Mergers and Acquisitions in Banking and Finance

MERGERS AND ACQUISITIONS
IN BANKING AND FINANCE
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What Works, What Fails, and Why
Ingo Walter
1
2004
1
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Library of Congress Cataloging-in-Publication Data
Walter, Ingo.
Mergers and acquisitions in banking and nance : what works, what
fails, and why / by Ingo Walter.
p. cm.
ISBN 0-19-515900-4
1. Bank mergers. 2. Financial institutionsMergers. I. Title.
HG1722.W35 2004
332.1'068'1dc22
2003015483
9 8 7 6 5 4 3 2 1
Printed in the United States of America
on acid-free paper
Preface
On April 6, 1998, the creation of Citigroup through the combination of

Citicorp and Travelers Inc. was announced to the general applause of
analysts and nancial pundits. The merger of equals created the worlds
largest nancial services rmlargest in market value, product range,
and geographic scope. Management claimed that strict attention to the
use of capital and rigorous control of costs (a Travelers specialty) could
be combined with Citicorps uniquely global footprint and retail banking
franchise to produce uncommonly good revenue and cost synergies. In
the four years that followed, through the postmerger Sturm und Drang
and a succession of further acquisitions, Citigroup seemed to outperform
its rivals in both market share and shareholder value by a healthy margin.
Like its home base, New York City, it seemed to show that the unmanageable could indeed be effectively managed through what proved to be
a rather turbulent nancial environment.
On September 13, 2000, another New York megamerger was announced. Chase Manhattans acquisition of J.P. Morgan & Co. took effect
at the end of the year. Commentators suggested that Morgan, once the
most respected bank in the United States, had at last realized that it was
not possible to go it alone. In an era of apparent ascendancy of universal
banking and nancial conglomerates, where greater size and scope
would be critical, the rm sold out at 3.7 shares of the new J.P. Morgan
Chase for each legacy Morgan share. Management of both banks claimed
signicant cost synergies and revenue gains attributable to complementary strengths in the two rms respective capabilities and client bases.
Within two years the new stock had lost some 44% of its value (compared
to no value-loss for Citigroup over the same period), many important J.P.
Morgan bankers had left, and the new rm had run into an unusual
number of business setbacks, even as the board awarded top management
some $40 million in 2002 for getting the deal done.
vi
Preface
Even acknowledging that the jury remains out in terms of the longterm results, how is it that two major deals launched by people at the top
of their professions, approved by boards presumably representing shareholder interests, could show such different interim outcomes? Is it in the
structure of the deals themselves? The strategic prole of the competitive
platform that resulted? The details of how the integration was accomplished? The people involved and their ability to organize and motivate
the troops? Or, in the light of both banks landing right in the middle of
some of the worst corporate and nancial market scandals in history, will
the two deals end up looking much the same? These are some of the
critical issues we attempt to address in this book.
The nancial services sector is about halfway through one of the most
dramatic periods of restructuring ever undergone by a major industry
a reconguration whose impact has carried well beyond shareholders of
the rms involved into the domain of regulation and public policy as well
as global competitive performance and economic growth. Financial services have therefore been a center of gravity of global mergers and acquisitions activity. The industry comprises a surprisingly large share of the
value of merger activity worldwide.
In this book I have attempted to lay out, in a clear and intuitive but
also comprehensive way, what we knowor think we knowabout reconguration of the nancial services sector through mergers and acquisitions (M&A). This presumed understanding includes the underlying
drivers of the mergers and acquisitions process itself, factual evidence as
to whether the basic economic concepts and strategic precepts used to
justify M&A deals are correct, and the efcacy of merger implementationnotably the merger integration dynamic.
Chapter 1 describes the activity-space occupied by the nancial services
industry, with a discussion of the four principal businesses comprising
the nancial services sectorcommercial banking, investment banking,
insurance, and asset management. This description includes proles of
subsectors such as retail brokerage, insurance brokerage, private banking,
and wholesale banking, and how they are linked in terms of the functions
performed. The objective of this introductory chapter is to provide a
helicopter overview of the nancial services businesses engaged in restructuring through mergers. The chapter provides some background for
readers not fully familiar with the industry or (as it often the case) familiar
only with a relatively narrow segment of the industry.
Chapter 2 positions nancial services M&A deal-ow within the overall
context of global mergers and acquisitions activity, assessing the structure
of M&A volume in terms of in-market and cross-market dimensions (both
functionally and geographically). It considers North American, European,
and selected Asian nancial services transactions in order to provide a
context for discussing the underlying causes of structural changes in the
industry, often under very different economic and regulatory conditions.
Preface
vii
Chapter 3 provides a comprehensive review of the economic drivers

of mergers and acquisitions in the nancial services sector. Where does
shareholder-value creation and destruction come from? How important
are economies of scale, economies of scope, market power, conicts of
interest and managerial complexity, too-big-to-fail support by taxpayers,
conglomerate discounts, and other factorsand how likely are they to
inuence market share and stock price performance of nancial services
rms engaged in M&A activity? It also suggests a framework for thinking
about nancial services M&A deals that integrates the economic and
nancial motivations raised in the preceding chapter into a consistent
valuation framework. From a shareholder perspective, mergers are supposed to be accretivethey are supposed to add value in terms of total
returns to investors. They almost always do that for the sellers. Often they
do not succeed for the buyers, who sometimes nd that the combined
rm is actually worth less than the value of the acquiring rm before the
merger. This chapter uses a building block approach to identify the
possible sources of shareholder value gains and losses in merger situations.
Chapter 4 is the rst of two that deal with merger integration. The
underlying economics of an M&A transaction in the end determine
whether the acquirer is doing the right thing. The managerial and behavioral dimensions of the integration process determine whether the
acquirer is doing the thing right. That is, failures and successes can
involve either strategic targeting or strategic implementation. Best for rms
and their shareholders is obviously doing the right thing right. Not so
good is doing the wrong thing and doing the right thing poorly. The
nancial sector has probably had far more than its share of mergers and
acquisitions that have failed or performed far below potential because of
mistakes in integration. This chapter focuses on the key managerial issues,
including the level of integration required and the historic development
of integration capabilities on the part of the acquiring rm, disruptions
in human resources and rm leadership, cultural issues, timeliness of
decision making, and interface management.
Chapter 5 continues the discussion on integration with specic regard
to information and transactions-processing technology. It has often been
argued that information is at the core of the nancial services industry
information about products, markets, clients, economic sectors, and geographies. At the same time, it is also one of the most transactionsintensive industries in the world. It stands at the heart of the payments
system of economies and engages in all kinds of transactions, ranging
from individual monetary transfers and stock brokerage to institutional
securities sales and trading. Transactions must be timely, accurate, and
inexpensive in order for nancial services rms to remain competitive, so
the industry invests billions in information technology (IT) systems annually. Whether things go right or wrong in mergers of acquisitions depends heavily on how the rms handle technology.
viii
Preface
Chapter 6 takes a look at the factswhat we know about whether

nancial sector mergers have worked or not. It considers all the evidence, attempting to do so in a careful and dispassionate way by avoiding
the kinds of unsupported assertions that often accompany M&A deals in
the nancial services sector. The chapter considers the evidence based on
well over 50 studies undertaken by central banks, nancial regulators,
management consultancies, and academics worldwide. Inevitably, there
is disagreement on some of the ndingsespecially because meaningful
international empirical work is extraordinarily difcult in this industry.
But the basic conclusions seem clear and compelling. Whether mergers
and acquisitions in the nancial services sector have been successful tends
to be difcult to assess in terms of shareholder value creation in the early
2000s. There is a need to separate between the company-related implications and the effects of the market at large, as reected by the evolution
of the post-bubble stock market decline. In addition, one needs to be
cognizant of the fact that unfavorable business conditions and other adverse circumstances can cast an economic shadow over even the bestconceived deals.
Chapter 7 puts nancial services M&A activity in the context of national and global nancial architecture. Restructuring in this industry
matters a great deal to the shareholders, managers, and employees of the
rms involved. But it also matters from the perspective of the safety and
soundness, efciency and creativity of the nancial system. The industry
is special in many ways. It deals with other peoples money. Its performance affects every other economic sector and the fate of whole economies. Problems it encounters can easily become systemic and can trigger
crises that are hard to contain and whose impact ranges far beyond the
industry itself. Chapter 7 considers what kinds of nancial structures
seem to be emerging as a result of reconguration through M&A deals
and what the nancial structures mean in the broader economic and
political context.
This book is based on two decades of observing and teaching about
the evolution of the nancial services industry in a rapidly evolving global
economic, regulatory, and technological environment. I have tried to take
a dispassionate approach to an issue unusually replete with both scorn
and hype. In this respect, a certain distance from the nancial rms doing
the restructuring has helped, as have discussions with academic colleagues, senior executives, and regulators. So has a growing body of
literature about what works and what doesnt.
A number of people assisted with various parts of this book. Gayle De
Long was extremely helpful in compiling the evidence on nancial sector
M&A available so far in the literatureI join her in paying tribute to her
father, George A. DeLong (19222002), a hero in every sense of the word.
Shantanu Chakraboty and David L. Remmers helped with several of
the case studies and issues related to merger integration, while Ralph
Welpe was instrumental in surveying the evidence on IT integration con-
Preface
ix
tained in Chapter 5. Harvey Poniachek provided helpful comments and

corrections on the nal manuscript. Particularly helpful in developing the
ideas and assembling facts behind this book over the years were Allen
Berger, Arnoud Boot, Lawrence Goldberg, Richard Herring, Christine Hirsczowicz, Ernst Kilgus, Richard Levich, David Rogers, Anthony Santomero, Anthony Saunders, Roy Smith, Gregory Udell, and Maurizio Zollo.
All are owed a debt of gratitude, although none can be held responsible
for errors of fact or interpretation.
Contents
1. Global Financial Services Reconguration
2. The Global Financial Services M&A Deal Flow
35
3. Why Financial Services Mergers?
60
4. Managing Financial Services Mergers and Acquisitions
99
5. The Special Problem of IT Integration
129
6. What Is the Evidence?
153
7. Mergers, Acquisitions, and the Financial Architecture
201
8. The Key Lessons
227
Appendix 1: Financial Service Sector Acquisitions
237
Appendix 2: Case Studies
263
References
281
Suggested Readings
289
Index
301

1
Global Financial Services
Reconguration
Few industries have encountered as much strategic turbulence in recent

years as has the nancial services sector. In response to far-reaching regulatory and technological change, together with important shifts in client
behavior and the de facto globalization of specic nancial functions and
markets, the organizational structure of the industry has been profoundly
displaced. A great deal of uncertainly remains about the nature of any
future equilibrium in the industrys contours. At the same time, a major
part of the industry has been effectively globalized, linking borrowers
and lenders, issuers and investors, risks and risk takers around the world.
This chapter presents a coherent analytical framework for thinking about
nancial rms worldwide, and spells out some of the key consequences
for their strategic positioning and strategy implementation by management.
The discussion begins with the generic processes and linkages that
comprise nancial intermediationthe basic nancial hydraulics that
ultimately drive efciency and innovation in the nancial system. It then
describes the specic nancial activities that form the playing eld of
nancial sector recongurationcommercial banking, securities and investment banking, insurance, and asset management. Virtually all M&A
activity in the nancial services sector takes place within and between
these four areas of activity.
A STYLIZED PROCESS OF FINANCIAL INTERMEDIATION
The central component of any structural overview of a modern banking

and nancial system is the nature of the conduits through which the
nancial assets of the ultimate savers ow to the liabilities of the ultimate
users of nance. These conduits involve alternative and competing modes
Mergers and Acquisitions in Banking and Finance
of nancial intermediation, or contracting, between counterparties in

nancial transactions both within and between national nancial systems.
A guide to thinking about nancial contracting and the role of nancial
institutions and markets is summarized in Figure 1-1. The diagram depicts
the nancial process (ow of funds) among the different sectors of the
economy in terms of underlying environmental and regulatory determinants or drivers, as well as the generic advantages needed to prot from
three primary linkages:
1. Fully intermediated nancial ows. Savings (the ultimate sources
of funds in nancial systems) may be held in the form of deposits
or alternative types of claims issued by commercial banks, savings organizations, insurance companies, or other types of nancial institutions that nance themselves by placing their liabilities directly with the general public. Financial institutions
ultimately use these funds to purchase assets issued by nonnancial entities such as households, rms, and governments.
2. Securitized intermediation. Savings may be allocated directly or
indirectly via duciaries and collective investment vehicles to
the purchase of securities publicly issued and sold by various
public and private sector organizations in the domestic and international nancial markets.
ENVIRONMENTAL DRIVERS
INFORMATION
INFRASTRUCTURE:
Market Data
Research
Ratings
Diagnostics
Compliance
Information Advantages
Interpretation Advantages
Transaction Cost Advantages
TRANSACTIONS
INFRASTRUCTURE:
Payments
Exchange
Clearance
Settlement
Custody
Risk Transformation (Swaps, Forwards, Futures, Options)
Origination
Securities
New Issues
Loans &
Advances
USERS OF FUNDS
Households
Corporates
Governments
Brokerage & Trading

Proprietary / Client-Driven
Securities
Broker/Dealers (B)
Banks (A)
Direct-connect
Linkages (C)
Distribution
Securities
Investments
Collective
Investment
Vehicles
Deposits &
Certificates
SOURCES OF FUNDS
Households
Corporates
Governments
Figure 1-1. Alternative Financial Intermediation Flows. Source: Roy C. Smith and Ingo
Walter, Global Banking, Second Edition (New York: Oxford University Press, 2003).
Global Financial Services Reconguration
3. Direct-connect mechanisms between ultimate borrowers and lenders.

Savings surpluses may be allocated to borrowers through various kinds of direct-sale mechanisms, such as private placements,
usually involving duciaries as intermediaries.
Ultimate users of funds comprise the same three segments of the economy as the ultimate sources of funds, namely the household or consumer
sector, the business sector, and the government sector.
1. Households may nance purchases by means of personal loans
from banks or by loans secured by purchased assets (hirepurchase or installment loans). These may appear on the asset
side of the balance sheets of credit institutions for the duration
of the respective loan contracts or on a revolving basis, or they
may be sold off into the nancial market in the form various
kinds of securities backed by mortgages, consumer credits, or
other kinds of receivables.
2. Businesses may borrow from banks in the form of unsecured or
asset-backed straight or revolving credit facilities or they may
sell debt obligations (for example commercial paper, receivables
nancing, xed-income securities of various types) or equities
directly into the nancial market.
3. Governments may likewise borrow from credit institutions (sovereign borrowing) or issue securities directly in the domestic
capital market or in various bond markets abroad (sovereign
issues).
Borrowers such as corporations and governments also have the possibility of privately issuing and placing their obligations with institutional
investors, thereby circumventing both credit institutions and the public
debt and equity markets. As noted, household debt can also be repackaged as asset-backed securities and sold privately to institutional investors.
In the rst mode of nancial contracting in Figure 1-1, depositors buy
the secondary nancial claims or liabilities issued by credit institutions
and benet from liquidity, convenience, and safety through the ability of
nancial institutions to diversify risk and improve credit quality by means
of professional management and monitoring of their holdings of primary
nancial claims (both debt and equity). Savers can choose from among a
set of standardized contracts and receive payments, services, and interest.
In the second mode of nancial intermediation in Figure 1-1, investors
can select their own portfolios of nancial assets directly from among the
publicly issued debt and equity instruments on offer. This method of
supplying funds may provide a broader range of options than standardized bank contracts, and permit the larger investors to tailor portfolios
more closely to their own objectives while still achieving acceptable liquidity through rapid and cheap execution of trades. Banks and other
nancial institutions that are part of the domestic payments mechanism

assist savers who choose this route. Investors may also choose to have
their portfolios professionally managed, for a fee, through various types
of mutual funds and pension funds (duciary asset pools)designated
in Figure 1-1 as collective investment vehicles.
In the third mode of nancial intermediation, institutional investors
can buy large blocks of privately issued securities. In doing so, they may
face a liquidity penaltydue to the absence or limited availability of a
liquid secondary marketfor which they are rewarded by a higher yield.
However, directly placed securities can be specically tailored to more
closely match issuer and investor requirements than can publicly issued
securities.
Value to ultimate savers and investors, inherent in the alternative nancial processes described here, comes in the form of a combination of
yield, safety, and liquidity. Value to ultimate users of funds accrues in the
form of a combination of nancing cost, transactions cost, exibility, and
liquidity. This value can be enhanced through credit backstops, guarantees, and derivative instruments such as forward rate agreements, caps,
collars, futures, and options. The various markets can be linked functionally and geographically, both domestically and internationally. Functional
linkages permit bank receivables, for example, to be repackaged and sold
to nonbank investors. Privately placed securities, once they have been
seasoned, may be sold in public markets. Geographic linkages make it
possible for savers and issuers to gain additional benets in foreign and
offshore markets, thereby enhancing liquidity and yield, reducing portfolio risk, or lowering transaction costs. Within a national nancial system
such as the United States, ow of funds accounts such as Table 1-1 attempt
to capture the structure of net borrowing and lending.
A variety of types of nancial services rms carry out the functions
described in Figure 1-1. Commercial banks, savings banks, and other thrift
institutions tend to dominate the deposit-taking and credit business identied at the beginning of the chapter as the fully intermediated mode of
nancial linkages. Investment banks and securities rms (broker-dealers)
tend to carry out the underwriting, trading, and distribution functions
bracketed in the second, capital markets-based form of nancial intermediation, along with advisory services and various other client-related
or proprietary activities. Asset managers are active in the allocation of
duciary asset pools on the right side of Figure 1-1, focusing on an array
of clients that runs from wealthy individuals to pension funds. And insurance companies basic business of risk management is complemented
by their role as nancial intermediaries (investing insurance reserves and
the savings component of life insurance) and as pure asset managers
(called third-party business in the insurance world).
These four types of institutions may be combined in various ways.
Commercial and investment banking may be undertaken by the same
rm, so may commercial banking and insurance (known as bancassurance
Table 1-1 Total Net U.S. Borrowing and Lending in Credit Markets (Excludes corporate equities and mutual fund shares)
7
(continued)
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
Total Net Borrowing

Domestic Nonnancial Sectors
Federal Government
Nonfederal Sectors
Household Sectors
Nonnancial Corporate Business
Nonfarm Noncorporate Business
Farm Business
State and Local Governments
Rest of the World
Financial Sectors
Commercial Banking
U.S. Chartered Commercial Banks
Foreign Banking Ofces in U.S.
Banking Holding Companies
Savings Institutions
Credit Unions
Life Insurance Companies
Government-Sponsored Enterprises
Federally related mortgage pools
ABS Issuers
Finance Companies
Mortgage Companies
2001
2002
2047.1
1125.9
5.6
1131.5
611.8
253.3
156.8
7.5
102.2
37.4
958.5
52.9
30.2
0.9
23.6
7.4
1.5
0.6
290.8
338.5
317.6
0.2
0.7
2308.6
1363.7
257.5
1106.2
756.9
62.1
131.8
8.0
147.4
22.5
922.4
48.3
30.3
0.2
18.2
13.8
2.0
2.0
232.4
328.1
263.9
43.7
0.7
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.
45.
46.
47.
48.
49.
Total Net Lending

Domestic Nonfederal nonnancial sectors
Household Sector
Nonnancial Corporate Business
Nonfarm noncorporate Business
State and Local Governments
Federal Government
Rest of the World
Financial Sectors
Monetary Authority
Commercial Banking
U.S. Chartered Commercial Banks
Foreign Banking Offers in U.S.
Banking Holding Companies
Banks in U.S. Afliated Areas
Savings Institutions
Credit Unions
Bank Personal Trusts and Estates
Life Insurance Companies
Other Insurance Companies
Private Pension Funds
State and Local Govt. Retirement Funds
Money Makers Mutual Funds
2001
2002
2047.1
24.1
52.7
11.5
2.0
38.1
6.0
320.6
1744.6
39.9
205.2
191.6
0.6
4.2
10.0
42.8
41.5
28.1
130.9
9.0
20.3
17.7
246.0
2308.6
84.6
55.7
2.2
0.9
25.8
7.7
416.9
1799.5
77.7
410.0
393.7
6.6
3.1
6.6
35.5
44.1
0.9
214.9
30.5
31.0
3.8
25.3
Table 1-1 (continued )
24. REITs
25. Brokers and Dealers
26. Funding Corporations
8
Source: Federal Reserve Flow of Funds Accounts.
2001
2002
2.5
1.4
55.2
18.6
1.8
1.9
50.
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
Mutual Funds
Closed-end Funds
Exchange Traded Funds
Government-Sponsored Enterprises
Federally Related Mortgage Pools
ABS Issuers
Finance Companies
Mortgage Companies
REITs
Brokers and Dealers
Funding Corporations
2001
2002
126.0
7.1
0.0
309.0
338.5
291.4
5.7
1.4
6.7
92.4
112.2
144.2
4.0
3.7
222.4
328.1
241.2
17.5
1.5
23.5
30.6
40.3
or Allnanz in parts of Europe). A number of insurance companies have

been active in the investment banking business. And virtually all types
of rms have targeted asset management as a promising eld of activity.
It is when the economic dynamics of the nancial intermediation process
is subjected to stresswhether from regulatory reforms or technological
change, or simply from changes in client behavior or strategic rethinking
of market opportunitiesthat restructuring pressure is felt among the
various players and corporate actions such as M&A deals usually follow.
SEARCHING FOR FINANCIAL EFFICIENCY
End users of the nancial system can usually be counted on to constantly

search for the best deals. Households seek the highest rates of return and
best investment opportunities, as well as the easiest access to credit on
the most favorable terms; corporations seek a lower cost of capital; public
sector agencies look for lower borrowing costs; and all end users look for
good ideas that will help them maximize their nancial welfare. Obtaining
the best price usually involves what economists call static efciency. Obtaining innovative products and services and harvesting productivity
gains within the nancial intermediation process usually involve what
economists call dynamic efciency. Both of these concepts will be discussed
in greater detail in Chapter 7.
Against a background of continuous pressure for static and dynamic
efciency, nancial markets and institutions have evolved and converged.
Table 1-2 gives some indication of recent technological changes in nancial
intermediation, particularly leveraging the properties of the Internet. Although not all of these initiatives have been successful or will survive,
some have clearly enhanced nancial intermediation efciencies. Internet
applications have already dramatically cut information and transaction
costs for both retail and wholesale end users of the nancial system, as
well as for the nancial intermediaries themselves. The examples of online banking, insurance, and retail brokerage given in Table 1-1 are well
known and continue to evolve and change the nature of the process,
sometimes turning prevailing business models on their heads. For example, nancial intermediaries have traditionally charged for transactions
and provided advice almost for free, but increasingly are forced to provide
transactions services almost for free and to charge for advice. The new
models are often far more challenging for market participants than the
older ones were.
At the same time, on-line distribution of nancial instruments such as
commercial paper, equities, and bonds in primary capital markets not
only cuts the cost of market access but also improves and deepens the
distribution processincluding providing issuers with information on
the investor-base. Figure 1-1 suggests that on-line distribution is only one
further step to cutting out the intermediary altogether by putting the
issuer and the investor or duciary into direct electronic contact with each
10
other. The same is true in secondary markets, as shown in Table 1-2, with
an array of competitive bidding utilities in foreign exchange and other
nancial instruments, as well as inter-dealer brokerage, cross-matching,
and electronic communications networks (ECNs). When all is said and
done, Internet-based technology overlay is likely to have turbocharged
the cross-penetration story depicted in Figure 1-1, placing greater competitive pressure on many of the participating nancial institutions.
Table 1-2 E-Applications in Financial Services 2002

Retail banking
On-line banking (CS Group, Bank-24, E*loan, ING Direct, Egg)
Insurance
ECoverage (P&C) (defunct 2002)
EPrudential term and variable life
Retail brokerage
E-brokerage (Merrill Lynch, Morgan Stanley, Fidelity, Schwab, E*trade, CSFB Direct)
Primary capital markets
E-based CP & bond distribution (UBS Warburg, Goldman Sachs)
E-based direct issuance
Governments (TreasuryDirect, World Bank)
Municipals (Bloomberg Municipal, MuniAuction, Parity)
Corporates (CapitaLink [defunct], Intervest)
IPOs (W.R. Hambrecht, Wit Soundview, Schwab, E*Trade)
Secondary Financial Markets
Forex (Atriax [defunct 2002], Currenex, FXall, FX Connect)
Governments (Bloomberg Bond Trader, QV Trading Systems, TradeWeb EuroMTS)
Municipals (QV Trading Systems, Variable Rate Trading System)
Corporates (QV Trading Systems)
Government debt cross-matching (Automated Bond System, Bond Connect, Bondnet)
Municipal debt cross-matching (Automated Bond System)
Corporate debt cross-matching (Automated Bond System, Bond Connect, Bondlink,
Bondnet Limitrader, BondBook [defunct 2001])
Debt interdealer brokerage (Brokertec, Primex)
EquitiesECNs (Instinet, Island, Redi-Book, B-Trade, Brut, Archipelago, Strike,
Eclipse)
Equities-cross-matching (Barclays Global Investors, Optimark)
Research (Themarkets.com)
End-user Platforms
Corporate nance end-user platforms
(CFOWeb.com [defunct])
Institutional investor utilities
Household nance utilities (Quicken 2002, Yodlee.com)
11
A further development consists of attempts at automated end-user

platforms. Both CFOWeb.com (now defunct) for corporate treasury operations and Quicken 2003 for households provided real-time downloads
of nancial positions, risk proles, market information, research, and so
on. By allowing end users to cross-buy nancial services from best-inclass vendors, such utilities could eventually upset conventional thinking
that focuses on cross-selling, notably at the retail end of the end-user
spectrum. If this is correct, nancial rms that are multifunctional strategies may end up trapped in the wrong business model, as openarchitecture approaches facilitating easy access to best-in-class suppliers
begin to gain market share.
Both static and dynamic efciency in nancial intermediation are of
great importance from the standpoint of national and global resource
allocation. That is, since nancial services can be viewed as inputs to real
economic processes, the level of national output and incomeas well as
its rate of economic growthare directly or indirectly affected. A retarded
nancial services sector can be a major impediment to a nations overall
economic performance. Financial system retardation represents a burden
on the nal consumers of nancial services and potentially reduces the
level of private and social welfare. It also represents a burden on producers by raising their cost of capital and eroding their competitive performance in domestic and global markets. These inefciencies ultimately
distort the allocation of labor as well as capital.
THE FACTSSHIFTS IN INTERMEDIARY MARKET SHARES
Developments over the past several decades in intermediation processes

and institutional design both across time and geography are striking. In
the United States commercial banksinstitutions that accept deposits
from the pubic and make commercial loanshave seen their market share
of domestic nancial ows between end-users of the nancial system
decline from about 75% in the 1950s to under 25% today. The change in
Europe has been much less dramatic, and the share of nancial ows
running though the balance sheets of banks continues to be well over 60%
but declining nonetheless. And in Japan banks continue to control in
excess of 70% of nancial intermediation ows. Most emerging-market
countries cluster at the highly intermediated end of the spectrum, but in
some of these economies there is also factual evidence of incipient declines
in market shares of traditional banking intermediaries as local nancial
markets develop. Classic banking functionality, in short, has been in longterm decline more or less worldwide.
Where has all the money gone? Although reversals occur in times of
nancial turbulence, disintermediation as well as nancial innovation and
expanding global linkages have redirected nancial ows through the
securities markets. Figure 1-2 shows developments in the United States
12

