Geographic banking deregulation and agency relationships: The
effect of the U.S. interstate banking deregulation on M&A
Name: Lilian den Outer Student number: 11409371
Thesis supervisor: dr. P. Ghazizadeh Date: June 2017
Word count: 9230
MSc Accountancy & Control, specialization Accountancy Faculty of Economics and Business, University of Amsterdam
Statement of Originality
This document is written by student Lilian den Outer who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Abstract
The U.S. interstate banking deregulation of the 1980s caused a banking merger wave that changed banks’ monitoring and financing behaviour. The findings of this research show that these changes positively affected the U.S. state-level amounts of M&A deals. This effect is stronger for diversifying M&A deals compared to concentrating M&A deals. These findings suggest that geographic deregulation not only is an important determinant of banks’ ability to finance M&A deals but also improves their ability to provide financing for M&A deals that are aligned with banks’ incentives.
Contents
1 Introduction ... 5
2 Literature review ... 8
2.1 Capital market frictions ... 8
2.2 Agency relationships ... 9
2.3 Hypothesis development ... 13
2.3.1 Monitoring channel ... 14
2.3.2 Financing channel ... 15
3 Methodology and data ... 17
3.1 Methodology ... 17 3.2 Data ... 18 4 Results ... 20 5 Conclusion ... 22 References ... 23 Appendices ... 29
1 Introduction
Firms seeking financing for investment projects can turn to the capital market where stock and bonds are traded (Stiglitz, 1972; Houston and Ryngaert, 1997). In a frictionless capital market providers of capital can increase the productivity of investments by perfectly allocating their funds to the most qualified firms (Greenwood and Jonanovic, 1990). However, frictions do exist and impede investment opportunities (Hubbard, 1997). Section 2.1 examines how capital market frictions can impede investment opportunities.
This research focuses on how asymmetric information and misalignment of incentives cause an agency problem between shareholders, debt holders, and management of the firm (Healy and Palepu, 2001). Agency relationships exist when there is ‘’a contract under which one or more persons (principal(s)) engage another person (agent) to perform some service on their behalf which involves delegating some decision-making authority to the agent’’ (Jensen and Meckling, 1976). In this relationship problems arise when after parties have entered an agreement, there are conflicting interests between the agent and principal and the agent does not act in the best interests of the principal. In the capital market setting the main agency relationships are between shareholders and the firm’s management, and between debt holders and shareholders (Masulis, 1988; Healy and Palepu, 2001).
Shareholders invest capital in a firm but usually do not actively manage the firm. They delegate this responsibility to the firm’s management. Therefore shareholders expect management to act in the shareholders’ best interest. An agency problem arises when there are conflicts of interests between the two parties. Monitoring management’s actions can reduce the agency problem. However, monitoring activities are costly and therefore shareholders often delegate this to debt holders. Debt holders usually have a larger outstanding debt than the invested capital per shareholder and therefore a greater incentive to perform the costly monitoring activities. Debt holders reduce potential agency problems by monitoring management’s activities and withholding financing (Huang et al., 2012).
The delegation of monitoring activities creates the second agency relationship. Banks perform services with decision-making activities for shareholders. Agency problems arise between the two parties when there is asymmetric information and/or conflicts of interests. Shareholders can mitigate the potential agency problem by ensuring that their incentives are aligned with those of management (Jensen and Meckling, 1976; Morck et al., 1998). Debt holders’ incentive always is maximization of the possibility of loan repayment,
regardless of their relationship with shareholders. Section 2.2 elaborates on the agency relationships and potential agency problems.
Section 2.3 examines the divergence in incentives with regard to mergers and acquisitions (M&A). Shareholders and management prefer using debt for high-risk capital projects such as M&A because it ‘’increases the likelihood of both good outcomes that disproportionately benefit shareholders, and bad outcomes that are disproportionately borne by debt holders’’ (Healy and Palepu, 2001:409). This limits their investment ability because debt holders will not provide financing for M&A deals that they consider too risky. Whether debt holders are willing to invest in high-risk M&A deals, depends on their monitoring and financing behaviour.
The U.S. interstate banking deregulation caused an intense period of bank mergers. The larger, consolidated banks experienced changes in their monitoring and financing behaviour. This research intends to determine how these changes affected the amount of M&A deals within the U.S by following the monitoring and financing channels of banks.
On the monitoring side, merged banks experienced a change in monitoring style from producing private information to relying more on publicly disclosed information (Chen and Vashishtha, 2017). Less monitoring activities by debt holders increases the risk of providing the loan. Merged banks also experienced an improved ability to geographically diversify their capital portfolio following the deregulation. Capital diversification allows banks to finance high-risk capital projects more freely without increasing the banks’ overall risk (Amore et al., 2013). The less risk averse behaviour of banks for individual loans suggests an increase in M&A deals associated with higher risk. The monitoring channel also shows that due to the increased geographic scope, banks’ experienced an improved ability to be more selective in their financing activities. This suggests an increase in M&A deals that are more aligned with banks’ incentives. Section 2.3.1 elaborates on the effects of the U.S. interstate banking deregulation through the monitoring channel.
On the financing side, the U.S. interstate banking deregulation resulted in an increased credit supply (Jayaratne and Strahan, 1998). The increased financing ability suggests an increase in all types of M&A deals. However some borrowers might experience a stronger increase in credit availability due to alignment of incentives with debt holders. Section 2.3.2 elaborates on the effects of the U.S. interstate banking deregulation through the financing channel.
Section 3.1 outlines the difference-in-difference analysis used to determine the causal relationship between the U.S. interstate banking deregulation and the state-level amount of M&A deals. Section 3.2 presents the data used for the sample of U.S. M&A transactions. Section 4 shows the results of the difference-in-difference analysis and describes the effects of the deregulation on M&A deals. Section 5 concludes the research.
2 Literature review
2.1 Capital market frictions
Firms that are interested in long-term investment opportunities can finance these in two ways. Firstly, firms can use their own financial resources. Advantages of internal financing include that firms do not require approval of external parties that provide the financing and are not dependent on the availability of funds at potentially high prices (Jensen, 1986). Secondly, firms can turn to the capital market, which consists of the equity (stock) market and the debt (bond) market (Stiglitz, 1972; Houston and Ryngaert, 1997). One of the activities of banks is the role of investor purchasing long-term debts (Duff and Einig, 2009).
Banks can increase the productivity of investments by allocating funds to the most qualified firms (Greenwood and Jovanovic, 1990). In a frictionless capital market there would be an optimal allocation of capital and banks would only allocate funds to the most qualified firms. The capital market environment however does contain frictions and these constraints affect investment opportunities (Hubbard, 1997). Healy and Palepu (2001) describe the following two situations in which asymmetric information and misalignment of incentives impede the efficient allocation of capital for banks.
