Knowledge that Transforms

This paper examines the relationship between mergers and acquisitions, efficiency, and scale economies in the US life insurance industry. We estimate cost and revenue efficiency over the period 1988–1995 using data envelopment analysis (DEA). The Malmquist methodology is used to measure changes in efficiency over time. We find that acquired firms achieve greater efficiency gains than firms that have not been involved in mergers or acquisitions. Firms operating with non-decreasing returns to scale (NDRS) and financially vulnerable firms are more likely to be acquisition targets. Overall, mergers and acquisitions in the life insurance industry have had a beneficial effect on efficiency.

Bank safety nets, originally proposed as a means of stabilizing financial systems, have become an important destabilizing influence. Government protection of bank debts encourages banks to undertake excessive risk, particularly in response to adverse shocks to asset values. Reforms that would remove the destabilizing moral hazard consequences of government protection are considered, both from the perspective of economic desirability and political feasibility. Requiring banks to maintain a minimal proportion of subordinated debt finance, and restricting the means by which government recapitalization of insolvent banks occurs are the central features of promising reforms to the safety net.

This article designs a framework for evaluating the causes, consequences, and future implications of financial services industry consolidation, reviews the extant research literature within the context of this framework (over 250 references), and suggests fruitful avenues for future research. The evidence is consistent with increases in market power from some types of consolidation; improvements in profit efficiency and diversification of risks, but little or no cost efficiency improvement on average; relatively little effect on the availability of services to small customers; potential improvements in payments system efficiency; and potential costs on the financial system from increases in systemic risk or expansion of the financial safety net.

We examine foreign acquisitions of United States banks around the time of the ownership change to determine whether the observed poor performance of foreign subsidiaries is the result of changes in business strategy or the preexisting characteristics of the target bank. We find that many of the problems were already present at the time of acquisition. However, changes in business strategy by the foreign owners were generally not successful in raising the bank’s performance level to that of its domestic peers.

We report simple regressions and Granger causality tests in order to understand the pattern of implied volatilities across exercise prices. We employ all calls and puts transacted between 16:00 and 16:45 on the Spanish IBEX-35 index from January 1994 to April 1996. Transaction costs, proxied by the bid–ask spread, seem to be a key determinant of the curvature of the volatility smile. Moreover, time to expiration, the uncertainty associated with the market and the relative market momentum are also important variables in explaining the smile.

US corporations can raise capital in the offshore market using Regulation S, adopted by the Securities and Exchange Commission (SEC) in 1990 and modified in 1996. We examine how offshore offerings are done under Regulation S, what types of companies use this market, the discount companies offer investors to compensate for illiquidity in the market, and the impact of the new disclosure requirements on capital raising in the offshore market. We find that small firms tend to raise capital in this market. During our sample period before the 1996 rule change the median market capitalization of reporting firms was $16.82 million with a median stock price of $1.13. The mean and median discount offered to foreign investors was 32.84% and 40.53%, respectively. Offerings during this period resulted in average share dilution of 11.97%. We find that before the disclosure requirements, firms were “gaming the system” by giving foreign investors just enough time to resell the securities back into the United States before the initial sale became public information. After the rule changes, Regulation S offerings are not perceived to be “shady”, and larger firms are now using the market, resulting in lower average discount and dilution.

The relevancy of changes in maturity structure is tested using a disaggregated measure of the maturity composition of government debt. Tests based on predictions from the market efficiency and rational expectations theories find evidence that maturity composition occasionally helps to predict future excess returns. The maturity composition is also found to be correlated with the term premium and future changes in the short rate. The evidence supports the claim that bonds with all the same characteristics except maturity are not perfect substitutes.

The appropriateness of financial reporting rules for derivative securities depends on corporations' reasons for using the instruments. Empirically, little is documented about how the instruments affect firms' risk exposures. This study examines derivatives' roles in firms initiating derivatives use. The results are consistent with firms using derivatives to hedge, and not to increase, entity risk. Firm risk (measured several ways) declines following derivatives use. Realized risk reductions and decisions to initiate derivatives programs vary across firms with the expected benefits from hedging. The findings emphasize the importance of hedge-accounting rules that incorporate the impact of derivatives and hedged items simultaneously.

We use an option pricing framework to model equity valuation when firms face costs associated with violating accounting-based debt covenants. Our model shows that the value of equity depends on two factors: the economic value of the firm and the probability that the firm violates the covenant. Consistent with the model's prediction that the `covenant' effect is greatest for firms near covenant violation, we find that responses to earnings that are less informative about future cash flows (losses and transitory earnings) are significant only for thrift institutions that are near violation of regulatory net worth covenants.

We identify manager/firm separations where managers quit for a new job and study abnormal returns associated with these events. Applying analyses from labor economics, we argue that the average ability of managers who resign for a similar position at another firm should be higher than that of managers who die suddenly. Controlling for age and tenure, we find that firms losing managers to other firms experience an average abnormal return of −1.51%, compared to +3.82% for firms whose managers die suddenly. We use differences in returns across groups to measure the value of differences in managerial ability.