“Relationship between merger announcement and stock returns: evidence from Indian banking” Muneesh Kumar AUTHORS Shalini Kumar Laurence PORTEU De La Morandiere Muneesh Kumar, Shalini Kumar and Laurence PORTEU De La Morandiere ARTICLE INFO (2011). Relationship between merger announcement and stock returns: evidence from Indian banking. Banks and Bank Systems, 6(4) RELEASED ON Wednesday, 08 February 2012 JOURNAL "Banks and Bank Systems" FOUNDER LLC “Consulting Publishing Company “Business Perspectives” NUMBER OF REFERENCES NUMBER OF FIGURES NUMBER OF TABLES 0 0 0 © The author(s) 2021. This publication is an open access article. businessperspectives.org Banks and Bank Systems, Volume 6, Issue 4, 2011 Muneesh Kumar (India), Shalini Kumar (India), Laurence Porteu de La Morandiere (France) Relationship between merger announcement and stock returns: evidence from Indian banking Abstract This paper examines the relationship between merger announcements with the stock returns in the Indian Banking during the period of 1999-2008. Using event study methodology, it attempts to ascertain whether the bidder banks experience significant abnormal returns during the post-announcement and pre-announcement periods. The results indicate that bidder banks may or may not experience any significant abnormal returns during the post-announcement period. No bank specific characteristics could explain the pattern of market reaction to merger announcements. How- ever, significant abnormal returns were observed in daily share prices in majority of the cases, during the pre- announcement period, indicating possibility of leakage of information in the market. Keywords: mergers in banks, merger announcement, consolidation in banking, market reaction, event study methodology, abnormal stock returns, pre-announcement, post-announcement, bidder banks, facilitated mergers, market driven mergers. JEL Classification: G21, D4. Introduction¤ commonly found in mature market economies. Such characteristics include dominance of state owned Banking industry around the globe has undergone banks and M&A transactions driven by policy in- significant transformation under the impact of tech- itiatives instead of market drivers. Present paper nological advances, deregulation and globalization. offers evidence in this regard from the Indian bank- An important aspect of this process has been consoli- ing sector that shares these characteristics with dation, as a large number of banks have been merged, banking sectors of many developing countries. amalgamated or restructured. Although, the process of consolidation began in 1980’s, it accelerated in the 1. Mergers and Indian banking system: 1990’s, leading to the present state of highly concen- an overview trated markets with just a few dominating players Like most developing economies, the banking sys- (Yassin 2011). During the late 1990s, macroeconomic tem in India comprises of different ownership pressures and banking crises forced banking indus- groups, public and private, and within private, do- try to alter its business strategies. The regulators mestic and foreign. Indian banking system has were under pressure to deregulate the banking sector been dominated by the public sector banks for a at the national level and open up financial markets very long time till smaller private banks as well as to foreign competition. This led to increased competi- foreign banks were allowed to coexist but even tion, particularly for the banks in the emerging econo- then their activities were restricted through entry mies that were hitherto operating in a protected envi- regulation and strict branch licensing (Kumbhar- ronment. This led to significant changes in the struc- kar, 2003). At the end of 1990’s, public sector ture of the banking industry, including, among others, banks accounted for nearly 90% of total assets and privatization of state-owned banks, mergers and acqui- deposits with the residual being almost equally sitions (M&A’s) and increased presence of foreign split between private and foreign banks but the banks. The financial value involved in the M&A’s multiplied over the years. As a result of these M&A’s, situation changed by the end of 2008, when private the number of banks has declined substantially both in banks also increased their share significantly to advanced and developing economies. 