Economic subjects | Finance » Tamás Kocsis - Mergers and Acquisitions in the European Unions Banking sector and their effects on the current Global Financial Crysis


Year, pagecount:2009, 56 page(s)



Uploaded:December 10, 2011

Size:228 KB

[BGE] Budapest Business School



Download in PDF:Please log in!


No comments yet. You can be the first!

Content extract

http://www.doksihu BUDAPEST BUSINESS SCHOOL FACULTY OF INTERNATIONAL MANAGEMENT AND BUSINESS INTERNATIONAL BUSINESS ECONOMICS COURSE Foreign economic enterprises specialization AVANS HOGESCHOOL INTERNATIONAL BUSINESS SCHOOL BREDA Faculty of International Management and Business Mergers and Acquisitions in the European Unions Banking sector and their effects on the current Global Financial Crisis School Mentor: Dr. Marinovich Endre Prepared by: Tamás Kocsis December, 2009 http://www.doksihu Executive Summary To render a comprehensive overview on the European merger activity in the financial sector and its linkage with current crises I needed to clarify the major topics like the rationale for mergers and their effect on the company’s performance. Then I extended these impacts for the economy as a whole and argued their beneficial results. I also implied the limitations of merger performance evaluations by exhibiting the outcome and event studies in this question. As the reader

shall see in later chapters it is quite difficult to evaluate these mergers, in fact it is underpinned that in most of the cases they do not deliver any value to the company. Then why do they occur? How can we control them? Do the regulators have all tools to curb the major market players? After discussing the basic economic effects of mergers I devoted a chapter for European Competition Policy which embraces Merger Control as well and attempted to answer the above mentioned questions. In this chapter I have tried to show the tools that competition authorites have on display to impede uneconomic mergers. By demonstrating two significant landmark cases in European Merger Policy I highlighted the development of merger performance evaluation and some controversies between the rulings of the European Courct of Justice and the Commission. Then I narrowed down the subject, exhibited the characteristics of bank mergers and evaluated post-merger performance by means of reliable literature and

researches in this topic. Mergers in the financial industry have further peculiarities and are providing a ‘hot issue’ with regard to the Global and European economic situation. This field includes lot of topics starting with market distortion through European Merger Control, managerial rewards and ending with the emergence of universal banks. All these factors played a significant role in the eruption of the crisis. I am striving to exhibit them with comprehensive examples and explaining why they served as the catalysts of the financial crisis. Regarding to this topic some interesting questions emerged: why did not we see the cautionary signs of the crisis? If we had seen them what would have been the necessary steps to prevent the crisis? On which extent do we need to expand the competence of the regulators? At the end of the report I am going to discuss the severe effects of the crisis on the European deal performance and try to explicate the anticipated reforms in the Banking

Industry. The European Bank packages and their effects on the Financial Services sector are also presented from another point of view than we got used to it because I concentrated on the controversial http://www.doksihu issues they raised during their implementation while in the same time I will not doubt the importance of these packages. By means of the latest reports available I am going to assess the magnitude of the crisis on the sector by comparing the results with earlier trends. Based on these reports and the and the political environment that sorrounds the financial sector I will provide some projections about how the future of banking will look like. I attempted to answer on all of the above mentioned questions by using the comprehensive literature written by such professionally recognized economists like Jose Padilla, Massimo Motta and the Swedish Lars-Hendrik Röller. Beside these literatures I also relied on the latest reports released by acknowledged companies like

PricewaterhouseCoopers and the Merrill Corporation. http://www.doksihu Table of content Executive Summary.4 1. Introduction 7 2. The Welfare effects from mergers8 2.1 Anti-competitive Effects 8 2.2 Efficiency gains from mergers10 2.11Rationalization of production 11 2.12 Economies of scale and scope 12 2.13 Technological progress 12 2.24 Purchasing economies 13 2.25 X-inefficiency 14 3. Right welfare standard 14 4. Merger Performance 17 4.1 Outcome studies18 4.11 Effects of mergers on productive and dynamic efficiency18 4.12 Effects of mergers on consumer welfare19 4.2 Event Studies 20 4.21 Effects of mergers on share prices 20 4.22 Additional conclusions to Empirical Research23 5. Merger policy in the EU 24 5.1 Competition Policy in the EU24 5.22 Merger Policy in the EU 26 5.3 Landmark cases concerning Merger Policy28 5.31 Airtours/ First Choice29 5.32 Lagardère/ Natexis/ VUP 30 6. Mergers and acquisitions in the European bank sector 32 6.1 Main characteristics of M&As in the

banking sector 32 6.2 Post-merger bank performance34 6.3 Special topic: Executive Compensation and mergers.39 7. The effects of the global financial crises on M&As 41 7.1 Characteristics of the European M&A activity in 2009 42 7.11 Financial Sector 44 7.2 Controversies of European Bank Rescue Packages 45 7.3 The future of banking 48 8. General Conclusions 53 Bibliography .55 http://www.doksihu 1. Introduction In business there is one simple rule: grow or die. In a company there is no standstill position, a firm should always develop either by using the newest technology on the market, cutting its unnescessary costs, invest more money in marketing or by improving its market share by acquring other firms. Companies who can not keep the pace with the others will fall behind by stagnating, loosing market share and customers and destroying shareholder value. They are going to be the perfect targets for bigger companies who are looking for quick growth which creates the rationale

for mergers on the different markets. We need to note that mergers and acquisitions are also “vital part any healthy economy and importantly, the primary way that companies are able to provide returns to owners and investors. This fact combined with the potential for large returns make acquisition a highly attractive way for entrepreneurs and owners to capitalize on the value created in a company.” (Sherman 2006) First of all I would like to introduce the efficiency factors that are making M&As so attractive for companies. After reading the first chapter it will be quite obvious that it is rather difficult to exploit these efficiences or synergies. The study is discribing the anti-competitive effects that are stemming from mergers and the competition policy instruments with which the authorities can control them. The development in merger control during the ’90-ies till the reform the first big reform in 2004 are providing an interesting topic from the merger performence

evaluation point of view. The introduction of the economic effects and policy issues are all entailing the better understandig of bank mergers and their connection of the current financial crisis which topic serves as the trigger of this study. After going through this report the reader shall become familiar with the interconnectivity of the emergence of universal or cross-border banks and the crisis. During the construction of the report I bumped into some other intresting subjects that are linked to the Banking Sector such as managerial hubris and executive compensation. I also devoted some sections for these topics since they are indirectly engendered the current economic situation. Bank packages that were ought to draw out the sector from the crisis also raised some controverisal issues on the basis of market distortion and sometimes thay are also clashing with the existing competition law which need to be reformed after 2004 again. Regulators have big responsibilty in this issue

since they have to ensure that the system will not compromise a future failure. The difficulty of their job is that they need to find the http://www.doksihu balance between affordable control and free movement of capital. This raises some questions about how the future banking system will look like. 2. The Welfare effects from mergers According to Williamsons’ “trade-off” model (1968) in which he collated the anticompetitive effect of a horizontal merger with the internal efficiences that are created by that merger it was concluded that small internal efficiences could offset the anti-competitive effects of a merger. I would like to to start this study with an explanation about the likeliness of the occurance of these anti-competitve effects and which possible efficiencies may be generated by mergers that may compensate for these anti-competitive effects. 2.1 Anti-competitive Effects Anti-competitive effects are on the top of competition authoroties’ list of concerns.

Regerding to this a comparison should be taken between the different effects of a merger on competition. On one hand a merger can distort competition be means of the creation of a dominant power on the market while on the other hand it can also result the increased likeliness of collusion between the players of that particular industry. Both of the above mentioned effects can entail increased consumer prices. In case of a merger between two or more firms, depending on the size of the firms, may cause a unilateral augmentation or emergence of substatial market power. According to the Market Power Handbook, market power by definition means “the ability of a firm or a group of firms to profitably charge prices above the competitive level for a sustained period of time”. (ABA 2005) Relying on the horizontal merger theory which states that before the merger effective competition withholds the market power of each firm in the market, we must see that a horizontal merger decreases the

number of competing firms on the market. This is the reason why is the loss of competition is considered to be the most decisive damage of mergers. The rational reaction of a consumer in case of a price increase is that he/she swithches to one of the competitors since the consumer’s choice have been shrink by the merger it distorts the consmer’s options. In relation with this after the price raise some demand will flow to the remaining competitors who will also find it profitable to enhance their prices. http://www.doksihu This explanation is underpinned by the oligopoly theory as well. Pre-merger firms are setting their prices and calculating their outputs independently of their competitors. But “after the merger, the merged firms maximize their joint profits, and thereby take into account the detrimental effect of quantity increases or price cuts on the market share of each others’ products”. (Röller [2000]) Thank to new market power conditions of the merged firm, it

will be able to increase the price while it ignores its competitors price level and may restrict outputs. Taking all these possibilities into account Padilla concluded that this behaviour leads to allocative inefficiency because a market outcome is allocatively efficient when the price is set equal to the marginal cost of production. (Padilla [2005]) As I have mentioned the coordinated effects of mergers may also enhance the risk of collusion. The retionale behind this hypothesis is coming from the assumption that the redution in the number of firms stimulates collusion because “the lower the lower the number of firms in the market, the higher the scope for collusion and the more likely that firms will charge higher prices”. (Motta [2004] p 251) Setting the price above the competition level is the most common form of coordination next to limited production or the division of the market. The impact of these effects on market price increases is relying on several factors. There is no

trigger for a merged firm to raise prices when: competitors with similar products are present, the likelihood of new market players is high, strong buyers have countervailing bargaining power; or one of the merging firms is failing. (Röller [2000]) The reader shall see the two-sided effect of price enhancement is illustrated in figure 1 which indicates the welfare effects of mergers below. This is the same approach that Williamson applied in his “trade-off” model. In the pre-merger state of the market “in a homogenous goods market where unit costs are constant, the competitive price P1 is equal to average cost (“AC”) in a long-run equilibrium”. We need to add here the following: if prior to the merger the firm already had market power P1 would already have been above AC. Since post-merger the market power grows as a result of that the price increases to a new level (P2). As a consequence of this process the price increase implicates its distributional effect in the form

of wealth transfer between consumers and producers. In later sections the study will shed light on the evaluation of this effect since, as we will see, entirely depends on the applied welfare standard. http://www.doksihu Following the same path “an increase in price above AC causes an allocative inefficiency, the dead-weight loss (C). As can be derived from figure 1, the analysis does not end at this point A decrease in the average cost of production from AC1 to AC2 leads to an increase in productive efficiency. This increase in productive efficiency (A) needs to be traded off against the net losses from reduced consumption (C).” Figure 1. Welfare effects of a merger (Ilzkovitz [2003] p 59) Source: Ilzkovitz, F. & Meiklejohn, R (2003) European Merger Control: Do We Need an Efficiency Defence? Journal of Industry, Competition and Trade, 3:1/2, p. 591 2.2 Efficiency gains from mergers As we have seen there are coupple of factors that can effect the outcome of the merger. In

this chapter I am going to discuss rationales for mergers that are stemming from efficieny gains that a merger can offer for the parties. Efficiencies from a horizontal merger can arise from various factors. A horizontal merger may support the effectiveness of the distribution channels which would most likely reduce the costs of the company. This fact is beneficial for the consumers since the price of the product would also decrease. When mergers occur the two firms inherit each others know-how and 1 Cited in: Kamerbeek, Sjoerd (2009). Merger Performance and Efficiences in Horizontal Merger Policy in the US and the EU; p. 26; Utrecht june, 2009 http://www.doksihu developments which would create further incentives for further research and development or savings from purchasing economies. The reader shall see below the further efficiencies that may arise from mergers and are based on the categorization used in the literature on the productivity measurement of mergers: 1.

