DONALD R. FRASER
HAO ZHANG
Mergers and Long-Term Corporate Performance:
Evidence from Cross-Border Bank Acquisitions
We provide evidence on operating performance changes at a sample of U.S.
banks acquired by non-U.S. banking organizations over the 1980-2001 period. Our sample allows us to compare directly the preacquisition performance of the targets with their postacquisition performance, a comparison
that has not been possible in prior studies. We find that these cross-border
acquisitions produce improved target performance. Cash flow profitability
at the target increases, labor utilization improves, and loan losses do not rise.
We also find evidence that the improvement in target operating performance
primarily takes place for those acquisitions that occur following passage of
the Reigle-Neal interstate branching legislation.
JEL codes: F23, G21
Keywords: cross-border banking, mergers and acquisitions.
NUMEROUS ACADEMIC sTmiEs have explored the effects of
mergers and acquisitions (Rhoades 1994). Most of the analysis has centered on providing evidence on the equity market reactions for the target firms, the bidder firms,
and the combined wealth effects for bidders and targets. These short-run, marketbased analyses are quite consistent in their findings: targets usually gain, bidders
lose or experience no market reaction, and there are few if any wealth effects for the
combined entity (Houston and Ryngaert 1994). In short, there is a transfer of wealth
from acquiring firm shareholders to target firm shareholders but no evidence of any
net wealth creation. For example, Andrade, Mitchell, and Stafford (2001) report that
the average abnormal returns for almost 4,000 completed financial and nonfinancial
mergers was -3.8% for bidders and +23.8% for the targets. Combined wealth effects
were, on average, zero. Focusing on bank mergers, DeLong (2003) observes that "on
This paper has benefited from the comments of two anonymous reviewers and especially from the
detailed comments of the editor. Naturally, all remaining errors are the sole responsibility of the authors.
DONALD R. FRASER is in the Department of Finance, Mays Business School, Texas A&M
University (E-mail: d-fraser@tamu.edu). HAO ZHANG is in the Department of Accountancy,
College of Business, City University of Hong Kong (E-mail:haozhang@cityu.edu.hk).
Received July 5, 2006; and accepted in revised form March 18, 2009.
Journalof Money, Credit and Banking, Vol. 41, No. 7 (October 2009)
© 2009 The Ohio State University
1504
: MONEY, CREDIT AND BANKING
average, bank mergers do not create value. A paradox is that they continue to occur"
(p. 5).1
Because most of these studies measure the short-run market reaction to an acquisition, they are only measuring the immediate market perceptions of the eventual,
long-run effects of combining the two firms. These perceptions may or may not be
correct. Malatesta (1983) has shown that measurements of the wealth effects of mergers are highly sensitive to model specification. Although long-run results are generally
consistent with short-run evidence (Loughran and Vijh 1997), evaluating the effects of
mergers by examining long-run stock performance of the combined firms is difficult
due to the existence of a large number of potential contaminants that may affect the
price of the combined firms over an extended period.
An alternative approach to evaluating the effects of acquisitions is provided by
Healy, Palepu, and Ruback (1992). They examine operating performance of the "combined" firm 3 years before and 3 years after the merger. Healy, Palepu, and Ruback
find that the "combined" firm, on average, produces postmerger improvements in
asset productivity as compared to comparable firms in the same industry. Further evidence using the same methodology and applying this methodology to bank mergers
is provided by Cornett and Tehranian (1992) and more recently by Comett, McNutt,
and Tehranian (2006). Their focus is on the long-term operating performance of commercial banks as a result of domestic (inter- or intrastate) mergers and acquisitions.
Using a measure of corporate performance based on operating cash flow return on
assets (OPCFROA) 2 that is derived from Healy, Palepu, and Ruback (1992), Cornett
and Tehranian find that merged banks outperform the industry. This better performance of merged banks stems primarily from their ability to grow more rapidly due
to attracting loans and deposits and also from enhanced worker productivity. In the
more recent paper, Cornett, McNutt, and Tehranian (2006) again find that the operating performance of merged banks improves, that large bank mergers produce bigger
gains, and that activity and geographically focusing mergers produce greater gains in
performance.
