Financial Determinants of Bank Takeovers

By Cheng, David C.; Gup, Benton E. et al. | Journal of Money, Credit & Banking, November 1989 | Go to article overview

Financial Determinants of Bank Takeovers


Cheng, David C., Gup, Benton E., Wall, Larry D., Journal of Money, Credit & Banking


Financial Determinants of Bank Takeovers

In recent years more takeovers have occurred in banking than in any other industry (Mergers & Acquisitions 1987). This activity resulted partly from liberalized laws affecting branch and interstate banking and partly from the number of failed banks.(1) As more states liberalize their laws regarding banking structure and regional pacts, takeovers of bank and nonbank financial institutions are expected to increase.(2) Thus, understanding the determinants of the prices paid in bank takeovers is important to the large portion of the banking industry that is either a potential target or potential bidder, or both. Greater knowledge of the determinants of purchase prices can also help shed light on commercial bank operations.(3)

Several recent studies examine the determinants of bank merger pricing. These studies tend to focus on the characteristics of the target, and to downplay the characteristics of the acquiror. These studies also tend to use a single proxy for each theoretical effect, for example, one measure of the target's earnings. The individual studies are reviewed below, but in general they find a positive relationship between purchase price and some measure of the target's potential growth and a negative relationship between purchase price and some measure of the ratio of the target's total assets to the acquiror's total assets. Other variables, including those for the target's profitability, are sometimes but not always statistically significant.

One difference between this study and prior studies is that this study places greater emphasis on acquiror-related characteristics. Acquirors tend to pay a premium for a controlling interest in banks. This premium suggests that the firm is more valuable to the acquiror than to the target's original owners. The greater value may arise because the acquiror can improve the target's profitability, for example, by exploiting economies of scale, or providing better management. Alternatively, the acquiror's management may be pursuing goals other than profit maximization as suggested by Shome, Smith, and Heggestad (1986). The acquiror may seek to become larger to obtain additional perks, or seek higher levels of growth or earnings.

A second difference is that this study includes more proxies for the profitability and growth of the target from the target's financial statements. Theory suggests that the purchase price is likely to be a function of the distribution of the target's future earnings, but provides little assistance as to the determinants of future profits. A common assumption is that future profitability ratios are correlated with historic profitability ratios and the expected future growth in earnings is correlated with historic growth of the institution. Prior studies then use a single return measure and one or two proxies for historic growth. The advantage of that approach is that it reduces the risk of multicollinearity problems in OLS estimation. The risk in limiting the number of proxies is that the selected variable may not be the best proxy available. Our study uses multiple proxies and uses principal components regression (PCR) to control for multicollinearity. PCR trades a small amount of bias for greater precision in coefficient estimation in the presence of highly correlated independent variables.

Section 1 of this study reviews recent literature on nonbank and bank takeovers. Section 2 describes the model used in the analysis; section 3 consists of the data base, methodology, and empirical results. Section 4 is a summary of the findings and suggestions for additional research.

1. PREVIOUS STUDIES OF BANK TAKEOVERS

In this section, we review why bank takeovers are different from nonbank takeovers and also survey recent studies that examine the financial determinants of firms engaged in takeovers.

Why Bank Takeovers Are Different from Nonbank Takeovers

Bank takeovers differ from nonbank takeovers because of the regulatory process involved. …

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