Figures and Tables
List of Abbreviations
Management Summary
1 Introduction
2 Literature Review
2.1 Theory of M&A Performance Changes and Strategic Similarities
2.1.1 The Agency Theory
2.1.2 The Synergy Theory
2.1.3 The Market Power Theory
2.1.4 The Concept of Strategic Similarities
2.1.5 Summary of the Theoretical Concepts
2.2 Empirical Evidence
2.2.1 The Agency Theory: Empirical Evidence
2.2.2 The Synergy Theory: Empirical Evidence
2.2.3 The Market Power Theory: Empirical Evidence
2.2.4 The Concept of Strategic Similarities: Empirical Evidence
2.2.5 Summary of the Empirical Evidence
2.3 The German Cooperative Banking Sector
2.4 Summary
3 Hypotheses
3.1 Hypotheses Development
3.2 Summary
4 Methodology and Data
4.1 Methodology
4.2 Data
4.3 Summary
5 Empirical Results
5.1 Empirical Results (H1 - H3)
5.2 Empirical Results (H4)
5.3 Summary
5.4 Remarks
6 Conclusion
References
Legislative Texts
Appendix
Table 1: Performance ratios (H1 - H3)
Table 2: Strategic variables (H4)
Table 3: Industry mean values (2005 - 2010)
Table 4: Descriptive statistics (H1 - H3), outlier adjusted
Table 5: Descriptive statistics (H1 - H3), outlier and industry adjusted
Table 6: Descriptive change statistics (H1 - H3), outlier and industry adjusted
Table 7: Test results (t-tests, sign-tests, H1 - H3)
Table 8: Correlation matrix for explanatory variables (H1 - H3)
Table 9: Results of the regression analyses (ΔROE, ΔROA, H1 - H3)
Table 10: Strategic characteristics of targets and bidders (H4)
Table 11: Similarity index (H4), outlier adjusted
Table 12: Correlation matrix for explanatory variables (H4)
Table 13: Result of the regression analyses (ΔROE, H4)
Table 14: Result of the regression analyses (ΔROA, H4)
Figure 1: Methodology, based on Akben-Selcuk and Altiok-Yilmaz (2011)
illustration not visible in this excerpt
In the following thesis I examine the performance effects of merger within the German cooperative banking sector on the basis of agency, synergy and market power related changes. Furthermore, from a strategic management perspective the role of strategic similarities is analyzed. Performance enhancing effects are found from a synergy and market power theory perspective in terms of a reduction in interest costs. Furthermore, problems with synergy gains in the area of personnel costs are discovered. These are so serious that they have hampered a significant change in overall bank performance. A change in market power is also measured in terms of a significant increase in other operating income. It is not possible to detect any significant change in agency related costs. Further, I describe that strategic similarities and size differences are not leading to increased profitability. Instead, differences in diversity of earnings are found to be performance enhancing. Therefore, the previously described increase in other operating income can also be facilitated by economies of scope: services that are originally only provided to the customers of one bank are in the post-merger period provided to the united institute’s combined customer base.
Bank mergers and acquisitions seem to be a well-investigated topic that is the focus of various research papers. But, the majority of M&A performance studies focus on listed banks and on the share price reactions of target and bidder banks around the merger event (Cyree, 2010). There is only a limited amount of papers that use a different context in terms of non-listed banks like German cooperative banks. During the last years, the German cooperative banking sector underwent extensive consolidation. The amount of banks has on the basis of M&A activities decreased from 1,794 since the year 2000 to currently 1,138 (BVR, 2011). This consolidation appears to be a response to increasing competitive pressure, developments in the integration of the European banking market, effects of the world financial crisis, changes in technological developments, political interventions and global regulation changes (Cabo and Rebelo, 2005; Altunbas and Marques, 2008; Davidson et al., 2009; Paul and Uhde, 2010). It is my goal to investigate if these mergers have been financially beneficial and therefore to contribute to this area of research. It has to be considered that current evidence on non-listed bank mergers in Germany is “virtually absent from literature”, due to “unavailability of public equity and/or balance sheet data” (Koetter, 2008).
