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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,*
aLally School of Management and Technology, Rensselaer Polytechnic
Institute, Troy, NY 12180, USAbBank of Finland, Helsinki, FinlandcDepartment of Economics, Finance, and Accounting, State University of
New York at Oneonta, USA
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), Chemmanurand 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
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)
*Corresponding author. E-mail: [email protected]
Applied Financial Economics ISSN 09603107 print/ISSN 14664305 online 2009 Taylor & Francis 1987
http://www.informaworld.com
DOI: 10.1080/09603100903251262
5/27/2018 Informational Externalities of Bank Initial Public Offerings - Evidence From Banking Industry
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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 con-
straints and asymmetric information between
industrial firms that go public and sell out to public
firms. They found that going public firms tend tohave 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 havefundamental 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 choosingIPO 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
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 transac-
tion 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 owner-
ship slowly in the years after IPO if going public is
considered as the first stage of gradual sell outstrategy (Zingales, 1995; Mello and Parson, 1998;
Paganoet 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 thetakeover 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 asym-
metric 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 incomparison 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. Rosenet 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 perfor-
mance 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.
III. Factors Affecting IPO Versus M&AChoice 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 restric-
tions. Prior to the federal regulation of McFadden
Act 1927, The National Banking Act of 1864 was
interpreted to ban national banks from branchingin 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
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 within-
state branching. Restrictions of intrastate branchingvaried 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 branch-
ing, including those that completely banned branch-
ing 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 eventu-
ally was converted into a subsidiary or branch.
In states with limited branching, banks made mul-
tiple 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 operateindependently 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 1956prohibited bank holding companies from buy out-
of-state banks, unless the states in which the target
banks located specifically permitted such acquisitions.
1 See, for example, Hunter and Wall (1989), Hawawini and Swary (1990), OKeefe (1996), Berger et al. (1999) and Wheelockand Wilson (2004).2 For example, Florida and New Hampshire still strictly ban branching. Alabama restricted branches in countries with lowerthan 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 branchingdetermination (Amel, 1993).
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This Act prohibited interstate banking, except for
19 small multistate BHCs that were given grand-
fathered 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 inter-
state 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 butHawaii 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 inter-
state 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
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 (Beattyet 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 share-
holders and management objectives (Schranz, 1993;
Hubbard and Palia, 1995). Reduced activity in the
corporate control market may contribute to increasedcosts 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
3 Maine started allowing out-of-state BHC to buy banks residing in Maine with reciprocity laws since 1978. However, becauseno other states established out-of-state acquisition rules, Maines laws remained inactive until 1980s, when New York andMassachusetts 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 statespost 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, increasedmarket power (Amel and Liang, 1992), diversification
(Demsetz and Strahan, 1997) and incentives of
managers and directors of potential targets
(Hadlocket 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 inrestricted 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 restrictionsrelated to intrastate or interstate banking activities
in the states where banks operated, the less (more)
likely the banks will go public (M&A).
Branching and acquisition barriers were signifi-
cantly reduced by the RiegelNeal IBBEA in 1994.
The act replaces existing state level legislations on
interstate activities by allowing bank holding compa-
nies to acquire banks in any state, effective from
30 September 1995. The interstate branching provi-
sion allows banks to consolidate their interstate
banking subsidiaries into a single bank, effectivefrom 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 inter-
state 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 anaffiliate 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 provi-
sion 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 theIBBEA enables them to convert their subsidiaries
into branching networks that many argue will reduce
the costs of running bank holding companies.
7 Evidence by Hubbard and Palia (1995) shows that turnover and the sensitivity of pay to performance for senior executivesincrease after states allow interstate banking, indicating an increased alignment between management and shareholders.8 Hadlocket al. (1999) show that bank managers with a large ownership stake might push for being acquired in the hope ofreceiving 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).
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Grabowskiet 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 corporatecontrol 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-of-
state 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 expe-
rience 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 intechnology, 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 providedcapital 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
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 thatregulators are likely to accept proposed banking
mergers in less concentrated local markets.
However, in competitive local markets, profitabil-
ity 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 vari-
ability 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. Youngbanks 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
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because the evaluation costs on going public firms
depend on the amount of information already avail-
able 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 betterdeal on specific aspects that fit the acquirers purposes
given their stage of growth, and receives better eval-
uation for the particular features. Therefore, every-
thing 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 aretypically followed by fewer analysts, and this asym-
metric information adversely determines the magni-
tude 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).
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 andLoughran (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 riskierloans that eventually made these banks relatively
experience larger loan write-off than the average
banking industry. We expect that banks that ulti-
mately 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 stayprivate using a size-matching sample.
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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 forbanks. 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 provid-
ing low-cost funds, and helping to boost profits whileat the same time reducing the interest rate risk. In
addition, for acquisition, deposit relationships may
provide even more value addition through the cross-
selling 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 berealized 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.
