Richard J. Rosen

Does Market Size Structure Affect Competition? The Case of Small Business Lending

Market size structure refers to the distribution of shares of different size classes of local market participants, where the sizes are inclusive of assets both within and outside the local market. We apply this new measure of market structure in two empirical analyses of the U.S. banking industry to address concerns regarding the effects of the consolidation in banking. Our quantity analysis of the likelihood that small businesses borrow from large versus small banks and our small business loan price analysis that includes market size structure as well as conventional measures yield very different findings from most of the literature on bank size and small business lending. Our results do not suggest a significant net advantage or disadvantage for large banks in small business lending overall, or in lending to informationally opaque small businesses in particular. We argue that the prior research that excluded market size structure may be misleading and offer some likely explanations of why our results differ.

Eat or Be Eaten: A Theory of Mergers and Firm Size

We propose a theory of mergers that combines managerial merger motives and a regime shift that may lead to some value-increasing merger opportunities. Anticipation of the regime shift can lead to mergers, either for defensive or positioning reasons. Defensive mergers occur when managers acquire other firms to avoid being acquired themselves. Mergers may also allow a firm to position itself as a more attractive takeover target and earn a takeover premium. The identity of acquirers and targets and the profitability of acquisitions depend, among other factors, on the distribution of firm sizes within an industry. ∗ The views in this paper are those of the authors and may not represent the views of the Federal Reserve Bank of Chicago or the Federal Reserve System. We thank Amit Goyal, Cabray Haines, Shah Hussain, Feifei Li, and Yihui Wang for excellent research assistance. We are grateful for helpful comments and suggestions by Andres Almazan, Antonio Bernardo, Sanjai Bhagat, Bhagwan Chowdhry, Michael Fishman, Gunter Strobl, S. Viswanathan, Ivo Welch, seminar participants at the University of Houston, Purdue University, and the University of Wisconsin-Madison, and conference participants at the AFA 2000 meetings and the Texas Finance Festival 2000. This is a substantially revised version of an early draft that was presented at these conferences. Of course, all remaining errors and shortcomings are solely our responsibility. Introduction The 1990s produced the greatest wave of mergers in U.S. history. Between 1995 and 2000, U.S. merger volume set a new record every year, expanding from

Is Three a Crowd? Competition Among Regulators in Banking

800 billion in 1995 to

Banking Market Conditions and Deposit Interest Rates

1.8 trillion in 2000. Due to the growth and importance of mergers, a substantial academic literature has developed to examine them. However, existing merger theories remain unable to reconcile certain key facts about merger activity. Two of the most important stylized facts about mergers are the following: First, the stock price of the acquirer in a merger decreases on average when the merger is announced. Recent work shows that this result is driven by negative announcement returns for very large acquirers, while small acquirers tend to gain in acquisitions (Moeller et al. (2004) and Kahl and Rosen (2002)). Second, mergers concentrate in industries that have experienced regime shifts in technology or regulation. Mergers may provide an efficient strategy for managers coping with such a shift and seeking to maximize the value of their firms (see, for example, Mitchell and Mulherin (1996), Andrade, Mitchell, and Stafford (2001), and Andrade and Stafford (2004)). The view that mergers are an efficient response to regime shifts by value-maximizing managers – the so-called neoclassical merger theory (see, for example, Mitchell and Mulherin (1996), Weston, Chung, and Siu (1998), and Jovanovic and Rousseau (2002)) can explain the second stylized fact. However, it has difficulties explaining negative abnormal returns to acquirers. Theories based on managerial self-interest or a desire for larger firm size and diversification (for example, Morck, Shleifer, and Vishny (1990)) can explain negative acquirer returns. However, they cannot explain why mergers are concentrated in industries undergoing a regime shift. This paper provides a theory of mergers that combines elements from both of these schools 1 See “The Year of the Mega Merger...”, Fortune Magazine, January 11, 1999, “Tales of the Tape: ’99 M&A Vol Hits Record...”, Dow Jones News Service, December 29, 1999, and “Year-End Review of Markets & Finance 2000..”, The Wall Street Journal, January 2, 2001. 2 Studies that find negative average returns to bidders include Asquith, Bruner, and Mullins (1987), Banerjee and Owers (1992), Bradley, Desai, and Kim (1988), Byrd and Hickman (1992), Jennings and Mazzeo (1991), Servaes (1991), Varaiya and Ferris (1987), and You, Caves, Smith, and Henry (1986). See Table 86 in Gilson and Black (1995). See also the recent survey by Andrade, Mitchell, and Stafford (2001). Bradley and Sundaram (2004) find, using a much larger sample of mergers in the 1990s, that most acquirers experience positive announcement returns. The negative announcement returns are concentrated among stock financed acquisitions of public targets that are large relative to the acquirer. 3 Other papers in which managerial motivations for mergers are prominent include Amihud and Lev (1981), Shleifer and Vishny (1989), and May (1995). Theoretical papers representing the neoclassical tradition include Gort (1969) and Rubin (1973). Negative acquirer announcement returns can be explained without appealing to agency conflicts between managers and owners if the takeover announcement reveals negative information about the acquirer’s profitability relative to expectations (see McCardle and Viswanathan (1994) and Jovanovic and Braguinsky (2004)).