Firstly, banks face an information problem also known as the ‘lemons’ problem. Akerlof (1970) defined this as a situation in which there is asymmetric information and conflicting interests between borrowers and lenders. Lenders have less information about the actual value and incentives of borrowers for the investment opportunity. It is therefore difficult as a lender to distinguish the ‘good’ from the ‘bad’ investment opportunities. This results in investment opportunities to be valued at average. This means that lenders will undervalue the ‘good’ opportunities and overvalue the ‘bad’ opportunities. The problem of asymmetric information about the value and incentives of the investment opportunity leads to an ‘adverse selection’, which creates a gap between the cost of external financing in an uninformed capital market and internally generated funds (Akerlof, 1970). This entails that lenders will charge a higher interest rate for their loan to compensate for their risk due to incomplete information. For borrowers the higher interest rate is an example of ‘information costs’ (Hubbard, 1997).
Secondly, banks face an ‘agency problem’. Jensen and Meckling (1976) define an agency relationship as ‘’a contract under which one or more persons (the principal(s))
engage another person (the agent) to perform some service on their behalf which involves delegating some decision-making authority to the agent’’. An agency problem arises when after parties have entered agreement, there are conflicting interest between the agent and principal and the agent does not act in the best interests of the principal. The costs incurred by the principal to limit divergences of both parties are known as ‘agency costs’ (Jensen and Meckling, 1976).
2.2 Agency relationships
Jensen and Meckling (1976) emphasize that the agency relationship and agency problem are quite general and exists in all organisations and at every level in firms, in universities, in mutual companies, in cooperatives, in governmental authorities and bureaus, and in unions. In all these situations contractual relations differ. In this research I will focus on the agency relationships of the capital market between shareholders and the firm’s management, and between debt holders and shareholders.
Masulis (1988) stresses that the agency relationship between shareholders (principals) and firm’s management (agent) has the most severe conflicts of interests. Shareholders are savers that invest capital in a firm but normally do not actively manage the firm. They delegate this responsibility to the firm’s management (Healy and Palepu, 2001). Management (agent) performs a service that involves decision-making on behalf of shareholders (principals). In a situation with conflicts of interests between shareholders and management, an agency issue arises. Shareholders’ interest is maximisation of the firm’s market value, whereas management’s interest often is personal benefit maximisation, even if this is at the expense of shareholders (Jensen and Meckling, 1976). Management can maximize personal benefits at the expense of shareholders in a corporate setting of ‘separation of ownership and control’. Fama and Jensen (1983) define this as ‘‘organisations in which important decision agents do not bear a substantial share of the wealth effects of their decisions’’. Because management does not receive a substantial share of the wealth effects it has an incentive to make decisions in self-interest while expropriating the funds received by shareholders (Bothwell, 1980). Examples of such decisions are to acquire perquisites, pay excessive compensation, or make investment or operating decisions that are harmful to the interests of outside investors (Jensen and Meckling, 1976). Murphy (1985) explains that investment decisions can conflict with shareholders’ interest when the investment only increases the size of the company without adding any value to the company’s shares. Managers are often
interested in expansion because their remuneration and prestige are positively correlated with company size. In the agency relationship between shareholders and management, shareholders bear the risk of moral hazard. This means that shareholders have entered a contract with the agent assuming that the agent would act in their best interest. However, conflicts of interests and asymmetric information create a situation in which management can expropriate shareholders’ funds and perform value-destroying activities in personal interests (Jensen, 1986).
Agency costs are additional costs resulting from resolving conflicts of interests between two parties (Ross et al., 2005). In the agency relationship between shareholders and the firm’s management, the shareholders are the principals and therefore the agency costs are borne by them (Ross et al., 2005). Jensen and Meckling (1976: 308) state that agency costs are the sum of: monitoring expenditures of the principal; the bonding expenditures by the agent; and the residual loss. Monitoring expenditures are costs related to monitoring the activities of the agent to limit potential aberrant activities of shareholders’ interest. Bonding expenditures, also known as ‘contracting costs’, are related to payments that management will receive when it does not make certain decisions that can harm shareholders’ interest. The residual loss is the reduction in share value due to divergent interests between shareholders and management.
Shareholders can reduce the agency problem by monitoring management (agent) to limit managerial actions that harm shareholders’ interests (Jensen and Meckling, 1976). The amount of agency costs related to these monitoring activities depends on how many principals are monitoring the agent. In a contractual situation, such as between shareholders and management, every single shareholder can perform monitoring activities individually. Diamond (1996) explains that the shareholder will compare the physical cost of monitoring (K) with the resulting savings (S) of contracting costs. This means that monitoring is worthwhile when the costs of monitoring are lower than the savings of contracting costs (K<S). When there are several shareholders (m) however, every shareholder has to monitor the additional information. This means that ((m x K) <
S) now holds. Diamond (1996) elaborates on the alternative that shareholders have for
monitoring individually, which is delegating it to one party such as the bank that has an outstanding loan with the company. Both parties have a stake in the firm, shareholders a stake in the firm’s equity and the bank a stake in the firm’s debt. Monitoring activities of the bank can reduce moral hazard issues and limit managerial actions of self-interest (Demiroglu and James, 2010). The bank usually has a larger outstanding debt than the
invested capital per shareholder, and therefore has a greater incentive to perform costly monitoring activities for the borrowing firm. The delegation of monitoring activities to the bank reduces (m) and therefore increases the difference between K<S. This situation in which shareholders benefit from the monitoring activities of banks without bearing the costs is known as ‘free-riding’ (Carletti et al., 2004). Vashishtha (2014) state that shareholders will not duplicate the costly monitoring activities and delegate the monitoring activities when they believe that the intervention of the bank benefits both creditors and shareholders (‘conflict resolution hypothesis’). Both parties have equal incentives, which is cost saving for the firm. Cost reduction improves the firm’s financial liquidity, which increases the chance that it can repay its loan to the bank and increases its firm value for shareholders.
When the bank performs the role of delegated monitor for shareholders a new agency relationship is created. The bank (agent) performs services with decision-making activities for shareholders (principals). When there are no such frictions as conflicts of interests between the two parties and no asymmetric information, there are no agency issues. However Diamond (1996) demonstrates that monitoring delegation gives rise to a new private information problem. In this setting, the bank (agent) now has more information about the firm’s activities than the shareholders (principals). This asymmetric information leads to delegation costs (D) when there misalignment of incentives. The ‘expropriation hypothesis’ describes a situation in which shareholders believe that the debt holder will use its position to preserve the value of its debt claim at the cost of the equity claims (Vashishtha, 2014). It is worthwhile for shareholders to have the bank as delegated monitor when the costs of using this financial intermediary are lower than not monitoring at all or monitoring themselves (‘direct monitoring’). Diamond (1996) uses the following equation: where (K+D) are the costs of having the bank as delegated monitor, (S) the costs of not monitoring at all, and (m x K) the costs of direct monitoring.