Perc ent
40
Commercial Banks
30
20
Insurance Companies
10
Pension Funds
Mutual Funds
0
1970
1980
1990
2000
Figure 1-2. U.S. Financial Assets, 19702000. Source: Board of Governors of

the Federal Reserve System.
from 1970 to 2000, highlighting the extent of commercial bank market

share losses and institutional investor gains. While the United States may
be an extreme case, even in highly intermediated nancial systems like
Germany (Figure 1-3) direct equity holdings and managed funds increased from 9.6 to 22.7% in just the 19902000 period.
Ultimate savers increasingly use the xed-income and equity markets
directly and through duciaries. Vastly improved technology enables such
markets to provide substantially the same functionality as classic banking
relationshipsimmediate access to liquidity, transparency, safety, and so
onat a higher rate of return. The one thing they cannot guarantee is
settlement at par, which in the case of transaction balances (for example
money market mutual funds) is mitigated by portfolio constraints that
require high-quality, short-maturity nancial instruments. Ultimate users
of funds have beneted from enhanced access to nancial markets across
a broad spectrum of maturity and credit quality by using conventional
and structured nancial instruments. Although market access and nancing cost normally depend on the current state of the market, credit and
liquidity backstops can be easily provided.
At the same time, a broad spectrum of derivatives overlays the markets,
making it possible to tailor nancial products to the needs of end users
with increasing granularity, further expanding the availability and reducing the cost of nancing on the one hand and promoting portfolio optimization on the other. The end users have themselves been forced to become
more performance oriented in the presence of much greater transparency
and competitive pressures, since justifying departures from highly disci-
13
1990 (%)
Stocks
2000 (%)
Investment funds
Investment funds
Stocks
12.3
5.2 4.4
10.4
31.4
38.4
26.6
27.4
Others*
20.6
Others*
23.3
Insurance
Shortterm
investments
with
banks
Insurance
Short-term investments with banks
Figure 1-3. Private Asset Allocation in German Households (*includes xed interest deposits, long-term investments with banks, and building society deposits). Data: Organization
for Economic Cooperation and Development.
plined nancial behavior on the part of corporations, public authorities,

and institutional investors has become increasingly difcult.
In the process, three important and related differences are encountered
in this generic nancial-ow transformation. First, by moving from banking to securities markets, intermediation has shifted from book-value to
market-value accounting. Second, intermediation has shifted from more
intensively regulated to less intensively regulated rms that generally
require less oversight and less capital. Third, the regulatory focus in this
context has migrated from institutions to markets. All three of these shifts
have clear implications for the efciency properties of nancial systems
and for their transparency, safety, and soundness. All three were severely
tested by the revelations of U.S. corporate scandals in the early 2000s,
which called into question just about every facet of the market-driven
system of corporate governancethe role of management, boards of directors, audit committee, and compensation committees within corporations and the role of auditors, lawyers, analysts, rating agencies, regulators, and institutional investors in the external environment of
corporations.
The following sections of this chapter will outline the key attributes of
each of the four pillars of the nancial services industry (commercial
banking, insurance, securities, and asset management) in order to indicate
the source of restructuring pressure and M&A deal ow. The four pillars
are depicted in a taxonomy of M&A transactions in Figure 2-1 in the
following chapter.
14
COMMERCIAL BANKING
Commercial banking encompasses a variety of different businesses involving products and markets that have highly differentiated structural
and competitive characteristics. Some are quite homogeneous and, unless
distorted by government policies, have many of the attributes of efcient
marketsintense competition, ease of entry and exit, low transaction and
information costs, rapid adjustment to change, and very thin prot margins. Others involve substantial monopoly elements, with high degree of
product differentiation, natural or articial barriers to entry, and substantial competitive power on the part of individual rms. There are at least
four broad product categories that dene the domain of commercial banking.
First, there is deposit taking in domestic markets, markets abroad, and
off-shore markets. This asset gathering involves demand and time deposits of residents and nonresidents, including those of individuals, corporations, governments, and other banks (redeposits). Competition for deposits is often intense, with funding costs dependent in part on the
perceived safety and soundness of the institution, its sophistication, the
efciency of its retail deposit-gathering capabilities, and the range of customer services it offers. On the other side of the commercial bank balance
sheet, lending remains a mainstay of the banking industry. Commercial
lending includes secured and unsecured loans to individuals, small business, corporations, other banks, governments, trade and project nance,
and so forth.
Competition in domestic markets for commercial banking services varies from exceedingly intense to essentially monopolistic in some of the
more concentrated nancial systems. Returns tend to vary with the degree
of competition prevailing in the local environment, the complexity and
riskiness of deals, and the creditworthiness borrowers. Specic commercial banking functions include initiation and maintenance of contact with
borrowers or other customers and the quality of credit risk assessment
and management.
Second, loan syndication is a key wholesale commercial banking activity. It involves the structuring of short-term loans and bridge nancing,
credit backstops and enhancements, longer-term project nancing, and
standby borrowing facilities for corporate, governmental, and institutional clients. The loan syndicate manager often sells down participations to other banks and institutional investors. The loans may also be
repackaged through special purpose vehicles into securities that are sold
to capital market investors. Syndicated credit facilities are put together
by lead managers who earn origination fees andjointly with other major
syndicating banksearn underwriting fees for fully committed facilities.
These fees usually differ according to the complexity of the transaction
and the credit quality of the borrower, and there are additional commitment, legal, and agency fees involved as well.
15
Global lending volume increased rapidly in the 1990s and the early
2000s. The business has been very competitive, with loan spreads often
squeezed to little more than 10 to 20 basis points. Wholesale loans tend
to be funded in the interbank market. In recent years, some investment
banks moved into lending that was once almost exclusively the domain
of commercial banks, and many commercial banks backed away from
lending to focus on structuring deals and trying to leverage their lending
activity into fee-based services. The rms coming in found it important
to be able to nance client requirements with senior bank loans (as least
temporarily), as well as securities issues, especially in cases of mergers
and acquisitions on which they were advising. Those departing the business were concerned about the high costs of doing business and the low
returns, although as commercial banks pressed into investment banking
they seemed to nd their lending and loan-structuring capabilities to be
a strategic asset, especially in tough economic times. (The problem of
lending-related cross-subsidies and conicts of interest will be discussed
in later chapters.)
Third are treasury activities, comprising trading and dealing in deposits to help fund the bank, foreign exchange contracts, nancial futures and
options, and so forth. These operations are functionally linked to position
the institution to prot from shifts in markets within acceptable limits of
exposure to risk. A key element is the management of sources and uses
of funds, namely, mismatching the maturity structure of commercial banking assets and liabilities in the light of the shape of the yield curve,
expectations about future interest rate movements, and anticipated liquidity needs. The bank must anticipate market developments more correctly and consistently than the competition, and it must move faster if it
is to earn more than a normal return on its capital. Those it trades with
must have different (less correct) expectations or be slower and less sophisticated if it is to excel in this activity. All of this must be accomplished
in an environment in which all major players have simultaneous access
to more or less the same information. It is a ercely competitive business.
Fourth, a traditional commercial banking product line comprises transactions nancing and cash management. These functions involve nancial
transfers, collections, letters of credit, and acceptances. Many of them have
a somewhat routine character, with relatively little scope for product differentiation and incremental returns. Still, there have been a number of
innovations, particularly in the areas of process technology, systems, and
data transmission, so that commercial payments have sometimes proven
to be quite attractive for banks.
Commercial banking activities have several characteristics that make
them a particular focus for M&A transactions. These include (1) highcost distribution and transactions infrastructures such as branch networks and IT platforms that lend themselves to rationalization; (2) overcapacity brought on by traditions of protection and distortion of
commercial banking competition, and sometimes by the presence of
16
public-sector or mutual thrift institutions and commercial banks (such

overcapacity presents an opportune target for restructuring, in the process
eliminating redundant capital and human personnel); (3) slow-growing
markets that rarely outpace the overall rate of economic growth and
usually lag it due to encroaching nancial disintermediation, exacerbating
the overcapacity problem; and (4) mature products that make innovation
difcult in the production of nancial services, combined with sometimes
dramatic innovation on the distribution side, notably Internet-based commercial banking.
INSURANCE
The principal activities of the insurance industry are non-life insurance,

life insurance, and duciary asset management (so-called third-party
business), which is discussed separately below. Non-life insurance includes property, casualty, and health-related operations. Reinsurance adds
a global activity that provides liability coverage for insurers themselves.
Life insurance comprises whole-life and term-life policies and, increasingly, savings and pension products that are annuity-based.
The two traditional sources of insurance company income are earnings
on policiesknown as technical prots and lossesand earnings on invested premiums from policyholders. Technical prots and losses refer to
the difference between policy premiums earned and claims and/or benets paid. In some countries, insurers are required to invest the majority
of their premiums in government bonds, but most countries allow investment in a range of high-quality, conservative assets, together with
establishing a technical reserve liability on their balance sheet. The technical
reserve reects the estimated cost of claims and benet payments that the
insurer could ultimately be required to pay.
The insurance industry has long had to contend with a rapidly changing and more difcult market environment. Non-life business weakened
in the 1990s due to falling premiums and stagnant demand growth, while
both non-life and life segments were adversely affected by lower interest
rates, resulting in reduced investment income. However, there were protsharing agreements on most of the xed income life business, while new
production was heavily unit-linked, which limited the damage to the
companies. Active asset and liability management also at times limited
damage to individual insurers.
Non-life Insurance
Across most geographic markets, non-life insurance premiums have declined since the mid-1990s. A general slack in demand and excess capacity
drove prices down. Until the World Trade Center terrorist attack in September 2001, premium levels had come down in the United States by 17%,
even though the value of new policies increased signicantly. Some risks
underwritten in the London market only commanded half the premiums
17
of a few years earlier. In most industrialized countries, the market growth

for personal non-life insurance has been sluggish as well, having grown
since the mid-1990s at a slower rate than GDP. Commercial lines of insurance hardly fared better. Multinational companies, which had been
large buyers of insurance in the past, were buying less coverage and in
some cases managed their global risks internally through self-insurance.
A growing number of companies felt that insurance was no longer an
absolute necessity. Some discovered that premiums signicantly exceeded
their actual losses over time.
Some non-life insurers were buoyed by the strong equity markets of
the late 1990s, which swelled the value of their investments and resulted
in the industrys highest net-asset values ever. Such rms suffered commensurately from subsequent equity market declines. Since capital determines underwriting capacity, the surplus capital generated during the
equity market boom created overcapacity in the industry. Excess capacity
led to intensied underwriting activity both in Europe and the United
States, triggering price wars, which made it difcult for weaker companies
to survive. Declining investment returns due to lower interest rates compounded the problem of falling premium revenues and protability. Nonlife insurance liabilities were backed largely by government bonds. The
losses incurred by a large number of insurers as a result of the events of
September 11, 2001, abruptly caused premiums to rise, eliminated overcapacity, and tended to raise equity values among non-life insurers and
insurance brokers, at least temporarily.
Life Insurance
Prospects in life insurance were more attractive for a time due to the
strong market growth since the early 1990s in retirement savings and
pensions. In industrialized countries, the pensions business beneted
from an aging population and threatened cutbacks in government social
security benets. However, life insurance was also affected by a yield
pinch. Historically, the investments for life policyholders in many countries were allocated to xed-income securities, mostly government bonds.
With these traditional life products, insurers guaranteed their clients a
xed rate of return that was usually set by regulators. However, the spread
between the insurers investment yield and its guarantee to policyholders
was dramatically narrowed due to declining interest rates.
This situation seriously damaged the protability of both old and new
business. The life of outstanding liabilities to policyholders often exceeded
that of the underlying bond assets, which periodically matured and had
to be rolled over at successively lower yields. For new policies, insurers
could only invest new premiums at rates that were either close to or below
those guaranteed to policyholders. By the early 2000s, some insurers had
started to reduce their guarantees to better match lower interest rates.
Life insurers fared better by promoting unit-linked products with variable returns for new life policies. Unit-linked products, also known as
18
separate asset account policies, were usually tied to the performance of

equity investments. Unlike traditional life products bearing a guaranteed
return, the investment risk under a unit-linked product was borne by the
policyholder. Under this business model, income was earned from asset
management fees rather than from participating in investment returns.
The unit-linked product provided another important benet by requiring
lower capital reserves than traditional policiessometimes as much as
25% of traditional products capital requirementssince clients were assuming the risks directly.
By the early 2000s, life insurance was thus in the process of reinventing
itself into what became increasingly an asset management-based business.
Indeed, some of the larger insurers had adopted a strategy of asset management as a core business by leveraging their investment expertise. These
companies offered separate asset management products to satisfy demand
from both retail and institutional clients and to compete with banks that
had made inroads into life insurance with annuity-linked products. Nonetheless, the life insurance industry as a whole fell on hard times in the
early 2000s.
Demutualization and Consolidation
Many insurersnotably in the life sectortraditionally operated as mutuals, in which ownership was vested in policyholders, not shareholders.
Without shareholder pressure, mutual insurance companies are often less
efcient than their shareholder-owned competitors. The mutual form of
ownership also hindered consolidation through mergers and acquisitions,
because a mutual is rst required to demutualize to become a stock companyafter obtaining consent from its policyholdersin order to use its
shares as acquisition currency. By the early 2000s, the trend toward demutualization had been under way for some time industrywide, especially in the United States and Japan. Some of the largest U.S. life insurance
companies, including Metropolitan Life, John Hancock, and Prudential,
proceeded down the demutualization track. In Europe there were significant insurance demutualizations, as well as Old Mutual, the dominant
South African insurer, which issued shares in London.
The insurance industry has become increasingly consolidated both
across and within national markets, and this trend is not likely to fade
anytime soon. Because of lower margins from intense competition, insurers felt increasingly pressured to diversify outside of their home markets
to spread risks and gain access to new business. Greater size has been
perceived to provide economies of scale and tighter control of expenses
through improved technology. Cost cutting has seemed clearly more
advantageous at the national level between domestic insurance rivals than
between companies based in different countries or expansion into other
segments of the nancial services industry with few overlapping operations.
19
Consolidation has also been viewed by many as a way to reduce industry overcapacity, especially in the non-life business. However, others
found such benets to be somewhat illusory, since size has not seemed to
provide greater market power and control over prices. The late 1990s and
early 2000s were notable for some of the largest mergers within the industry. In addition, there were external shocks such as the creation of the
euro-zone, where national legislation usually required that insurers back
their liabilities largely with assets denominated in the same currency. With
the introduction of the euro, this restriction was effectively removed for
insurers operating in the euro-zones participating countries. The disappearance of currency risks also encouraged the growth in equity investments by insurers, with a shift away from a country-based investment
approach to a pan-European sector-based approach. Finally, a single currency provided much greater access to the European bond market through
its larger size and greater diversity of nancial instruments. This allowed
insurers to achieve a better matching of assets and liabilities by buying
longer-term bonds across borders. For example, a Spanish insurer could
add German government bonds of a longer maturity than were available
locally to its portfolio.
Both life insurance and non-life insurance were overdue for restructuring, but for different reasons. In non-life, the issue was overcapacity and
a boom-bust cycle that was exacerbated by the losses associated with the
2001 World Trade Center terrorist attack in New York. In life insurance,
underwriting problems due to falling interest rates, continued demutualization, as well as efforts to focus on asset-gathering forms of life insurance, provided motivation for continued consolidation. Added to this was
the fact that the national markets of some of the major insurers were close
to saturation, so that growth would have to come from expansion into
other markets, and the result was bound to be a spate of M&A activity
within the insurance sector.
SECURITIES SERVICES
Securities services are among the nancial-sector activities that have had
important catalytic effects on the global economy. Investment banks have
been key players. They help reduce information and transaction costs,
help raise capital, bring buyers and sellers together, improve liquidity,
and generally make a major contribution to both the static (resourceallocation) and dynamic (growth-related) dimensions of economic efciency.
Figure 1-4 is a convenient way to represent the scope and breadth of
the global securities markets. At the core of the market structure are
foreign exchange and money market instruments. There is virtually complete transparency in these markets, high liquidity, large numbers of buy-
20
U.K., Canada, Australia ...
Euro-zone
Japan
Risks:
Market
Credit
Performance
Forex
and money
T-bonds
markets
Corporate bonds & municipals
Equity-linked products
Equity
U.S.
Emerging
markets
Switzerland
Figure 1-4. Stylized Structure of Global Financial Markets.
ers and sellersprobably as close to the economists denition of perfect

competition that one gets in global nancial markets.
Moving out from the center of the diagram, the next most perfect
market comprises sovereign debt instruments in their respective national
markets, which carry no credit risk (only market risk) for residents, and
are usually broadly and continuously traded. Sovereign debt instruments
purchased by foreign investors, of course, also carry foreign exchange risk
and the (arguably minor) risk of repudiation of sovereign obligations to
foreign investors. If these sovereign debt instruments are denominated in
foreign currencies, they carry both currency risk and country risk (the
risk of inability or unwillingness to service foreign currency debt). Sovereign debt instruments run the gamut from AAA-rated obligations that
may be traded in broad and deep markets all the way to noninvestment
grade, highly speculative country junk.
Next come state, local, and corporate bonds, which range across the
quality spectrum from AAA-rated corporate and municipal securities that
trade in liquid markets fractionally above sovereigns all the way to highyield noninvestment grade and nonrated bonds. Also included in this
category are asset-backed securities and syndicated bank loans, which
may be repackaged and resold as bonds, such as collateralized loan obligations (CLOs).
Then there are common stocks of corporations that trade in secondary
markets and constitute the core of the brokerage business. Equity securi-
21
ties are underwritten and distributed by investment banks. Between corporate bonds and equities lie hybrid nancial instruments such as convertible bonds and preferred stocks and warrants to buy securities at some
time in the future, which in turn can sometimes be stripped and sold
in the covered warrant market. Well out on the periphery of Figure 1-4
are venture capital and private equity, investments that tend to be speculative and have little or no liquidity until an exit vehicle is found through
sale to another company or an initial public offering.
As one moves from the center of Figure 1-4 to the periphery in any
given nancial market environment, the tendencies are for information
and transactions costs to rise, liquidity to fall, and risks (market risk,
credit risk, and/or performance risk) to rise. Along the way, there are a
host of structured nancial products and derivatives that blend various
characteristics of the underlying securities in order to better t into investors portfolio requirements and/or issuer or borrower objectives.
There are also index-linked securities and derivatives, which provide opportunities to invest in various kinds of asset baskets.
Finally, each geographic context is different in terms of market size,
composition, liquidity, infrastructure, market participants, and related factors. Some have larger and more liquid government bond markets than
others. Some have traditions of bank nancing of business and industry,
while others rely more heavily on public and private debt markets. Some
have broad and deep equity markets, while others rely on permanent
institutional or control group shareholdings. Some are far more innovative and performance-oriented than others. In addition to structural
differences, somesuch as the euro-zone since its creation in 1999may
be subject to substantial and rapid shift. Such discontinuities can be highly
favorable to the operations of wholesale and investment banking rms
and can provide rich opportunities for arbitrage. But they can also involve
considerable risk.
Securities rms that perform well tend to have strong comparative
advantages in the least perfect segments of the global nancial market.
Banks with large positions in traditional markets that are not easily accessed by others are examples of this. Sometimes, nancial intermediaries
specialize in particular sectors, types of clients, regions, or products. Some
have strong businesses in the major wholesale markets and as a result are
able to selectively leverage their operating platforms to access markets
that are less efcient and more rewarding. They may also be able to crosslink on a selective basis both the major and peripheral markets as interest
rates, exchange rates, market conditions, and borrower or investor preferences change. For example, a savvy intermediary could nance the
oating-rate debt needs of a highly-rated American corporation by issuing
xed rate Australian dollar bonds at an especially good rate, and then
swap the proceeds into oating rate U.S. dollars. These kinds of crosslinkspermitting the intermediary to creatively marry opportunistic
users of nance to opportunistic investors under ever-changing market
22
conditionsoften separate the winners from the losers in global capital

markets.
The securities industry thus involves a range of businesses that service
the nancial and strategic needs of corporate and institutional clients,
trading counterparties, and institutional investors. The principal functions
of the securities industry are the following.
Market Access
The securities market new-issue activity usually involves an underwriting

function that is performed by investment banks. Corporations or government agencies issue the securities. Sovereign governments tend to issue
bonds to the markets directly, without underwriting. The U.S. securities
market accommodates the greatest volume of new issues, and the international securities markets based in Europe comprise most of the rest.
Underwriting of debt securities is usually carried out through domestic
and international syndicates of securities rms with access to local investors, investors in various important foreign markets such as Japan and
Switzerland, and investors in offshore markets (for example, Eurobonds)
by using one of several distribution techniques. In some markets private
placements occur when securities are directed not at public investors but
only at selected institutional investors. Access to various foreign markets
is facilitated by means of interest-rate and currency swaps (swap-driven
issues). Some widely distributed, multimarket issues have become known
as global issues. In some markets, intense competition and deregulation
have narrowed spreads to the point that the number of rms in underwriting syndicates has declined over time. In some cases, a single participating rm handles an entire issue in a so-called bought deal.
Commercial paper and medium-term note (MTN) programs maintained by corporations, under which they can issue short-term and
medium-term debt instruments on their own credit standing and more or
less uniform legal documentation, have become good substitutes for bank
credits. Financial institutions provide services in designing these programs, obtaining credit ratings, and dealing the securities into the market
when issued. In recent years, MTN programs have become one of the
most efcient ways for corporate borrowers to tap the major capital markets.
Underwriting of equity securities is usually heavily concentrated in the
home country of the issuing rm. Normally, the investor base and the
secondary market trading and liquidity are found in the home country.
Corporations periodically issue new shares for business capital. Another
important source of new supplies of stocks to the market has come from
government privatization programs. New issues of stocks may also involve companies issuing shares to the public for the rst time (initial
public offerings) or later as secondary issues, or existing shareholders of
large ownership positions selling their holdings and companies selling
additional shares to existing shareholders (rights issues).
23
Trading
Once issued, bonds, notes, and shares become trading instruments in the
nancial markets, and underwriters usually remain active as marketmakers and as proprietary investors for their own accounts. Secondary
market trading is also conducted in other instruments, including foreign
exchange (a market traditionally dominated by commercial banks but
increasingly penetrated by insurance companies and investment banking
rms as well), derivative securities of various types, and commodities
and precious metals. Trading activities include market-making (executing
client orders, including block trades), proprietary trading (speculation for
the rms own account), program trading (computer-driven arbitrage between different markets), and risk arbitrage (usually involving speculative
purchases of stock on the basis of public information relating to pending
mergers and acquisitions).
Brokerage
So-called agency business is an important and traditional part of the

securities and investment banking industry. Its key area is brokerage,
involving executing buy or sell orders for customers without actually
taking possession of the security or derivative contract, sometimes including complex instructions based on various contingencies in the market. Brokerage can be oriented to retail or wholesale (institutional) business. Many of the nancial market utilities discussed earlier are aimed at
providing more efcient vehicles for classic brokerage functions as they
affect both individual and institutional investors.
Investment Research
Research into factors affecting the various nancial markets, individual

securities and derivatives, specic industries, and macroeconomic conditions have become an important requirement for competitive performance in investment banking. Research is made available to clients by
more or less independent analysts within the rm. Research analysts
reputation and compensation depend on the quality of their insights,
which are usually focused on specic industries or sectors in the case of
equity research. The value of research provided to clients depends critically on its quality and timeliness, and is often compensated by business
channeled through the rm, such as brokerage commissions and underwriting or advisory mandates. Closely allied are other research activities
often highly technical modeling exercisesinvolving innovative nancial
instruments that link market developments to value-added products for
issuer-clients, investor-clients, or both. Over the years, research carried
out by investment banks (called sell-side research) became more important
in soliciting and retaining investment banking clients, a condition that
increasingly placed their objectivity in question. This eventually developed to the point of absurdity, as analysts were shown to have sold out
to the investment banking side of their rms, thus becoming little more
24
than gloried salespeople. Investigations and prosecution eventually led

to charges of fraudulent and misleading research and a $1.4 billion settlement with leading securities rmsand the likelihood of major class
action litigation to come.
Hedging and Risk Management
Hedging and risk management mainly involves the use of derivative

instruments to reduce exposure to market and credit risk associated with
individual securities transactions or markets affecting corporate, institutional, or individual clients. These include forward rate agreements,
interest-rate and credit swaps, caps, oors and collars, various kinds of
contingent contracts, as well as futures and options on an array of nancial
instruments. It may be quicker, easier, and cheaper, for example, for an
investor to alter the risk prole of a portfolio by using derivatives than
by buying and selling the underlying instruments. In modern wholesale
nancial markets, the ability to provide risk management services to clients depends heavily on a rms role in the derivatives market, particularly over-the-counter (OTC) derivatives that allow structuring of what
are frequently highly complex risk management products.
Advisory Services
Corporate nance activities of investment banks predominantly relate to

advisory work on mergers, acquisitions, divestitures, recapitalizations,
leveraged buyouts, and a variety of other generic and specialized corporate transactions. They generally involve fee-based assignments for rms
wishing to acquire others or rms wishing to be sold (or to sell certain
business units) to prospective acquirers.
The M&A business is closely associated with the market for corporate
control. It may involve assistance to, and fund-raising efforts for, hostile
acquirers or plotting defensive strategies for rms subjected to unwanted
takeover bids. It may also involve providing independent valuations and
fairness opinions for buyers or sellers of companies to protect against
lawsuits from disgruntled investors alleging that the price paid for a
company was either too high or too low. Such activities may be domestic,
within a single national economy, or cross-border, involving parties from
two countries. The global M&A marketplace has been extraordinarily
active from time to time, with roughly half of the deal volume involving
the United States.
As part of the M&A business, sales of state-owned enterprises (SOEs)
to the private sector became a major component of global wholesale nancial services beginning in the early 1980s. Such business generally
involves the sale of the initial public offering of a large corporation but
can also involve the sale of SOEs to corporate buyers, as well as advisory
roles. And there are advisory assignments to governments on how the
privatization processes should work in order to satisfy the public interests.
25
Businesses for sale have run the gamut from state-owned manufacturing
and services enterprises to airlines, telecommunications, infrastructure
providers, and so on. Sellers use various approaches such as sales to
domestic or foreign control groups, local market otations, global equity
distributions, sales to employees, and others.
Principal Investing
So-called merchant banking, a term used by American investment

