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Manu Sharma
Doctor in Finance, SMC University Switzerland
Faculty: University Institute of Applied Management Science
Panjab University, India
Abstract
This research examines mergers and acquisitions in the United States banking industry
involving the formation of mega banks. It uses event study methodology and accounting
performance techniques to determine the valuation affects of structural changes that are the
result of the merger. When a merger is announced, it often causes abnormal stock price
jumps for both the acquirer and Target Company at or around the date of the
announcement. Acquisitions that concentrate on increasing the diversity of the business
earned the highest abnormal returns. However, other types of mergers neither create nor
destroy shareholder value. Stock return alone does not paint the entire picture of the value
created by the merger. This research study will assess the mergers using accounting
performance techniques as well as stock price analysis to understand the likelihood that the
value creation is stable, and not simply reactionary on the part of the shareholders.
Introduction
Creating value is the primary reason for mergers and acquisitions. There are many reasons for wishing
to engage in mergers and acquisitions. In some cases, the company might be a good bargain with future
potential gains. In other cases, one of the companies may be in financial trouble and the merger might
be a way to fix their predicament. Even a company that is in financial disrepair maybe a good bargain
once the problems are fixed.
Sometimes the backing of a larger company is all that the smaller companies need to return to
profitability. In the case of an acquisition, the purchaser is speculating that the company will be of
greater value at some future point in time. There are many financially motivated reasons why a
company may choose to merge or acquire another company.
Large scale mergers eliminate competition and secure a greater market share. In some cases, an
acquisition may take place so that one company can acquire its competition. Regardless of the primary
reason for the merger or acquisition, one can be certain that at least one company will benefit from it.
In many cases, there will be a mutual benefit and the combined company will be more profitable. Some
companies were created to be sold, providing quick cash revenue for their owners, as opposed to the
long-term gains that are the typical reason for starting a business.
Mergers and acquisitions to create the mega banks are quickly changing the structure of the
banking industry in the United States. There are many questions that need to be answered in the
formation of an opinion of whether these changes are good or bad. In order to answer this question
thoroughly, one must consider all of the effects of on the various players involved in the merger or
acquisition. Shareholder value is only one aspect of value creation.
62 European Journal of Economics, Finance And Administrative Sciences - Issue 19 (2010)
This study will focus on answering the question of whether mergers and acquisitions create a
value for shareholders of both acquirers and targets in mergers involving major banking corporations.
It will examine how shareholders react to potential losses and gains through stock price manipulation.
This research will attempt to answer the question of whether the creation of a mega bank is a
good situation for shareholders. This study will focus on five primaries cases to make its
determination. It will examine the merger of JP Morgan and Chase Manhattan Corp., JP Morgan Chase
and Bank One, Bank of America and Fleet Boston, Citicorp and Travelers Group Inc. and Pacific
Northwest Bancorp., and Wells Fargo & Co. It will examine the valuation affects that are a result of
these transactions. It will also examine social capital and the effects of these mergers and acquisitions
on the communities in which they are located.
The accounting technique gives a measure of the assets, revenue and liability of the two
involved banks prior to acquisition and the same of the combined firm after the acquisition.
Furthermore, accounting studies employ control firms in order to control for economy.
The accounting techniques help in accessing the firm’s liability and assets for the future. It
gives the total assets available for future investments. It gives a good account of the total returns of the
merged organization in terms of equity and thereby helps in accessing the value created by the merger.
It gives the real account of the company’s fortunes in terms of physical without any consideration for
the market. The company’s future in terms of the revenue available for new investments is accessed
only through accounting techniques. But in modern public organization the shareholder’s support
greatly the company’s future in long term. Hence the accounting technique alone cannot predict the
value created by the merger.
The partial contradictory results of event studies and accounting studies raise an important
question which has remained unanswered until now: Can we freely choose between both approaches
when analyzing the performance of corporate bank mergers? So far, despite the contradictory results,
the two approaches measuring the economic gains of mergers have been employed as substitutes.
In most of previous literatures (Healy, Palepu and Ruback (1992)) they find a great relation
between the two methods. They find a significant positive relationship between the measures of the
two and hence they advocate the use of both as substitutes. Both the studies predict the future of the
organization in different terms, former in terms of shareholders support and the latter in terms of
company’s assets and liabilities.
