MODELING BANK MERGERS IN THE 1990s: THE POTENTIAL DILUTION EFFECT

As mergers become increasingly important in the financial services industry, the need for proper sensitivity analysis to assess the financial impact of the merger is essential. Unlike industrial mergers, there is almost always initial dilution in a bank merger. This is because of the homogenous nature of bank P/E ratios and the high premium over book value that is typically paid. The problem of dilution was further compounded by an SEC ruling in March of 1996 that restricted the repurchase of outstanding shares for two years after merger under a pooling of interests financial recording. Given these factors, the initial dilution can only be overcome by more rapid postmerger earnings growth by the holding company. The author models the factors that affect the growth rate after merger and indicates the relative importance of the premium paid, the size of the merging institutions, the absence or presence of synergy and a number of other variables.