World Journal of Management and Behavioral Studies 1 (1): 01-05, 2013 ISSN 2306-840X IDOSI Publications, 2013 DOI:

: 10.5829/idosi.wjmbs.2013.1.1.1101

Should Banks Merger with the Cement Industry: Empirical Study of Pakistan
1

Ashfaq Ahmad and 2Mohammad Saeed

Govt. College Model Town, Lahore, Pakistan 2 Govt. M.A.O College, Lahore, Pakistan

Abstract: To reduce cost most of the banks are involved in merging activities. This will not only diversify their risks but also increases their revenues. Taking the same notion the present study is an attempt to explore whether banks should merge with the cement industries. For this purpose data was collected from banks and Karachi Stock Exchange for the period of 2004-2009. Results of the present study regarding profitability were mixed, in certain cases, this merger will benefit the banks and in certain cases, this will benefit the cement industries. Key words: Merger % Banks % Cement Industries % Karachi Stock Exchange INTRODUCTION The banking companies have been experiencing extensive merging activities to reduce their costs, diversify risks, increase revenue and increase the profitability margin. Now days the debatable topic in this regard is that letting banks to engage in certain financial activities outside the commercial banking. Most of the large banking companies are trying to reduce the barriers to merge with the non banking sectors. These banking companies are of the point of view that when non-banking companies i.e. insurance and real estate are allowed to involve in the banking activities then why banks are not allowing entering in non banking activities (banking companys act 1956). Critics of the expended banking companies argued that if banking companies are allowed in the prohibited activities that the risks of banks will increase and their profitability will be reduced (competitive Equality Banking act 1987). The present study is an attempt to see the impact on the profitability and risks of the banks if the banks merge with the cement sector. In this regard two measures of profitability and two measures of risks were taken. Literature Review: Financial theory argued that firms should merge with other firms to enhance the share holders value. Milbourn, Boot and Thakor [1] present two explanations that why should banks merge with the other firms i.e. (1) these type of activities is an attempt to increase the shareholders wealth and (2) to enhance the reputation of their chief executive officers (CEOs) who would likely to receive more compensation and try to increase the assets of their banks. Craig and dos Santos [2] argued that there is another benefit of the banks merger that is scale and scope economies and more importantly is the managers X- efficiencies. Along with two other benefits of the banks merger and acquisition are diversifying the risks and increase the volume too big to fail. This also helps them to increase their profitability as well. According to the study of Craig and dos Santos (1996), the per-merger risks of the banks were higher as compared to the post merger risks. Berger, Saunders, Scalise and Udell [3] suggest that dynamic effects of the banks merger such as restructuring and change the methods influence on performance of the business after merger. They are very hard to predict at the time of merger. Rolls [4] hubris hypothesis predicts that conclusion makers at acquiring firms on standard overpay for their target acquisitions. According to [5] the zeal of consolidation is based on the point that gain can be accrued by reducing the expenses, reduce volatility and increase the market power as well. He further argued that managers most of the time overbid or over estimate the assets of newly acquired business. Berger and Humphrey [6] argued that about 20 to 25 percent of the costs, X-efficiency is there in the banking industry. Thus this helps that there is still a potential that this efficiency can be increased through merger. But in

Corresponding Author: Ashfaq Ahmad, Govt. College Model Town Lahore, Pakistan. E-mail: ashfaq.ahmad.warraich@gmail.com

World J. Manage. & Behav. Stud., 1 (1): 01-05, 2013

actual all the banks merge in the 1980s remain unable to get the benefit of cost efficiency. The literature about the ratios and the x-efficiency indicates that the average difference now days and the merged banks of 1980s is round about 5% only [7-8]. In addition, [6] found no correlation among those mergers that reduce costs and that who predicted to reduce their costs. Peristiani, [8] in his study found that most of the managers remain unable to produce the x-efficiency after the merger. He further argued that after the merger efficiency of the merged organization depends on the managers that how well they increase the quality of their assets. There is also no evidence that support that merger increase the efficiency of the merged organization. Later studies also indicate the mixed results. Craig and dos Santos [2] found that merged banks perform better as compare to the pre merger. Pilloff [5] found that there is no significant change in the Return on Equity (ROE) after the merger of firms. However when the same has been studied by the Pilloff after taking the income before provisions instead of net income the changer were found to be quiet significant in ROE. So an increase in the ROE was found after merger. In addition to this [9] note that there is no change in the ROE of the merged firms after their merger but still this increase their efficiency and income as well. Peristiani [7] also found the same results that merger does not change the ROE. According to [10] diversified multibank holding companies provide certain benefits to the banks. Banks benefit from environmental diversification. Thus diversified multibank holding companies acquire a bit less capital and lend more. DeLong [14] argued that mergers in which both of the firms perform the similar activities they benefit the shareholders in terms of increase their value and those mergers that merge environmentally does not increase the value of stockholders. In their studies, [11,12] studied that whether the diversified firms reduce the value of shareholders or not. Both of the studies argued that they found no evidence that the diversification reduce the value of the shareholder or firms, rather they find that diversification is one of the factor that increase that value. Berger and DeYoung [13] studied that weather the technological improvements facilitate the geographical expansion of the banks to merge with the others and allow parent organizations to have greater control and they decrease the agency costs associate with the distance from the head office by reducing the overtime. He argued that banking companies have significant control and this also increase the overtime. On the other hand he further added that agency costs associated with the distance 2