Methodolgy
A convenience sample of 20 quarterly time points in the event window from 2 year prior to the merger
through to 2½ years after the merger, including the announcement date and the date of completion for
each merger: t = {T1 … T20}. The event study methodology will utilize stock market abnormal price
returns (ASPR) of both the acquiring and target companies to determine if shareholders experienced an
abnormal change in stock value, as well as examine the Sharpe Ratio. The accounting performance
technique will utilize operating cash flows, absolute cash flows as well as returns on equity for both
pre- and post-merger periods.
E[ R − R f ] E[ R − R f ]
S= =
σ Var[ R − R f ]
where R is the asset return, Rf is the return on a benchmark asset, such as the risk free rate of return,
E[R − Rf] is the expected value of the excess of the asset return over the benchmark return, and σ is the
standard deviation of the excess return (Sharpe 1994). The Sharpe Ratio is used to characterize how
well the return of an asset compensates the investor for the risk taken. When comparing two assets
each with the expected return E[R] against the same benchmark with return Rf, the asset with the higher
Sharpe Ratio gives more return for the same risk. The Sharpe ratios for this study will be computed at 2
year prior to the merger, the beginning of the event window; at the announcement and 2½ years after
the merger, the end of the event window.
Return on Equity
Return on Equity (return on average common equity, return on net worth) measures the rate of return
on the ownership interest (shareholders' equity) of the common stock owners. ROE is viewed as one of
the most important financial ratios. It measures a firm's efficiency at generating profits from every
dollar of net assets, and shows how well a company uses investment dollars to generate earnings
growth. ROE is equal to a fiscal year's net income (after preferred stock dividends but before common
stock dividends) divided by total equity (excluding preferred shares), expressed as a percentage.
Net Income
ROE =
AverageStockholder ' sEquity
ROE is best used to compare companies in the same industry, in this case, banking.
Data Analysis
A convenience sample of 20 quarterly time points in the event window from 2 year prior to the merger
through to 2½ years after the merger, including the announcement date and the date of completion for
each merger: t = {T1 … T20}. The event study methodology will utilize stock market abnormal price
returns (ASPR) of both the acquiring and target companies to determine if shareholders experienced an
65 European Journal of Economics, Finance And Administrative Sciences - Issue 19 (2010)
abnormal change in stock value, as well as examine the Sharpe Ratio. The accounting performance
technique will utilize operating cash flows, absolute cash flows as well as returns on equity for both
pre- and post-merger periods.
Descriptive Statistics
The following descriptive statistics are based on the historical data retrieved and computed for the
study cases. The measures shown in Table 1 are the means and cumulative measures for abnormal
stock price returns; and Sharpe ratios computed at time periods T1 (2 year prior to the mergers) and T9
(taken at the date of the announcement of the proposed mergers). The Table 2 shows measures for the
variable for Event Study Methodology after the merger. The Table 3 shows Buyer and Target average
measures for the variable for Accounting Performance Techniques before the mergers. The Table
shows average measures for the variable for Accounting Performance Techniques after the mergers.
Table 1:
Note: Abnormal returns (ASPR) are computed from the average differences between a single stock or portfolio's
performance in regard to the average market performance over a set period of time. If the market average performs
better than the individual stock then the abnormal return will be negative. The cumulative abnormal returns (CASPR)
will be calculated over the whole event window of the study prior to the mergers.
Note: The Sharpe Ratio is used to characterize how well the return of an asset compensates the investor for the risk taken.
When comparing two assets each with the expected return E[R] against the same benchmark with return Rf, the asset
with the higher Sharpe Ratio gives more return for the same risk.
66 European Journal of Economics, Finance And Administrative Sciences - Issue 19 (2010)
Table 2: Merger/Acquisition Measures for the variable for Event Study Methodology after the merger
Sharpe Ratio Sharpe Ratio Bank Ind. Bank Ind. Sharpe Bank Ind. Sharpe
Buyer Merged Banks Mean ASPR CASPR (T10) (T20) Mean ASPR Ratio (T10) Ratio (T20)
Table 3: Buyer and Target average measures for the variable for Accounting Performance Techniques before
the mergers
Bank
B‐Buyer, Industry
T‐Target Banks Mean ROE Mean OCF Mean ACF Mean ROE
Bank Industry
Buyer Merged Banks Mean ROE Mean OCF Mean ACF Mean ROE
6.59%
1B: Citi Group 8.26% 2804 ‐490
6.36%
2B: Wells Fargo & Co. 8.57% 9462 ‐938
6.39%
3B: JP Morgan Chase & Co. 3.50% ‐11077 ‐143
6.06%
4B: Bank of America 7.20% ‐3965 1102
6.01%
5B: JP Morgan Chase & Co. (Bank One) 4.04% ‐35013 2201
The figure 1, figure 2, figure 3, figure 4 and figure 5 shows ASPRs’ values, Sharpe’s ratio
values, ROE Values, OCF Values and ACF values on quarterly basis for Acquirers before and after the
Merger. The figure 6, figure 7, figure 8, figure 9 and figure 10 shows ASPRs’ values, Sharpe’s ratio
values, ROE Values, OCF Values and ACF values on quarterly basis for banking industry on quarterly
basis for the same time period before and after the Merger.
