The impacts of stricter merger legislation on bank mergers and acquisitions: Too-Big-To-Fail and competition
Introduction
Mergers and acquisitions in the banking sector continue to draw a lot of attention. Recent merger talks between Deutsche Bank and Commerzbank, for example, captured media headlines and roiled emotions both within and outside Germany for months.1 M&As among large banks capture the spotlight because they determine the banking landscape for many years to come, witness the consolidation wave in the banking sector across Europe during the 1990s that created the market structure with which the industry entered the turbulence of the 2007 financial crisis. What is often less appreciated next to, for example, concerns over financial stability is how M&A outcomes are shaped by merger control, which is an important leg of antitrust policy.
In this paper we study the impact of antitrust policy on mergers in the banking sector. We find that new merger control legislation in Europe is associated with an increase in the expected profitability of mergers that take place, reflected in an economically meaningful increase in announcement premia on targets. We attribute this effect to a reduction in mergers that create large banking organizations that are “too big to fail” (TBTF) in a given country. TBTF mergers are associated with lower target announcement returns which are consistent with concerns over economic nationalism in large domestic mergers as reported by Dinc and Erel, 2013. Thus, having fewer such mergers increases the average merger premium.
To establish these findings we analyze a data set of bank mergers and acquisitions announced between 1986 and 2007 in 15 European countries that experienced changes in merger control legislation during this time period. We employ a difference-in-differences design around the legal changes to compare transactions before and after the change in legislation. We find that announcement premia across our sample increase by around 6–7 percentage points for all transactions after the introduction of the new legislation. The effect increases to 14–16 percentage points when specifically considering mergers that involve a change of control, which are those within the scope of merger control legislation.
We trace the higher premia to a reduction in the prevalence of mergers creating TBTF banks. In this we follow Penas and Unal, 2004 in defining TBTF mergers with reference to total assets as a share of a country’s GDP. After enactment of the new merger legislation the probability of a merger creating a TBTF bank is about 8–10 percentage points lower than before. In addition, we estimate that in our sample target premia for these TBTF mergers are about 12–15 percentage points lower. Jointly, this implies that on average mergers after the introduction of merger control legislation have higher target premia, as they are less likely to create TBTF banks.
We investigate other plausible explanations for the higher target premia based on changes in the profitability, cost efficiency, and risk profile of the firms involved and find that these are unaffected by the merger control legislation and thus do not appear to explain the higher target premia we observe. Similarly, changes in announcement premia could reflect changes in the way mergers create market power for the firms involved. Indeed, preventing mergers that create excessive market power is the notional goal of the type of merger control legislation we study. We consider several proxies for the increase in market power associated with the mergers in our sample, including size, geographic and industry overlap, and the stock market response of rival banks. While there is some evidence for a decrease in size and in the incidence of bank-to-bank mergers, which is suggestive of a limited pro-competitive effect of the merger control legislation, overall on balance, changes in market power do not appear to be strong enough to explain our headline target announcement finding.
Like much of the vast existing literature, our results highlight the importance of regulations for the banking sector and economic performance. This point has been developed comprehensively, for example, by Jayaratne and Strahan, 1996 and Beck et al., 2010. What makes our findings particularly notable within that context is that the merger control regulations we study apply to the economy as a whole and are not targeted at the banking sector in particular, unlike the deregulation waves studied in much of the literature for the US banking sector. We show that these national, economy-wide merger regulations nonetheless affect the banking sector in important ways.
The remainder of this paper is structured as follows. Section 2 places the paper in the literature. Section 3 describes the data set of bank mergers and merger control legislation changes studied in this paper. Section 4 introduces merger announcement effects. The main analysis on the effect of the merger legislation on announcement premia and the underlying changes in the bank mergers we observe is presented in Sections 5 and 6. Section 7 concludes.
Section snippets
Literature context
This paper connects to three main strands of the literature. First, we study the intersection of regulations and the banking sector. There is a substantial existing literature here, much of which analyzes the effect of deregulation on banking, in particular the stepwise reform of the US banking industry over the 20th century as limits to branching and interstate operations were relaxed. Degryse et al. (2015) provide a recent overview of much of this literature. Jayaratne and Strahan, 1996 show
Data
We analyze a sample of bank mergers assembled from three sources. First, information on bank mergers is taken from SDC Platinum Mergers and Acquisitions. Second, the targets and acquirers in these transactions are matched with Datastream to extract stock market returns and additional financial data. Third, the data on merger legislation changes in European countries are from Carletti et al., 2015. Table 1 presents an overview of the data sources, variables, and definitions.
SDC Platinum Mergers
Merger announcement effects
Significant gains in the stock prices of merger targets around the announcement of an acquisition are commonly observed in corporate takeovers (Jensen and Ruback, 1983). Becher (2000) and others document similar effects for mergers in the banking industry. The gains take the form of significantly positive cumulative abnormal returns (CARs) of on average around 10–30 percent.
We compute CARs for targets and acquirers in our sample using a standard market model. We regress daily returns of a
Merger legislation changes lead to more profitable mergers
We analyze the impact of changes in merger legislation on the bank mergers in our data set. These include properties of the transaction as a whole as well as properties of the individual firms involved.
What explains more profitable mergers after the legislation changes?
Plausible explanations for why mergers are more valuable under the new merger control legislation relate to the properties of the mergers happening as well as to the economic and regulatory environment. We find that the increase in profitability is associated with a change in the likelihood of mergers taking place that can be classified as too-big-to-fail. We investigate a number of plausible alternative explanations, connected to effects on profitability, efficiency, risk structure, the size
Conclusion
We study the impact of merger control on bank mergers exploiting a wave of legislation changes introduced in Europe between 1989 and 2004. We find that the legislation changes increased the announcement returns of target banks by about 6–7 percentage points, increasing to 14–16 percentage points for mergers involving a change in control. We also find that the higher returns are associated with a decline in the propensity for mergers to create TBTF banking institutions after the legislation
Credit Author Statement
All authors contributed equally.
Acknowlgedgments
We thank Charles Calomiris (editor), Martin Hellwig, Elena Loutskina, Jozsef Molnar, Darius Palia, Nicolas Schutz, the seminar participants at the Centre for European Economic Research ZEW (Mannheim), European Commission DG Competition (Brussels), Max Planck Institute (Bonn) and participants at the Conference on Empirical Legal Studies (Berkeley), the EUI Alumni Conference (Florence), the MaCCI Law and Economics Conference on Financial Regulation and Competition (Mannheim) for helpful comments.
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