African Journal of Business Management Vol. 5(32), pp. 12624-12631,14 December, 2011 Available online at http://www.academicjournals.org/AJBM DOI: 10.5897/AJBM11.

2220 ISSN 1993-8233 2011 Academic Journals

Full Length Research Paper

Stochastic dominance approach of analysis for stock market valuation of financial consolidation in Taiwan
Yuan Chang1* and Hooi Hooi Lean2
1

Department of Business Education, National Changhua University of Education, Taiwan, Republic of China. 2 School of Social Sciences, Universiti Sains Malaysia, Malaysia.
Accepted 20 September, 2011

To examine whether stock market values financial consolidation in Taiwan since 2002, this paper compares the stock market performance of financial-holding-company banks (FHC-bank) with independent banks using Taiwans daily data from 2003 to 2009. While the ultimate goal of a typical public-traded bank is to maximize its stockholders wealth, based on stock returns distribution, we employ stochastic dominance (SD) approach to examine relative performance between FHC-banks versus independent banks. The advantage of SD approach is that it lightens the problem that can arise if the asset returns are not normally distributed because it utilizes the whole distribution of returns. Since SD is nonparametric, SD tests do not require any specific assumptions on investors utility function or the returns distribution of asset and thus avoid the joint test problem inherent in the standard approach. Most of our evidence shows that there is little dominance in stock returns of FHCbanks relative to independent banks. Thus, Taiwans stock market does not value financial consolidation during our sample period. Key words: Financial-holding-company banks (FHC-banks), independent banks, stochastic dominance.

INTRODUCTION Following the trend of financial liberalization around the globe, Taiwans government lifted the long-standing restrictions on the establishment of financial institutions in 1988. The Banking Act was amended in 1989, which permited new entrants into the banking industry. Several new and private banks joined banking markets but consequently resulted in overbanking problem in domestic financial market. Obviously, the consequence of abundant entrants leaded to cut-throat competition and then has seriously worsened the overall financial conditions of all banks. According to the Taiwan Ministry of Finance, overall nonperforming loan ratio climbed from around 3% at the end of 1995 to a highest record of 8.78% in March 2002. The banking sector in Taiwan suffered from increasing non-performing loans and decreasing profitability duo to deregulation in 1989. In order to alleviate the overcompetition of banks and elevate the financial system to a new stage of competitiveness in global financial markets, Taiwan government decided to conduct banking financial reforms before millennium. Almost at the same time, in the United States, the announcement of the Citigroup merger in 1998 sped up the process of financial consolidation, and afterwards the Congress passed the Gramm-Leach-Bliley Act (GLBA) in 1999. Through the roof of Financialholding-company banks (FHC), a financial institution can engage in banks, insurances and securities at the same time. The GLBA in U.S. encourages the financial regulators in Taiwan government to speed up the financial consolidation reforms. In 2000, Taiwan passed the amended Banking Law and the Financial Institutions Consolidation Law, while in 2001, FHC Act was stipulated to encourage the consolidation within and cross banking sectors. The FHC holds atleast 25% shares of banks, insurance and

*Corresponding author. E-mail: ccuecon@yahoo.com.tw. Tel: 886-920-671950. Fax: 886-49-2390387. JEL classification: C14, C21, G21