K + D ≤ min [S, m x K] (1)
In the agency relationship between shareholders and management, the bank could mitigate potential moral hazard problems by monitoring management’s activities and withholding financing (Huang et al., 2012). In the agency relationship between debt holders and shareholders, management can play a role in mitigating potential agency issues for shareholders. Shareholders can ensure that incentives of shareholders are
aligned with those of management through managerial ownership (Jensen and Meckling, 1976; Morck et al., 1988). Where separation of ownership and control causes a misalignment of incentives between shareholders and management, managerial ownership creates alignment of incentives between the two parties because management also becomes shareholder. The mechanism of stock-based compensation plans align incentives for a longer period of time as these are not exercisable until after usually three or four years (Chen and Warfield, 2005). These two measures provide incentives for management to make decisions in shareholders’ interests at the expense of debt holders. The increased influence of the bank as delegated monitor is therefore limited. This reduces the agency issue for shareholders in the agency relationship between shareholders and debt holders in which the debt holder is the delegated monitor.
Managerial ownership reduces the agency issue for shareholders in the agency relationship between shareholders and debt holders. For debt holders however, managerial ownership increases agency issues. The debt holder (principal) has asymmetric information concerning managerial actions and their incentives are not aligned. The bank’s incentive is maximisation of the possibility of loan repayment, whereas the management’s incentive is maximisation of shareholder welfare (Healy and Palepu, 2001). Management can expropriate the value of the bank’s loan by using it issuing more senior claims, by paying out the cash received as dividend, or by taking on high-risk capital projects (Smith and Warner, 1979). By using debt for high-risk capital projects, management ‘‘increases the likelihood of both good outcomes that disproportionately benefit shareholders, and bad outcomes that are disproportionately borne by debt holders’’ (Healy and Palepu, 2001: 409).
Banks as debt holder can mitigate their agency issue with the following two mechanisms. Firstly, banks can monitor and potentially block high-risk capital projects if the bank considers them too risky (Huang et al., 2012). Secondly, the bank can substitute due diligence and monitoring activities by setting debt contract terms. Manove et al. (2001) describes this as the ‘lazy bank hypothesis’, in which banks increase covenants and collateral to protect them from downside risk.
2.3 Hypothesis development
When providing loans for high capital projects such as mergers and acquisitions (M&A) misalignment of incentives can exist between shareholders, debt holders, and management. Shareholders are merely interested in maximization of their welfare and therefore prefer ‘concentrating deals’. This type of M&A deal is between firms that operate within the same industry and can therefore generate efficiency gains but also increases a firm’s business risk, as it is concentrated in one industry. The increased risk causes a higher share price volatility, which positively affects it share price and is therefore beneficial for shareholders. Debt holders that provide the financing for the deal are merely interested in limiting the credit risk they face and therefore prefer ‘diversifying deals’. This type of M&A deal is between firms that operate in different industries and can therefore reduce the business risk of the acquiring firms. The interests in concentrating and diversifying deals cause a misalignment of incentives between debt holders and shareholders. Debt holders do not benefit from increases in share prices and only bear the risk of concentrating deals. Whereas shareholders’ share price is negatively affected due to diversifying deals that benefit banks. Management’s incentives to engage in M&A deals can be to increase firm value (concentrating deals), to reduce business risk (diversifying deals), or because of empire building motives. The ‘empire-building’ theory describes management desire to engage in M&A activities for power motives as firm expansion leads to increased remuneration and prestige (Rhoades, 1983; Black, 1989). Investments based on empire building motives can be in both concentrating and diversifying M&A deals. Figure 1 shows the types of deals that the three different parties are interested in. The missing arrow between shareholders and the debt holder indicates the misalignment of incentives between the two parties.
Figure 1: Preferred M&A deals of parties in agency relationship
Management: Concentra.ng, Diversifying, Empire building Debt holder: Diversifying Shareholders: Concentra.ng
In the 1980’s the passage of the U.S. interstate banking deregulation caused a wave of mergers in the banking sector. This significantly altered banks’ ability and incentives to monitor and finance borrowers (Berger et al., 1999). For a specification on why countries (de-) regulate their banking sectors and on the U.S. interstate banking deregulation, I refer to the Appendix. How the deregulation, which led to banking mergers, affected banks’ behaviour with regard to M&A deals will be discussed along the monitoring and financing channel.
2.3.1 Monitoring channel
The U.S. interstate banking deregulation caused a wave of banking mergers1. The larger, consolidated banks are less effective at collecting and processing soft information, but may be more efficient at processing hard, public information (Chen and Vashishtha, 2017:59). The change in monitor style affected the type of information supplied by firms about their investments2. Monitoring activities are performed to reduce misalignment of incentives. Therefore a reduction in monitoring activities following the deregulation suggests an increase in riskier, concentrating M&A deals.
H1: The U.S. interstate banking deregulation positively affected the amount of concentrating M&A deals within the U.S.
Following the deregulation, banks’ opportunity for capital diversification improved due to geographic expansion3. Capital diversification allows banks to finance high-risk capital projects more freely without increasing the banks’ overall risk (Amore et al., 2013). Concentrating M&A deals are associated with higher risks for banks. Therefore the improved capital diversification opportunities suggest an increase in concentrating M&A deals.
H2: The U.S. interstate banking deregulation positively affected the amount of concentrating M&A deals within the U.S.
1 Banks were able to expand their operations across states through acquiring local banks in other deregulated states
(Jayaratne and Strahan, 1998). The merger wave led to a drop in the total number of banks in the U.S. (Kerr and Nanda, 2009).
2 Diamond (1984) and Fama (1985) show that banks, as providers of debt capital, are in a unique position to access and
produce soft, private information about their borrowers. Prior to the deregulation, small local banks performed costly monitoring activities to determine the level of risk associated with a loan (Dick and Lehnert, 2010). Stein (2002) and
2 Diamond (1984) and Fama (1985) show that banks, as providers of debt capital, are in a unique position to access and
produce soft, private information about their borrowers. Prior to the deregulation, small local banks performed costly monitoring activities to determine the level of risk associated with a loan (Dick and Lehnert, 2010). Stein (2002) and Berger et al. (2005) argue that the changed organisational structure of merged banks fundamentally changed the nature of bank monitoring. This consequently affected their lending practices (Chen and Vashishtha, 2017).