Rationalization of production 2. Economies of scale an scope 3. Technological progress 4. Purchasing econommies 5. X-inefficiency These efficiencies are stemming from basic economic theory. The positive effects of the above mentioned efficiencies are differing merger by merger. They affected by many factors such as the size of the merging firms, the intensity of the competition. (Röller [2000]) 2.11Rationalization of production The rationalization of production between the merging firms is the most common motives. These non-synergies allow output or cost adjusments that would not be possible otherwise. “A no-synergies merger is one in which the merged entity’s outputs, prices and total costs were feasible for the parties pre-merger, with different competitive behavior but without deep changes in production”. One substantial category of “no-synergies” efficiencies is the “rationalization” of output among the facilities of the merging firms. The Horizontal Merger

Guidelines published by the Antitrust Division and the Federal Trade Commission explicitly speak of “shifting production among facilities formerly owned separately, enabling the merging firms to reduce the marginal cost of production”(further MC). (Farrell [2000] p 10) Differences in MC may stem from a variety of sources. The two firms may differ in the amount of physical capital or may have asymmetrical capacity constraints.16 Furthermore, one of the firms could have an inherent competitive advantage, due to a patent or other superior knowledge. If these two firms merge, rationalization can occur by the transfer of production from the plant with higher MC to the plant with lower MC. Production levels across the plants will be optimally allocated, if MC is equal at all plants. This rationalization could even lead to the extreme case of shutting down production at the plant, which produces http://www.doksihu at a higher MC for all relevant production levels. By rationalization,

costs savings are realized without changing the firms joint production capabilities. Clearly, rationalization has a positive effect on productive efficiency. The Guidelines state that such efficiences are more likely occur than some others since the time allocation of them are rather quickly. 2.12 Economies of scale and scope Comparing it to rationalization of production, economies of scale in the production enable the joint production possibilites of the firm after the merger. A firm can benefit from ecomoies of scale when its average cost decreases while its output increases. In practice ths would mean that post-merger both firms has certain fixed costs that do not increase as total output increases. Even if production is minimal the firm will have some expenditure on inevitable operations or with other words on indivisible costs such as the purchasing of materials, billing of customers, marketing and human resources. Obviously before the merger these costs were treated separately

but after the merger the firm will be able to imply these costs over the larger combined output. This is how the duplication of fixed costs is avoided by the merger These economies of scale can be achieved quite quickly in the short-run. (Röller [2000]) In the long-run, by means of the combination of the assets economies of scale could become more effective. Previously independent investments in physical capital can be coordinated postmerger which could lower MC by the attainment of superior technology or through specialization. Economies of scope are achieved when the cost of production of two products together is lower than the sum of the cost of producing these two products separately. For example, a common input is required to produce both products. If the above mentioned ideal state of the firm will become practice the post-merger company will be able to lower the cost of production which will lead to productive efficiency. 2.13 Technological progress In today’s fast growing

economies and in the times of the informational revolution it is also a significant to keep the pace with market. The know-how of one firm could be prevail for another one. Spread of know-how across the merging parties may also entail productive efficiency improvements. It the merging parties are at a different level in terms of http://www.doksihu technological or administrative facilities, technological progress can be stimulated by sharing knowledge and skills. This diffusion can be either one-way or twoway One-way diffusion occurs when the firm with inferior know-how learns and adopts all skills from the partner with superior know-how. Two-way diffusion is possible when the merging parties are able to combine complementary assets and skills to improve technological progress. (Röller [2000]) Moreover a merger can be influential on dynamic efficiency. The merger may alter the incentives to engage in costly R&D. Besides the economies of scale that can be attained in R&D

expenditures, the merger could help to internalize some of the benefits from R&D among the merging firms, and thereby creating an increased incentive for R&D. (Röller [2000].) Röller who devoted several researches to this topic expects this effect because a horizontal merger reduces the number of market players through the fromation of a new company from former cmpetitors. I would like to exhibit the importance of technology with an up-to-date example: the German car manufacture Opel which is in the possession of the American GM that went through harsh times during the financial crisis that is why the sale of Opel emerged as an option for them. The Chinese Beijing Auto was among the possible buyers but the German were afraid of that the Chine expansion focuses only on the exploitation and the know-how of Opel that was developed through decades. With this takeover Beijing Auto could have attain valuable competitive advantage on the market without any expense on R&D. The

offer was finally rejected by GM because they realized the fact that the transaction would result more harmful on their business than the capital they could have gained on it. 2.24 Purchasing economies The next factor is the emergence of purchasing economies which can be the offspring of increased bargaining power. If upstream suppliers use two-part tariffs, consisting of a fixed fee and a price per unit, the merger allows the merged firm to devide the fixed fee between the combined amount of supplies. This decreases the average price for their goods Furthermore, if the merger increases the bargaining power of the merged firm, quantity discounts may be negotiated with the upstream suppliers. We need to add here, however, that if the merged firm will have substantial bargaining power after the merger and there is little bargaining power on http://www.doksihu the side of the upstream supplier, this could have significant anti-competitive effects. Finally, a merger may lead to a lower

cost of capital. These purchasing economies have both redistributive and real cost reducing effects.Therefore purchasing economies affect both allocative and productive efficiency. (Röller [2000]) 2.25 X-inefficiency In the corporate world management is in control of the firm while the shareholders ar the owners of the company. Such separation in the power structure could lead to X-inefficiency This phenomenon stems from the fact that there is difference between the goals os the shareholders and the management. The first wants to maximize the profit of the company while the goal of the latter could diverge from profit maximization such as personal ambitions to keep the power, to become the chief executive of a big company or to avoid fire excess personnel. This problem could be cured or allayed by the implementation of a profit maximizing system but some other economists like Manne and Marris ague that the market for corporate control will solve this principal-agent problem. (Manne

[1965]) They argue the x-inefficiency decreases the firm’s share price which creates an option for other firms to take over the company and reorganize the company. The threat of take-over puts pressure on the management to maximize profits and thus creates incentives to avoid Xinefficiencies. Nonetheless it is questionable whether this take-over risk credible since takeovers are very costly and therefore may only be occur in case of severe mismanagement (Ilkovitz [2003].) 3. Right welfare standard In the last chapter I indicated the anti-competitive and efficiency effects that may arise from a merger. I have explained these effects by means of figure 1 on page 8 Thank to increased market power the post-merger firm is able to set the price above cost, indeed producing an allocative inefficiency (area C, figure 1.) Thus the price increase results a transfer of wealth to the producer (area B). As consequence of this consumers are worse off because they have to pay more for the goods.

As I have already explicated internal efficiencies may lower the average cost of production and thereby generate an increase in producer surplus which is displayed as area “A”. Total welfare is reached experienced http://www.doksihu The previous two sections described both the anti-competitive and efficiency effects that may arise from a merger. I have illustrated both of these effects in figure 1 Due to increased market power the merged firm is able to raise price above cost, thus yielding an allocative inefficiency. This is shown by area C In addition, the rise in price leads to a transfer of consumer wealth to the producer (B). Consumers are worse off because they have to pay a higher price for the products. The internal efficiencies described above may lower the average cost of production, and thereby generate an increase in producer surplus. Total welfare of may emerge if the sum of producer and consumer surplus, increases or decreases, depending on the relative sizes of

area C and A. If the efficiency effect (A) is larger than the dead-weight loss (C), total welfare will increase. Williamson is arguing that a merger should be allowed, provided that the productive efficiency gain, which is a real resource gain, exceeded the deadweight loss. (Williamson [1968]) According to Röller the magnitude of the efficiency effect that need to recoup the losses from the increased price is defined by degree of competition, both before and after the merger. “The size of the efficiency effect depends on the industry output. The size of the losses from the increased price depends on the price-cost margin.” (Röller [2000] p 30) Assuming that both the expected cost reduction and the expected output reduction are known, the expected welfare gains and losses from the merger can be calculated as the fraction premerger mark-up price divided by the costs times the expected output reduction would be approximately equal to the welfare losses from the merger. The fact that

Williamson’ approach is based on the hypothesis that all firms in the industry are participating in the merger reduces the applicability of his analysis by the evaluating proposed mergers. (Padilla [2005]) Röller also has some doubts with Williamson’s arguments: “in practice only a few firms in the industry will participate in the merger, and there will be some form of competition before and after the merger”. Since there is couple of competition models the authorities should always apply the correct one on the particular merger they need to investigate. (Röller [2000].) Röller discovered that the regulators have difficult task in finding the right competition model because they are not always able to attain the necessary information about the market they need to investigate. Furthermore he pointed out another limitation of the Williamson model: it “only evaluates the effects of a merger in one market; it does not evaluate possible efficiency effects that the merger may

have in other markets.” (Röller [2000] p 30) http://www.doksihu In addition to this to exhibit the rationale for the proposed merger, it is of interest for the merging firms to claim as high efficiencies as possible and thus the regulators need to investigate these claims very critically. As the Williamson model relies on the pre-merger assessment of the anticipated cost and output reduction it may not be useful in regulatory evaluations. Indeed these two pre-merger factors are hardly predictable Despite all of these limitations of the Williamson model it is still valuable from the point of view that it argues for the application of a total welfare approach in merger analysis. The effect of mergers on allocative, productive and dynamic efficiency is not likely to occur, especially not in the same direction or with same magnitude. Consequently competition authorities are often bumping into complex economic trade-offs. Most economists are on a common denominator concerning that the

effects of a merger on all three types of efficiency can only be taken as a basis of merger analysis when a total welfare standard is applied, under which “the effects of a merger on both consumer welfare and industry profits receive consideration”. (Röller [2000] p 30) Jose Padilla was the first who shed light on the main difference between a total welfare and the consumer welfare standard lies in the treatment of efficiencies. The main characteristic of consumer welfare standard that it brings competitive, or price effects of mergers into prominence. A merger could be submitted by the authorities even if it raises price but the aggregate benefit to consumers is positive since it increased the quality of the product. (Renckens [2007].) In consumer welfare standard only those efficiencies are permitted that benefit consumers through lower prices. The transfer of wealth from consumers to producers (area B in figure 1) is considered as negative. Thus, a merger will only be allowed

if the efficiency effect (area A) is larger than both areas B and C in figure 1. In comparison to this a total welfare standard is not affected by the distributional effect of the merger. It does not take into accountthe distributional effect of the merger (area B). Consequently the total welfare standard allows a merger even if it raises price after the merger. Some economists have attained the viewpoint that the total welfare standard should be applied in merger analysis because it is very difficult to evaluate the redistributive effects of a merger prior to the deal. (De la Mano [2002]) On the other hand Heyer indicated the contradiction of consumer and producer surplus. His argument was that “in a sense an economy’s producers are consumers as well, although consumers of products they do not produce themselves. (Heyer [2006]) http://www.doksihu Padilla underpinned Heyer’s conclusion by stating that we should not prioritize consumer surplus over producer surplus since it is