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securities, hoping to create economies of scale and scope to save cost and improve performance of consolidated banks.Since the passed of FHC Act, 14 FHCs are established successively. In the early stage, 13 banks joined the FHCs. Later on, an additional four banks joined in. Thus, there are now a total of 17 FHC-banks and 17 independent banks in Taiwan. Although the backdrop and thus the presupposition of Taiwans financial reform are based on the conventional wisdom in banking literature which argues that banks could reduce their risks and improve performance through diversification, empirical test about whether this policy improve stockhoders wealth is also needed, especially, recent alarmed financial tsunami shows that banks with higher and aggressive diversity could increase risks and result in worse performance. Therefore, does a bank, subordinated to financial holding company (FHC-bank thereafter) outperform a bank to be stand-alone (independent bank thereafter)? This is a greatly-concerned issue by government decision makers and academic researchers, especially since the passage of the Financial Holding Company Act in 2001 to reconstruct financial hierarchy in Taiwan. Theoretically, Diamond (1984), Ramakrishnan and Thakor (1984), and Boyd and Prescott (1986) suggested that banks could achieve credibility in their role as screeners or monitors of borrowers through diversification, thus supported that FHC-bank is superior because banks that engage in deposit-loan activity can facilitate the efficient provision of other financial services, such as insurance or underwriting of securities (Diamond, 1991; Rajan, 1992; Saunders and Walter, 1994; Stein, 2002). Similarly, securities and insurance underwriting, brokerage and mutual fund services and other activities can produce additional information that improve loan making decisions. Thus, banks in financial conglomerate, because of 3C (cross-selling, cost down and capital down), could enjoy economics of scale and scope that boost performance and market valuations. Also, under framework of financial holding company, the service of one-stop shopping from banking, insurance, and securities is possible. On the contrary, an alternative view suggests that independent banks may have specialization advantage 1 and lower systematic risks. For example, some independent-banks are specialized in credit card or custodian business and then join the FHC has no particular advantages for them. Also, independent bank could have lower systematic risk because a FHC-bank with diversified activities will reinforce agency problem between insiders and outsiders. For examples, Jensen (1986) proposed that insiders have incentives to expand the range of financial activities if this diversification enhances personal advantages or extract private benefits from the financial institution. Although their focus is not financial
1 Shen (2002) described the advantages and disadvantages of banks being subordinated to FHC and independent.

institution, Jensen (1986), Berger and Ofek (1995), Servaes (1996), and Denis et al. (1997) argue that the benefits of diversification are less than the costs. Therefore, conflicts of interest and agency problems have adverse implications on the performance or markets valuation of a bank. A bank should focus and take the maximum advantage of managing expertise and thus reduce agency problems. The number of empirical studies comparing the performance of FHC-bank and independent bank is rare, probably because the banks with similar assets size in and not in FHC are rare. Shen (2002) examined CAMEL indicators of 50 FHC-banks and 44 independent ones in U.S between 1997 and 1998, and found that on average, the former outperform the latter. Hsu and Chang (2005) studied the influence of passage of FHC Act on bank operational efficiency in Taiwan. They found that FHCbanks outperform independent-banks before and after passage of FHC Act, and this gap widens after passage of that Act. Boyd and Graham (1988) found banks which are merged with insurance companies have lower risk of bankruptcy. Rose (1989) suggested that banks engaged in non-bank product lines will reduce cash flow risk. Templeton and Severiens (1992) found that banks with diversification among other financial services will reduce their unsystematic risk. Berger et al. (1999) showed that higher financial service consolidation drives greater diversification of risk. On the contrary, Berger et al. (1987) and Berger and Humphrey (1991) provided little evidence of large economies of scope by estimating the trans-log cost function of banks, similar with the results of Ferrier et al. (1993) and Pulley and Humphrey (1993). DeYoung and Roland (2001) found that U.S banks with lower traditional lending activities and higher fee-based activities have higher revenue volatility and thus risks. Stiroh (2004) showed that noninterest diversification is negatively related to banks performance. Other studies examine the effects of conflicts of interest when a bank both makes loans and sells its securities. For examples, Kroszner and Rajan (1994), Puri (1996), Gande et al. (1997, 1999), and Schenone (2004) found the results of banks which make loans to a firm and underwrite its securities will sell securities to the public at inflated prices to subsidize their lending operations. Cerasi and Dal-tung (2000), and Acharya et al. (2006) suggested that there are diseconomies of scope that arise through weakened monitoring incentives and a poorer quality loan portfolio when a risky bank expands into additional industries and sectors. Laeven and Levine (2007) found that financial conglomerates engaging in multiple lending activities have lower market value than they would if they were split into separate financial institutions. While numerous studies are concentrated on U.S. and European banking markets, leaving the Asian emerging economies such as Taiwan (with relative importance in stock market Asia) passed over; this is the first motivation for our paper. Secondly, banks performance comparisons

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Table 1. FHC-banks vs. independent-banks.

FHC-banks First Commercial Bank Hua Nan Commercial Bank Cathay United Bank Bank SinoPac E.SUN Commercial Bank Taishin International Bank Mega International Commercial Bank China Development Industrial Bank Chinatrust Commercial Bank Taipei Fubon Bank Chiao Tung Bank Fuhwa Commercial Bank Jih Sun International Commercial Bank International Bank of Taipei Grand Commercial Banks Fubon Commercial Bank Cathay Bank
Source: website of Financial (http://www.fscey.gov.tw).

