International mergers and acquisitions of financial firms

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International mergers and acquisitions of financial firms
Biswas, Rita, Ph.D.
Texas A&M University, 1990

UMI

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INTERNATIONAL MERGERS AND ACQUISITIONS OF FINANCIAL
FIRMS

A Dissertation
by
RITA BISWAS

Submitted to the Office of Graduate Studies of
Texas A&M University
in partial fulfillment of the requirements for the degree of
DOCTOR OF PHILOSOPHY

December 1990

Major Subject:

Finance

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INTERNATIONAL MERGERS AND ACQUISITIONS OF FINANCIAL
FIRMS

A Dissertation

by

RITA BISWAS

Approved as to style and content by:

<1
Donald R. Fraser
(Chair of Committee)

L

"A

A rvind M ahajan
(Member)

Michael J. Alderson
(Member)

A sghar Za
(Member)

Gary Trenndpohl'
'fH ead of Department)

December 1990

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ABSTRACT

International Mergers and Acquisitions of Financial Firms
(December 1990)
Rita Biswas, B.A., Calcutta University;
M.A., Calcutta University;
M.S., University of Rochester;
Chair of Advisory Committee: Dr. Donald R. Fraser

This study investigates the valuation effects of international mergers
an d acquisitions of financial firm s.

A bnorm al re tu rn s accruing to

shareholders of financial firms participating in international m ergers and
acquisitions are hypothesized to be statistically different from those arising
out of domestic acquisitions.
Several factors may be responsible: first, the degree of informational
asym m etry is higher in international acquisitions vis-a-vis dom estic ones the differences will be m ore pronounced depending on the extent of
previous presence of the acquirer in the target country. Further, to the extent
m ark ets

are

im perfect, sh a re h o ld e rs

m ay p erceiv e

b en efits

from

international diversification, w hich causes an upw ard revaluation of the
shares of those financial firms announcing international acquisitions.

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Third, the abnorm al returns arising out of the international 'intent-toacquire' announcem ent m ay include a higher penalty for the greater risk

inherent in obtaining inter-country regulatory approval, as com pared to a
dom estic 'intent-to-acquire' announcem ent.
Fourth, since regulations affect the set of participating bidders and
targets an d hence the com petitive pressure in the acquisitions market, both
the division of gains betw een bidder and target shareholders as well as the
prem ia p aid in any p articu lar acquisition, m ay be different from their
domestic counterparts.
U sing a sam ple of 220 international acquisition events, spanning
eleven countries, over the time period 1977-1987, this study tests the above
h yp o th eses u sing the event stu d y m ethodology and finds significant
differences bewteen domestic and international acquisitions.
Finally, the stu d y also identifies a possible set of determ inants of the
v aluation effects o f international bank acquisitions.

The determ inants

include the method of paym ent and the extent of the acquisition.
The overall evidence provides insight into the underlying factors
m otivating these acquisitions.

It also provides evidence on the degree of

com petition and segm entation in the international m arket for bank control.

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DEDICATION

TO DAVAI

It's not a recipe after all,

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ACKNOWLEDGMENTS

It still surprises m e w hy Dr. Fraser continued to chair my
dissertation for it seemed like every time I warm ed up to a meaningful pace I
would take off to some remote country for a wild vacation. Obviously he is a
very patient man. I thank him for his generous help and only hope that I
can do justice to his faith and confidence in me.
To Dr. Mahajan I owe special thanks for that extra pressure and
m otivation he provided w henever I felt discouraged about the dissertation.
Some of his optim ism rubbed off and I actually found myself thinking about
finishing up!
I w ould like to thank the entire departm ent at Texas A&M for
their friendly cooperation. Things w ere so much simpler due to the (almost
24-hour) open door policy of all the faculty - in particular I w ould like to
m ention Drs. A lderson, Dubofsky, K annau, Lummer and Dr. Zardkoohi
(from the departm ent of Management) for letting me use them as a walking
encyclopaedia in Finance. For non-academic problems, I was fortunate to
have Charlotte Paton's friendship to bide m e by. Thank you, Charlotte.
W ords can never express w hat I owe my parents and w hat I
w ould like to thank them for. Still, I w ould like to take this opportunity to
tell them that I could not have come so far if they had not instilled the right