While the results of these studies using operating performance provide important
insights into the effects of bank acquisitions on performance, the differences between
the operating and market based results remain puzzling. The differences may, of
course, reflect differences in sample selection or in measures of performance. However, in assessing these prior operating performance-based studies, it is important to
recognize that the comparisons between pre- and postmerger operating performance
is not between the preacquisition and postacquisition operating performance of the
target (or the bidder). Rather it is between the preacquisition operating performance of
the imaginary "combined" target and bidder and the postacquisition performance of
the actually combined entity. Observed differences in operating performance are then
attributed to the merger event. The main problem with this "combined" approach is
1. Milboum, Boot. andIThakor (1999) argue that the expansion of the size and scale and scope of banks
through mergers may be due to a desire to increase shareholder wealth and/or to increase the reputation
and (presumably) the compensation of management.
2. OPCFROA is defined to be the pretax operating cash flow return on assets, calculated as income
before taxes and extraordinary items plus interest on notes and debentures subordinate to deposits as a
percentage of the book value of assets.
DONALD R. FRASER AND HAO ZHANG
" 1505
that it cannot isolate the effects of an acquisition on the target from those on the bidder.
A more appropriate measure of the effects of a merger or acquisition on corporate
performance thus would be the difference between the performance of the target (or
the bidder) before and after the acquisition. 3 Unfortunately for most acquisitions,
including most bank acquisitions, the target disappears as a separate entity so that
only the performance of the merged entity can be examined.
We provide direct evidence on the effect of mergers on target performance by selecting a sample of international bank acquisitions in which U.S.-based banks are
acquired by non-U.S.-based banking organizations. U.S. banks that are acquired by
foreign banks remain stand-alone, separate subsidiaries with their own financial statements and subject to the same regulatory scrutiny as any other domestic banks. As
such, data become available for making comparisons between the financial performance of the target before and after acquisition. This regulatory anomaly allows us
to provide evidence on this important issue using a database that was not available
to prior researchers. We are able to provide direct evidence on the effects of these
acquisitions on corporate performance rather than the indirect evidence provided in
prior studies from domestic acquisitions.
Our evidence from the sample of cross-border acquisitions provides useful comparisons with a separate stream of literature that focuses on the reasons for cross-border
acquisitions and the effects of such acquisitions on the acquired banks. Indeed, there
is a very substantial literature on cross-border acquisitions, both in the financial sector
and in the nonfinancial sector. For example, Amihud, DeLong, and Saunders (2002)
show that banks involved in cross-border acquisitions do not experience any changes
in their market-based risk measures and that, while their abnormal returns are negative, they are not as negative as in domestic acquisitions. Buch and DeLong (2004)
show that the deregulation of banking markets is likely to lead to more cross-border
acquisitions. Further, Peek, Rosengren, and Kasirye (1999) provide evidence of relatively poor performance of U.S. subsidiaries of foreign banks and attribute that to
relatively weaker U.S. targets available. In the nonfinancial sector, Denis, Denis, and
Yost (2002) show that firms that globally diversify but do not diversify by industry have discounts in their stock prices as compared to similar domestic-only firms.
However, their study excludes financial and utilities firms.
Our sample consists of 83 mergers in the 1980-2001 period in which U.S. banks
were acquired by non-U.S. banking organizations. In order to maximize comparability
with Cornett and Tehranian (1992), with Cornett, McNutt, and Tehranian (2006), and
also with Healy, Palepu, and Ruback (1992), we use the same measure of operating
performance, OPCFROA, as they do. We use OPCFROA as the principal, though not
the only, measure of the postacquisition performance of the acquired bank.
Our evidence suggests that U.S. banks that are acquired by foreign banks have
below industry standard operating performance in the 3 years immediately before
acquisition, but that their performance improves to the same level or to a better level
than the industry in the 3 years after acquisition. Our results also indicate that recent
3. This is conceptually equivalent to the act of privatization causing changes in the privatized bank
(e.g., Megginson 2005).
