Applied Financial Economics, 2009, 19, 19872007

The choice of IPO versus M&A: evidence from banking industry

Bill Francisa, Iftekhar Hasana,b and Dona Siregarc,*
Lally School of Management and Technology, Rensselaer Polytechnic Institute, Troy, NY 12180, USA b Bank of Finland, Helsinki, Finland c Department of Economics, Finance, and Accounting, State University of New York at Oneonta, USA
a

This study investigates factors influencing private banks exit strategy between going public (Initial Public Offering (IPO)) and being a target in Merger and Acquisitions (M&A). Evidence indicates that a bank with high liquidity, operating in a geographical deregulatory environment is more likely to go for the M&A option. Larger and older institutions, improved economic environment, increased recent trend of choosing IPOs and smaller difference in premiums paid between the alternative choices are likely to encourage banks to opt for IPO as an exit strategy. We observe the existence of self-selection in making the exit choice and find that the average transaction value of bank IPOs (M&As) would have been higher (lower) had the banks chosen to engage in M&A (IPOs).

I. Introduction Going public can be viewed as a choice faced by a private firm. At some point, a private firm may opt to go public for economic and financial reasons, or for the interest of the owners or managers. Under this argument, theoretical studies on the decision between going public and staying private have been widely developed. Zingales (1995) offers an explanation on the role of initial public offering in maximizing the proceeds obtained by the owner of a firm. Subsequent studies include Mello and Parsons (1998), Pagano et al. (1998), Pagano and Roell (1998), Chemmanur and Fulghieri (1999), Maksimovic and Pichler (2001) and Boot et al. (2006). Rosen et al. (2005) study the choice of going public or remaining private for a sample of banking institutions. A more recent approach by Brau et al. (2003) and Poulsen and Stegemoller (2008), yet not much explored, suggests that besides going public, there
*Corresponding author. E-mail: siregadd@oneonta.edu

exists another appealing exit route for a private firm, that is, takeover. Going public and takeover can be seen as two comparable paths as both represent an access to capital funds, a liquidity method to the owners, and a way to shift ownership and control. Although they are comparable, they are different in ways to achieve each purpose. Going public allows private firms to access capital funds through capital markets, while takeover enables firms to access funds through the acquirers. Going public provides a liquidity method to the owners through holding the issued stock, whereas takeover is through cash or acquirers stock. Finally, Initial Public Offering (IPO) enables owners to maintain control and ownership, while takeover results in relinquished or substantial diminished control and ownership. Given the major similarities and differences between going public and takeover, the choice can be influenced by several factors. Using cross industry data as the subject of analysis, Brau et al. (2003)

Applied Financial Economics ISSN 09603107 print/ISSN 14664305 online 2009 Taylor & Francis http://www.informaworld.com DOI: 10.1080/09603100903251262

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1988
report that the choice is driven by factors of industry characteristics, market timing, demand for funds and deal-specific factors, such as firm size, insider ownership and liquidity. Poulsen and Stegemoller (2008) analyse differences in growth, capital constraints and asymmetric information between industrial firms that go public and sell out to public firms. They found that going public firms tend to have greater growth opportunities and face more capital constraints. Our work offers a better understanding on factors that are unique to banking institutions ignored by previous research (Brau et al., 2003; Poulsen and Stegemoller, 2008). We focus on the empirical question of the decision between IPO and takeover in the banking industry. We are motivated by the observation that while many private banks chose for takeover, still a number of privately held banks decided to go public. We inquire why some private banks decided to be taken over while some others preferred to go public in the midst of the industry transformation. Building on the previous study by Brau et al. (2003), we put emphasis on regulatory and market competitive factors as the determinants of the choice. We also consider the impact of the individual bank financial characteristics on the choice. Our goal is to test factors that may affect private banks choice between going public and takeover. We hypothesize that regulatory, market competitive environments and bank financial characteristics have influence on private banks to choose between IPO and takeover. Since the IPO and takeover have fundamental consequences that lead to changes in banks future decision on investment, financing, as well as ownership of the owners and managers, it is important to discover the factors that may influence private banks to choose one path from the other. Results show that unrestricted branching and banking activities increase the likelihood that banks will merge. Age and size are positively related to the probability that the banks will conduct IPOs. Private banks with high liquid asset are more likely to involve in Mergers and Acquisitions (M&A). Furthermore, analysis of self-selectivity in choosing IPO and M&A based on Transaction Value (TV) is performed. It is found that the mean of observed TV of bank IPOs is lower than that of bank M&A. The TV of Bank IPOs would have been higher had the banks chosen to engage in M&A, while the TV of Bank M&A would have been lower had the banks chosen to go public. The article is organized as follows. Section II lays out similarities and differences between IPO or M&A

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and closely related papers. Section III presents factors and hypotheses for the two alternative choices. Section IV describes the research design including data and methodology. Section V presents results, and the summary appears in Section VI.

II. IPO Versus M&A IPO and M&A provide many similar benefits to the owners and managers of private banks. They are comparable paths as both represent an access to capital funds, a liquidity method to the owners and a way to shift ownership and control. Access to capital funds can be achieved directly from a public market when private firms choose to go public, and indirectly through their acquirers when they opt for takeover. A varying level of liquidity needs of the owners can be obtained through a design of transaction through either an IPO or takeover. An IPO allows the founders to convert some of their paper wealth into cash at a future date, while a takeover can provide such a design through cash proportion in the transaction. The other comparable aspect is that the level of ownership and control can be shifted after either IPO or takeover. The owners of private firms can establish a level of controlling ownership after IPO by retaining a proportion of primary to secondary shares (Brennan and Franks, 1997), or by tailoring ownership slowly in the years after IPO if going public is considered as the first stage of gradual sell out strategy (Zingales, 1995; Mello and Parson, 1998; Pagano et al. 1998). In a takeover, change of control and ownership can be determined by the methods of payment. Typically, cash payment implies that the owners of the target must relinquish the control to the acquirer at the time of transaction. At the other extreme case, fully stock payment may consequently offer a control power to the targets owners. Brau et al. (2003) explore factors that influence firms to choose between going public and takeover. They find that firms in more concentrated industries are more likely to go public. Going public is also more likely when IPO market is hotter than the takeover market, and when the cost of debt is high. IPO is also more likely for firms that have lower market-to-book ratios, lower debt level and are larger in size. The study is drawn from samples of firms across industries. However, this study lacks data at individual firm level, including for banks. Poulsen and Stegemoller (2008) investigate the choice of private companies between going public and takeover using industrial firms as their sample

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of study. Focusing on firm-specific factors to identify difference in growth, capital constraints and asymmetric information between the two alternatives, they find that firms that eventually go public have greater opportunities and face more capital constraints. Studies have investigated motivations of bank mergers and analysed features of target banks in comparison to their comparable banks that stay independent.1 Studies on going public banks are very limited. Houge and Loughran (1999) analysed the long-run performance of banks following IPO and changes in operating performance of banks around the time of new equity issues. They find that returns over a 5-year post-offering holding period are significantly below benchmarks. The banks exhibit significant low levels of loan loss prior to IPO, but increase loan loss allowance up to the industry average in the subsequent years following IPO. They suggest that the provision of loan losses increases as banks adopt marginally riskier loan investments. Rosen et al. (2005) use banks to examine the decision to go public in comparison to similar banks that stay private. Matching samples by asset size, they find that going public banks are riskier, more likely to be acquired and also more likely to become acquirers than those that remain private. Following IPO, banks show deteriorating performance measured by return on equity or return on assets, or ratio of charge offs to total loans. In addition, banks are found to go public in a period of high stock market returns.

1989
and GlassSteagall Act of 1933. The amendment gave national banks the same power of the state-chartered banks to establish branches. Regardless of the passage of the McFadden and GlassSteagall Acts, however, many states continued implementing restrictions on bank branching. Prior to the 1970s most states had laws restricting withinstate branching. Restrictions of intrastate branching varied from state to state, but typically state authorities formulated the regulations on the basis of minimum size of population, administrative region boundaries, the presence or adequacy of a bank in the allowed boundaries, the distance of a new branch from existing bank or branch and the size of a branch (Amel, 1993).2 By 1970, 39 states restricted branching, including those that completely banned branching and others that put limits on branching. Only 11 states allowed statewide branching. Most states with restrictions on intrastate branching only allowed banks to expand by acquiring a bank, which eventually was converted into a subsidiary or branch. In states with limited branching, banks made multiple acquisitions to expand their network. In states with statewide branching, a bank could expand by acquiring any bank located in the same state (Amel, 1993; Carrow and Heron, 1998; Kroszner and Strahan, 1999; Johnson and Rice, 2007). Bank Holding Company (BHC) structure was used as a way to circumvent branching restrictions. A Multi-Bank Holding Company (MBHC) owns multiple banks and places them under the same ownership. However, technically, they cannot operate as a single network. Each bank has to operate independently and meet all regulatory requirements, and the bank subsidiary is treated as if it runs as a stand-alone bank. Although the creation of MBHC was allowable, some states also placed restrictions on the BHC expansion within the states. These restrictions include the ban on BHC to own more than one bank and limitation on BHCs expansion by setting the percentage of state bank deposits that could be controlled (Amel and Liang, 1992; Savage, 1993; Johnson and Rice, 2007) In addition to intrastate branching, banks are historically restricted to expand across state borders. The Douglas amendment to the BHC Act of 1956 prohibited bank holding companies from buy outof-state banks, unless the states in which the target banks located specifically permitted such acquisitions.