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values in me. I hope they are proud of the good job they did. My wish is that
I can continue to provide them m any more instances like this.
Life as a doctoral student at College Station was m ade tolerable
(even bordering on FUN at times) also because of all the friends I had there.
To m ention a few, Anu, Deepak, Liz, Ashok, Jim and Shaubhik - I am indeed
fortunate to have friends like you.
A nd then of course there's the other advisor I have - my
husband, Amit. W ithout his help/hindrance I could not have solved Ito's
Lemma, coded in Fortran, hand-gathered daily prices from the microfilm,
played D igger for 17 hours continuously, printed m y dissertation and
com pleted it w hen I did. W ithout his help/hindrance, I could have learnt
TeX, m astered SAS and kept my sanity.

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TABLE OF CONTENTS
Page
ABSTRACT ...................................................................................................

iii

DEDICATION ..............................................................................................

v

ACKNOWLEDGMENTS ..............................................................................

vi

TABLE OF CONTENTS .............................................................................

viii

LIST OF TABLES

..................................................................................

x

I

INTRODUCTION ....................................................................

1

n

REVIEW OF RELEVANT LITERATURE

6

CHAPTER

..........................

2.1.....................Introduction ............................................
2.2 Com peting Theories of Mergers and
Acquisitions ..........................................................
2.3 Bank M ergers, Regulation and Interstate

Expansion ............................................................
2.4 Foreign Mergers and Acquisitions ........................
2.5Evidence from the U.K., Japan, and Canada ...........
2.6 International Banking Trends: US. Expansion
A b ro ad...................................................................
2.7 International Banking Trends: Foreign Banking
in the U.S.A............................................................
2.8Effects of the International Banking Act of 1978
2.9
Conclusion ............................................

m

6
6
12
21
25
29
31
38
39

ISSUES AND TESTABLE IMPLICATIONS ........................

41

3.1 Theory of International Banking ..........................
3.2 Factors Determ ining the M edium for Foreign
Expansion .............................................................

3.3 Potential Valuation Effects of International
Banking ....................

41

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43
47


ix

3.4 Diversification and Risk Reduction as a
Potential Motive ..................................................
3.5 The Method of Payment ..........................................
IV

49
50

METHODOLOGY AND ESTIMATION PROCEDURES

53

4.1
4.2
4.3
4.4
4.5

V

Introduction ..............................................................
M easurement of Abnormal Returns ...................
Test Statistics and the Null Hypothesis ...............
Tests of Differing Effects Between G ro u p s
Wealth Effects and the Division of Gains
Analysis .................................................................
4.6 Regression Analysis .................................................
4.7 Data Sources and Sample Selection ........
4.8 Criteria for Qualifying as an International
Financial Acquisition ..........................................
4.9 Final Sample Selection Criteria .............................
4.10 Data Availability Problems ...................................
4.11 Sub-sample Data Sources and Description
4.12 Sample Statistics ......................................................

53
54
57
58

63
64
65
66
66

EMPIRICAL RESULTS ...........................................................

71

Introduction ........................................
Overall Valuation Effects ........................................
International Versus Domestic Acquisitions .....
Categories of International Acquisitions A Comparison .......................................................
5.5 Multiple Regression Analysis ................................
5.6 Wealth Effects and the Division of Gains ............

71
72
76

58
60
61

5.1
5.2
5.3
5.4

VI

SUMMARY AND CONCLUSIONS

................................

REFERENCES .....................................................

SUPPLEMENTARY SOURCES CONSULTED

81
94
97
103
106

.................