1506 :
MONEY, CREDrT AND BANKING
(1994 and thereafter) acquisitions result in much improved operating performance
for the acquired banks. These cross-border bank acquisitions thus create value by
improving target performance and appear to do so without any increase in risk. In
summary, our results using a more appropriate sample than in prior studies are generally consistent with Comett and Tehranian (2006, and Healy, Palepu, and Ruback
1992) and inconsistent with most of the prior event study based literature. While this
may not necessarily lead to market benefits to the acquiring firms (for example, if they
overpay for the acquisition), our results do, at least, indicate that these acquisitions
produce operating benefits.
1. SAMPLE CONSTRUCTION
We use Thomson's Financial Securities Data to identify the dates and identity
of U.S.-based banks acquired by non-U.S.-based banks in the 1980-2001 period.
We then extract financial data for these banks from the Call Reports filed with the
FDIC and available electronically from the Federal Reserve Bank of Chicago. We
restrict our sample to U.S. commercial banks acquired by non-U.S. commercial banks.
This leaves us with a sample of 83 commercial banks acquired by non-U.S. banking
organizations.
Table I shows the time distribution of these 83 acquisitions across the 1980-2001
period. At least one cross-border acquisition takes place each year over this 21-year
TABLE I
SUWAIRY STATISMCS ON
Thm DIsmmunON OF AcQUISmONS, 1980-2001
DisNion of acquisiflon years
Year
Number ofacquisitions
1981
1982
1980
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
2
1
2
6
1
3
0
7
13
1
0
7
0
0
16
6
2
1
Total
83
1998
1999
2000
2001
7
2
3
3
Percent of toua
2.4
1.2
2.4
7.2
1.2
3.6
0
8.4
15.6
1.2
0
8.4
0
0
19.2
7.2
2.4
1.2
8.4
2.4
3.6
3.6
100
DONALD R. FRASER AND HAO ZHANG
" 1507
period, except for 1986, 1990, 1992, and 1993. Acquisitions are particularly active
from 1994 (after the elimination of restrictions on interstate branching made possible
by the 1994 Reigle-Neal Act) onward, which is consistent with Buch and DeLong's
(2004) argument that cross-border acquisitions will be more common after the lifting
of regulatory constraints. For the sample as a whole from 1980 to 2001, the mean
book value of these banks at the year-end prior to the acquisition is $5053.8 million
(median = $472.9 million). The mean book value of total assets for the subperiod
before 1994 is $3449.5 million (median = $633.3 million) whereas the mean book
value in the subperiod in and after 1994 is $6788.2 million (median = $185.7 million).
These data suggest that the foreign banks targeted smaller U.S. banks later in our
sample period, perhaps with the intent of using these as devices to ultimately expand
geographically.
All acquisitions in the sample are voluntary and the targets are healthy in the sense
that none is "encouraged"/"assisted" by any regulatory agency. To control for external
economy and industry effects, we divide all commercial banks into four quartiles by
total assets and calculate performance measures for each of the four quartiles for
each year in the 1980-2001 period. The performance pre- and postacquisition of a
commercial bank in a year is adjusted by the performance of the quartile to which the
bank belongs.
2. EMPIRICAL RESULTS
2.1 Cash Flow Returns
Table 2 provides industry-adjusted OPCFROA in the 3 years before and after the
acquisition. These industry-adjusted results show that U.S. banks acquired by nonU.S. banks had OPCFROA that were generally lower by about 16 basis points than
comparable banks before acquisition. However, their performance improved to normal levels for comparable banks for the 3 years after acquisition. These results thus
suggest that the foreign banking organizations were acquiring poorly performing U.S.
banks presumably with the expectation that they could improve their performance.
Indeed, this is exactly what happened because there is no longer any difference in the
operating cash flow ratios for the target banks versus the comparable banks in the period after acquisition. The improvement in OPCFROA, as measured by the difference
between adjusted-medians before and after acquisitions, is statistically significant. Examining the percent positives provides additional evidence that is consistent with this
finding.
We also split the samples into two subperiods: before and after 1994. The improvement in performance is only apparent in the latter subperiod, where after
3 years OPCFROA rose to 48 basis points above those of comparable banks. Whether
the much improved performance of the U.S. bank subsidiaries was due to improved management, or opportunities provided by banking deregulation or other
factors, is difficult to say. We provide some additional information in the tables that
follow.