banks, involves nancial institutions placing their clients and their own
capital on the line in private investments of (usually) nonpublic equity
securities, private equity, venture capital, real estate, and leveraged buyouts and certain other equity participations. It sometimes involves large,
essentially permanent stakeholdings in business enterprises, including
board-level representation and supervision of management. Or it may
involve short-term subordinated lending such as bridge loans or mezzanine nancing to assure the success of an M&A transaction. Firms began
to participate in these investments in the late 1980s to take advantage of
the opportunity to participate in the high expected returns emanating
from their natural deal ow.
An important dimension of merchant banking involves venture capital
and private equity investments, often through limited partnerships, with
the idea that the investment banks would not only benet from the success
of the investment per se, they would also arrange the initial public offering
and any other nancial services needed afterwards. Virtually all of the
global investment banks have now established private equity or venture
capital units, although in the early 2000s many of them took massive
losses in their private equity portfolios.
Securities Infrastructure Services
Finally, there is an array of services that lies between buyers and sellers
of securities, domestically and internationally, that is critical for the effective operation of securities markets. These services center on domestic
and international systems for trading and for clearing and settling securities transactions via efcient central securities depositories (CSDs). They
are prerequisites for a range of activities, often supplied on the basis of
quality and price by competing private-sector vendors of information
services, analytical services, trading services and information processing,
credit services, securities clearance and settlement, custody and safekeeping, and portfolio diagnostics.
Investor services represent nancial market utilities that tend to be
highly scale and technology intensive. Classic examples include Euroclear,
a Belgian cooperative that was pioneered by (and had a longstanding
operating agreement with) J. P. Morgan. Many banks and securities rms
have stakes in investor services utilities, which can generate attractive
risk-adjusted returns for nancial services rms if all-important costs and
26
technologies are well managed. There is an ongoing debate as to whether

such utilities ought to be vertically integrated (with stock exchanges, for
example) or independent and competing actively for transaction-ow.
Competition and Restructuring in Securities Services
All of these activities have to be organized in an effective structure that

in most cases has come to form a so-called full-service global wholesale
banking capability. Such a structure comprises market-assess services
(debt and equity originations), trading and brokerage, corporate advisory
services including M&A activities, principal investing, asset management,
and (sometimes) investor services, and could take the form of an independent investment bank or the investment banking division of a universal bank or nancial conglomerate. The top rms in the investment banking industry today comprise a relatively small number of U.S.
independent rms such as Goldman Sachs, Lehman Brothers, Merrill
Lynch, and Morgan Stanley, together with investment banking divisions
of universal banks and nancial conglomerates such as Citigroup, Credit
Suisse First Boston, Deutsche Bank, Dresdner Kleinwort Wasserstein, J.P.
Morgan Chase, and UBS Warburg. There are also regional securities activities conducted by banks and independent or afliated securities
houses in the signicant markets such as the United States, Canada,
France, Spain, the Nordic countries, Japan, Hong Kong, China, Singapore,
and a variety of others.
There is an active debate concerning the optimal organization of the
securities industry. Some argue that its fast-moving, opportunistic nature
in a mark-to-market environment and its heavy reliance on innovation
and creativity make this industry best suited to independent rms that
have relatively light and mobile structures, ideally with substantial equity
ownership by management. Others argue that the industry has become
increasingly capital intensive, both in supporting trading positions and
nancing deals, so that some of the most active rms may be found among
investment banking divisions of nancial conglomerates. Still others
maintain that structural cohabitation is possible, with investment banking
monoline specialists and generalists joined by smaller boutiques in a lively
cocktail of rms competing for market share. So far, the jury remains out,
although it seems likely that further M&A activity will characterize the
shape of the industry going forward.
ASSET MANAGEMENT
As of 2002, the global total of assets under management was estimated at

close to $56 trillion, comprising some $14 trillion in pension fund assets,
about $9 trillion in mutual fund assets, another $9 trillion in duciary
assets controlled by insurance companies, and perhaps $24 trillion in
private client assets. Not only is this already massive industry likely to
experience substantial growth in comparison with other segments of the
27
nancial services sector, but also cross-border volumeboth regional and

globalis likely to take an increasing share of that activity. Within this
high-growth context, asset management attracts competitors from a broad
range of strategic groupscommercial and universal banks, investment
banks, trust companies, insurance companies, private banks, captive and
independent pension fund managers, mutual fund companies, and various types of specialist rms. This rich array of contenders, coming at the
market from several very different starting points, competitive resources,
and strategic objectives, makes the market for institutional asset management a highly competitive one.
A schematic that is consistent with the overall dynamics of nancial
intermediation ows shown in Figure 1-1, which depicts the structure of
asset management services, is presented in Figure 1-5. Retail investors
have the option of placing funds directly with nancial institutions such
as banks or by purchasing securities from retail sales forces of brokerdealers, possibly with the help of fee-based nancial advisers. Alternatively, retail investors can have their funds professionally managed by
buying shares in mutual funds or unit trusts (again possibly with the help
of advisers), which in turn buy securities from the institutional sales desks
of broker-dealers (and from time to time maintain balances with banks).
Private clients are broken out as a separate segment of the asset management market, and are usually serviced by private bankers. The bankers
bundle asset management with various other services such as tax planning, estates, and trusts, and place monetary assets directly into nancial
instruments, commingled managed asset-pools, or sometimes publicly
Capital Market
Securities
Commercial paper
Investment grade bonds
Noninvestment grade
bonds
Equities
Private placements
Venture capital
Private equity
Banking
Deposits
Loan participations
Asset
managers
Mutual funds
Closed- Openend
end
Financial
advisers
Private
bankers
Retail clients
Private clients
Fund
consultants
Defined
benefit
pensions plans
Defined
contribution
pension plans
Foundations,
endowments,
financial
reserves
Figure 1-5. Organization of the Asset Management Industry.
Financial
advisers
28
available mutual funds and unit trusts. In between retail and private
clients is another category, mass afuent, that many nancial institutions
have decided to target.
Foundations, endowments, and nancial reserves held by nonnancial
companies, institutions, and governments have several options regarding
asset management. They can rely on in-house investment expertise to
purchase securities directly from the institutional sales desks of banks or
securities broker-dealers, use nancial advisers to help them build efcient portfolios, or place assets with open-end or closed-end mutual funds.
Pension funds take two principal forms, those guaranteeing a level of
benets and those aimed at building beneciary assets from which a
pension will be drawn (see below). Dened benet pension funds can
buy securities directly in the market or place funds with banks, trust
companies, or other types of asset managers, often aided by fund consultants who advise pension trustees on performance and asset-allocation
styles. Dened contribution pension programs operate in a similar way
if they are managed in-house, creating proprietary asset pools and also
(or alternatively) providing participants with the option to purchase
shares in publicly available mutual funds.
The structure of the asset management industry encompasses signicant overlaps among the four types of asset pools to the point where they
are sometimes difcult to distinguish. An example is the linkage between
dened contribution pension funds and the mutual fund industry, and
the association of the disproportionate growth in the former with the
expansion of mutual fund assets. There is a similar but perhaps more
limited linkage between private client assets and mutual funds, on the
one hand, and pension funds, on the other. This is particularly the case
for the lower bound of private client business (which is often commingled
with mass-marketed mutual funds) and pension benets awarded highincome executives (which in effect become part of high-net-worth portfolios).
The underlying drivers of the market for institutional asset management are well understood.
1. A continued broad-based trend toward professional management of discretionary household assets in the form of mutual
funds or unit trusts and other types of collective investment
vehicles, a development that has perhaps run much of its course
in some national nancial systems but has only begun in others.
2. The growing recognition that most government-sponsored pension systems, many of which were created wholly or partially
on a pay-as-you-go (PAYG) basis, have become fundamentally
untenable under demographic projections that appear virtually
certain to materialize. These pension systems must be progressively replaced by asset pools that will generate the kinds of
29
returns necessary to meet the needs of growing numbers of

retirees who are living longer.
3. Partial displacement of traditional dened benet public and
private sector pension programs backed by assets contributed
by employers and working individuals. This displacement is a
result of the evolving demographics, rising administrative costs,
and shifts in risk-allocation by a variety of dened-contribution
schemes.
4. Reallocation of portfolios that have been overweightedfor regulatory, tax, or institutional reasonsto domestic nancial instruments (notably xed-income securities) toward a greater role
for equities and nondomestic asset classes. This shift not only
promises higher returns but also may reduce the beneciaries
exposure to risk due to portfolio diversication across both asset
classes and economic and nancial environments that are less
than perfectly correlated in terms of total investment returns.
Mutual Funds
Competition among mutual funds can be among the most intense anywhere in the nancial system. The competition is heightened by the aforementioned analytical services that track performance of funds in terms of
risk and return over different holding periods and assign ratings based
on fund performance. These fund-rating services are important, because
the vast majority of new investments tend to ow into highly rated funds.
For example, in the United States during the 1990s, about 85% of all new
money was allocated to funds rated four-star or ve-star by Morningstar,
Inc. In addition, widely read business publications distribute regular
scoreboards among publicly available mutual funds based on such ratings
and, together with specialized investment publications and information
distributed over the Internet, have made mutual funds one of the most
intensely competitive parts of the retail nancial services sector. These
developments are mirrored to varying degrees in Europe as well, notably
in the United Kingdom.
Despite clear warnings that past performance is no assurance of future
results, a rise in the performance rankings often brings in a ood of new
investments and management company revenues. The individual asset
manager is compensated commensurately and sometimes moves on to
manage larger and more prestigious funds. Conversely, serious performance slippage causes investors to withdraw funds, taking with them a
good part of the managers bonus and maybe his or her job, given that
the mutual fund companys revenues are vitally dependent on new investments and total assets under management. With a gradual decline in
the average sophistication of the investor in many markets as mutual
funds become increasingly mass market retailoriented and interlinked
30
with pension schemes, performance ratings, name recognition, and

branding appear to be progressively more important in dening competitive performance in the industry.
In addition to promoting their performance, when favorable, mutual
fund companies and securities broker-dealers have aggressively added
banking type services. These services include checking and cash management accounts, credit cards, and overdraft lines. The service providers
offer user-friendly, integrated account statements and tax reporting. Client
contact is based on easy access by telephone, mail, and the Internet.
Commercial bank competitors in the mutual fund business have seen their
retail competitive advantage become increasingly reliant on a fragile combination of high-cost branch networks and deposit insurance. Securities
rms have likewise increased their mutual fund activity, presumably with
the view that this part of the securities industry is more capable of supporting signicant, sustained returns than is wholesale investment banking, such as debt and equity capital markets and corporate advisory services, where competition has become cutthroat, often capital-intensive, and
subject to a high degree of earnings instability. Insurance companies have
also considered the mutual fund business to be a strong candidate for
strategic development, especially in the face of competition in their traditional annuities business and the cross-links that have emerged in some
countries between the pension fund and mutual fund industries. There
have also been successful examples of direct fund distribution even in
heavily bank-dominated nancial systems. Competition in the mutual
funds business thus covers a rich array of players, ranging from commercial banks and securities broker-dealers to specialized mutual fund
companies, discount brokerages, insurance companies, and nonnancial
rms. Such interpenetration of strategic groups, each approaching the
business from a different angle, tends to make markets exceedingly competitive, especially with the growth of hedge funds.
Various observers have argued that consolidation in the mutual fund
business is inevitable. Factors that seem to argue for greater industry
concentration in the future are economies of scale and band-name concentration among progressively less sophisticated investors in taxable
funds and mutual funds that are part of retirement accounts battling for
attention among the enormous number of funds. Arguments against further concentration include shifts in performance track records and the role
of mutual fund supermarkets in distribution, which increase the relative
marketing advantage of smaller funds. One factor that may promote continued fragmentation of the mutual fund industry is that size itself can lead
to signicant performance problems. So far, at least, evidence of dramatically increased concentration remains elusive, although reshufing via
M&A transactions has been substantial.
31
Pension Funds
The pension fund market has proven to be one of the most rapidly growing sectors of the global nancial system, and promises to be even more
dynamic in the years ahead. Consequently, pension assets have been in
the forefront of strategic targeting by all types of nancial institutions,
including banks, trust companies, broker-dealers, insurance companies,
hedge funds, mutual fund companies, and independent asset management rms. Pension assets in 1995 in countries where consistent and comparable data are available (Australia, Canada, Japan, Switzerland, the
United Kingdom, and the United States) were estimated to amount to $8.2
trillion, roughly two-thirds of which covered private sector employees;
the balance covered public sector employees. By 2002, these had grown
to $14.2 trillion. The basis for such growth is, of course, the demographics
of gradually aging populations colliding with existing structures for retirement support, which in many countries carry heavy political baggage.
These structures are politically exceedingly difcult to bring up to the
standards required for the future, yet eventually doing so is inevitable.
The expanding role of dened-contribution plans in the United States
and elsewhere has led to strong linkages between pension funds and
mutual funds. Numerous mutual fundsnotably in the equities sector
are strongly inuenced by 401(k) and other pension inows. These linkages are reected in the structure of the pension fund management industry. For example in the United States in 2002, among the top-25 401(k)
plan fund managers, three were mutual fund companies, ten were insurance companies, ve were banks, one was a broker-dealer, two were
diversied nancial rms, and four were specialist asset managers. In
Europe pension funds business has changed signicantly over the years
as well. In 1987 banks had a market share of about 95%, while insurance
companies and independent fund managers split the rest about evenly.
But by 2002 independent fund managers had captured over 40% of the
market, banks were down to about 55%, and insurance companies accounted for the rest.
Private Clients
One of the largest pools of professionally managed assets in the world is

associated with high-net-worth individuals and families, generally
grouped under the heading of private banking. Total funds under management have been variously estimated at up to $27 trillion in 2003significantly exceeding the size of the global pension asset poolalthough the
condentiality aspect of private banking makes such estimates little more
than educated guesses.
Private clients asset management objectives are an amalgam of preferences across a number of variables, among which liquidity, yield, security, tax efciency, condentiality, and service level are paramount. Each
of these plays a distinctive role. Traditional private banking clients were
32
concerned with wealth preservation in the face of antagonistic government policies and ckle asset markets. Clients demanded the utmost in
discretion from their private bankers, with whom they often maintained
lifelong relationships initiated by personal recommendations. Such highnet-worth clients have to some degree given way to more active and
sophisticated customers. Aware of opportunity costs and often exposed
to high marginal tax rates, they consider net after-tax yield to be more
relevant than the security and focus on capital preservation traditionally
sought by high-net-worth clients. They may prefer gains to accrue in the
form of capital appreciation rather than interest or dividend income, and
tend to have a more active investment response to changes in total rates
of return.
The environment faced by high-net-worth investors is arguably more
stable today than it has been in the past. The probability of revolution,
conventional war, and expropriation has declined over the years in Europe, North America, the Far East, and Latin America, even as the nancial markets themselves underwent serious turmoil. Nevertheless, a large
segment of the private banking market remains highly security conscious.
Such clients are generally prepared to trade off yield for stability, safety,
and capital preservation, although global terrorism may once again be
changing investor preferences.
Like everyone else, high-net-worth clients are highly sensitive to taxation, perhaps all the more so as cash-strapped politicians target the
rich in a constant search for scal revenues. International nancial markets have traditionally provided plenty of tax-avoidance and tax-evasion
opportunities, ranging from offshore tax havens to private banking services able to sidestep even sophisticated efforts to claim the states share.
And secrecy is a major traditional factor in private bankingsecrecy
required for personal reasons, for business reasons, for tax reasons and
for legal or political reasons. Condentiality, in this sense, is a product
that is bought and sold as part of private asset management business
through secrecy and blocking statutes on the part of countries and high
levels of discretion on the part of nancial institutions. The value of this
product depends on the probability and consequences of disclosure, and
is priced in the form of lower portfolio returns, higher fees, suboptimal
asset allocation, or reduced liquidity as compared with portfolios not
driven by condentiality motives.
Finally, there is the level of service. While some of the tales of personal
services provided for private banking clients are undoubtedly apocryphal,
the fringe benets offered to high-net-worth clients may well inuence
the choice of and loyalty to a particular nancial institution. Such benets
may save time, reduce anxiety, increase efciency, or make the wealth
management process more convenient. Personal service is a way for asset
managers to show their full commitment to clients accustomed to high
levels of personal service in their daily lives. The essence of private banking is to identify each clients unique objectives, and to have the exibility
33
and expertise to satisfy these as fully as possible in a highly competitive

marketplace.
Overall, the private banking business is highly fragmented. In 2002 the
largest player was UBS AG, with $428 billion in private client assets under
management, but accounting for only about 1.8% of the estimated global
total. Indeed, the 11 top rms only accounted for 9.5% of total private
client assets, indicating the degree of fragmentation in this business.
Competitive Restructuring in Asset Management
The foregoing discussion has noted that various kinds of nancial rms
have emerged to perform asset-management functions. Such rms include
commercial banks, savings banks, postal savings institutions, savings cooperatives, credit unions, securities rms (full-service rms and various
kinds of specialists), insurance companies, nance companies, nance
subsidiaries of industrial companies, mutual fund companies, nancial
advisers, and various others. Members of each strategic group compete
with one another, as well as with members of other strategic groups. There
are two questions. First, what determines competitive advantage in operating distribution gateways to the end-investor? Second, what determines competitive advantage in the asset management process itself?
One supposition is that distribution of asset management services is
both scope and technology-driven. That is, services can be distributed
jointly with other types of nancial services and thereby benet from cost
economies of scope as well as demand economies of scope (cross-selling).
This joint distribution would tend to give retail-oriented nancial services
rms such as commercial and universal banks, life insurance companies,
and savings institutions a competitive advantage in distribution. At the
same time, more specialized rms may establish cost-effective distribution
of asset management services by using proprietary remote-marketing
techniques such as mail, telephone selling, or the Internet or by renting
distribution through the established infrastructures of other nancial intermediaries such as banks, insurance companies, or mutual fund supermarkets. They may also gain access through fund management consultants and nancial advisers.
The asset management function itself depends heavily on portfolio
management skills as well as economies of scale, capital investment, and
technologies involved in back-ofce functions, some of which can be outsourced. Since duciary activities must be kept separate from other nancial services operations that involve potential conicts of interest, either
through organizational separation or Chinese walls, there is not much
to be gained in the way of economies of scope.
Intersectoral competition, alongside already vigorous intrasectoral
competition, is what will make asset management one of the most competitive areas of nance, even in the presence of rapid growth in the size
of the market for asset management services. Certainly the dynamics of
34
competition for the growing pools of dened-benet and denedcontribution pension assets in various parts of the world, and its crosslinkage to the mutual fund business, has led to various strategic initiatives
among fund managers. These initiatives include mergers, acquisitions,
and strategic alliances among fund managers, as well as among fund
managers, commercial and universal banks, securities broker-dealers, and
insurance companies.
SUMMARY
This initial chapter has presented a conceptual prole of nancial intermediation and related activities that can be used to frame the relevant
questions that drive the industrys evolving structure. How can end users
of the nancial system optimize their own interests as sources or users of
nancial ows? How can nancial intermediaries position themselves in
the structure of nancial ows in order to provide client value-added,
secure acceptable market share, and achieve sustainable protability?
What is the activity space of each of the four major pillars of the nancial
services industrycommercial banking, investment banking, insurance,
and asset managementand how do they interact as rms seek to position themselves in the most advantageous way possible?
The objective here has been to set the stage for understanding the
industrys reconguration and the mergers and acquisitions deal ow
that has become the principal vehicle for bringing it about.
2
The Global Financial Services
M&A Deal Flow
The previous chapter provided a structural framework within which the

reconguration of the nancial services sector can be explained in an
historical context, assessed in terms of ongoing or rumored transactions,
and sometimes predicted going forward. If a new nancial intermediation
channel opens up as a result of technological or regulatory change, it is
virtually certain that end users of the nancial system will sooner or later
try out those channels, thereby rewarding the innovators. Established
rms then have three choices: (1) they can stand and ght to beat back
the threat of disintermediation by making an economic case that the new
approach is not in clients best interests or threatens to reduce access to
other types of nancial services of value to clients, perhaps coupled with
appeals to the regulatory authorities for protection, (2) they can go with
the ow and build their own capacity in the new areas that pose a competitive threat, (3) or they can acquire one or more of the rms that have
developed a solid foothold in the new area of nancial services activity.
Examples of each of these responses abound. Early in the 1990s, J.P.
Morgan sponsored a new electronic Dutch auction platform for allowing large corporations to efciently distribute conventional corporate
bonds to institutional investors, which provided both the investors and
the issuers with substantial savings in transaction costs without sacricing efcient pricing or liquidity. Merrill Lynch and other major bond
underwriters mounted a vigorous attack on this threat to their bread
and butter bond underwriting business, pointing out various alleged
shortcomings as well as torpedoing the whole exercise by buying
the rst couple of deals. The entrenched players response to Dutch auction initial public offering (IPO) platforms pioneered by rms such as
W.R. Hambrecht & Co. and Wit Soundview was not much different, although the innovators managed to obtain a small market share and may
come back in a signicant way in the future. In the late 1990s, when
35
36
e-brokerage threatened Merrill Lynchs vast sales force of nancial consultantsthe heart of its private client businessthe rm publicly denigrated do-it-yourself e-brokerage as a threat to clients nancial lives.
Within a year, Merrill and its retail brokerage competitors had developed
ways of integrating e-brokerage into their legacy distribution platforms,
providing clients with multiple options and providing the rms (through
wrap fees) with a presumably more stable source of revenues.
Technology shifts that make existing nancial products or processes
obsolete represent one kind of stimulus to M&A transactions in the nancial services sector. If the new technologies seem promising and exceed
the capabilities of a nancial rm, a properly executed acquisition can
have substantial value in terms of both market share and protability, as
in the case of Swiss Bank Corporations acquisition of OConnor Partners,
a derivatives specialist, in 1992. As various e-based transaction platforms
emerged in the 1990s, such as electronic communications networks
(ECNs), established players often acquired them or took equity participations. Technology-driven change can be both rapid and disruptive, with
uncertain outcomes. Some of this M&A activity takes on the character of
strategic insurance.
Besides shifts in technologies, other external forces driving M&A activity in the nancial services sector are linked to regulatory change. In 1974,
the so-called Mayday in the United States introduced negotiated stock
brokerage commissions and eroded the ability of many securities rms to
compete. Some went out of business, but most were bought by other rms
to form entities more capable of surviving in the new deregulated environment. In 1986 more or less the same thing happened in the United
Kingdom, with the so-called Big Bang, which eliminated the distinction
between brokers and dealers (single-capacity rms) and the exclusivity
of narrow franchises. At the same time, a London Stock Exchange ruling
that outside ownership of LSE member rms could not exceed 29.9% was
lifted to 100%, which allowed all kinds of banks and other nancial rms
to become registered broker-dealers.
The objective was to make London a far more competitive nancial
center, and it succeeded. But in the process virtually all of the former
specialists were acquired by British merchant banks, British clearing
banks, and European and U.S. universal and commercial banks to form
multicapacity rms much better able to survive in the new deregulated
environment. Many banks turned out to have overpaid by overestimating
the quality of what they were buying or the sustainability of prot margins under the new conditions. The United Kingdom went through further consolidation a decade later, with all but two of the traditional British
rms in the securities industry acquired by foreigners (see below).
Regulatory triggers of nancial sector M&A activity have been common in other regions as well. Examples include liberalization of market
access for foreign banks and insurers in countries such as Australia, Mexico and other Latin American countries, China, Korea, Taiwan, and many
The Global Financial Services M&A Deal Flow
37
others. Usually the policy objective is to create a leaner and more

performance-oriented nancial system by improving the management of
local rms acquired by foreigners and forcing local rms that remain
independent to face new competition and greatly improve performance.
Sometimes this works so wellas in the Australian case in the 1980s
that the new foreign entrants do far worse than they anticipated.
Other changes in competitive barriers may be regional, as in the United
States with the lifting in 1978 of the 1927 McFadden Act restrictions on
interstate banking. The change in law made possible the creation of large
regional, superrregional, and national banking companies through serial
acquisitions of smaller banks by rms such as BancOne, Wells Fargo, Fleet
Financial, Key Corp., and PNC Corp. As always, some have done much
better than others. Nor have large banking companies succeeded in extinguishing small local and community banks. There remain almost 8,000
banks in the United States, and there is a constant ow of new bank
charters awarded. Evidently banking entrepreneurs think they can survive against competition from the giants based on superior local information and relationships, better quality of service, and the ability of outsource some of the size-sensitive functions. New technologies often aid
the entrepreneurs.
Another example of regulatory change is the liberalization of line-ofbusiness barriers that existed for decades in the United States (the GlassSteagall provisions of the Banking Act of 1933 and the Bank Holding
Company Act of 1956) and in Japan (Article 65 of the Japan Financial Law
of 1949). In the American case the Gramm-Leach-Bliley Act of 1999 effectively eliminated barriers and allowed qualied banks to acquire insurance companies as well as securities rms (and vice-versa), making it
possible for the rst time since the Great Depression to create (for better
or worse) multifunctional nancial rms such as Citigroup, Bank of America, and J.P. Morgan Chase. The idea was to create a level playing eld
where business logic and the demands of the marketplace, rather than
regulatory dictates, determine the structural form of nancial rms in a
way that was consistent with safety and stability. Many people thought
that the sweeping away of 36 years of barriers to competition between
different types of nancial services rms would lead to an immediate
spate of cross-market mergers and acquisitions to form massive multifunctional nancial services conglomerates. By 2003, they were still waiting.
Besides regulatory changes and technological change, the principal
driver of nancial sector M&A deal ow reects the various strategies of
the players involved. Somewhere along the line many rms in this industry decided that they were going to be growth plays from the perspective of investors and command the valuations commonly associated
with growth stocks. But how to grow? One option is to expand geographically. Another is to add clients. And a third is to add products. These are
not mutually exclusive, but they all have in common reliance on M&A
38
transactions as one of the principal tools. Whatever the M&A motivation,

one has to ask whether the ultimate objective is indeed maximizing shareholder value or some other objective, such as executive compensation,
rm size and market share, or just plain hubris. These issues will be
discussed in the following chapter.
IN-MARKET AND CROSS-MARKET TRANSACTIONS
The basic M&A drivers in nancial services described in the previous

section have, to a signicant extent, been reected in the process of nancial industry reconguration summarized in Figure 2-1.
First, in-market transactions have been most intense in the commercial
banking sector, notably retail banking. Extensive banking overcapacity in
some countries has led to substantial consolidation that has often involved
M&A activity. Excess retail banking capacity has been slimmed down in
ways that usually release redundant labor and capital. In some cases this
process has been retarded by large-scale involvement of public sector
institutions and cooperatives that operate under less rigorous nancial
discipline. Most of the shrinkage in U.S. commercial banking, from almost
15,000 banks to about 8,000 banks, has been the product of M&A deals
that included periods of high-volume activity by regional and superrregional consolidators. In the process, the commercial banking industry has
Figure 2-1. Multifunctional Financial Linkages.
39
become far more efcient, yet without precluding the continued existence
and prosperity of small community banks.
In-market M&A activity has also occurred in the insurance sector, both
life and non-life, as well as insurance brokerage. Insurance rms such as
AIG in the United States and Aegon in the Netherlands are the products
of sequential acquisitions, both domestically and around the world
although the fact that many of the worlds leading life insurance companies were mutuals and had to make any acquisitions in cash arguably
dampened M&A activity as a restructuring force in the life insurance
business. The two global insurance brokerage rms Aon and Marsh &
McLennan are both products of large numbers of acquisitions in what
was once a highly fragmented business.
Similarly, in-market consolidation in investment banking had been a
long-standing phenomenonnotably the accelerated consolidation triggered by deregulation in the United States and the United Kingdom noted
earlier. Finally, asset management has also seen substantial in-market
restructuring as larger fund managers acquired smaller ones unable to
exploit scale economies or lacking sufcient marketing reach.
Another dimension of nancial services consolidation is reected in
cross-market M&A transactions. At the retail level, commercial banking
activity has been linked strategically to retail brokerage, retail insurance
(especially life insurance), and retail asset management through mutual
funds, retirement products, and private client relationships. Sometimes
this product linkage has occurred selectively and sometimes by using
multiple distribution channels coupled to aggressive cross-selling efforts.
At the same time, relatively small and focused rms have sometimes
continued to prosper in each of the retail businesses, especially where
they have been able to provide superior service or client proximity while
taking advantage of outsourcing and strategic alliances. In wholesale nancial services, similar links have emerged. Wholesale commercial banking activities such as syndicated lending and project nancing have often
been shifted toward a greater investment banking focus, while investment
banking rms have placed growing emphasis on developing institutional
asset management businesses in part to benet from vertical integration
and in part to gain some degree of stability in a notoriously volatile
industry.
The result has been M&A activity on the part of commercial banks and
universal banks acquiring investment banks, exploiting the U.S. regulatory liberalization in 1999 that allowed them to do so. This activity paralleled to some extent the acquisition of brokers and jobbers as well as
merchant banking rms in the United Kingdom, mostly by commercial
and universal banks. Earlier, a number of insurance companies had likewise acquired investment banks. Most of these were later divested (one
of the more recent being the sale by Groupe AXA of Donaldson Lufkin
Jenrette to Credit Suisse in 2000). Only Prudential Financial retains an inhouse securities rm, Prudential Securities, which basically focuses on
40
Table 2-1 Disappearing Investment Banks, 19862003
Kuhn Loeb (1986)