112

VITA .........................................................................................

114

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LIST OF TABLES
Table

Page

1 Summary of Previous Studies

.......................................................

40

2

Distribution of Bidders and Targets .............................................

68

3

Overall Bidder Returns in International Acquisitions ............

73

4

Overall Target Returns in International Acquisitions ..... .......

75

5

Overall Bidder Returns in Domestic Acquisitions ....................

77

6 Differences Between Domestic and International Bidders ......

79

7 Overall Target Returns in Domestic Acquisitions......... ...............

80

8 Differences Between Domestic and International Targets .......

82

9 Evidence on Product Diversification : Bidders ..........................

84

10 Evidence on Product Diversification : Targets ...........................

86

11 Evidence on Method of Payment Differences : Bidders ...........

87

12 Evidence on Method of Payment Differences : Targets ............

88

13 Evidence on Old Versus N ew Targets ...........................................

91

14 Evidence on Controlling Interest: Bidders ...................................

92

15 Evidence on Controlling Interest Targets ....................................

93

16 W ealth Effects Analysis: Bidders ......................................................

99

17 W ealth Effects Analysis: Targets .......................................................

100

18 Division of Gains Analysis ................................................................

101

19 Division of Gains Analysis (Positives Only) ..................................

102

20 Comparison with Previous Studies

104

................................................

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1

CHAPTER I

INTRODUCTION

In A ugust 1983, Mitsubishi Bank Limited, the fourth largest bank in
Japan, acquired the Bancal Tristate Corporation from its U.S. owners. The
New York Times (August 15, 1983, Page 18) reported that "banking specialists
say the subsidiaries of Japanese banks have been able to attract business by
offering low er interest rates for borrowers and higher rates for depositors.
They are aided, in part, by the lower cost of capital to their parent banks in
Japan that enables them to undercut their American competitors."

Is this

entirely correct? If so, does it apply to other bank acquisitions too? Does this
explain the observed trends in international banking? If not, then w hat are
the determ ining factors of the ownership pattern and structure of the world
banking industry?
International banking trends have reversed from the dom inance of
U.S. banks operating abroad in the 1960’s to the growing influence of foreign
banks in the U.S. in the 1970's and 1980's. Further, mergers and acquisitions

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2

have em erged as the popular m edium for this wave of foreign expansion,
outdoing alternative means such as opening a branch or subsidiary. Does an
economics-based cost-benefit analysis explain this choice? Or, is it explained
by imperfections such as tax and regulation differentials?
O n the other hand, consider the micro- and macro-economic im pact of
this global trend of foreign expansion in the banking industry.
P areto-optim al phenom enon?

Is this a

Should it be allow ed to continue, laissez

faire? Or, should the relevant regulatory authorities intervene to foster it?
Perhaps it should be curbed w ith regulatory intervention.
The current literature is inadequate for providing accurate answers to
the above questions.

From the realm of international trade, one of the

theories p u t forw ard to provide a rationale for the foreign expansion of a
b an k is the fam iliar R icardian com parative ad v an tag e theory.

In a

com petitive w orld economy, a bank locates in the country which allows it to
p ro d u ce a particular service a t the lowest cost.

This com parative cost

advantage enables it to compete with the host-country banks.

The m ore traditional reasoning is simple:

global com panies need

global banks. Each bank has a differentiated package of services and its close
relationship w ith a firm is one differentiated product.

Therefore, banks

follow their domestic customers abroad under the belief that their previously
estab lish ed relatio n sh ip w ill g iv e them an edge ov er th eir foreign
com petitors.

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3

If a bank believes it has a firm-specific advantage, such as a particular
lending technique developed at home, then it has the m otive to expand
abroad.

This strategy w ould work so long as the advantage was not a

function of its hom e country’s factor endow m ents;

for instance, if the

lending technique involved a specific type of skilled labor then this w ould no
longer be a motive for going abroad.