1508
: MONEY, CREDIT AND BANKING
TABLE 2
INDusTmY-ADjusTED B&NK MELkNs OF ANNuAL OPERATING PREAX CASH FLow FOR 83 AcQuismoNs BETwEEN
1980 AND 2001
Year relative to acquisition
-3
-2
-1
Median annual performance from
years -3 to -I
1
2
3
Median annual performance from
years I to 3
Median annual difference
between performance in years
1 to 3 and years -1 to -3
Indust•y-adjusted
percent positive
Number of
observations
-0.04%-0. 03 d
-0.13
-0.16c
0.A8
0A8
0.41
0.A6
79
80
78
-0.14
-0.02
0.07
-0.10
0A0
0.50
0.62
0.50
76
64
55
Inzlustry-adjutved
bank medians
0.06'-
0.60
No.ra Pretax operating cash flow return er assets is incore before taxes and extraordinary items plus interest on notes and debentures
subordinate to deposits as a percentage of the book value of asets at the beginning ofeach year. Idustry-3djusted values are computed as the
difference between the firm value and average value offthequartile to that the firm belongs.Test statistics are based on Mann-Whimey-Wilcox
p-values.
'Significantly different from 0 at the F%level.
bSignificantly different from 0 at the 5% level.
cWilcoxon signed ranks test statistics significant at the 1%level.
dViilcoxon signed ranks test statistics significant at the 5% level.
2.2 FinancialRatios
We provide further insights into the sources of postacquisition improvement in
OPCFROA by evaluating the acquisition-related changes in a number of bank performance ratios. These ratios are similar to those used in Cornett and Tehranian (1992)
and in Comett, McNutt, and Tehranian (2006).
Table 3 shows how the specific ratios are defined. Table 4 provides the actual
financial measures for our sample banks and for the differences in these ratios between
ourbanks and comparable banks forthe entire period (1980-2001) and two subperiods
(1980-1993, 1994-2001). The measures are provided as averages for the 3 years
before the acquisition and as averages for 3 years after. The overall results of the
entire period are in Panel A. The results of the first and second subperiods are in
Panels B and C, respectively.
Profitabilityindicators.We define two profitability indicators as "return on assets"
and "return on equity." The results suggest that the acquired banks earned less in
the pre-acquisition period than comparable banks. These differences are significant
(-0.22% and -2.60%). However, by the postacquisition period, profitability was no
longer significantly different than the industry average. These results are consistent
with the cash flow measures reported earlier.
We also find that there were substantial differences in the operating performance of
the acquired banks between these two subperiods. Most of the changes in the operating
performance of the sample banks took place in the second subperiod. Profitability of
DONALD R. FRASER AND HAO ZHANG : 1509
TABLE 3
DEFINMONS OF RATIOS USED
BETWEFN 1980 AND 2001
TO ANALYzE AcruAL PERFORMANCE
Ratio
Profitability
1. Return on assets
2. Return on equity
Capitaladequacy indicator
3. Capital to assets
Credit quality indicator
4. Charge-offs to loans
Efficiency indicators
5. Expenses to revenues
6. Assets to employees
7. Income to employees
8. Return on loans
Liquidity risk indicators
9. Loans to assets
10. Liquidity ratio
Growth indicator
11. Asset growth rate
OF U.S. BANKs ACQUIRED BY NoN-U.S. BANKs
Definition
value of total assets
Net income after taxes as a percentage of book
Net income after taxes as a percentage of book value of total assets
Net income after taxes as a percentage of book value of total equity capital
Core capital as a percentage of book value of total assets
Net charge-offs on loans as a percentages of total loans and leases
Operating expenses as a percentage of operating revenue
Book value of total assets per full-time employee
Net income after taxes per full-time employee
Interest and fees on loans as a percentages of total loans
Total loans as a percentages of book value of total assets
Cash and government securities as a percentages of book value of total
assets
Change in book value of total assets as a percentage of book value of total
assets in the previous year
the target banks improved dramatically, from below comparable banks to well above
them during this period.
Capitaladequacy indicator.The capital to asset ratios for the acquired banks were
no different from the comparable banks in the years before and after acquisition for
the entire time period. Looking at these ratios for the two subperiods, we observe
that the U.S. bank targets that were acquired in the first subperiod had higher than
average capital ratios. Indeed, this might have been an attractive feature of the target.