“unclear why a merger criterion that embraces not only efficiency but also distributive justice should be biased by construction in favor of consumers.” (Padilla [2005] p 27) In opposition with Padilla and Heyer, Fridolfsson is reasoning in favor of the consumer welfare standard because the application of it would be easier for the regulators. (Fridolfsson [2005].) The importance of the chosen welfare standard is relying in its influence on the merger analysis. The magnitude of the decisions of competition authorities is depending on the welfare standard as well. If the regulators are pro-consumer then they will take the efficiencies into account less strong than in a total welfare standard. This dilemma occurs everytime when competition authorities are facing a merger case. In the fifth chapter I am going to give an overview about the ruling competition policy of the European Union and also going to provide examples on contradictory decisions that changed the approach of merger

analysis but first. In the nex chapter I will discuss the the empirical evidence on the performance of mergers. 4. Merger Performance In earlier sections of this report I summarized the most important efficiency gains that could be arose from mergers. In this chapter I am going to evaluate the empirical evidences on the performance of merger whether in practice efficiences are generated by merger. Two major types of studies are evaluating merger performance: event studies and outcome studies. Financial economists appreciate mergers as a “market process of allocating scarce resources to their most effective use”. (Tichy [2001] p347) To prove this hypothesis financial economists have chosen the method of investigating the abnormal reaction of share prices around the announcement of a merger. This method of research is called ‘event studies’. If their assumption is proved to be correct and stock market is efficient then the share prices would reflect “the present value of

future profits generated by the firms”. (Duso [2006] p 1) On the other hand there are the industrial organizational economists who are much more skeptical conrerning the ability of the market to correctly anticipate mergers’ competitive effects. They research the firms’ economic performance and measure the (accounting) profits http://www.doksihu of the merging entities before and after the merger. These studies are called “outcome studies”. In this chapter I will exhibit the outcome studies concerning the connection between the mergers and productive efficiency and consumer welfare. Furthermore I will show the effects of mergers on share prices as an event study. 4.1 Outcome studies 4.11 Effects of mergers on productive and dynamic efficiency Not many studies have addressed this subject, but according to Schenk bank mergers show that mergers at best lead to very little improvements in productive efficiency. (Schenk [2006].) In fact, a comprehensive research with a sample

of 57 U.S banking mergers by Berger and Humphrey revealed some significant conclusions concerning the effect of a merger on productive efficiency. During the period of 1981 and 1989 the calculations tended to show that on average the mergers were failed to improve productive efficiency and because of diseconomies of scale the performance of the post-merger financial institutions even decreased on average. What we can conclude from these results is there do exist some very successful mergers as well as some very unsuccessful ones. (Berger & Humphrey [1992]) Akhavein along with Berger and Humphrey investigated another field of mergers: the effect of large mergers on efficiency and prices. In their study they indicated that bank mergers can potentially increase X-efficiency. They came to this conclusion because banks in their sample had 20-25% higher costs in comparison with the best-practice banks this is why a possible efficiency transfer could bring us to X-efficiency

improvements. These threes researchers were pioneers on the field of efficiency observations. Furthermore they were the first on who made a distinction between internal efficiency and profit efficiency. Profit efficiency concentrates the cost and revenue effects of the choice of the output indeed it provides more in-depth analysis about these factors. They doubted the hypothesis that banks by means of mergers may be able to enhance profit efficiency simply by superior product combinations. Based on their findings they pointed out that merged banks experience a 16% growth in profit efficiency relative to other large banks. (Akhavein [1997]) http://www.doksihu These outcome studies showed that the effect of mergers on productivity tends to show a little or negeative trends in production efficiency. However we cannot draw the conclusion that mergers have rather little effect on productive efficiency since the sample was not large enough to state that. Although, on average, mergers do

not improve productive efficiency there are some counterexamples for successful mergers and I also have to add that there is a great variance in the results. In addition the studies of Akhavein, Berger and Humphry were observing the banking sector so we are also not allowed to draw conclusion outside of the banking sector. On the other hand if one important thing could be conclude from these studies is that efficiency gains from every merger should be observed on a case-by-case basis. 4.12 Effects of mergers on consumer welfare As I have discussed before in case of a merger synergies between the two firms can enhance the productivity of the post-merger firm. Albeit in practice practice it turned out that these snyergies rarely occur. “By definition, a synergy will not be achieved by one firm unilaterally without the merger. Of course, this does not conclude the enquiry into merger-specificity, because there could be a less restrictive alternative form of cooperation or trade between

the firms (or trade with other willing partners).” (Farrell [2000] p 10) So we should make a clear distinction between non-synergy and synergy mergers. The first one means only the consolidation of the once separate operations while the latter is the actual improvement, development of the production to become more effective. According to Shapiro a merger with synergy is more beneficial for the consumers because inderctly it also affects the price of the outputs. In practice unfortunately the real driving force of mergers are usually non-synergy mergers. Non-synery mergers also have the “feature” that they merger-specific when the parties posses market power so they are then unlikely to benefit consumers. Shapiro also observed firms that merged but they were lack of market power. In this case there were more need for seeking for efficiency so we can conclude that firms without market power and firms that do not directly compete with each other, should often find it less difficult

to achieve synergies. There is an exceptional situation in favour for synergies between firms possessing relevant market shares “if the market shares are sticky, firms that are initially very small may http://www.doksihu have much less chance to grow to efficient scale than firms that start out fairly large.” (Farrell [2000] p. 28) In a 1990 article Farrell proved that only quite high reductions in the in marginal cost are required for a merger in order to lower rather than raise prices. In his study Farrell observed two companies with each having a 20% market share, in a unit-elastic market, “the price will rise unless economies of scale strong enough that doubling all inputs yields at least 2.4 the output”. (Farrell [2000] p 28) Others like Hausman and Leonard came to the same conclusion as Farrell; they offer a numerical example in which a merger between a brand of 50% market share and a brand with a 5% market share, which leads to a 10% reduction in marginal costs for

both merging brands, generates consumer benefits. From these studies only one conclusion can be drawn which is the following: only substantial economies of scale or other synergies are required for significant mergers to produce developments in consumer surplus. (Farrell [2000]) 4.2 Event Studies 4.21 Effects of mergers on share prices Event studies are focusing on the abnormal reaction of the share prices of the merging firms around the announcement of the merger. This methodology assumes that capital markets are efficient and therefore are able to correctly anticipate mergers’ competitive effects. Jensen and Ruback observed a 25 years long period (1956-1981) by means of event studies. According to their findings they concluded that around the announcement of the merger , target’s share prices increased by 20-30%. (Jensen and Ruback [1983]) If we are comparing it with the variance in share prices of a non-merging group, this amount of variance between the share prices was

abnormal. The period under scrutiny showed less positive effects in terms of abnormal price changes on the bidder’s share: four percent for tender offers and zero percent for mergers. These results would indicate a positive postmerger total return as the target’s share prices are growing while the bidder’s share prices stay unchanged. However Jensen and Ruback avoided this type of classification since in most of http://www.doksihu the cases the bidding firm tend to be larger than the target firms. Therefore a small percentage decrease to bidders may be larger in absolute value than large percentage increase to targets. Other economists like Bradley, Desai and Kim surveyed with a sample of 263 successful tender offers between 1963 and 1984. The share prices of the targets increased by 32% on average while they found that bidders realize a small increase of about one to two percent. However it turned out from their study that these small gains decreased at the end of the 1970s

and turned into negative in the 1980s. (Tichy [2001]) On the other hand the combined gains resulted 7% in favor for the merger. This study was a milestone on the field of event studies because it was the first which was statistically significant. Even larger gains were found by Stulz, Walking and Song who found a significant gain of about 11%. (Stulz [1990]) Opposition to this Schenk found that in case of 110 very large acquisitions bidder’s abnormal returns tended to decrease. Between 1993 and 2001 his research showed that the shrink of the returns lied between -3,4% and -8.5% Another peculiarity of the study was the role of the observation time: “when the abnormal returns are measured over a longer period after the announcement of the merger, returns to bidders tend to decrease”2. (Schenk[2006]) Schenk’s observations seemed to be underpinned by another researcher who gathered 32 event studies and investigated the abnormal returns as well. Tichy applied event studies with

different observation windows and came to the conclusion that returns to bidders decrease in the long-term. His research contests the efficient market hypothesis, since it states that, in the short-run, capital markets are unable to correctly predict merger performance. Therefore share prices may not correctly represent future profits. (Shiller [1984] ) 2 Cited in: Kamerbeek, Sjoerd (2009). Merger Performance and Efficiences in Horizontal Merger Policy in the US and the EU; p. 26; Utrecht june, 2009 http://www.doksihu Figure 2. Decreasing long run run returns to bidders Source: Tichy, Gunther (2001). What Do We Know about Success and Failure of Mergers? Journal of Industry, Competition and Trade, 1(4),p. 3533 All of the above mentioned event studies are based on the wide-spread assumption that capital markets are efficient. Indeed we need to treat these empirical literatures on the effects of mergers on share prices prudentially since studies on the on the effects of mergers on

share prices of the merging firms do not make difference between the market power effect and the efficiency effect of mergers. Eckbo applied a different approach on this field He intended to observe the effect of a merger on competitors’ share prices. As an explanation on this viewpoint his argument was that mergers motivated by market power increases are beneficial for competitors because these will be able to enhance output and increase prices slightly. In sharp comparison to this mergers inspired by efficiencies will distort competitors interests since they it will lower their competitiveness relative to the merged firm. (Eckbo [1983]) 3 Cited in: Kamerbeek, Sjoerd (2009). Merger Performance and Efficiences in Horizontal Merger Policy in the US and the EU; p. 26; Utrecht june, 2009 http://www.doksihu In addition to this we need to note here that the empirical evidence on competitors share prices is unconvincing since most of the studies found only insignificant or modest

effects. (Röller [2000].) To summarize the effects of mergers on share prices according to the above mentioned event studies: targets gain abnormal returns of around 20-30%, bidders gain slightly in the short-run but face negative returns in the long-run. All in all the effects of mergers on share prices are indicating positive performance changes, but further investigations are needed to ensure the effects stemming from efficiency and increased market power. 4.22 Additional conclusions to Empirical Research Beside the above mentioned conclusions that can be drawn from empirical research. Economists came across some important factors that can affect merger performance. If we just take Scherer and Ravenscraft who found that horizontal mergers are significantly more profitable than vertical mergers. Conglomerate mergers have the highest chance of failure They also conclude that the success of the mergers is highly depends on the relatedness of the activities of the merging firms.

(Ravenscraft [1988]) Generally speaking these empirical evidences indicate that mergers between firms with similar products or markets tend to be more successful. Another explanation for the fact that horizontal mergers are more profitable than conglomerate mergers may be that horizontal mergers create larger opportunities for market dominance. Furthermore the success of a merger also depends on the means of finance. Most of the studies carried out in this topic showed that mergers paid for in cash are likely to perform better than mergers via stock exchanges. In addition, mergers of equal size are less successful relative to mergers in which the bidder is considerable larger than the target. (Schenk [2006]) Finally, merger experience is not a guarantee (but without doubt an advantage) for a higher chance of success than would be the case for a first acquisition. These elements determine the success of a merger and therefore should be taken into account by the competition authorities

in their assessment of proposed mergers. However the authorities should also be very reluctant to approve a merger that creates significant market power, solely based on efficiency considerations. Thus the scope to assess efficiencies should http://www.doksihu be small and the standard of proof should be high, since in practice efficiencies are often not generated by a merger. 5. Merger policy in the EU In this chapter I am going to introduce the merger policy of the EU which is basically included in the Competition Policy. To attain a better overview about this broad topic I will start with the development of the policy. Further on I will discuss the importance of competition law and close this chapter by exhibiting the some significant landmark cases which shaped competition policy during the years. 5.1 Competition Policy in the EU In 1952 the Treaty of Rome established the foundations of competition policy in Europe. In contrast, the USA established its competition policy only

at the end of the 1990s with the Sherman Act. The main goal of Competition policy on both continents is to assure the welfare of the citizens this is why it plays an important role in Europe and in the US. The competition authority in the European Union is the European Commission. The European Commission finds itself in a substantially different position to a national authority. In the first place, its institutional independence should not be in question. As reflected in the EU treaties, its independence from national and political interests is fundamental to its mission of promoting the ‘common interest’ of the European Union as a whole. The Commission is supported by the Directorate-General for Competition; they are the investigatory body of the Commission. (Horváth [2002]) After the Treaty of Rome the next remarkable step in the history of competition police was the introduction of the merger policy (this is going to be discussed in the next part of this chapter) in 1989 and