reduces over time. He further concluded that distance is negatively associated with costs, profits and marginal control. According to [14] market has improved its ability to predict that weather two firms should merge with each other or not, over the time. He further added that it is difficult to find that what type of merger will cause long time increase the value of merger, but the market predict it better if the bank is been monitored through its stock analysis. Thus the monitoring increase the ability to predict about the successful merger of the firms. The mergers that increase long-term return on assets (ROA) or efficiency ratios during the first years of her study tend to focus activities (similarity in activities), whereas those factors that influence performance in the later years tend to have similar geographic locations or payment in stock. [15] is of the point that the profitability of the merger is not associated with the increase in return on assets (ROA), or the board of directors but, in fact the ability of the CEO of the bank that how well he use the swap or options of the bank. The larger the percentage of shares controlled by the CEO, the more likely the bank will be acquired. The findings of the [15] resemble with the findings of [16]. On the other hand, [16] argued that profitability of the bank acquired is negatively related to the outstanding shares of the bank. In the present study, we worked on a different topic that banks should allow to merge with the non-banking companies. While doing so we will examine that profitability and risks of pre and post merger. The results of the present study will be a contribution and this will be helpful for the bankers to merge with the non-banking firms without much hesitation. Methodology Population, Sample and Sampling Technique: To see the merging effect of banks with the cement industries, all the companies listed in Karachi stock exchange and all the banks registered with the web of state bank of Pakistan considered as population. As there are approximately 207 banks registered with the web of central bank of Pakistan and 661 companies registered with the web of Karachi Stock exchange according to the figures of 2009. Out of these 661 industries 21 belonging to the cement sector, between which two industries have been declared as bankrupt. For the present study, five banks and five cement industries have been selected on the basis of simple random sampling basis. Data was collected from the web of Karachi stock exchange and state bank of Pakistan from 2004-2009.

World J. Manage. & Behav. Stud., 1 (1): 01-05, 2013

Variables: Here in this study we use two dependent and two independent variables that will tell us weather banks should merge with the other firms or not. Profitability Ratios: Profitability ratio measures the overall performance of the banks and cement industries. One of the major objective of the present study is to fine the profitability when the bank will merge with the cement industries. ROA is the measurement of the managements success that how well they are using the assets of the organization but this measurement does not tell us from where the assets are been financed. On the other side ROE tell us about the overall impact of operations on the stockholders this also tell us from where the assets are been financed. Risk Measures: Banks are trying to reduce the level of risks while merging or acquiring other business. To calculate the risk level here we use debt to equity ratio and z value. Z value is calculated with the help of following formula, i.e. Z = X-median/ S.D Where X represents the mean score of banks and industries on yearly basis and S.D is the standard deviation of values. Data Analysis Premerger Results: The performance of a buyer premerger can have a major impact on the performance of the merged firm. A feeble institution may try to postponement recognizing its problems by making an acquisition of a stronger firm. Thus, it is important to consider the buyers pre-merger performance. Table 1 represent the median values of return on equity (ROE) of both banks and cement industries for the five years. The values in the table indicate that the median of the banks and cement industries is above their averages, which is good. On the other hand figures indicates that from 2004-2006 the return on equity of the cement industries was much better and after that from 2007-2008 the return of banks was better than cement industries. Table 2- indicates the data regarding return on assent (ROA) of the banks and cement industries before their merger for the five years. Here in this table the median of the banks is below the average which is not good for them and the median of the cement industries is above their average values. If we compare the return on assets of the

Table 1: Profitability (ROE) of banks and cement industries Year 2004 2005 2006 2007 2008 2009 Median (Banks) 0.2877 0.317 0.284 0.254 0.187 0.176 Median (Cement Industry) 0.347 0.359 0.34 0.088 -0.026 0.114

Table 2: Profitability (ROA) of banks and industries Year 2004 2005 2006 2007 2008 2009 Median (Banks) 0.0165 0.0171 0.0222 0.0157 0.0137 0.0114 Median (Cement Industry) 0.155 0.144 0.101 0.042 -0.013 0.043