3 Goetz et al. (2013) show the improved ability of capital diversification over geographic areas and industries. Ellison and
The deregulation increased banks’ scope of operations due to fewer geographic restrictions. It provided banks access to alternative markets and clienteles. This resulted in banks being less willing to provide loans that require more monitoring and banks’ therefore became more selective in their lending4. Banks therefore prefer investments that are aligned with their incentive of low credit risk i.e. diversifying M&A deals. Management can pursue diversifying M&A deals for business stabilization and/or for empire building incentives. Regardless of the management’s incentive, an investment in a diversifying M&A deal results in a lower credit risk for the bank and is therefore aligned with its incentives. The improved potential of matching loans with banks’ incentives suggests an increase in diversifying M&A deals following the deregulation.
H3: The U.S. interstate banking deregulation positively affected the amount of diversifying M&A deals within the U.S.
2.3.2 Financing channel
Following the deregulation the consolidated banks experienced an increased credit supply5. Banks with higher amounts of capital were able to provide more financing for investment projects. This suggests an increase in both diversifying and concentrating M&A deals following the deregulation.
H4: The U.S. interstate banking deregulation positively affected the total amount of M&A deals within the U.S.
However, increased credit supply of banks does not automatically lead to increased credit availability for all borrowers 6(Berger et al., 1999; Karceski et al., 2005). The changes in the monitoring environment of banks (as discussed in section 2.3.1) suggest the following changes to credit availability of borrowers. After the deregulation
4 Stein (2002) and Berger et al. (2005) explain that the consolidated banks may be less willing to lend to ‘difficult’
borrowers that require more monitoring. Sapsford (2004) states that banks become more selective in their lending after the deregulation as they gained access to alternative markets and clienteles.
5 Black and Strahan (2002) and Pilloff (2004) show that the deregulation caused a drop in the total number of banks
and therefore an increase in capital for the consolidated banks. The larger banks experienced increased efficiency, which increases their capital (Jayaratne and Strahan, 1998). Demsetz and Strahan (1997) and Liang and Rhoades (1991) show that capital ratios of large banks decline when they diversify their capital.
6 The problem of asymmetric information between a bank and borrowers and potential misalignment of incentives
can impede the flow of credit (Stiglitz and Weiss, 1981). Determinants for credit availability among other factors consist of: the nature and quantity of borrowers’ information provision (Berger and Udell, 2002); if there is a pre-existing relationship between the bank and borrowers (Cole, 1998); the borrowers’ operational geographic location and industry (Sapsford, 2004; Amore et al., 2013).
banks monitoring style changed and affected their role as delegated monitor. Shareholders prefer banks to provide the financing for M&A deals but both parties prefer different M&A deals, which causes an agency conflict. Management ultimately decides what type of investment the firm will make. Diversifying M&A deals are aligned with both banks’ incentives of lower credit risk and management’s incentive of empire building and decreased business risk. The alignment of incentives in combination with banks’ improved ability to be more selective, suggests a stronger increase in diversifying M&A deals compared to concentrating M&A deals.
H5: The U.S. interstate banking deregulation had a stronger effect on the amount of diversifying M&A deals within the U.S. than on concentrating M&A deals.
3 Methodology and data
3.1 Methodology
I use a difference-in-difference model with panel data to determine the causal relationship between the U.S. interstate banking deregulation and M&A (Stock and Watson, 2011). The difference-in-differences model is a version of fixed effects estimation and often used to determine the effect of a treatment or policy. It compares outcomes of a certain variable before and after a treatment/policy and compares these observations with a ‘control group’ that has not been affected by the treatment/policy (Stock and Watson, 2011). The difference-in-difference estimator is the average change in the dependent variable for those in the treatment group minus the average change in the dependent variable for those in the control group (Stock and Watson, 2011). The advantage of using the difference-in-difference model is that it controls for omitted variables and absorbs nationwide shocks or common trends that might affect the outcome of interests (Amore et al., 2013: 839).
Gormley and Matsa (2011) propose a matching difference-in-difference estimator while using panel data to identify M&A deals of firms incorporated in states that passed the deregulation in that year and compare them with M&A deals of firms not incorporated in those states. With this model M&A deals can be grouped on state level to determine the effect of the interstate banking deregulation while controlling for unobserved variables that differ between states and for variables that vary through time but not across states.
𝑇𝑜𝑡𝑎𝑙 𝑀&𝐴!" = 𝛼!𝐷𝑒𝑟𝑒𝑔𝑢𝑙𝑎𝑡𝑖𝑜𝑛!"+ 𝛽!+ 𝛾!+ 𝜀!" (1)
𝐶𝑜𝑛𝑐𝑒𝑛𝑡𝑟𝑎𝑡𝑖𝑛𝑔 𝑀&𝐴!" = 𝛼!𝐷𝑒𝑟𝑒𝑔𝑢𝑙𝑎𝑡𝑖𝑜𝑛!"+ 𝛽!+ 𝛾!+ 𝜀!" (2)
𝐷𝑖𝑣𝑒𝑟𝑠𝑖𝑓𝑦𝑖𝑛𝑔 𝑀&𝐴!" = 𝛼!𝐷𝑒𝑟𝑒𝑔𝑢𝑙𝑎𝑡𝑖𝑜𝑛!"+ 𝛽!+ 𝛾!+ 𝜀!" (3)
The difference-in-difference regression model with fixed effects captures the effect of the interstate banking deregulation on the level of total/concentrating/diversifying M&A by comparing state-level outcomes before and after each deregulation year vis-à-vis deregulation passed later (Amore et al., 2013). Where total/concentrating/diversifying M&A is the total amount of total/concentrating/diversifying M&A deals in state s in year
t; 𝛼 is the difference-in-difference estimator; Deregulation is a dummy variable with the
value of 1 in all state-years following deregulation and 0 in all state-years prior to deregulation; 𝛽 are the year-specific fixed effects; 𝛾 are the state-specific fixed effects; and 𝜀 is the error term. Following Gormley and Matsa (2016) M&A deals are considered diversifying when the primary standard industrial classification (SIC) industry of the acquirer does not coincide with any SIC code of the target firm. M&A deals are considered concentrating when the primary SIC industry of the acquirer is equal to that of the target firm. Following Strahan (2002) I will determine the effect of the U.S. interstate banking deregulation on diversifying M&A on state-level as this provides a balanced panel data set because states do not enter or exit the sample.
3.2 Data
To determine the effect on the U.S. interstate banking deregulation on diversifying M&A deals I use data from the Thomson Reuters – Securities Data Company (SDC) database and from the Wharton Research Data Services – Compustat database.
