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Merger-related cost savings in the production of bank services

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  • J. Christina Wang
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    Abstract

    This paper utilizes a new flow measure of the true output of bank services to analyze the impact of mergers on the cost and productivity of Bank Holding Companies (BHCs) over the period 1987-1999. It shows that there are conceptual problems in the output measures used in previous studies, which may be the reason for their paradoxical findings: Bank mergers are estimated to lead to significant increases in profit, without cost savings or increases in market power. This paper also points out the problematic understanding of diversification in previous studies. To remedy these problems, this paper uses a new measure that accounts coherently for risk in measuring bank service output and recognizes that the funds banks borrow and lend are a special intermediate input. Once one accounts for the better diversification resulting naturally from mergers, the commonly used, book-value-based output measure shows little improvement in cost productivity. In contrast, the new flow measure of bank output shows more improvement, although it is still insignificant-partly because the sample size is relatively small. The gap widens further when one corrects for possible bias in the new output estimate. Thus, the new measure of bank output has the potential to resolve the paradox found in the existing literature, by showing that mergers do lead to cost savings.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 03-8.

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    Date of creation: 2003
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    Handle: RePEc:fip:fedbwp:03-8

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    Keywords: Bank holding companies ; Bank mergers ; Banks and banking - Costs ; Productivity ; Economies of scale;

    References

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    1. Arellano, M, 1987. "Computing Robust Standard Errors for Within-Groups Estimators," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 49(4), pages 431-34, November.
    2. Hannan, Timothy H., 1991. "Bank commercial loan markets and the role of market structure: evidence from surveys of commercial lending," Journal of Banking & Finance, Elsevier, vol. 15(1), pages 133-149, February.
    3. Mester, Loretta J., 1996. "A study of bank efficiency taking into account risk-preferences," Journal of Banking & Finance, Elsevier, vol. 20(6), pages 1025-1045, July.
    4. J. Christina Wang, 2003. "Productivity and economies of scale in the production of bank service value added," Working Papers 03-7, Federal Reserve Bank of Boston.
    5. Allen N. Berger & Timothy H. Hannan, 1987. "The price-concentration relationship in banking," Research Papers in Banking and Financial Economics 100, Board of Governors of the Federal Reserve System (U.S.).
    6. Allen N. Berger & David B. Humphrey, 1997. "Efficiency of Financial Institutions: International Survey and Directions for Future Research," Center for Financial Institutions Working Papers 97-05, Wharton School Center for Financial Institutions, University of Pennsylvania.
    7. Lewellen, Wilbur G, 1971. "A Pure Financial Rationale for the Conglomerate Merger," Journal of Finance, American Finance Association, vol. 26(2), pages 521-37, May.
    8. Jalal D. Akhavein & Allen N. Berger & David B. Humphrey, 1996. "The Effects of Megamergers on Efficiency and Prices: Evidence from a Bank Profit Function," Center for Financial Institutions Working Papers 96-03, Wharton School Center for Financial Institutions, University of Pennsylvania.
    9. Berger, Allen N. & Mester, Loretta J., 1997. "Inside the black box: What explains differences in the efficiencies of financial institutions?," Journal of Banking & Finance, Elsevier, vol. 21(7), pages 895-947, July.
    10. Allen N. Berger & David B. Humphrey, 1992. "Megamergers in banking and the use of cost efficiency as an antitrust defense," Finance and Economics Discussion Series 203, Board of Governors of the Federal Reserve System (U.S.).
    11. Pilloff, Steven J, 1996. "Performance Changes and Shareholder Wealth Creation Associated with Mergers of Publicly Traded Banking Institutions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(3), pages 294-310, August.
    12. Allen N. Berger & David B. Humphrey, 1990. "Measurement and efficiency issues in commercial banking," Finance and Economics Discussion Series 151, Board of Governors of the Federal Reserve System (U.S.).
    13. Rhoades, Stephen A., 1993. "Efficiency effects of horizontal (in-market) bank mergers," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 411-422, April.
    14. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
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    Cited by:
    1. Panetta, Fabio & Schivardi, Fabiano & Shum, Matthew, 2005. "Do Mergers Improve Information? Evidence from the Loan Market," CEPR Discussion Papers 4961, C.E.P.R. Discussion Papers.
    2. Al-Khasawneh, Jamal Ali & Essaddam, Naceur, 2012. "Market reaction to the merger announcements of US banks: A non-parametric X-efficiency framework," Global Finance Journal, Elsevier, vol. 23(3), pages 167-183.

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