III. Factors Affecting IPO Versus M&A Choice in Banking Industry Regulation-related factors Restrictions on geographic entry may affect the choice between going public and selling out. Banks were subjected to severe entry barriers in the form of intrastate branching and interstate banking restrictions. Prior to the federal regulation of McFadden Act 1927, The National Banking Act of 1864 was interpreted to ban national banks from branching in the states where state banks were allowed to branch. The inequality restriction between the banks was ceased by the passage of McFadden Act of 1927
1

See, for example, Hunter and Wall (1989), Hawawini and Swary (1990), OKeefe (1996), Berger et al. (1999) and Wheelock and Wilson (2004). 2 For example, Florida and New Hampshire still strictly ban branching. Alabama restricted branches in countries with lower than a specified population level. Minnesota prohibited branching, but permitted facilities within 1000 feet of the main office. Other states used a combined measure consisting of bank size, population served and distance from main office as a branching determination (Amel, 1993).

1990
This Act prohibited interstate banking, except for 19 small multistate BHCs that were given grandfathered rights that allow them to continue to operate in multistates. Since no state allowed such acquisitions defined in the Act, interstate banking was effectively prohibited until 1980s.3 Both federal and state laws historically prohibited banks from establishing branches across state lines. As mentioned previously, the McFadden Act of 1927 established in-state branching laws for national banks and for state-chartered banks that are members of the Federal Reserve System. However, the Act prohibited these banks from branching outside their home state. The passage of the BHC Act of 1956 provided states with controls to rule interstate banking activities by BHC; however, it does not provide powers for states to regulate these banks on interstate branching. Interstate branching restrictions continued on these banks until the RiegleNeal Interstate Banking and Branching Efficiency Act (IBBEA) was passed in 1994. Prior to this Act, only eight states permitted some degree of interstate branching, but it only applies to state nonmember banks (Savage, 1993).4 Since 1970s, more states started relaxing bank branching, and in 1980s, more states allowed interstate banking laws for MBHC. Throughout the rest of the century, individual states set up their own banking legislation. The level of deregulation and the time it was introduced varied from one state to another. As of 1994, five states had laws that limited intrastate branching, seven states had statewide branching with restrictions and the remainder allowed full statewide branching. All states but Hawaii had allowed regional interstate banking by BHC by the year 1994 (Amel, 1993; Carrow and Heron, 1998; Kroszner and Strahan, 1999). The RiegleNeal IBBEA of 1994 is a culmination of deregulation on interstate banking and branching. It replaces the existing state-level legislation on interstate banking and branching. The Act allows BHC to acquire banks in any state and permits nationwide interstate branch banking. The interstate branch provision permits banks to consolidate interstate banking subsidiaries into a single bank.5 The long-standing geographic restrictions have contributed to the fragmented structure of the US banking industry and to the geographic restrictions
3

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on competition. Geographic restrictions limit entries into local bank markets and impair the market for corporate control. Existing studies provide some insights on how intrastate and interstate geographic restrictions may affect the likelihood of banks to go public or engage in takeover. Geographic restrictions are found to prevent entry to local markets (Beatty et al., 1985; Amel and Liang, 1992). Such restrictions on entry may allow many inefficient banks to survive during the geographic restriction era. Barrier to entry helps the existence of limited competition in local deposit and loan markets. Lack of competition allows some banks to acquire market power that in turn, to some extent, may distort the efficiency of banks. For example, banks may operate inefficiently because management does not screen loan based on competitive rates, or banks accept negative Net Present Value (NPV) loans because the market power allows banks to seek economic rent (Berger et al., 1995).6 The intrastate and interstate geographic barriers limited the set of banking organizations that are eligible to acquire banks. For example, many states restricted acquisition to acquiring banks in the same location. Even if branching by merger is permitted, branching restrictions based on the percentage of deposits controlled within the state may also insulate banks from a takeover threat. This lack of corporate control market to discipline management would result in inefficiency, due to misalignment of shareholders and management objectives (Schranz, 1993; Hubbard and Palia, 1995). Reduced activity in the corporate control market may contribute to increased costs and reduced profitability for banks that operate in the states with geographic restrictions. Schranz (1993) finds that banks located in states with strict restrictions on take over are less profitable than banks in states without such restrictions. Jayaratne and Strahan (1998) find that operating costs and loan losses decrease after statewide intrastate branching and interstate banking deregulation. They suggest that branching restrictions limit the growth of banks and reduced the efficiency of banks on average. As the intrastate and interstate banking regulations are lifted, the potential acquirers increase and the market for corporate control becomes more active. Banks can obtain benefits from takeover, including

Maine started allowing out-of-state BHC to buy banks residing in Maine with reciprocity laws since 1978. However, because no other states established out-of-state acquisition rules, Maines laws remained inactive until 1980s, when New York and Massachusetts passed interstate banking laws. 4 The states that allowed the interstate branching by 1994 are Alaska, Massachusetts, Nevada, New York, North Carolina, Oregon, Rhode Island and Utah. 5 See Carrow and Heron (1998) and Johnson and Rice (2007) for further discussions on the authorities of individual states post the IBBEA Act. 6 For evidence on market power, see e.g. Berger and Hannan (1998).

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better disciplines of the management of banks (Schranz, 1993; Hubbard and Palia, 1995).7 Jayaratne and Strahan (1998) reported that banks loan losses and operating costs fell sharply following the removal of interstate branching. They suggest that low-cost, high profit banks grow at the expense of their less efficient rival banks. Other studies also indicate increased scale of economies, increased market power (Amel and Liang, 1992), diversification (Demsetz and Strahan, 1997) and incentives of managers and directors of potential targets (Hadlock et al., 1999).8 The reduction in geographic restrictions may also promote IPO activity. Banks now face much less restrictions to expand their business across borders or within the state. In response to the expansion opportunity, banks can go public to raise funds and use them to support their business expansion. Going public would also provide a bank with stocks that can be used for acquisition in the future (Pagano et al., 1998). Rosen et al. (2005) find evidence that going public banks are more likely to become acquirers than their counterparts who remain private after controlling for size, age and profitability of the bank. This finding indicates that becoming acquirers is an important motivation that drives banks to go public. However, although by going public is hypothetically possible for banks to become acquirers, it involves a sequence of transitions and entails different sets of regulatory requirements. As a result, going public becomes a costlier choice for the banks for this particular objective, and this is especially difficult for banks that had been operating less efficiently in restricted geographic era. Therefore, the lessening of intrastate and interstate restrictions is expected to have a positive impact on M&A activities. It is predicted that the relaxation of geographic restrictions affects privately held banks to more likely engage in acquisitions. As the deregulation is left to an individual state, each state introduced the deregulation in different years. The years when interstate and intrastate legislations became effective for each state follow those reported by Amel (1993) and Kroszner and Strahan (1999). Hypothesis 1: The lower the regulatory restrictions related to intrastate or interstate banking activities in the states where banks operated, the less (more) likely the banks will go public (M&A).
7

1991
Branching and acquisition barriers were significantly reduced by the RiegelNeal IBBEA in 1994. The act replaces existing state level legislations on interstate activities by allowing bank holding companies to acquire banks in any state, effective from 30 September 1995. The interstate branching provision allows banks to consolidate their interstate banking subsidiaries into a single bank, effective from 1 June 1997. The nationwide interstate banking and branching replaces the previous regional interstate banking that had been introduced prior to the passage of the Act. Many individual state laws already permitted interstate banking, but only eight states allowed some forms of interstate branching.9 Six states allowed interstate branching under reciprocal laws, Nevada allowed interstate branching in counties with a population of less than 100 000 with nonreciprocal laws and Utah permitted nonreciprocal interstate branching.10 Methods of out-of-state branching are extended by the passage of the IBBEA. Branching across state lines prior to IBBEA can be carried out only by two ways. First, a bank can charter a new subsidiary or de novo bank in a state other than the state where the banks headquarters are located. Second, a bank can acquire an out-of-state bank and then convert it to a subsidiary of the parent bank. Following the IBBEA, BHC can merge subsidiary or branch in four ways (Johnson and Rice, 2007). First, the BHC can separately acquire chartered institutions. Second, it allows interstate agency operations that permit a bank subsidiary of a BHC to act as an agent of an affiliate of the BHC without being legally considered as a branch of that affiliate. Third, the Act allows banks to consolidate acquired banks or individual branches into branches of the acquiring bank, and the last is branching by establishment of a new branch office of a banking company across state borders as long as the states statute expressly allows opening of a new branch by out-of-state banks. Many believe that the interstate branching provision of the IBBEA will have greater influence on the activity of corporate control. As the cost of entry decreases, bank holding companies can increase their opportunities nationwide, and at the same time the IBBEA enables them to convert their subsidiaries into branching networks that many argue will reduce the costs of running bank holding companies.

