Changes in cost and profit efficiency

An alternative way to analyze the impact of mergers on bank efficiency is to find changes in cost efficiency (CE) and profit efficiency (PE) from one year before the

merger to each of three post-merger years. These changes are calculated for the merging and non-merging banks.46

Also, we focus on the combined firm relative to a control group. The control group is particularly important in our analysis because it permits an assessment of whether any observed changes in the combined firm simply reflect changes in the economic environment or instead are unique to the merger events. Therefore, efficiency is estimated for each bank involved in a merger: (i) the acquiring bank during the available years before the merger, (ii) the acquired bank during the available years before the merger and (iii) the merging bank during the available years after the merger. The ex post change in CE of the merged banks (∆CE) is the difference between the CE of the merged banks

(CE_m) and weighted-sum of the ex ante CE of the acquirer bank (CE₁) and acquired

bank (CE₂), that is ) ) ( ) ( ( ) ( − _{1 1 −1} + _{2 2 −1} = ∆CE CE_m w CE _t w CE _t

where w₁ and w₂are weights for the acquiring and acquired banks before the merger

such that w₁+w₂=1. The weights used are based on total assets (TA), so that

) /(TA₁ TA₂ TA

w_i = _i + , where i is 1 for the acquiring bank and 2 for the acquired bank. For non-merging banks, the change in CE is

1

−

− =

∆CE CE_t CE_t . Similarly, we find the changes in profit efficiency.

Table 3.8 displays the changes in profit efficiency. We notice that there are statistically significant improvements in profit efficiency for the 1987, 1993 and 1999

mergers. Our findings are consistent with those reported by Berger (1998), who provides similar evidence associated with megamergers.47

Table 3.8

Changes in profit efficiency for merging banks (1987-1999)

Year 1987 1993 1999 Mergers Peer group Mergers Peer group Mergers Peer group All Mergers Pre- merger 0.496 0.514 0.553 0.566 0.571 0.582 Post-merger 0.654 0.532 0.700 0.589 0.783 0.669 Changes 0.158* 0.018 0.147** 0.023* 0.212* 0.087 Large Mergers Pre- merger 0.516 0.493 0.564 0.570 0.583 0.591 Post-merger 0.640 0.511 0.707 0.581 0.745 0.626 Changes 0.124** 0.018* 0.143** 0.011 0.162* 0.035 Small Mergers Pre- merger 0.485 0.520 0.539 0.568 0.579 0.583 Post-merger 0.523 0.488 0.573 0.572 0.633 0.590 Changes 0.038** -0.032 0.034* 0.046 0.054** 0.007* *(**) Changes are significantly different from zero at the 5%(1%) level.

Notes: The pre-merger cost (profit) efficiency level is the combined cost (profit) level of the acquired and acquiring banks weighted by their asset size.

Small mergers include all mergers in which both the acquirer’s total assets and the total of the acquired banks’ total assets are below the median value ($450 million). Large mergers are those mergers above the median .On average, over the sample period around 55% of the mergers are small mergers and 45% are large mergers.

Clearly, profit efficiency tends to increase significantly after mergers. For 1987 mergers, the pre-merger profit efficiency was 0.496 and rose to 0.654 for the merging banks after the merger. For 1993 mergers, the pre-merger profit efficiency was 0.553 and rose to 0.700 for the merging banks after the merger. As for 1999, the pre-merger profit efficiency was 0.571 and rose to 0.783. Another interesting finding in this table is that banks engaged in mergers are less profit efficient on average than their peer group prior to merger. However, they become more profit efficient than the peer group after the merger. This indicates that mergers are able to improve the profit efficiency, and it suggests that profit efficiency motivations were driving U.S. bank mergers in the 1980s and 1990s.

Table 3.7 reveals pre-merger and post-merger cost efficiencies as well as the changes in cost efficiency for the 1987, 1993 and 1999 mergers. As we can see from this table, the improvement in cost efficiency is significant only for the 1993 and 1999 mergers. The results presented in this table also confirm our earlier findings that banks that engaged in mergers in the 1990s were more cost efficient on average than other banks and they were able to improve their cost efficiency level following the mergers. Notably, comparing the cost and profit efficiency improvements of merging banks with the improvement of its peer group suggests that this is a merger related improvement in efficiency and not a result of the economic environment of the banks. The spreading of fixed costs, such as branch offices, computer equipment, and customer information across several financial products and services, would constitute the most likely rational for such gains.

3.5.1.5 Small mergers versus large mergers

In order to find whether size of the mergers affects our results, we analyze our results separately for large mergers and small mergers. Cost and profit efficiency levels of firms both before and after the merger are computed relative to the peer group in order to assess performance changes. In the case of cost efficiency (Table 3.7), our findings can be almost completely attributed to the subsample of small banks. Mergers in which small banks are involved show larger improvements compared with the large bank mergers. For 1993 mergers, small banks mergers moved from a score of 0.856 to score of 0.887, registering a significant 5% increase. On the other hand, large banks show a significant improvement of only 1.5%. Small bank mergers in 1999, moved from a score of 0.946 up to 0.983, yielding a 4% increase in cost efficiency level. Large banks record an increase of only 1.8%. Our results indicate that when small banks combine, there is improvement on average in cost efficiency. These findings suggest that small banks may have taken an advantage in the merger market, including easier integration of computer and accounting systems and fewer internal struggles for control. As for the profit efficiency (Table 3.8), the results in general indicate that banks involved in mergers have a higher profit efficiency level compared to the group of non-merging peer banks. Large merging banks are chiefly responsible for this finding. Mergers of large banks recorded higher improvements in profit efficiency compared to the small bank mergers. They achieved 24%, 26% and 27% improvements for the 1987,1993 and 1999 mergers respectively. These results suggest that when large banks are merged, the average result is considerable improvement in profit efficiency. In the case of small bank mergers, improvements were much smaller, averaging around 7.0% for the 1987, 1993 and 1999

mergers. In short, our results indicate that bank mergers appear to significantly improve profit efficiency relative to other banks. Improvements also appear to be greater in the 1990s. Another interesting finding from the above analysis is that large banks are less efficient in cost efficiency terms compare to small ones. There are a couple of possible explanations for this finding. First, the large majority of non-performing loans are concentrated mainly in large banks. Further, it is worth noting that there is a substantial difference between the cost and profit efficiency estimates. Large banks are more efficient in profit terms than small banks. Larger banks may have the ability to exercise monopoly power, which allows them to earn more profits despite having relatively high costs.

Table 3. 9

Pre- merger cost efficiency for acquiring and acquired banks

1987 1993 1999

Mergers Peer group Mergers Peer group Mergers Peer group

All mergers Acquiring bank 0.776 0.753 0.889* 0.863** 0.964* 0.913* Acquired bank 0.790 0.688 0.872* 0.877** 0.892* 0.895** Large mergers Acquiring bank 0.783* 0.786 0.796** 0.891* 0.923** 0.986** Acquired bank 0.769 0.772 0.782** 0.886** 0.844* 0.888* Small mergers Acquiring bank 0.787 0.799 0.852* 0.873** 0.957* 0.989* Acquired bank 0.795* 0.810 0.854** 0.795** 0.874* 0.895*

* (**) Paired difference test results show that acquiring and acquired banks have significantly lower cost efficiency compared to their peers i.e. significantly different from zero at the 5%(1%) level.

Notes: The pre-merger cost (profit) efficiency level is the combined cost (profit) level of the acquired and acquiring banks weighted by their asset size.