There are three theories that are often used in M&A research to explain changes in the financial performance of involved companies. The first of these theories, the agency theory, describes the relationship between owners of a company and its managers. The separation of ownership and control requires the usage of arrangements that are suitable to align the interest of both parties, counteract the management’s opportunistic behavior and reduce informational asymmetries (Eisenhardt, 1989). But, all arrangements are connected with costs, which include compensation, monitoring expenditures and costs that arise from the managements’ actions that are not in line with the owners’ best interests. In this context, Carpenter et al. (2009) describe that mergers can be used “to discipline ineffective managers” and therefore facilitate a reduction of agency related costs, which is expected to be beneficial for the company’s overall financial performance. Campa and Hernando (2006) support these expectations with empirical evidence and report “significant improvements in the target banks performance [….]” and abnormal positive excess returns for target bank shareholders around the date of the announcement. From a bidder bank perspective, the mergers are neither beneficial for the shareholders nor performance enhancing measured in terms of ROE, which might indicate that the bidder‘s managers do not act in the best interest of their shareholders. The second theory that is used to describe M&A performance changes is the synergy theory, which explains M&A effects resulting from operational and financial synergies (Hankir et al., 2011). Davidson et al. (2009) conclude that “the merging banks benefited by exploiting operational and managerial synergies to improve their cost efficiency [….]”. Further, Altunbas and Marques (2008) describe that the “potential for scale economies is often one of the main reasons given by practitioners to justify M&A”. The third theory, the market power theory, predicts gains for banks on the basis of an increase in market power and therefore on the possibility to “appropriate more value from customers” and to “improve [….] interest expense ratios” (Carpenter et al., 2009; Davidson et al., 2009). A recent stock market based study from Hankir et al. (2011) is able to confirm the validity of this theory for 10.8% of all included merger cases.
As a starting point for the investigation of the financial performance changes, I use the research question: “What is the change in financial performance following a merger in the German cooperative banking sector?” According to the described theories, it is expected that performance changes can be facilitated by a reduction in agency cost, synergy effects and increased market power. Therefore, I use three subordinated research questions in order to investigate M&A performance effects: “Is it possible to increase the merged banks’ financial performance by reducing agency costs?”, “Is it possible to increase the merged banks’ financial performance by tapping into synergy effects?” and “Is it possible to increase the merged banks’ financial performance by extracting more value from the customers?”. In contrast to studies based on stock market data, it will not be possible to analyze share prices as an indicator for performance changes of the merger. The shares of cooperative German banks (Geschäftsanteile) are not traded on exchanges, but given back to the cooperative company in exchange for their value (Geschäftsguthaben). The leaving member has no right to receive any additional payments out of the cooperative’s reserves or other assets (§73 GenG). Therefore, it will be necessary to focus on data from the cooperatives’ annual statements, which is an established approach to value non-listed companies (Cyree, 2010).
In addition to the previously described performance research, I will investigate the expected variance of the performance change from a different perspective, namely on the basis of factors that have been identified in the strategic management literature. Although, the strategic management research has analyzed various moderating factors it is still “largely unexplained” what “impacts the financial performance of firms engaging in M&A activity” (Covin et al., 2004). The focus of this thesis lies on one of the major areas presented in the strategic literature, namely strategic similarities. They are expressed in terms of resource allocation patterns, which are used as an indicator of the underlying strategies that banks pursue. On the basis of the concept of strategic similarity it is expected that shared strategic characteristics result in superior performance, because firms with a similar set of competencies are better positioned to fully exploit synergies and avoid conflicts that are connected with merging dissimilar strategies (Ramaswamy, 1997; Altunbas and Marques, 2008). The literature also includes a contradicting perspective that predicts e.g. benefits in terms of a lower systematic risk for a “company’s investment portfolio by investing in unrelated business” (Hellgren et al., 2011 based on Trautwein, 1990). Altunbas and Marques (2008) report empirical evidence for the first perspective and describe that higher strategic similarity e.g. in the earnings diversification strategy leads to an improvement in performance. The resulting research question is: “Does higher strategic similarity between cooperative merging partners lead to increased performance?” Further topics like different performance changes for mergers in different countries, cross-border and even between different types of banks are not considered, because cooperative banks cannot be merged (or only under very certain conditions) with banks outside the cooperative banking sector (Paul and Uhde, 2010). In line with this remark the newspaper Handelsblatt reports that all previous attempted mergers between cooperative banks and banks from other sectors have been cancelled (Drost and Köhler, 2008). Other major moderating factors that have been identified through the literature like e.g. acquisition experience of merging banks are not considered to limit the scope of the thesis.
This thesis contributes to the current M&A research in various ways: First, it focuses on the cooperative banking sector that is far less well investigated than the commercial banking sector due to the lack of suitable publicly available data (Koetter, 2008; Fitch Ratings, 2010; Kontolaimou and Tsekouras, 2010; Standard & Poor’s, 2010). The data has only lately been published through the governmental service www.ebundesanzeiger.de, which allows free access to the annual financial data (years 2006-2010). Secondly, the validity of three important theories will be tested in a cooperative market context. Thirdly, the role of strategic similarities including a set of control variables like size and performance differences is also investigated.
The remainder of this thesis is organized as follows: chapter two includes a review of the relevant literature, chapter three describes the development of the hypotheses, chapter four the methodological approach and chapter five presents the empirical results and possible limitations. The dissertation’s conclusion is presented in chapter six.
As the basis for the further development of the research approach, this chapter provides an overview of the current academic M&A literature dealing with financial performance changes and the role of strategic similarities in this context.