Table 3: Risk measure (Debt to Equity Ratio and Z values) Year 2004 2005 2006 2007 2008 2009 Median (Banks) 1.165 1.375 1.099 1.582 1.113 0.907 Z -1.19 -2.06 -0.58 -1.02 -1.09 0.47 Median (Cement Industry) 0.919 0.924 0.78 0.704 0.728 1.042 Z -0.67 -0.70 0.44 0.39 0.32 -0.14

Table 4: ROA and ROE Year 2004 2005 2006 2007 2008 2009 ROE (Median) 0.275 0.362 0.275 0.176 0.0964 0.141 ROA (Median) 0.0871 0.0971 0.0834 0.0443 0.0126 0.0446

Table 5: Risk measure Z-Values Year 2004 2005 2006 2007 2008 2009 Median 1.042 1.149 0.939 1.143 0.920 0.974 Z-Values -0.28 -0.54 0.37 0.21 0.10 0.52

banks and cement industries before their merger again the cement industries has much more return on assets as compared to the banking sector. Table 3 represents the median and z values of banks and cement industries. Z values of banks denote that there are very less chances of risk although there debt to equity ratios median is much higher. In the year 2009, the value indicates that there is a 47% chance of risk involved in the banks. On the other hand z-values of the cement industries indicates a mixed situation in the first and

World J. Manage. & Behav. Stud., 1 (1): 01-05, 2013

second year of analysis there were negative chances of risks involved and from third to fifth year the chances of risk increase. Cement industries have to face the highest probability of risk in the year 2006. Post Merger Impact: It is observed from the literature that usually after the merger the performance and efficiency of the merged firm reduces. To measure this first of all financial statement of the banks and cement industries are consolidated and after that we find the following changes regarding profitability and risks. Table 4 represents the analysis regarding ROE and ROA after a supposed merger of banks and cement industries on yearly basis. The median values of ROE showed a mixed result in some years after merger it will be better for the banks and in certain cases, this will be better for the cement industries. The values indicate that this merger will be more beneficiary for the cement industries instead of banks regarding return on their equity. Table also indicates the data regarding median values of ROA after the merger of banks and cement industries. The values denote that after the merger, the return on assets of the banks will be increased and on the other hand, this will reduce the return of the cement industries. Table 5 represents the data regarding the z-values (probability of risks) after the merger of the banks and cement industries. These values clearly indicates that after the merging with the cement industries the probability of risk for the banks will increase and as far as concern with the cement industries, for them the probability of risk is less as compared to pre merger. If the banks merger with the cement industries then their chance of risk increases up to 52% in 2009. Limitations and Direction for Future Studies: The basis aim of the present study was to find out about the profitability and risk measures if the banks merge with the cement industries. Other sectors should also be considered regarding merger with the banks in future. In the present study, we measure profitability with the help of return on assets and return of equity and risk with the help of debt to equity and its z values, there must involve other measures regarding the profitability and risks by the future researchers. Another limitation of the study is sample size; the results might be more generalized by increasing the sample size.

CONCLUSION The basic aim of the present study was to find the profitability and risk measure if the banks merge with the cement industries in Pakistan. The earlier studies of the merger indicate that after the merger the performance of the merged firm reduces. It is more difficult to merge when the target institution is large relative to the buyer than when the target is a much smaller institution. Same was the case in the present study but the results of the present study regarding profitability were mixed, in certain cases, this merger will benefit the banks and in certain cases, this will benefit the cement industries. As far as concern with the risks, this merger will prove more risky for the banks as compared to the cement industries and the banks will invest in the risky companies. REFERENCES 1. Milbourn, T.T., A.W.A. Boot and A.V. Thakor, 1999. Megamergers and expanded scope: Theories of bank size and diversity. Journal of Banking and Finance, 23: 195-214. Craig, B. and J.C. Dos Santos, 1996. Performance and asset management effects of bank acquisitions. Working paper, Federal Reserve Bank of Cleveland, No. 96-119, Cleveland, OH. Berger, A.N., A. Saunders, J. Scalise and G.F. Udell, 1998. The effects of bank mergers and acquisitions on small business lending, Journal of Financial Economics, 50: 187-229. Roll, R., 1986. The hubris hypothesis of corporate takeovers, Journal of Business 59: 197-216. Villalonga, B. 2003. Does diversification cause the diversification discount? Unpublished paper, Harvard Business School, Cambridge, MA. Pilloff, S.J., 1996. Performance changes and stockholder wealth creation associated with mergers of publicly traded banking institutions. Journal of Money, Credit and Banking 28: 294-310. Berger, A.N. and D.B. Humphrey, 1992. Megamergers in banking and the use of cost efficiency as an antitrust defense. Antitrust Bulletin, 37: 541-600. De Young, R., 1997. Bank mergers, X-efficiency and the market for corporate control. Managerial Finance, 23: 32-47.

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