E.F. Hutton (1987)
Morgan Grenfell (1989)
Drexel Burnham (1990)
Shearson Lehman American Express
(1993)
Kidder Peabody (1994)
Baring Brothers (1995)
Kleinwort Benson (1995)
Alex Brown (1997)
Dillon Read (1997)
Hoare Govett (1997)
Robertson Stephens (1997)
Montgomery Securities (1997)
Peregrine Securities (1997)
BZW (1998)
S.G. Warburg (1998)
NatWest Markets (1998)
Cowen & Co, (1998)

Yamaichi Securities (1998)
Paribas (1998)
Hambrecht & Quist (1998)
Charterhouse (1999)
Phoenix Securities (1999)
Bankers Trust Company (1999)
Furman Selz (1999)
Schroders (2000)
Robert Fleming (2000)
PaineWebber (2000)
J.P. Morgan (2000)
Donaldson Lufkin Jenrette (2000)
Wasserstein Perella (2000)
Beacon (2000)
ING Barings (2001)
Dresdner Kleinwort Wasserstein (2001)
Robertson Stephens (2002)
Name drops: Dean Witter (2002), PaineWebber (2003), Salomon Smith Barney (2003).
retail brokerage, and even that business was partially sold to Wachovia
Bank. Among the major banks there have been similar divestitures, for
example Robertson Stephens by Fleet Financial in 2002. Outside the
United States there were similar developments, including acquisition of
Indosuez by Credit Agricole, Banque Paribas by Banque Nationale de
Paris, Morgan Grenfell by Deutsche Bank, Hoare Govett by ABN AMRO,
Barings by ING Groep, Wasserstein Perella by Dresdner Bank, and a
number of others. Again, some were later divested as rms such as Barclays and National Westminster Bank exited key investment banking activities and sold these businesses to Credit Suisse and Bankers Trust,
respectively. The latter was subsequently taken over by Deutsche Bank.
Table 2-1 and Figure 2-2 show the progressive disappearance of U.S.
and U.K. securities rms, mostly though acquisitions but in some cases
such as Barings, Drexel Burnham Lambert, E.F. Hutton, and Kidder Peabodydue to malfeasance as a primary or contributory factor in their
demise.
At the same time there has been substantial cross-market activity linking banking and insurance under the rubric of Allnanz or bancassurance.
Firms such as Citigroup, ING Groep, Allianz AG, Fortis Group, Lloyds
TSB, and others offer both banking and insurance. In most cases these
strategies involve acquisitions of insurance companies by commercial
banking organizations or vice versa. The results have been decidedly
mixed, ranging from considerable successes to unmitigated disasters. As
always, the devil is in the details.
41
Figure 2-2. Evolution of British Merchant Banks 19862003.
42
Table 2-2 Completed Global M&A Transactions 19852002

($ billionsthousands of transactions)
$ Value
U.S. Domestic
All industries
All nancial services
8,103.7
2,935.6
45.1%
41.3%
93.6
33.0
35.9%
37.4%
U.S. Cross-Border
All industries
2,411.3
589.6
13.4%
8.3%
28.2
5.6
10.8%
6.3%
Non-U.S.
All industries
7,464.0
3,588.8
41.5%
50.4%
138.8
49.7
53.3%
56.3%
Total
All industries
17,979.0
7,114.0
100.0%
100.0%
260.6
88.3
100.0%
100.0%
Data: Thomson Financial Securities Data, author calculations.
Finally, each of the other three types of nancial rms have aggressively
expanded their presence in asset management, often through cross-market
M&A deals. Market valuations of asset management companies have
consequently been quite high in comparison with other types of rms in
the nancial services industry, and this has been reected in prices paid
in M&A transactions.1 Besides gaining access to distribution and fund
management expertise, the underlying economics of this deal-ow presumably have to do with the realization of economies of scale and economies of scope, making possible both cost reductions and cross-selling of
multiple types of funds, banking and/or insurance services, investment
advice, high-quality research, and so on in a one-stop-shopping interface
for investors.
Table 2-2 shows that mergers and acquisitions in the nancial services
sector have comprised a surprisingly large share of the total volume of
M&A activity worldwide. Including only transactions valued in excess of
$100 million, during the period 19852002 the cumulative total value of
M&A transactions worldwide in all industries amounted to about $18
trillion. Of this total, M&A transactions in the nancial services industry
had a cumulative value of about $7 trillion, or 40% of the global total.
1. For example, at midyear 1996 in the United States, when the price to earnings ratio (based on
expected 1996 earnings) for the S&P 500 stocks averaged 16.2, the price-earnings ratios of the top-ten
domestic commercial banks with strong retail banking businesses averaged 10.3, the top life and casualty
insurance companies averaged price-earnings ratios of about 10, the top-eight publicly owned investment
banks (including J. P. Morgan and Bankers Trust) only 7.9, while the price-earnings ratios of the top-nine
asset managers averaged about 14. The average share price to book value ratio for the top ten U.S.
commercial banks in 1996 was 1.83, for the top investment banks it was only 1.27, while for the top-nine
asset managers it was 4.64.
43
Tables 16 in Appendix 1 contain all of the major M&A deals in the

nancial services industry during 19902002 in the United States, Europe,
and Asia and indicates when the transaction was announced and its value.
From the deal list it is clear that the majority of the transactions occurred
in the banking sector, followed by insurance. Indeed, as Figure 2-3 shows,
the bulk of these transactions (by value) involved commercial banking
well over 60% of the totalwith about 25% involving the insurance industry and the balance involving asset management companies, securities
broker-dealers, and other types of nancial rms. Relative to all other
industries, commercial banking ranked second only to telecommunications in both the United States and Europe during the period 19852002,
as shown in Table 2-3, with insurance ranked seventh in the United States
and third in Europe.
As noted earlier, nancial services M&A transactions can be either inmarket or cross-market, in addition to being either domestic or crossborder. During the 19852002 period, most nancial services M&A transactions were in-market (that is, within banking, insurance, securities, and
so forth), with rms acquiring or merging with similar rms, rather than
cross-market (between generic activities; for example, banks acquiring insurance companies), as Table 2-4 shows. As discussed, until late 1999 the
United States had in place signicant barriers to cross-market M&A activitynamely, the Glass-Steagall provisions of the Banking Act of 1933
and the Bank Holding Company Act of 1956. These barriers certainly
contributed to the fact that such a large proportion (85%) of the M&A
activity was within each of the sectors and rather than between them.
Nevertheless, in Europe, where such restrictions have not limited the
100%
90%
18%
25%
80%
70%
28%
24%
25%
27%
34%
60%
50%
40%
30%
59%
68%
78%
61%
63%
77%
44%
20%
10%
0%
19861988
19891991
Banking
19921994
Insurance
19951997
Securities
19981999
2000/01
Asset Management
Figure 2-3. Worldwide Financial Services Merger Volume, 19862002.
2002
44
Table 2-3 Merger-Intensity Rankings of Industry Groups

of U.S. and European Buyers, 19852002
Acquirer Industry
Investment and commodity rms/
dealers/exchanges
Telecommunications
Commercial banks, bank holding
companies
Business services
Oil and gas; petroleum rening
Radio and television broadcasting
stations
Electric, gas, and water distribution
Insurance
Drugs
Electronic and electrical equipment
Chemicals and allied products
Prepackaged software
Food and kindred products
Computer and ofce equipment
Measuring, medical, photo equipment; clocks
Aerospace and aircraft
Transportation equipment
Paper and allied products
Credit institutions
Printing, publishing, and allied
services
Health services
Machinery
Metal and metal products
U.S.
Acquirer Rank Val.
Rank
($mils)
1
# of
Deals
1886712.1 21427
European
Acquirer Rank Val.
Rank
($mils)
1
1038258.7
2
3
826320.7
797346.6
2622
6615
2
3
764393.1
729971.5
4
5
6
519058.4 12025
512473.8 3539
492668.0 2280
10
6
22
175877.4
255266.3
55930.6
7
8
9
10
11
12
13
14
15
441075.4
388266.3
297546.9
266854.2
216618.8
190625.3
185730.6
164173.4
149222.1
1745
3283
1599
3116
2044
3854
2135
1778
3609
5
4
9
15
8
40
7
52
28
441943.8
464484.0
214471.5
105363.9
234303.2
24468.9
247812.1
4463.7
44632.1
16
17
18
19
20
147746.9
126989.6
125745.1
120169.4
117521.8
579
1215
851
893
2703
24
12
20
46
14
47136.3
114772.1
70869.1
10215.4
109860.4
21
22
23
116291.7
116029.8
114372.9
3657
2803
2225
49
23
18
7731.6
48727.6
94235.8
process of nancial restructuring, over 74% of the transactions by value

were likewise within the individual nancial services sectors. This suggests that the dynamics of nancial services industry restructuring in the
United States and Europe may have been quite similar, driven by the
economics of consolidation within the industrys various functional domains. It is interesting that the relative volume of insurance deals was
substantially higher in Europe than in the United States.
Finally, the bulk of M&A transactions ow was domestic during the
19852002 period, that is, within national nancial systems, as shown in
Table 2-5. This suggests that much of the volume concerned the consolidation of domestic banking systems, with M&A transactions being the
Table 2-4 Volume of In-Market Mergers and Acquisitions in the United States and Europe, 19852002 (billions of U.S. dollars and percent)
Target Institution
Acquiring
Institution
45
Commercial
banks
Securities
rms
Insurance
companies
World Total
Europe
U.S.
Banks
Securities
Insurance
Banks
Securities
Insurance
Banks
Securities
Insurance
1260
(52.2%)
111
(4.6%)
128
(5.3%)
71
(2.9%)
282
(11.7%)
36
(1.5%)
63
(2.6%)
96
(4.0%)
365
(15.1%)
594
(50.9%)
14
(1.2)%
73
(6.3%)
30
(2.6%)
182
(15.6%)
19
(1.6%)
0.3
(0.0%)
49
(4.2%)
200
(17.2%)
370
(47.5%)
53
(6.8%)
50
(6.4%)
24
(3.1%)
48
(6.2%)
12
(1.5%)
52
(6.7%)
39
(5.0%)
131
(16.8%)
79.0%
Source: Thomson Financial Securities Data.
83.7%
(70.4)
Table 2-5 Volume of Cross-Border Mergers and Acquisitions in the United States and Europe, 19852002 (billions of U.S. dollars and percent)
Target Institution
Acquiring
Institution
46
Commercial
banks
Securities
rms
Insurance
companies
World Total
U.S.non-U.S.
Europenon-Europe
Intra-Europe
Banks
Securities
Insurance
Banks
Securities
Insurance
Banks
Securities
Insurance
Banks
Securities
Insurance
185
(25.9%)
31
(4.3%)
26
(3.6%)
68
(9.5%)
98
(13.7%)
28
(3.9%)
11
(1.5%)
17
(2.4%)
249
(34.9%)
58
(19.1%)
10
(3.3%)
1
(0.3%)
44
(14.5%)
61
(20.1%)
22
(7.2%)
4
(1.3%)
6
(1.8%)
98
(32.3%)
79
(28.3%)
8
(2.9%)
24
(8.6%)
18
(6.5%)
19
(6.8%)
3
(1.1%)
4
(1.4%)
4
(1.4%)
121
(43.4%)
63
(22.7%)
7
(2.5%)
2
(0.7%)
40
(14.4%)
40
(14.4%)
19
(6.9%)
4
(1.4%)
11
(4.0%)
90
(32.5%)
Source: DeLong, Smith, and Walter (1998) and Thomson Financial Securities Data. The rst gure is the dollar value (in billions) of M&A activity and the second number in parentheses is the
percentage of the total (these sum to 100 for each 3 3 matrix). Figures reported are the sum of the equity values of the target institutions.
47
principal vehicle for removing excess capacity and promoting domestic

consolidation. The largest share of cross-border volume was in the insurance industry, suggesting that perhaps the underlying economics were
somewhat different in that sector, with market-extension in the face of
saturated domestic markets arguably representing an important motivation.
Whereas line-of-business and geographic restrictions have characterized the United States for all but the last several years covered by the
M&A data, fostering a more narrow geographic and line-of-business focus
to nancial sector restructuring than might have occurred otherwise, this
was not the case in Europe. The EU Second Banking Directive and directives covering investment services and insurance all had in common the
single passport, allowing nancial rms to operate throughout the European Union (EU) in competition with local institutions. This did not
mean a true level playing eld, however, since the EU lacked a coherent
set of takeover rules during this period and continued to be characterized
by strong nationalism and the perceived need for national champions
in the nancial sector, particularly banking.
Cross-border restructuring in the United Kingdom was probably the
most liberal, with most securities rms and a number of banks, insurance
companies, and asset managers taken over by foreign players. The largest
deal was the acquisition of Midland Bank by HSBC. Still, there were also
a number of cross-border deals in France, Germany, Italy, Spain, Portugal,
and the Nordic and Benelux countries.
SURVIVORSHIP
As one would expect, the nancial services landscape around the world
has been profoundly altered by M&A activity in all of the four sectors of
the industrybanks, insurance companies, broker-dealers, and asset
managers.
Table 2-6 shows the worlds largest banks by asset size in 1989 and
2002. Note that none of the top-10 banks in 1989 remained on the list
without at least one important merger or acquisition, sometimes several.
Similarly all of the top-10 banks in 2002 had at least one important merger
during the previous decadea complete churning of this particular cohort of nancial institutions.
Much the same is true in the life and non-life insurance industries,
although the dynamic is quite different. In the life sector the largest rms
were traditionally mutuals (owned by their policyholders). Over time
many of them demutualized through initial public offerings, creating a
cohort in 2001 in which all except the remaining Japanese life insurers
and TIAA-CREF (a pension fund for university professors classied as an
insurance company due to the guaranteed nature of some of its pension
products) had become stock companies, beneting from access to the
capital markets and the strategic exibility that goes with it (see Table
48
Table 2-6 The Worlds Largest Banks (assets in billions of U.S. dollars)
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
March 1989
February 2002
Dai-Ichi Kangyo
$1,096 1.
Sumitomo Bank
800 2.
Fuji Bank
751 3.
Mitsubishi Bank
701 4.
Sanwa Bank
653 5.
Industrial Bank of Japan
595 6.
Credit Agricole
516 7.
Citicorp
489 8.
Norinchukin Bank
483 9.
Banque Nationale de Paris
468 10.
Total Top 10
$6,552
Mizuho1
$1,178
Citigroup
$1,051
Sumitomo-Mitsui Banking Corp2
840
Deutsche Bank AG
809
751
Mitsubishi Tokyo Fin. Group3
UBS
747
BNP Paribas
727
HSBC
696
J.P. Morgan Chase
694
Hypo Vereinsbank AG
642
$8,135
Merger of Dai-Ichi Kangyo Bank, Fuji Bank, IBJ and Yasuda Trust established as a holding company in Sept.
2000.
2
Announced October 14, 1999.
3
Merger of Bank of TokyoMitsubishi, Mitsubishi Trust and Banking, Nippon Trust and Tokyo created April
20, 2001.
1
2-7). In the non-life sector, however, most of the largest rms had been
traditionally public companies, and the rms on the 2001 list (excepting
State Farm, which remains a mutual) had been through at least one M&A
transaction during the previous decade. Some rms had experienced
many more (see Table 2-8).
Table 2-9 shows the worlds largest asset managers in 2002, a rich array
of contenders based in various nancial services strategic groups. Some
have a commercial banking background as trust companies, managing
assets for dened benet pension funds. Others are insurance companies
undertaking third-party duciary business and leveraging off expertise
Table 2-7 Worlds Largest Life Insurance Companies, 2001
Ranking
Company
Country
1
2
3
4
5
6
7
8
9
10
AXA
ING Group
Nippon Life
CGNU
Generali
DAI-ICHI Mut. Life
Prudential
TIAA-CREF
Sumitomo Life
Metlife
France
Netherlands
Japan
Britain
Italy
Japan
Britain
U.S.
Japan
U.S.
Revenues
($mil)
92,782
71,206
68,055
61,499
53,333
46,436
43,126
38,064
37,536
31,947
Type
Stock
Stock
Mutual
Stock
Stock
Mutual
Stock
Mutual
Mutual
Stock
49
Table 2-8 Worlds Largest Non-life Insurance Companies, 2001
Rank
Company
Country
1
2
3
4
5
6
7
8
9
10
Allianz
State Farm
AIG
Munich Re
Zurich
Berkshire
Allstate
Royal & Sun
Loews
Swiss Re
Germany
U.S.
U.S.
Germany
Switzerland
U.S.
U.S.
Britain
U.S.
Switzerland
Revenues
($mil)
Type
71,022
47,863
45,972
40,672
37,434
33,976
29,134
25,570
20,670
18,688
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
gained in managing their own insurance reserves. Still others are independent asset managers such as mutual fund companies, some of which
have become prominent in managing dened contribution retirement assets. Finally, investment banks have pushed aggressively into asset management, particularly mutual funds used for savings and retirement vehicles. Table 2-10 shows the pattern of M&A activity in the asset
management industry, a pattern that is indicative of the degree to which
fund managers have been acquired by banks, investment banks, and insurers over the years.
Among the various nancial businesses that depend critically on human capital, M&A transactions have been especially problematic in asset
management. History shows that it is very easy to overpay and that
Table 2-9 Worlds 20 Largest Asset Managers, 2001
Firm
UBS AG
Kampo
Deutsche Bank AG
Fidelity Investments
Credit Suisse
AXA
Barclays Global Inv.
State Street
Allianz AG
J.P. Morgan Fleming
Assets under
management
($ billions)
1,438
1,230
1,079
886
837
802
801
724
641
638
Firm
Merrill Lynch
Capital Group
Mellon
Morgan Stanley
Citigroup
Vanguard
Invesco
Putnam
Amvescap
Northern Trust
Source: Institutional Investor, July 2001 (U.S. data) and November 2001 (non-U.S. data).
Assets under
management
($ billions)
557
556
510
472
464
389
384
370
333
323
50

Table 2-10 Merger and Acquisitions Activity in the Asset Management
Industry (January 1985June 2003, Millions of U.S. $ and Number of
Transactions)
Total Asset
Managers
Total
Global Target
European Target
U.S. Target
Other Target
Total Asset
Managers
312,966
110,888
117,703
84,375
Open-end Mutual
Fund Managers
(7,821)
(3,171)
(2,237)
(2,413)
23,521
10,388
5,366
7,767
(459)
(204)
(159)
(96)
Total
European
Acquirer
U.S. Acquirer
U.S. Target
U.K. Target
Cont. Eur. Target
117,703 (2,237)
55,295 (1,291)
55,593 (1,880)
25,942 (181)
41,055 (1,119)
49,832 (1,685)
84,527 (1,931)
10,241
(79)
3,753 (128)
Open-end Mutual
Fund Managers
Total
European
Acquirer
U.S. Acquirer
U.S. Target
U.K. Target
Cont. Eur. Target
5,366 (159)
3,490 (41)
6,921 (163)
1,849 (8)
3,455 (38)
6,742 (148)
3,475 (148)
0 (2)
0 (3)
Data: Thompson Financial Securities Data, author calculations.
skill and judgment of individuals and teams in a highly fragmented industry is the key competitive variable. So many of the real success stories
in the industry involve well-executed organic growth, such as Fidelity,
Capital International, Vanguard, and TIAA-CREF, while some of the disasters involve acquisitions that have been difcult to integrate, control,
and leverageZurich Financial Services, has provided one example. That
hardly means it cannot be done, as Amvescap demonstrates. And asset
management acquisitions can prove especially problematic to manage
through the equity market cycle, when attractive revenue-driven deals
executed in bull markets look very different in downturns, when attention
turns to cost cutting, layoffs, and compensation cuts imposed on asset
managers who in fact outperformed.
Finally, Table 2-1 and Figure 2-2 have already illustrated the disappearance of the vast majority of independent securities rms over the last
several decades, mostly through being acquired by other securities rms
or by commercial and universal banking organizations. Most of the activity has been in the United States (long hampered by the Glass-Steagall
Act) and in the United Kingdom. Figure 2-4 is an illustration of how the
major securities rms in todays competitive landscape got to where they
1990
2002
Swiss Bank
OConnor
S.G. Warburg
Dominguez Barry
Bunting
JD Anderson
Dillon Read
Giubergia
UBS
Brunswick
PaineWebber
UBS
Omega
Merrill Lynch
Smith New Court
Carnegie Italia
FG Inversiones
McIntosh
DSP
Midland Walwyn
Davis Dorkum Hare
Yamaichi
Herzog
Deutsche Bank
Morgan Grenfell
CJ Lawrence
NatW(US & Asia)
Bankers Trust
Alex Brown
NDB
CS(FB)
51
BZW (EU & Asia
Garantia
Merrill Lynch
DE Soft
Phatra
NatWest (EU)
Schroders Jpn
DLJ
Dean Witter
AB Assesores
Quilter
Morgan Stanley
Deutsche
Bank
Crdit Suisse
First Boston
Morgan
Stanley
Salomon
Smith Barney
Nikko Securities
Schroders (ex Jpn)
Citigroup
JP Morgan
Chase(2)
H&Q
Fleming
Goldman Sachs
Hull Trading
SLK
JPMorgan
Goldman
Sachs
Figure 2-4. Global Investment Banking Consolidation (1). NOTES: (1) Not including insurance companies and asset management, (2) Chase includes Chemical Bank and Manufacturers Hanover. Data: UBS AG.
52
were as of 2002, such that the principal rms in terms of investment

banking transaction ow in 2002 represented a varied group of major
independent rms and investment banking divisions of commercial banks
and nancial conglomerates (Table 2-11). A favorite topic of conversation
has been whether any of the independents in this industry will ultimately
be able to survive, or whether all will eventually be absorbed into nancial
juggernauts, and what will be gained and lost in the process.
CROSS-HOLDINGS AND NONFINANCIAL SHAREHOLDINGS
One development in the restructuring of the nancial services sector that

has long been present in Europe, but not in the United States, involves
cross-holdings among nancial rms, as shown in Figure 2-5 as of 2002.
Here banks and insurance companies have held minority shares in each
other, both within and between their respective segments of the nancial
services industry. Sometimes these have been part of consortia, cooperation agreements, joint ventures, or strategic alliances, with crossshareholdings used to cement such arrangements. Sometimes they have
been defensive holdings to make sure signicant blocks of shares are in
friendly hands in case of hostile takeover attempts.
Sometimes, too, they have been strategic initiatives to give rms a
seat at the table in the event that further restructuring developments and
opportunities appeared. Most of the grander schemes along these lines
have been judged failures. Joint ventures and strategic alliances rarely
work for very long in this sector and usually develop a dynamic whereby
one partner buys out the other or they go their separate ways. Nonetheless, the industry has seen a number of successful tactical alliances that
helped cooperating rms achieve strategic goals in particular opportunistic situations. The classic example is the original alliance between Credit
Suisse and First Boston Corporation during the 1970s heyday of the Eurobond market.
Some cross-holdings, are the products of history, such as the one between Dresdner Bank, Allianz AG, and Munich Re. As the left-hand part
of Figure 2-6 shows, there had been a structure of cross-holdings between
the three rms, traceable in part to the fact that Allianz and Munich Re
shared a cofounder and had a history of cooperation in areas such as
reinsurance. Allianz and Dresdner Bank (long Germanys second largest)
had reciprocal shareholdings as well, with cooperation including efforts
to sell each others products through their respective distribution networks. Another cooperation arrangement and shareholding involved Allianz with HypoVereinsbank, Germanys largest regional bank, based in
Munich.
In 2001 Allianz agreed to acquire Dresnder Bank, following two unsuccessful attempts by Dresdner to merge, rst with Deutsche Bank and
then with Commerzbank. At the heart of the deal was the unbundling of
the cross-shareholdings of Allianz AG, Munich Re, HypoVereinsbank, and
Table 2-11 Global Wholesale Banking Rankings, 2002 ($ million)
Firm Rank 2002*
53
J.P. Morgan (2)

