Wealth Effect of Mergers & Acquisitions in an Emerging Market: A Case Study of Pakistans Banking Sector

Sana Tauseef Lecturer, Economics and Finance Institute of Business Administration (IBA), Karachi Email: sasghar@iba.edu.pk and Mohammed Nishat, PhD Professor, Economics and Finance Institute of Business Administration (IBA), Karachi Email: mnishat@iba.edu.pk

Abstract
This study investigates the short term market response associated with the announcement of seven mergers and acquisitions (M&As) in the banking sector of Pakistan during the period 2003 to 2008 using the event study methodology. We categorize the sample M&A deals as (1) Acquisition of Pakistani banks by the foreign investors, (2) Merger of Pakistani banks with the other domestic banks and (3) Merger of Pakistani banks with the foreign banks operating in Pakistan. The results indicate statistically significant investor reactions around the merger announcements. For individual target and bidder banks, the cumulative abnormal returns (CARs) range from significant positive to significant negative. The combined mean CARs for the target banks group and bidder group are both positive and statistically significant. The mean CAR for the combined banks in the domestic mergers is also positive but is largely impacted by the substantial positive CAR of one bidder bank.

Key Words: Merger & Acquisition, Wealth effect, emerging market, banking JEL: G34, G38, E21, G21, F40

Electronic copy available at: http://ssrn.com/abstract=1653690

Wealth Effect of Merger & Acquisition in an Emerging Market: A Case Study of Pakistans Banking Sector

1. Introduction
In the face of technological advancement, globalization, and increased competition, the firms all over the world are trying to maintain their competitive position. There is a growing trend towards consolidation to reap the benefits through synergies, thereby, enhancing efficiency and performance. The same trend has been observed in Pakistan. In the recent past, after 1998, there are a large number of mergers taking place every year, both within and across sectors. Although there is mounting evidence available for developed economies on the issue, little research exists to examine the value creation through mergers in smaller and less developed markets. Considering the large number of mergers and acquisitions taking place in different sectors of Pakistan, there is a need to study the wealth creation for the shareholders of targets and bidders. Building on the earlier studies done on the topic in developed and other less developed countries, we attempt to examine the wealth impact of mergers deals in Pakistan. Of all the mergers that took place during the mentioned period, more than 50% occurred in the financial sector, including banks, leasing companies, modarabas, and mutual funds. This resulted mainly due to the SBPs regulatory policies, which focused on consolidating the weak financial institutions by strengthening their capital base. According to the State Bank of Pakistans BSD Circular No. 06 dated October 28, 2005, all locally incorporated banks were required to raise their minimum Paid up Capital (net of losses) to Rs. 5 billion by December 31, 2008, Rs. 6 billion by December 31, 2009, Rs. 10 billion by December 31, 2010, Rs. 15 billion by December 31, 2011, Rs. 19 billion by December 2012, and Rs. 23 billion by December 31, 2013. With this policy of SBP, the banks which were not able to meet the requirements were merged with other banks or were acquired by some large banks. Keeping in view the global crisis and domestic economic slowdown, the State Bank of Pakistan as per the BSD Circular No. 07 dated 15th April 2009 has slashed the paid-up capital limit to be maintained by the banks. The banks are now required to raise their minimum Paid up Capital (net of losses) to Rs. 10 billion by December 31, 2013, but the trend towards consolidation continues and therefore there is a need to study the wealth impact of the merger and acquisition deals in the banking sector. A lot of empirical research has been done to explore the wealth effect of merger activity in the developed economies, especially U.S., U.K., and Europe. The studies conducted to analyze the wealth creation through mergers use different measures. One set of studies uses the event study methodology, looking at the short to medium run stock performance of the bidder, target and the merged entity. This methodology is based on the assumption of efficient market where the stock prices react in a timely and unbiased manner to new information (Fama 1970; Roberts 1967).