Evidence by Hubbard and Palia (1995) shows that turnover and the sensitivity of pay to performance for senior executives increase after states allow interstate banking, indicating an increased alignment between management and shareholders. 8 Hadlock et al. (1999) show that bank managers with a large ownership stake might push for being acquired in the hope of receiving an attractive takeover premium. 9 For further explanation and examples on interstate banking prior to the IBBEA, see Savage (1993). 10 For further explanation and examples on interstate branching pre- and post-IBBEA, see Johnson and Rice (2007).

1992
Grabowski et al. (1993) show that branch banking is a more efficient organizational form than the BHC when performance is measured by nonparametric frontiers. Carrow and Heron (1998) find that investors anticipated that BHCs gain benefits from the relaxation of interstate branching restrictions. Due to the perceived increased benefits coming from the interstate branching, we expect that the corporate control activities will increase as the interstate branching comes into effect. A study by Johnson and Rice (2007) also finds that the M&A increases following the interstate branching. The number of banks decreases over time and the number of out-ofstate branches increases. The effect of the nationwide deregulation will be tested to examine its impact on the decision of going public or M&A. The hypothesis is that banks tend to choose to go M&A instead of IPO, since engaging in M&A can increase the potential of scale of scope and scale of economy more aggressively after the passage of the Act, while the cost of organizational form reduces. Hypothesis 2: Banks are less (more) likely to go public (M&A) in the period when geographical unrestricted banking activities are permitted. Certain types of depository institutions may experience changes in the environment of the banking industry that lead them to favour going public than sellout. A large number of banks and thrifts have issued an initial public offering of stock. The issue of stock is a response of savings and loans to increased growth opportunities that are caused by changes in technology, increased competition in the savings and loan competition, risk bearing and potential scale and scope economies (Masulis, 1987; Carhill and Hasan, 1997; Esty, 1997). Opportunities to grow opened up as electronic funds transfer technology allowed depository institutions to achieve greater economy of scale and scope. The types of services savings and loans could offer also expanded as dictated by the Depository Institution Deregulation and Monetary Control Act of 1980 and the Depository Institutions Act of 1982. However, a higher volatility in interest rate and interest rate level increased variability of earnings and leverage ratios. Going public provided capital to savings and loans to anticipate increased growth opportunities and to prevent insolvency from losses and uncertainty in earnings. In the new environment, stock type improves thrifts access to capital, and allows thrifts to grow steadily in the increasingly competitive environment. Studies show that a certain type of depository institutions prefers to go public because changes in their circumstances give them substantial forces

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to favour the benefits from going public. Based on previous evidence, this study will test the hypothesis that savings institutions are more likely to choose IPO than the other type of institution. Hypothesis 3: Depository intermediaries chartered as savings institutions are more (less) likely to go public (M&A). Market competitive environment Local market environment where banks operate may influence the decision to go public or takeover. In less concentrated local loans and deposits markets, banks may be able to increase market concentration, up to an extent, by merger. Being in less competitive markets bring benefits to banks. These banks can raise their expected profits and reduce risk. Rhoades and Ruts (1982) show that banks that can increase market concentration experience higher profits and less variability in net income. Another benefit is that regulators are likely to accept proposed banking mergers in less concentrated local markets. However, in competitive local markets, profitability is more uncertain and pressures for investment in new products and services are more intense (Rhoades and Ruts, 1982; Masulis, 1987; Esty, 1997). Going public can provide capital that can be used to invest in new services, raise the level of liabilities, and to provide cushion against losses and lower probability of insolvency. As in competitive local markets variability in earnings is higher, going public can provide banks more benefits to offset the negative effects from high uncertainty of earnings. Given these two competing arguments, the effect of market competitive environment on the decision of banks to go public or sellout will be left to the outcome of the empirical testing. Hypothesis 4: The more competitive the local market, the more likely that banks will go public (M&A). Bank fundamental factors Banks, like other business, have a growth cycle in terms of financing and investing. As banks grow, their financial needs and investments change. Young banks may heavily depend on internal financing or acquisition of deposits. As banks become mature, banks are more likely to go public to meet their need for growth, especially in response to encouraging conditions, such as good economic environment (Ritter and Welch, 2002; Brau et al., 2003; Pastor and Veronesi, 2005), or deregulation (Esty, 1997). A model by Chemmanur and Fulghieri (1999) also predicts that older firms are more likely to go public

The choice of IPO versus M&A

because the evaluation costs on going public firms depend on the amount of information already available in the public domain about the firm and its management, which is positively related to the years of establishment of the firm.11 Younger banks may be at a disadvantage due to lack of information available to investors. These banks may find that acquisition provides a better deal on specific aspects that fit the acquirers purposes given their stage of growth, and receives better evaluation for the particular features. Therefore, everything else being the same, older banks are expected to be more likely to go public. The age of a bank is measured from the time when the bank is found to the time when it goes public or engages in M&A. Hypothesis 5: Older banks are more (less) likely to go public (M&A). Bank size represents the resources and capability of the bank to successfully compete as a publicly traded entity. Even before accessing the public market, a bank should consider its resources for the direct and indirect costs involved in issuing new securities. Pagano and Roell (1998) point that IPOs involve high explicit fixed costs. Ritter (1987) has estimated that the fixed cost of going public can reach $2 50 000 and the variable costs are about 7% of the gross proceed of the IPO. As the costs are not linear to size, smaller banks will face the costs at a larger proportion than banks with bigger size. In addition to the direct costs of going public, smaller banks may experience larger asymmetric information between issuers and investors. They are typically followed by fewer analysts, and this asymmetric information adversely determines the magnitude of IPO pricing. On the other hand, small banks may find sellout as a better option than going public. They may not be adversely affected by the cost of going public that can hinder them even from the beginning stage of going public, or the costs of higher underpricing because the small banks possess high asymmetric information. Thus, for the size factor, it is predicted that bigger banks prefer to go public. The variable that will be used to measure the size is total assets. Total asset is widely used as a proxy of size for banks. The higher the asset of a bank, the more likely that the bank chooses to go public. Hypothesis 6: The bigger (smaller) the size, the higher the probability that banks go public (M&A).

1993
Banks manage the amount of capital to reduce the chance of bank failure, to meet capital adequacy set by regulatory authorities, and to lessen moral hazard by reducing the incentive of bank owners to take risk. Banks with substantial growth in the past would eventually opt to raise capital, as capital ratio holding becomes shrinking due to growth in their asset size prior to going public. Findings by Houge and Loughran (1999) and Rosen et al. (2005) show IPO banks in general grow significantly faster in their assets prior to the stock issuance. Poulsen and Stegemoller (2008) also find that going public firms tend to grow significantly in total assets and capital expenditures prior to the public offering. These banks may find it necessary to increase their capital holding to meet the requirement and to provide a cushion against unpredicted losses. Houge and Loughran (1999) suggest that some banks went public to take advantage of growth opportunities, and invested the capital raised from the offering in marginally riskier loans that eventually made these banks relatively experience larger loan write-off than the average banking industry. We expect that banks that ultimately go public exhibit low capital-to-asset ratio. The target banks are expected to have relatively higher capital-to-asset ratio than going public banks. The target banks are also found to have a high growth in total assets (Hunter and Wall, 1989; OKeefe, 1996). With other things constant, banks that experience the same growth as others but hold higher capital ratio may find takeover a better option. Acquirers may place higher values to banks with excess capital. At the same time, acquirers may find them attractive since excess capital can be used as a means to help them grow once acquisitions complete. In addition, return on equity of target banks would rise following the reduction of capital holding of the targets. To test the effect of capital ratio to the likelihood of going public or takeover, capital ratio is measured by standardizing it to total assets. Banks with relatively lower capital ratio are predicted to go public. Hypothesis 7: The lower (higher) the capital, the higher the probability that banks go public (M&A). Core deposits may also be a factor in determining the choice between going public and acquisition. Core deposits are the base of demand and savings accounts that banks can expect to maintain for an extended

11

In spite of this common prediction, Rosen et al. (2005) find that younger banks are more likely to go public than stay private using a size-matching sample.