Independent banks Hsinchu International Bank Taichung Commercial Bank Tainan Business Bank Taitung Business Bank EnTie Commercial Bank Farmer Bank Taiwan Corporative Bank Chang Hwa Bank Bank of Overseas Chinese Cosmos Bank Pan Asia Commercial Bank Bank of Kaohsiung Union Bank of Taiwan Chinese Bank Far Eastern International Bank Taiwan Business Bank Ta Chong Bank
Commission, Executive Yuan

Supervisory

of various existing papers are not based on stockholders wealth. For a typical public-traded company, the goal is to maximize its stockholders wealth based on stock returns distribution, thus our paper are based in stock markets performance comparisons to analyze relative performance between FHC-banks versus independent banks. Thirdly, near a decade after FHC Act, we need an ex post evaluations of the policy impacts of the change in legislation and regulatory environment of Taiwans banking industry, which might provide an exogenous motive for banks to diversify and thus impacts on their stockholders wealth. Based on Hadar and Russell (1969), Hanoch and Levy (1969), and Rothschild and Stiglitz (1970), Whitmore (1970) introduced stochastic dominance (SD) theory to economics research. The basic principle underlying SD grounds on the maximization of expected utility. An advantage of this approach is that it lightens the problems that can arise if the asset returns are not normally distributed because it utilizes the whole distribution of returns. Moreover, since SD is nonparametric, SD tests do not require any specific assumptions on investors utility function or the returns distribution of asset and thus avoid the joint test problem inherent in the standard approach. SD rankings also have direct interpretations in terms of expected utility and thus provide an appealing basis to relate investors revealed preferences to their risk attitudes (Fong, 2009). This paper investigates the stock performance with the SD approach between FHC-banks and independent banks in Taiwan Stock Exchange (TWSE).

BRIEF ACCOUNT OF FHC IN TAIWAN Wheelock (1993) suggested that the overdevelpoment of banking is more responsibile than any other factos for the banking disaters. Starting from the middle of 1980's, Taiwan started to deregulate its financial markets, such as liberalization for bank branch expansion in 1984, removal of interest rate control in 1985 and policy reform for introduction of newly-establish banks. However and unfortunately, as Wheelock (1993) said, overbanking problem soon emerged, overall health of the banking system quickly decreased. As Taiwans first financial reform proposed by President Chen, the government referred to U.S Financial Services Modernization Act (Gramm-Leach-Bliley Act) for removal of separation prohibition of banking and investment (Glass-Steagall Act) to strengthen financial industry, Finance Holding Company Act passed in 2001 and 14 domestic financial holding companies were established successively in Taiwan. Table 1 summarizes the names, dates of approbation for establishment, date of open for business and banks subordinated to each of the 14 financial holding companies. In order to get complete financial information about banks, we collect data of banks which are Taiwan Stock Exchange listing companies. In our sample period from 2003 to 2009, 13 banks are subordinated to financial holding companies, which are (1) Bank SinoPac, (2) Hua Nan Commercial Bank, (3) Cathay United Bank, (4) First Commercial Bank, (5) E.SUN Commercial Bank, (6) Taishin International Bank, (7) International Commercial

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Bank of China, (8) China Development Industrial Bank, (9) Chinatrust Commercial Bank, (10) Taipei Fubon Bank, (11) Chiao Tung Bank, (12) Fuhwa Commercial Bank, (13) Jih Sun International Commercial Bank. There are 4other banks which are defined as FHCbanks but go through consolidation during our sample period : (1) International Bank of Taipei, which are consolidated into Sinopac Holdings in 2005Q2; (2) Grand Commercial Bank, merged into Chinatrust Commercial Bank in 2003Q4; (3) Fubon Commercial Bank, merged with Taipei Bank merged into Taipei Fubon Bank and the former is eliminated and (4) Cathay United Bank, which are merged with United World Chinese Commercial Bank in 2003Q4, the former is eliminated and former is the surviving bank but the merged bank is re-named as Cathay United Bank. For these 4 banks subordinated to financial holding companies, we have their data from 2002Q1 (first quarter of 2002) to one quarter before effectiveness of consolidation. During our sample periods, independent banks are: (1) Hsinchu International Bank, (2) Taichung Commercial Bank, (3) Tainan Business Bank (renamed as Kings Town Bank in 2006Q1), (4) Taitung Business Bank, (5) EnTie Commercial Bank, (6) Farmer Bank, which merged into (7) Taiwan Corporative Bank in 2006Q2, (8) Chang Hwa Bank, (9) Bank of Overseas Chinese, (10) Cosmos Bank, (11) Pan Asia Commercial Bank (renamed as Bowa Bank 2005Q2), (12) Bank of Kaohsiung, (13) Union Bank of Taiwan, (14) Chinese Bank, (15) Far Eastern International Bank, (16) Taiwan Business Bank and (17) Ta Chong Bank.