My sample of total M&A deals is obtained from the SDC database. Following Gormley and Matsa (2016) I wanted to analyse all the M&A transactions in the ten years before and in the ten years after the first and last state adoption of the interstate banking deregulation. This would have led to a research time period of 1968-2003 being ten years before Maine was the first state to pass the deregulation and ten years after Montana passed the deregulation in 1993. However, in 1997 the Interstate Banking and Branching Efficiency Act (IBBEA) of 2004 was enacted which encouraged states to permit interstate branching (Strahan, 2002). Following Strahan (2002) and Amore et al. (2013) I end my sample at the time of the interstate branching implementation to ensure that my findings on the effect on the interstate banking deregulation are not contaminated by the passage of interstate branching laws. This leads to a sample period of 1968-1996.
I selected M&A deals with the announcement date between January 1, 1968 and December 31, 1996. Following Huang (2012) and Gormley and Matsa (2016) I excluded M&A deals meeting any of the following criteria: (1) financial firms (SIC code between 6000-6999) and utility firms (SIC code between 4900-4949), (2) the acquiring firm controlled more than 50% of the target prior to the announcement date of less than 100% after the acquisition was completed, (3) the transactions value was less than $1million, (4) the ultimate parent of the acquirer and the target are the same, (5) the deal was not
completed within one thousand days of the announcement date, (6) if the ratio of the deal size to market value of the acquirer’s assets if less than 1%, or (7) non-U.S. acquirer.
To determine the state of incorporation of the acquirer and to calculate the market value of the acquirer’s assets and I merged the observations of the SDC database with the Compustat database using firm specific CUSIP-codes. After applying all the filters the sample consists of 356 M&A deals from 36 out of 51 states over the period 1978-1996.
To determine the sample for concentrating M&A deals a subsample is created by selecting the observations of which the acquirer’s primary industry SIC code is equal to the target’s primary industry SIC code. To determine the sample for diversifying M&A deals a second subsample is created by selecting the observations of which the primary industry SIC code of acquirer and target are not equal.
To create panel data sets all observations of total/concentrating/diversifying M&A deals were grouped per state of incorporation of the acquirer and year of announcement. All the years of interstate banking deregulation per state are obtained from Strahan (2002) (See table 1 in the appendix).
4 Results
Table 1 provides the results for the regression of equation (1), (2), and (3) from section 3.1. The coefficient 𝛼!,!,! are the difference-in-difference estimators that measure the effect of the U.S. interstate banking deregulation on the state-level amount of total, concentrating, and diversifying M&A deals.
Gormley and Matsa (2016) and Amore et al. (2013) excluded the state of Delaware from their sample because over 50% of M&A observations were from firms incorporated in Delaware. In this sample 61% of the observations are from firms incorporated in Delaware, therefore all observations from Delaware are dropped from the sample. The high amount of incorporated firms in Delaware can be explained by the favourable legal treatment of incorporation in Delaware (Strahan, 2002). Keeping the observations of Delaware in the sample could potentially mislead the analysis of the effect of the deregulation on M&A because the observations consist of more than half of the total sample observations.
Following the monitoring channel, I expected an increase in both concentrating and diversifying M&A deals. Regression (2) shows a modest increase in the state-level amount of concentrating M&A deals followings the deregulation. The difference-in-difference estimator shows a yearly increase of 0,03 concentrating M&A deals on state-level. The result is significant at 10%. Therefore H1 and H2 can be accepted and I can pose that the U.S. interstate banking deregulation positively affected the amount of concentrating M&A deals within the U.S.
Regression (3) shows an increase in the state-level amount of diversifying M&A deals after the passage of the deregulation. The difference-in-difference estimator shows that states in the years after the deregulation experienced 0,22 more diversifying M&A deals per year. The regression result is significant at 10%. Therefore I can accept H3 and pose that the U.S. interstate banking deregulation positively affected the amount of concentrating M&A deals within the U.S.
Following the financing channel, I expected an increase in the total amount of M&A deals and a stronger increase in diversifying M&A deals compared to concentrating M&A deals.
Regression (1) shows an increase in the state-level amount of total M&A deals in the years following the deregulation. The difference-in-difference estimator shows a yearly increase of 0,28 M&A deals on state level. The result is significant at 5%.
Hypothesis 5 poses that the U.S. interstate banking deregulation had a stronger positive effect on diversifying M&A deals compared to concentrating M&A deals. The regression for diversifying M&A deals shows a difference-in-difference estimator of 0,22 compared to 0,03 for concentrating M&A deals. As explained in section 2.3.2, I expect that the aligned incentives of management and debt holders due to the deregulation caused a stronger increase in diversifying M&A deals compared to concentrating M&A deals.
Table 1. Regression results
Dependent variables
Total M&A Concentrating M&A Diversifying M&A
(1) (2) (3)
Deregulation 0,2832732** 0,0311082* 0,2171562*
Year fixed effects Yes Yes Yes
State fixed effects Yes Yes Yes
Additional controls No No No
Number of obs. 356 127 229
This table reports the difference-in-difference estimator that follows from the
5 Conclusion
I provide evidence that the U.S. interstate banking deregulation caused an increase in domestic M&A deals. The effects are larger for diversifying M&A deals than for concentrating M&A deals. The deregulation caused changes in banks’ monitoring and financing behaviour, which resulted in increases in M&A deals. The incentives of debt holders (who provide the financing) and management (who ultimately decide on the investment) are more aligned with diversifying M&A deals, which explains the stronger increase. To the best of my knowledge, this is the first study to provide evidence on the causal link between the U.S. interstate banking deregulation and M&A deals. It is still a topic of debate whether banking deregulation is preferable. It is therefore important to determine the effects of deregulation on banks’ behaviour. This research shows an increase of M&A deals following deregulation during the 1980s and 1990s. In the past two decades U.S. firms have shown high growth rates in M&A activities. The importance of the effects of banking deregulation on M&A has therefore increased.
The U.S. interstate banking deregulation resulted in a stronger increase in diversifying M&A deals compared to concentrating M&A deals. In the agency relationship between shareholders and debt holder, management can reduce the agency problem for shareholders through alignment of incentives. The increase in diversifying M&A deals however implies an alignment of incentives between management and debt holders. This finding intensifies the importance of the effects of banking deregulation on M&A activities, as it suggests a divergence from shareholders’ interest.
In summary, my research suggest that the geographic deregulation is not only an important determinant of banks’ ability to finance M&A deals but also improves their ability to provide financing for M&A deals that are aligned with banks’ incentives.
References
Adams, R.M. (2012) Consolidation and merger activity in the United States banking industry from 2000 through 2010, Finance and Economics Discussion Series of Federal Reserve Board, 51. Akerlof, G.A. (1970) The market for ‘Lemons’: Quality uncertainty and the market mechanism,
The Quarterly Journal of Economics, 84(3), pp. 488-500.
Akhavein, J.D., Berger A.N. and Humphrey, D.B. (1997) The effects of bank mega-mergers on efficiency and prices: Evidence from the profit function, Review of Industrial Organisation, 12.
