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The dollars and sense of bank consolidation

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  • Joseph P. Hughes
  • William W. Lang
  • Loretta J. Mester

Abstract

For nearly two decades banks in the United States have consolidated in record numbers--in terms of both frequency and the size of the merging institutions. Rhoades (1996) hypothesizes that the main motivators were increased potential for geographic expansion created by changes in state laws regulating branching and a more favorable antitrust climate. To look for evidence of economic incentives to exploit these improved opportunities for consolidation, the authors examine how consolidation affects expected profit, the riskiness of profit, profit efficiency, market value, market-value efficiencies, and the risk of insolvency. Their estimates of expected profit, profit risk, and profit efficiency are based on a structural model of leveraged portfolio production that was estimated for a sample of highest-level U.S. bank holding companies in Hughes, Lang, Mester, and Moon (1996). Here, the authors also estimate two additional measures that gauge efficiency in terms of the market values of assets and of equity. Their findings suggest that the economic benefits of consolidation are strongest for those banks engaged in interstate expansion and, in particular, interstate expansion that diversifies banks' macroeconomic risk. Not only do these banks experience clear gains in their financial performance, but society also benefits from the enhanced bank safety that follows from this type of consolidation.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 98-10.

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Date of creation: 1998
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Handle: RePEc:fip:fedpwp:98-10

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Keywords: Bank mergers;

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References

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  1. Blair, Roger D & Heggestad, Arnold A, 1978. "Bank Portfolio Regulation and the Probability of Bank Failure: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(1), pages 88-93, February.
  2. Joseph P. Hughes & Loretta J. Mester, 1997. "Bank capitalization and cost: evidence of scale economies in risk management and signaling," Working Papers 96-2, Federal Reserve Bank of Philadelphia.
  3. McAfee, R. Preston & McMillan, John., 1990. "Organizational Diseconomies of Scale," Working Papers 728, California Institute of Technology, Division of the Humanities and Social Sciences.
  4. Joseph P. Hughes & William Lang, 1997. "Recovering Technologies That Account for Generalized Managerial Preferences: An Application to Non-Risks-Neutral Banks," Departmental Working Papers 199521, Rutgers University, Department of Economics.
  5. Allen N. Berger & Loretta J. Mester, 1997. "Inside the black box: what explains differences in the efficiencies of financial institutions?," Finance and Economics Discussion Series 1997-10, Board of Governors of the Federal Reserve System (U.S.).
  6. Joseph P. Hughes, 1998. "Measuring efficiency when market prices are subject to adverse selection," Working Papers 98-3, Federal Reserve Bank of Philadelphia.
  7. 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.
  8. Joseph P. Hughes & Choon-Geol Moon, 1997. "Efficient Banking Under Interstate Branching," Departmental Working Papers 199609, Rutgers University, Department of Economics.
  9. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  10. Choon-Goel Moon & Joseph P. Hughes, 1997. "Measuring Bank Efficiency When Managers Trade Return for Reduced Risk," Departmental Working Papers 199520, Rutgers University, Department of Economics.
  11. Saxonhouse, Gary R, 1976. "Estimated Parameters as Dependent Variables," American Economic Review, American Economic Association, vol. 66(1), pages 178-83, March.
  12. Jalal D. Akhavein & Allen N. Berger & David B. Humphrey, 1997. "The effects of megamergers on efficiency and prices: evidence from a bank profit function," Finance and Economics Discussion Series 1997-9, Board of Governors of the Federal Reserve System (U.S.).
  13. Tufano, Peter, 1996. " Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 51(4), pages 1097-1137, September.
  14. Joseph P. Hughes & William W. Lang & Choon-Geol Moon & Michael S. Pagano, 1998. "Measuring the efficiency of capital allocation in commercial banking," Working Papers 98-2, Federal Reserve Bank of Philadelphia.
  15. Chong, Beng Soon, 1991. "The Effects of Interstate Banking on Commercial Banks' Risk and Profitability," The Review of Economics and Statistics, MIT Press, vol. 73(1), pages 78-84, February.
  16. Benston, George J & Hunter, William C & Wall, Larry D, 1995. "Motivations for Bank Mergers and Acquisitions: Enhancing the Deposit Insurance Put Option versus Earnings Diversification," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 777-88, August.
  17. Oliver E. Williamson, 1967. "Hierarchical Control and Optimum Firm Size," Journal of Political Economy, University of Chicago Press, vol. 75, pages 123.
  18. Mester, Loretta J., 1991. "Agency costs among savings and loans," Journal of Financial Intermediation, Elsevier, vol. 1(3), pages 257-278, June.
  19. Steven J. Pilloff & Anthony M. Santomero, 1996. "The Value Effects of Bank Mergers and Acquisitions," Center for Financial Institutions Working Papers 97-07, Wharton School Center for Financial Institutions, University of Pennsylvania.
  20. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
  21. Koehn, Michael & Santomero, Anthony M, 1980. " Regulation of Bank Capital and Portfolio Risk," Journal of Finance, American Finance Association, vol. 35(5), pages 1235-44, December.
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