reformed in 2004. We also have to mention article 81 and 82 of the Treaty of Rome, which are responsible for the antitrust areas. Article 81 covers vide variety of behaviors among which the most obvious http://www.doksihu illegal example is the formation of cartels between the competitors. To be precise I would like to cite the official text from the Treaty: “The following shall be prohibited as incompatible with the common market: all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market, and in particular those which: (a) directly or indirectly fix purchase or selling prices or any other trading conditions; (b) limit or control production, markets, technical development, or investment; (c) share markets or sources of supply; (d) apply dissimilar conditions to

equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; (e) make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.” (TEEC [1952] Art 81) Article 82 serves as the completion of the antitrust regulations since it extends the effect of the policy on firms in dominant position and ensures they will not abuse this position. According to this law “any abuse by one or more undertakings of a dominant position within the common market or in a substantial part of it shall be prohibited as incompatible with the common market in so far as it may affect trade between Member States”. (TEEC [1952] Art 82.) Such abuse can stem from the following roots: (a) “directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions; (b) limiting production,

markets or technical development to the prejudice of consumers; (c) applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; (d) making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.” (TEEC [1952] Art 82) The Commission is empowered by the Treaty to apply these prohibition rules and enjoys a number of investigative powers to that end (e.g inspection in business and non business http://www.doksihu premises, written requests for information, etc). It may also impose fines on firms who violate EU antitrust rules. Since 1 May 2004, all national competition authorities are also empowered to apply fully the provisions of the Treaty in order to ensure that competition is not distorted or restricted. National courts may also apply these

prohibitions so as to protect the individual rights conferred to citizens by the Treaty. (EC website) Furthermore European Competition Policy also includes issues affected by liberalization. For this purpose Article 86 entrusted the Commission to carry out investigations concerning cases in which “public undertakings and undertakings to which Member States grant special or exclusive rights”. The Commission must "where necessary, address appropriate directives or decisions to Member States" which enact or "maintain in force any measure contrary to the rules contained in the Treaty. (TEEC [1952] Art 82) Last but not least state aids are also part of the policy. The main goal of State Aid Control is to ensure government interventions do not distort competition and the trade on the Single European Market. It also aims to ascertain that government intervention do not interfere with the smooth functioning of the internal market or harm the competitiveness of EU companies.

According to European Law state aid is defined as “an advantage in any form whatsoever conferred on a selective basis to undertakings by national public authorities”. (TEEC [1952] Art. 87) The corresponding article is Article 87 of the European Community Treaty State aids on the other hand exclude subsidies offered by governments which are obviously enhancing entrepreneur activities. The role of state aids in the crisis management will be discussed in the later chapters of this paper. 5.22 Merger Policy in the EU From this report’s point of view merger policy is far the most influential on takeovers that is why I would like to extract it on a more detailed way. As I have already mentioned the Merger Regulation part of the Competition Policy was established in 1989. It set up a “onestop shop where companies apply for regulatory clearance for mergers and acquisitions above certain worldwide and European turnover thresholds”. (Europa press release [2001] p1) In the scope of the

reformed Merger Regulation, adopted in 2004, was the introduction of flexibility into the investigation timeframes while setting the degree of predictability a level http://www.doksihu higher. It intensified the ‘one-stop shop’ concept, and clarified the substantive test so that the Commission now has the power to investigate all types of harmful scenarios in a merger, from dominance by a single firm to coordinated and non-coordinated effects in oligopolistic markets. (EC website) The 2004 Regulation also introduced a new streamlined referral system in order to put in place a more rational corrective mechanism of case allocation between the Commission and Member States. It ensured that the authority or authorities best placed to carry out a particular merger investigation should deal with the case. Amendments to the referral system have been complemented by a new Notice on the principles, criteria, and methodology upon which referral decisions should be based. A revised Notice

on a simplified procedure was adopted in 2005, further reducing regulatory burden on undertakings for certain concentrations that rarely, if ever, raise competition concerns. Furthermore, a set of best practices was adopted on the conduct of merger investigations to provide guidance for interested parties on the day-to-day conduct of European Commission merger control proceedings. These best practices were designed to streamline and make more transparent the investigation and decision-making process, ranging from issues of economic indicators to rights of the defense. The 2004 Merger Regulation was complemented by Guidelines on the assessment of horizontal mergers. These Guidelines set out the analytical approach the Commission takes in assessing the likely competitive impact of mergers and reflect the re-wording of the substantive test for the competitive assessment of mergers in the 2004 Merger Regulation. The objective was to provide guidance to companies and the legal community

alike as to which mergers may be challenged. The Guidelines explain the circumstances in which the Commission may identify competition concerns, but also provide clear quantitative indications as to when the Commission is unlikely to intervenefor example, when a merger results in market concentration levels below certain specified levels. They also set out the factors that may mitigate an initial concern that a merger is likely to harm competition and the conditions under which efficiency gains resulting from the merger will be taken into account. In addition, with the aim of providing guidance to undertakings, a 2001 Notice on remedies sets out the general principles applicable to remedies acceptable to the Commission in merger proceedings. The Notice describes the main types of commitments that have been accepted by http://www.doksihu the Commission, the specific requirements which proposals of commitments need to fulfil in both phases of the procedure, and the main requirements

for the implementation of commitments. Similarly, a 2005 Notice provides guidance on the interpretation of the notion of ancillary restraintsthat is, restrictions directly related and necessary to concentrations. In order to provide legal certainty to the undertakings concerned, the Notice explains the Commissions practice and sets out principles for assessing whether and to what extent the most common types of agreements are deemed to be ancillary restraints. The assessment of all proposed merger transactions must be based on sound economic theory and analysis and high-quality investigative techniques. As part of these efforts, in 2007, the Commission adopted Guidelines for the assessment of mergers between companies that are in a so-called vertical or conglomerate relationship. The Guidelines provide examples, based on established economic principles, of where vertical and conglomerate mergers may significantly preclude effective competition in the markets concerned, but also provide

‘safe harbors’, in terms of market share and concentration levels below which competition concerns are unlikely to be identified. In order to improve the transparency, predictability, and consistency of the Commissions policy and to ensure that it is based on a sound economic framework, a revised Remedies Notice, published in 2008, adapted the 2001 Notice in the light of an extensive study undertaken by the Commission into the implementation and effectiveness of remedies, recent judgments of the European Courts, and the 2004 Merger Regulation. 5.3 Landmark cases concerning Merger Policy After the introduction to the European competition policy and a detailed overview about the European Merger Policy I found it of interest to give real life examples on cases which meant to be turning points in terms of competition policy issues. In this chapter I am going to exhibit two landmark cases, namely the Airtours/ First Choice and the Lagardère/ Natexis/ VUP. These two cases had huge

impact on European Competition Policy by creating precedents for further cases or by adopting new techniques in econometrical analysis. http://www.doksihu 5.31 Airtours/ First Choice The importance of this case lies on the fact that this case (along with two others: Schneider/Legrand and TetraLaval/Sidel) triggered the reform of the competition policy in 2004, establishing the new Horizontal Merger Guidelines. The case started with a proposed acquisition by Airtours for First Choice. Both companies were UK-based packaged tour players. “In the market for "short-haul" packaged tours (those primarily from the UK to continental Europe/Mediterranean destinations) the transaction would have combined the second and fourth largest firms, creating the largest firm (with a 32% share). Post-acquisition, the three largest firms (Airtours, Thompson and Thomas Cook) would have had 79% of the market.” (McDermott,Will&Emery website [2002]) The Commission came to the conclusion

that the merger distorts the market by creating a position of “collective dominance” among the three major tour operators. The Commission came up with several factors that may increase the likelihood of collusion between the market players after the merger. These factors included product homogeneity, little growth in demand, inelastic demand, similar cost structure across the competitors, market transparency, commercial links between operators, difficult entry in the market and small buyer’s power. At the end of their analysis they came to the conclusion, based on past competition that in the past there had been a trend towards collusion so they took that into consideration in the assessment of the collective dominance. However the Court was convinced that the conclusions on the competitive status of the pre-merger market are weak. It also highlighted that “competition in the pre-merger market must be adopted as a benchmark in evaluating if, and to what extent, the proposed

merger is likely affect competition and create conditions favorable to collusion”. According to this precedent the Court ascertained where the merger “does not bring about any change to the preexisting competitive scenario”; the merger has to be authorized because it does not allay competition by creating a dominant position. (Polverio [2006].) Airtours, therefore, raises (and solves) the question relating to the standard of proof. What market features must the Commission look at, in order to conclude that a merger will lead to post-merger collusion or make such collusion more sustainable? The EU Horizontal Merger Guidelines use both market shares and concentration thresholds to decide whether a merger will be challenged or not. Similar to the US, concentration levels are http://www.doksihu measured by the HHI. The abbreviation HHI stands for the Herfindhal-Hirschmann Index which is a standard index of concentration, and it is the most often used in antitrust analysis. It is

given by the sum of the squares of market shares of the firms in the industry. It can vary between 0, when the market is entirely fragmented (each firm has a market share close to 0) and 10000 when there is only one firm on the market which has 100% market share. Under the HHI standard, the post-acquisition HHI would have been about 1,800 with an increase of about 500 points as a result of the transaction, which are levels of concern in the US. (Motta [2004]) This index had been introduced in 2004 (indirectly the above mentioned case also played a significant role in the introduction of this new index) and it enables the Commission to investigate the cases from another angle than they used to. Post-merger market shares of 50% or more may in them be evidence of the existence of a dominant market position, and thus raise competitive concerns. Post-merger market shares of 25% or less are presumed to be compatible with the common market. Furthermore, the Commission uses HHI levels as an

initial indicator of the existence or absence of competitive concerns. The Commission is unlikely to challenge a merger with a post-merger HHI below 1000. The Commission is also unlikely to challenge a merger with a post-merger HHI between 1000 and 2000 and an addition to the HHI of less than 250 points. Mergers with a post-merger HHI of above 2000 and an addition of not more than 150 points are also unlikely to be challenged. Other factors, such as that one of the merging parties are an important innovator, recent entrant, or maverick could increase the likeliness that the Commission will challenge the merger. Thus, the EU Horizontal Merger Guidelines also provide for certain thresholds that indicate the safe harbors. (US Department of Justice website [2004]) 5.32 Lagardère/ Natexis/ VUP This case is a prominent example of merger control in the media sector. Lagardère/ Natexis/ VUP affected the French book publishing and sales sector. (EC website [2004]) At first I would like to

introduce the parties of this merger. VUP was the biggest publisher, marketer and distributor of French-language books. Lagardère, through its subsidiary Hachette Livre, is second, just behind VUP. Lagardère also does business in the retail sale of books, television and radio, and the publication and distribution of newspapers; by this http://www.doksihu transaction it would acquire control of VUPs entire publishing assets in Europe, which are currently held in trusteeship on its behalf by Natexis Banques Populaires. In 2003 the Commission started a detailed investigation on the basis of anticompetitive effects in three different fields of the booking market: the purchase and sale of publishing rights, the distribution and sale of books by publishers to retailers (including fiction books, books for young people, school books, dictionaries and even general encyclopedias). The analysis observed the possibility of the threat of a reduction of supply or an increase in prices as a

result of the strong positions the merged company would hold. (Europa Press Release [2003]) The main particularity of this case was the above mentioned analysis which was an econometric study carried out for the European Commission by Professor Marc Ivaldi. The magnitude of the unilateral effects is the results of this study on the retail market of books on general literature by the retailers to the final consumers. Unilateral effects in Lagardère/ Natexis/ VUP case: - the unilateral effects measure the impact of a concentration on the public selling prices, the final consumer surplus and the profits of the companies - before the merger with VUP, if Hachette Livre decided to increase prices unilaterally, some of these final consumers would turn to other competing publishers, among which VUP - as a result of the merger with VUP, Hachette absorbs a part of these competitive pressures and can thus recover a part of these customers. The results of the study confirmed the doubts of