Amore, M.D., Schneider, C. and Žaldokas, A. (2013) Credit supply and corporate innovation,
Journal of Financial Economics, 109, pp. 835-855.
Risk Management Group of the Basel Committee on Banking Supervision (2000) Principles for the management of credit risk, Basel Committee on Banking supervision.
Bencivenga, V. and Smith, B. (1991) Financial intermediation and endogenous growth. Review of
Economic Studies, 58, pp. 195-209.
Berger, P.G. and Ofek, E. (1995) Diversification’s effect on firm value, Journal of Financial
Economics, 37, pp. 39-65.
Berger, A.N., Demsetz, R.S. and Strahan, P.E. (1999) The consolidation of the financial services industry: Causes, consequences, and implications for the future, Journal of Banking & Finance, 23(2), pp. 135-194.
Berger, A.N. and Udell, G.F. (2002) Small business credit availability and relationship lending: The importance of bank organisational structure, The Economic Journal, 112(477), pp. 32-53.
Berger, A.N., Miller, N., Petersen, M., Rajan, R. and Stein, J. (2005) Does function follow
organisational form? Evidence from the lending practices of large and small banks, Journal of
Financial Economics, 76, pp. 237-269.
Black, B. (1989) Bidder overpayment in takeovers, forthcoming in Stanford Law Review.
Black, S.E. and Strahan, P.E. (2002) Entrepreneurship and bank credit availability, The Journal of
Bothwell, J.L. (1980) Profitability, risk, and the separation of ownership from control, The Journal
Of Industrial Economics, 28(3), pp. 303-311.
Boyd, J.H. and De Nicolo, G. (2005) The theory of bank risk taking and competition revised, The
Journal of Finance, 60(3), pp. 1329-1343.
Bruner, R.F. (2002) Does M&A pay? A survey of evidence for the decision-maker, Journal of
Applied Finance, 12(1), pp. 48-68.
Carletti, E., Cerasi, V. and Daltung, S. (2004) Multiple-bank lending: Diversification and free-riding in monitoring, Sveriges Riksbank Working Paper Series, 165.
Cetorelli, N. and Strahan, P.E. (2006) Finance as a barrier to entry: Bank competition and industry structure in local U.S. markets, Journal of Finance, 61(1), pp. 437-461.
Chan, Y., Greenbaum, S. and Thakor, A. (1986) Information reusability, competition and bank asset quality, Journal of Banking and Finance, 10, pp. 243-253.
Chen, Q. and Vashishtha, R. (2017) The effects of bank mergers on corporate information disclosure, Journal of Accounting and Economics.
Cheng, Q. and Warfield, T.D. (2005) Equity incentives and earnings management, The Accounting
Review, 80(2), pp. 441-476.
Cole, R.A. (1998) The importance of relationships to the availability of credit, Journal of Banking
& Finance, 22(6), pp. 959-977.
Demiroglu, C. and James, C.M. (2010) The information content of bank loan covenants, The
Review of Financial Studies, 23(10).
Demsetz, R.S. and Strahan, P.E. (1997) Diversification, size, and risk at bank holding companies,
Journal of Money, Credit and Banking, 29(3), pp. 300-313.
Demyanyk, Y., Ostergaard, C. and Sørensen, B. (2007) U.S. banking deregulation, small
businesses, and interstate insurance of personal income, Journal of Finance, 62, pp. 2763-2801.
Diamond, D. (1984) Financial intermediation and delegated monitoring, Review of Economic Studies, 51(3), pp. 393-414.
Dick, A. and Lehnert, A. (2010) Personal bankruptcy and credit market competition, Journal of
Finance, 65, pp. 655-686.
Ellison, G. and Glaeser, E.L. (1999) The geographic concentration of industry: Does natural advantage explain agglomeration?, The American Economic Review, 89(2), pp. 311-316.
Evans, P., Hasan, I. and Lozano-Vivas, A. (2008) Deregulation and convergence of banking: The EU experience, Finnish Economic Papers, 21(2).
Fama, E.F. (1985) What’s different about banks?, Journal of Monetary Economics, 15, pp. 29-39.
Fama, E.F. and Jensen M.C. (1983) Separation of ownership and control, The Journal of Law and
Economics, 26(2), pp. 301-325.
Greenwood, J. and Jovanovic, B. (1990) Financial development, growth, and the distribution of income, Journal of Political Economy, 98, pp. 1076-1107.
Goetz, M., Laeven, L. and Levine, R. (2012) The valuation effects of geographic diversification: Evidence from U.S. banks, Unpublished working paper, Federal Reserve Bank of Boston, IMF,
and University of California, Berkeley.
Goetz, M., Laeven, L. and Levine, R. (2013) Identifying the valuation effects and agency costs of corporate diversification: Evidence from the geographic diversification of U.S. banks, Review
of Financial Studies, 26(7), pp. 1787-1823.
Gormley, T.A. and Matsa, D.A. (2011) Growing out of trouble? Corporate responses to liability risk, The Review of Financial Studies, 24(8), pp. 2781-2821.
Gormley, T.A. and Matsa, D.A. (2014) Common errors: How to (and not to) control for unobserved heterogeneity, The Review of Financial Studies, 27(2), pp. 617-661.
Gormley, T.A. and Matsa, D.A. (2016) Playing it safe? Managerial preferences, risk, and agency conflicts, Journal of Financial Economics, 122(3), pp. 431-455.
Huang, S., Srinivasan, A. and Lu, R. (2012) Do banks monitor corporate decisions? Evidence from bank financing of mergers & acquisitions, Research Collection Lee Kong Chian School of
Healy, P.M. and Palepu, K.G. (2001) Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature, Journal of Accounting and
Economics, 31, pp. 405-440.
Hellmann, T.F., Murdock, K.C. and Stiglitz, J.E. (2000) Liberalization, moral hazard in banking, and prudential regulation: Are capital requirements enough? The American Economic Review, 90(1), pp. 147-165.
Houston, J.F. and Ryngaert, M.D. (1997) Equity issuance and adverse selection: A direct test using conditional stock offers, Journal of Finance, 52(1), pp. 197-219.
Hubbard, R.G. (1997) Capital market imperfections and investment, NBER Working Paper, 5996. Jarrow, R.A. and Turnbull, S.M. (1995) Pricing derivatives on financial securities subject to credit
risk, Journal of Finance, 50(1), pp. 53-85.
Jayaratne, J. and Strahan, P. (1998) Entry restrictions, industry evolution, and dynamic efficiency: evidence from commercial banking, Journal of Law and Economics, 41, pp. 239-274.
Jensen, M.C. (1986) Agency costs of free cash flow, corporate finance and takeovers, The
American Economic Review, 76(2), pp. 323-329.
