Is the Market for Corporate Control of Large Banks Effective?

Abstract

This paper presents a model of the disciplinary takeover to investigate the effectiveness of the market for corporate control of large banks. Based on the model, this paper examines the operating performance as well as the stock market performance of large US banks involved in the acquisitions during the 2007 to 2009 global financial crisis. The results indicate that the market for corporate control of large banks was not effective in two aspects: the market did not distinguish strong banks from weak banks before the crisis and acquiring banks did not improve their performance after the acquisitions. Such ineffectiveness reflects the fundamental weakness of the market of large banks: stock prices are not a reliable guide for valuation because of information asymmetry, pro-cyclicality and high leverage related to bank business models. As a result, large bank takeovers were often carried out without proper valuation and too late to save target banks if they were nearly insolvent or insolvent. Moreover, some takeover decisions were made by managers without a long-term view as they were under the threat of takeover and the pressure of short-termism. Finally, government interventions to support takeovers reduced the effect of information asymmetry, but at the expense of the taxpayer. Therefore, the fundamental weakness of the market of large banks needs to be addressed if takeovers are to be used effectively to fight future financial crises.