1994
period of time. They include deposits that are acquired from noninterest bearing deposit demand account, NOWs and savings accounts. Core deposits are seen as an essential and stable source of funds for lending. They are influential because the accounts generally carry lower interest rates than other funds obtained from the open market, making them valuable low-cost funds for banks. Using low-cost core deposits as source of funds allows banks to generate high margin products because interest rates differential between typical loans and core deposit funds can be significant. In addition, these accounts experience less interest rate sensitivity than other short-term accounts, and may insulate borrowers against exogenous changes in aggregate credit risk (Berlin and Mester, 1999). Perhaps the most important feature of core deposits is that customers usually open these accounts and remain with the banks for quite a long time. They usually stay with the banks and emphasize on relationship with the banks. This makes core deposits a stable source of funds for lending. Core deposits can be attractive for both going public and bank acquisition. The volume of core deposits would give an edge to banks that are about to go public. Having a strong deposit base along with the possibility of expanding products offered to the customers of these accounts could lead to potential earnings in the future. For a bank acquisition, the buyer receives a built-in base of stable customer relationships through accounts associated with core deposits. These deposits benefit the buyer by providing low-cost funds, and helping to boost profits while at the same time reducing the interest rate risk. In addition, for acquisition, deposit relationships may provide even more value addition through the crossselling opportunities to these customers. However, everything else being the same, banks with a higher level of core deposits can be especially valuable in the view of acquirer due to tax benefit of these accounts. Core deposits can be viewed as intangible assets to banks; they become worthless or meaningless when they are separated from the business. In the valuation of acquisition, intangible assets can be amortized for federal income tax purposes. As a result, significant tax savings may be realized from acquiring banks with a higher volume of core deposits. We predict that banks with relatively higher core deposits will tend to be acquired. In addition, evidence in the bank merger literature suggests that core deposit is one of strategic profiles of target banks (Hunter and Wall, 1989). Wheelock and Wilson (2004) also find that higher the core deposit ratio is positively related to merger probability.

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Hypothesis 8: The lower (higher) the banks core deposit, the more likely that the bank goes public (M&A). Any banking organization must ensure that adequate liquidity is maintained in order to meet customer withdrawal requirements, satisfy contractual liabilities, fund operations and for loans. Sources of liquidity include assets readily convertible to cash, including investments and other securities with maturity in 1 year or less, interest bearing balances at other banks and short-term debt that is money market related. In the financial market, an excess liquidity signals inept management who may not be efficient in asset management. On the other hand, high liquidity may signal a higher value to potential acquirers as more liquidity means less risky and also more unused assets that can be used for new capital budgeting decisions to the acquirers. OKeefe (1996) find that compared to banks that stay independent, the probability of engaging in merger increases with bank liquidity. Therefore, it is expected that banks with low liquidity are more likely to go public. Hypothesis 9: The lower (higher) the liquidity, the more likely that banks go public (M&A).

IV. Data and Methodology Data The sample used for the analysis consists of bank IPO and bank takeover samples. The bank IPO sample is obtained from the Securities Data Company (SDC) Global New Issues database for US banks that went public in the period 1985 to 1999. The initial sample of IPO consists of 361 banks. Then the FDIC certificate number and Fed ID number for each bank are matched. We found 337 banks with the ID numbers. Each bank is also required to have sufficient data available for the hypothesis tests. As some of the banks did not have data available from the FDIC database, the final IPO sample consists of 272 banks. In the same way, the bank takeover sample is initially drawn from the SDC M&A database for US bank M&As that occurred between 1985 and 1999. We utilized all US banks that are privately held targets and completed the M&A deals with US bank acquirers. The initial number was 4393. The list was matched with the merger list provided by Federal Reserve Bank of Chicago, and selected only the M&As that are not involved in government assistance.

The choice of IPO versus M&A

This gave 790 banks. Finally, due to data availability, the target banks sample has 440 banks. The FDIC database provides most of the data needed for the hypothesis tests. The FDIC database provides financial data and history of all entities filing the Report of Condition and Income (Call Report) and some savings institutions filing the OTS Thrift Financial Report (TFR). The entities include commercial banks, savings banks and savings and loans. Other databases employed in this study include Center for Research in Security Prices (CRSP) (for the stock market returns). The years when state allowed intra or interstate banking activities are provided by Kroszner and Strahan (1999). The years are used to define whether a state already allowed intrastate branching or interstate banking when a bank went public or are acquired. This is to reflect intrastate and interstate banking activity restrictions. Methodology The aim of the analysis is to test factors that may affect privately held banks to choose between IPO and M&A. A binomial choice model is developed with the regulatory, market competitive environment and firm fundamental factors as the influencing aspects contributing to the decision taken by private banks. This problem is suitable for examination and testing using a logistic regression methodology. The binomial choice variable is one for banks that choose to go public, and zero for banks that decided to go M&A, with the influencing factors as independent variables in the logistic regression method. The maximum likelihood estimation method is performed for the following model:   3 X Pi ln j Xji 4 X4i 0 1 Pi j1 where i j 1, 2, 3 j4 j 5, . . . , 9 i-th observation, regulatory environment factors (STATEREG, DEREG, SVINST), market competitive environment factors (MSA), firm fundamental factors (AGE, LASSET, CAPITAL, CORE, LIQUIDITY), control variables.
9 X j5

1995
The logistic model defines Pi eXi  =1 eXi  as the probability that i-th bank will offer IPO. Xi is the vector of factors that are used to distinguish banks that went public from M&A, and  is the vector of estimated coefficients. Pi =1 Pi is the odds indicating how often IPO happens relative to how often it does not occur. The logit, i.e. natural log of the odds, is linearly related to the explanatory variables. Variables Variables used for the logistic regression estimations are as follows. The regulatory environment factors consist of three variables: state regulation (STATEREG), bank deregulation at national level (DEREG) and type of banks (SVINST). A dummy variable is used for each of these variables. STATEREG equals one if the states in which banks went public or merged allowed full intrastate branching or interstate banking activities. DEREG depicts the geographical deregulation on banking industry at the national level. Effective from 1997, geographical restriction is eliminated as a result of RiegelNeal Act. A dummy variable of one is assigned if banks went public or M&A in the postderegulation era, the year of 1997, else a dummy variable of zero is assigned. Type of bank institution is represented by SVINST, which equals one for savings banks and zero for commercial banks. We define savings banks as savings institutions and savings and loans associations. The market competitive factor is represented by Metropolitan Statistical Area (MSA).12 Antitrust analysis has relied on the definition of a banking market at the MSA level (Dick, 2008). MSA is to indicate whether a bank is in MSA area or not. The dummy variable is utilized for this purpose, with MSA equal to one for banks operated in MSA areas. Urban banking markets are considerably less concentrated than rural areas as the number of banks competing in urban areas is larger than that in rural markets. Firm fundamental factors have five variables: AGE, LASSET, CAPITAL, CORE and LIQUIDITY. AGE is measured as years from when a bank is established to the year when the bank went public or involved in M&A. LASSET is the log of total assets. CAPITAL is the level of equity of a bank divided by total assets, CORE is the level of core deposit over total assets and LIQUIDITY is the ratio of the sum of securities and cash to total assets. Control variables include economic environment factor measured by Standard and Poor (S&P) returns

j Xji

13 X j10

j Xji ui

j 10, . . . , 13
12

Many recent papers define local banking market by MSA, see Dick (2008) for a recent example.

1996
at the day when the banks go public or when the M&A deal is completed. The market practice factors comprise LPREMIUM and TIMING variables. LPREMIUM is measured by taking the natural logarithm of the difference between the premium paid for public bank targets and that for private bank targets. TIMING is a lagged relative volume that measures the volume of IPOs over the volume of M&A in the previous year when a bank conducted IPO or M&A. These factors are used to control economics and market practices, which are found to be influential (Brau et al., 2003).

B. Francis et al.
The MSA variable is a proxy used to identify whether a bank operates in a high competition market. Overall, more than half of the banks going public operate in highly competitive local markets. Around 79% of the bank IPOs are located in MSA areas, almost 90% for savings institution IPOs and around 67% for commercial bank IPOs. Looking at the descriptive statistics of firm fundamental factors, the average age of the bank that chooses IPO is 64.5 years, with the savings institutions that do so older than the commercial banks (84 years versus 40 years). The rest of the firm fundamental factors are also interesting to look at. The average size, measured by the log of total assets, is 12.0696 ($174 million) for the full sample. The savings institutions ($305 million) are much larger than the commercial banks ($89 million). For capital ratio, the full sample has an average of 0.0739. Savings institutions are found to have a much lower capital ratio than commercial banks do (0.0539 versus 0.0984). Similarly, the liquidity ratio of savings institutions (0.2400) is lower than that of commercial banks (0.2666). However, the core deposit ratio is shown to be higher in the savings institutions (0.8188 compared to 0.7521), although the magnitude may not be considerably larger. In summary, savings institutions that choose IPO are more mature and larger than commercial banks that choose IPO, and their fundamental structures are quite different. Savings institutions seem to rely on core deposits, while commercial banks hold more capital and liquidity. Table 2 shows descriptive statistics for the full sample of bank M&As, savings institutions and commercial bank sub-samples.