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 contrac-
tual liabilities, fund operations and for loans. Sourcesof liquidity include assets readily convertible to cash,
including investments and other securities with matu-
rity 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 ofengaging 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.
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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 includecommercial 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 indepen-
dent variables in the logistic regression method.
The maximum likelihood estimation method is
performed for the following model:
ln Pi
1Pi
0
X3j1
jXji 4X4i
X9j5
jXjiX13
j10
jXjiui
where
i i-th observation,
j 1,2, 3 regulatory environment factors(STATEREG, DEREG, SVINST),
j 4 market competitive environment
factors (MSA),
j 5, . . . , 9 firm fundamental factors (AGE,
LASSET, CAPITAL, CORE,
LIQUIDITY),
j 10, . . . , 13 control variables.
The logistic model defines Pi eXi=1eXi as
the probability that i-th bank will offer IPO. Xiis the
vector of factors that are used to distinguish banks
that went public from M&A, and is the vector of
estimated coefficients.Pi=1Piis the odds indicat-
ing 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 estima-
tions 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 post-
deregulation 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
Antitrustanalysis 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 con-
centrated 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 orinvolved 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
12 Many recent papers define local banking market by MSA, see Dick (2008) for a recent example.
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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 ofM&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).
V. Empirical Results and Discussion
Figure 1 presents the distribution of IPO and M&A
samples over the period January 1985 to December1999. 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 orsavings and loans associations.
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 funda-mental 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 funda-
mental structures are quite different. Savings institu-
tions 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.
Fig. 1. Number of bank IPOs and M&As in the sample by yearNote: The sample consists of 272 bank IPOs and 440 bank M&As from January 1985 to December 1999.
1996 B. Franciset al.
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Table1.
DescriptivestatisticsforthesampleofbankIPOs
PanelA.F
ullsample
PanelB.Savingsinstitutions
PanelC.Commercialbanks
Variable
Mean
SD
Minimum
Maximum
Mean
SD
Minimum
Maximum
Mean
SD
M
inimum
Maximum
Regulatoryfactors
STATEREG*
0.9302
0.2554
0
1
0.5000
0.5017
0
1
0.9508
0.2171
0
1
DEREG
0.1324
0.3395
0
1
0.0200
0.1405
0
1
0.2705
0.4461
0
1
SVINST
0.5515
0.4983
0
1
NA
NA
NA
NA
NA
NA
N
A
NA
Marketcompetitiveness
MSA
0.7868
0.4104
0
1
0.8800
0.3261
0
1
0.6721
0.4714
0
1
Firmfundamentalfactors
AGE
64.5368
44.8384
0
165
83.9533
40.1481
1
165
40.6639
38.4185
0
137
LASSET
12.0696
1.4000
9.1089
16.3690
12.6301
1.3114
9.1089
16.3690
11.3842
1.1870
9.2281
16.1000
CAPITAL
0.0739
0.0740
0.0662
0.7435
0.0539
0.0344
0.0662
0.2242
0.0984
0.0983
0.0435
0.7435
CORE
0.7892
0.1355
0.1562
1.0148
0.8188
0.1287
0.3639
1.0148
0.7521
0.1351
0.1562
0.9235
LIQUIDITY
0.4048
0.2554
0.0072
1.3155
0.3661
0.2400
0.0348
1.3155
0.4534
0.2666
0.0072
1.2827
Economicfactor
MRET(%)
0.1587
0.8039
4.3510
2.2040
0.2591
0.7587
4.3510
1.8730
0.0352
0.8430
4.3510
2.2040
Industrypracticefactors
LPREMIUM
4.8044
0.6513
2.8326
6.2454
4.7463
0.4867
1
6.2454
4.8760
0.8057
2.8326
6.2454
TIMING
8.1764
15.5053
0.4000
85.3333
4.0517
12.2276
0.4
85.3333
13.2477
17.5304
0.4000
85.3333
Notes:Thefullsampleconsis
tsof272USbankIPOsfromJanuary
1985toDecember1999.STATEREG
isadummyvariableequaltooneifthestatewhereanIPOis
locatedpermittedfullintrastateorinterstatebanking.SVINSTisadummyvariableequaltooneiftheIPO
isasavingsinstitution(savingsbanksorsavingsandloans).
DEREGisadummyvariablewithavalueofoneiftheIPOgoespubliconoraftertheyearoftheRiegelNealAct(1997).