H0 = h

and and

H j ( x ) = H j 1 ( t ) dt
x a

for

f,

H = F,G

j = 1, 2,3 .

(1)

The most commonly-used SD rules that correspond with three broadly defined utility functions are first-, second- and third-order SD denoted by FSD, SSD and TSD respectively. Under FSD criterion, all investors are non-satiation which means investor prefers more to less, regardless his risk preference. If the CDF of Ys return is below Zs for all values, we say that prospect Y dominates prospect Z at first-order. Mathematically, it is denoted as

Y f1 Z

if and only if

F1 ( x ) G1 ( x ) . SSD assumes that the Y f2 Z

if and only if

non-satiation investors are risk averse. Prospect Y dominates prospect Z at second-order, denoted

F2 ( x ) G2 ( x ) . In addition, TSD assumes that the risk averse

investor has decreasing absolute risk aversion (DARA), or in other word he prefers positive skewness. Prospect Y dominates prospect Z at third-order, denoted

F3 ( x ) G3 ( x ) for all possible return x.

The existence of SD implies that the expected utility of the investor is always higher when holding the dominant asset than holding the dominated one and, consequently, the dominated asset would not be chosen. As noted by Levy (1992, 1998), hierarchical relationship exists in SD. FSD implies SSD, which in turn implies TSD; the reverse is not true. There are statistical tests for SD which have been well developed, for example, McFadden (1989), Klecan et al. (1991), Kaur et al. (1994), Anderson (1996, 2004), Davidson and Duclos (2000), Barrett and Donald (2003) and Linton et al. (LMW, 2005). We choose to use DD test in this study because Wei and Zhang (2003), Tse and Zhang (2004) and Lean, Wong and Zhang (2008) reported that DD test is powerful and less conservative in size. Furthermore, DD test is flexible if the series being examined is dependent. For any two prospects, Y and Z with CDFs F and G respectively and with a grid of pre-selected points x1, x2 xk, the order-j DD test statistics,

Y f3 Z

if

and

only

if

DATA AND METHODOLOGY As aforementioned, although there are 17 independent banks and 14 FHC listing on Taiwan Stock Exchange (TWSE), however, complete daily data of stock returns is collected from Taiwan Economic Journal (TEJ) for only 5 independent banks and 13 FHCbanks listed in TWSE. The sample period of study is from January 2, 2003 to December 25, 2009, which includes the recent global financial crisis. For the 5 independent banks, we name it as I1, I2, , I5. For the 13 FHC banks, they are named as F1, F2, , F13. We use a nonparametric approach based on stochastic dominance (SD) to compare the stock return between FHC banks and independent banks. Hadar and Russell (1969), Hanoch and Levy (1969), Rothschild and Stiglitz (1970) and Whitmore (1970) lay the foundation of SD analysis. The basic principle of SD is grounded in maximizing expected utility. Thus, SD rankings have direct interpretations in terms of expected utility. Since SD approach utilizes the whole distribution of returns, the problems of asset returns not normally distributed can be minimized. Moreover, there are no specific assumptions on investors utility function when employing SD test. This can avoid the joint test problem intrinsic in the standard statistical testing approach. If all non-satiated investor prefer the distribution of stock return of a FHC bank to the independent bank, then risk compensation is unlikely to be an explanation for the profitability of FHC banks. Suppose an investor is choosing between two risky prospects Y and Z, let F and G be the cumulative distribution functions (CDF) and, f and g are the corresponding probability density functions (PDF) respectively. Defined as:

T j ( x) (j = 1, 2 and 3) is formulated as:

Fj ( x ) G j ( x ) V j ( x)
(2)

T j ( x) =

V j ( x) = VYj ( x) + VZj ( x) 2VYj,Z ( x),

H j ( x) =

N 1 ( x hi )+j 1 , N ( j 1)! i =1

N 1 1 2( VHj ( x) = ( x hi ) + j 1) H j ( x) 2 , H = F , G; h = y, z; 2 N N (( j 1)!) i =1 N 1 1 j 1 VYj, Z ( x) = ( x yi )+j 1 ( x zi )+ Fj ( x)G j ( x) N N (( j 1)!) 2 i =1

where

Fj

and

Gj

are defined in (1). Bishop et

al. (1992)

