms. Rather, diversification increases bank profitability and, as a consequence also market valuations. This indirect performance effect does not depend on whether diversification was achieved through organic growth or through M&A activity. We further demonstrate that previous results in the literature on the impact of diversification on bank value presumably differ due to the way diversification is measured, and the negligence of the indirect value effect via bank profitability. Our evidence against a conglomerate discount in banking remains robust also during the sub-prime crisis.     

A note on foreign bank ownership and monitoring: An international comparison

This paper empirically analyzes the relation between foreign bank ownership and the three pillars of the New Basel Capital Accord (i.e., capital regulatory oversight, supervisory oversight, and market discipline). Using a new database covering 153 countries, we find that countries with greater market discipline have a lower presence of foreign banks operating in their economy. Furthermore, our evidence indicates that capital regulatory oversight and supervisory oversight are not significantly related to foreign bank ownership.     

The effects of focus versus diversification on bank performance: Evidence from Chinese banks

This paper investigates the effects of focus versus diversification on bank performance using data on Chinese banks during the 1996–2006 period. We construct a new measure, economies of diversification, and compare the results to those of the more conventional focus indices, which are based on the sum of squares of shares in different products or regions. Diversification is captured in four dimensions: loans, deposits, assets, and geography. We find that all four dimensions of diversification are associated with reduced profits and higher costs. These results are robust regardless of alternative measures of diversification and performance. Furthermore, we observe that banks with foreign ownership (both majority and minority ownership) and banks with conglomerate affiliation are associated with fewer diseconomies of diversification, suggesting that foreign ownership and conglomerate affiliation may play important mitigating roles. This analysis may provide important implications for bank managers and regulators in China as well as in other emerging economies.     

Market response to bank relationships: Evidence from Korean bank reform

This paper examines how the forced closure of failing banks and the transfer of their loans to surviving banks affect the market value of firms that borrow from the closed banks. Pre-existing relationships between firms and the banks that acquire their loans are detrimental to the positive valuation effects of the event. Banks may have an incentive to favor pre-existing relationships to increase the value of previously extended loans. Therefore, loan renewals to firms with prior relationships do not signal borrower quality to the market, which is aware of the banks’ conflicts of interest. This study highlights the importance of the specific mechanisms employed to replace failed banks without decreasing the value of their client firms.     

The prediction of bank acquisition targets with discriminant and logit analyses: Methodological issues and empirical evidence

This paper uses discriminant and logit analyses to develop prediction models to identify bank acquisition targets. We consider several methodological issues, such as whether the choice of the estimation technique, the selection of variables, the use of raw versus industry relative data, the train-and-test sampling scheme, and the criteria for model evaluation affect the predictive accuracy of the developed models. Both estimation methods generate remarkably similar model performance rankings, while differences are revealed in the relative importance of variables when using raw versus industry relative data. We find that in most cases there is a fair amount of misclassification, consistent with previous studies in non-financial sectors, which is hard to avoid given the nature of the problem.     

The effects of bank relationships on firm private debt restructuring: Evidence from an emerging market

Our paper seeks to examine the direct benefit of bank relationships for a distressed borrower by assessing its influence on the success of firm private debt restructuring. We find that a distressed firm with a stronger bank relationship has a greater probability to successfully restructure its debt through private renegotiation. Accordingly, an analysis of credit rating recovery provides complementary evidence on the factors of successful debt restructuring. A duration analysis of the length of time needed for a debt restructuring to be completed is fully consistent with our documented results. We conclude that in a bank dominated financial system like Taiwan's where firms are heavily bank-dependent, the bank-firm relationship is of crucial importance to the success of financially distressed firms in private debt restructuring.     

Corporate ownership structure and bank loan syndicate structure

Using a novel data set on corporate ownership and control, we show that the divergence between the control rights and cash-flow rights of a borrowing firm's largest ultimate owner has a significant impact on the concentration and composition of the firm's loan syndicate. When the control-ownership divergence is large, lead arrangers form syndicates with structures that facilitate enhanced due diligence and monitoring efforts. These syndicates tend to be relatively concentrated and composed of domestic banks that are geographically close to the borrowing firms and that have lending expertise related to the industries of the borrowers. We also examine factors that influence the relation between ownership structure and syndicate structure, including lead arranger reputation, prior lending relationship, borrowing firm informational opacity, presence of multiple large owners, laws and institutions, and financial crises.     

Board characteristics and Chinese bank performance

Using a sample of 50 largest Chinese banks during the period of 2003–2010, we explore a comprehensive set of board characteristics (size, composition and functioning of the board) and analyze their impacts on bank performance and bank asset quality in China. We find that the number of board meetings and the proportion of independent directors have significantly positive impacts on both bank performance and asset quality while board size has a significantly negative impact on bank performance. We find new evidence that the degree of bank boards’ political connection is negatively correlated with bank performance and asset quality. The findings suggest that the board of directors plays a significant role in bank governance in China.     

Valuation and systemic risk consequences of bank opacity

We examine the effects of opacity on bank valuation and synchronicity in bank equity returns over the years 2000–2006 prior to the 2007 financial crisis. As expected, investments in opaque assets are more profitable than investments in transparent assets, and taking profitability into account, have larger valuation discounts relative to transparent assets. The valuation discounts on opaque asset investments decline over the 2000–2006 period only to be followed by a sharp reversal in 2007. The decline is coincident with a rise in bank equity share prices, decrease in transparent asset holdings by banks, and greater return synchronicity – evidence consistent with a feedback effect.     