Figure 1: ASPRs’ values for Acquirers before and after the Merger
60%
40%
20%
Citi
A WFC
S
0% JPMorgan
P
R BOA
JPM
‐20%
‐40%
‐60%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Event Window
68 European Journal of Economics, Finance And Administrative Sciences - Issue 19 (2010)
Figure 2: Sharpe Ratios’ values for Acquirers before and after the Merger
Figure 3: Mean ROE values for acquiring Banks before and after the merger
25.00%
20.00%
15.00%
Citi
R 10.00% WFC
O
JP Morgan
E
5.00% BOA
JPM Bank
0.00%
‐5.00%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Event Window
69 European Journal of Economics, Finance And Administrative Sciences - Issue 19 (2010)
Figure 4: OCF values for acquiring Banks before and after the merger
60,000
40,000
20,000
O Citi
C 0 WFC
F
JP Morgan
(20,000) BOA
JPM Bank One
(40,000)
(60,000)
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Event Window
Figure 5: ACF values for acquiring Banks before and after the merger
20,000
15,000
10,000
Citi
WFC
5,000
A JP Morgan
C
F BOA
0
JPM Bank
One
(5,000)
(10,000)
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Event Window
70 European Journal of Economics, Finance And Administrative Sciences - Issue 19 (2010)
Figure 6: ASPR values for Banking Industry for comparable period of Acquirers.
Banking Industry ASPR for Comparable period of
Acquriers
30.00%
25.00%
20.00%
15.00%
10.00% Bank Ind. Citi Group
Bank Ind. Wells Fargo
ASPR
5.00%
Bank Ind. JP Morgan
0.00% Bank Ind. BOA
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Bank Ind. JPM‐Bank One
‐5.00%
‐10.00%
‐15.00%
‐20.00%
Event Window
Figure 7: Sharpe Ratio values for Banking Industry for comparable period of Acquirers.
Banking Industry Sharpe Ratio for
Comparable period of Acquriers
3.5000
3.0000
2.5000
Sharpe Ratio
2.0000 Bank Ind. Citi Group
Bank Ind. Wells Fargo
1.5000
Bank Ind. JP Morgan
1.0000 Bank Ind. BOA
0.0000
1 2 3 4 5 6 7 8 9 1011121314151617181920
Event Window
71 European Journal of Economics, Finance And Administrative Sciences - Issue 19 (2010)
Figure 8: Return on Equity values for Banking Industry for comparable period of Acquirers.
Banking Industry ROE for Comparable Period of
Acquirers
18.00%
16.00%
14.00%
12.00%
Return on Equity
10.00% Bank Ind. Citi Group
Bank Ind. Wells Fargo
8.00%
Bank Ind. JP Morgan
6.00%
Bank Ind. BOA
4.00% Bank Ind. JPM‐Bank One
2.00%
0.00%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Event Window
Conclusion
In this research we have studied the cases of five mega mergers. Our objective is to analyze whether
these acquisitions pronounced success. We have made an effort to judge the justifiability of merger on
the ground of value creation. In this purpose we have used the two techniques. The first is the event
study methodology, for which the target variables are abnormal stock price return (ASRP), cumulative
abnormal stock price return (CASRP) and the Sharpe ratio. The second method is the accounting
performance techniques, in which the target variables are return on equity (ROE), an indicator of
profit, and the cash flow variables such as operating cash flow (OCF) and absolute cash flow (ACF).
The definitions of the aforesaid variables are given in the research methodology.
Findings from the results of accounting study methodology (deferential statistics) show that the
for the sample of mergers and acquisitions of the five mega-banks analyzed in this study, significant
value was created for Citigroup, Wells Fargo and BOA where as no significant value was created in
both the JP Morgan Chase mergers including JP Morgan and Bank One.
Here the event study methodology tend to differ from accounting study methodology as event
study has shown that value creation didn’t happen for any of the mergers where as accounting study
has shown that the value creation did happen for three out of the five mergers studied.
72 European Journal of Economics, Finance And Administrative Sciences - Issue 19 (2010)
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