V. Empirical Results and Discussion Figure 1 presents the distribution of IPO and M&A samples over the period January 1985 to December 1999. The bars represent the number of bank IPOs and bank takeovers in each year. As shown in the graph, a larger number of banks went public in the years between 1985 and 1988. The trend reverses in early 1989, with a larger number of banks chose to be acquired. Table 1 reports descriptive statistics of variables for the whole sample of bank IPOs, and for savings institution and commercial bank sub-samples. As shown in Table 1, more than 90% banks went public during the time when states in which they located have allowed full intrastate or interstate banking. About half of the sample is savings institutions or savings and loans associations.

Fig. 1. Number of bank IPOs and M&As in the sample by year Note: The sample consists of 272 bank IPOs and 440 bank M&As from January 1985 to December 1999.

Table 1. Descriptive statistics for the sample of bank IPOs Panel B. Savings institutions Minimum 0 0 0 0 0 9.1089 0.0662 0.1562 0.0072 4.3510 2.8326 0.4000 6.2454 85.3333 4.7463 4.0517 0.4867 12.2276 2.2040 0.2591 0.7587 4.3510 1 0.4 165 16.3690 0.7435 1.0148 1.3155 83.9533 12.6301 0.0539 0.8188 0.3661 40.1481 1.3114 0.0344 0.1287 0.2400 1 9.1089 0.0662 0.3639 0.0348 165 16.3690 0.2242 1.0148 1.3155 1.8730 6.2454 85.3333 1 0.8800 0.3261 0 1 0.6721 40.6639 11.3842 0.0984 0.7521 0.4534 0.0352 4.8760 13.2477 1 1 1 0.5000 0.0200 NA 0.5017 0.1405 NA 0 0 NA 1 1 NA 0.9508 0.2705 NA Maximum Mean SD Minimum Maximum Mean SD 0.2171 0.4461 NA 0.4714 38.4185 1.1870 0.0983 0.1351 0.2666 0.8430 0.8057 17.5304 Panel C. Commercial banks Minimum 0 0 NA 0 0 9.2281 0.0435 0.1562 0.0072 4.3510 2.8326 0.4000 Maximum 1 1 NA 1 137 16.1000 0.7435 0.9235 1.2827 2.2040 6.2454 85.3333

Panel A. Full sample SD 0.2554 0.3395 0.4983 0.4104 44.8384 1.4000 0.0740 0.1355 0.2554 0.8039 0.6513 15.5053

The choice of IPO versus M&A

Variable

Mean

Regulatory factors STATEREG* 0.9302 DEREG 0.1324 SVINST 0.5515

Market competitiveness MSA 0.7868

Firm fundamental AGE LASSET CAPITAL CORE LIQUIDITY

factors 64.5368 12.0696 0.0739 0.7892 0.4048

Economic factor MRET (%)

0.1587

Industry practice factors LPREMIUM 4.8044 TIMING 8.1764

Notes: The full sample consists of 272 US bank IPOs from January 1985 to December 1999. STATEREG is a dummy variable equal to one if the state where an IPO is located permitted full intrastate or interstate banking. SVINST is a dummy variable equal to one if the IPO is a savings institution (savings banks or savings and loans). DEREG is a dummy variable with a value of one if the IPO goes public on or after the year of the RiegelNeal Act (1997). *indicates that the variable is INTRA, instead of STATEREG, for Savings Institutions sub-sample. INTRA is a dummy variable equal to one if the state where an IPO is located allowed full intrastate branching. MSA is a dummy variable with a value of one if the IPO is located in a Metropolitan Statistical Area. AGE is the number of years an IPO has been established to the year of its going public. LASSET is the log of total assets. CAPITAL is total capital divided by total assets. CORE is total core deposits divided by total assets. LIQUIDITY is the sum of cash and securities divided by total assets. NA is not applied. MRET (%) is market returns. LPREMIUM is the log of the premium difference between public and private targets. TIMING is a market timing variable measured by calculating the number of M&A in the previous year divided by the number of IPOs over the same time period.

1997

1998

Table 2. Descriptive statistics for the sample of bank M&As Panel B. Savings institutions Minimum Maximum Mean SD Minimum Maximum Mean SD Panel C. Commercial banks Minimum Maximum

Panel A. Full sample SD

Variable

Mean

Regulatory factors STATEREG 0.9955 DEREG 0.3182 SVINST 0.2114 0.0673 0.4663 0.4087 0.4493 37.4379 0.9254 0.0322 0.0784 0.2951 0.8492 0.8820 17.4818 2.8326 0.4000 6.2454 85.3333 4.5966 20.2345 0.8655 15.3705 3.0827 3.8609 0.0540 0.7971 3.0827 2.8326 2.6364 1 8.9121 0.0043 0.4526 0.0032 193 14.9431 0.2357 0.9842 1.6807 53.5914 11.4608 0.0837 0.7778 0.4130 37.6893 1.1084 0.0441 0.0936 0.3045 1 8.9121 0.0097 0.4526 0.0032 174 14.9431 0.2357 0.9842 1.3612 1.4492 6.2454 53.6667 0 1 0.6774 0.4700 0 1 0.7304 40.1971 11.2740 0.0916 0.7841 0.5364 0.1040 4.7937 18.2603 0 0 0 1 1 1 0.8280 0.2473 NA 0.3795 0.4338 NA 0 0 NA 1 1 NA 0.9942 0.3362 NA

0.0760 0.4731 NA 0.4444 36.9834 0.8610 0.0281 0.0727 0.2875 0.8630 0.8803 18.0358

0 0 NA 0 2 9.3846 0.0043 0.4797 0.0219 3.0108 2.8326 0.4000

1 1 NA 1 193 13.9357 0.2087 0.9220 1.6807 3.8609 6.2454 85.3333

Market competitiveness MSA 0.7205

Firm fundamental factors AGE 42.9705 LASSET 11.3200 CAPITAL 0.0899 CORE 0.7824 LIQUIDITY 0.5090

Economic factor MRET

0.0712

Industry practice factors LPREMIUM 4.7530 TIMING 18.6295

Notes: The full sample consists of 440 US bank M&As from January 1985 to December 1999. STATEREG is a dummy variable equal to one if the state where a target bank is located permits full intrastate or interstate banking. SVINST is a dummy variable equal to one if the target is a savings institution (savings banks or savings and loans). DEREG is a dummy variable with a value of one if the bank engages in M&A on or after the year of the RiegelNeal Act (1997). MSA is a dummy variable with a value of one if the target bank is located in a Metropolitan Statistical Area. AGE is the number of years a bank has been established to the year of its mergers. LASSET is the log of total assets. CAPITAL is total capital divided by total assets. CORE is total core deposits divided by total assets. LIQUIDITY is the sum of cash and securities divided by total assets. NA means not applied. MRET (%) is market returns. LPREMIUM is the log of the premium difference between public and private targets. TIMING is a market timing variable measured by calculating the number of M&A in the previous year divided by the number of IPOs over the same time period.

B. Francis et al.

The choice of IPO versus M&A

The findings in regulatory factors indicate that around 21% of the bank M&A sample is depository intermediaries chartered as savings institutions. Of the full sample, around one-third of the banks are taken over in the period when banking activities are geographically unrestricted. Only around 25% of savings institutions, and about one-third of commercial banks are acquired in that period of time. Thus, on average, less than half of private bank takeovers occur during the geographical deregulation era. For the market competitive environment factor, it shows that around two-thirds of target banks are located in urban areas. About 73% of commercial banks are located in competitive local market compared to a small percentage (68%) of savings institutions. On average, over half of the target banks operate in high competition market. Description of age, size, capital ratio, core ratio and liquidity ratio of bank that choose M&A are shown under firm fundamental factors. The average age of the bank M&A sample is 43 years. The length of establishment is longer (around 54 years) for savings institutions than for commercial banks (40 years). The size of bank that chose M&A is 11.32, or $82 million on average, with savings institutions ($95 million) larger than the commercial banks ($79 million). The capital ratio of the bank M&A sample is around 0.09. This ratio level is quite similar between savings institutions (0.0837) and commercial banks (0.0916). The core deposit ratio is also quite similar between savings institutions (0.7778) and commercial banks (0.7841). The average core deposit ratio is 0.7824 for the full sample. The last variable, liquidity, is found to be lower for savings institutions (0.413) than for commercial banks (0.5364). In brief, savings institutions that choose merger are older and larger than commercial banks that do so, and the commercial banks have a higher liquidity ratio than the savings institutions do. The average market return is 0.0712% for bank takeovers. In particular, the average market return is 0.054% for savings institution targets, and 0.104% for commercial bank targets. This shows that, on average, commercial banks are acquired during the time when the economic environment is better. Turning to descriptive statistics of market practice factors, the log of the difference in premium paid between public bank targets and private bank targets is around 4.753 or $116 million. The average premium difference is 4.5966 ($98 million) for savings institution M&A, and 4.79 ($121.5 million) for commercial bank M&A. The TIMING (volume of mergers divided by volume of IPO) suggests that banks are more likely to agree to takeover during heavy periods of M&A deals. This is especially

