The Role of Bank Advisors in Mergers and Acquisitions
Allen, Linda, Jagtiani, Julapa, Peristiani, Stavros, Saunders, Anthony, Journal of Money, Credit & Banking
This paper looks at the role of commercial banks and investment banks as financial advisors. In their role as lenders and advisors, banks can be viewed as serving a certification function. However, banks acting as both lenders and advisors face a potential conflict of interest that may mitigate or offset any certification effect. Overall, we find evidence of a net certification effect for target firms but conflicts of interest for acquirers. In particular, target firms earn higher abnormal returns when the target's own bank is hired as merger advisor, consistent with the bank's role as certifier of the (more informationally opaque) target's value to the acquirer. In contrast, we find no net certification role for acquirers. There are at least two possible reasons for this. First, certification of value may be less important for acquirers because it is the target firm that must be priced in a merger. Second, acquirers may utilize commercial bank advisors in order to obtain access to bank loans to finance activities in the postmerger period. Thus, an acquirer may choose its own bank (with whom it has had a prior lending relationship) as an advisor in a merger. However, this choice weakens the certification effect and creates a potential conflict of interest because the advisor's merger advice may be distorted by considerations related to the bank's past and future lending activity.
JEL code: G21
Keywords: relationship banking, investment bank advisors, certification effect, conflict of interest effect, mergers, acquisitions.
FINANCIAL INTERMEDIARIES are specialists in information production and processing. As advisors to both targets and acquirers, financial institutions utilize their information gathering expertise to ascertain the reservation price of the merger counterparty, the potential for synergistic gains, as well as the risks of the transaction.
Commercial banks may be well positioned to offer advisory services if they have established lending and other customer relationships with either party to a merger. During the course of a long-term customer relationship, a commercial bank obtains private information about a firm's cash flows, financial resources, and other exposures that can be useful in estimating the future prospects of a proposed merger. Indeed, if the role of the financial advisor in a merger is to provide information, then commercial banks, especially those with prior lending relationships, potentially have a comparative advantage over investment banks in advising their customers--particularly since, until very recently, investment banks did not make commercial loans. (1) The banking literature (see Chan, Greenbaum, and Thakor 1986, for example) suggests that information generated in the course of a lending relationship may be reusable and therefore transferable. This transfer is feasible because while SEC regulations and the U.S. bankruptcy code prohibit the transfer of information from an investment bank subsidiary to a related commercial bank subsidiary, there are no restrictions on the reuse of information obtained in the course of a standard lending relationship (e.g., on information flows from the bank's lending department to the investment bank). (2)
Following a parallel literature dealing with underwriting activities, we refer to a bank's ability to obtain private information about a customer and to use this information in supplying services such as merger advice to the customer as the certification effect. (3) Investment banks may also be privy to private information obtained, for example, in the course of underwriting activities. However, underwriting episodes are discrete and intermittent, corresponding to the relatively short time period surrounding the issue registration, offering period, and after-market support period. In contrast, commercial bank lending and other relationships are often long standing and continuous, requiring the ongoing monitoring of the firm's activities. …