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proposed to test the null hypothesis for a pre-designed finite numbers of values x. Specifically, the following hypotheses are tested:

H 0 : Fj ( xi ) = G j ( xi ) for all xi , i = 1, 2,..., k ; H A : Fj ( xi ) G j ( xi ) for some xi ; H A1 : Fj ( xi ) G j ( xi ) for all xi , Fj ( xi ) < G j ( xi ) for some xi ; H A 2 : Fj ( xi ) G j ( xi ) for all xi , Fj ( xi ) > G j ( xi ) for some xi .

comparison and to make the statistical inference based on the SMM distribution for k =10 and infinite degrees of freedom2. This allows the examination of the consistency of both magnitudes and signs of the DD statistics between any two consecutive major partitions without violating the independent assumption.

EMPIRICAL RESULTS Table 2 reports the descriptive statistics of the stock returns for independent and FHC-banks during sample period. Daily mean return of FHC-banks is higher than the independent banks in average for about 70% (0.0491 and 0.0283%, respectively). Because all the banks have positive daily mean return, neither FHC- nor independent banks experienced any negative average return even though the global financial crisis happened during the sample period. Although FHC-banks have higher return than independent banks, their average standard deviation is lower as well (2.2794 and 2.3017%, respectively). Based on the mean-variance criterion, FHC-banks are superior to the independent banks with higher return and lower risk. In addition, higher Sharpe ratio of FHC-banks than independent banks (0.0213 versus 0.0117) also shows that investment in FHC-banks is better off. However, the independent banks have larger skewness and kurtosis in average than the FHC banks. Hence, we conclude that FHC banks are better off than the independent banks from the descriptive statistics and mean-variance criterion. This is consistent with the literature such as Boyd and Graham (1988), Rose (1989) and Templeton and Severiens (1992) which show evidence that diversified banks are with lower risks. Then, we do the pair-wise SD comparisons by employing the DD test for all banks in these two groups. To do this, we replace the first variable (F) with FHCbank and the second variable (G) with independent bank in Equation 2. If the FHC-bank stochastically dominates the independent bank at order-j, there will not be any significantly positive Tj but there will be some significantly negative Tj. The DD test results are summarized in Table 3. In general, the number of cases that FHC bank dominates independent bank (15 cases) are approximately equal to the number of cases that FHC bank is dominated by independent bank (14 cases). A non-satiation risk-averse investor is indifferent between FHC-banks and independent banks to maximize his expected utility, on average, based on their stock return during the sample period. In other word, being a FHC-bank does not bring any obvious advantages on stock market performance in term of motivate a risk-averse investors preference to buy its stock. We can observe some domination for individual bank.

We note that in these hypotheses, both

HA

is set to be exclusive of

H A1

and H A 2 , which means that if either

H A1

or

H A2

is

accepted, we will not say hypothesis, DD showed that

Tj ( x )

HA

is accepted. Under the null is asymptotically distributed

as the Studentized Maximum Modulus (SMM) distribution (Richmond, 1982) to account for joint test size. To implement the DD test, the test statistic at each grid point is computed and the null hypothesis is rejected if the test statistic is significant at any grid point. The SMM distribution with k and infinite degrees of freedom, denoted by M , is used to control for the probability of rejecting the overall null hypotheses. The following decision rules are adopted based on 1- percentile of and Ury (1979):
k If T j ( xi ) < M , for i = 1,..., k , accept H 0 ; k k if T j ( xi ) < M , for all i and T j ( xi ) > M , for some i, accept H A1 ; k k if T j ( xi ) < M , for all i and T j ( xi ) > M , for some i, accept H A2 ; and k k if T j ( xi ) > M , for some i and T j ( xi ) > M , for some i, accept H A .

k M ,

tabulated by Stoline

Accepting either H0 or HA implies non-existence of any SD relationship, non-existence of any arbitrage opportunity between these two prospects and neither of these two prospects are preferred to one another. However, if

H A1 or H A 2

of order one is

accepted, a particular prospect stochastically dominates another prospect at first-order. In this situation, arbitrage opportunity can exist and any non-satiated investor will be better off if s/he switches from the dominated prospect to the dominant one. On the other hand, if