1999
obvious for savings institutions (20) compared to commercial banks (18). Thus, timing may encourage savings institutions to undertake merger deals. These sections present descriptive statistics of the bank IPO and bank M&A samples for each variable. They summarize the data used in the analysis for each sample. The next section gives an idea how the two samples differ in terms of their central tendencies. Difference test between bank IPO and bank M&A samples Tests of the mean differences between IPO and M&A samples for all factors are presented in this section. t-tests are conducted to test whether the mean between bank IPOs and bank targets for each variable are equal. Thus, the null hypothesis is that the mean difference is zero. The alternative hypothesis is that the difference is not equal to zero. The associated p-value less than 0.01 rejects the null hypothesis at a 1% level of confidence (two sided) and leads to the conclusion that the means of IPO and M&A samples are different. Table 3 reports the results of the tests. Overall, the means of regulatory factors, market competitiveness, most of the firm fundamental factors and market timing are significantly different between the IPO and M&A samples, with corresponding p-values less than 0.01. Interesting results on firm fundamental factors show related financial characteristic of banks that may affect the choice between IPO and M&A. On average, the age of banks chosen IPO is 64.5 years compared to 43 years for banks that are the target of M&A. Banks conducting IPOs are found to be larger than target banks, with an average size of $175 million for bank IPOs and $82 million for target banks. A t-test confirms these differences in means for age and size. The capital ratio of bank IPOs is shown to be lower (0.0739) than that of target banks (0.0899). The liquidity ratio is also lower for bank IPOs (0.4048 compared to 0.509). These two variables are also found to be significantly different at a 1% level of confidence. Thus, it can be concluded that fundamental characteristics of banks may contribute to the decision of banks to go public rather than engage in M&A. Tests on the economic factor show that means of bank IPO and bank M&A stock market returns are considerably different. Banks apparently conduct IPOs when stock market returns are relatively high (0.1587%) on average, while bank takeovers occur when stock market returns are relatively low (0.0712%). Although the t-test for this factor is not significant at the 1% level, the result supports

2000

Table 3. Differences in means between bank IPOs and bank M&As using full samples Panel A. IPO sample (N272) Median Mean SD Median Mean SD Panel B. M&A sample (N440) t-value p-value

Variable

Description

Regulatory factors STATEREG State allow intra or interstate banking dummy DEREG Fully implementation of RiegelNeal dummy SVINST Savings institutions dummy 1.0000 0.0000 1.0000 1.0000 63.0000 12.0222 0.0671 0.8226 0.3632 0.1730 4.7573 1.4390 4.8044 8.1764 0.1587 0.8039 0.6513 15.5053 64.5368 12.0696 0.0739 0.7892 0.4048 44.8384 1.4000 0.0740 0.1355 0.2554 26.0000 11.2538 0.0855 0.7905 0.4707 0.0487 4.7573 8.9091 0.7868 0.4104 1.0000 0.9302 0.1324 0.5515 0.2554 0.3395 0.4983 1.0000 0.0000 0.0000 0.9955 0.3182 0.2114 0.7205 42.9705 11.3200 0.0899 0.7824 0.5090 0.0712 4.7530 18.6295

0.0673 0.4663 0.4087 0.4493 37.4379 0.9254 0.0322 0.0784 0.2951 0.8492 0.8820 17.4818

5.09 5.7 9.91 1.98 6.92 8.58 3.96 0.83 4.72 1.36 0.83 8.09

<0.0001 <0.0001 <0.0001 0.0484 <0.0001 <0.0001 <0.0001 0.4082 <0.0001 0.1737 0.4061 <0.0001

Market competitive factor MSA Metropolitan statistical area dummy

Firm fundamental factors AGE Number of years a bank was established LASSET Logarithmic of total assets CAPITAL Capital/total assets CORE Core deposit/total assets LIQUIDITY Cash and securities over total assets

Economic factor MRET Market returns (%)

Industry practice factors LPREMIUM Logarithmic of premium difference between public target and private target TIMING Relative volume of mergers to IPOs in the previous year

Notes: Differences in the mean values between IPO and M&A samples are provided below. The t-test values are shown along with the associated significance levels of the parametric tests. The samples consist of 272 US bank IPOs and 440 US bank M&As from January 1985 to December 1999. STATEREG is a dummy variable equal to one if the state where a bank is located permits full intrastate or interstate banking. SVINST is a dummy variable equal to one if the bank is a savings institution (savings banks or savings and loans). DEREG is a dummy variable with a value of one if the bank goes public or engages in M&A on or after the year of the RiegelNeal Act (1997). MSA is a dummy variable with a value of one if the bank IPO or bank target is located in a Metropolitan Statistical Area. AGE is the number of years a bank has been established to the year of its IPO or merger. LASSET is the log of total assets. CAPITAL is total capital divided by total assets. CORE is total core deposits divided by total assets. LIQUIDITY is the sum of cash and securities divided by total assets. MRET (%) is market returns. LPREMIUM is the log of the premium difference between public and private targets. TIMING is a market timing variable measured by the number of M&A in the previous year divided by the number of IPOs over the same time period.

B. Francis et al.

The choice of IPO versus M&A

previous studies that suggest the stock market as an indicator of IPO activity. Additionally, the decision to go public or merge seems to be related to market timing. Findings indicate that banks tend to go public during the clustering of IPO activity, and to be acquired when prior merger activity is intense (8.1764 for bank IPO versus 18.6300 for bank M&A). This result is in line with the studies by Mitchell and Mulherin (1996) and Brau et al. (2003). While the mean tests provide some interesting description of the samples for each variable, the variables relationships to the decision of banks to go public or to be acquired is the focus of this study. Logistic regression analyses of the choice are presented and discussed in the next section. Logistic regressions results The sample under examination includes firms that choose either IPO or to be acquired. By examining these two samples, we are able to analyse different factors affecting the relative attractiveness of IPO versus M&A for privately held banks. To examine this, a binomial choice model has been developed. The dependent variable is a binomial choice of either going public or being acquired. A value of one is assigned for every bank, which conducts an IPO, and a value of zero is assigned for each bank acquisition. A logistic regression method is performed and, to complete the estimation, the maximum likelihood method is used, since the data are at the individual level. Table 4 presents the results of the estimation using logistic regression. In general, the results show that nine of the twelve factors have coefficients that are significantly different from zero. Furthermore, the sign of each significant coefficient is consistent with its corresponding hypothesis. The significance of the regulatory factor coefficients indicates that they have an influence on banks decision on IPO versus M&A. Specifically, banks are less likely to go public if regulatory restrictions related to intrastate and interstate banking activities in the states where the banks operated are higher. Similarly, unrestricted geographical banking activities discourage banks from going public. Banks are less likely to go public in the period of unrestricted geographical banking activities. As predicted, it is also found that depository intermediaries chartered as savings institutions are more likely to go public. The significance level of the effects of state regulation and deregulation are 5 and 1%, respectively, and 10% for the savings institutions dummy variable. Turning to the firm fundamental factors, it is found that three of the five factors contribute significantly

2001
to the decision made by private banks. They are age, size and liquidity ratio. The positive signs of the age and size variables support the conjectures that as banks grow and become mature in products, they are more likely to go public. The positive sign of size confirms the hypotheses that small banks will be more likely to be deterred from going public by the direct costs of going public and the impact of high asymmetric information on IPO pricing. Thus, the larger a bank is, the more likely it is to go public. Another fundamental factor that significantly affects the decision of IPO versus M&A is liquidity ratio. The negative sign of the liquidity ratio variable suggests that private banks with a lower liquidity ratio are more likely to go public. Moreover, although the remaining firm factors do not significantly contribute to a banks decision, the results qualitatively support the hypotheses. The signs of the core deposit ratio and liquidity ratio coefficients also support their related hypotheses. The logistic model also includes control variables. We include the market return as a proxy of economic factor, following Brau et al. (2003). Other things being equal, we find that banks are more likely to go public when the market return is higher. As market return is used as a proxy for the economic environment, the result suggests that the better the economic environment, the higher the probability that the bank conducts an IPO. Market practice factors also contribute to the decision of banks to go public or to agree to merge. The coefficients of the premium difference and market timing variables are found to be significant at the 1% level. Premium difference is found to positively influence the probability of banks to go public. The higher the difference in premium paid between public target banks and private target banks, the more likely that the banks go public. This is in line with the work of Zingales (1995). Furthermore, market timing is also an important factor in private banks decisions between the choices. Banks are more likely to go public during relatively high volumes of IPO. The clustering effect observed supports previous study by Brau et al. (2003). Further, we examine the likelihood of banks to go public or merge using sub-samples. The method utilized for the savings institution and commercial bank sub-samples is similar to that applied for the logistic regression using the full sample. Each subsample has data for banks conducting IPOs and M&A. The dependent variable is a binomial choice of either IPO or M&A. A value of one is assigned for every bank that conducts IPO and a value of zero is used for each bank acquired. Table 4 presents the results of the estimation using logistic regression for the savings institution