Due to the large amount of M&A research topics, such as target selection, approaching targets, legal aspects, managing the integration process or HRM topics, it is necessary to follow the approach of other researchers and focus on a specific research area, in this case the described financial performance changes (Rupert and Sherman, 2006; Davidson et al., 2009). In addition, I will also use the concept of strategic similarities to investigate the performance changes from the strategic management perspective. Once again, I will follow the approach of other researchers and focus on this specific aspect of the strategic management perspective (Ramaswamy, 1997; Altunbas and Marques, 2008).
The following subchapter (2.1) includes the theoretical foundations of performance changes and the role of strategic similarities. Afterwards, the latest empirical findings are described (subchapter 2.2), which are sorted according to their different approaches to find empirical evidence for the theory and within this structure from geographically broad (US and/or Europe) to narrow (Germany). Due to the fact that the financial industry is frequently used as context for M&A research, it is possible to follow the example of Campa and Hernando (2006), Rupert and Sherman (2006) and Koetter (2008) and focus solely on empirical evidence from this industry. As described in the introduction, it has to be considered that current evidence on non-listed bank mergers in Germany is “virtually absent from literature”, due to “unavailability of public equity and/or balance sheet data” (Koetter, 2008). The third subchapter deals with corresponding aspects of the German banking market and the cooperative financial sector.
M&A research has developed along two major disciplinary lines in terms of financial and strategic management research. In the early stage of M&A research, financial researchers have focused on the share price effects of mergers and later also on performance changes expressed in accounting ratios. The variance in the performance changes around M&As is a subject of interest to the strategic management literature, which investigates the role of various variables that are expected to be moderating the M&A performance change (Cartwright and Schoenberg, 2006). This subchapter puts emphasis on three major theories that are used by financial researchers to explain performance changes: the agency, synergy and market power theory. Afterwards, the concept of strategic similarities is elucidated. Each of the following four subchapters starts with the foundations of the respective theoretical concept and continues with possible critique and a proposal on how the theory can be used in M&A research.
The first of the three theories that is used to explain performance changes is the agency theory. Eisenhardt (1989) describes the theory as follows: “Agency theory is directed at the ubiquitous agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work. Agency theory attempts to describe this relationship using the metaphor of a contract.” But there are two problems: The first problem, the agency problem, occurs when there is a goal conflict between the principals and the agents and it is problematic or costly for the principals to verify the agents’ actions. The second problem, risk sharing, occurs when both parties have different preferences towards taking risks. The theory is based on the following assumptions concerning “people (e.g., self-interest, bounded rational, risk aversion), organizations (e.g., goal conflict among members) and information (e.g., information is a commodity which can be purchased)”. Eisenhardt (1989) also describes the two general lines of the theory: the positivist agency theory and the principal-agent research. The first line deals with identifying conflicting circumstances and describing the possibilities to reduce the management’s (agent) self-interest behavior. In this context, the board of directors is also included in the agency theory as a monitoring instrument of the stockholders over the management. The second line mentioned focuses on finding the optimal contractual solution that aligns the positions. A more current review of the agency theory by Shapiro (2005), which is partly based on Eisenhardt (1989), describes the theory in similar lines. Economic studies “typically focus on the relationship between owners and managers” and include the following aspects: Principals must ensure that the selected agents act on their behalf. But, this cannot be presupposed, because managers act opportunistically. To solve this conflict of interest and the information asymmetry between both parties the principal has several possibilities to monitor the agents’ behavior (e.g., “boards of directors, auditors, supervisors (and) structural arrangements”). Further, the principals compensate the agents in terms of a “behavior-oriented contract” (salary) or an “outcome-oriented contract”, which includes “commissions, bonuses, piece rates, equity ownership, stock options (and) profit sharing”. Eisenhardt (1989) predicts that the second alternative is more suitable to align both positions or in other words, to ensure that the agent acts in the principal’s interest. All arrangements are connected with costs. These agency costs include the compensation, monitoring costs and costs that arise from the agents’ actions that are not in line with the principals’ best interests. Further, it is described that “agents are risk averse” and “principals are risk neutral”, due to the fact that agents are not able to diversify their risks. In addition to these descriptions that back up Eisenhardt’s (1989) outline, Shapiro (2005) also includes some critical remarks. “The assumption that complex organizational structures and networks can be reduced to dyads of individuals”, is one of them. Agents can serve multiple principals with heterogeneous goals and furthermore, they can be themselves “the principal in a long chain of principal-agent relationships both inside and outside the corporation.” Further, the assumption of self-interest and the own profit maximization goals of agents are also questioned. Heracleous and Lan (2010) include most of these points of criticism and even go one step further and introduce a new perspective on the agency theory and recommend the adoption of the following key aspects to cope with current ideas of cooperate social responsibility and team production: “redefining the principal from shareholders to the corporation, redefining the status of the board from shareholder’s agents to autonomous fiduciaries and redefining the role of the board from monitors to mediating hierarchs”. The shareholders are put into the team production unit that also includes other important stakeholders like employees and management.