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The other set of studies looks at the accounting performance indicators, like ROE and various cash flow measures, to compare the pre and post merger performance. Such studies believe that the gains or losses resulting from a merger eventually appear in the firms accounting records (Tuch and Sullivan 2007). Both set of studies have ended in variable results. Short run event studies including the US takeovers during 1960s (Asquith 1983) and UK takeovers during 1950s (Franks and Harris 1989) reported significant positive returns to the acquirers. However, the remaining event studies, both short run and long run, conducted on US and UK takeovers provide either no significant change or report significant negative returns for the acquirers (Tuch and Sullivan 2007). On the other hand, the target firms announcement returns in US and Europe are found to be large and significantly positive (Kiymaz and Baker 2008). According to these researches, the mergers merely transfer the wealth and the target shareholders gain at the expense of the acquiring firms and no wealth is created in process. A study covering 54 mergers including 13 European banking markets of European Union and the Swiss market for the period 1988 to 1997 has reported positive and significant increase in the shareholder wealth of bidder and target banks (Cybo-Ottone and Murgia 2000). Campa and Hernando (2004) found a negative return around the bid announcement for the regulated European Union acquirers and reported no significant return for the bidders from unregulated industries. In Canada, the acquiring firms are reported to have positive returns (Ben-Amar and Andre 2006). The evidence from the research using accounting information is also mixed. The studies examining the post-bid accounting performance of the acquirers for the period between 19481977 in UK reported either a decline in the profitability following the merger (Meeks 1977; Ravenscroft and Scherer 1987) or significantly lower returns for the acquirers compared to the non-acquirers (Dickerson 1997). The study by Healy (1992) reports an improvement in the asset productivity (measured through operating Cash flow return on market value of assets) of the acquiring firms in US. Andrade (2001) also finds an improvement in the post merger performance (measured through ratio of cash flow to sales) for the US mergers. The study conducted by Altunbas and Marques (2004) on mergers taking place during the period 19922001 in Europe reported superior post merger performance; however, the improvement in performance following the cross border mergers is reported to be more compared to the performance improvement of banks entering into domestic mergers. Since the researches using the accounting information use different measures to capture the change in performance, they are difficult to compare. The mixed evidence on the returns from mergers encouraged the researchers to examine the different bid characteristics to identify the drivers of differential performance. These studies report that for strategically closer institutions the performance improves more than for dissimilar institutions, thereby supporting the synergy hypotheses (Altunbas and Marques 2004; Tuch and Sullivan 2007). Moreover, the institutions performing very well prior to mergers are not able to improve their performance as much as the low performers in both the domestic and cross border mergers. The studies also report that the
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Electronic copy available at: http://ssrn.com/abstract=1653690