the Commission concerning the merger: as the result of the merger on the retail market s of all general literature books (pocket and hardcover formats) by the retailers to the final consumer, the study indicated that the prices of the books would increase significantly. In addition to this consumer surplus would also fall rapidly which is equivalent to a considerable part of the turnover of the industry in the field of general literature. The final decision of the Commission authorized Lagardère to acquire part of the publishing business of Editis (formerly VUP). According to the analysis with this partly acquisition Lagardère removed the concerns regarding the creation of dominant position. The commitments meant that the transaction no longer poses any competition problems and can therefore be authorized. (Bulletin of the EU website [2004]) http://www.doksihu 6. Mergers and acquisitions in the European bank sector In previous sections I exhibited the mergers generally from

different point of views. Now I would like to narrow down this broad topic and start to discuss the role of mergers in the European bank sector. As the reader will see there are lots of peculiarities regarding this question. I am going to highlight the differences between the mergers and their motives in the banking sector and I will also strive to give an explanation on the past year trends. The reader shall examine the characteristics of bank mergers, attain an overview about researches concerning pos-merger bank performance and finally shall become familiar a special topic that can not be left out when we are speaking about the financial sector: executive compensation and mergers. 6.1 Main characteristics of M&As in the banking sector The European banking sector has experienced a rapid growth in terms of mergers and acquisitions in the 1990s. There were several factors that enhanced this process, within many technological and financial innovations, the introduction of the euro

and the outstanding volume of value creation were the most significant. As I have already mentioned in previous chapters many studies concluded that M&As are far from the proof of their economic effectiveness. Their effects on banking performance including profitability and efficiency are also questionable. At first I would like to assess the 1994-2000 period when two major changes determined the banking sector. The two regulatory changes can be associated with the completion of the EU’s single market program and this period also covers the introduction of the euro at the end of the century. These significant adjustments in the system served as catalysts in the crossborder M&A activity in banking (Ayadi, Pujals [2005]) According to a comprehensive research (the two economists observed altogether 151 announced and completed M&As) transactions in the banking sector carried out by Rym Ayadi and Georges Pujals. The findings showed some trends in the sector, such as

acceleration in the M&A activity since 1996, the emergence of ‘mega banks’ at national level since 1999 and a slower development of cross-border transactions at Community level http://www.doksihu Figure 3: National and Pan-European banking M&As (1994-200) Source: “Banking mergers and acquisitions in the EU: overview, assessment and prospects” by Rym Ayadi and Georges Pujals; Vienna; 2005” During the period 1994 and 2000 M&A activity reached its peak in 1998. The total value of all transactions equaled to a total of €262 billion, showing a rapidly increasing trend in terms of the average annual value. At the end of the decade average transaction value reached its peak which was also reflected in the emergence of ‘mega-banks’ operating at a national scale in the major EU countries. To provide some examples: BNP Paribas in France, SCH and BBVA in Spain, IntesaBCI and UniCredit in Italy, RBoS Group in UK and Bayerische Hypo Vereinsbank in Germany. As a

result of these nationally active ‘mega banks’ a more concentrated banking market emerged. (Ayadi, Pujals [2005]) It also turned out from the research that this shift towards larger banks is due to a structural and dynamic consolidation process. This tendency lasted until the end of the decade and seems to have a spillover effect on the pan-European M&As. This tendency seem to have a logical basis too: “when the possibilities for acquisitions are exhausted in a domestic market and the concentration threshold is attained, banking institutions will look for other potential external growth opportunities in other markets”. (Ayadi, Pujals [2005] p 15) Although the statistical results showed the dominance of domestic M&As during the period of 1994 and 2000; a significant boom could be observed during the last two years, when crossborder transactions first reached 42% of the total value in 1999 and 30% in 2000. This light gross can be partly attributed to the elimination of

the currency barriers. The Scandinavian and Benelux countries were indeed very active in cross-border actions not only as acquirers but also as targets. The reason for their activeness was their small and quickly saturated market and their advanced domestic consolidation process. It is also important to mention the importance cross-industry transactions which triggered the emergence of conglomerates that paired banking activities with insurance companies. In relation to this topic we should http://www.doksihu highlight the Belgium and the Netherlands who were pioneers on this field by the establishment of KBC, ING and Fortis. (Ayadi, Pujals [2005]) 6.2 Post-merger bank performance Post-merger bank performance is usually measured by means of financial ratios. In this section I am going to discuss several findings that are based on balance-sheet ratio analysis and profit and loss efficiency analysis. Rym Ayadi and Georges Pujals carried out a deep research concerning the measurement

of bank performance. They observed eight individual cross-border and domestic bank mergers with different characteristics. The characteristics depended on the geographical position (domestic or cross-border) and on the initial specialization of the bank (investment banks, mortgage banks and savings banks). By means of this method the researchers could attain reliable examples on almost each type of bank mergers. However we need to mention here that the distinction between these banks was sometimes hard because of the historical trend toward the universal banking concept. In their balance-sheet ratio analysis they have used such reliable ratios like cost to income, non-interest expenses to total assets and interest expenses to total assets. “The cost to income ratio reflects the ability of the bank to generate revenue from its expenditures.” (Ayadi, Pujals [2005] p.34) Non-interest expenses should be directly affected by the cost savings that are usually associated with the

frequently cited as resulting from horizontal bank mergers. The interest expenses to total assets ratio may be significantly affected by the way the bank chooses to obtain deposits. Return on assets (ROA) and return on equity (ROE) ratios were also included in the analysis. ROA is a common indicator for banking performance; it reflects the ability of a bank to generate profits from the assets at its disposal. ROE is an alternative measure for profitability and illustrates the returns on owners’ investment. We also need to mention some risk indicators such as the capital ratio and liquidity ratio which are responsible for the assessment of a bank from the risk point of view. The capital ratio is designed to show “a bank’s ability to absorb credit and other losses. The liquidity ratio is calculated from liquid assets to total deposits. The higher this ratio the stronger is the position of a bank to avert liquidity shocks but as liquid assets tends to be low yielding, a higher ratio

results lower earnings. (Ayadi, Pujals [2005].) http://www.doksihu After discussing the most important ratios applied in the performance analysis I would like to exhibit the findings and conclusions that Rym Ayadi and Georges Pujals came across. They could conclude that majority of the case studies showed a clear cost cutting. More generally these reductions were mainly thanked to interest expenses savings rather than a reduction in personnel and administrative expenses. This fact could stem from two roots: labor market rigidities and the power labor unions. Another important finding was that the majority of the case studies showed only a little improvement in profitability as measured by the ROA. From the targets’ point of view this factor plays a significant role. This was explained by the fact that the acquiring banks were much more profitable comparing to the targets. It also turned out that the acquiring banks are intended to diversify their revenue sources whatever their

initial activities are. From the cost and profit efficiency scores analyses the researchers strengthen the hypothesis that the cost efficiency of the consolidated bank improves postmerger. This could be explained by that the targets were usually less efficient prior to the merger. This also supports the hypotheses of transfer of best practices from the acquiring bank to the target and the existence of an efficient market for corporate control in European banks. Concerning cross-border mergers Ayadi and Pujals found that the findings resulted a relapse for cost efficiency for the acquiring bank and a slight improvement for the targets. However there was something that raised their attention: cost efficiency scores for the targets involved in a cross-border merger are higher than the ones involved in domestic mergers. They found a comprehensive explanation on it as well: in cross-border mergers the targets are usually coming from banks with better cost-management. What we can conclude

from the above mentioned findings is that the acquiring bank is more efficient than the peer group and this difference is more stressed in case of cross-border transactions. In order to avoid generalization we need to point out the importance of case by case results to ensure the relevance of these results. (Ayadi, Pujals [2005]) Here we also need to take into consideration the findings of Yener Altunbas andd David Marques published in the Journal of Economics and Business in 2008. The two economists found that “the relative size of targets compared with bidders tends to be smaller in domestic than in cross-border deals”. They also came to the point that generally mere efficient banks merging with relatively smaller and better capitalized ones’ with more diversified sources of income. In their survey they draw the conclusion that there are improvements in performance after the merger has taken place especially in the case of cross-border M&As. On average, they found that

“consistency in the efficiency and deposit strategies of merging partners is http://www.doksihu performance-enhancing, both for domestic and for cross-border M&As”. (Altunbas [2006] p.13) For domestic mergers dissimilarities in earnings, loan and deposit strategies result a fall in the performance. In contrast to that, differences in capitalization, technology and innovation strategies were proved to be performance-improving. Another interesting conclusion was the inverse relation of the same factors in case of crossborder M&As, “differences in loan and credit risk strategies are performance-enhancing, whereas a lack of coherence in capitalization, technology and financial innovation strategies has a negative effect on performance”. (Altunbas [2006] p13) This underlies the widespread view that difficulties often emerge when integrating institutions with widely different strategic orientation. Now I would like to discuss the two major types of ‘mega banks’:

global investment banks and universal retail banks. The former is highly concentrated on a worldwide scale and specialized in a few activities like M&A advisory, capital market activities (foreign exchange, derivatives, equities, etc.), corporate financing (export, real estate) for international clients Deutsche Bank, Credit Suisse Group and UBS are the significant European players on this field. These institutions have already reached a critical size which is inevitable in this segment since high fixed costs inherent in these activities just as well-organized distribution channels around the world. Between 2001 and 2002 when the performance of the global economy experienced rough times cyclicality could have been observed among investment banking activities according to a European Economic Advisory Group (EEAG) report, released in 2006. Consequently, after this period many European banking institutions (like British Barclays and Natwest, the Dutch ING and ABN Amro and the French

BNP Paribas and Societé Genarale) have reorganized their capital into less cyclical banking activities for example to retail and asset management. As I have already mentioned a shift could be also experienced towards ‘universal retail banking’. These are “multi-specialized banking institutions which are involved in retail activities”; they are representing the majority in Europe. The logic behind these ‘mega banks’ is to associate specialized subsidiaries with branch network oriented to retail business. They are entitled for serving private customers, SMEs and corporations and “to offer complementary financial services such as insurance, asset management, private banking and corporate and investment activities”. Recently the asset management business served as an engine for the segment “owing to the favorable http://www.doksihu retirement schemes for savings and the likely synergies between the production subsidiaries and their distribution networks”. (Ayadi,

Pujals [2005] p 62) As the study of Ayadi and Pujals have already shed light on the fact that domestic mergers are superior in the number of transactions prior to cross-border mergers, the specialists of EEAG came almost to the same conclusion except they investigated the causes more deeply. Among the obstacles the more limited economies of international diversification, differences in language, regulation, and corporate culture played the most important roles. These hindering factors can delay or even prevent an efficient restructuring and reorganization of the target. According to Berger this leads to organizational diseconomies and reduces the potential of banks to exploit benefits from economies of scale and scope and increased X-efficiency from cross-border M&A. Furthermore I need to mention here the role of the consumers since they could be more reluctant to change in case of a foreign institution. (EEAG [2006]) Beside these the preference of national champions seemed to be

a barrier also. Comprehensive examples on the attitude of fostering national champions include the merger of BBVA (Spanish) with first Unicredito and later with BNL in Italy and ABN Amro’s (Dutch) acquisition of Antonveneta. Although the acquisition of BA was finally approved, the intended takeover of the BNL failed. The basis of the objections against the merger was ‘prudential control and formal errors’. The EU Commission brought actions against Italy for “infringement of the principle of free movement of capital”. The Commission doubted the transparency of the supervisory review process carried out by Bank of Italy. Afterwards the Commission launched a survey on the barriers to cross-border mergers in the banking industry which investigated that protectionism in banking markets might not only be an Italian problem. According to the scrutiny on of the main barriers to the integration of European banking markets is the “misuse of supervisory powers and political

interference”. (Koehler [2007].) Fortunately there are also success stories in cross-border merger history. In the Scandinavian countries and the Benelux countries the banks realized the benefits of cross-border mergers (like attain local expertise and access to high-margin deposits) and carried out several crossborder mergers. However we need to note that the cultural and legal differences between these countries are less likely to occur. I would like to refer here to one more exceptional example: Banco Santander (Spanish) was able to acquire the UK based Abbey because the UK does not have a protectionist attitude. The British antitrust authority blocked the takeover of Abbey by Lloyds TSB in 2001 but did not block the acquisition by Banco Santander. The reasoning of http://www.doksihu the antitrust authority was that “Santander comes from an increasingly competitive domestic market in Spain that has induced efficiency gains and allowed international expansion (mostly in Latin

