Faculty Economics and Business

Corporate Master Business Administration

EBA 6333 Firms, Institutions and Competition Dr. Evan Lau

MERGER INCREASED EFFICIENCY AND DECREASED EFFICIENCY

T. Nanthakumaran s/o Thulasy [13030170]

Question 2

Explain the case where merger increased efficiency and the case where merger decreased efficiency. Provide suitable example for each case

Mergers can be known as the combination of one or more corporations, LLCs, or other business entities into a single business entity. The purpose of joining of two or more companies is to achieve greater efficiencies of scale and productivity. A merger also can generate capital to enter markets or launch products which the company would not be able to do so as separate entities. Additionally, companies may possess

complementary best practices and technical knowledge that makes it easier for them to compete in the market.

The level of merger activity can be traced back to the liberalization of the markets. Declining trade barriers, progress in transport and information technology and the establishment of uniform norms, standards and procedures has integrated markets worldwide. The geographical expansion creates the potential for an increase in productivity. Firms can realize economies of scale and economies of scope by expanding their production to foreign markets. Mergers, particularly cross-border mergers, then represent the fastest way of acquiring access to new markets and, later on, of achieving cost savings. The main reason companies merge is to save costs of production, particularly in a merger of former competitors. However, market integration also increases the number of competitors. As a result, the position of companies, both in domestic markets and in their traditional markets abroad, becomes vulnerable. Joining forces with a rival can help reduce competitive pressures. Besides cost savings, mergers may also be motivated by the desire for more market power.

Merger Increased Efficiency

Firms have been intensively using merger as a strategic tool for corporation restructuring. Efficiency impact of merger has been a topic of considerable discussion
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in empirical research. A number of studies reported improvement in efficiency due to mergers. According to Al-Sharkas et al. (2008) used the techniques of Stochastic

Frontier Analysis (SFA) and Data Envelopment Analysis (DEA) to investigate the impact of mergers on cost and profit efficiency of the US banking sector. Their findings suggest the evidence of improvement in both types of efficiencies following the mergers. Berger and Humphrey (1992) analyzed the efficiency effect of mergers by taking 57 bank mergers. They used the performance measures of X efficiency rank and total efficiency rank. The study concluded that efficiency gains may be created when a more efficient bank takes over the less efficient bank, otherwise there will be no improvement in the efficiency after the merger.

Bank mergers and acquisitions may enable banking firms to benefit from new business opportunities that have been created by changes in the regulatory and technological environment. Berger et al. (1999, p 136) pointed the consequences of mergers and acquisitions, which may lead to changes in efficiency, market power, economies of scale payments and scope, availability of services to small customers and

systems efficiency. Besides, improvement in cost and profit efficiency,

mergers and acquisitions could also lead banks to earn higher profits through the banks market in leveraging loans and deposit interest rates. Some evidence also suggested that U.S. banks that involved in M&As improved the quality of their outputs in the 1990s in ways that increased costs, but still improved revenues than costs (Berger and Mester (2003, p 88). profit productivity by increasing

According to Cornett et al (2006) finds that after merger revenue enhancement and cost reduction improved performance of banks and these results are more significant for large banks relatively to small ones. According to Jalal D. Akhavein et al (1997) finds that merged banks realized statistically significant increase in profit efficiency relatively to other banks, and these improvements are high for the banks that are inefficient prior to merger. Using a small sample size of 10 banks, Sufian (2004) investigates the impact of the recent mega merger program among the domestically incorporated Malaysian commercial banks. He found that Malaysian banks have
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exhibited an average overall technical efficiency level of 95.9% during the period of study. He concludes that the merger was particularly successful for the small and medium sized banks, which have benefited most from expansion and via economies of scale.

Pilloff and Santomero (1996) argue that mergers and acquisition activities can significantly reduce operating costs from the fact that larger firms can be more efficient if redundant facilities are eliminated. On the other hand, DeYoung et al. (2009) argues that mergers and acquisitions can increase firm size. Firms with large size can increase market power in determining higher prices or generating profits. Vennet (1996) studied the impact of mergers on the efficiency of European Union banking industry by using some key financial ratios and stochastic frontier analysis for the period 1988-93 and found that merger improve the efficiency of participating banks. Akhavein et.al (1997) examined the price and efficiency effect of mega mergers on US banking industry and found that after merger banks have experienced higher level of profit efficiency than before merger.