hostile takeovers, where the takeover activity takes place despite of the target managements opposition, are associated with better performance if excessive takeover premiums are not paid. This is taken as an indication that the hostile takeovers play a governance role and target the firms where managers are under performing (Tuch and Sullivan 2007). Although there is extensive evidence available for developed countries on the issue, little research exists for the emerging and less developed economies. In a study of cross border mergers and acquisitions by the Chinese firms positive and significant wealth gains were found for the acquiring firms (Boateng, Qian and Tianle 2008). Mishra and Goel (2005) in their study of a merger deal in Indian energy and petrochemical sector found that despite the deal appearing favorable to the shareholders of bidder company, the announcement returns for bidders were found to be negative. The returns for the target firm were positive but the combined firm was reported to have negative excess returns. Such negative returns were linked to the managerialism hypothesis, indicating that the acquirers management is motivated by its own self-interest and is not pursuing the merger deal for their shareholders benefit (Nishra and Goel 2005; Tuch and Sullivan 2007). In the Indian banking Industry, merger announcements were found to have a positive and significant wealth effect both for the bidder and the target banks (Anand and Singh 2008).

2. Data and Research Design

Our research uses the standard event study methodology to measure the impact of merger announcements on the wealth of the merging firms shareholders. To conduct the study, we consider the following seven mergers/acquisitions that occurred in the banking sector of Pakistan during the period 2003 to 2008: Acquisition of Saudi Pak Commercial Bank Limited by M/s Shaukat Tarin & Consortium, merger of PICIC commercial bank with and into NIB, merger of Prime Commercial Bank with and into ABN Amro (Pakistan) Limited, acquisition of majority shares of Crescent Commercial Bank Limited by SAMBA Financial Group, merger of Union Bank Limited with and into Standard Chartered Bank (Pakistan), merger of Trust Investment Bank Ltd., Fidelity Investment Bank Ltd., and Doha Bank into Trust Commercial Bank Ltd (a new entity), and merger of Platinum Commercial Bank with and into Khadim Ali Shah Bukhari and Co.1 Table 1
Serial Number Bidder Bank Target Bank/s Announcement Date Merger/ Acquisition Date March 31,

1
1

Consortium including

Saudi Pak Bank Bank January 07, 2008

Table 1 illustrates the sample mergers/acquisitions with the respective announcement dates and the effective merger dates.

2 3 4 5 6 7

Muscat and Japans Nomura NIB ABN Amro (Pakistan) Limited Samba Financial Group Standard Chartered Bank (Pakistan), Trust Commercial Bank (new entity) KASB

2008 PICIC Commercial Bank Prime Commercial Bank Crescent Commercial Bank Union Bank Limited Trust Inv.Bank Ltd, Fidelity Inv.Bank Ltd., and Doha Bank Platinum Commercial Bank June 29, 2007 Mar 05, 2007 Nov 17, 2006 August 09, 2006 August 06, 2003 February 25, 2003 Dec 31, 2007 Sept 01, 2007 March 31, 2007 Dec 30, 2006 May 05, 2004 May 08, 2003

The sample mergers and acquisitions fall into three broad categories: I. Acquisition of Pakistani banks by the foreign investors. The acquisition of Saudi Pak Bank (renamed as Silkbank) by a Consortium comprising of IFC, Bank Muscat, Nomura International and Sinthos Capital and the acquisition of Crescent Bank by SAMBA Financial group were the foreign ventures attracted by the Pakistan's strongly performing banking sector and reflected the investor-friendly policies pursued by the Government of Pakistan. Merger of Pakistani banks with the other domestic banks. The merger of NIB and PICIC has resulted in NIB Bank becoming the seventh largest bank in the country in terms of the distribution network. The amalgamation of Trust Investment Bank Limited (TIBL) and Fidelity Investment Bank Limited (FIBL) together with the Doha Bank Pakistan Branches created Trust Commercial Bank Limited which was then merged with and into the Crescent Commercial Bank. The acquisition of Platinum Commercial Bank Limited by KASB was the first merger of a stock brokerage firm with a commercial bank in Pakistan and the name of the company was subsequently changed to KASB bank Limited. Merger of Pakistani banks with the foreign banks operating in Pakistan. After the acquisition of and amalgamation with Union Bank, the new entity Standard Chartered Bank (Pakistan) Limited was incorporated in Pakistan and currently it is the largest international bank operating in Pakistan. The amalgamation of Prime Bank with ABN Amro allowed the new entity ABN Amro Pakistan limited to increase its branch network in the country and become the second largest international bank in Pakistan.

II.

III.

The study tests the following hypothesis:

The merger announcements in the banking sector of Pakistan do not create shareholders wealth for the merging banks In order to test the hypothesis, the study requires the announcement dates for each of the five mergers, the window period and the clean period data for each merger deal. Announcement date (t=0) is the date on which the information about the merger deal was first made public. These dates are obtained from the news clipping available on the websites of Daily Business Recorder (www.brecorder.com.pk) and Daily Dawn (www.dawn.com.pk). The event window has been taken from t=-30 to t=+30, where t=-30 represents 30 days before the merger announcement date (t=0) and t=+30 represents 30 days after the merger announcement is made. We employ the single-factor market model to compute the abnormal return for each bank stock in the 60-day window. The market model parameters are computed using an estimation period of 180 days before the window period for each participating firm. The period of 30 days prior to the announcement date is not included in this clean period to prevent the events influence on the parameter estimates. The following market model is employed for the parameter estimations: ARit = Rit E(Rit) where, ARit = Abnormal return for bank stock i on day t. Rit = Actual return of bank stock i at time t. E(Rit) = Expected return on bank stock i at time t. This is measured by the following equation: E(Rit) = + Rmt = Ordinary least squares estimate of the intercept of the market model regression. = Ordinary least squares estimate of the coefficient in the market model regression. Cumulative abnormal returns are used to explore whether the share holders of the each bidder and target bank gained or loosed from the respective merger deal. These CARs are computed for the period surrounding the merger announcement (-30 to +30), i.e., from 30 days before the merger announcement to 30 days after the merger announcement, using the following equation: t=30 CAR = ARt t=-30