21.5% and 20.5% in terms of total assets and depo- sits respectively but still public sector banks con- A number of studies have been conducted in the tinued to play a dominant role in the Indian banking. mature markets to find out how the stock markets Another feature of Indian banking is that in the pub- react to the merger announcements and whether the lic sector banks, Government owns 51% to 55% investors perceive the merger announcement as share and the remaining is with the private share- good or bad news for the banks. However, not much holders. Thus, the issue of mergers involving public attention seems to have been paid to this issue in the sector banks is just not a policy issue as it involves developing economies. The results may differ sig- private interest as well. nificantly, particularly in view of the fact that de- veloping countries share peculiar characteristics not A number of steps were taken by Reserve Bank of India (RBI) based on the recommendations of the first Narasimham Committee on Financial Reforms in ¤ Muneesh Kumar, Shalini Kumar, Laurence Porteu de La Moran- 1991. The reforms aimed at creating a more profitable, diere, 2011. efficient and sound banking system through entry de- 23 Banks and Bank Systems, Volume 6, Issue 4, 2011 regulation, branch de-licensing, deregulation of inter- highest percentage of office overlap receive signifi- est rates, etc. However, the second Narasimham cant positive and higher abnormal returns than Committee 1998 recommended mergers of large In- banks in mergers with fewer office overlaps. The dian banks to make them strong enough for supporting study analyses stock returns of acquiring and target international trade. Based on the recommendations of banks (19 bank mega mergers) to assess the finan- the committee, there was a string of mergers in Banks cial markets expectations as to the overall perfor- of India during the late 90’s and early 2000. Howev- mance results from such deals. The results indicate er, consolidation of banks through M&A’s is not a that the merger announcement were generally asso- new phenomenon for the Indian Banking system, ciated with negative abnormal returns to acquiring which has been going on for several years. There bank shareholder’s and positive abnormal returns to have been several bank amalgamations in India in the target bank stocks. This is because management was post-reform period. In all, there have been 33 M&A’s either attempting to maximize its own utility and not since the nationalization of 14 major banks in 1969. that of its shareholders or it simply paid too much Of these mergers, 25 involved mergers of private for the target institutions. sector banks with public sector banks, while in the Steven J. Pilloff (1996) uses both the accounting remaining eight cases, mergers involved private sec- and market data to study the gains achieved in a tor banks. Out of 33, 21 M&A’s took place during sample of forty-eight mergers involving publicly the post-reform period with as many as 17 mer- traded institutions that merged between 1982 and gers/amalgamations took place during 1999 and after. 1991. To assess the overall gain in wealth, the con- Prior to 1999, the amalgamations of banks were pri- solidated sum of acquirer and target abnormal return marily triggered by the weak financials of the bank is measured. The results suggest that merger an- being merged, whereas in the post-1999 period, there nouncement typically do not lead to overall gain in have also been mergers between healthy banks, dri- stockholder wealth. The abnormal return findings ven by the business and commercial considerations suggest that on average market does not expect (Leeladhar, 2008). Out of 17 mergers, financial data mergers to lead to gains in performance, a result regarding share prices was available only for 13 banks. consistent with actual measured performance gains. Though, the total assets of the merged (target banks) David A. Becher (2000) examines the valuation was fairly large at the time of merger and was around effects of sample of 558 bank mergers from 1980- Rs 39,000 crores, there is not enough research to indi- 1997. The overall results indicate that bank mergers cate implication of the merger announcement on the create wealth. A basic event study is done to calcu- wealth of the shareholders. This particular area could late abnormal returns for target and bidder firms and be a matter of interest not only to the shareholders who the author focuses on two different widow periods, are an important stakeholder of a banking firm but also 36 day window and an 11 day window. The returns to to policy makers because in a country like India where the bidder firms are statistically negative in the 11- public sector banks dominate the banking industry, it is day window, while the returns to the target firms and the Government who is the major owner of such en- combined firms remain statistically positive in both terprises and will incur financial loss if mergers are not windows. Their results are also consistent with the creating any wealth. Most of the bank mergers in notion that bank mergers occur for synergistic rea- India are policy driven and not market driven, hence sons and are not the result of empire building. it is important for the policy makers to understand that their policies have added value for all the stake- Houston Ryangert (2001) analyzes a sample of 64 holders or not. largest bank mergers in the US between 1985 and 1996. They obtain managements estimates of pro- 2. Literature review jected cost savings and revenue enhancements and A number of studies have been conducted to ex- found that mergers occurring in the 1990’s appear amine the impact of consolidation in Banking on to result in positive revaluations of the combined value of bidder and target banks, though the re- shareholder’s wealth.