Jensen, M.C. and Meckling, W.H. (1976) Theory of the firm: Managerial behaviour, agency costs and ownership structure, Journal of Financial Economics, 3, pp. 305-360.
Jiménez, G., Lopez, J.A. and Saurina, J. (2013) How does competition affect bank risk-taking?,
Journal of Financial Stability, 9, pp. 185-195.
Johnson, C. and Rice, T. (2008) Assessing a decade of interstate bank branching, The Washington
and Lee Law Review, 65, pp. 73-127.
Karceski, J., Ongena, S. and Smith, D.C. (2005) The impact of bank consolidation on commercial borrower welfare, Journal of Finance, 60(4), pp. 2043-2082.
Keeley, M.C. (1990) Deposit insurance, risk and market power in banking, American Economic
Kerr, W. and Nanda, R. (2009) Democratizing entry: banking deregulation, financing constraints, and entrepreneurship, Journal of Financial Economics, 94, pp. 124-149.
Liang, J.N. and Rhoades, S.A. (1991) Asset diversification, firm risk, and risk-based capital requirements in banking, Review of Industrial Organisation, 6, pp. 49-59.
Lintner, J. (1965) Security prices, risk, and maximal gains from diversification, The Journal of
Finance, 20(4), pp. 587-615.
Manove, M., Padilla, A.J. and Pagano, M. (2001) Collateral versus project screening: A model of lazy banks, RAND Journal of Economics, 32, pp. 726-744.
Marquez, R. (2002) Deregulation and bank policy, Journal of Banking and Finance, 8, pp. 557-565. Masulis, R. (1988) Debt/Equity choice, Ballinger Publishing Company.
Meckl, R. (2004) Organising and leading M&A projects, International Journal of Project Management, 22(6), pp. 455-462.
Merton, R.C. (1974) On the pricing of corporate debt: The risk structure of interest rates, The
Journal of Finance, 29(2), pp. 449-470.
Morck, R., Shleifer, A. and Vishny, R.W. (1988) Management ownership and market valuation: An empirical analysis, Journal of Financial Economics, 20(1-2), pp. 293-315.
Murphy, K.J. (1985) Corporate performance and managerial remuneration: An empirical analysis,
Journal of Accounting and Economics, 30, pp. 245-278.
Nieto, M. J. and Wall, L.D. (2015) Breaking down geographic barriers on banks: U.S. and EU recent experiences, Federal Reserve Bank of Atlanta.
Pilloff, S.J. (2004) Bank merger activity in the United States, Board of Governors of the Federal Reserve
Systems, staff study 176.
Rhoades, S.A. (1983) Power, empire building, and mergers, D.C. Heath & Co., Lexington, M.A.
Ross, S.A., Westerfield, R.W. and Jaffe, J. (2005) Corporate Finance, International Edition, 7thed.,
Sapsford, J. (2004) Executives see rise in ‘’tying’’ loans to other fees, The Wall Street Journal, A1. Smith, C. and Warner, J. (1979) On financial contracting: An analysis of bond covenants, Journal
of Financial Economics, 7, pp. 117-161.
Stein, J. (2002) Information production and capital allocation: Decentralized versus hierarchical firms, Journal of Finance, 57, pp. 1891-1922.
Stiglitz, J.E. (1972) Some aspects of the pure theory of corporate finance: Bankruptcies and take-overs, The Bell Journal of Economics and Management Science, pp. 458-482.
Stiglitz, J.E. and Weiss, A. (1981) Credit rationing in markets with imperfect information,
American Economic Review, 71(3), pp. 393-410.
Stock, J.H. and Watson, M.W. (2011) Introduction to econometrics, 3rd ed. (Boston: Addison-Wesley).
Strahan, P.E. (2002) The real effects of U.S. banking deregulation, The Wharton Financial
Institutions Center, 2(39).
Sitglitz, J.E. (1972) Some aspects of the pure theory of corporate finance: Bankruptcies and take-overs, The Bell Journal of Economics and Management Science, 3(2), pp. 458-482.
World Bank (2017) Banking Crisis.
https://www.worldbank.org/en/publication/gfdr/background/banking-crisis
World Bank (2012) Global Financial Development Report: Rethinking the role of the State in finance, World Bank, Washington D.C.
Vashishtha, R. (2014) The role of bank monitoring in borrowers’ discretionary disclosure: Evidence from covenant violations, Journal of Accounting and Economics, 57, pp. 176-195. Wong, K.P. (1997) On the determinants of bank interest margins under credit and interest rate
Appendices
Regulation and deregulation
Banks perform monitoring activities and use covenants and collateral mechanisms to protect their outstanding loans from downside risk. Wong (1997) explains that outstanding loans are subject to performance and the bank does not know ex ante what proportions of its outstanding loans will perform. Banks can partially limit the downside risk on individual loans through monitoring and debt contracts. Frictions will complicate the optimal allocation of capital to investment opportunities. Thus banks will always bear a risk when providing a loan (Healy and Palepu, 2001).
Outstanding loans of banks are subject to non-performance thus banks are subject to downside risk and ultimately can face a credit risk (Jarrow and Turnbull, 1995; Wong, 1997). The Basel Committee on Banking Supervision defines credit risk as ‘‘the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions’’. Banks become ‘insolvent’ when they face negative capital ratios i.e. higher liabilities than assets. When multiple banks in a country face solvency problems at the same time it can lead to a banking crisis, in which these financial institutions experience difficulties repaying contracts (The World Bank, 2017). Hellmann et al. (2000) explain that a banking crisis does not only affect one particular sector of the economy but also the whole economy in shock waves. Governments have implemented prudential banking regulations to protect the banking system from these so called ‘systemic risks’ and to create market transparency about the banks’ activities.
Governmental banking regulation comes in many forms including: capital and reserve requirements, corporate governance, financial reporting and disclosure requirements, credit rating requirements, large exposures restrictions, activity and affiliation restrictions, and geographic limitations.
This research focuses on the effects of geographic deregulations on the monitoring and financing behaviour of banks. Governments enact geographic limitations to reduce competition between banks and to impede to possibility of geographic capital diversification (Nieto and Wall, 2015).
With regard to competition, it is currently still a topic of research and political debate whether banking competition is preferable or not (Cetorelli and Strahan, 2006). Proponents
claim that, as in other industries, competition in the banking industry is desirable for efficiency and maximization of social welfare. Opponents however, emphasize that competition increases risk taking behaviour and due to its roles and functions, there are some properties that distinguish the banking industry from other industries. Therefore opponents state that it is important that the banking sector is efficient, but also stable (World Bank, 2012).