To examine the wealth effect for the shareholders of the bidder banks group and target banks group, the daily average abnormal returns in a 60-day window is computed for the bidder block and the target block by using the following equation for arithmetic average: AVG ARt = ARit/n Where, n = Number of banks in the bidder and target groups.

The cumulative average abnormal returns for the days surrounding the merger announcement (30 to +30) is estimated for each group (bidder and target). The cumulative average abnormal returns for the event window is also computed for the target group in each category. Abnormal returns of the combined banks (for category 22) will be calculated to assess the market expectations and reactions to the merger deals. The market values (i.e. market capitalization) of the bidder and target banks for the day before the merger announcement (t=-1) are used to compute the market value weights.3 The weighted average cumulative abnormal returns are then estimated for each merger announcement. Table 2
Bidder Bank S. No. 1 NIB PICIC Commercial Bank Fidelity Inv.Bank Ltd., and Doha Bank Platinum Commercial Bank Target Bank/s Date (value as on) June 28, 2007 Market Capitalisation Bidder Bank 7,126,426,640 Target Bank Market Value Weights

12,088,147,500

37.089%

62.911%

Trust Commercial Bank (new entity) KASB

August 2003

05,

422,476,200

357,075,000

54.195%

45.805%

February 24, 2003

575,446,500

492,800,000

53.868%

46.132%

The average AR (abnormal return) for each target and bidder bank, the average CAR (cumulative abnormal return) for each target and bidder, the average CAR for the target banks group and bidder group, the average CAR for the targets in each of the three M&A categories, and the CARs of combined entities are then tested for statistical significance using t-statistic. Statistically significant AR or CAR implies that there are abnormal returns associated with merger announcements.

2 3

The required data is not available for the other two categories. Exhibit 2 illustrates the market value of equity as on the previous day of the merger announcement (t=-1)

3. Empirical Results
Table 3A provides the details of the regression results for all target and bidder banks. These coefficients were used to estimate the expected returns for the respective bank during the event window. Table3B gives the mean residual return for each bank and the t-statistic. From the target group, Saudi Pak Bank and Prime Commercial Bank reported significant negative mean AR. For each of the other target bank, the mean AR is statistically insignificant. Table 3C summarizes the mean CAR over the 61-day event window for each bank. From the target group, six banks out of seven are found to have significant and substantial positive or negative CAR. Saudi Pak Bank, Fidelity Investment, Union Bank and Prime Commercial Bank have shown significant negative mean CAR. Crescent Commercial and PICIC have earned significant positive mean CAR. In the bidder banks, NIB has earned a substantial and statistically significant positive mean CAR, where as the other two banks, Trust Investment and KASB have earned significant negative mean CARs.

Target and Bidder Groups: For the bidder group, the mean CAR (cumulative abnormal returns) is positive (18.33%) and statistically significant. This combined CAR is propped up due to a substantial positive CAR earned by PICIC. The CAR of the bidders in the time window -24 to +30 is positive. In relative terms, the CAR increased by 25.88% during the 24 days prior to the merger announcement (-24 to -1) and then declined by 4.6% during the 30 days following the merger announcement (+1 to +30). On the day of announcement (t=0), the bidder group earned a positive return of 0.63%.