The effect of reference point prices on mergers and acquisitions

Prior stock price peaks of targets affect several aspects of merger and acquisition activity. Offer prices are biased toward recent peak prices although they are economically unremarkable. An offer's probability of acceptance jumps discontinuously when it exceeds a peak price. Conversely, bidder shareholders react more negatively as the offer price is influenced upward toward a peak. Merger waves occur when high returns on the market and likely targets make it easier for bidders to offer a peak price. Parties thus appear to use recent peaks as reference points or anchors to simplify the complex tasks of valuation and negotiation.     

Reforms in Thai bank governance: The aftermath of the Asian financial crisis

This paper provides an empirical analysis of Thailand's bank governance reforms after the 1997 Asian financial crisis and then examines the stock market's response. Unlike the pre-crisis period, we find that the bank sector returns (or return volatilities) have become more Granger causal to the overall stock market in the post-crisis period. Announcements of bank governance reforms are also generally associated with significant change in bank sector returns. This adds to the proposition that improved bank governance is related to improved bank performance as measured by their bank stock returns.     

The effect of mergers on implied volatility of equity options

This paper uses a sample of 25 large mergers from 1996 to 2004 to study the effect of mergers on the implied volatilities of equity options. The results indicate a statistically significant increase in volatility beyond the amount predicted if the transaction were effectively nothing more than a portfolio combination of the target and acquirer. The disparity suggests that, at least for the first 18 months after the transaction becomes effective, market participants expect mergers to increase risk. Integration risk and uncertainty about the extent to which efficiency gains and greater market power are realized are possible explanations for the discrepancy.     

The role of risk management in mergers and merger waves

We show that merger activity and particularly waves are significantly driven by risk management considerations. Increases in cash flow uncertainty encourage firms to vertically integrate and this contributes to the start of merger waves. These effects are incremental to previously identified causes of wave activity. Our risk management hypothesis is further supported by cross-sectional differences in the likelihood that a firm vertically integrates, and by the post-acquisition characteristics of vertically integrating firms. These results are consistent with the view (from the industrial organization literature) that vertical integration is an operational hedging mechanism that reduces the cost of increased uncertainty.     

CEO pay incentives and risk-taking: Evidence from bank acquisitions

We analyze how the structure of executive compensation affects the risk choices made by bank CEOs. For a sample of acquiring U.S. banks, we employ the Merton distance to default model to show that CEOs with higher pay-risk sensitivity engage in risk-inducing mergers. Our findings are driven by two types of acquisitions: acquisitions completed during the last decade (after bank deregulation had expanded banks' risk-taking opportunities) and acquisitions completed by the largest banks in our sample (where shareholders benefit from ‘too big to fail’ support by regulators and gain most from shifting risk to other stakeholders). Our results control for CEO pay-performance sensitivity and offer evidence consistent with a causal link between financial stability and the risk-taking incentives embedded in the executive compensation contracts at banks.     

Risk management,corporate governance,and bank performance in the financial crisis

The recent financial crisis has raised several questions with respect to the corporate governance of financial institutions. This paper investigates whether risk management-related corporate governance mechanisms, such as for example the presence of a chief risk officer (CRO) in a bank’s executive board and whether the CRO reports to the CEO or directly to the board of directors, are associated with a better bank performance during the financial crisis of 2007/2008. We measure bank performance by buy-and-hold returns and ROE and we control for standard corporate governance variables such as CEO ownership, board size, and board independence. Most importantly, our results indicate that banks, in which the CRO directly reports to the board of directors and not to the CEO (or other corporate entities), exhibit significantly higher (i.e., less negative) stock returns and ROE during the crisis. In contrast, standard corporate governance variables are mostly insignificantly or even negatively related to the banks’ performance during the crisis.     

Investor protection and the value effects of bank merger announcements in Europe and the US

Investor protection regimes have been shown to partly explain why the same type of corporate event may attract different investor reactions across countries. We compare the value effects of large bank merger announcements in Europe and the US and find an inverse relationship between the level of investor protection prevalent in the target country and abnormal returns that bidders realize during the announcement period. Accordingly, bidding banks realize higher returns when targeting low protection economies (most European economies) than bidders targeting institutions which operate under a high investor protection regime (the US). We argue that bidding bank shareholders need to be compensated for an increased risk of expropriation by insiders which they face in a low protection environment where takeover markets are illiquid and there are high private benefits of control.     

The effects of firm-initiated clawback provisions on bank loan contracting

Although firm-initiated clawbacks reduce accounting manipulation, they also induce managers to engage in suboptimal activities (e.g., reduce research and development (R&D) expenses) to achieve earnings targets. To assess the effectiveness of clawback provisions, we examine their impact from debtholders' point of view. We find that banks use more financial covenants and performance pricing provisions in the loan contracts and decrease interest rates after firms initiate clawbacks. Moreover, we also find that loan maturity increases and loan collateral decreases subsequent to clawback adoption. Taken together, our findings indicate that firm-initiated clawback provisions enhance financial reporting quality, thereby reducing the information uncertainty that financing providers face.     

The identification of acquisition targets in the EU banking industry: An application of multicriteria approaches

In this paper we develop classification models for the identification of acquisition targets in the EU banking industry, incorporating financial variables that are mostly unique to the banking industry and originate from the CAMEL approach. A sample of 168 non-acquired banks matched with 168 acquired banks is used over the period 1998-2002, covering 15 EU countries. We compare and evaluate the relative efficiency of three multicriteria approaches, namely MHDIS, PAIRCLAS, and UTADIS, with all models developed and tested using a 10-fold cross validation approach. We find that the importance of the variables differs across the models. However, on the basis of univariate test and the results of the models we could state that in general after adjusting for the country where banks operate, acquired banks are less well capitalized and less cost and profit efficient. The results show that the developed models can achieve higher classification accuracies than a naïve model based on random assignments. Nevertheless, there is fair amount of misclassification that is hard to avoid given the nature of the problem, showing that as in previous studies for non-financial firms, the identification of acquisitions targets in banking is a difficult task.