By the postacquisition period, however, the target's capital ratios were not statistically
different than the average. Targets acquired in the second subperiod went from lower
capital ratios to an industry average.
Credit quality indicator.Loan charge-offs that were slightly lower than the industry
norm prior to acquisition, increased to about average for the comparable banks for the
entire period. Thus, the improvement in overall profitability appears to come at a cost
of somewhat greater credit risk, but not beyond industry standards. The same result
holds for the first subperiod but not the second subperiod. During the 1994-2001
period, the loan charge-offs for acquired banks improved from being no different
from comparable banks before acquisition to lower than those of comparable banks
afterward. Thus, the improvement in profitability came with reductions in credit risk
for targets acquired during the second subperiod.
Efficiency indicators.Net expense and return on loans remained at levels similar to
comparable banks before and after acquisition during the entire period. However,
1510 " MONEY, CREDIT AND BANKING
efficiency in the use of employees increased dramatically. The ratio of assets to
employees went up substantially, as did the income to employee ratio. These results
largely hold for the two subperiods and are more pronounced during the 1994-2001
period.
TABLE 4
COMPAIUSON OF AVERAGE F[i.AxRcIAL RATIOS IN TIlE 3
YEARsBEFOrE
Ao
ArrER AcQUISmTON: 1980-2001
Panel A. Entire period (1980-200 1)
Irdttustty-adjusted bank means
Variables
Profitabilityindicators
Return on assets
Return on equity
Capitaladequacy indicator
Capital to assets
Creditquality indicator
Charge-offs to loans
Efficiency indicators
Net expense to net revenues
Return to loans
Assets to employees
Income to employees
Premerger
Postrnerger
-0.22%b
-2.60%
-0.12%
-1.03%
-0.02%
0.48%
0.10%
1 .57 %d
0.52
0.57
0.50%
0.59
0.56
-3.94X
-1.27%
848.65X` 0
45.94Xd
0.31
0.53
0.70
0.57
7.70%'
-0.13%
0.2%
0.72%
0.53
0.54
5.64%
1.32%
0.56
-0.69%
6.71X
2.54%
157.59X
-43.94X
2.77X
1.27%
1006.24X'
1.52X
7.50%
-0.85%
4.32%
Growth indicator
Asset growth rate
Portion positive
-0.67%
-0.02%'
Liquidity risk indicators
Loans to assets
Liquidity ratio
Post and pretnerger difference
Panel B. First subperiod (1980-1993)
Industry-adjusted bank means
Variables
Prvfitabilityindicators
Return on assets
Return on equity
Capitaladequacy indicator
Capital to assets
Credit quality indicator
Charge-offs to loans
Efficiency indicators
Net expense to net revenues
Return to loans
Assets to employees
Income to employees
Liquidity risk indicators
Loans to assets
Liquidity ratio
Growth indicator
Asset growth rate
Prernerger
PovtnrSer
Post- and premtrgerdifference
Portin positive
0. 15 %b
-0.40%
-0.27%
1.07%
-0.42%
-0.67%
0.31
0.42
1.07%b
1.39%
0.32%
0.52
-1.01%
-0.7%
0.47
1. 17X
-2. 2 0 %b
-93.32X
2.02X
I.69XM
-0.12%
378.6Xb
--7A2X
0.52X
2.08%
471.92Xb.,
9.44X
0.50
0.51
0.69
0.42
12.46%
-0.42%
9 .8 6 %b
-0.19%
-2.60%
0.23%
0.47
0.35
-0.91%
-3.00%
0.45
-0.