The present study provides an analysis of the financial m arket effects
of foreign acquisitions and attem pts to explain some of the determ inants of
these effects.
A pproxim ately 220 acquisition events were identified over the time
period 1977-1987, w here the bidder and the target belong to two different
nations. Using financial data and event study methodology, the effect of each
of these events on the participating firm s' shareholders is docum ented.
Next, stratifying the sample in different ways, with respect to specific criteria
such as the size of the target, the exchange rate betw een the currencies
involved, the n atu re of the bidder or target, the m ethod of paym ent and
others, the valuation effects of each of these is documented.
For comparison purposes, the same analysis is conducted on a control
group, i.e. on a sam ple of dom estic acquisitions.

The valuation effect

differentials for each subsample provides insights into the m otivating factors
of international acquisitions. Finally, a regression analysis is done on the
wealth effects using measurable proxies of the above stratification criteria as
independent variables.

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4

The significance of the study of financial m ergers and acquisitions
across national borders should not be underestimated. Investigating the set
of motivating macro and micro factors can provide useful insights, especially
with respect to policy prescriptions. While the prim ary concern underlying

dom estic an d corporate m ergers centers around the issue of m arket
concentration alone, transnational financial mergers involve socioeconomic
and political issues such as reciprocity relations with other governments, the
need for the enhancem ent of dom estic financial m arkets, the degree of
governm ent control, etc., to nam e just a few. Therefore, there is m ore to the
m arket for international bank control than merely viewing it as a m arket in
w hich alternative m anagerial team s com pete for the rights to m anage a
bank’s resources.
W hile the literature has been prolific in the analysis of dom estic
m ergers and acquisitions of both corporate and financial firms, it has only
begun to investigate international corporate m ergers and is particularly
limited for international mergers of financial firms. One of the purposes of
the present study is to fill this void in the literature.
With respect to the methodology, most of the recent literature on bank
m ergers has used accounting data and various regression techniques to
examine the im pact of a merger on the profitability of the relevant banking
firms. However, the efficient-markets and rational-expectations hypothesis
posits that security prices reflect all available inform ation.

Hence, any

unanticipated changes result in a current change in security prices, and the
price change is an unbiased estimate of the value of the changes in a firm's

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5

future cash flows an d riskiness.

This hypothesis underlies a variety of

m ethods for estim ating the effects of unanticipated changes on shareholder
wealth, including the event study methodology commonly em ployed in the
study of corporate mergers.

Thus, the use of financial data rather than

accounting data m ay result in a more precise evaluation of the effects of a
bank merger.
In this introductory chapter, we have presented the objectives and
m otivation for this study.

C hapter tw o review s some of the relevant

literature in the broad area of mergers and acquisitions w ith respect to the
issues raised and analyzed, and the results of these studies. C hapter three
discusses the issues relevant to the study of transnational m ergers and
acquisitions of financial firms and identifies their testable im plications.
Chapter four describes the methodology and estimation procedures followed
by a description of the data sources and sam ple selection.

C hapter five

reports and analyzes the results and compares them to the implications of
the hypotheses. The final chapter provides a summ ary of the key findings
and conclusions of this study.

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6

CHAPTER II

REVIEW OF RELEVANT LITERATURE

2.1. Introduction
M ergers and acquisitions are strategic decisions w hich have received
w idespread attention in the literature.

They have been analyzed from a

variety of p o in ts of view including the m otives, financial econom ies
involved, com petitive effects and w ealth effects

(see Jensen and Ruback,

1983, for a com prehensive review, and m ore recently, Jarrell, Brickley and
N etter, 1988, for the empirical evidence since 1980).
W ith regard to the wealth effects, the general conclusion has been that
takeovers generate abnorm al returns for the shareholders of target firms.
However, the evidence on returns to the shareholders of acquiring firms is
less clear (see Roll, 1986, for a review). W hile some have found a positive
w ealth effect for shareholders of acquiring firms (e.g. Bradley, 1980, Schipper
and Thom pson, 1983, and Dennis and McConnell, 1986), others have found
their effect to be negative (Dodd, 1980 and Firth, 1980).