Citigroup/Salomon Smith Barney
Goldman Sachs & Co (4)
Deutsche Bank AG (8)
Credit Suisse First Boston (6)
Merrill Lynch & Co Inc (3)
Morgan Stanley (5)
Banc of America Securities LLC
Lehman Brothers (9)
UBS Warburg (7)
Bear Steams & Co Inc (15)
ABN AMRO (13)
Barclays Capital (12)
BNP Paribas SA (14)
Lazard (17)
HSBC Holdings PLC (16)
Rothschild (26)
Royal Bank of Scotland Group
(19)
Dresdner Kleinwort Wasserstein
Global Debt
U/W & Private
Placements
Global Equity
U/W & Private
Placements
M&A
Advisory
Completed
37,337
70,379
41,887
262,193
349,156
197,037
207,219
262,111
176,331
216,483
153,633
257,572
223,434
140,398
74,041
87,935
44,276
17,491
46,286
40,324
14,743
38,916
47,308
26,703
8,363
15,988
16,226
4,036
2,819
182,831
208,220
320,750
127,075
211,999
173,145
195,095
29,040
133,664
133,064
83,806
29,636
3,147
36,714
57,500
1,349
55,088
149,956
47,256
130,109
28,579
93,434
25,436
47,153
Syndicated
Bank Loans
419,326
228,004
8,651
86,746
24,142
7,513
12,626
218,394
20,724
9,447
*2001 ranking in parentheses. Data: Thomson Financial Securities Data.
359
28,722
Total
Market
Share
3,757
906,935
851,780
582,562
569,809
553,648
503,419
466,729
455,779
446,165
397,333
247,228
208,361
188,407
185,459
149,956
145,818
130,109
125,769
11.28%
10.59%
7.24%
7.08%
6.88%
6.26%
5.80%
5.67%
5.55%
4.94%
3.07%
2.59%
2.34%
2.31%
1.86%
1.81%
1.62%
1.56%
8,264
109,934
1.37%
MTNS
Arranged
25,093
20,115
15,801
134,026
16,479
99,123
15,822
46,349
18,217
15,162
18,989
64,529
30,094
41,062
3,000
Country:
Fortis
Belgium
KBC
France
AGF
Germany
West
LB
Austria
Italy
54
Spain
Socit
Generale
Crdit
Agricole
AXA
Credit
Lyonnais
CCF
Deutsche
Bank
Allianz
Commerzbank
Munich Re
AMB
BCI
San Paolo
Generali
Banca
Intesa
La
Caixa
BSCH
BNP Paribas
Dresdner
Bank
Bank
Austria
Unicredito
Italiano
Banco
Popular
HVB
ERGO
Erste
Bank
BNL
Mediobanca
Banca
di Roma
INA
BBV
Portugal
UK
BES
BPI
NatWest
BCP
Royal Bank
of Scotland
Switzerland
Netherlands
Figure 2-5. Financial Services Crossholdings in Europe. Data: UBS AG.
CS Group
Swiss Re
ABN Amro
Swiss
Life
ING
Banco
di
Napoli
55
Figure 2-6. Simplifying the Allianz Crossholding Structure. Source: Allianz AG.
Dresdner Bank. A 2001 German tax reform abolished a long-standing

capital gains tax on liquidations of shareholdings in other companies,
effective at the beginning of 2002, and was no doubt a catalyst for the
merger. It allowed better utilization of capital while avoiding punitive
taxes. Much of the i25 billion purchase price was paid for with asset
trades of Allianz and Dresdner holdings amounting to i17 billion, or 68%
of the deal value.
Allianz relinquished to Munich Re its interests in HypoVereinsbank,
including its own 13.6% stake and a 2.5% interest that belonged to Dresdner. Allianz also re-acquired 10% of its own shares by buying Dresdner.
As a consequence of the transaction, Munich Re and HypoVereinsbank,
by then Germanys second largest bank, forged closer tieswith Munich
Re emerging with an interest greater than 25% in the Bavaria-based bank.
As part of the agreement to reduce its cross-holdings with Munich Re,
Allianz intended to redeploy the released capital in its core businesses
and in the process rationalize the domestic insurance businesses of both
rms.2
In addition, European banks and insurance companies long had equity shareholdings in all kinds of business enterprises (see for example
Figure 2-7). Some of these could be traced to rescue efforts by banks of
their clients, which resulted in debt conversions into equity. Some had
to do with how enterprises were nanced in their early stages in the
2. Allianz purchased Munich Res 45% interest in Bayerische Versicherungsbank and its 49.9% shareholding in Frankfurter Versicherung. Munich Re would in turn acquire the 36.1% interest held by Allianz
in Karlsruher Lebensversicherung. Allianz also agreed with Munich Re in April 2001 to acquire its 40.6%
stake in Allianz Lebenversicherung (Allianz Leben).
56
absence of broad and deep local capital markets. Simultaneously, investors needed to build sensible asset portfolios and nd outlets for investable funds without the benet of sophisticated capital markets. Governments often encouraged such shareholdings, and in some cases
reinforced by them with public sector stakes in either nancial institutions or corporations, or both. Not least, close Hausbank relationships between nancial and nonnancial rms reinforced and perpetuated such
stakes.
As viable nancial markets developed in various countries and the
nancial institutions themselves came under pressure to use their capital more efciently, the institutions began to consider dissolving these
stakes. The process is ongoing in Europe and is progressively having an
impact on the industrial landscape as well as nancial markets. Somewhat similar developments can be seen in Asia (notably in Japan and
Korea), in these cases triggered by nancial crises or prolonged economic stagnation.
In another joint venture example, Bank of America in 2002 undertook
a $1.6 billion deal purchase of BSCHs Grupo Financiero Sern in Mexico,
the third largest bank in Mexico, in an effort to tap into the $10 billion
in annual worker remittances by Mexicans employed in the United
States, a ow that involves some $1 billion in fees annually. The deal
improved Bank of Americas competitive position against Citigroup and
HSBC, which both have the necessary networks in both Mexico and the
United States, and bolstered BSCH in competition with the Mexican activities of its main Spanish rival, BBVA, which controls Grupo Financiero Bancomer, the largest Mexican bank. BSCH (who also needed the
$700 million capital gain to bolster its capital, impaired by losses in Argentina) obtained extensive U.S. distribution in the project, while Bank
of America obtained a Mexican presence that would not have made
sense on a stand-alone basis, and was able to better compete with Citigroup.
COHABITATION?
In terms of the leading rms (in terms of market capitalization) existing

in the four principal sectors of the nancial services industry today, Tables
2-12 and 2-13 show that the majority have been through at least one M&A
transaction involving a minimum of 25% of the respective rms market
capitalization. That includes all of the top-10 banks and most of the others
as well. Additionally, Zurich Financial Services made major acquisitions
such as Scudder and BATs nancial services businesses, only to sell them
a few years later to Deutsche Bank. Similar important acquisitions have
been undertaken by Generali, Marsh McLennan, Merrill Lynch, and
Schwab, while Goldman Sachs opened itself to public ownership in 1999
in part to take advantage of its shares as currency in possible future M&A
deals.
57
Figure 2-7. Legacy German Crossholding Structure. Source: E. Wenger, University of Wurzburg, 1993.
Table 2-12 Top Financial Firms by Market Capitalization (in U.S. $ Billions)
1990
2003
Industrial Bank of Japan

Fuji Bank
Mitsui Taiyo Kobe Bank
Sumitomo Bank
Dai-Ichi Kangyo Bank
Mitsubishi Bank
Sanwa Bank
Nomura Securities
Long-Term Credit Bank
Allianz AG
Tokai Bank
Mitsubishi Trust & Banking
Deutsche Bank
AIG
Bank of Tokyo
57.1
52.0
46.3
46.0
44.8
44.0
41.2
25.5
24.8
24.6
21.3
17.2
16.4
16.3
15.9
Citigroup
AIG
HSBC Holdings
Bank of America
Berkshire Hathaway
Wells Fargo
RBS Group
Fannie Mae
UBS AG
J.P. Morgan Chase
American Express
Wachovia
Morgan Stanley
Barclays
US Bankcorp
210.9
151.0
127.0
111.1
109.0
81.7
75.1
73.2
67.6
66.7
54.7
54.2
49.6
46.2
45.5
Data: Morgan Stanley Capital International, 2003.
Table 2-13 Global Financial Services Firms Ranked by Market Value

(September 30, 2002, in U.S. $ Billions)
United States
Citigroup
AIG
GE Capital*
Berkshire Hathaway
Bank of America
Wells Fargo
Wachovia
BancOne
American Express
JP Morgan Chase
Morgan Stanley
Fifth Third Bancorp
US Bancorp
Goldman Sachs
Washington Mutual
Europe
150.1
142.8
99.3
97.4
95.9
81.8
44.9
43.8
41.4
37.9
37.1
36.7
35.6
31.8
30.4
Rest of World
HSBC plc
RBS Group plc
UBS AG
Lloyds TSB plc
Barclays plc
HBOS Group plc
BNP Paribas
Deutsche Bank AG
ING Group
Grupo Santander
BBVA
Credit Suisse
Unicredito Italiano
Allianz AG
Munich Re
95.7
54.6
52.1
41.2
39.6
34.9
29.1
28.2
27.6
24.3
23.8
23.3
22.5
22.2
18.8
Mitsubishi Tokyo
Sumitomo
NAB
Nomura
UFJ
Royal Bank
Mizuho
Commonwealth
ANZ
Scotiabank
WestPac
Kookmin (Korea)
Bank of Montreal
Toronto Dominion
CIBC
41.9
31.5
27.9
25.7
23.3
22.4
22.0
20.4
14.4
14.2
13.3
11.6
11.4
11.2
9.3
*Earnings volatility-adjusted GECS contribution to GE multiplied by GE market capitalization. Data: Bloomberg.
58
59
Moreover, the structural evolution of the industry cuts across both time
and geography. Just about all of the top rms in 1990 went though such
transactions in the following 10 years, and the same is true of the survivors
on the 2002 list. The action is no less dramatic in Europe and Japan than
in the United States, although the underlying causes have often been very
different.
3
Why Financial Services Mergers?
The rst chapter of this book considered how reconguration of the nancial services sector ts into the process of nancial intermediation
within national economies and the global economy. The chapter also explored the static and dynamic efciency attributes that tend to determine
which channels of nancial intermediation gain or lose market share over
time. Financial rms must try to go with the ow and position themselves in the intermediation channels that clients are likely to be using in
the future, not necessarily those they have used in the past. This usually
requires strategic repositioning and restructuring, and one of the tools
available for this purpose is M&A activity. The second chapter described
the structure of that M&A activity both within and between the four major
pillars of the nancial sector (commercial banking, securities, insurance,
and asset management), as well as domestically and cross-border. The
conclusion was that, at least so far, there is no evidence of strategic dominance of multifunctional nancial conglomerates over more narrowly
focused rms and specialists, or vice versa, as the structural outcome of
this process.
So why all the mergers in the nancial services sector? As in many
other industries, various environmental developments have made existing institutional congurations obsolete in terms of nancial rms competitiveness, growth prospects, and prospective returns to shareholders.
We have suggested that regulatory and public policy changes that allow
rms broader access to clients, functional lines of activity, or geographic
markets may trigger corporate actions in the form of M&A deals. Similarly, technological changes that alter the characteristics of nancial services or their distribution are clearly a major factor. So are clients, who
often alter their views on the relative value of specic nancial services
or distribution interfaces with vendors and their willingness to deal with
multiple vendors. And the evolution and structure of nancial markets
60
61
make it necessary to adopt broader and sometimes global execution capabilities, as well as the capability of booking larger transactions for
individual corporate or institutional clients.
WHAT DOES THE THEORY SAY?
Almost a half-century ago, Miller and Modigliani (1961) pioneered the

study of the value of mergers, concluding that the value to an acquirer of
taking over an on-going concern could be expressed as the present value
of the targets earnings and the discounted growth opportunities the target offers. As long as the expected rate of return on those growth opportunities is greater than the cost of capital, the merged entity creates value
and the merger should be considered. Conversely, when the expected rate
of return on the growth opportunities is less than the cost of capital, the
merged entity destroys value and the merger should not take place.
To earn the above-market rate of return required for mergers to be
successful, the combined entity must create new cash ows and thereby
enhance the combined value of the merger partners. The cash ows could
come from saving direct and indirect costs or from increasing revenues.
Key characteristics of mergers such as inter-industry versus intra-industry
mergers and in-market versus market-extending mergers need to be examined in each case.
Put another way, from the perspective of the shareholder, M&A transactions must contribute to maximizing the franchise value of the combined rm as a going concern. This means maximizing the risk-adjusted
present value of expected net future returns. In simple terms, this means
maximizing the following total return function:
NPVf
) E(C )
E(R
(1 i )
n
t0
where E(Rt) represents the expected future revenues of the rm, E(Ct)
represents expected future operating costs including charges to earnings
for restructurings, loss provisions, and taxes. The net expected returns in
the numerator then must be discounted to the present by using a risk-free
rate it and a composite risk adjustment t, which captures the variance of
expected net future returns resulting from credit risk, market risk, operational risk, reputation risk, and so forth.
In an M&A context, the key questions involve how a transaction is
likely to affect each of these variables:
Expected top-line gains represented as increases in E(Ft) due to
market-extension, increased market share, wider prot margins,
successful cross-selling, and so forth.
Expected bottom-line gains related to lower costs due to economies
of scale or improved operating efciency, usually reected in improved cost-to-income ratios.
62
Expected reductions in risk associated with improved risk management or diversication of the rm across business streams,
client segment, or geographies whose revenue contributions are
imperfectly correlated and therefore reduce the composite t.
Each of these factors has to be carefully considered in any M&A transaction and their combined impact has to be calibrated against the acquisition price and any potential dilutive effects on shareholders of the acquiring rm. In short, a transaction has to be accretive to shareholders of
both rms. If it is not, it is at best a transfer of wealth from the shareholders
of one rm to the shareholders of the other.
MARKET EXTENSION
The classic motivation for M&A transactions in the nancial services

sector is market extension. A rm wants to expand geographically into
markets in which it has traditionally been absent or weak. Or it wants to
broaden its product range because it sees attractive opportunities that
may be complementary to what it is already doing. Or it wants to broaden
client coverage, for similar reasons. Any of these moves is open to build
or buy alternatives as a matter of tactical execution. Buying may in many
cases be considered faster, more effective, or cheaper than building. Done
successfully, such growth through acquisition should be reected in both
the top and bottom lines in terms of the acquiring rms P&L account
and reected in both market share and protability.
Figure 3-1A is a graphic depiction of the market for nancial services
as a matrix of clients, products, and geographies (Walter 1988). Financial
institutions clearly will want to allocate available nancial, human, and
technological resources to those identiable cells in Figure 3-1A that
promise to throw off the highest risk-adjusted returns. In order to do this,
they will have to appropriately attribute costs, returns, and risks to specic
cells in the matrix. But beyond this, the economics of supplying nancial
Figure 3-1A. Strategic

Positioning.
63
Figure 3-1B. Client-Specic

Cost Economies of Scope, Revenue Economies of Scope, and
Risk Mitigation.
services often depend on linkages between the cells in a way that maximizes what practitioners and analysts commonly call synergies.
Client-driven linkages such as those depicted in Figure 3-1B exist when
a nancial institution serving a particular client or client group can supply
nancial serviceseither to the same client or to another client in the
same groupmore efciently. Risk mitigation results from spreading exposures across clients, along with greater earnings stability to the extent
that earnings streams from different clients or client segments are not
perfectly correlated.
Product-driven linkages depicted in Figure 3-1C exist when an institution can supply a particular nancial service in a more competitive
manner because it is already producing the same or a similar nancial
service in a different client dimension. Here again there is risk mitigation
to the extent that net revenue streams derived from different products are
not perfectly correlated.
Geographic linkages represented in Figure 3-1D are important when
an institution can service a particular client or supply a particular service
more efciently in one geography as a result of having an active presence
Figure 3-1C. Activity-Specic

Economies of Scale and Risk
Mitigation.
64
Figure 3-1D. Client, Product,

and Arena-Specic Scale and
Scope Economies, and Risk
Mitigation.
in another geography. Once again, the risk prole of the rm may be

improved to the extent that business is spread across different currencies,
macroeconomic and interest-rate environments, and so on.
Even without the complexities of mergers and acquisitions, it is often
difcult for major nancial services rms to accurately forecast the value
to shareholders of initiatives to extend markets. To do so, rms need to
understand the competitive dynamics of specic markets (the various cells
in Figure 3-1) that are added by market extensionor the costs, including
acquisition and integration costs. Especially challenging is the task of
optimizing the linkages between the cells to maximize potential joint cost
and revenue economies, as discussed below.
ECONOMIES OF SCALE
Whether economies of scale exist in nancial services has been at the heart
of strategic and regulatory discussions about optimum rm size in the
nancial services industry. Does increased size, however measured, by
itself serve to increase shareholder value? And can increased average size
of rms create a more efcient nancial sector?
In an information- and distribution-intensive industry with high xed
costs such as nancial services, there should be ample potential for scale
economies. However, the potential for diseconomies of scale attributable
to disproportionate increases in administrative overhead, management of
complexity, agency problems, and other cost factors could also occur in
very large nancial rms. If economies of scale prevail, increased size will
help create shareholder value and systemic nancial efciency. If diseconomies prevail, both will be destroyed.
Scale economies should be directly observable in cost functions of nancial services suppliers and in aggregate performance measures. Many
studies of economies of scale have been undertaken in the banking, insurance, and securities industries over the yearssee Saunders and Cornett (2002) for a survey.
65
Unfortunately, studies of both scale and scope economies in nancial

services are unusually problematic. The nature of the empirical tests used,
the form of the cost functions, the existence of unique optimum output
levels, and the optimizing behavior of nancial rms all present difculties. Limited availability and conformity of data create serious empirical
problems. And the conclusion of any study that has detected (or failed to
detect) economies of scale or scope in a sample selection of nancial
institutions does not necessarily have general applicability. Nevertheless,
the impact on the operating economics (production functions) of nancial
rms is so importantand so often used to justify mergers, acquisitions,
and other strategic initiativesthat available empirical evidence is central
to the whole argument.
Estimated cost functions form the basis of most empirical tests, virtually all of which have found that economies of scale are achieved with
increases in size among small banks (below $100 million in asset size). A
few studies have shown that scale economies may also exist in banks
falling into the $100 million to $5 billion range. There is very little evidence
so far of scale economies in the case of banks larger than $5 billion. More
recently, there is some scattered evidence of scale-related cost gains of up
to 20% for banks up to $25 billion in size (Berger and Mester 1997). But
according to a survey of all empirical studies of economies of scale
through 1998, there was no evidence of such economies among very large
banks (Berger, Demsetz, and Strahan 1998). The consensus seems to be
that scale economies and diseconomies generally do not result in more
than about 5% difference in unit costs.
The inability to nd major economies of scale among large nancial
services rms also pertains to insurance companies (Cummins and Zi
1998) and broker-dealers (Goldberg, Hanweck, Keenan, and Young 1991).
Lang and Wetzel (1998) even found diseconomies of scale in both banking
and securities services among German universal banks.
Except the very smallest banks and non-bank nancial rms, scale
economies seem likely to have relatively little bearing on competitive
performance. This is particularly true since smaller institutions are often
linked together in cooperatives or other structures that allow harvesting
available economies of scale centrally, or are specialists not particularly
sensitive to the kinds of cost differences usually associated with economies
of scale in the nancial services industry. Megamergers are unlikely to
contributewhatever their other merits may bevery much in terms of
scale economies unless the fabled economies of superscale associated
with nancial behemoths turn out to exist. These economies, like the
abominable snowman, so far have never been observed in nature.
A basic problem may be that most studies focus entirely on rmwide
scale economies. The really important scale issues are likely to be encountered at the level of individual nancial services. There is ample evidence,
for example, that economies of scale are both signicant and important
for operating economies and competitive performance in areas such as
66
global custody, processing of mass-market credit card transactions, and

institutional asset management but are far less important in other areas
private banking and M&A advisory services, for example.
Unfortunately, empirical data on cost functions that would permit identication of economies of scale at the product level are generally proprietary and therefore publicly unavailable. Still, it seems reasonable that a
scale-driven M&A strategy may make a great deal of sense in specic
areas of nancial activity even in the absence of evidence that there is
very much to be gained at the rmwide level. And the fact that there are
some lines of activity that clearly benet from scale economies while at
the same time observations of rmwide economies of scale are empirically
elusive suggests that there must be numerous lines of activity where
diseconomies of scale exist.
COST ECONOMIES OF SCOPE
M&A activity may also be aimed at exploiting the potential for economies
of scope in the nancial services sectorcompetitive benets to be gained
by selling a broader rather than narrower range of productswhich may
arise either through cost or revenue linkages.
Cost economies of scope suggest that the joint production of two or
more products or services is accomplished more cheaply than producing
them separately. Global scope economies become evident on the cost
side when the total cost of producing all products is less than producing
them individually, whereas activity-specic economies consider the
joint production of particular nancial services. On the supply side, banks
can create cost savings through the sharing of transactions systems and
other overheads, information and monitoring cost, and the like.
Other cost economies of scope relate to informationspecically, information about each of the three dimensions of the strategic matrix (clients, products, and geographic arenas). Each dimension can embed specic information, which, if it can be organized and interpreted effectively
within and between the three dimensions, could result in a signicant
source of competitive advantage to broad-scope nancial rms. Information can be reused, thereby avoiding cost duplication, facilitating creativity in developing solutions to client problems, and leveraging clientspecic information in order to facilitate cross-selling. And there are
contracting costs that can be avoided by clients dealing with a single
nancial rm (Stefanadis 2002).
Cost diseconomies of scope may arise from such factors as inertia and
lack of responsiveness and creativity. Such disenconomies may arise from
increased rm size and bureaucratization, turf and prot-attribution
conicts that increase costs or erode product quality in meeting client
needs, or serious conicts of interest or cultural differences across the
organization that inhibit seamless delivery of a broad range of nancial
services.
67
Like economies of scale, cost-related scope economies and diseconomies should be directly observable in cost functions of nancial services
suppliers and in aggregate performance measures.
Most empirical studies have failed to nd cost economies of scope in
the banking, insurance, or securities industries. The preponderance of
such studies has concluded that some diseconomies of scope are encountered when rms in the nancial services sector add new product ranges
to their portfolios. Saunders and Walter (1994), for example, found negative cost economies of scope among the worlds 200 largest banks; as the
product range widens, unit-costs seem to go up. Cost-scope economies in
most other studies of the nancial services industry are either trivial or
negative (Saunders & Cornett 2002).
However, many of these studies involved institutions that were shifting
away from a pure focus on banking or insurance, and may thus have
incurred considerable start-up costs in expanding the range of their activities. If the diversication effort in fact involved signicant front-end costs
that were expensed on the accounting statements during the period under
study, we might expect to see any strong statistical evidence of diseconomies of scope (for example, between lending and nonlending activities
of banks) reversed in future periods once expansion of market-share or
increases in fee-based areas of activity have appeared in the revenue ow.
If current investments in stafng, training, and infrastructure ultimately
bear returns commensurate with these expenditures, neutral or positive
cost economies of scope may well exist. Still, the available evidence remains inconclusive.
OPERATING EFFICIENCIES
Besides economies of scale and cost economies of scope, nancial rms

of roughly the same size and providing roughly the same range of services
can have very different cost levels per unit of output. There is ample
evidence of such performance differences, for example, in comparative
cost-to-income ratios among banks and insurance companies and investment rms of comparable size, both within and between national nancial
services markets. The reasons involve differences in production functions,
efciency, and effectiveness in the use of labor and capital; sourcing and
application of available technology; as well as acquisition of inputs, organizational design, compensation, and incentive systemsthat is, in just
plain better managementwhat economists call X-efciencies.
Empirically, a number of authors have found very large disparities in
cost structures among banks of similar size, suggesting that the way banks
are run is more important than their size or the selection of businesses
that they pursue (Berger, Hancock, and Humphrey 1993; Berger, Hunter,
and Timme 1993). The consensus of studies conducted in the United States
seems to be that average unit costs in the banking industry lie some 20%
above best practice rms producing the same range and volume of
68
services, with most of the difference attributable to operating economies

rather than differences in the cost of funds (Akhavein, Berger, and Humphrey 1997). Siems (1996) found that the greater the overlap in branch
ofce networks, the higher the abnormal equity returns in U.S. bank
mergers, although no such abnormal returns are associated with increasing concentration levels in the regions where the bank mergers occurred.
This suggests that any gains in shareholder-value in many of the nancial
services mergers of the 1990s were associated more with increases in
X-efciency than with merger-related reductions in competition.
If very large institutions are systematically better managed than smaller
ones (which may be difcult to document in the real world of nancial
services), there might conceivably be a link between rm size and
X-efciency. In any case, from both a systemic and shareholder-value
perspective, management is (or should be) under constant pressure
through boards of directors to do better, maximize X-efciency in their
organizations, and transmit that pressure throughout the enterprise.
Table 3-1 presents cost savings in the case of three major U.S. M&A
transactions in the late 1990s: Nations BankBank of America, BancOne
First Chicago NBD, and CiticorpTravelers. In each case the cost economies were attributed by management to elimination of redundant
branches (mainly BancOneFirst Chicago NBD), elimination of redundant
capacity in transactions processing and information technology, consolidation of administrative functions, and cost economies of scope (mainly
Citigroup). Despite the aforementioned evidence, each announcement
also noted economies of scale in a prominent way, although most of the
purported scale gains probably represented X-efciency benets. In any
case the predicted cost gains on a capitalized basis were very signicant
indeed for shareholders in the rst two cases, but less so in the case of
the formation of Citigroup because of the complementary nature of the
legacy Citicorp and Travelers businesses.
It is also possible that very large organizations may be more capable of the massive and lumpy capital outlays required to install and
Table 3-1 Purported Scale and X-Efciency Gains in Selected U.S. Bank Mergers
Bank
Announced Savings
Blended
Multiple
BankAmerica
BancOne
$1.3 billion over 2

years after tax
$600 million
17 trailing
earnings
17
Citigroup
$930 million
15
Potential Share Value Gains