Despite these critiques, the theory’s benefit is its applicability in different areas of research. One of these areas is mergers and acquisitions, in which it is in general assumed that “resistance to takeover bids is not in the stockholder’s interest, but it may be in the interest of managers because they can lose their jobs during a takeover” (Eisenhardt, 1989). Other authors like Carpenter et al. (2009) support this line of thinking and use the presented outline of the agency theory in a current M&A research model and mention that a majority of M&A researches operate “explicitly or implicitly” on this basis. It is e.g. used in the description of the market for corporate control: If companies are managed by ineffective agents, this will be reflected in the company’s share price that will be lower in relation to a company that is managed by effective managers. These ineffective managed companies are described to be the target of takeovers, because of the expected possible gains for the acquirer. Therefore, “acquisitions may be value enhancing when they are used to discipline ineffective managers”.
Besides the possibility to draw agency cost related conclusions from share prices, the topic can also be approached on the basis of the free cash flow perspective. According to the theory it is expected that agents who have vast amounts of free cash at their disposal tend to act opportunistically instead of investing in projects that are beneficial for their principals. It is stated that a reduction of free cash flow reduces such behavior, which can be achieved by countermeasures in terms of decreasing the amount of available cash by paying out dividends to the shareholders or paying interest for debt (Berger and Bonaccorsi di Patti, 2006; Aggarwal and Kyaw, 2010). “Payouts to shareholders reduce the resources under managers’ control, thereby reducing managers’ power, [….]” and their possibility to be involved in wasteful activities. The second alternative to downsize the amount of free cash flows differs from the first in a significant way: Dividend payments can be cut in the future because they are only a “promise” to the shareholders and not a legal obligation as interest payments for debt are. Holders of debt have the right to file for bankruptcy if a company fails to meet its obligation, which results in a loss of control for the involved management (Jensen, 1986). Therefore, ”greater financial leverage (increasing the amount of borrowed funds in relation to capital) may affect managers and reduce agency costs through the threat of liquidation, which causes personal losses to managers of salaries, reputation perquisites, etc., and through pressure to generate cash flow to pay interest expenses” (Berger and Bonaccorsi di Patti, 2006). Thus, “the threat cased by failure to make debt service payments serves as an effective motivating force to make […] organizations more effective” (Jensen, 1986).
Carpenter et al. (2009) and DeYoung et al. (2009) show circumstances, in which managers use acquisitions to satisfy their self-interest. On the basis of Eisenhardt (1989) and Shapiro’s (2005) description of the agency theory it can be concluded that problems e.g. in terms of contractual or monitoring problems lead to such behavior. Ownership effects are explained to be relevant in this context. High and low levels of manager ownership in a company are described to be misaligning management’s interest with shareholders’ interests. It is stated that large shareholders fulfill external monitoring roles better and might trigger mergers to counteract poor management (Carpenter et al., 2009).
These descriptions are further supported by Collins et al. (2007) and their research model that links bank governance with acquisition performance. The authors describe that empirical M&A research shows that target shareholders usually benefit and that “very few studies detect positive returns to acquiring bank shareholders (in the US).” They assume that the poor results “point to poor governance arrangement” and describe three counter-measures in terms of executive compensation and managerial ownership incentives (fixed salary vs. performance related incentives; high vs. low level of stock ownership), board composition (amount of independent directors in relation to the overall amount) and board diversity (e.g. in terms of female or ethnic diversity).
In conclusion, the agency perspective explains the relationship between principals and agents and the instruments that align both positions. In the context of M&A it is used to explain changes in the financial performance of a company. Mergers are leading to performance enhancement, if they are used to discipline ineffective managers (Carpenter et al., 2009). But, it is also possible that mergers are misused by managers to satisfy their self-interest, if the principals’ interests are not aligned with the agents’ interests by instruments like monitoring, management ownership and compensation (Collins et al., 2007). Furthermore, it is described that lower levels of free cash reduce the possibilities of agents getting involved in wasteful activities.
According to the previous descriptions, it is possible that one merger is simultaneously used to discipline ineffective managers and satisfy the self-interests of others, depending on the point of view: The agents of the targeted bank are disciplined or replaced by the agents of the bidder bank, but, at the same time, these managers of the bidder bank can fulfill their own opportunistic goals like increased job security. The former owners of the target might now benefit from increased agent performance, but are still dealing with a set of agents that act opportunistically, although their performance level might be higher than the level of the previous agents.