Hellmann et al. (2000) find that increased competition can undermine prudent bank behaviour. The findings of Hellmann et al. (2000) were built on theoretical literature of the ‘franchise value paradigm’ of Keeley (1990). Jiménez et al. (2013: 186) explain this theory as ‘’that banks limit their risk-taking in order to protect the quasi-monopoly rents granted by their government charters. Increased competition would erode those rents and the value of the charters, which would likely lead to greater bank risk-taking and greater financial instability’’. The increased risk-taking of banks is explained by a reduction of banks’ screening and monitoring activities, which increases the overall portfolio credit risk (Chan et al., 1986). The reduction in screening and monitoring activities in combination with a dispersion of borrower-specific information due to an increase in the number of banks in a market, results in higher funding costs and greater access to credit for low-quality borrowers (Marquez, 2002).
With regard to capital diversification, prior research shows consistent results. Diversification is the solution for concentration risk, which is the unequal distribution of exposure to different risk sources (Boyd and De Nicolo, 2005). Following the ‘modern portfolio theory’, banks can reduce their insolvency risk by reducing the return variance of their outstanding loan portfolio by diversifying their capital over borrowers, industries, and geographic areas (Diamond, 1984; Liang and Rhoades, 1991; Goetz et al., 2013). Capital diversification improves a banks’ ability to bear credit risk from individual loans (Demyanyk et al., 2007: 2771). If capital diversification reduces a banks’ insolvency risk, why would governments enforce delimitations on geographic capital diversification?
Demsetz and Strahan (1997:1) found that the size of banks and capital diversification are correlated, but also show that large banks use the advantage of diversification to operate with lower capital ratios and pursue riskier activities. Their findings are consistent with Liang and Rhoades (1991) who state that capital ratios decline when banks diversify their assets, and with Akhavein et al. (1997) who find a shift in outputs following capital diversification from low-risk securities to higher-risk loans. Therefore, a reduction in a bank’s insolvency risk when diversifying its capital portfolio is not a given. The extent to which the insolvency risk decreases depends on banks’ own risk taking behaviour. Prior research shows that increased diversification
has led to banks financing more high-risk projects and operating with lower capital ratios (Demsetz and Strahan, 1997; Amore et al., 2013).
Governments can impede the potential increased risk taking behaviour due to capital diversification by imposing geographic limitations. For small banks, geographic restrictions for their operations hamper their growth opportunities. As mentioned before, capital diversification and size are correlated. Large banks have more capital and therefore more capital diversification options. For large banks, geographic restrictions block capital diversification over geographic areas.
Despite the on-going debate if increased competition and capital diversification due to geographic delimitations in the banking industry is preferable, both the United States and the European Union imposed geographic delimitations in its banking sectors (Strahan, 2002; Evans et al., 2008).
U.S. interstate banking deregulation
In 1956 in the U.S. the Douglas Amendment was added to the Bank Holding Company (BHC) Act. The amendment prohibited a BHC from acquiring banks outside the state where it was headquartered unless the target bank’s state permitted such acquisitions (Strahan, 2002). As states all impeded the cross-state ownership transactions the amendment effectively prevented interstate banking. This entails that banks were not able to operate outside of their own state. Nieto and Wall (2015) state that the geographic limitation was implemented for two reasons. Firstly, the geographic limitations protected small banks from competition of larger banks by blocking expansion across state lines. Secondly, it tied banks to the fates of their local communities, by limiting the banking system’s ability to reallocate resources away from local borrowers experiencing some financial distress (i.e. limitation of capital diversification).
The state of Maine was the first to pass a deregulation law allowing entry by out-of-state BHCs if, in return, banks from Maine were allowed to enter those states and buy local banks. For four years no other states followed the deregulation and therefore BHCs from Maine were not able to actually enter other states. The states of Alaska and New York deregulated in 1982 and all other states – except Hawaii – followed in the next ten years (Johnson and Rice, 2008).
The deregulation entailed geographic delimitation of banks’ operating areas. However the geographic expansion was only permitted under certain conditions. Firstly, both states had to pass the deregulation law before banks from one state could operate in the other state and visa
versa. Secondly, banks were only allowed to operate in a different state if it acquired an existing local bank. Geographic expansion was therefore only possible through mergers and acquisitions (M&A). Thirdly, banks were not to use the newly acquired banking assets for operations outside of the acquired bank’s state. The acquired assets of the local bank were folded into the total amount of assets of the acquiring bank, but were only to be used for operations in the acquired bank’s state. ‘’State-level moves toward interstate banking therefore did not lead to interstate branching’’ (Strahan, 2002: 5). The acquired banks became subsidiaries of the out-of-state bank, not a branch. For example, bank ‘A’ in Texas acquires bank ‘B’ in Colorado. The acquisition of B’s assets are added to A’s totals assets. However as A is from a different state than B, the acquired assets have to be used for operations in Colorado. Bank A can only use the assets for business operations in Colorado.
Year of state-level interstate banking deregulation
Table 1: Year of state-level interstate banking deregulation
State Year of interstate banking deregulation Included in M&A sample Included in diversifying M&A sample
Alabama 1987 Yes No
Alaska 1982 No No
Arizona 1986 Yes No
Arkansas 1989 No No
California 1987 Yes Yes
Colorado 1988 Yes Yes
Connecticut 1983 Yes Yes
Delaware 1988 Yes Yes
D.o. Columbia 1985 No No
Florida 1985 Yes Yes
Georgia 1985 Yes Yes
Hawaii Not deregulated by 1996 No No
Idaho 1985 No No
Illinois 1986 Yes Yes
Indiana 1986 Yes Yes
Iowa 1991 No No
Kansas 1992 Yes Yes
Kentucky 1984 No No
Louisiana 1987 No No
Maine 1978 Yes Yes
Maryland 1985 Yes Yes
Massachusetts 1983 Yes Yes
Michigan 1986 Yes Yes
Minnesota 1986 Yes Yes
Missouri 1986 Yes Yes
Montana 1993 No No
Nebraska 1990 No No
Nevada 1985 Yes Yes
New Hampshire 1987 Yes Yes
New Jersey 1986 Yes Yes
New Mexico 1989 No No
New York 1982 Yes Yes
North Carolina 1985 Yes Yes
North Dakota 1991 No No
Ohio 1985 Yes Yes
Oklahoma 1987 Yes No
Oregon 1986 Yes Yes
Pennsylvania 1986 Yes Yes
Rhode Island 1984 Yes Yes
South Carolina 1986 Yes Yes
South Dakota 1988 No No
Tennessee 1985 Yes Yes
Texas 1987 Yes Yes
Utah 1984 Yes Yes
Vermont 1988 No No
Virginia 1985 Yes Yes
Washington 1987 Yes Yes
West Virginia 1988 No No
Wisconsin 1987 Yes Yes
Wyoming 1987 Yes Yes
