Academic journal article Journal of Commercial Banking and Finance

Cluster Analysis of the Financial Characteristics of Depository Institution Merger Participants and the Resulting Wealth Effects

Academic journal article Journal of Commercial Banking and Finance

Cluster Analysis of the Financial Characteristics of Depository Institution Merger Participants and the Resulting Wealth Effects

Article excerpt

ABSTRACT

Cluster analysis is used to analyze the mergers of depository institutions, drawing on previous work in the non-financial sector. The majority of merger studies focus on single motivation factors or limited participant characteristics and fail to account for the heterogeneity within merger samples. This paper furthers the merger literature by separating depository institution mergers into homogeneous groups of bidders and targets based on the pre-merger financial characteristics of each. This allows the analysis of the influence of intergroup differences on the returns to both bidding and target firms. Cluster membership is analyzed and results interpreted. A test for cluster membership is performed and findings reconciled with existing merger theories.

INTRODUCTION

The merger and acquisition activity of depository institutions has increased dramatically in recent years, with various theories hypothesized regarding the cause of this action. In addition, much attention has been devoted to the merger and acquisition activities of non-financial firms, with most utilizing a cross-sectional regression analysis to explain the pre- and post-merger returns of both bidders and targets. While this method has met with much success, it does suffer from some apparent weaknesses in its explanatory power. Alternative statistical techniques, many of which are found in the non-parametric realm of tests, have been implemented in attempts to offset the drawbacks of ordinary least squares regression. In this paper cluster analysis is used to analyze the mergers of depository institutions, drawing on previous work in the non-financial sector. Mergers are separated by pre-merger financial characteristics of both bidders and targets. This insures that the within-group differences are small relative to among-group differences. This provides a homogeneous group of mergers, which is analyzed for among-group differences in returns to both parties, allowing the financial data for both bidding firms and target firms to capture potential interactions among their characteristics.

As noted earlier, the merger and acquisition activity of depository institutions can be described as at least frenzied during the decade of the 90's. Researchers attempt to explain this phenomenon through deregulation, competition, institutional efficiency, market share, product diversity and a host of other reasons. Efforts are also made to utilize non-financial institution merger hypotheses to explain the cause and effect of this activity, with results that can be described as contradictory at best. However, considering basic differences in financial make-up and the merger process in general, there are various reasons to expect differences in merger studies targeting depository financial institutions versus non-financial institutions. As stated by Chang, Gup and Wall (1989) depository institution mergers take an extensive amount of time (which increases merger uncertainty) due to the need for regulatory approval. Also, the nature of the assets acquired differs significantly when comparing depository institutions and industrial firms. When a bidder successfully acquires a depository institution target, it is buying a set of relationships generated by the existing management rather than a set of physical assets [Baradwaj et al. (1990)]. The uncertainty related to keeping current management in place makes this type of merger fundamentally different than those of other industries. Additional differences between the industrial and bank sector addressed by Zhang (1998) include degree of regulation, degree of competition and ownership structure. Degree of regulation refers to the fact that banks exert disproportional influence on the economy as compared to non-financial firms. Thus, for reasons of financial prudence and monetary control, the bank sector and mergers between its participants are heavily regulated. Degree of competition simply refers to non-bank financial institutions' increasing presence in areas traditionally dominated by banks. …

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