The basic concept behind the synergy theory includes the utilization of different classes of resources to create value. According to the resource-based view, “which offers a useful approach to understand synergistic acquisitions”, the “amount of the resources held by the firm, relative to the total amount present in the economy and the availability of opportunities to utilize this resource” determine the amount of created value (Chatterjee, 1986; Krishnan et al., 2009). Therefore, “resources contribute to the advantage of one firm over another” (Krishnan et al., 2009). The literature includes different definitions of the term “resource” such as “inputs to the production process” or "stocks of available factors that are owned or controlled by the firm". Frequently, it is described that resources can be categorized as tangible resources like capital and buildings and intangible resources like skills and competencies. It has to be considered that this resource-based view is also criticized, because it focuses on the company’s internal potential as a source of competiveness and neglects “the need for external market orientation to achieve competitive success” (Broderick et al., 1998).
Nevertheless, the concept of synergies is frequently used in the context of M&A research (Altunbas and Marques, 2008). Chatterjee (1986) describes that there are three types of synergies. These are described as “cost of production related (resulting in operational synergy)”, “cost of capital related (resulting in financial synergy)”, and “price related (resulting in collusive synergy)”. This overview can also be found in more current articles like Hankir et al. (2011). They describe that the synergy theory “explains M&A transactions motivated by the intention of realizing merger synergies that will boost future cash flows and enhance firm value” and include operational and financial synergies as an underling structure of the synergy theory. Both types of synergies are either achieved by “increased firm size (scale) or as a result of firm-specific combination advantages (scope)”. Chatterjee’s (1986) third element in terms of the collusive synergy is approached as a separate topic in Hankir et al. (2011), a circumstance that will be dealt with after a more detailed explanation of operational and financial synergies.
The first type of synergies - the operational synergies “can stem from combining operations of hitherto separate units (for example a joint sales force)” and the transfer of knowledge (Hellgren et al., 2011 based on Trautwein, 1990). Further, Hankir et al. (2011) describe in similar terms the possibilities for “revenue increases, resulting from cross and/ or up-selling (and) cost reductions due to efficiency gains”. Hellgren et al. (2011) explain that financial synergies result in lower costs of capital e.g. “by lowering the systematic risk by investing in unrelated business”, “increasing the company’s size, which may give it access to cheaper capital”, or the creation of an internal capital market that “may operate on superior information and therefore allocate capital more efficiently” (Trautwein, 1990). Hankir et al. (2011) adds to these points also “new opportunities in financial engineering, tax savings, or cash slack.”
Besides operational and financial synergies, Chatterjee (1986) includes a third element (collusive synergy) that is also used by Hankir et al. (2011). But they use Chatterjee’s (1986) collusive synergy as a separated market power theory. I will follow this structure, which is also applied by other researches like Carpenter et al. (2009) and include the market power theory as a separate topic. Furthermore, one other element of the synergy theory is explained in Hellgren et al. (2011), labeled managerial synergies. They are achieved when “the bidder’s managers possess superior planning and monitoring abilities that benefit the target’s performance” (Trautwein, 1990). It is noticeable that this last concept of managerial synergies is similar to Carpenter et al. (2009) explanation of the agency theory. Trautwein’s (1990) further description of mergers as a “disciplinary force” for agents supports this assumption. I follow Eisenhardt (1989) and Shapiro (2005) and attribute superior management performance as an agency related topic.
In conclusion, there are quite consistent descriptions of the synergy theory in M&A research papers concerning the existence of operational and financial synergies (Chatterjee, 1986; Trautwein, 1990; Hankir et al., 2011; Hellgren et al., 2011). Furthermore, Chatterjee (1986) describes the possibilities of collusive synergy, which will be treated as a separate approach in the following subchapter. Hellgren et al. (2011) also put emphasis on the possibilities to benefit from managerial synergies that are treated as agency related in the context of this thesis.
This subchapter follows the previously established structure and starts with the definition of the theoretical concept: "Market power is the ability of a market participant or group of participants (persons, firms, partnerships, or others) to influence price, quality, and the nature of the product in the marketplace" (Shepherd, 1970 quoted in Montgomery, 1985). “In turn, market power can lead to […] high [….] profits” (Montgomery, 1985). Although, “empirical tests [….] show conflicting strands of results” in the context of M&A research, the market power theory is frequently used to analyze M&A performance changes accordingly. It includes “anticompetitive effects” as a result of mergers, or in other words, “takeovers will result in a lessening of competition and increasing market prices” (Hankir et al., 2011). Both, targets and bidders will be able to demand higher prices at the expense of their customers. Hellgren et al. (2011) based on Trautwein (1990) use similar descriptions as Hankir et al. (2011) and interpret (horizontal) mergers “as planned strategic action to achieve market power that creates a wealth transfer from customers to the owners.” The authors label this approach as the monopoly theory. Further support for these definitions is also included in Carpenter et al. (2009).