America)”. (EEAG report [2006]) From these findings EEAG could conclude that ownership matters in a sense that it influences the location of corporate control centers and the associated externalities. Local and regional authorities have incentives to attract and keep corporate headquarters. “However, if all regions give subsidies or protect their firms, they may neutralize each other and imply both large budgetary costs and welfare losses. Such protectionist attitudes may be self-defeating” (EEAG report [2006] p.114) As I have already explicated for banks, expanding into new products and geographical areas has a number of advantages. This kind of expansion allows universal banks to diversify both their risks and sources of revenue preventing them from the harmful effects of geographical or product-related shocks. Furthermore for a universal bank that is involved in investment banking it is much easier to allocate additional financial funds in order to obtain certain investment

banking deals. This hypothesis underlies the assumption of Houston, James and Marcus (1997) that “banks create effective internal capital markets which means diversification would reduce the cost of financing for banks”. (Altunbas [2006] p4) On the other hand from a current viewpoint (global financial crisis) we should allude on the argument of the above mentioned hypothesis raised by Winton in 1999. In his argument he contested that diversification reduces the odds of bank failure and improves performance. He stated: “when banks’ loans have very high downside risks, diversification can actually increase the odds of bank failure, particularly if diversification involves expansion into sectors where the bank lacks expertise”. (Altunbas [2006] p4) This was 7 years later, in 2006 confirmed by Acharya in an empirical study on a sample of Italian banks. He found that for high-risk banks, diversification produced even riskier banks (Archaya [2006].) Researchers like Prahalad and

Bettis observed the disadvantages of diversification. As a financial institution grows it also becomes more complex and it is more difficult for managers to control the bank. Typical problems like less efficient internal control, duplicated expenses, failure in the creation of the right incentives and in the rationalization of the workforce may occur. Obstacles can emerge in the common corporate culture for universal banks With respect to that, “inefficiencies may be created when managers apply their existing ‘dominant’ logic to newly acquired but strategically dissimilar banks” http://www.doksihu Likewise, managers may choose diversification to reduce risk stemming from product-related shocks even when shareholder wealth would be more likely to be maximized by not entering into new lines of business or geographical areas. (Altunbas [2006] p13) It seems that the profit maximization and rapid expansion was superior above sustainable development for these banks in the past

years. Although it their intention was to satisfy the expectations of the shareholders by diversifying their businesses at the end both the banks and the consumers (including the states) had to pay huge costs to overcome the effects of uncontrolled diversification. I am going to discuss the current situation in the last chapter 6.3 Special topic: Executive Compensation and mergers As I have explicated the integration of the European banking market accelerated in the past years. A result of this process was the rise of the cross-border M&A transactions all over Europe. To be able to manage and integrate these large institutions successfully managerial genius was inevitable because of the complexity of the whole process. In case of a successful M&A where the synergies emerged due to the good decisions, bonuses seemed to be a rational way of compensation. Since in previous sections I showed it is quite difficult to evaluate the value creation of a merger especially in the Banking

Sector, Rym Ayadi thought that it is important to search for alternative explanations in this question. He released a study for the topic performance and executive compensation in 2005. This study shed light on the interconnectivity of bank mergers and managerial bonuses. As he alluded: “Managerial hubris, empire building by entrenched CEO’s may offer a plausible explanation for the lack of significant improvement in bank’s performance”. (Ayadi [2008] p98) He underpinned this hypothesis with an empirical research which showed that between 1990 and 2000, 50% of the mergers failed to deliver shareholders returns in the Financial Services Industry. He explored two possible explanations for this fact: “managerial power may influence board decisions with regard to deal thus influencing indirectly performance” or in other cases “executive compensation may be used as powerful tool to reward and motivate executives, aligning their interests with the shareholders’ interests and

enhancing deals’ performance”. http://www.doksihu Another point of view is stemming from the shareholder model where control and ownership is separated within the firm which provides a safe haven for managers to chase other objectives than profit maximization. Some of them might prefer to serve his/her own interests. I need to add here that this problem is more likely to occur where shareholding is passive. Ayadi also concluded from a previous study that managers are also motivated in pursuing mergers because they are afraid of a possible hostile takeover which is the direct result of the acceleration of bank mergers in the financial industry. This the only way they can maintain their own positions within the company. In his study he used a comprehensive sample of 52 bank mergers that have taken place between European banks in the EU15 plus Norway and Iceland during the period 1996-2006. The significance of this scrutiny lies in the fact that it embraces the period under which

the regulatory changes have been carried out by the EU Commission and covers the introduction of the Euro as well. Their findings strengthened the anticipated hypothesis that the value is created when a more experienced manager is sitting on the top. In fact there is a relation between experience and value creation. Since higher experience is usually entailed with stronger managerial power Ayadi came to the conclusion that it helps the exploitation of synergies. They observed profitability of the pos-merger bank in terms of the age of the CEO as well. In this case younger and probably more motivated CEOs were dominating (the age of CEOs varied on the scale of 34 and 69). They are also seeking carrier successes and reputation through successful deals. Their second part of the research aimed to investigate if better bank performance is linked to higher post deal executive compensation. Unfortunately Ayadi and Arnaboldi found no statistically significant link between and post M&A

compensation. Nevertheless Ayadi terminated that “higher executive remuneration seems independent of internal drivers such as bank performance but explained by external factors such as competitors’ compensation and inflation”. (Ayadi [2008] p121) What was on the other hand very interesting in the last part of this study is that the two researchers added that “the balance sheet information on CEO remuneration is barely opaque and are mainly referring on variable compensation and retirement benefits”. (Ayadi [2008] p.122) They came to the conclusion in 2007 that European regulators and banks should endeavor towards the direction of more transparent compensation system. http://www.doksihu 7. The effects of the global financial crises on M&As As we know the World went through a global financial crisis in the past 1,5 year. The optimist experts have already decleared the end of this crisis while others are arguing with this and commited themselves for a ’w’ shaped

crisis, in other words for a crisis that haIs two downturns. The aim of this chapter is to investigate the effects of the financial crisis on the European M&A activitiy. I already referred on the risks of diversification in the previous chapter. As economists know by now these risks proved to be correct and served as catalysts in the beginning of the crisis. Too high level of diversification of universal banks entailed opacity in the system, meanwhile the responsible managers reported higher turnovers to the shareholders who did not know anymore in what kind of business does the profit coming from. By pumping in high risk investments these banks were jeopardizing with the capital of the shareholders. Here I need to add that managers started to seek for high-risk portfolios to satisfy the return expectations of their shareholders. This strategy boosted the overall complexity of the bank and ultimately drove up the cost base, in return stimulating further risk-seeking behavior. Then

the mortgage bubble which was mainly financed by these universal and specialised banks reached its critical mass and exploded. This should not have been a problem since it happened in the USA but because of globalisation and the interdependence of the financial markets the American mortgage crisis spilled over Europe and to the whole World. The demand decreased in almost every industry, while the level of unemployment increased. In Europe banks with long history and heritage ceased to exist while others were saved by the joint action of European governments and the EU. Bank packages offered to the critical players could compensate the crisis but also raised some controversial issues among the people. With reason they challenged the fact that the state should give billions of euros from the tax payers for banks who failed to serve public interests. After the general introduction of the current situtation I am going to exhibit the merger performance in the past 1,5 year, in a later

section discuss the controversial issues that bank packages raised and the in the future of banking section I am going to discuss the imminent post-crisis changes in the banking system. http://www.doksihu 7.1 Characteristics of the European M&A activity in 2009 I am going to investigate the current situation of the M&A activity based on the reports of several Market Research Institutes like PriceWaterhouseCoopers and Merrill Corporation. As it was expected the credit crunch and global economic downturn severly depressed the European M&A activity. The change in the aggregate value was dramatic While the crisis started in 2008 its first impact on the European merger market showed up only in the first half of 2009, but the stumble started in the last quarter of 2008 when quarterly deal volumes fell by 21,6%. So it was not a bring surprise for economists that the deal activity was keeping on its decrease through the first half of 2009. Most of the companies spent their their

time by boosting their business in order to avoid too big losses. Companies also applied tools like divestments and defensive corporate plays; these characterized the first half of 2009. Figure 4: Quarterly M&A activity volume 2003-2009 Source: Merrill Corporation half-year report on European Deal Drivers 2009 p. 8 In the second quarter of 2009 M&A activity totalled 745 transactions which almost equal to 2003 second quarter results (that was the lowest quarter in M&A activity recently). In the first http://www.doksihu half of 2009 valuations totalled 130,1 billion euros. However these results could be shocking at first glance there are some numbers that could show the light at the end of the tunnel: in the first two quarters the decline in deal volume was only 5%-5%. If we compare it to the last quarter of 2008 (21,6%) it seems to be mitigated. Paralelly to these deal valuations are continuing their decrease which is “partially attributable to to the relative

reduction in the number of high-profile governmental bail-outs across Europe”. (Merrill report [2009] p6) Figure 5: Mix of deals by industry sector Source: Merrill Corporation half-year report on European Deal Drivers 2009 p.10 Industrials and Chemicals deals determined the M&A activity over the first half of 2009, acconting for 316 of the 1530 deal that took place over the period. Among the EU 27 countries the largest proportion of deal flow has taken place in the UK and Ireland. These two countries were responsible for 282 deals (18,4% of the total). Not surprisingly in terms of valuations the Benelux region was the single largest region accounting for €28,2 bn worth of deals. (Merrill report [2009]) http://www.doksihu Figure 6: Mix of deals by geographic region Source: Merrill Corporation half-year report on European Deal Drivers 2009 p.10 According to the forecasts of Merrill, the fact that the European M&A volumes have hopefully reached their bottom provides a

stable fundament for a prospective deal flow over the second half of the year. This hypothesis is strengthened by the likelihood of stability that seems to be returning on wider financial markets. 7.11 Financial Sector Concerning the financial sector which suffered the most severe shock due to the crisis, trends continued in the first half of 2009. Governments carried on underpinning the sector in order to prevent further collapses. In close relation to this trend 5 from the top 15 Financial Services in Europe involved national governments raising or taking their stakes in once proudly independent commercial organizations. A further 5 among the leading international banks had to give up operations that were once meant to be their flagships. I need to mention here Barclay’s sale of its asset management arm Barclays Global Investors (BGI) to BlackRock for cash and shares at a value of €9,7 bn. This transaction can also demonstrate the fact that there are still some means of

financing at the top level of the market, at least “as long as the target and the terms of the transaction are right”. (Merrill report [2009] p14) The deal also http://www.doksihu underpins the attitude of Barclay’s management team: avoiding government intervention and retaining their independence. Figure 7: Quarterly trends in the financial sector Source: Merrill Corporation half-year report on European Deal Drivers 2009 Generally speaking both in terms of volume and value deals in the financial sector were bottoming. Here I would like to highlight the outstanding value of deals in the last quarter of 2008 which was without doubt the deepest phase of the crisis. This figure thanks to the governmental bailouts on the European market and the joint actions carried out by the leading governments (like UK, France, Germany, etc.) in the EU M&As in the financial sector were mainly triggered by “distressed sales”. What we can conclude is that there are still deals to be