$22.1 billion on $133 billion M-cap
(17 %)
(16 %)
(8%)
69
maintain the most efcient information-technology and transactionsprocessing infrastructures (these issues are discussed in greater detail in
Chapter 5). If spending extremely large amounts on technology results in
greater operating efciency, large nancial services rms will tend to
benet in competition with smaller ones. However, smaller organizations
ought to be able to pool their resources or outsource certain scale-sensitive
activities in order to capture similar gains.
REVENUE ECONOMIES OF SCOPE
On the revenue side, economies of scope attributable to cross-selling arise

when the overall cost to the buyer of multiple nancial services from a
single supplier is less than the cost of purchasing them from separate
suppliers. These expenses include the cost of the service plus information,
search, monitoring, contracting, and other transaction costs. Revenuediseconomies of scope could arise, for example, through agency costs that
may develop when the multiproduct nancial rm acts against the interests of the client in the sale of one service in order to facilitate the sale of
another, or as a result of internal information transfers considered inimical
to the clients interests.
Managements of universal banks and nancial conglomerates often
argue that broader product and client coverage, and the increased
throughput volume or margins such coverage makes possible, leads to
shareholder-value enhancement. Hence, on net, revenue economies of
scope are highly positive.
Demand-side economies of scope include the ability of clients to take
care of a broad range of nancial needs through one institutiona convenience that may mean they are willing to pay a premium. Banks that
offer both commercial banking and investment banking services to their
clients can theoretically achieve economies of scope in several ways. For
example, when commercial banks enter new activities such as underwriting securities, they may also be able to take advantage of riskmanagement techniques they have developed as a result of making loans.
Moreover, rms that are diversied into several types of activities or
several geographic areas tend to have more contact points with clients.
Commercial banks may also benet from economies of scope by underwriting and selling insurance. Lewis (1990) emphasizes the similarities
between banking and insurance by suggesting how the very nature of
nancial intermediation provides insurance to depositors and borrowers.
In retail banking, for example, banks issue contracts to depositors that are
similar to insurance policies. Both depositors and insured entities have a
claim against the respective institution upon demand (in the case of depositors) or upon the occurrence of some event (in the case of those
insured). The institution has no control over when the clients demand
their claims and must be able to meet the obligations whenever they arise.
70
Both types of institutions rely on the law of large numbers. As long as the
pool of claimants is large enough, not all will request payment simultaneously.
The banking-insurance cross-selling arguments have continued both
operationally and factually. Credit Suisse paid $8.8 billion for Winterthur,
Switzerlands second largest insurer, in 1997. The Fortis Group combines
banking and insurance, albeit unevenly, in the Benelux countries. The
ING Group is the product of a banking-insurance merger that has since
acquired the U.S. insurer ReliaStar and the nancial services units of
Aetna. Allianz has acquired Dresdner Bank AG.
On the positive side, it is argued that there is real diversication across
the two businesses, so that unit-linked life insurance is strong in bullish
stock markets as funds ow out of bank savings products, and vice versa
in down stock markets, for example. Capital can be deployed more productively in bancassurers, which are in any case less risky and less capital
intensive than pure insurance companies. And it seems cross selling actually works well in countries like Belguim and Spain.
On the negative side, it is argued that banking and insurance are difcult and not particularly protable to cross-sell, and that dual capabilities
dont help much in building market share against pure banking or insurance rivals. They have very different time horizons and capital requirements, and it is hard to argue that there are major gains in scale economies
or operating efciencies. It is also suggested that there are hidden correlations that make bancassurers more risky than they seemin the stock
market of the early 2000s, for example, insurance reserves, asset management fees, and underwriting and advisory revenues all collapsed at the
same time, causing massive share price losses among bancassurers. Citigroups spinoff of its nonlife business in 2002 suggests that management
sees little to be gained in retaining that business from a shareholder value
perspective.
Most empirical studies of revenue gains involving cross-selling are
based on survey data and are therefore difcult to generalize. For example, Figure 3-2 shows the results of a 2001 survey of corporate clients by
Greenwich Research on the importance of revenue economies of scope
between lending and M&A advisory services. The issue is whether companies are more likely to award M&A advisory work to banks that are
also willing lenders or whether the two services are separable, so that
companies go to the rms with the perceived best M&A capabilities (probably investment banking houses) for advice and to others (presumably
commercial banks) for loans. Survey data seem to suggest that companies
view these services as a single value-chain, so that banks that are willing
to provide signicant lending are also more likely to obtain M&A advisory
work. Indeed, Table 3-2 suggests that well over half of the major M&A
rms (in terms of fees) in 2001 were indeed investment banking units of
commercial banks with substantial lending power.
71
Not at all
important
Extremely important
16%
24%
Important or
slightly
important
32%
28%
Very important
Figure 3-2. Importance

of Lending to Earn M&A
Business. Base: 626 U.S.
Companies. Source: Greenwich
Associates, 2002.
This process is sometimes called mixed bundling, meaning that the price
of one service (for example, commercial lending) is dependent on the
clients also taking another service (for example, M&A advice or securities
underwriting). However, making the sale of one contingent on the sale of
the second (tying) is illegal in the United States. Modeling of client preferences is said to be easier in broad-gauge nancial rms and provides
the client with signicantly lower search and contracting costs. But mixedbundling approaches to client services probably contributed so some disastrous lending by commercial banks in the energy and telecom sectors
in recent years. Monoline investment banks were derided by some of
the large commercial banks with investment banking divisions as being
Table 3-2 Comparative Wholesale Banking Volumes (Cumulative 20002002)

Firm
JP Morgan Chase*
Citigroup*
Merrill Lynch
Goldman Sachs
Morgan Stanley
CSFB*
Deutsche Bank*
UBS*
Lehman Brothers
Banc of America Securities*
Dresdner Kleinwort Wasserstein*
Barclays Capital*
Rank
Share
Volume
1
2
3
4
5
6
7
8
9
10
11
12
11.99
11.80
9.92
9.86
9.85
8.37
5.67
5.51
5.16
4.81
3.31
2.28
3,980
3,915
3,292
3,273
3,146
2,812
1,882
1,713
1,713
1,596
1,099
757
*Denotes rms combining commercial banking and securities activities.
72
Table 3-3 Potential for Cross-selling: Citigroup Product Lines
Distribution
Channels
Checking
Credit cards
Loans/mortgage
Life insurance
Home insurance
Vehicle insurance
Long-term care
Mutual funds
Annuities
Wrap fee
Securities brokerage
Primerica
Insur.
Tel.
Citibank Commercial Financial Private Retail
Branches
Credit
Services Bank Securities Agents Marketing
CCI1
CCI
CCI
TRV
TRV
TRV
CCI
CCI
TRV
TRV
TRV
TRV
TRV
CCI
CCI
CCI
TRV
TRV
CCI
TRV CCI
TRV
TRV
TRV
TRV
TRV
TRV
TRV
TRV
TRV
TRV
TRV
TRV
TRV
TRV
TRV CCI
TRV CCI
TRV CCI
CCI Citicorp, TRV Travelers.

Source: Citicorp, 1998.
incapable of providing the full value chain of investment banking services.

The derision disappeared soon thereafter. The bankruptcies of Enron,
WorldCom, Global Crossing, K-Mart, and Adelphia and credit problems
in a host of other rms in the United States and elsewhere even led to
speculation of future breakups of multiline wholesale nancial services
rms.
However, it is at the retail level that the bulk of the revenue economies
of scope are likely to materialize, since the search costs and contracting
costs of retail customers are likely to be higher than for corporate customers. As Table 3-3 suggests, the 1998 merger of Travelers and Citicorp to
form Citigroup was largely revenue-driven to take maximum advantage
of the two rms strengths in products and distribution channels, as well
as geographic coverage. In general, this is the basis of the European
concept of bancassurance or Allnanzthat is, cross-selling, notably between banking and insurance services.
A survey of U.S. households conducted at about the time of the Citigroup merger suggested that the apparent value of that deal in terms of
revenue economies of scope was quite sound. Even though U.S. banking,
securities, and insurance had long been separated by regulations dating
back to the 1930s, a large-sample study of U.S. households revealed a
willingness, perhaps enthusiasm, to have all nancial needs provided by
a single vendor (Figure 3-3). That is, the reduced search, transactions and
contracting costs were perceived to yield substantial benets to households.
Yet the same study also showed that respondents were concerned about
73
Agree/Strongly Agree
Other Responses
39
61
Figure 3-3. I Would Prefer To Have All My Needs Met By One Financial Institution. Source: Council on Financial Competition Research, 1998.
whether they were in fact getting the best price, quality, and services from
a single multifunction vendor, and whether that vendor would be able to
cover all of the households nancial services needs. This is shown in
Table 3-4. Whether justied or not, these kinds of concerns are perceptual
(the grass is always greener . . .) and may affect the prospects for revenue economies of scope in a particular nancial services merger. The same
survey suggested that the respondents were in fact using more rather than
fewer nancial services vendors, a nding that undercuts the argument
that there is perceived client value in single-source procurement of nancial services (Figure 3-4).
This sort of evidence suggests that U.S. households are more opportunistic and willing to shop around than the most ardent advocates of
cross-selling would hope. Thus, the share of wallet that nancial services vendors expect to achieve by broadening their product range may in
the end be disappointing. This sort of conclusion may, of course, be different in other environments, particularly in Europe where universal
banking and multifunctional nancial conglomerates have always been
part of the nancial landscape. But even here the evidence of effective
Table 3-4 Perceived Benets and Drawbacks of Cross-selling

Benets (among
households using more
than one institution
It would be convenient
to deal with one
institution
It would be easier to
deal with one
institution (would
simplify my life)
Rank
54.2
45.7
Drawbacks (among
households using more
than one institution
The institution may not
offer me the best
prices
The institution may not
offer all the products
my households need
Source: Council on Financial Competition Research, 1998.
Rank
56.7
46.6
74

40
35
34
35.1
30.2
30.7
Percentage of
consumers
30
25
21.1
17.5
20
14.1
15
1993
1996
10.5
10
5
0
One
Two
Three
Four or more
Figure 3-4. With How Many Financial Providers Do You Currently Hold Relationships? Source: Council on Financial Competition Research, 1998.
cross-selling and leveraging the value of rms through revenue economies

of scope is spotty, at best.
Taken to its extreme, the future could well belong to a very different
household nancial services business model, perhaps one like that depicted in Figure 3-5. Here households take advantage of user-friendly
interfaces to access Web service servers and integrated nancial services
platforms. These platforms, early versions of which are already in use,
allow real-time linkages to multiple nancial services vendors, such as
Yodlee.com and Myciti.com. For the client, such platforms combine the
feel of single-source purchasing of nancial services while accessing
best-in-class vendors on an open-architecture basis. The client, in other
words, is cross-purchasing rather than being cross-sold.
Absent the need for continuous nancial advice, such a business model
can reduce information costs, transactions costs, and contracting costs
while providing efcient access to the universe of competing vendors.
Even advice could be built into the model through independent nancial
advisers (IFAs) or nancial services suppliers who nd a way to incorporate the advisory function through such delivery portals. If in the future
such models of retail nancial services delivery take hold in the market,
some of the rationale for cross-selling and revenue economies of scope
used to justify nancial-sector mergers and acquisitions will clearly become obsolete.
Despite an almost total lack of hard empirical evidence, revenue economies of scope may indeed exist. But these economies are likely to be
very specic to the types of services provided and the types of clients
served. Strong cross-selling potential may exist for retail and private clients between banking, insurance, and asset management products, for
example. Yet such potential may be totally absent between trade nance
American
Express
account
Employee
credit
union
Washington
Mut. home
equity loan
Household
finances
Fidelity
401(k)
account
75
Schwab
brokerage
account
Chase
checking
account
Citibank
Mastercard
account
Webservice
server
Home PC
or
other device
Figure 3-5. Prototype On-Line

Personal Finance Platform.
and mergers and acquisitions advisory services for major corporate clients. So revenue-related scope economies are clearly linked to a rms
specic strategic positioning across clients, products, and geographic areas of operation as depicted in Figure 3-1 (Walter, 1988).
Indeed, a principal objective of strategic positioning is to link market
segments together in a coherent pattern. Such strategic integrity permits
maximum exploitation of cross-selling opportunities, particularly in the
design of incentives and organizational structures to ensure that such
exploitation actually occurs. Without such incentive arrangements, which
have to be extremely granular to motivate people doing the cross-selling,
no amount of management pressure and exhortation to cross-sell is likely
to achieve its objectives. These linkages are often extraordinarily difcult
to achieve and must work against corporate and institutional clients who
are willing to obtain services from several vendors, as well as newgeneration retail clients who are comfortable with nontraditional approaches to distribution such as the Internet. In cross-selling, as always,
the devil is in the details.
Network economics may be considered a special type of demand-side
economy of scope (Economides 1996). Like telecommunications, banking
relationships with end users of nancial services represent a network
structure wherein additional client linkages add value to existing clients
by increasing the feasibility or reducing the cost of accessing them. Socalled network externalities tend to increase with the absolute size of
the network itself. Every client link to the bank potentially complements
76
every other one and thus potentially adds value through either one-way
or two-way exchanges through incremental information or access to liquidity.
The size of network benets depends on technical compatibility and
coordination in time and location, which the universal bank is in a position
to provide. And networks tend to be self-reinforcing in that they require
a minimum critical mass and tend to grow in dominance as they increase
in size, thus precluding perfect competition in network-driven nancial
services. This characteristic is evident in activities such as securities clearance and settlement, global custody, funds transfer and international cash
management, forex and securities dealing, and the like. And networks
tend to lock in users insofar as switching-costs tend to be relatively high,
thus creating the potential for signicant market power.
IMPACT OF MERGERS ON MARKET POWER AND
PROSPECTIVE MARKET STRUCTURES
Taken together, the foregoing analysis suggests rather limited prospects

for rmwide cost economies of scale and scope among major nancial
services rms as a result of M&A transactions. Operating economies (Xefciency) seems to be the principal determinant of observed differences
in cost levels among banks and nonbank nancial institutions. Demandside or revenue-economies of scope through cross-selling may well exist,
but they are likely to be applied very differently to specic client segments
and can be vulnerable to erosion due to greater client promiscuity in
response to sharper competition and new distribution technologies. However, there are other reasons M&A transactions may make economic sense.
In addition to the strategic search for operating economies and revenue
synergies, nancial services rms will also seek to dominate markets in
order to extract economic returns. By focusing on a particular market,
merging nancial rms could increase their market power and thereby
take advantage of monopolistic or oligopolistic returns. Market power
allows rms to charge more or pay less for the same service. In many
market environments, however, antitrust constraints ultimately tend to
limit the increases in market power. Managers of nancial services rms
often believe that the end game in competitive structure is the emergence
of a few rms in gentlemanly competition with each other, throwing off
nice sustainable margins. In the real world such an outcome can easily
trigger public policy reactions that break up nancial rms, force functional spinoffs, and try to restore vigorous competition. Particularly in a
critical economic sector that is easily politicized, such as nancial services,
such reactions are rather likely, despite furious lobbying by the affected
rms.
The role of concentration and market power in the nancial services
industry is an issue that empirical studies have not yet examined in great
depth. However, suppliers in many national markets for nancial services
77
have shown a tendency toward oligopoly. Supporters have argued that

high levels of national market concentration are necessary in order to
provide a platform for a viable competitive position. Without convincing
evidence of scale economies or other size-related gains, opponents argue
that monopolistic market structures serve mainly to extract economic
rents from consumers or users of nancial services and redistribute them
to shareholders, cross-subsidize other areas of activity, or reduce pressures
for cost containment. They therefore advocate vigorous antitrust action to
prevent exploitation of monopoly positions in the nancial services sector.
A good example occurred late in 1998 when the Canadian Finance
Ministry rejected merger applications submitted by Royal Bank of Canada
and Bank of Montreal (Canadas largest and third-largest banks), as well
as by Canadian Imperial Bank of Commerce and Toronto Dominion Bank
(the second and fth largest). Only Scotiabank (the fourth largest) did not
apply to merge. The mergers would have left just three major banks in
Canada, already one of the most highly concentrated banking markets in
the world, two of which would have controlled over 70% of all bank
assets in the country. The banks justied their proposed mergers in terms
of prospective scale and efciency gains and the need to compete with
U.S. banks under the rules of the North American Free Trade Agreement
(NAFTA), which would at the same time provide the necessary competitive pressure to prevent exploitation of monopoly power.
Concerns about the wisdom of the two mergers were expressed by the
Ministry of Finance and the Canadian Federal Competition Bureau, specically regarding access to credit by small businesses, branch closings in
suburban and rural areas, excessive control over the credit card and retail
brokerage businesses, concentration of economic power, reduced competition in banking generally, and problems of prudential control and
supervision. Instead, a subsequent task force report noted that it was time
to let foreign banks expand operations in Canada, allow banks and trust
companies to offer insurance and auto leasing services, make the disclosure of service fees clearer and privacy laws stricter, and create an ombudsman to oversee the nancial sectorhardly the reaction the banks
proposing the mergers had in mind.
The key strategic issue is the likely future competitive structure in the
different dimensions of the nancial services industry. It is an empirical
fact that operating margins tend to be positively associated with higher
concentration levels. Financial services market structures differ substantially as measured, for example, by the Herndahl-Hirshman Index (HHI),
which is the sum of the squared market shares (Hs2), where
0HHI10,000 and market shares are measured, for example, by deposits, assets, or capital. HHI rises as the number of competitors declines and
as market share concentration rises among a given number of competitors.
Empirically, higher values of HHI tend to be associated with higher degrees of pricing power, price-cost margins, and return on equity across a
broad range of industries, as shown in Figure 3-6. HHI is, of course, highly
78

30
Pulping machinery
25
Return on capital, %
20
Mobile
Handsets
Air compressors
Pharmaceutical
15
Stainless steel
Reinsurance
10
Rock
crushers
Wholesale
Banking**
Steel
0
0
500
1,000
1,500
2,000
Index of concentration*
2,500
3,000
3,500
Figure 3-6. Global Levels of Concentration and Return on Invested

Capital Across Industries. (*Sum of the squares of competitors market shares. **Ten-year average, estimated on allocated capital.)
Source: J. P. Morgan and author estimates.
sensitive to the denition of the market and pressuposes that this denition is measurable.
An interesting historical example of the effects of market concentration
is provided by Saunders and Wilson (1999) and reproduced in Figure
3-7. During the 1920s, the U.K. government designated a limited number
of clearing banks with a special position in the British nancial system.
Spreads between deposit rates and lending rates in the United Kingdom
quickly rose, as did the ratio of market value to book value of the designated banks equities. Both were apparently a reection of increased market power, in this case conferred by the government itself. Then, in the
1960s and 1970s this market power eroded with U.K. nancial deregulation, as did the market-to-book ratio.
Geographically, there are in fact very high levels of banking concentration in countries such as the Netherlands, Finland, and Denmark and low
levels in relatively fragmented nancial systems such as the United States
and Germany. In some cases, public sector institutions such as postal
savings banks and state banks tend to distort competitive conditions, as
do nancial services cooperatives and mutualsall of which can command substantial client loyalty. But then, nobody said that the nancial
services industry has to be the exclusive province of investor-owned rms,
and other forms of organization long thought obsolete (such as coopera-
79
Figure 3-7. Market and Book Value of U.K. Bank Assets, 18931993. MVBVA Ratio of the
market value of assets to the book value of assets. BCAP Book value of capital. Source:
Anthony Saunders and Berry Wilson, The Impact of Consolidation and Safety-Net Support on
Canadian, U.S. and U.K. Banks, 18931992, Journal of Banking and Finance, 23 (1999), pp. 537
571.
tives in Europe and credit unions in the United States) have continued to
exist and often to prosper.
Despite very substantial consolidation in recent years within perhaps
the most concentrated segment of the nancial services industrynamely,
wholesale banking and capital markets activitiesthere is little evidence
of market power. With some 80% of the combined value of global xedincome and equity underwriting, loan syndications and M&A mandates
captured by the top ten rms, according to Smith and Walter (2003) the
Herndahl-Hirshman index was still only 549 in 2002 (on a scale from
zero to 10,000). (See Table 3-5.) This nding suggests a ruthlessly competitive market structure in most of these businesses, which is reected
in the returns to investors in the principal players in the industry.
Nor is there much evidence so far that size as conventionally measured
(for example, by assets or capital base) makes a great deal of difference
so far in determining wholesale banking market share. The result seems
to be quite the opposite, with a long-term erosion of returns on capital
invested in the wholesale banking industry, as suggested in Figure 3-8.
Furthermore, there are a variety of other businesses that combine various functions and show very few signs of increasing competition. An
example of such a business is asset management, in which the top rms
are European, American, and Japanese rms that function as banks,
Table 3-5 Global Wholesale Banking and Investment Banking Market Concentration
Top Ten Firms

% of market share
Herndahl Index
80
Number of Firms from

United States
Europe
Japan
Top Twenty Firms
% of market share
Herndahl Index
Number of Firms from
United States
Europe
Japan
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
40.6
171.6
46.1
230.6
56.0
327.8
64.2
459.4
62.1
434.1
59.5
403.0
55.9
464.6
72.0
572.1
77.9
715.9
77.0
664.0
80.0
744.0
74.12
603.0
71.3
549.4
5
5
0
7
3
0
5
5
0
9
1
0
9
1
0
9
1
0
8
2
0
8
2
0
7
3
0
8
2
0
8
2
0
7
3
0
7
3
0
80.5
392.7
75.6
478.4
78.1
481.4
76.0
439.5
81.2
517.6
93.3
620.9
97.1
764.0
96.3
709.0
97.5
784.0
91.5
639.0
91.0
591.1
8
11
1
15
4
1
15
5
0
14
5
1
14
6
0
13
7
0
11
8
1
12
8
0
9
11
1
8
11
1
10
10
0
81
60%
50%
Return on Equity
40%
30%
20%
10%
0%
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
-10%
Figure 3-8. Large Investment Banks Return on Equity (19802001). Source: Sanford
Bernstein, 2002.
broker-dealers, independent fund management companies, and insurance

companies. Asset management is among the most contestable in the entire
nancial services industry with a Herndahl-Hirshman index of 540 for
the top 40 rms in the industry, and shows very few signs of increasing
concentration in recent years.
Although some national markets may be highly concentrated and exhibit signs that market power can be exploited by nancial services rms
to the advantage of their shareholders, there seems to be little sign of this
in the United States, so far despite the decline in the number of banking
organizations from almost 15,000 to about 8,000 over a decade or so and
the development of a number of powerful national and regional players
in areas such as credit cards, mortgage origination, and custody (see
Figure 3-9).
In short, although monopoly power created through mergers and acquisitions in the nancial services industry can produce market conditions to reallocate gains from clients to the owners of nancial
intermediaries, such conditions are not easy to achieve or to sustain.
Sometimes new playerseven relatively small new entrantspenetrate
the market and destroy oligopolistic pricing structures, or there are good
substitutes available from other types of nancial services rms, and consumers are willing to shop around. Vigorous competition (and low
Herndahl-Hirshman indexes) seems to be maintained even after intensive M&A activity in most cases by a relatively even distribution of
market shares among the leading rms, as in the case of global wholesale
banking, noted earlier.
82

Retail Banking
Percentage of total
deposits held by
top 30 bank holding
companies
Total deposits:
$3.6 trillion
55%
61%
Mortgage
Origination
Percentage of
origination
by top 10;
ranked by
value
of loans outstanding
Total
originations:
$1.073 trillion
Credit Cards
Percentage of
total credit issued
by top five; ranked
by value of outstandings
Total industry
outstanding:
$478.7 billion
Corporate Lending
Percentage of
syndicated loans
to large corporation
in which the top five
players served as the
agent bank*
Total syndicated
loans outstanding:
$1.9 trillion
Custody Banks
Percentage of total
held by top 10;
ranked by global
assets under
management
Total worldwide
assets under
management:
$37.24 trillion
(approx.)
Other banks
thrifts and
credit unions
Investment Banking
Percentage of
wholesale
origination held by
top-ten firms (global)
Volume: $11.5
trillion
92.5%
92.5%
61.9%
45%
39.7%
39%
37%
1995
2000
1995
40.6%
40%
26.7%
Bank holding
cos.
61%
26%
2000
1995
2000
1990
2000
1990
2000
1990
2000
Figure 3-9. Financial Services Concentration Ratios in the United States (* the agent bank
arranges a nancing pool in which other banks participate). Sources: First Manhattan Consulting Group; Inside Mortgage Finance; the Nilson Report; Loan Pricing Corp.; Federal
Reserve; Institutional Investor.
ASYMMETRIC INFORMATION, KNOW-HOW,

