Impact of Independent Directors and the Regulatory Environment on Bank Merger Prices: Evidence from Takeover Activity in the 1990s By: Elijah Brewer III, William E. Jackson III and Julapa

This article examines the primary motivation of the bank merger waves in the 1990s. Our investigation of the factors that determine bid premiums paid for target banks focuses on the importance of the financial characteristics of the targets, composition of their boards of directors, and the regulatory environment. The value of the target bank to the acquiring bank should reflect its present discounted value of future net cash flows. Thus, at a minimum, the bid price should be a combination of the stand-alone value of the net assets of the target bank and the net cash flows from highervalued deposit insurance as a result of the proposed merger. Finance literature also suggests that in large transactions, such as mergers and acquisitions, the value of independent outside directors can be very important as internal governance mechanisms for protecting the interest of shareholders and help to mitigate shareholder/management agency problems. In addition, regulation could also play an important role in determining the number and type of bank merger transactions. Prior to the Riegle-Neal Act banks were restricted by federal and state laws from expanding across state lines. We examine whether bank merger prices were higher or lower as a result of these restrictions. We find a variety of interesting and important results. We find that higher performing targets, as measured by return on assets, are offered higher bid premiums. We also find that lower risk targets, as well as those that may provide some diversification benefits, are offered higher prices. We find that changes in the regulatory environment had a significant impact on bank merger activities in general, and bank merger prices in particular. For example, merger bid premiums increased by approximately 35 percent on average from the preto the postRiegle-Neal periods. Finally, consistent with the literature on non-financial firms, our results provide strong support for the proposition that during takeovers independent boards act to increase the wealth of the shareholders of target banks.