Table 3A Summary Statistics-Bidder and Target Banks

Target Banks Saudi Pak Bank Crescent Commercial Bank PICIC Fidelity Investment Bank Platinum Commercial Bank Union Bank Prime Commercial Bank Bidder Banks NIB Trust Investment Bank KASB 0.295 -0.147 -0.017 0.480 0.102 0.357 0.484 0.044 0.591 0.139 0.688 0.993 1.160 -0.141 0.999 0.808 0.645 0.844 0.018 0.240 8

Table 3B Abnormal Returns-Bidder and Target Banks

Mean AR Target Banks Saudi Pak Bank Crescent Commercial Bank PICIC Fidelity Investment Bank Platinum Commercial Bank Union Bank Prime Commercial Bank Bidder Banks NIB Trust Investment Bank KASB * significant at 5% level. -0.387 0.617 0.298 -0.514 -0.082 0.199 -0.534 1.596 -0.452 -0.107 Standard Error 0.188 0.396 0.262 0.543 0.442 0.249 0.175 0.416 0.503 0.354 t-statistic -2.061* 1.559 1.136 -0.947 -0.187 0.800 -3.051* 3.838* -0.899 -0.303

Table 3C Abnormal Returns-Bidder and Target Banks

Mean CAR Target Banks Saudi Pak Bank Crescent Commercial Bank PICIC Fidelity Investment Bank Platinum Commercial Bank Union Bank Prime Commercial Bank Bidder Banks NIB Trust Investment Bank KASB *significant at 5% level. -14.075 31.860 12.501 -5.650 0.129 -2.007 -15.736 65.582 -2.460 -8.122 Standard Error 0.537 1.355 1.041 1.533 0.829 0.675 1.087 3.674 1.163 0.803 t-statistic -26.230* 23.513* 12.009* -3.686* 0.155 -2.973* -14.483* 17.851* -2.116* -10.109*

Table 4 shows the announcement effects of bidder group into various sub-periods within the event window. The increase in CAR during the 20 days through 11 days prior to the announcement accounted for 60.97% of the total increase in the event window. The positive trend in CAR continued till the announcement date. During the 20 days following the merger announcement (+1 to +20) the CAR declined which was followed by an increase in the CAR for the last 10 days in the event window (+21 to 30) and this increase accounted for 20.22% of the total increase.
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Over the event window, the target group accumulated a CAR of -3.52%. The CAR increased by 5.85% between the period of one to prior to announcement to one day after the merger announcement (-1 to +1). Exhibit 4 shows a mixed trend in CAR for the target group during the 61 day event window. The CAR improved during the period -20 to +1 by 8.57% after which it started declining. CAR declined by 12.06% during the period +2 to +30. The mean CAR for the group is positive and significant. The mean CARs for both the target and bidder groups, thus, are positive and significant at 5%. Anand and Singh (2008) found the same trend in their study for the bidders and targets of the Indian private sector banks. Table 4 CAR-Announcement Effect for Target and Bidder groups
Sub-period Target Group CAR Announcement Effect (-30 to 0) Announcement Effect (0 to +30) Announcement Effect (-30 to +30) Bidder Group CAR Announcement Effect (-30 to 0) Announcement Effect (0 to +30) Announcement Effect (-30 to +30)
-30 to -21 -20 to -11 -10 to -1 0 +1 to +10 +11 to +20 +21 to +30 -30 to 0 0 to +30 -30 to +30