AND EMBEDDED HUMAN CAPITAL
One argument in favor of mergers and acquisitions in the nancial services industry is that internal information ows in large, geographically
dispersed, and multifunctional nancial rms are substantially better and
involve lower costs than external information ows in the market that are
available to more narrowly focused rms. Consequently, a rm that is
present in a broad range of nancial markets and geographies can nd
proprietary and client-driven trading and product-structuring opportunities that smaller and narrower rms cannot. Furthermore, an acquisition
that adds to breadth of coverage should be value-enhancing by improving
market share or pricing if the incremental access to information can be
effectively leveraged.
A second argument has to do with technical know-how. Signicant
areas of nancial servicesparticularly wholesale banking and asset managementhave become the realm of highly specialized expertise. An
acquisition of a specialized rm by a larger, broader, more heavily capitalized rm can provide substantial revenue-related gains through both
market share and price effects. As noted in Chapter 2, in the late 1990s
and early 2000s large numbers of nancial boutiques and independent
securities rms have been acquired by major banks, insurance companies,
the major investment banks, and asset managers for precisely this pur-
83
pose, and anecdotal evidence suggests that in many cases these acquisitions have been shareholder-value enhancing for the buyer. This success
has also been seen in other industries, such as biotech. The key almost
always lies in the integration process and in the incentive structures set
in place to leverage the technical skills that have been acquired.
Closely aligned is the human capital argument. Technical skills and
entrepreneurial behavior are embodied in people, and people can move.
Parts of the nancial services industry have become notorious for the
mobility of talent, to the point that free agency has characterized employee
behavior and individuals or teams of people almost view themselves as
rms within rms. Hiring of teams has at times become akin to buying
small rms for their technical expertise, although losing them (unlike
corporate divestitures) usually generates no compensation whatsoever. In
many cases the default question is Why stay? as opposed to the more
conventional, Why leave?
It is in this context of high-mobility of embedded human capital that
merger integration, approaches to compensation, and efforts to create a
cohesive superculture appear to be of paramount importance. These
issues are discussed in the next chapter, and take on particular pertinence
in the context of M&A transactions, where in the worst case the acquiring
rm loses much talent after paying a rich price to buy a target.
DIVERSIFICATION OF BUSINESS STREAMS, CREDIT QUALITY,
AND FINANCIAL STABILITY
One of the arguments for nancial sector mergers is that greater diversication of income from multiple products, client-groups, and geographies
creates more stable, safer, and ultimately more valuable institutions.
Symptoms should include higher credit quality and debt ratings and
therefore lower costs of nancing than those faced by narrower, more
focused rms.
Past research suggests that M&A transactions neither increase nor decrease the risk of the acquiring rm (Amihud et al. 2002), possibly because
risk-diversication attributes (such as cross-border deals) have played a
limited role in banking so far. Regulatory constraints that limit access to
client-groups or types of nancial services could have similar effects.
It has also been argued that shares of multifunctional nancial rms
incorporate substantial franchise value due to their conglomerate nature
and their importance in national economies. However, Demsetz, Saidenberg, and Strahan (1996) suggest that this guaranteed franchise value
serves to inhibit extraordinary risk taking. They nd substantial evidence
that the higher a banks franchise value, the more prudent management
tends to be. Thus, large universal banks with high franchise values should
serve shareholder interests, as well as stability of the nancial system and
the concerns of its regulators, with a strong focus on risk management,
as opposed to banks with little to lose. This conclusion, however, is at
84
variance with the observed, massive losses incurred by European universal banks in recent years in lending to highly leveraged rms, real estate
lending and emerging market transactions, and by U.S. nancial conglomerates that in the early 2000s found themselves in the middle of an epic
wave of corporate scandals, bankruptcies, and reorganizations.
TOO BIG TO FAIL GUARANTEES
Certainly the failure of any major nancial institution, including one that
is the product a string of mergers, could cause unacceptable systemic
consequences. Therefore, the institution is virtually certain to be bailed
out by taxpayersas happened in the case of comparatively much smaller
institutions in the United States, France, Switzerland, Norway, Sweden,
Finland, and Japan during the 1980s and 1990s. Consequently, toobig-to-fail (TBTF) guarantees create a potentially important public subsidy for the kinds of large nancial organizations that often result from
mergers.
In the United States, this policy became explicit in 1984 when the U.S.
Comptroller of the Currency, who regulates national banks, testied to
Congress that 11 banks were so important that they would not be permitted to fail (see OHara and Shaw 1990). In other countries the same
kind of policy tends to exist and seems to cover more banks (see U.S.
GAO 1991). The policy was arguably extended to non-bank nancial rms
in the rescue of Long-term Capital Management, Inc. in 1998, which was
arranged by the U.S. Federal Reserve. The Fed stepped in because, it
argued, the rms failure could cause systemic damage to the global
nancial system. The same argument was made by J.P. Morgan, Inc. in
1996 about the global copper market and the suggestion by one of its
then-dominant traders, Sumitomo, that collapse of the copper price could
have serious systemic effects. Indeed, the speed with which the central
banks and regulatory authorities reacted to that particular crisis signaled
the possibility of safety-net support of the global copper market, in view
of major banks massive exposures in complex structured credits to the
copper industry. Most of the time such bail-out arguments are self-serving
nonsense, but in a political environment and apparent market crisis they
could help create a public-sector safety net sufciently broad to limit
damage to shareholders of exposed banks or other nancial rms.
It is generally accepted that the larger the bank, the more likely it is to
be covered under TBTF support. OHara and Shaw (1990) detailed the
benets of being TBTF: without assurances, uninsured depositors and
other liability holders demand a risk premium. When a bank is not permitted to fail, the risk premium is no longer necessary. Furthermore, banks
covered under the policy have an incentive to increase their risk so as to
enjoy higher expected returns. Mergers may push banks into this desirable
category. The larger the resulting institution, therefore, the more attractive
85
will be an equity stake in the rm and the higher should be the abnormal
return to shareholders upon the merger announcement.
Kane (2000) investigated the possibility that large bank mergers enjoy
not only increased access to TBTF guarantees but also greater market
power and political clout. He nds that the market reacts positively when
two large U.S. banks announce a merger, especially if they are headquartered in the same state. Acquirers can increase the value of government
guarantees even further by engaging in derivatives transactions. Such
instruments increase the volatility of a banks earnings, volatility that is
not fully reected in the share price if the institution is judged too big to
fail. Although Kanes study did not distinguish between the market reacting to increased TBTF guarantees or increased efciency, he pointed
out that long-term efciency has seldom materialized after mergers. He
suggested further study to determine whether acquiring banks increase
their leverage, uninsured liabilities, nonperforming loans, and other risk
exposures, all of which would suggest that they are taking advantage of
the TBTF guarantees.
One problem with the TBTF argument is to determine precisely when
a nancial institution becomes too big to fail. Citicorp was already the
largest bank holding company in the United States before it merged with
Travelers. Therefore, the TBTF argument may be a matter of degree. That
is, the benets of becoming larger may be marginal if nancial rms
already enjoy TBTF status.
CONFLICTS OF INTEREST
The potential for conicts of interest is endemic in all multifunctional

nancial services rms (see Saunders and Walter 1994). A number of
reasons for this have been suggested.
First, when rms have the power to sell afliates products, managers
may no longer dispense dispassionate advice to clients and have a
salesmans stake in pushing house products, possibly to the disadvantage of the customer.
Second, a nancial rm that is acting as an underwriter and is unable
to place the securities in a public offering may seek to ameliorate this loss
by stufng unwanted securities into accounts over which it has discretionary authority.
Third, a bank with a loan outstanding to a client whose bankruptcy
risk has increased, to the private knowledge of the banker, may have an
incentive to encourage the corporation to issue bonds or equities to the
general public, with the proceeds used to pay down the bank loan. One
example is the 1995 underwriting of a secondary equity issue of the Hafnia
Insurance Group by Den Danske Bank. The stock was distributed heavily
to retail investors, with proceeds allegedly used to pay down bank loans
even as Hafnia slid into bankruptcy (see Smith and Walter 1997b). The
86
Commercial lender
Loan arranger
Wholesale
Debt underwriter
Equity underwriter
M&A advisor
Strategic financial advisor
Equity analyst
Debt analyst
Board member
Commercial lender
Loan arranger
Debt underwriter
Equity underwriter
M&A advisor
Strategic financial advisor
Equity analyst
Debt analyst
Board member
Institutional asset manager

Insurer
Reinsurer
Clearance & settlement provider
Custodian
Transactions processor
Deposit taker
Stockbroker
Retail
Life insurer
P&C insurer
Private banker
Retail lender
Credit card issuer
Mutual fund distributor
Mutual fund adviser
Principal Investor
Institutional asset manager

Insurer
Reinsurer
Clearance & settlement provider
Custodian
Transactions processor
Deposit taker
Stockbroker
Life insurer
P&C insurer
Private banker
Retail lender
Credit card issuer
Mutual fund distr.
Mutual fund adviser
Prin. Investor
Figure 3-10. Indicative Financial Services Matrix.
case came before the Danish courts in successful individual investor litigation supported by the government.
Fourth, in order to ensure that an underwriting goes well, a bank may
make below-market loans to third-party investors on condition that the
proceeds are used to purchase securities underwritten by its securities
unit.
Fifth, a bank may use its lending power activities to coerce a client to
also use its securities or securities services.
Finally, by acting as a lender, a bank may become privy to certain
material inside information about a customer or its rivals that can be used
in setting prices, advising acquirers in a contested acquisition, or helping
in the distribution of securities offerings underwritten by its securities
unit (see Smith and Walter 1997a). More generally, a rm may use proprietary information regarding a client for internal management purposes,
which at the same time harms the interests of the client.
The potential for conicts of interest can be depicted in a matrix such
as shown in Figure 3-10 (Walter 2003). Each of the cells in the matrix
represents a different degree and intensity of interest conicts. Some are
serious and basically intractable. Others can be managed by appropriate
changes in incentives or compliance initiatives. And some are not sufciently serious to worry about. Using a matrix approach to mapping
conicts of interest clearly demonstrates that the broader the client and
87
product range, the more numerous the potential conicts of interest and
the more difcult the resulting management problems become.
An interesting case of conicts of interest in business client relationships came to light in 2003. A small Dutch commercial bank, SNS Bank
NV, invested $15 million in a Citigroup offshore xed-income investment
vehicle, Captiva Finance Ltd., with the intent that this part of its portfolio
be invested conservatively. The Captiva assets were under independent
management, replaced in 1998 by another independent manager which,
after allegedly poor performance, was in turn replaced by an asset management unit of Citibank. SNS claimed it never had the opportunity to
vote on the management changes, as it was entitled to do, and that its
requests to unload its Captiva stake were ignored by Citibank. By late
2001 the $15 million investment had dwindled to $3 million. The suit
argued that most of the losses were incurred under Citibank management,
which had failed to re itself, and that some of the defaulted bonds had
been underwritten by Citigroups Investment Banking unit. Throughout,
it appeared, Citigroup collected the fees as underwriter, fund manager,
and duciary while SNS collected the losses.1
Shareholders clearly have a stake in the management and control of
conicts of interest in universal banks. They can benet from conict
exploitation in the short term, to the extent that business volumes or
margins are increased as a result. On the one hand, preventing conicts
of interest is an expensive business. Compliance systems are costly to
maintain, and various types of walls between business units can have
high opportunity costs because of inefcient use of information within
the organization. Externally, reputation losses associated with conicts of
interest can bear on shareholders very heavily indeed, as demonstrated
by a variety of accidents in the nancial services industry. Indeed, it
could well be argued that conicts of interest may contribute to the priceto-book-value ratios of the shares of nancial conglomerates and universal
banks falling below those of more specialized nancial services businesses.
The conict of interest issue can seriously limit effective strategic benets associated with nancial services M&A transactions. For example,
inside information accessible to a bank as lender to a target rm would
almost certainly prevent the bank from acting as an adviser to a potential
acquirer. Entrepreneurs may not want their private banking affairs dominated by a bank that is also involved in their business nancing. A mutual
fund investor is unlikely to have easy access to the full menu of available
equity funds through a universal bank offering competing in-house products. These issues may be manageable if most of the competition is coming
from other universal banks. But if the playing eld is also populated by
1. Florence Fabricant, Putting All the Eggs in a One-Stop Basket Can be Messy, New York Times,
January 12, 2003.
88
aggressive insurance companies, broker-dealers, fund managers, and

other specialists, these issues will prove to be a continuing strategic challenge for management.
Should a major conict of interest arise, the repercussions for a rms
reputation could be quite detrimental. For example, J.P. Morgan, Inc.
simultaneously served as commercial banker, investment banker, and adviser to the Spanish Banco Espanol de Credito (Banesto), as well as being
an equity holder and fund manager for co-investors in a limited partnership holding shares in the rm. In addition, Morgans vice chairman
served on Banestos Supervisory Board. When Banesto failed and the
conicts of interest facing J.P. Morgan were revealed, the value of the
rms equity fell by 10% (see Smith and Walter 1995). And in 2002 Citigroup lost over 10% of its market capitalization on two separate trading
days due to investors worries about its involvement in a number of
corporate scandals.
Another example focuses on the equity analyst conicts of interest in
the late 1990s and early 2000s. Analysts working for multifunctional nancial rms wear several hats and are subject to multiple conicts of
interest. They are supposed to provide unbiased research to investors. But
they are also expected to take part in the securities origination and sales
process that is centered in their rms corporate nance departments. The
rms argue that expensive research functions cannot be paid for by attracting investor deal-ow and brokerage commissions, so corporate nance has to cover much of the cost. This fact and the compensation
packages sometimes commanded by top analysts (occasionally exceeding
$20 million per year) provide the best demonstration of which of the two
hats dominates. Prosecution of Merrill Lynch by the Attorney General of
the State of New York in 2002, a $1.4 billion global settlement, and a
frantic scramble by all securities rms to reorganize how equity research
is structured and compensated simply validated facts long known to
market participants.
Mechanisms to control conicts of interest can be market-based,
regulation-based, or some combination of the two. Within large rms
there appears to be a reliance on the loyalty and professional conduct of
employees, both with respect to the institutions long-term survival and
the best interests of its customers. Externally, reliance appears to be placed
on market reputation and competition as disciplinary mechanisms. The
concern of a bank for its reputation and fear of competitors are viewed
as enforcing a degree of control over the potential for conict exploitation.
But conicts that emerged during the corporate governance mess of the
early 2000s suggested to many that tougher external controls over the
activities of banks and other nancial rms might be needed.
89
CONGLOMERATE DISCOUNT
It is often argued that the shares of multiproduct rms and business

conglomerates tend to trade at prices lower than shares of more narrowly
focused rms (all else equal). There are two basic reasons why this conglomerate discount is alleged to exist.
First, it is argued that, on the whole, conglomerates tend to use capital
inefciently. Empirical work by Berger and Ofek (1995) assesses the potential benets of diversication (greater operating efciency, less incentive to forego positive net present value projects, greater debt capacity,
lower taxes) against the potential costs (higher management discretion to
engage in value-reducing projects, cross-subsidization of marginal or lossmaking projects that drain resources from healthy businesses, misalignments in incentives between central and divisional managers). The authors demonstrate an average value loss in multiproduct rms on the
order of 1315%, as compared to the stand-alone values of the constituent
businesses for a sample of U.S. corporations during the period 19861991.
This value loss turned out to be smaller when the multiproduct rms
were active in closely allied activities within the same industrial sector.
The bulk of value erosion in conglomerates is attributed by the authors
to overinvestment in marginally protable activities and crosssubsidization. In empirical work using event-study methodology, John
and Ofek (1995) show that asset sales by corporations result in signicantly improved shareholder returns on the remaining capital employed,
both as a result of greater focus in the enterprise and value gains through
high prices paid by asset buyers.
Such empirical ndings from event studies covering broad ranges of
industry may well apply to diversied activities carried out by nancial
rms as well. If retail banking and wholesale banking are evolving more
highly specialized, performance-driven businesses, one may ask whether
the kinds of conglomerate discounts found in industrial rms may also
apply to universal banking and nancial conglomerate structures, especially as centralized decision making becomes increasingly irrelevant to
the requirements of the specic businesses, run by specialists in markets
demanding specialist standards of performance.
A second possible source of a conglomerate discount is that investors
in shares of conglomerates nd it difcult to take a view and add pure
sectoral exposures to their portfolios. In effect, nancial conglomerates
prevent investors from optimizing asset allocation across specic segments of the nancial services industry. Investors may avoid such stocks
in their efforts to construct efcient asset-allocation proles. This is especially true of highly performance-driven managers of institutional equity portfolios who are under pressure to outperform cohorts or equity
indexes. So the portfolio logic of a conglomerate discount may indeed
apply in the case of a multifunctional nancial rm that is active in retail
banking, wholesale commercial banking, middle-market banking, private
90
banking, corporate nance, trading, investment banking, asset management, and perhaps other businesses. In effect, nancial conglomerate
shares mimic a closed-end mutual fund that covers a broad range of
businesses. Consequently, both the portfolio-selection effect and the
capital-misallocation effect may weaken investor demand for the rms
shares, lower equity prices, and produce a higher cost of capital than if
the conglomerate discount were absent. This higher cost of capital would
have a bearing on the competitive performance and protability of the
enterprise.
THE ISSUE OF NONFINANCIAL SHAREHOLDINGS
The nancial conglomerate issue tends to be amplied when a bank or

nancial rm has large-scale shareholdings (including private equity
stakes) in nonnancial corporations. In such a case, the shareholder in the
rm in effect obtains a closed-end fund that has been assembled by bank
managers for various reasons over time and may bear no relationship to
the investors own portfolio optimization goals. The value of such a nancial rm then depends on the total market value of its shares (to the
extent they can be marked to market), which must be held by the investor
on an all-or-nothing basis, plus the market value of the rms own businesses.
There are wide differences in the role that banks and other nancial
rms such as insurance companies play in nonnancial corporate shareholdings and in the process of corporate control (see Walter 1993a). These
are stylized in Figure 3-11.
Figure 3-11. Alternative FinancialNonnancial Corporate Control Linkages.
In the equity-market system, industrial rms are semi-detached

from banks. Financing of major corporations is done to a signicant extent through the capital markets, with short-term nancing
needs satised through commercial paper programs and bank facilities, longer-term debt through straight or structured bond issues and medium-term note programs, and equity nancing
through public issues or private placements. Research coverage
tends to be extensive. Commercial banking relationships with major companies can be very importantnotably through backstop
credit lines and short-term lending facilities. These relationships
tend to be between buyer and seller, with close bank monitoring
and control coming into play mainly for small and medium-size
rms or in cases of credit problems and workouts. Corporate control in such Anglo-American systems tend to be exercised
through the takeover market on the basis of widely available public information, with a banks function limited mainly to advising
and nancing bids or defensive restructurings. The governments
role is normally arms length in nature, with a focus on setting
ground rules that are considered to be in the public interest. Relations between government, banks, and industry are sometimes
antagonistic. Such systems depend heavily on effective governance, efcient monitoring, and conict-resolution mechanisms,
which is why the U.S. corporate scandals of 20012002 were so
damaging: they called into question the key pillars of the system.
The nancial intermediary-based system centers on close bank
industry relationships, with corporate nancing needs met mainly
by retained earnings and bank nancing. The role of banks carries
well beyond credit extension and monitoring to share ownership,
share voting, and board memberships in such systems. Capital
allocation, management changes, and restructuring of enterprises
is the job of nonexecutive supervisory boards on the basis of
largely private information, and unwanted takeovers are rare.
Mergers and acquisitions activity tends to be undertaken by relationship-based universal banks. Capital markets tend to be relatively poorly developed with respect to both corporate debt and
equity, and there is usually not much of an organized venture
capital market. The role of the state in the affairs of banks and
corporations may well be arms length in nature, although perhaps
combined with some public sector shareholdings.
In the nancial-industrial crossholding approach, interrm boundaries are blurred through equity crosslinks and long-term suppliercustomer relationships. Banks may play a central role in equity crossholding structuresas in Japans keiretsu networks
and provide guidance and coordination, as well as nancing.
There may be strong formal and informal links to government on
the part of both the nancial and industrial sectors of the economy.
91
92
Restructuring tends to be done on the basis of private information

by drawing on these business-banking-government ties, and a contestable market for corporate control tends to be virtually nonexistent.
The state-centered approachperhaps best typied in the French
traditioninvolves a strong role on the part of government
through national ownership or control of major universal banks
and corporations, as well as government-controlled central savings
institutions. Banks may hold signicant stakes in industrial rms
and form an important conduit for state inuence of industry.
Financing of enterprises tends to involve a mixture of bank credits
and capital market issues, often taken up by state-inuenced nancial institutions. Additional channels of government inuence
may include the appointment of the heads of state-owned companies and banks, with strong personal and educational ties within
the business and government elite.
These four stylized bank-industry-government linkages make themselves felt in the operation of banks and other nancial rms in various
ways. The value of any nancial rm shareholdings in industrial rms is
embedded in the value of the enterprise. The combined value of the bank
or insurer and its industrial shareholdings, as reected in its market capitalization, may be larger or smaller than the sum of their stand-alone
values. For example, rms in which a bank or insurer has signicant
nancial stakes, as well as a direct governance role, may be expected to
conduct most or all signicant commercial and investment banking or
insurance activities with that institution, thus raising the value of the rm.
However, if such tied sourcing of nancial services raises the cost of
capital of client corporations, this increased cost will in turn be reected
in the value of banks or insurers own shareholdings, and the reverse if
such ties lower client rms cost of capital. Moreover, permanent shareholdings may stunt the development of a contestable market for corporate
control, thereby impeding corporate restructuring and depressing share
prices, which in turn are reected in the value of the bank or insurer to
its own shareholders. Banks may also be induced to lend to afliated
corporations under credit conditions that would be rejected by unafliated lenders, and possibly encounter other conicts of interest that may
ultimately make it more difcult to maximize shareholder value.
MANAGEMENT AND ADVISOR INTERESTS IN M&A DEALS
Overinvestment is one reason managers may promote bank mergers and

acquisitions that do not in the end create value. Managers may choose to
overinvest for several reasons. They may want to expand the size of their
organizations since managerial compensation tends to be positively related to rm size. Sometimes boards even compensate managers speci-
93
cally for doing deals. Managers may also want to diversify their employment riskthat is, the risk of losing their professional reputations
or jobs if the rm for which they are working has low earnings or enters
bankruptcy. By engaging in diversifying projects, managers can learn a
variety of transferable skills. This occurs even if such projects do not
benet stockholders (see Amihud and Lev 1981).
In his cash-ow theory, Jensen (1986) posits that managers with more
cash ow than they need may engage in value-destroying diversication
through overinvestment. When managers have access to free cash ow
dened as cash in excess of that needed for operations and positive-net
present-value projectsthey may choose not to return the cash to shareholders in the form of increased dividends. Instead, they invest in projects
that do not necessarily have expected positive net-present values such as
value-destroying mergers.
Investment bank advisors likewise have a strong desire for deals to be
completed. Rau (2000) nds that an investment banks market shares is
in fact unrelated to the ultimate performance of acquirers advised by that
bank in the past. What counts is that the investment bank has completed
large numbers of deals in the past and is able to charge high success fees.
The incentive to get the deal done can be quite strong regardless of
long-term prospects of the deal itself.
HOW SHOULD SHAREHOLDERS THINK ABOUT
FINANCIAL SERVICES M&A DEALS?
The chief executive of one particularly acquisitive U.S. bank has been
quoted as saying, With bank mergers . . . two plus two equals either three
or ve.2 This statement nicely summarizes matters. The question is
whether in an M&A situation the positives outweigh the negatives as
discussed hereall balanced against the price paid either in cash or (if
paid in stock) in terms of the dilutive effect on existing shareholders.
There is usually no need to worry about the shareholders of the target
rm. If boards are doing their jobs, they either receive an acceptable cash
price or they can decide to sell their shares immediately after announcement. If they decide to hold, they are in the same boat as the shareholders
of the acquiring rm, which is where the problem lies. So both old and
new shareholders of the surviving entity must nd a way to weigh the
pluses and minuses discussed in this chapter, with all of the risks and
uncertainties that this involves.
FROM BOOK VALUE OF EQUITY TO MARKET VALUE OF EQUITY
In any M&A deal that combines two publicly traded companies, it is easy
to nd out what the two rms were worth prior to the announcement of
2. Richard Kovacevich, CEO of Wells Fargo, as quoted in Davis (2000).
94

Value of Equity
300
250
200
150
100
50
0
BMVE
Scale
Scope
X-efficiency
Market
power
TBTF
support
Conflicts
of Interest
Conglomerate
discount
PMVE
Principal Sources of Value Gain or Loss
Figure 3-12. Loss-Recapture and/or Gain Augmentation in M&A Transactions.
the transaction, assuming the announcement effect was not already embedded in the share price. This is the pro forma, baseline market value of
equity (BMVE in Figure 3-12).
It is based on the pro forma combined book value of equity (BVE). In
the case of a bank, BVE is the sum of (1) the par value of shares when
originally issued, (2) the surplus paid in by investors when the shares
were issued, (3) retained earnings on the books of the bank, and (4)
reserves set aside for loan losses (Saunders & Cornett 2002). Depending
on the prevailing regulatory and accounting system, BVE must be increased or decreased by unrealized capital gains or losses associated with
assets such as equity holdings carried on the books of the bank at historical
cost and their prevailing replacement values (hidden reserves), as well as
the replacement values of other assets and liabilities that differ materially
from historical values due to credit and market risk considerationsthat
is, their marked-to-market values.
This calculation gives the presumptive adjusted book value of equity
(ABVE). This value, however, is not normally revealed in bank nancial
statements due to a general absence of market-value accounting across
broad categories of banking activities. Only a few commercial banking
products such as trading account securities, derivatives, and open foreign
exchange positions tend to be traded in liquid markets so that their market
value can be determined. Some loans and credit derivatives are today
also traded actively. Similar problems arise in insurance companies. However, the ABVE is a much more reliable guide in the case of investment
95
banks, where a much greater proportion of the balance sheet is marked

to market on a real-time basis, and in the case of asset managers.
The franchise value of the rm can be dened as the difference between
ABVE and BMVE. After all balance sheet values have been taken into
account and priced out, there may still be a material difference between
the resulting constructed value of equity and the current market value of
equity. This difference represents the markets assessment of the present
value of the risk-adjusted future net earnings stream, capturing all known
or suspected business opportunities, costs, and risks facing the institution.
Much of it is associated with reputation and brand value. Franchise value
may be highly positive, as in the case of PepsiCo or Nestle in the nonnancial sector, or it could be signicantly negative, with the rms stock
trading well below its adjusted book valuefor instance, if there are large
perceived losses embedded in the rms internal or external portfolio of
activities.
The franchise value can also affect the management of risk. As noted
earlier, Demsetz, Saidenberg, and Strahan (1996) argue that the franchise
value of banks also serves to inhibit extraordinary risk-taking. They nd
substantial evidence that the higher a banks franchise value, the more
prudent management tends to be. This suggests that large nancial rms
with high franchise values should serve shareholder interests (as well as
the interests of the regulators) by means of appropriate risk management
as opposed to banks with little to lose.
Tobins Q is dened as the market value of a rms equity divided
by the book value. If the Q ratio is signicantly below 1, for example, it
may be that breaking up the rm can serve the interests of shareholders.
That is, the adjusted book value of equity possibly could be monetized as
a result of the breakup, in the same way as restructurings have raised
shareholder value under the right circumstances in industrial companies.
The Q ratio for well-run nancial rms having a positive franchise value
should normally be signicantly in excess of 1 and is clearly susceptible
to enhancement through managerial or shareholder action.
An M&A transaction can take place at the market price (no premium)
or above the market price, representing a so-called control premium.
The economics of the combined entity centers on the price-to-book ratio
paid for the target rm. As noted, the shareholders of the target rm
capture the control premium. Whether the shareholders of the buying
rm benet depends on whether the net gains from the transaction over
time exceed, on a present-value basis, the control premium paid for the
target rm. The price recorded on the balance sheet of the acquiring rm
reects this goodwill and has to be amortized according to prevailing
accounting rules against pretax earnings. It is easy to see why overpaying
for acquisitions can be a real show-stopper for shareholders, if the economic gains of the transactions turn out to fall well short of expectations.
At least in the United States, commercial bank acquisitions during the
period of intensive M&A activity in the 1990s have occurred at price-to-
96
book value ratios of about 2.0, sometimes as high as 3.0 or even more. In
eight of the eleven years covered by one study (Smith and Walter 1999),
the mean price-to-book ratio for the U.S. banking industry acquisitions
was below 2.0, averaging 1.5 and ranging from 1.1 in 1990 to 1.8 in 1985.
In two years, the price-to-book ratio exceeded 2.0in 1986 it was 2.8 and
in 1993 in was 3.2. These values presumably reect the opportunity for
the acquired institutions to be managed differently and to realize the
incremental value needed to reimburse the shareholders of the acquiring
institutions for the willingness to pay the premium in the rst place.
If in fact the potential to capture value for multifunctional nancial
rms exceeds that for the traditional U.S. type, separated commercial
banks reected in such studies, this should be reected in higher merger
premiums in banking environments outside the United States and within
the United States after the 1999 liberalization of line-of-business restriction
as a result of the Gramm-Leach-Bliley Act. Pressure for shareholder value
optimization may not, of course, be triggered by an active and contestable
market for corporate control, but in such markets it probably helps. Comparing cost, efciency, and protability measures across various national
environments that are characterized by very different investor expectations and activism suggests that external pressure is conducive to realizing
the potential value of shareholder equity in banking.
When nancial rms engage in M&A transactions, managing for shareholder value means maximizing the potential market value of equity
(PMVE) that the combined organization may be capable of achieving. The
intent is to optimize the building-blocks that make up potential value of
equity as depicted in Figure 3-12economies of scale, economies of scope,
X-efciency, market power, and TBTF benets, while minimizing valuelosses from any diseconomies that may exist as well as avoiding to the
extent possible conict-of-interest problems and any conglomerate discount
SUMMARY
Assessing the potential effects of mergers or acquisitions in the nancial