2002

Table 4. Logistic regression estimation predicting IPO versus M&A using full sample, savings institutions sub-sample and commercial banks sub-sample Full sample Model 1 4.4612** (2.0226) 1.5073 (1.9046) 1.9812 (2.5491) Model 2 Model 3 Model Model 1 Model 2 Savings institutions Commercial banks Model 3 3.6867 (2.4136)

Parameter

Intercept

Intrastate deregulation

15.8022*** (4.8624) 2.0070*** (0.5881)

Interstate deregulation

4.1161** (2.0127) 0.8166*** (0.2168) 1.5629** (0.6220) 1.8076*** (0.3626) 5.8964*** (1.2890) 1.7004** (0.8581) 0.9413** (0.4001) 0.771* (0.4105)

2.1348 (2.5388) 0.6456** (0.2587) 1.2605* (0.6894)

STATEREG

DEREG

1.9684** (0.7857) 2.0440*** (0.3545)

Geographic deregulation

1.9027** (0.8524)

SVINST

MSA

AGE

LASSET

CAPITAL

CORE

LIQUIDITY

MRET

LPREMIUM

TIMING 670.871 231.3373*** 0.2912 0.3942 654.403 247.8055*** 0.3084 0.4174

0.4308* (0.2293) 0.0423 (0.2399) 0.0067** (0.0028) 0.4408*** (0.1051) 0.4093 (2.2331) 1.2502 (1.1273) 1.3301*** (0.3738) 0.2364** (0.1185) 0.5965*** (0.1732) 0.041*** (0.0073) 1.3799** (0.6549) 0.0262*** (0.0083) 0.9426*** (0.2496) 18.0869** (7.3524) 2.1908 (2.5723) 2.4814** (1.0593) 0.8708*** (0.3357) 1.8717*** (0.4674) 0.0600*** (0.0150) 706.427 195.7813*** 0.2527 0.39421 118.027 199.5715*** 0.5661 0.7700

0.4059* (0.2333) 0.0266 (0.2427) 0.0072** (0.0028) 0.4477*** (0.1070) 0.7061 (2.2526) 1.4646 (1.1525) 1.3398*** (0.3818) 0.2113* (0.1197) 0.5448*** (0.1758) 0.037*** (0.0071)

2.3790*** (0.7826) 0.5967*** (0.2202) 0.0048 (0.2340) 0.0076*** (0.0027) 0.4076*** (0.1008) 0.0067 (2.2617) 0.4051 (1.0916) 1.1600*** (0.3662) 0.2049* (0.1113) 0.1281 "(0.1198) 0.0400*** (0.0073)

0.5546* (0.2896) 0.0005 (0.0037) 0.1251 (0.1382) 0.0792 (2.4322) 3.2897** (1.5056) 1.1218** (0.4476) 0.0039 (0.1396) 0.2821 (0.1997) 0.0219*** (0.00787) 465.125 40.8555*** 0.0904 0.1309

0.5867** (0.2424) 0.0001 (0.0038) 0.1400 (0.1396) 0.0377 (2.4585) 3.4246** (1.5228) 1.0648 (0.4545) 0.0170 (0.1399) 0.2344 (0.2033) 0.0205*** (0.0077) 458.453 47.545*** 0.1044 0.1512

0.5291* (0.2883) 0.0009 (0.0037) 0.0952 (0.1357) 0.0224 (2.4328) 3.1292** (1.4873) 1.0670** (0.4457) 0.0179 (0.1360) 0.0576 (0.1375) 0.0196** (0.00783) 470.745 35.3253*** 0.0785 0.1136

2 log L Likelihood ratio R2 Max-rescaled R2

B. Francis et al.

Notes: The dependent variable is a binary variable with one for banks conducting IPO, and zero for banks undertaking merger deals. Full sample consists of 272 bank IPOs and 440 acquired banks. Saving institution sub-sample consists of 243 banks in total. Commercial bank sub-sample has 467 banks. INTRA is a dummy variable with value of one if the state already allowed full intrastate branching when a bank went public or was merged. INTER is a dummy variable with value of one if the state allowed interstate banking when a bank went public or was merged. ***, ** and * indicate significance at 1, 5 and 10% levels, respectively.

The choice of IPO versus M&A

Table 5. Logistic regression estimation of IPO versus M&A by acquirer status Private acquirer Variable Intercept INTRA STATEREG DEREG SVINST MSA AGE LASSET CAPITAL CORE LIQUIDITY MRET TIMING 2 log L Parameter estimate 6.12 1.66 NA 1.81 1.61 1.32 0.02 1.23 3.27 3.18 3.12 0.68 0.05 86.156 Chi-square 1.23 4.68 NA 4.49 3.23 3.32 2.73 11.52 0.28 0.61 7.73 4.60 10.66 58.82 Pr>Chi-square 0.2665 0.0305 NA 0.0341 0.0724 0.0683 0.0983 0.0007 0.5943 0.4344 0.0054 0.0320 0.0011 <0.0001 Public acquirer Parameter estimate 0.47 NA 2.67 1.19 0.56 0.01 0.01 0.38 0.98 1.06 1.39 0.25 0.04 627.546 Chi-square 0.06 NA 6.26 20.95 5.50 0.00 5.14 12.69 0.20 0.82 12.98 3.94 31.47 190.62

2003

Pr>Chi-square 0.8134 NA 0.0123 <0.0001 0.0190 0.9823 0.0234 0.0004 0.6508 0.3660 0.0003 0.0471 <0.0001 <0.0001

Notes: Logistic regression estimation for private acquirers use the same variables that are applied on full sample. Results are quasi-complete separation for private acquirer when STATEREG is used. INTRA variable is used, instead. INTRA is a dummy variable with value of one if the state already allowed full intrastate branching when a bank went public or was merged. STATEREG is a dummy variable equal to one if the state where a target bank is located permitted full intrastate or interstate banking.

sub-sample. Using the same variables applied to the full sample in the logistic regression estimation for savings institutions gives us a quasi-complete separation. Thus, to obtain a converge estimation, the INTRA variable is used instead of the STATEREG. INTRA is a dummy variable with a value of one if, when a bank goes public or merges, the state allowed full intrastate branching. In general, the results show that eight factors support the hypotheses. They are: market returns, state regulation, deregulation, premium difference, market timing, age, size and liquidity ratio. The table also reports results for the commercial banks sub-sample. Overall, the likelihood of commercial banks to go public agrees with the hypotheses. State regulation and deregulation variables are shown to encourage the decision of commercial banks to go public. Commercial banks with lower core deposits and liquidity ratios are also more likely to go public rather than merge. Market timing has an influence as well and going public during intense IPO activity is more common. Choice of IPO versus M&A by acquirer status M&As usually involve two major statuses of acquirers: public and private acquirers. This section provides results from examining the choice of IPO versus merger for these two categories. The method used is the logistic regression with a binomial dependent variable of either going public or being

a target. A value of one is for bank IPOs and a value of zero is for bank acquisitions. Table 5 provides the findings of the likelihood of a bank going public versus being the target of a private acquirer. Logistic regression estimation for private acquirers using the same variables applied for the full sample results in quasi-complete separation. Therefore, similarly, the INTRA variable is used. The definition of INTRA variable follows that of the savings institution sub-sample estimation. As shown in Table 5, the coefficient signs of nine of the twelve factors follow the conjectures. Market returns have a positive effect on the likelihood of banks to go public. Clustering of IPO activity increases the likelihood of banks to go public rather than undertake mergers. Geographical restrictions negatively influence the likelihood of banks to go public. Savings institutions are found to be less likely to go public when the acquirers are privately held. General findings of firm fundamental factors are also found when the choice analysis is modelled for private acquirers. Older and larger banks tend to go public, as do banks with less liquidity ratio. The results using public acquirers in a binomial model are included in Table 5. The signs of the coefficients confirm the hypotheses built for the banks to go public or merge. Regulatory and three of the firm fundamental factors are found to be significant, at the 5% level of confidence or better. In summary, the analysis of bank choice between going public and dealing with M&A, using the full