*indicatesthatthevariableis
INTRA,insteadofSTATEREG,forS
avingsInstitutionssub-sample.INTRA
isadummyvariableequaltooneifth
estatewhereanIPOis
locatedallowedfullintrastate
branching.MSAisadummyvariablew
ithavalueofoneiftheIPOislocatedinaMetropolitanStatisticalArea.AGE
isthenumberofyears
anIPOhasbeenestablishedt
otheyearofitsgoingpublic.LASSET
isthelogoftotalassets.CAPITAListotalcapitaldividedbytotalassets.COR
Eistotalcoredeposits
dividedbytotalassets.LIQUIDITYisthesumofcashandsecurities
dividedbytotalassets.NAisnotapplie
d.MRET(%)ismarketreturns.LPRE
MIUM
isthelogofthe
premiumdifferencebetweenp
ublicandprivatetargets.TIMINGisamarkettimingvariablemeasuredbycalc
ulatingthenumberofM&Ainthepreviousyeardividedbythe
numberofIPOsoverthesam
etimeperiod.
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Table2.
DescriptivestatisticsforthesampleofbankM&As
PanelA.Fullsample
PanelB.Savingsinstitutions
PanelC.Commercialbanks
Variable
Mean
SD
Minimum
Maximum
Mean
SD
Minimum
Maximum
Mean
SD
M
inimum
Maximum
Regulatoryfactors
STATEREG
0.9955
0.0673
0
1
0.8280
0.3795
0
1
0.9942
0.0760
0
1
DEREG
0.3182
0.4663
0
1
0.2473
0.4338
0
1
0.3362
0.4731
0
1
SVINST
0.2114
0.4087
0
1
NA
NA
NA
NA
NA
NA
N
A
NA
Marketcompetitiveness
MSA
0.7205
0.4493
0
1
0.6774
0.4700
0
1
0.7304
0.4444
0
1
Firmfundamentalfactors
AGE
42.9705
37.4379
1
193
53.5914
37.6893
1
174
40.1971
36.9834
2
193
LASSET
11.3200
0.9254
8.9121
14.9431
11.4608
1.1084
8.9121
14.9431
11.2740
0.8610
9.3846
13.9357
CAPITAL
0.0899
0.0322
0.0043
0.2357
0.0837
0.0441
0.0097
0.2357
0.0916
0.0281
0.0043
0.2087
CORE
0.7824
0.0784
0.4526
0.9842
0.7778
0.0936
0.4526
0.9842
0.7841
0.0727
0.4797
0.9220
LIQUIDITY
0.5090
0.2951
0.0032
1.6807
0.4130
0.3045
0.0032
1.3612
0.5364
0.2875
0.0219
1.6807
Economicfactor
MRET
0.0712
0.8492
3.0827
3.8609
0.0540
0.7971
3.0827
1.4492
0.1040
0.8630
3.0108
3.8609
Industrypracticefactors
LPREMIUM
4.7530
0.8820
2.8326
6.2454
4.5966
0.8655
2.8326
6.2454
4.7937
0.8803
2.8326
6.2454
TIMING
18.6295
17.4818
0.4000
85.3333
20.2345
15.3705
2.6364
53.6667
18.2603
18.0358
0.4000
85.3333
Notes:Thefullsampleconsistsof440USbankM&AsfromJanuary1985toDecember1999.STATEREGis
adummyvariableequaltooneifthest
atewhereatargetbank
islocatedpermitsfullintrasta
teorinterstatebanking.SVINSTisad
ummyvariableequaltooneifthetargetisasavingsinstitution(savingsbanksorsavingsandloans).
DEREGisadummyvariablewithavalueofoneifthebankengage
sinM&AonoraftertheyearoftheR
iegelNealAct(1997).MSAisadumm
yvariablewithavalue
ofoneifthetargetbankislo
catedinaMetropolitanStatisticalArea.AGEisthenumberofyearsabankhasbeenestablishedtotheyearofitsm
ergers.LASSETisthe
logoftotalassets.CAPITAL
istotalcapitaldividedbytotalassets.COREistotalcoredepositsdividedbytotalassets.LIQUIDITYisthesumofcas
handsecuritiesdivided
bytotalassets.NAmeansno
tapplied.MRET(%)ismarketreturn
s.LPREMIUM
isthelogofthepremiumdifferencebetweenpublicandprivatetargets.TIMINGis
amarkettimingvariablemea
suredbycalculatingthenumberofM&Ainthepreviousyeardividedbythe
numberofIPOsoverthesametimepe
riod.
1998 B. Franciset al.
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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 commer-
cial 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. Thelast 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 practicefactors, 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
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 andbank 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 hypoth-
esis 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 64.5years 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 thanengage 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
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Table3.
DifferencesinmeansbetweenbankIPOsandbankM&Asusingfullsamples
PanelA.IPOsample(N272)
PanelB.M&Asample(N440)
Variable
Description
Median
Mean
SD
Median
Mean
SD
t-value
p-value
Regulatoryfactors
STATEREG
Stateallowin
traorinterstatebankingdummy
1.0000
0.9302
0.2554
1.0000
0.9955
0.0673
5.09
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