In summary, it can be stated that the descriptions of the market power theory predict a wealth transfer from customers to the company’s owners. This transfer is facilitated by an increase in the company’s market power in the context of M&A.
In addition to the previously described theories that are used to explain performance changes in the context of M&A, the strategic management literature has identified various variables that are described to be moderating the expected performance changes around M&A. A recent meta-study focusing on post-acquisition performance and the role of moderators includes four major areas of factors that have been analyzed in the literature like e.g. the companies’ acquisition experience and the role of strategic similarities (Covin et al., 2004). As mentioned in the introduction, the focus of this thesis is limited to the second topic. On the basis of the concept of strategic similarity it is expected that having shared strategic characteristics will result in superior financial performance, because firms with a similar set of competencies are better positioned to fully exploit synergies and avoid conflicts that are connected with merging dissimilar strategies (Ramaswamy, 1997; Altunbas and Marques, 2008). The following paragraphs include the theoretical principles behind this concept and are based on the line of argumentation presented by Ramaswamy (1997), Covin et al. (2004) and Altunbas and Marques (2008).
The foundations of the strategic management literature go back to authors such as Miles and Snow or Porter and their typology including three strategic types of organizations (Defenders, Analyzers and Prospectors), or respectively in terms segmentation, differentiation and cost leadership strategy. A strategy is according to Porter (1991) the “act of aligning a company and its environment", or in other words, the alignment of a company’s strategic strength (supply perspective) and strategic scope (demand perspective) in which the three strategies (in terms of segmentation, differentiation and cost leadership) can be found: cost leadership emphasizes “low cost relative to competitors”, differentiation requires the focus on creating a “product or a service, that is recognized industry wide as being unique” and the focus strategy includes the concentration “on a particular group of customers, geographic markets, or product line segments” (e.g. described in Davis and Dess, 1984; Coleman et al., 1987; Porter 1991).
Since these articles, researchers have used resource allocation patterns to analyze the underlying strategic orientation of companies. Davis and Dess (1984) connect e.g. a high operating efficiency with Porter’s low cost strategy and high costs for advertising with a diversification strategy. One frequently mentioned point of criticism in this context is the measurement of the intended and the implemented strategy. Based on the companies’ research allocation patterns it is possible to draw a conclusion about the currently implemented strategy, but problematic to assess the intended strategy. The intended strategy of a company can differ from an implemented strategy, because it has e.g. not been implemented properly or it is currently being adapted (Davis and Dess, 1984; Coleman et al., 1987).
More current research papers still deduct firm specific strategies from resource allocation patterns expressed in accounting ratios (Ramaswamy, 1997; Altunbas and Marques, 2008). “Consequently, if two firms exhibit very similar resource allocation patterns as measured across a variety of strategically relevant characteristics [….], they can be considered to be strategically similar” (Covin et al., 2004). The strategically relevant characteristics are in the context of M&As in the banking industry measured in terms of operational efficiency, emphasis on marketing activity, client mix, earnings diversification strategy, risk propensity, liquidity risk strategy, market coverage, technology and innovation (Ramaswamy, 1997; Altunbas and Marques, 2008).
The integration of two strategically similar companies leads to a higher post-merger performance, because such companies that are able to benefit from scale synergies. “For instance, if a firm competing on the basis of low cost and efficiency in operations were to merge with another organization with a set of similar competencies, the resulting firm would be better positioned to fully exploit the synergistic benefits of combining similar skills” (Ramaswamy, 1997).
Further, “business relatedness is said to enable the acquiring firm’s managers to effectively employ their ‘dominant logic’” (Covin et al., 2004). The dominant logic is described by Bettis and Prahalad (1995) as an information filter used by managers to process external data and to incorporate it “into the strategy, systems values, expectations, and to thus reinforce the behavior of the organization.” A change of this dominant logic would require a learning process of the new logic, but also an unlearning of the old logic, which is described to be a long-lasting process.
The strategic management literature also includes a contradicting perspective that predicts e.g. benefits in terms of a lower systematic risk for a “company’s investment portfolio by investing in unrelated business” (Hellgren et al., 2011 based on Trautwein, 1990). This possibility, which overlaps with the previous subchapter, will be addressed in subchapter 2.2.2 that includes two articles with contradicting empirical evidence. In this context, it is also noticeable that “acquisition performance increases when high-performing firms pair with low-performing targets.” Carpenter et al. (2009) explain this on the basis that such targets still leave room for performance improvements. But, they also pinpoint that acquiring an underperforming target is connected with high risk and therefore, the possibility of failure.