2004
sample, the savings institutions and commercial bank sub-samples and the sub-samples regarding the statuses of the acquirers, provides stable results for the regulatory factors and a number of firm fundamental factors (i.e. age, size and liquidity). Local market competition and two firm fundamental factors (i.e. capital and core deposit) show mixed results. The mixed findings of local market competitiveness may be a result of differences in regulatory requirements between savings institutions and commercial banks. Mixed results in capital and core deposits may exhibit differences in reasons for going public. Savings and loans go public and focus on the need of capital, while commercial banks go public to seek more stable sources of funds as they face a higher competition to acquire this type of deposits. Self-selectivity This study is also interested in testing the presence of self-selection generated by banks from making the choice. The observed distribution of TV, i.e. the value received from going public or takeover, may be determined by these choices. Following the work of Heckman (1976), it is assumed that the value received by banks is determined by banks reservation on the capital. Thus, the assumption tells that banks do not obtain the capital in an arbitrary way. In other words, the self-selection is to test the argument that the choice based on the need of capital is not made randomly. Furthermore, it is also interesting to forecast the mean of TV for the alternative choice, i.e. estimate the mean TV for banks that go public had they chosen M&A, and the mean TV for banks that engage in M&A had they chosen IPO. For the first purpose, a common model, in which using a dummy variable (e.g. I 1 if banks go public; I 0 if banks choose M&A) along with other exogenous characteristics affecting TV may result in biased estimates. The dummy cannot be treated exogenously if the decision for IPO or M&A is based on individual bank self-selection. This is because the decision may have interaction with observed or unobserved characteristics that can lead to inconsistent estimates of the parameters (Maddala, 1999). To test the self-selectivity, we define: TVIPOi Xi IPO uIPOi TVM&Ai Xi M&A uM&Ai Ii Zi "i bank selection function Ii 1 if Ii 4 0 1 2 EIPO 0, 3 4 Ii 0 if Ii  0

B. Francis et al.
5

The observed TVi is defined as TVi TVIPOi TVi TVM&Ai if Ii 1 if Ii 0 6 7

Equation 1 defines the TV received from going public and Equation 2 from takeover. Equation 3 defines the decision function of banks when choosing between going public and M&A. However, what is observed is only the TV when the choice is going public (Ii 1) or when banks engage in M&A (Ii 1), as going public and M&A are mutually exclusive and both TVi cannot be observed simultaneously for any one firm. The econometric methodology utilized for this purpose follows Heckman (1976). Specific studies in finance that are similar to this study are those by Dunbar (1995) and Francis and Hasan (2004). Heckman (1976) has developed a two-step procedure for obtaining consistent estimates of IPO and M&A . The detailed procedure is as follows. In the first step of the Heckman procedure, Equation 5.3 is estimated as the selection process, which is responsible for the selection bias. A probit model is used for this purpose. The dependent variable in the probit analysis is a dummy variable indicating that a private bank chooses IPO or M&A. A dummy with value of one for banks that go public, and value of zero for banks that engage in M&A. The independent variables in the probit model are those used in the likelihood analysis. From the probit estimation of the selection equation, selection bias control factors (Zi =Zi and Zi =1 Zi ) are constructed. In the second step, the bias control factors are used as an additional independent variable along with other variables in Ordinary Least Square (OLS) estimates of Equations 8 and 9. TVIPOi Xi IPO IPO Zi =Zi IPO 8 TVM&Ai Xi M&A M&A Zi =1 Zi M&A 9 where Xi is a vector of firm characteristics affecting TV, () is the density function of the standard normal distribution and () is the distribution function of the standard normal. EM&A 0

The parameters IPO and M&A represent the covariance between tIPOi and "i and the covariance between tM&Ai and "i, respectively. Consistent

The choice of IPO versus M&A

estimates of parameters are obtained using OLS by including Zi =Zi or Zi =1 Zi as an additional variable to its related TV equation to correct for possible self-selection bias, which otherwise leads to nonzero expectation of the errors. Tests for selectivity are tests for IPO 0 and M&A 0. For the OLS estimations, the dependent variable (TV) is measured by the log of total proceeds divided by the log of total equity for IPO equation, total proceed is the total dollar amount raised in the market excluding over-allotment. TV is the log of the total amount paid divided by the log of total equity for M&A equation. The independent variables to measure the effect on TV are MRET, TIMING, CORE, LIQUIDITY, ROA and EARN. ROA is return on assets, and EARN is the ratio of total earning assets to total assets. These variables are considered to affect the TV (see e.g. Cheng et al., 1989; Ritter and Welch, 2002). Table 6 presents interesting results from the selfselectivity test. The table shows the results of the TV equations for the IPO and M&A with the samples being corrected for self-selectivity. It can be seen that the coefficient of IPO and M&A are significant at the 1% level. Thus, the model suggests that selfselectivity in individual banks exists. Furthermore, the interpretation of IPO and M&A give some insight about the choice and its related TV received; the interpretation follows Roy (1951). The second purpose of the self-selectivity analysis is to predict the mean of TV for the alternative choice, i.e. estimate the mean TV for banks that go public had they chosen M&A, and the mean TV for banks that engage in M&A had they chosen IPO. It is

2005
obtained from the following models (Roy, 1951; Maddala, 1999). ETVM&Ai jIi 1 Xi M&A M&A Zi =Zi 10 ETVIPOi jIi 0 Xi IPO IPO Zi =1 Zi 11 Equation 10 is the expression for the mean TV of bank IPOs had they chosen M&A, and Equation 11 expresses the mean TV of bank M&As had they chosen IPO. The results are presented in Table 7 and reported as mean forecasted TV if the other choice were used. Table 7 shows that the mean of observed TV of bank IPOs is 1.021. The TV would be higher than this had the banks chosen to engage in M&A (1.144). The mean of observed TV of bank M&As is 1.064, and the TV would be lower than this had the banks chosen to go public (0.790).
Table 7. Summary of observed and forecasted TV Choice Observed IPO M&A IPO 1.021 0.790 M&A 1.144 1.064

Notes: TV is measured by log of total proceeds divided by log of total equity for bank IPOs, and log of total amount paid divided by log of total equity for bank M&As.

Table 6. Heckman estimation on determinants of TV Variable name Intercept MRET TIMING CORE LIQUIDITY ROA EARN  Market returns (%) Relative volume of mergers to IPOs in the previous year Core deposit/total assets Cash and securities over total assets Return on assets Total earning assets/total assets Lambda IPO 0.956*** (0.248) 0.008 (0.012) 0.003*** (0.001) 0.153** (0.067) 0.081** (0.036) 0.010 (0.012) 0.114 (0.271) 0.162*** (0.024) 0.1621 266 M&A 1.115*** (0.093) 0.013*** (0.004) 0.001*** (0.0002) 0.048 (0.044) 0.026** (0.012) 0.013*** (0.004) 0.053 (0.095) 0.060*** (0.014) 0.0804 406

Adj R2 Number of observations

Notes: The dependent variable is the log of total proceeds divided by the log of total assets for bank IPO, and the log of total amount paid divided by the log of total assets for bank M&A. The sample size is 272 for bank IPOs and 440 for acquired banks. ***, ** and * indicate significance at 1, 5 and 10% significance levels, respectively.

2006
VI. Conclusions This study examines factors that may influence privately held banks to choose between IPO and M&A. The motivation for conducting this analysis of the banking industry is the fact that, in the last two decades, the depository industry has experienced tremendous changes in ownership structure, deregulatory environment and market competition. While many banks experienced consolidation through M&A, many others decided to go public and compete in the stock market. This study investigates the relative importance of different factors that influenced banks decisions to go public or engage in M&A. Using a sample of 272 bank IPOs and 440 bank M&As from January 1985 to December 1999, factors that are used to identify the tendencies of banks are regulation, the market competitive environment and firm fundamental factors. Overall, evidence provides consistent support for seven of the nine proposed hypotheses. They are regulatory factors and a number of firm fundamental factors (i.e. age, size and liquidity). Specifically, reduction in geographic restrictions banks makes more likely to engage in takeover. Depository institutions chartered as savings institutions are more likely to go public. Banks that actually go public tend to be bigger and older banks. Banks with better liquidity position are more likely to choose takeover. Self-selectivity of banks to choose IPO and M&A based on their reservation on TV is also examined. The observed distribution of TV is determined by these choices with the assumption that the value received by banks is determined by banks reservation on TV. The results on self-selectivity analysis suggest that self-selection exists. In particular, it is found that the observed TV of banks choosing IPO is lower than that of those engaged in M&A. The mean TV of bank IPOs would have been higher had the banks chosen to engage in M&A, while the mean of observed TV of bank M&As would have been lower had the banks chosen to go public. This may capture the value of control of IPO.

B. Francis et al.
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