-0.364

1.650

2.580

2.324

-1.023

-7.681

-1.002

6.190

-7.382

-3.516

-5.88%

26.66%

41.68%

37.54%

31.48%

-13.86%

-104.05%

-13.57%

-10.35%

46.93%

73.39%

66.10%

-29.10%

-218.46%

-28.5%

176.05%

-209.95%

10.264 39.98%

12.849 50.05%

1.927 7.51%

0.630 2.45%

-1.449

-7.409

4.262

25.670

-4.597

21.074

13.70% 48.7% 60.97% 9.14% 2.99%

-31.52% -6.88%

-161.17% -35.16%

92.71% 20.22%

Targets in different categories: The CARs for the targets of foreign acquirers (category 1) are positive over the entire event window except for the 30th day prior to the merger announcement. The announcement effects for various sub-periods of the event window are given in exhibit 3. During the period of 30 days prior to the merger announcement till the announcement day (-30 to 0), the CAR increased by
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15.25% and in the period between the 1st day of announcement till 30 days (+1 to +30), it decreased by 8.24%. On the announcement day, these shareholders of these targets earned an average abnormal return of 4.91%. The mean average CAR for targets in foreign acquisitions in 8.89% and is statistically significant. In the domestic merger deals (category 2), the average CAR for the target group is 2.32% and is statistically significant. CARs over the event window, however, show a mixed trend. During the period of 30 days prior to the merger announcement till the announcement day (-30 to 0), the CAR increased by 8.28% and in the period between the 1st day of announcement till 30 days (+1 to +30), it decreased by 14.34%%. Table 5 CAR-Announcement Effect for Category-wise Targets
Sub-period
-30 to -21 -20 to -11 -0.195 -10 to -1 4.621 0 +1 to +10 -0.456 +11 to +20 -4.268 +21 to +30 -3.520 -30 to 0 15.254 0 to +30 -8.244 -30 to +30 7.009

Targets in Category 1 5.915 CAR Announcement 38.78% Effect (-30 to 0) Announcement Effect (0 to +30) Targets in Category 2 -1.565 CAR Announcement -18.90% Effect (-30 to 0) Announcement Effect (0 to +30) Targets in Category 3 -4.840 CAR Announcement Effect (-30 to 0) Announcement Effect (0 to +30)

4.913

-1.28%

30.29%

32.21%

59.59%

-5.53%

-51.77%

-42.70%

7.921

0.841

1.085

-1.985

-9.525

-2.839

8.282

-14.348

-6.066

95.64%

10.15%

13.10%

7.56%

-13.83%

-66.39%

-19.79%

-5.911

3.148

1.593

-0.148

-8.329

4.273

-6.010

-4.204

-10.215

-80.53%

-98.35%

52.38%

26.51%

37.89%

-3.52%

-198.12%

101.64%

In the merger of domestic banks with the foreign banks operating in Pakistan (category 3), the result is contrary to the result for the targets of first two merger types. The targets in this category earned a significant negative average CAR (-8.87%). For most of the event window, the CARs for these targets are negative. On the day of announcement, these targets earned an average abnormal return of 1.59%.
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Combined banks: The mean ARs and CARs for the three combined banks in domestic mergers are given in exhibit 6. The average CAR for the combined banks is positive and substantial. However, the combined CAR has been increased largely due to a very high CAR earned by the merger deal of NIB and PICIC. In the NIB-PICIC merger, the shareholders of both banks have accumulated substantial positive CARs, with a mean CAR of 16.77%. The returns earned by the bidder (PICIC), however, are much higher compared to those earned by the target shareholders. The other two merger deals have reported negative mean CARs showing that the merger deals accumulated losses for the combined entities. For these two merger deals, both bidders and targets reported negative CARs.

Table 6
NIB-PICIC 0.779 0.237 3.288* 32.188 1.919 16.772* TRUST-FIDELITY -0.413 0.474 -0.870 -1.820 1.195 -1.523 KASB-PLATINUM -0.096 0.277 -0.347 -4.316 0.481 -8.980* Combined Group 0.090 0.2101 0.4295 8.684 0.745 11.657*

Mean AR Standard Error t-statistic Mean CAR Standard Error t-statistic *significant at 5%

4. Summary and Concluding Remarks

The paper investigates the short-term value creation associated with the mergers and acquisitions in the banking sector of Pakistan from 2003 to 2008. The wealth for the shareholders of target and bidder banks is examined by estimating the abnormal returns and cumulative abnormal returns for a 61-day period surrounding the merger announcement. The study finds that the targets and bidders of the bank mergers in Pakistan accumulate significant returns associated with merger deals. For the individual target or bidder bank, these abnormal returns range from significant positive to significant negative. For the combined target group and bidder group, the study documents positive mean cumulative return. This is the first study of value creation surrounding the merger deals in the context of Pakistans banking sector. However, the study includes a small sample of seven merger deals and examines the short term wealth effects. Future researches can be conducted on larger set of merger deals. The studies can also be conducted for the merger deals in other sectors of the market. Moreover, medium to long-term effects can also be examined either through the event study methodology
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or through examining the firms accounting performance indicators before and after the merger deals.

References
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