The previous subchapters include the theoretical foundations of three theories that are frequently used to explain merger performance effects: agency, synergy and market power theory. Firstly, it has been described that from an agency perspective mergers can either be performance enhancing if they are used to reduce agency costs or can reduce financial performance if the merger is used to satisfy managers’ self-interests. Both situations can occur during one merger, depending on the point of view. Secondly, performance changes can be expected on the basis of the synergy theory that presents possibilities for operational and financial synergies. Thirdly, the market power theory predicts an increase in market prices. Furthermore, from the strategic management literature the concept of strategic similarities is used to explain varying M&A performance outcomes.
After dealing with the theoretical foundations the current empirical evidence is described in the following subchapters. In a first step, the empirical evidence is presented from a performance perspective according to the three theories agency, synergy and market power. Afterwards, the articles analyzing the role of strategic similarities are included. It is the aim of these subchapter to underpin the presented theories with empirical data and therefore to confirm their validity. Each of the four topics is presented separately in one of the following subchapters.
The focus of this first review lies on the agency perspective with its three major elements in terms of agents, principals and the instruments that align their interests. Azofra et al. (2008) test if poorly managed banks are more often likely to be acquired, which is in line with the assumption that mergers are a suitable instrument to protect shareholders from poor management (Eisenhardt, 1989; Carpenter et al., 2009). The authors are not able to confirm the hypothesis due to possible problems with the chosen sample. As the authors have indicated in their work, it is likely that “the motives behind financial M&As may be different in commercial banks, savings banks and cooperatives”. Other researchers like Campa and Hernando (2006) report on the basis of a sample of European mergers in the financial industry (listed companies) support for the hypothesis that target banks are usually performing to a lesser degree in terms of a cost to income ratio than the industry average. A further article that deals with European commercial banks is Altunbas and Marques (2008). In which it is stated that: “Results from the descriptive analysis show that the overall statistical picture is of large, generally more efficient banks merging with relatively smaller and better capitalized institutions with more diversified sources of income.” Koetter (2008) who based his findings on a sample of German cooperative and savings banks describes a similar finding concerning the efficiency of targets and acquirers on the basis of a cost and profit efficiency indicator. It should be remarked that the author’s sample also contains multiple mergers in contrast to other authors that exclude such kinds of mergers to avoid possible bias (Cornett et al., 2006; Bauer et al., 2009).
A further research approach is applied by Bauer et al. (2009) who focus on the cooperative credit unions in the US. Their amount has decreased from 11,992 (end of 1994) to 8,362 federal insured unions (beginning of 2007). Credit union members, the principals, do not require return on equity capital. Instead they benefit from higher deposit rates and lower lending rates in comparison to competing banks. Further, it is mentioned, that due to this absence of leveraged equity owners, credit union mergers do not focus on the maximization of shareholder wealth e.g. in terms of increasing share prices and that the normal motivation behind merger decisions like synergy and agency are not fully established in a US cooperative environment. Therefore, the authors aim to investigate motives connected with mergers between credit unions further, by pinpointing three groups that might benefit from the mergers: the members of the acquired institute, the members of the acquiring credit union and the National Credit Union Administration (NCUA). The NCUA administrates the National Credit Union Share Insurance Fund (NCUSIF), which deals with failing credit unions (“all institutions [….] are jointly and severally responsible”). Bauer et al. (2009) report a positive ex post-merger performance increase for the target members, little effect on the acquiring firm’s members and support for the thesis that “most mergers are instigated by regulators to avert using insurance funds to bail out failing institutions.” The acquirer’s members do not clearly benefit which can be explained on the basis of an agency problem in terms of aligning the interest of members and their agents (Collins et al, 2007). A second explanation can be described on the basis of the agency theory’s weakness mentioned by Shapiro (2005), who explains that multiple principals might have different goals and therefore, that the individual power of the principals might matter. In this case it can be anticipated that the agents act on behalf of the most powerful principal in terms of the NCUA, who has more influence on the agents than the members. Bauer et al. (2009) do not include further empirical evidence in terms of the quality of monitoring instruments or information about the power of the different principals, which can be used for a further explanation of the found changes.
Performance changes measured in terms of abnormal stock returns in the context of the merger’s announcement date are presented in Cornett et al. (2006). They report increasing target share prices and a negative abnormal return for bidder bank shareholders around the announcement day. The asset quality in terms of allowance for loan losses to loans and loan loss provision to loans is increasing, which can be interpreted as reduction of risk and therefore as empirical evidence for the assumption that the acquiring bank’s agents try to minimize their employment risk at the cost of the principals’ return (Collins et al., 2007). Further information about the quality of the governance structures is not included. According to DeYoung et al. (2009) the finding of Cornett et al. (2006), based on a sample of US banks (1990-2000), is consistent with other US research literature prior to the year 2000. “Target shareholders earned strong positive abnormal returns (and) bidder stockholders earned marginally negative returns [….].” The consequences concerning the risk level are not presented in a similarly clear conclusion. Likewise, Campa and Hernando (2006) report for the EU a positive excess return for target shareholders and “essentially zero” excess returns for acquiring firm shareholders around the announcement date. The results have to be acknowledged with caution. Depending on the used event timeframe around the merger, the results vary for the target shareholders between significant and insignificant.
