Regulatory constraints and merger performance: The case of geographic restrictions in banking

Previous economic research has suggested that historically, geographic restrictions on commercial banking—such as prohibition of branch expansion and interstate banking—impeded operating efficiency and bank profitability, and that removal of these restrictions generated increased efficiency through rapid industry consolidation. If this is the case, then bank mergers in the period after deregulation should create value. Yet most previous empirical studies show little evidence of net value creation at the time of merger announcement, and there appears to be no improvement in the average post-acquisition operating performance of merged banks.; This study examines bank mergers and regulatory constraints during two periods, 1986–1987 and 1993–1995, and finds important cross-sectional differences in merger outcomes. In particular, more recent mergers do result in increases in the combined value of bidder and target stocks, and involve a significant upward shift in the relative market value of target banking assets. Increased target market values are consistent with increased expansion opportunities made available by the removal of geographic constraints.; Greater value creation at announcement is partly driven by expected gains from cost reductions and efficiency enhancements made possible through consolidation of branch operations. With further relaxation of branch banking restrictions, the opportunity for these gains increased in the 1990s. As a result, acquisitions of less efficient targets produced higher announcement returns, and there was an increase in the relative frequency of mergers within the same geographic market.; Abnormal announcement returns are heavily influenced by pre-merger profitability, efficiency, and capital structure, and at announcement the market values mergers between banks that are similar in lending activity and capital structure. For long-term shareholder return measures, bank activity, efficiency, and pre-merger performance have little explanatory power. However, the increased selection and geographic diversification made possible by the deregulation of interstate banking are important factors in explaining long-term improvement in merger outcomes.