2.2. Competing Theories o f Mergers and Acquisitions

In an attem pt to resolve the above m entioned contradictory results,
Asquith, Bruner an d Mullins (1983), have found that bidding firms receive
positive cum ulative excess returns throughout merger program s involving

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7

multiple acquisitions (up to four) for the sam e bidding firm. They attribute
the differences betw een their results and prior work to failures by earlier
studies to control for target size, success of the m erger bid, and the time
period in which the bid occurred.
H alpern (1983), in a survey of event studies related to acquisitions,
suggested th at a preferable technique to obtain evidence on the m otivation
for m ergers is to blend the residual m ethodology w ith m icroeconom ic
foundations, such as the method of payment, found in the in d u strial
organization literature. Carleton et al, (1983) and Wansley, Lane and Yang
(1983a, 1987), have incorporated the paym ent m ethod into m erger studies
and conclude that cash takeovers and securities exchanges are distinctly
different. Cum ulative average residuals to target firms in cash transactions
were found to be approxim ately tw ice the level observed in securities
exchanges (33.54 percent versus 17.47 percent). Even after accounting for firm
size and the time pattern of cash and securities acquisitions, the difference is
significant.
H ansen (1987) presents a theory for the choice of exchange m edium in
mergers an d acquisitions.

The model he uses is one of bargaining under

asymmetric information. W hen a target firm knows its value better than a
potential acquirer, the acquirer will prefer to offer stock, w hich has desirable
contingent-pricing characteristics, rather than cash.

Either tax effects or

asymmetric inform ation on the acquiring side can make the acquirer's choice
a nontrivial one.

W ith asym m etry on bo th sides of the transaction, a

signalling equilibrium develops, w hereby the target uses both exchange
m edium offered and the amount of any stock offer as signals of the acquiring

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8

Yang, and Carleton et al, is consistent w ith this payment method signalling
hypothesis.
A squith and Kim (1982) have investigated the possibility that the
positive abnormal returns earned by the acquired firms' stockholders come at
the expense of other claimants. That is, mergers may impose a loss on some
claim ants of the m erging firms, and the stockholders' positive abnormal
retu rn s m ay sim ply reflect negative abnorm al retu rn s to these other
claimants. Since a merger is a corporate investment, the stockholders may
earn positive abnorm al returns (even if there is no real synergy) at the
expense of bondholders by increasing the firm's risk through the merger.
Asquith and Kim's results, however, show that while the stockholders

of target firms gain from a merger bid, no other securityholders either gain or
lose.

To provide direct evidence on the existence of diversification effects

and incentive effects, they test w hether the b o n d h o ld ers’ retu rn s are
dependent upon the correlation between the returns of the m erging firms
and w hether the size of the bondholders' and stockholders’ returns in
individual mergers are correlated. Their results are consistent w ith a capital
m arket that efficiently resolves conflicts of interest between stockholders and
bondholders.
While trading on nonpublic information is illegal, the enforcement of
this law has been erratic, particularly in the area of trading in advance of
m erger announcements. Keown and Pinkerton (1981) and Keown et al (1985)
p ro v id e

ev id en ce

confirm ing

statistically

th a t

im p e n d in g

m erger

announcem ents are poorly held secrets, and trading on this nonpublic

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9

inform ation abounds.

Specifically, leakage of inside information is a

pervasive problem occurring at a significant level up to twelve trading days
prior to the first public announcem ent of a proposed merger.
M ore recently, Lloyd, H and an d M odani (1987) have provided
evidence that manager-controlled firms do not pursue the same objectives as
ow ner-controlled firms.