In contrast to the presented articles dealing with principals’ performance changes, Anderson et al. (2004) focus on the CEOs’ benefits from M&A. They analyze in their research the relationship between the CEOs’ or agents’ incentives and the principals’ anticipated gains in terms of cumulative abnormal returns around the event. In contrast to the widespread assumption that “boards of directors naively follow a policy of benchmarking CEO compensation according to firm size and award CEOs of recently-merged banks an undeserved compensation windfall”, Anderson et al. (2004) find a positive relation between anticipated gains and CEO compensation. The connection between “increases in asset size due to merger and post-merger changes in CEO compensation” is not supported. Further, it is noticeable that the amount of long-term CEO compensation (e.g. in terms of stock-options) in relation to the total amount of compensation has increased, which can be interpreted as a supporting argument for using outcome-oriented contracts to align the interests of principals and agents. This connection has already been anticipated in Eisenhardt (1989).
The previous paragraphs include four approaches to test M&A performance changes from an agency theory perspective. The first approach is presented by Azofra et al. (2008), Campa and Hernando (2006), Altunbas and Marques (2008) and Koetter (2008). They test if poorly managed banks are more often the target in M&A than well performing ones on the basis of an EU sample. Three of the four articles include empirical evidence for this hypothesis and therefore for the concept of corporate control described by Carpenter et al. (2009). Only Koetter (2008) presents results for German cooperative and savings banks. The second approach is used by Bauer et al. (2009), who describe a positive ex post-merger performance increase for the target members, little effect on acquiring firm’s members and support of the thesis that “most mergers are instigated by regulators to avert using insurance funds to bail out failing institutions.” Thirdly, Campa and Hernando (2006) and Cornett et al. (2006) mention quite consistently for the US and EU that performance changes measured in abnormal stock market returns are found for target bank shareholders and that acquiring bank shareholders do not benefit or even have a negative abnormal return. This finding is in line with this work’s concluding remarks of the theoretical foundations of the agency theory; it is possible that one merger can simultaneously be used to discipline ineffective managers and to satisfy self-interests of others, depending on the point of view. A fourth method is used in Anderson et al. (2004), who analyze the connection between agents’ incentive and the anticipated gains and describe a positive relationship. Thus, most researchers present empirical evidence in line with the theoretical descriptions of the agency theory, which makes it a valid perspective for this thesis.
The following articles include empirical evidence for the second theoretical perspective, the synergy theory. The first paragraph focuses on operational synergies and the following on financial synergies.
Rupert and Sherman (2006) describe synergy effects on the basis of internal operating performance data of one US merger. In their underlying model they identify personnel and operating inputs and seven outputs including elements like teller transactions, marketing, night deposits and safe deposit visits. It is reported that the bank’s branch operating savings are equal to 7.8 % of the previously measured branch resources or 0.28 % of the banks overall operating expenses (after six months). Another study focusing on operating synergies is the work of Cornett et al. (2006). In comparison to Rupert and Sherman (2006), Cornett et al. (2006) base their findings on a broader US sample of 134 mergers (1990-2000) including publicly and non-publicly traded banks. The authors concluded that the increase in operating performance measured after a merger is statistically significant. The source of this change is also investigated and measured in terms of nine performance indicators that represent a cluster of accounting ratio. “Almost all of the operating efficiency measures change significantly before versus after the bank merger in a manner that suggests the merger results in significant cost cutting.” Revenue enhancements are also reported e.g. in terms of returns on loans. A third article describing the operating performance changes around mergers is the work of Davidson et al. (2009). They base their findings on a sample of thirty-five mergers between listed European banks (1992 - 1997) and also report a detailed overview of the changes of different operating ratios at an organizational level. In this market context the main performance indicator has not changed significantly after a merger. The found “positive and significant post-merger returns are not due to the merger itself but could be due” to the already higher pre-merger level. The profitability and capitalization ratios are decreased and in contrast to the prior US research, an improvement in cost-efficiency is reported (“enabled by exploiting operational and managerial synergies”), “although the improvement was not large enough to offset the profitability decrease”. The previously mentioned article of Koetter (2008) describes post-merger efficiency improvements for app. half of the investigated German mergers (cooperative and savings banks) in terms of improvements in cost and profit efficiency. The improvements of the cost indicator values are in comparison to the profit indicator only minor. In his terminology, a merger must fulfill two conditions to be labeled successful. “First, merged institutes must exhibit efficiency levels above the average of non-merging banks. Second, merged institutions must exhibit efficiency changes between merger and evaluation year above the efficiency changes of non-merging banks.”
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