H A1

or

H A2

is accepted for order two or three, a

particular prospect stochastically dominates the other at second- or third-order. In this situation, arbitrage opportunity does not exist and switching from one prospect to another will only increase investors expected utilities, but not wealth (Jarrow, 1986; Falk and Levy, 1989). DD test compares the return distributions at a finite number of grid points. Richmond (1982) argued that too many grids will violate the independence assumption required by the SMM distribution while Barrett and Donald (2003) noted that too few grids will miss information of the distributions between any two consecutive grids. Tse and Zhang (2004) suggested that an appropriate choice of k for a reasonably large sample ranges from 6 to 15. To make more detailed comparisons without violating the independence assumption, we follow Fong et al. (2005), Lean et al. (2007) and Wong et al. (2008) to make 10 major partitions with 10 minor partitions within any two consecutive major partitions in each

Refer to Lean et al. (2008) for the reasoning. Critical value is 3.254 for 5% level of significance tabulated in Stoline and Ury (1979).

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Table 2. Descriptive statistics for independent and FHC banks in Taiwan.

Banks Independent I1 I2 I3 I4 I5 Average FHCF1 F2 F3 F4 F5 F6 F7 F8 F9 F10 F11 F12 F13 Average

Mean 0.0302 0.0607 0.0057 0.0069 0.0380 0.0283

Std. dev. 2.2241 2.5702 2.2884 1.9675 2.4583 2.3017

Skewness 0.1834 0.2292 0.1640 0.1991 0.2514 0.2054

Kurtosis 1.4315 1.3615 1.6337 3.0330 1.2711 1.7462

Sharpe 0.0136 0.0236 0.0025 0.0035 0.0154 0.0117

0.0360 0.0592 0.0683 0.0147 0.0319 0.0974 0.0518 0.0297 0.0771 0.0624 0.0296 0.0466 0.0337 0.0491

2.0826 2.2025 2.2826 2.1554 2.0943 2.6982 2.1053 2.4410 2.7792 1.9701 2.2865 2.3546 2.1804 2.2794

0.0854 0.0682 0.0752 0.1191 0.1076 0.1173 0.1492 0.2068 0.1330 0.2486 0.1151 0.0640 0.1979 0.1298

2.2214 1.7427 1.5959 1.7272 2.0815 0.7090 2.1180 1.4288 0.6165 2.9471 1.4941 1.6265 2.0224 1.7178

0.0173 0.0269 0.0299 0.0068 0.0152 0.0361 0.0246 0.0122 0.0277 0.0317 0.0129 0.0198 0.0154 0.0213

The independent banks, I1~I5 are Chang Hwa Bank, Tainan Business Bank (now known as King's Town Bank), Bank of Kaohsiung, Union Bank of Taiwa and EnTie Commercial Bank. Among FHCbanks, some of them are from Table 1, and others are newly established.

Table 3. SD tests results between independent and FHC banks in Taiwan.

Bank F1 F2 F3 F4 F5 F6 F7 F8 F9 F10 F11 F12 F13 Total

I1 N N N N N T N T T D N T* N

I2 D D N D D N D N T D N N D

I3 D* N N N N T D N T D N N N

I4 N N T N N T N T T N T T N

I5 D N N N D N D N T D N N N

#D 3 1 0 1 2 0 3 0 0 4 0 0 1 15

#T 0 0 1 0 0 3 0 2 5 0 1 2 0 14

D means dominates at second-order and third-order; T means is dominated at second-order and third-order; N means no stochastic dominance and * refers to first-order dominance. For example, F1 D I2 means bank F1 dominates bank I2 at second-order and third-order; F1 N I1 means there is no stochastic dominance between F1 and I1; F6 T I1 means bank F6 is dominated by bank I1 at second-order and third-order. #D means number of independent bank that is dominated by the particular FHC bank; #T means number of independent bank that dominates the particular FHC bank. For example, row F1 shows bank F1 dominates 3 independent bank banks and it is not dominated by any independent bank.

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Table 4. SD tests results between independent and FHCBanks using after-matching samples.

Bank F5 F8 F9 F10 F11 Total

I1 N T T D N

I2 D N T D N

I3 N N T D N

I4 N T T N T

I5 D N T D N

#D 2 0 0 4 0 6

#T 0 2 5 0 1 8

Similar with Table 3.