In particular, they found that m anager-controlled

companies have a significantly greater tendency to engage in conglomerate
m ergers than do firms w ith strong owner control. They m easure the degree
of ow ner control versus m anager control of a firm by the percent of stock
held by a single interest.

For instance, a single interest with a significant

percentage of stock has substantial stake in the firm ’s results and will
m onitor the firm's m anagers closely.

Further, a large holder will have a

relatively easy tim e rem oving unsatisfactory m anagem ent.

If the stock is

scattered am ong m any holders of insignificant percentage, managers have
little fear of them and are free to pursue their own interests.
Synergism is defined as the incremental wealth to the shareholders of
both m erging firms due to the merger - net of any potential gains achievable
through investors' personal diversification over the common stocks of the
m erging firms. Choi and Philippatos (1983) and m ore recently, Davidson,
G arrison and H enderson (1987) m easure the synergistic effects of mergers on
the stockholders of the acquiring and acquired firms. The evidence suggests
operational a n d /o r financial synergy, with nonconglomerate mergers being
m ore frequently synergistic.

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10

H earth and Zaima (1986) point out that, while earlier studies have
concentrated on price m ovem ents around the date of the first public
announcem ent of the im pending m erger, their approach is different.

In

their opinion, the announcem ent date constitutes only one of two im portant
events du rin g the merger process. The other is the resolution date, the date
the merger is either called off or completed. Considering a selloff as a reverse
merger, H earth and Zaima look at the w ealth effects of voluntary selloffs on
the shareholders of both divesting an d acquiring firms an d find that the

m arket reaction to a selloff occurs throughout the entire divestiture process
an d is n o t lim ited to th e p re-announcem ent period. As uncertainty
concerning the selloff appears closer to resolution, the m arket reaction
continues.
W ith respect to m ergers and m arket concentration, Eckbo's (1985)
results im ply that the levels of concentration and m arket shares found in the
D epartm ent of Justice’s m erger guidelines are unlikely to identify truly anti­
competitive mergers. His empirical evidence fails to support the prediction
of the market concentration doctrine which is that a horizontal m erger is
more likely to have collusive, anti-competitive effects the greater the mergerinduced change in industry concentration.
So far, the two main thrusts of enquiry in m any studies on takeovers
and m ergers have been to provide an economic rationale for such activity
w ithin the context of a theoretical m odel, and to investigate ex post the
economic benefits (either in total or to various parties), and the implications
for pricing efficiency. According to Davidson (1985), a second theoretical line

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11

of enquiry which deserves attention is as follows: if gains do exist, then first,
is the m ethod of reporting offers efficient in the sense that this should result
in a takeover /m erg er offer being attractive to all parties, an d second, how
w ould these gains rationally be split between the various groups, and to what
extent w ould this split be a Pareto im provem ent or be allocatively efficient.
In this context, Davidson studies the efficiency of the bidding mechanism in
takeovers and the im plied apportionment of value gains, given that there
m ay be inform ation asym m etry between the shareholder groups or their
agents, th e m anagers (taking the agency theory view of the ow nershareholder as the principal and the manager as the agent). He finds that

w here debt securities are in issue, protection should be given to bondholders,
if the takeover is to result in Pareto im provem ent.

The extent of value

transference depends crucially on the state of the bidder, post-takeover.
Finally, Smirlock, Beatty and Majd (1985) provide an excellent survey
on the issue of taxes and mergers.

M ergers occur w hen there are

opportunities for reducing the taxes paid by the two involved parties. Also,
the role of increasing debt capacity is essentially a tax-induced motive because
of the deductability of interest paym ents.

The gains to m erger are from

increasing the portion or total am ount of profits available to shareholders.
However, taxation can only be a motivation for a merger if consummation of
the m erger is either required to obtain the tax benefits or the tax gains exceed
the total costs of the merger or there are no lower cost alternatives.

The

stu d y concludes that tax code provisions are a significant influence on
m erger activity.

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