brokered, well capitalized firms are still acquiring others and despite the recession advisory services are still needed. (Merrill report [2009]) 7.2 Controversies of European Bank Rescue Packages As I have already in the past section, European Bank Packages played a significant role in the stabilization of the market. In this section first I am going to elaborate the conditions of the http://www.doksihu packages and later I am going to exhibit the controversial issues they raised. These packages have not been centralized by the European Central Bank; the ECB only provided a general framework, goals to achieve for the Member States (MS). According to this a collective action plan was released in a declaration by the euro zone countries at their summit on October 12, 2008: their aim was to facilitate the funding of banks by means of guaranteeing “new short- and medium- term bank senior debt issuance”. (Posch [2009]) The Member States attached some conditions to the state

guarantee: “Such guarantees are to be made available at market conditions to all financial institutions operating in the country that meet the regulatory capital requirements and other nondiscriminatory objective criteria.” (Posch [2009] p 1) They set the time frame of the state support until 31 December, 2009 which means that this scheme will be a temporary and also limited in amount. On one hand the MS realized the need for actions in order to prevent the failure of strategically important financial institutions on the other hand they strived on focusing on taxpayers’ interests. Furthermore the euro area countries wanted to ensure that existing management and shareholders bear the due of consequences of the intervention. Finally all of them supported the idea that recapitalization should be followed by a restructuring plan. The European Central Bank (ECB) reacted also very quickly on the crisis and advocated interbank money market by their announcement on the flexibility of

accounting rules. The severity of this issue could be exemplified by the fact that the Euro zone countries called upon the Commission and the competition authorities to apply flexibility in state aid decisions. As a consequence to this the Commission ensured the MS about its guidance on state guarantees and recapitalization. (Posch [2009]) The ECB jointly with the Commission published a set of objectives that are recommended to take into consideration midst of the implementation of bank packages: - Microeconomic Objectives - Macroeconomic Objectives - Fiscal Objectives - Safeguarding Market Integrity - Avoiding Market Distortion Microeconomic objectives are ought to give a helping hand for financial institutions that are struggling with solvency problems due to the unusual business climate. Most important aim of this objective is to prevent the failure of “systematically important financial institutions”. http://www.doksihu Macroeconomic objectives are trying to

stimulate the MS to ensure the financial system’s capacity to fund the economy. Fiscal Objectives are emphasizing the taxpayers’ interests by minimizing the losses resulted from state aid packages. Safeguarding market integrity objective highlights the responsibility of management who should bear the due consequence of the intervention in order to avoid the emergence of moral hazard stemming from state assistance. Furthermore Fiscal Objectives are serving long-term financial stability after state intervention has ceased. Avoiding Market Distortion objectives are referring on the risk of creating competitive distortion between banks in different MS by the subsidization of financial institutions. This objective also includes the risk of unfairness in the system by subsidizing the unreliable banks instead of the stable ones’. Beside the above mentioned economic criteria political legitimacy of state actions should also take into account before defining plans of action. (Posch

[2009]) The bank packages have been approved very quickly in the MS after the 2008 October. The MS included recapitalization and refinancing measures that were essential for the economies. At first look these packages are seemed to be alike in terms of instruments applied and general requirements, however there are also significant differences between them. All together 19 EU members have introduced bank saving actions. The MS “have earmarked a total of some € 2.8 trillion” (which is the 22% of the EU’s GDP) for these measures Around €300 billion of this amount have been made available for recapitalizing banks and approximately €2.5 trillion for state guarantees of liabilities (Posch [2009]) In their study about European bank packages the economists of the Austrian National Bank: Posch, Schmitz and Weber; analyzed the conflicts of objectives embraced in the EU bank packages. One of their considerable findings was the following: “Although much effort has been extended to

ensure a harmonized EU approach, the Member States in fact enjoy great leeway in designing national bank packages, which leads to competitive distortion.” (Posch [2009] p. 1) When applying the joint framework the MS preferred micro- and macroeconomic objectives instead of fiscal objectives. This fact led to the unfavorable situation where taxpayers are paying the costs of bank failures while the bank sector is not forced to contribute in the action. The conflict between these two objectives doubted the political legitimacy of the measures. They observed that in countries where state guarantees were the only means of assistance against the crisis countries favored short-term financial security and market integrity against avoiding moral hazard and maintaining long-term stability. As they stated in their report the http://www.doksihu central problem in this issue is “the politically motivated decision of the EU MS” to avoid forcing bond and money market creditors to share in the

losses. (Posch [2009] p1) Although the EU has attempted to solve the above mentioned conflicts between the objectives by attaching conditions to the state aid there are also some other possibilities in the system that can be deployed. In their analysis the above mentioned Austrian economists questioned the incompatibility of dividend restrictions, state influence on company management and salary caps with the all of the objectives specified by the EU. As a result they also shed light on the unavoidable contradiction between the objectives concerning the requirements to maintain lending and solve borrowers’ debt problems. It also seems to be an incorrect decision that the EU let the MS to decide the way of implementation of the packages which was followed by the divergence in scope and design of the packages. This policy enhanced the development of micro- and macroeconomic objectives while mitigated the significance of market distortion avoidance. (Posch [2009]) The question of the

differences between these bank packages has not been answered yet. Relying on their findings Posch, Schmitz and Weber assumes that the differences can stem from two roots: in best-case scenario they are just “an expression of an appropriate adjustment to the different circumstances in the financial sectors of individual Member States” or they could also come from the influential power of the financial sector on the policy making. All in all the opacity around the implementation of these bank packages seem to be prevailing in the Member States, for example in case of the pricing of state aids. This type of attitude could be very detrimental for the future especially if we take into consideration that such lack of transparency abetted the current financial crisis. 7.3 The future of banking In the last section of my assignment I would like to provide a comprehensive picture about the future changes in the banking sector. I am going to exhibit the future prospects that the banking

sector faces if it wants to restore its reputation based on a report constructed by PriceWatehoouseCoopers and released in 2009 The crisis has raised the attention of the industry that sever changes should be implemented on a short-term basis to ensure the stability of the system in the long-run. As I already mentioned typical reactions on the crisis have been short-term by nature, most of the time triggered by the need for survival. Short-term actions will not be able solve problems http://www.doksihu that are owing to fundamental and systematic issues. There are plenty of questions that needs to be answered with regard to risk management, capital and liquidity requirements, regulatory environment and the efficiency of existing business models. These topics are just the priority one’s that have to be solved as soon as possible. The institutions that can overcome these issues the fastest will be the leaders of their industry in the future and can ensure their survival in the new

world. Following this path, “the banks must decide on their strategy and how they can build the right business model to deliver it”. In order to reach their new targets they should employ and attract the right people on their board. Parallel to this banks need to reward these new workforces fairly and transparently. After a transition period towards stability those financial institutions will succeed that can first “identify the market segments where they add value and where there are customers who are willing to pay for their products and have the courage to invest in these businesses while shrinking others”. Change management and effective monitoring of progress will also play a decisive role in this process. (PWC report [2009]) Those Banks who were targets of government intervention will face more severe obstacles in the run to catch up with the independent one’s. The best opportunities for them are to rely on their existing customer relationships and to concentrate on

their core businesses. The competitive advantage of the independent banks is attributable to their flexibility to reap their relative strengths and the ability to improve their competitive position through sustainable growth and mergers and acquisitions. In the future, there should be some efforts for the better understanding of the cost base since this was a problematic factor in the past. This could be achieved through application of activity-based costing. Beside the earmarked cost-cuts banks should not forget the importance of business modernization. Financial institutions must strive to simplify the complexity of their business and integrate their systems better in order to be able to satisfy their customers. Efficiency improvement is going to determine the industry’s future. If banks will show resistance for these changes they will risk facing explicit regulations from the authorities. (PWC report [2009].) The crisis facilitates transformational and operating changes in the

business model which otherwise are rarely undertaken. These large-scale reforms in the system will revive the sector and provide impetus for long-term sustainable growth. After consolidating their assets and deciding on their mix of products and services on disposal thy can manage and deliver to their customers, banks should redefine their position “on the mono-line – universal bank” axis (this step will be crucial regarding to the future operations). I already alluded the universal bank http://www.doksihu concept and the risk of diversification in earlier chapters, according to the forecasts of PWC there will be significant changes in the once flourishing model. Very soon they should realize that they lack the ability of managing all their activities coherently. They will not be able to “serve their franchise with owned product and infrastructure”. (PWC report [2009] p6) Among these universal banks only those will retain their position who realizes that with an adequate

set of products and services which quality is unquestionable, they can create more value than a limited range of fully owned products and services. The reaction time on the need for change will also determine the future position of these banks with regard to this the upcoming 12 month will decide who will be the winners an the losers in the long run. In the past couple of years banks have often boosted their quarterly figures by bringing highrisk profile portfolios into prominence. “As investors’ return expectations kept on increasing this became a continuous process”. (PWC report [2009] p11) Needless to say that this kind of behavior was unsustainable in the long run and indirectly contributed in the eruption of the crisis. Hopefully the management has learned the lesson and in the future banks will control thoroughly their costs, returns and risks and will “ensure that they are in a sustainable equilibrium”. (PWC report [2009] p11) To reach this both the management has to

come out with realistic return scenarios and both the shareholders have to curb their overambitious expectations. With regard to these measures the return on equity of banks will definitely decrease but in exchange for that the banks’ risk profile will decline more sharply. A change in the required capital analysis can be projected concerning credit risk. As a side effect of the crisis banks will face higher regulations These regulations are very useful one hand since they have the power of forcing banks for the imminent changes. On the other hand they could be also harmful for the system if the regulators are attending to control the whole sector by overloading the banks with potentially damaging regulations. Financial institutions should prevent these kinds of actions if such measures are likely to occur. In addition to that regulatory demands for information from banks have increased significantly. These regulations are inevitable in the process of restoration of confidence.

“But regulation alone will not sole the problem: in particular it is the enforcement of good governance, the right behaviors and the right rewards that will restore confidence n the banking sector, enabling the banks’ financial position to be rebuilt.” (PWC report [2009] p.13) Future banks who have undertaken these structural reforms should implement them very quickly in order to convince the regulators about their competence in their own sector and thus indirectly encouraging regulators to implement their measures at the right level do not tease the financial sector unreasonably high bureaucracy. http://www.doksihu When we are speaking about the financial sector we can not sidestep the topic of its special business culture with the egoistic managers and unrealistic reward system which factors also played an important factor prior to the crisis. This is the reason why the management of he banks must strive to develop better ways of fairly rewarding while not encouraging risk

taking behavior. The reform of the rewarding system should be carried out in front of the public to ensure the restoration of the moral crisis. The compensation system and the business culture should be reformed in a way that it encourages only responsible risk-taking performance. Regulators are also looking at the reform of the remuneration system as a core issue. Among the MS, British regulators have reacted the fastest on this problem. In his detailed report on the crisis (Turner Review) Lord Turner made recommendations regarding to this topic in March 2009. In the Code of Practice, the UK Financial Service Authority (FSA) settled down its principles which are seemed to be influential in the area of compensation. The ten principles are entitled to solve the problem, among them I am going to quote the four most important one:  “A firm must establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk

management”  “Assessments of financial performance used to calculate bonus pools should be based principally on profits. A bonus pool calculation should include an adjustment for current and future risk, and take into account the cost of capital employed and the liquidity required.”  “The assessment process for the performance-related component of an employee’s remuneration should be designed to ensure assessment is based on long-term performance.”  “The fixed component of remuneration should be a sufficient proportion of total remuneration to allow a firm to operate a fully flexible bonus policy.” (Turner [2009].) These principles traced out the path for financial institutions with regard to compensation policy. The moral crisis which is partly stemming from the remuneration system has another effect on the industry too. As the reputation of the financial sector in the course of the crises have reached its bottom, the popularity of the banking industry

among young graduates have fallen http://www.doksihu rapidly. These young, motivated graduates (analysts of PWC are calling them Generation Y) have different set of values as their predecessors. Generation Y brings ethical concerns into prominence in its career choices which fact makes the banking sector less attractive for them. This should trigger banks to develop new ways to attract good people as well as how to retain their high performers. (PWC report [2009]) All in all the future of banking will be determined by the attempts to correct the mistakes committed in the past. This is why it was urgent to investigate the factors that caused the financial crisis. In Europe the UK was a pioneer on this field by means of the Turner Review From the EU Commission’s side it was Jacques de Larosière, who has prepared a similar report in February, 2009. He came to almost the same conclusions as Lord Turner Both analysts made recommendations with regard to the future. These two reports

are serving as basis for future regulatory measures. Important lessons from the past could be the following: integration of group-wide control functions, such as risk, compliance, HR, and internal audit has been unnecessary; senior management has in some extent ignored the cautionary signs attained from these control functions and the complexity of banks of banks in terms of products, geographic coverage and cultural norms has undermined to properly understand and therefore manage their risks. This latter fact was further intermingled with by the banks overdependence on quantitative risk analytics, which has proven to be unsound Given these lessons and the catastrophic failure of the banking industry, it is in the interests of the government, taxpayers, regulators, investors and the banks themselves to ensure that these lessons are learned and that the necessary preventive actions are approved and carried out by the boards of the banks their regulatory authorities. http://www.doksihu