3 1 %b
2.09%1
(Continued)
DONALD R. FRASER AND HAO ZHANG
: 1511
TABLE 4
CONTINUED
Panel C. Second subperiod (1994-2001)
Industry-adjasted bank means
Variables
Premerger
Profitabilityindicators
Return on assets
-0.61%a
-4.79%a
Return on equity
Capitaladequacyindicator
Capital to assets
Credit quality indicator
Charge-offs to loans
Efficiency indicators
Net expense to net revenues
Return to loans
Assets to employees
Income to employees
Liquidity risk indicators
Loans to assets
Liquidity ratio
Growth indicator
Asset growth rate
Postmerger
Post- and premerger difference
Portion positive
0.02%
0 .6 3
0.64
2.98%a
7 . 7 7 %b.c
0.66
0.76%'
0.63
%b.c
-1.12%'
-0.36%
-0.31%
-0.38%'
-0.07%
0.46
1.68Xu
-2.87%
406.37X
-0.93X
-2.37%
1569.18X'
-2.68X'
0.50%
1162.81X','
0.23
0.55
0.72
9.56X'
98.71X','
0.66
3.12%'
1.23%0
0.58
0.65
8 . 7 7 %d
0.62
-89.15X
2.50%
-1.29%9
5.62%a
-0.06%
1.25%
10.02%a
Nom Industry-adjusted values are computed as the difference between the average finn value and average value of the quartile to which the
fiss belongs.
aSignificantly different from 0 at the 1%level.
bSignificantly different from 0 at the 5% level.
cWilcoxon signed ranks test statistics significant at the 1% level.
dWricoxon signed ranks test statistics significant at the 5% level.
Liquidity risk indicators.Target banks had higher commitments to loans prior to the
acquisition and retained the greater focus on loans after the acquisition. However,
the difference between the target bank loan ratios and the industry norm remained
the same. We also observe no differences in our second measure of liquidity holdings
of cash and U.S. government securities-either before or after acquisition as compared
to the industry norm.
Growth indicator.There is some evidence of increases in target bank asset size after
acquisition. However, this result appears to be driven by the acquisitions that took
place during the 1994-2001 period. Acquisitions during the 1980-1993 period did
not experience significant asset growth after acquisition. These results can be at least
partially explained by growth opportunities made possible by the 1994 Reigle-Neal
Act.
2.3 Other Considerations
Our sample allows for direct comparisons of the pre- and postacquisition performances of our targets. However, the possibility exists that the financial results of the
target after acquisition may be distorted if a transfer pricing system is put into place
1512 : MONEY, CREDIT AND BANKING
that favors the target. While certainly a potential complication to our interpretation
of the financial data on the targets, this potential bias is mitigated by the fact that
the target U.S. banks in our sample are examined and regulated as entities separate
from their parents and that there are significant regulatory limits on the transactions
between U.S. banks and their foreign parents. Also, because the large, publicly traded
acquirers in our sample provide consolidated financial statements, the principal motive for using transfer pricing would be to minimize the tax burden for a given level
of operating performance.
We also perform an event analysis using the stocks of the acquirers to see how
the market reacts to these acquisitions. We find insignificant 2-day, 5-day, and 11day cumulative abnormal returns. Moreover, we further subdivided these cumulative
abnormal returns according to EU and non-EU acquirers (roughly one-half of our
acquirers are from EU countries) and found no significant differences in the abnormal
returns for these two groups.
3. CONCLUSIONS
Direct comparisons of the pre- and postacquisition operating performance of target
banks indicate that the cross-border acquisitions in our sample were performanceenhancing events. Target operating performance as measured by cash flow operating
profit and by more common measures of operating returns improved. Equally important, increases in operating performance do not appear to be at the expense of
increased credit risk that was not significantly affected. This evidence thus sheds
light on the puzzle from event studies of bank acquisitions that acquirers usually lose
but that they continue to make acquisitions.
Our results suggest that foreign acquirers of U.S. banks have generally acquired
U.S. targets that were slightly below the industry norm in terms of their cash flow
performance. The foreign parents were able to improve the performance of the targets
significantly in the 3 years after acquisition, in some cases to above the industry
norm. Evidence of improvement in performance includes a more efficient usage of
labor and no increase in loan loss. These results are generally consistent with those
providedby Comett andTehranian (1992) and Comett, McNutt, and Tehranian (2006).
Improvements in the operating performance of the target should be accompanied by
improvements in the operating performance of the combined entity. However, our
results have the advantage of not mixing together the operating performance of the
acquiring firm and the target firm.
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DONALDR. FRASERANDHAOZHANG
: 1513
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TITLE: Mergers and Long-Term Corporate Performance: Evidence
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SOURCE: J Money Credit Bank 41 no7 O 2009
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