New banking powers: A portfolio analysis of bank investment in real estate☆

Banks are able to switch among three options for a primary federal regulator: the FDIC, the Federal Reserve, and the OCC. We examine why they switch and what the results of switches are. We find support for the hypothesis that competition among regulators has beneficial aspects. Regulators seem to specialize in offering banks that are changing strategy the ability to improve performance by switching regulators. There is also evidence that the ability to switch regulators allows banks to get away from bank examiners who desire a quiet life, that is, examiners who attempt to minimize the effort they spend on work.

Why Do Firms Go Public? Evidence from the Banking Industry

This paper addresses the impact market conditions on bank deposit interest rates. Examining data for 1988-2000, we find that rates are affected by market size structure (defined as the distribution of market shares of banks of different sizes whether or not the market share is achieved entirely in that local market). This is in addition to the effects of market concentration noted in earlier work. We also find large differences between urban and rural markets. In rural areas, changes in market concentration have no effect on deposit rates. These findings have implications for antitrust policy in banking.

Betcha can’t acquire just one: merger programs and compensation

Abstract A new banking power currently under consideration is bank direct equity investment in real estate. A portfolio analysis of the possible effect of this new power is presented using two sets of data on returns to direct real estate investment. While it is estimated that there can be benefits from bank diversification into this area, the results suggest that risk may be increased, rather than reduced, if real estate investment exceeds certain relatively low levels of concentration.

Are Covered Bonds a Substitute for Mortgage-Backed Securities?

The lack of data on private firms has made it difficult to empirically examine theories of why firms go public. However, both public and private banks must disclose financial information to regulators. We exploit this requirement to explore the going-public decision. Our results indicate that banks that convert to public ownership are more likely to become targets than control banks that remain private. Banks that go public are also more likely to become acquirers than control banks. IPO banks grow faster than control banks after going public, although there is some evidence that their performance deteriorates.

Why Do Borrowers Make Mortgage Refinancing Mistakes

This paper examines the evolution of merger programs, that is, repeated acquisitions by the same firm. Most acquisitions are made by firms with merger programs. Acquisitions that are part of programs are different from one-off acquisitions both in the effect on CEO compensation and in the reaction of the stock market. CEO compensation rises more after growth from program acquisitions than after internal growth or growth from one-off acquisitions. During a merger program, the increase in CEO compensation is much larger when the acquirer’s stock price is increasing than at other times. This is not true for other types of growth. Merger programs also show a distinct evolution. Initially, program mergers are received better by the stock market than are one- off mergers. ; As a program progresses, however, the acquisitions tend to have lower announcement reactions and long-run returns. In addition, the effect on CEO compensation is smaller for mergers later in a program. There is evidence that some firms are predisposed to make acquisitions. Firms that have made acquisitions in the recent past and that already pay their CEOs well are more likely to make future acquisitions. This suggests that there may be a managerial motivation for merger programs: firms where CEOs can expect to get large compensation increases from acquisitions are more likely to have merger programs.

The Effect of Monetary Policy on the Availability of Credit: How the Credit Channel Works

Given the problems in the mortgage-backed securities (MBS) market during the financial crisis, some suggest that covered bonds (CB) might be a substitute for MBS. This could lead to a number of policy alternatives in countries where regulation and business have been mainly leaning to one of these types of securities. Examining the use of CB and MBS in the U.S. and Europe, we find that the two often seem to be used for different purposes. Banks are more likely to use CB when they have liquidity needs while MBS are associated with risk management and agency problems. Introducing MBS to markets where only CB are common or CB to markets where only MBS are common could have large effects.