Merger Decreased Efficiency

Although a merger can help a bank grow larger or become more diversified, the majority of banking cost studies suggest that neither transformation will significantly reduce costs at most banks. Most studies of scale economies find only modest savings that are fully exploited by the 3 time a bank has $100 to $200 million in assets, followed eventually by slight scale diseconomies as the bank grows larger. Studies of scope economies find little evidence that offering a wide range 4 of products gives a bank a cost advantage over its less diversified rivals. Avkiran (1999) analysed four cases of banks mergers in Australia. Though acquiring banks were more efficient than target banks, the acquiring bank did not always maintain its pre-merger efficiency. Hence, the role of mergers in efficiency gains was not necessary positive.

Shih (2003) contended that merging failing banks is likely to create banks more likely to fail than the predecessor banks but merging relatively healthy banks is likely to create banks less likely to fail. During the 1997-1998 Asian economic crisis, policy makers were likely to take interventionist measures, such as encouraging or forcing banks to merge. Government has exposed the vulnerabilities of the small banking institutions and the need for these institutions to maintain a high level of capital. Furthermore, given the fact that much of the required financing in Malaysia was intermediated through the banking system, the risk associated with cyclical downturn in the economy would be much concentrated in the banking system. In order to minimize the potential impact of systemic risks on the banking sector as a whole, following the deepening of the financial crisis, the Government took stronger measurers to promote (force) merging of banking institutions. Subsequently, ten banking groups were formed. The ten banking groups or anchor banks are: Malayan Banking Berhad, RHB Bank Berhad, Public Bank Berhad, Bumiputra-Commerce Bank Berhad, Multi-Purpose Bank Berhad, Hong Leong Bank Berhad, Perwira Affin Bank Berhad, Arab-Malaysian Bank Berhad, Southern Bank Berhad and EON Bank Berhad. Each bank had minimum shareholders funds of RM2 billion and asset base of at least RM25 billion. In this situation, bank mergers would likely create even weaker banks and worsen the banking sector crisis. Rezitis (2008) used a Generalized Malmquist productivity index on five merged banks in Greek and concluded that banks that participated in merging activity experienced a decline in technical efficiency and in total factor productivity. Hence, merged banks did not experience an improvement in performance. In India, guided by the central bank, most of the weak banks are being merged with healthy banks in order to avoid financial distress and to protect the interests of depositors. Hence the motivation behind the mergers may not be increase in operating efficiency of banks but to prevent financial distress of weak banks. Hence it is not examine the long term performance and efficiency gains from bank mergers.

Conclusion that can be made here is that merger depends on the economic situation and financial performance of banks. Nevertheless, the acquiring banks did not always maintain their premerger efficiency levels. Inefficiencies grew during the first
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post-merger year but the results were inconclusive during the subsequent post-merger years. Merger-related efficiencies are taken into account in all the competition policies reviewed but in different ways. A comparison demonstrates that most diversities concerning efficiency defense are based on different legal, procedural and institutional approaches. Besides, there are also similarities in considering cost savings due to mergers. In all competition laws, efficiencies are contemplated in indefinite terms in order to have leeway for the diverse forms of cost savings. But the three competition policies differ regarding the scope of accepted efficiencies.

References Afza T. (2012), The Impact of mergers on efficiency of banks in Pakistan . Sufian. (2004), The Efficiency Effects of Bank Mergers and Acquisitions in a

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Journal of Financial Management, pg 9158-9163. 2) Development Economy: Evidence from Malaysia. International Journal of Applied Econometrics and Quantitative Studies, pg 53-74. 3) Naseer A. Do Bank mergers lead to efficiency gains? The Case Study of bank Sufian, F. (2006), The Efficiency Effects of Bank Mergers and Acquisitions: A Pardeep Kaur. (2010), Impact of Mergers on the Cost Efficiency of Indian mergers in Pakistan. Working Paper, pg 1-7. 4) Non-Stochastic Window Event Analysis Approach. Journal of Economic, pg 1-37. 5) Commercial Banks. Journal of Business and Economics, pg 27-50.