F10 performs the best as it dominates four independent banks while F9 performs the worst because it is dominated by all the five independent banks. F1 and F7 also doing quite well in dominating three independent banks while F6 is dominated by three independent banks. There are two cases of FSD: F1 is FSD I3 while I1 is FSD F12. Many studies such as Jarrow (1986) and Falk and Levy (1989) claim that if FSD exists, under certain conditions arbitrage opportunities also exist, and investors will increase their wealth and expected utilities if they shift from holding the dominated asset to the dominant one. However, Wong et al. (2008) claim that if FSD exists statistically, arbitrage opportunities may not exist, but investors can increase their expected wealth as well as their expected utility if they shift from holding the dominated asset to the dominant one. In general, the FSD should not last for a long period of time because market forces induce adjustments to a condition of no FSD if the market is rational and efficient. In a situation where the FSD holds for a long time and all investors increase their expected wealth by switching their asset choice, we claim that the market is neither efficient nor rational. Another possibility for the existence of FSD to be held for a long period is that investors do not realize that such dominance exists. While our comparisons are based on FHC-banks and independent banks, one might wonder if we could attribute the stock market performance difference to the effects of banks joining FHC on performance. Because of banks characteristic variables such as scale, debt ratio and the ratio of revenue from non-traditional activities to total revenue, we try to match similar-in-characteristics FHC-banks with independent banks. Why we do this is that because the classification of FHC- versus independent banks is not a random process and may be endogenously determined. For example, banks with better accounting performance in the past tend to join FHC, or banks with large scale tend to join FHC. If this possibility exists, stock market performance differences between two group may not be attribute to effect of joining FHC. Rubin (1973a, b) developed matching theory, and then Rosenbaum and Rubin (1983, 1985a, b) proposed propensity score matching (PSM), both are intuitive methods

to match samples with similar charactersitics. The basic concept of Rubin (1973a, b) is that non-participants of experiment (firms without doing CSR) that have similar characteristics with participants (CSR firms) are called the controlled samples. Thus, the changes owing to the experiment between treatment sample and control sample is referred to as experimental or treatment effect (purely joining-FHC effects). The PSM firstly estimate the probability of including in the experiment (propensity score) by all samples using characteristic variables as the explanatory variables. Then for each firm in the treatment sample, firms in the control samples are selected as matched samples according to the closeness of the estimated probability (Shen and Chang, 2009). We employ Rosenbaum and Rubins (1983, 1985a, b) PSM to collect samples of FHC-banks which share similar characterisic varaibles with independent banks. For simplicity, characteristic variables are ASSET (natural log current-period total assets), DEBTL (last-period debt ratio) and PROFITL (last-period after-tax profits levels). Thus, after matching, we have 5 FHC-banks and 5 independent banks. Based on after-matching samples, the DD test results are summarized in Table 4. In general, the number of cases that FHC bank dominates independent bank (6 cases) are approximately equal to the number of cases that FHC bank is dominated by independent bank (8 cases). A non-satiation risk-averse investor is indifferent between FHC-banks and independent banks to maximize his expected utility, on average, based on their stock return during the sample period. In other word, being a FHC-bank does not bring any obvious advantages on stock market performance in term of motivate a riskaverse investors preference to buy its stock. We can observe some domination for individual bank. F10 performs the best as it dominates four independent banks while F9 performs the worst because it is dominated by all the five independent banks. F5 is also doing quite well in dominating two independent banks while F8 is dominated by two independent banks.

Conclusion Taiwans financial consolidation reform in 2001 are based on the conventional wisdom which advocates that bank diversification reduce risks and enhence performance. In addtion, recent financial tsunami shows that financail diversification lead to higher risks and lower performance, now, nearly a decade after FHC Act was passed, we need an evaluations of the policy impacts of the change in legislation and regulatory environment of Taiwans banking industry, which provide an further motive for banks to diversify and policy implication for stockholders wealth of banks. Empirically evidence shows that there is dominance in stock returns of FHC-banks relative to independent banks. Thus, Taiwan stock market does not price financial

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consolidation during our sample period, and government policy persuades banks to stretch their optimal scope and aggressively diversify themselves in order to improve in stockholder wealth of banks. Future study needs to match samples for similar size or other characteristic variables (Rosenbaum and Rubin, 1985a, b) to control for scale effect on performance and lengthening the data to examine the synergic effects of bank consolidation on performance is also needed.
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