SPATIAL MARKET EXPANSION THROUGH MERGERS

Abstract

In this paper we present a model that studies firm mergers in a spatial setting. A new model is formulated that addresses the issue of finding the number of branches that have to be eliminated by a firm after merging with another one, in order to maximize profits. The model is then applied to an example of bank mergers in the city of Barcelona. Finally, a variant of the formulation that introduces competition is presented together with some conclusions.

Several studies have analyzed the economic and financial consequences of bank mergers. Rhoades (1998) looked at nine large bank mergers with substantial market overlap in the early 1990s. He found that all produced significant cost cutting in line with the pre-merger projections due to branc h reductions. Piloff (1996) looked at 48 bank mergers in the 1980s, relating announcement period abnormal returns to accounting based performance measures. He found higher abnormal returns that offer the greatest potential for cost reductions (measured by geographic overlap and premerger cost measures). Piloff also found that industry-adjusted profitability of the merged banks does not change, that total expenses to assets increases, and that revenues rise in the five year period around the merger. Houston, et al. (2001) looked at analysts' estimates of projected cost savings and revenue enhancements associated with bank mergers. They found that analysts’ estimates of increases in combined bank value associated with a merger are due mainly to estimated costs savings rather than projected revenue enhancements. Finally, Avery, et al. (1999) looked at mergers during the period 1975 through 1998 involving banks with significant geographic overlap (measured by the number of branches in a ZIP code per capita). They found that these mergers resulted in a significant decrease in branches per capita.

In this paper we present a model that addresses the issue of mergers in a spatial setting. In the next section a new model is formulated that addresses the issue of finding the number of branches that have to be eliminated by a firm after merging with another one, in order to maximize revenues. The model then is applied to an example in the city of Barcelona. Finally, a variant of the formulation is presented together with some conclusions.

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