8. General Conclusions There were several factors that played a significant role in the outbreak of the financial crisis. This report intended to cover up those that stemmed from mergers and acquisitions in the European Banking sector. In my opinion the coefficients that are connected to banking M&As and indirectly entailed the crisis can be grouped around four important areas: emergence of universal banks, lack of transparency in the financial sector, not efficient regulatory tools and unreasonably high executive remuneration. This sequence is also the descending order of the factors which means that they are differing in magnitude. They are not just having different size of impacts on the crisis but are also interconnected with each other and are creating a complex issue from this question. The logic behind this interdependence of factors is that the emergence of universal banks increased the diversification in the system which led to higher opacity in the system and prevented

the regulators to have a clear overview about the whole process even though that they aware of this fact. They could have been familiar with the problem through the researches and studies (e.g by Altunbas and Marques in 2006) which were devoted to this topic years before the crisis. I think even if they have known the problem intimately the long bureaucratic procedures would have delayed the implementation of changes before the crisis. In addition to this the high expectations by shareholders and the high rewards offered by them for higher returns or for successful mergers which consequently created higher diversification, deepened the crisis. The human factor is connected to this last factor by managerial hubris. Lack transparency occurred also in terms of the managerial rewards and prevented economists to carry out comprehensive analyses in this question. As we could see from the latest reports on the European financial sector and M&A results the crisis swept through the industry

and created a fertile soil for both regulatory and cultural changes. The Member States reacted suddenly and efficiently on the new challenges and saved the banking sector from the collapse. Nevertheless the banking packages left some open doors and contradictory objectives behind. These objectives were created to serve the sustainable growth of the European Banking sector but I suppose because of the lack of time that the developers faced, left these conflicts of objectives in the system. On the other hand the opacity around the implementation of these bank packages seems to be prevailing in the Member States, for example in case of the pricing of state aids. This type of attitude could be very detrimental for the future especially if we take into consideration that such lack of transparency abetted the current financial crisis. http://www.doksihu Although the future of banking has not been determined yet there are some guidelines that seem to be prevailing with regard to managerial

rewards, increased regulatory control and self-control by the banks. If the latter will be effective the other two factors should not be that harmful for the sector. In other words the most important is that the banks should realize that it is their own interest to speed up the significant structural and cultural changes otherwise they will be forced to do so. The government side of this question is also influential since they are also under the pressure of the frustrated tax payers who financed the government bailouts. Their and also the European Union’s task is to find the golden mean between regulatory control and the continuation of the European capital market integration. However it is more or less clear who and what has to be done to develop a sustainable and responsibly risk taker system it will be seen whether all the above mentioned parties can accomplish their duties or those will be right who are relying on the hypothesis that economic crises are decoded in the system

itself and are inevitable by nature. http://www.doksihu Bibliography ABA, section of antitrust law (2005). Market Power Handbook: Competition Law and Economic Foundations. Chicago: ABA Acharya, V., Hasan, I, & Saunders, A (2006) Should banks be diversified? Evidence from individual bank portfolios? Journal of Business; 79; 1355–1412. Akhavein J.D, Berger AN & Humphrey DB (1997) The Effects of Megamergers on Efficiency and Prices: Evidence from a Bank Profit Function. Review of Industrial Organization; 12; pp. 100-101; 1997 Altunbas, Yener; Marques, David (2006). Mergers and acquisitions and bank performance in Europe: The role of strategic similarities; Journal of Economics and Business;2008. Ayadi, Rym; Arnaboldi Francesca (2008). Markets and Compensation for Executives in Europe;part 2; Banking Mergers and Acquisitions in Europe: Performance and Executive Compensation (p. 97-127) Ayadi, Rym; Pujals, Georges (2005). Banking mergers and acquisitions in the EU: overview,

assessment and prospects; Vienna; 2005. Berger, Allen N. & Humphrey, David B (1992) Megamergers in Banking and the Use of Cost Efficiency as an Antitrust Defense; Antitrust Bulletin; 37(3); 541-600. Bulletin of the EU website; Individual cases; Lagardère/Natexis/VUP; 2004. web link: De la Mano, M. (2002) For the customer’s sake: the competitive effects of efficiencies in European merger control (EC DG Enterprise Paper No 11). Luxembourg: Office for Official Publications of the European Communities, p. 19 Duso, T., Gugler, K & Yurtoglu, B (2006) Is the Event Study Methodology Useful for Merger Analysis? A Comparison of Stock Market and Accounting Data. WZB Markets and Politics; Working Paper No; SP II 19, p. 1 Eckbo, B. Espen, (1983) Horizontal Mergers; Collusion, and Stockholder Wealth Journal of Financial Economics (JFE); 11; 241-273.; 1983 Europa Press Release (2001). Commission launches wide-ranging discussion on reform of

merger control regime; Brussels 11.122001 web link: 0&language=EN&guiLanguage=en http://www.doksihu Europa Press Release (2003); Commission initiates detailed inquiry into Lagardères acquisition of VUP; Brussels; 2003. web link: European Commission website; Competition Policy; Overview; Media Mergers; web link: http://ec.europaeu/competition/sectors/media/overview enhtml European Economic Advisory Group (2006). Report on the European Economy 2006; Chapter 5; Mergers and Competition Policy in Europe; 8. March 2006 Farrell, Joseph; Shapiro, Carl (2000). Scale Economies and Synergies in Horizontal Merger Analysis; University of California at Berkeley; October 2000 Fridolfsson, S. & Stennek, J(2005) Why Mergers Reduce Profits and Raise Share Prices-A Theory of Preemptive Mergers. Journal of European Economic

Association, 3, 1083-1104 2005. Heyer, K. (2006) Welfare Standards and Merger Analysis: Why Not the Best? Competition Policy International; 2(2); p. 3; 2006 Horváth, Zoltán (2002). Kézikönyv az Európai Unióról; chapter 10; Competition Policy; p 259-264; fifth edition; Budapest; 2002. Ilzkovitz, F. & Meiklejohn, R (2003) European Merger Control: Do We Need an Efficiency Defence? Journal of Industry, Competition and Trade, 3:1/2, p. 62; 2003 Jensen, Michael C., Ruback & Richard S (1983) The Market for Corporate Control: The Scientific Evidence. Journal of Financial Economics 11(1-4); 5-50; 1983 Kamerbeek, Sjoerd (2009). Merger Performance and Efficiences in Horizontal Merger Policy in the US and the EU; p. 26; Utrecht june, 2009 Koehler, Matthias (2007). Merger Control as Barrier to EU Banking Market Integration; Centre for European Economic Research; 2007. Manne, H.G (1965) Mergers and the Market for Corporate Control The Journal of Political Economy, 73 (2), 110-120;

1965. McDermott,Will&Emery website (2002). Recent Airtours / First Choice EU Merger Decision; june, 2002. web link: http://www.mwecom/indexcfm/fuseaction/publicationsnldetail/object id/2c230d4e-e0134a37-9797-4a6e83568dd7cfm Merrill Corporation (2009): Half-year report on European Deal Drivers 2009; The comprehensive review of mergers and acquisitions in the EMEA region; England Motta, Massimo (2004). Competition policy: theory and practice; page 234-239; 2004 Motta, M. (2004) Competition Policy: theory and practice Cambridge: Cambridge University Press, p. 251 http://www.doksihu Padilla, A.J (2005) Efficiencies in Horizontal Mergers: Williamson Revisited In: WD Collins (Ed.); Issues in Competition Law and Policy; Chicago: American Bar Association Press, p. 27; 2005 Polverino, Fabio (2006); Assessment of Coordinated Effects in Merger Control: Between Presumption and Analysis; University of Chicago Law School; 2006. Posch, Michaela; Schmitz, Stefan W.; Weber, Beat (2009) Financial

Stability Report; EU Bank Packages: Objectives and Potential Conflicts of Objectives; Vienna Prahalad, C. K, & Bettis, R A (1986) The dominant logic: A new linkage between diversity and performance. Strategic Management Journal, 7, 485–501 PricewaterhouseCoopers Report (2009).The future of banking; Returning stability to the banks and the banking system Ravenscraft D.J; Scherer, F Michael (1988) Mergers and Managerial Performance; In: JC Coffee (Ed.), Knights, Raiders and Targets; New York: Oxford University Press; 1988 Renckens, A. (2007) Welfare Standards, Substantive Tests, and Efficiency Considerations in Merger Policy: Defining the Efficiency Defense. Journal of Competition Law and Economics, 3(2), pp. 155-156; 2007 Röller, L-H., Stennek, J & Verboven, F (2000) Efficiency Gains from Mergers (Working Paper No. 543); Stockholm: The Research Institute of Industrial Economics, pp 49-50; 2000 Schenk, Hans (2006). Mergers and Concentration Policy; In: Bianchi, P, Labory, S

(Ed), International Handbook of Industrial Policy; 2006. Sherman, Andrew J.; Hart; Milledge A (2006) Mergers and Acquisitions from a to z; 2006 Shiller, R.J (1984) Stock Prices and Social Dynamics Brookings Papers on Economic Activity; 2; 457-510; 1984. Stulz, Rene M., Ralph A Walking, & Moon H Song (1990) The Distribution of Target Ownership and the Division of Gains in Successful Takeovers; The Journal of Finance; XLV; 817–833; 1990. Tichy, Gunther (2001). What Do We Know about Success and Failure of Mergers? Journal of Industry; Competition and Trade; 1(4); p. 353 Treaty Establishing the European Community (1952). Article; 81; 82; 87; Rome; 1952 Turner, Lord Adair (2009). The Turner review; A regulatory response to the global banking crisis; London http://www.doksihu US Department of justice website (2004); workshops; Concentration Indices and Market Shares in the EU Horizontal Merger Guidelines; Washington; 2004. web link:

http://www.justicegov/atr/public/workshops/docs/202601bhtm Williamson, Oliver E. (1968) Economies as an Antitrust Defence: The Welfare Trade-offs American Economic Review, 58, 18- 36.; 1968 Winton, A. (1999) Don’t put all your eggs in one basket? Diversification and specialization in lending. Wharton School Center for Financial Institutions Working Paper; 00–16; September