services sector is as straightforward in concept as it is difcult to calibrate
in practice. The positives include economies of scale, improvements in
operating efciency (including the impact of technology), cost economies
of scope, revenue economies of scope, impact on market structure and
pricing power, improved nancial stability through diversication of revenue streams, improvements in the attraction and retention of human
capital, and possibly presumptive TBTF support. The negatives include
diseconomies of scale, higher operating costs due to increased size and
complexity, diseconomies of scope on either the cost or revenue sides (or
both), the impact of potential conicts of interest on the franchise value
97
of the rm, and a possible conglomerate discount that appears in the

share price. Bigger is sometimes better, sometimes not. It all depends.
In terms of the evidence reviewed in this chapter, the relevant management lessons appear to include the following:
Dont expect too much from economies of scale.
Dont expect too much from cost economies of scope, and be prepared to deal with any cost diseconomies that may arise.
Exploit demand-side economies of scope where cross-selling makes
sense, most likely with retail, private, and middle-market corporate clientsand much more arguably with major corporate and
institutional clients.
Optimize operating economies or X-efciencies through effective
use of technology, reductions in the capital-intensity of nancial
services provided, reductions in the work force, incentivecompatible compensation practices, and other hallmarks of just
plain better management.
Seek out imperfect markets that demonstrate relatively low price
elasticity of demand, ranging from private banking services to
equity transactions that exploit fault lines across capital markets
to leading-edge, emerging-market transactions that have not as yet
been commoditized to dominant fortress market-share positions
in particular national or regional markets, with particular clientsegments, or in particular product lines. The half-lives of market
imperfections in banking differ enormously, and require careful
calibration of delivery systems ranging from massive investments
in infrastructure to small, light, entrepreneurial, and opportunistic
teams. A key managerial challenge for multifunctional nancial
rms is to accommodate a broad array of these activities under
one roof.
Specialize operations using professionals who are themselves specialists.
Where possible, make the political case for backstops such as underpriced deposit insurance and TBTF support. Although this is a
matter of public policy, shareholders clearly benet from implicit
subsidies that come without too many conditions attached.
Pay careful attention to limiting conicts of interest in organizational design, incentive systems, application and maintenance of
Chinese walls, and managerial decisions that err on the side of
caution where potential conicts of interest arise.
Minimize the conglomerate discount by divesting peripheral nonnancial shareholdings and noncore businesses, leaving diversication up to the shareholder. The gain in market value may well
outweigh any losses from reduced scope economies and earnings
diversication. Pursuing this argument to its logical conclusion, of
98
course, challenges the basic premise of universal banks and nancial conglomerates as structural forms.
Pay careful attention to the residual franchise value of the rm
by avoiding professional conduct lapses that lead to an erosion of
the banks reputation, uncontrolled trading losses, or in extreme
cases criminal charges against the institution. Its never a good
idea to cut corners on compliance or building an afrmative culture that employees understand and value as much as the shareholders.
If a strategic direction taken by the management a nancial rm does
not exploit every source of potential value for shareholders in M&A situations, then what is the purpose? Avoiding an acquisition attempt from
a better-managed suitor, who will pay a premium price, does not seem
as unacceptable today as it may have been in the past. In a world of more
open and efcient markets for shares in nancial institutions, shareholders
increasingly tend to have the nal say about the future of their enterprises.
4
Managing Financial Services
Mergers and Acquisitions
The previous chapters of this book have provided the setting for M&A
transactions in the nancial sector: where they t in the value-chain of
nancial services, the factual ow of deals, and their impact on the industry. The chapters have also detailed the underlying concepts and rationale
regarding gains and losses with respect to market share and protability.
These considerations ought to determine strategic positioning, doing the
right thing, a strategic approach that provides good prospects for sustained nancial performance. But even if a strategic plan is well conceived,
it equally needs to be well executed, thus doing the thing right.
In the traditional process of mergers and acquisitions, the post-merger
integration phase is commonly applied after the deal is consummated.
This approach, however, usually results in delays and frictions that diminish the benets of the transaction. A more efcient approach used by
rms that have engaged in numerous successful mergers and acquisitions
seems to have applied the integration process early on and carried it out
in a highly disciplined way.
This chapter centers on the issue of merger integration and its inevitable
costs, which are important in a present-value sense because they are
relatively certain and are incurred early in the process compared, for
example, to revenue synergies, which may be quite speculative and take
years to materialize. Even the best of mergers or acquisitions can be
defeated by poor integration. Much of the thinking and evidence in this
area falls in the realm of organizational behavior and business strategy
and policy.
ORGANIZATIONAL STRUCTURE
Many M&A transactions are organizationally straightforward. The target

rm is folded into the existing organizational structure of the acquirer
99
100
and simply disappears. Others may require the acquiring rm itself to

reorganize and, for example, to structure the acquired entity as a separately capitalized subsidiary. Reasons for such restructuring might include
regulatory constraints, the design of management performance incentives,
and branding and market-access issues. Reorganization requires some sort
of new institutional prole that is appropriate for the activities of multifunctional nancial rms. The broadest reorganizations target most or all
client segments (at least in their home markets) and make an effort to
provide each with a full range of the appropriate nancial services. Outside the home market, rms may adopt a narrower competitive prole,
perhaps focusing on wholesale banking and securities activities, asset
management and private banking, or perhaps a self-standing retail presence abroad. This presents shareholders with an amalgam of more or less
distinct businesses that are linked together in a complex network that
draws on a set of centralized nancial, information, human, and organizational resources. Such a prole can be extraordinarily difcult to manage in a way that achieves an optimum use of invested capital, as noted
in the previous chapter.
Multifunctional nancial rms may take a number of more or less
distinct forms.1 These are stylized in Figure 4-1.
A fully integrated nancial rm (Type-A) provides a broad range
of nancial services (banking, asset management, securities, and
insurance) under a single corporate structure supported by a single
capital base. This comes close to the classic European-style universal bank.
A partially integrated nancial rm (Type-B) conducts both commercial and investment banking within the same entity but undertakes insurance underwriting and distribution, as well as perhaps mortgage banking, asset management, lease nancing,
factoring, management consulting, and other specialized activities
through separately capitalized subsidiaries, either because such
activities are separately regulated or because they involve signicant potential for exploitation of conicts of interest, or a combination of such factors.
In a Type-C nancial rm, a commercial bank, whose core business
as a credit institution is taking deposits and making commercial
loans, forms the parent of subsidiaries engaged in a variety of
other nancial services ranging from investment banking to insurance.
A nal multiline nancial rm structure (Type-D) involves creation
of a holding company, which controls afliates engaged in commercial banking, investment banking, insurance, and possibly
other types of nancial and nonnancial businesses.
1. For a detailed discussion, see Saunders and Walter (1994).
Managing Financial Services Mergers and Acquisitions
101
Figure 4-1. Organization Structures of Multiline Financial Firms.
The specic structures that nancial rms adopt are driven by regulatory considerations, the characteristics of the nancial services involved,
and demand-side issues relating to market structure and client preferences. American regulation of multiline rms incorporating a commercial
banking function, for example, mandates a Type-D form of organization.
This was historically the case under the Glass-Steagall provisions of the
Banking Act of 1933, requiring separation of banking (taking deposits and
extending commercial loans) and most types of securities activities (underwriting and dealing in corporate debt and equities and their derivatives, as well as state and local revenue bonds). Permitted non-banking
business had to be carried out through separately capitalized subsidiaries,
and there were strict rewalls between them. U.S. bank holding companies were enjoined from most types of insurance underwriting and
distribution. This changed with the 1999 Gramm-Leach-Bliley Act, which
eliminated the securities and insurance prohibitions but continued to
mandate the holding company structure.
British multifunctional nancial rms have traditionally followed the
102
Type-C model, with securities and insurance activities (if any) carried out
via subsidiaries of the bank itself. Most continental European countries
seem to follow the Type-B model, with full integration of banking and
securities activities within the bank itself (despite functional regulation),
and insurance, mortgage banking, and other specialized nancial and
nonnancial activities carried out through subsidiaries. The Type-A universal banking model, with all activities carried out within a single corporate entity, seems not to exist even in environments characterized by a
monopoly regulator such as, for example, the Monetary Authority of
Singapore.
From a strategic perspective, the structural form of multifunctional
nancial rms appears to depend on at least two factors: (1) the ease with
which operating efciencies and scale and scope economies can be
exploited, which is determined in large part by product and process
technologies, and (2) the comparative organizational effectiveness in optimally satisfying client requirements and bringing to bear market
power.2
TYPOLOGY OF MERGERS AND ACQUISITIONS INTEGRATION
There are at least four strands to the conceptual basis for integrating
mergers and acquisition that seem to apply to the nancial services sector
and that bear on the problems of integration. The rst is the strategic t
(resource relatedness) view. M&A transactions in related sectors or markets that appear to demonstrate a strategic t should perform better than
in unrelated situations due to the possible benets of economies of scale,
scope, and market power that can be achieved. However, the empirical
evidence in the management literature has produced inconsistent results
(Lubatkin 1987; Haspelagh and Jemison 1991), indicating that resource
relatedness may represent value potential but is not a guarantor of success
in post-M&A performance. Strategic t issues are more extensively dealt
with in the economics literature, discussed in Chapter 3.
Second is the organizational t view. The argument is that poor postacquisition performance of M&A transactions is linked to organizational
problems encountered during the integration process. Several studies
(Buono and Bowditch 1989; Datta 1991) have indicated that differences in
human and organizational factors can have a severely negative impact on
post-acquisition performance. The argument is essentially process-driven.
Corporate performance is determined by the post-M&A integration process, in which value creation takes place through the transfer of particular
skills (Kitching 1967; Porter 1987; Haspelagh and Jemison 1991). The au2. In this context, Switzerland presents an interesting case study, with the two major universal banks
operating under a single set of domestic regulatory parameters having adopted rather different structural
forms.
103
thors emphasize that deals are not one-off transactions, but rather a means
for carrying out corporate renewal.
The entire M&A sequence in this view is split into two interactive
processes: namely, the decision-making process in the pre-transaction stage
and the integration process in the post-transaction stage. The justication
for M&A deals is the transfer of strategic capabilities that provide a sustainable competitive advantage to the rm, thereby leading to long-term
shareholder value creation for the combined enterprise. Strategic capabilities need to be aligned with the underlying motivation and contribution
to a specic business strategy, as depicted in Table 4-1.
Third is the resource-based view, which attributes performance variances
between rms to the difference in the way rm managers build, maintain,
and defend their resources (Hamel, Prahalad, and Doz 1989; Crossan and
Inkpen 1992). Resources are considered valuable not for their inherent
characteristics but for the way in which they are used either individually
or in combination (Penrose 1959).
Fourth is the knowledge-based view, which considers that human resources dominate the material resources of the rm. Such services tend to
Table 4.1 M&A Objectives in Corporate Renewal
Strategic Capabilities
Strategic Motivation
Combination benets
Market share
Domain strengthening
Strengthen existing areas
of competencies, usually in restructuring situations [ex: horizontal
acquisitions].
Domain extension
Apply existing capabilities
to new adjacent business or vice versa.
Resource sharing
Economies of scope/
scale
Functional skills
Processes
Domain exploration
Move into new business
needing new capabilities. Leverage industry
specic learning, with
goal of greater commitment to acquisition.
Contribution to Specic
Business Strategy
Acquiring specic business
capability
Piecemeal approach in acquiring different capabilities to build broadbased business strategy.
Acquiring a platform
Will only become integral
part of business strategy
with greater investment
of resources.
Acquiring a business position
Acquisition implements
the strategy.
General management
skills
Financial planning, HR
Source: Philippe Haspeslagh and David Jemison, Managing Acquisitions (New York: Free Press, 1991).
104
vary according to changes in human capital and skills. So there is a strong

link between the knowledge of employees and the benets to be extracted
from available material and nancial resources (Penrose 1959). The
uniqueness of employee knowledge is identied as the source of sustainable competitive advantage (Nonaka 1994). However, knowledge is tacit,
difcult to replicate, and transferable through learning by doing, observation, and imperfect imitation. If knowledge, embedded in human
capital, is the most important element of value creation and is inherently
difcult to manipulate (especially in the nancial services industry), how
can it be effectively transferred through the M&A integration process?
Firm learning concepts may be especially applicable in this area, as
discussed below.
PRE-MERGER INTEGRATION ISSUES
A number of managerial issues that can cause major integration problems

must be considered in advance of an M&A transaction. First, is the chemistry right? Are the personalities of the senior executives from both rms
compatible? The importance of complementarity needs to be stressed. In
some nancial mergers, such as Banco SantanderCentral Hispano
(BSCH) in 1999, a wide divergence in personalities and styles between
the two CEOs can help minimize clashes during integration, since each
may exercise a unique leadership role (see Appendix 2, Table 2). Possible
leadership structures are depicted in Table 4-2. Optimally, key senior
executive posts in the combined rm should be determined prior to the
announcement of the transaction, with roles in the new leadership structure claried as much as is realistically possible in order to minimize
confusion, frictions, and turf battles during the integration process.
Second, as discussed later in this chapter, corporate culture is crucial
to the integration process. It is also important to the success of the combined entity, since most of the key M&A benets are tied to successful
human interactions. This involves understanding the extent of cultural
gaps that may exist. Determining whether a cultural gap is functional,
social, or rooted in other causes needs to be clearly established in the preM&A stage and seriously addressed by senior management on both sides.
If the cultural gap is deemed too wide and unlikely to be narrowed during
integration, the transaction should be reconsidered. And the integration
approach to be used should be determined by the extent of the cultural
gap, the main purpose of the merger or acquisition, and the operating
environment of the acquired rm or merger partner.
Personal interactions represent the main elements in the M&A integration process but provide some of the most serious challenges due poor
acquirer information about the target rm, together with uncertainty
about the acquisitions purpose and its perceived implications on the part
of employees of the target rm (Haspeslagh and Jemison 1991). Symptoms
include a lack of exibility in implementing the integration process when
Table 4-2 Alternative Leadership Structures, Characteristics, Advantages, and Disadvantages
Federal
Collegiate
Advantages
Disadvantages
Examples
1 overall CEO subordinate (CEOs

of acquired rms). The CEO and
top senior management of acquired
rm remains in place
Triumvirate or quartet of Co-CEOs
having equal power
Builds consensus
Need strong charisma to maintain

authority
UniCredito
Builds consensus
Compromise solution
May be a negative in fast-paced

I-banking.
Personality clashes, with one or more
CEOs actually leaving, causing
disruption down the chain of
command. Compromises leading to
severe delays in deciding on key
integration issues (conversion of IT
platform, staff cuts).
Fortis, Dexia
105
Characteristics
Two Co-CEOs
One from each rm
Builds consensus
Compromise solution
Single CEO
The CEO of dominant rm takes

over, with other CEO forced/eased
out before integration begins.
The CEO of one rm takes over new
CEO role, with a former CEO of
other rm as the designated successor
One voice
Fast decision making
Single CEO
Builds consensus
Compromise solution
One voice
Fast decision making
Source: Steven Davis, Bank Mergers: Lessons for the Future (London: Macmillan Press, 2000).
HypoVereinsbank,
Banco Bilbao Vizcaya
(where the Spanish
govt. had to intervene to appoint a
successor).
May cause disruption in acquired
rm due to climate of uncertainty/
hostility
If the most talented former CEO goes
last, he may leave prematurely before his anticipated appointment
date.
Landesgirokasse (Germany)
106
faced with new conditions, as well as psychic loss (morale erosion) and
talent defections due to uncertainty and fear generated among the target
rms employees. This requires balancing expectations between determinism and excessive exibility, providing quality and presence of institutional leadership, and selecting the appropriate level of gatekeeping (interface management) between the two rms in order to lter out
interferences in the operations of the target company on the part of the
acquirer.
The integration approach is viewed as a balance between two forces:
(1) the strategic t, that is, the relationship of target to the acquired rm
or between merging partners, and the manner in which the value or
strategic capability is to be extracted, and (2) the organizational tthe
need to preserve the targets strategic capability after the acquisition
which is dependent on how essential the preservation of the target rms
culture is to the survival of the strategic capabilities to be acquired.
ALTERNATIVE APPROACHES TO MERGER INTEGRATION
Three merger-integration approaches have been identied in the management literature, all based on clinical case studies. Ultimately, each of these
approaches depends on the strategic intent underlying the specic M&A
initiative being undertaken, as summarized for a number of cae studies
in Appendix 2.
First, the absorption approach usually applies to M&A transactions
within the same nancial services sector (commercial banking, investment
banking, insurance, asset management) in which one of the main justications is the realization of economies of scale or operating efciencies
due to overlapping operations. The absorption approach can apply to
both market strengthening (such as Wells Fargo and First Interstate Bank)
and market extension (such as Deutsche Bank and Bankers Trust). The
cultural gap needs to be bridged quickly due to the fast-paced nature of
the absorption approach.
Second, the symbiotic approach generally applies to cross-sector transactions (for example, between commercial banking and investment banking, commercial banking and insurance), in which cultural differences
and practices can be fairly wide, and therefore may take time to bridge.
Examples include Citibank and Travelers, CIBC and Wood Gundy. However, a high level of integration at least in some functional areas is eventually necessary in order to benet from scope-related M&A benets such
as cross-selling and leveraging of distribution channels. A symbiotic type
of approach has also been used in market-strengthening situations (inmarket deals) in which the cultural gap between the two organizations
was deemed too wide to bridge quickly and therefore the slower symbiotic approach was chosen. A notable example is the NorwestWells Fargo
transaction.
107
Table 4-3 Types of Integration Approaches
Need for Organizational Autonomy
Need for Strategic

Interdependence
Low
High
Preservation
Symbiotic
[Holding]
Absorption
High
Low
Source: Phillippe Haspeslagh and David Jemison, Managing Acquisitions (New York: Free Press, 1991).
Third, the preservation approach involves, as the main justication for a

merger or acquisition, leveraging knowledge about the new business or
industry area of the acquired rm and/or specic skills and business
competencies (best practices) that could be transferred back to the parent or to the parents other afliates. In most cases, the cultural gap
between the two rms is wide due to cross-sector differences, and is
therefore kept separate from that of the acquiring rm by granting a high
level of autonomy. In nancial services, a preservation approach can be
used when the acquiring rm is interested in obtaining a platform in a
new sector of the industry or in a new national market, but does not yet
itself have those activities within which to integrate the acquired rm.
Some banks, such as Banc One, in the past have used a preservation
approach in order to leverage knowledge about possible best practices.
Banc One also used a preservation approach to facilitate the negotiation
process for their acquisitions because of the non-threatening nature of this
approachthat is, the target rm is left more or less intact after the
acquisition.
A mapping of each of these approaches onto the need for strategic
interdependence and the need for organizational autonomy is provided
in Table 4-3. The context, characteristics, and challenges for each type of
integration approach are highlighted in Table 4-4. The key issues that
need to be addressed are
Client retention and extension (client franchise)

Geographic presence in major markets
Product coverage and branding
Revenue economies of scope, distribution channel leveraging and
broadening (cross-selling)
Economies of scale and operating efciencies
Human resources, redundancies, retention, and skill leveraging
Table 4-4 Integration ApproachesContext, Characteristics, and Challenges
Applicable
Context
(Capabilities)
Absorption
Symbiotic
Applicable
Context
(Acquisition
Purpose)
Examples
Approach Characteristics
Domain
Resource
strengthsharing
ening.
(economies
of scope/ Domain
scale).
extension.
General
management
skills.
Electoluxs acquisition of Zanussi in

1984 to broaden its
product range.
Much overlap (same sector,

same geographic area).
Domain
Resource
strengthsharing
ening.
(economies
of scope/ Domain
scale).
extension.
General
management
skills.
ICTs acquisition of
Usually a large gap in culBeatrice Chemicals.
ture differences (sector,
cross-border).
A high level of integration

does not mean centralization (Zanussi was
absorbed into Electroluxs
decentralized operations)
First co-exist and then

become increasingly interdependent as the cultural
gap narrows.
The most complex integration approach due to its
gradual nature, requiring
capability transfer (for ex:
synergies), while preserving those capabilities.
Therefore, there is a need
for boundary preservation while providing
permeability (semipermeable membrane).
Functional
skills.
Preservation Functional
skills
Domain
exploration.
Rationalization of resources
is usually the primary
M&A motive.
BPs 1979 acquisition Main acquisition motive is

to accumulate learning:
of Hendrix, a
Dutch animal feed
(1) learn about an
industry as a possible
company. Desire to
new domain; (2) expose
diversify away
acquiring rm to a diffrom oil, yet in a
ferent business that may
eld (protein)
be relevant to its core
where BP wanted
activities.
to increase its
learning, BP had
Complete need to preserve
made earlier forays
different identity & culinto synthetic proture
tein production
from oil.
108
Approach Challenges
Balancing Expectation
Institutional Leadership
Interface Management
Less exibility required

due to programmed
nature of approach.
Senior management of
acquired rm to create
conditions for staff of
acquired rm to
transfer allegiances.
Gate-keeping temporarily
needed to monitor
pace, timing, and
nature of interactions.
Difculty in assessing
accruing benets from
skill transfer, therefore
continuous need for
reassessment, but
exibility runs against
managerial instincts.
Even-handedness is
crucial regardless of
size.
Complexity in striking the

right balance between
preserving the identity
of the acquired rm
and promoting the
appropriate ow of
information exchange
Failure to reconrm
acquired rms purpose
will not provide
reassurance.
Gate-keeping is crucial to
preserve boundary
(autonomy) around
acquired rm.
Resistance of target rm
increases if expected
benets are too clearly
specied.
Excessive exibility
(autonomy) results in
reduced learning
opportunities.
109
110
Capital base and debt rating

Technology platform
Physical infrastructure
Leveraging of institutionalized know-how
Clearly, the overall integration process will be driven by the underlying

objective of the transaction. Mistargeted approaches can be disastrous in
this sector, since the nancial services industry depends critically on human capital, which is often highly mobile.
DECIDING ON THE INTEGRATION LEVEL BY IMPACT AREA
The integration level targeted for each M&A impact area may not be the
same as the overall level of integration. Table 4-5 depicts this and also
notes implications for the BSCH and Banc One merger sequences. For
example, in the preservation approach a few impact areas such as information technology (IT) and data-processing functions, as well as accounting and audit systems, may be targeted for high integration while the
remaining areas may remain autonomous or only loosely aligned with
those of the acquiring rm.
Since the absorption and symbiotic approaches both aim at a high overall
level of integrationalthough achieved at different speedsmost impact
areas should be targeted similarly (see Table 4-5). However, there may be
some exceptions, especially in symbiotic acquisitions in which some areas
are intentionally not targeted for a high degree of integration. This appears
to have been the case, for example, with the Banco SantanderCentral
Hispano merger, in which management decided after the merger to integrate and align most of the two predecessor banks functions, systems,
policies, and procedures progressively but to maintain separate retail
brands and product groups. Nevertheless, exceptions to high levels of
integration-specic impact areas may just represent caution on the part
of management, which could eventually move to fully integrate all aspects
of the combined business.
Given that a preservation-type of acquisition aims at maintaining a high
degree of autonomy in the acquired rm, one would expect that integration levels across most impact areas would be relatively low, therefore
mostly occupying the space in the low integration column in Table 4-5.
The acquirer may nevertheless want to aggressively integrate some functional areas in order to introduce effective nancial and operational control. For example, in the case of Banc Ones numerous acquisitions up to
the mid-1990s, high integration levels were targeted for IT, accounting,
and auditing functions and systems, although this was usually a very
slow process. Branding was also rapidly integrated, since the Banc One
name was effectively franchised to acquire institutions. All remaining
areas were not initially targeted for high integration, as indicated in Table
4-5.
Table 4-5 Targeted Integration Level by Impact Area

Integration Level
Impact Area
High
Medium
Low
IT & data processing functions

Operations (back-ofce) functions
Front-ofce functions
Physical facilities
HR policies
Operating procedures
Accounting/audit systems
IT and data processing systems
Product range
Brands
BSCH
Integration Level
Impact Area
High

Physical facilities
HR policies
Product range
Brands
Medium
Low
X
X
?
?
?
X
X
X
X
X
Banc One through the mid-1990s

Integration Level
Impact Area
High

Physical facilities
HR policies
Product range
Brands
Medium
Low
X
X
X
X
X
X
X
X
X
X
111
112
Key issues in merger integration are speed and communication. The

decision process and communication of the actions affecting key integration impact areas should be as rapid as possible in order to minimize
uncertainty confronting staff and clients. Management often has to contend with several different integration schedules and priorities relating to
individual impact areas:
Front-ofce and client coverage functions

Accounting and audit systems
Human resources and compensation policies
Operating procedures and reporting lines
Product range and delivery
Branding and marketing
IT systems, data processing, and back-ofce functions
The last of these issues will be discussed separately in the following

chapter.
THE ISSUE OF PERSONNEL RETENTION
The replacement or retention of personnel in M&A situations is in part

determined by the integration approach used, and especially by the degree of existing overlap between the two rms. In-market deals such as
the consolidation of two commercial banks operating in the same geographic area usually involve considerable personnel redundancies, especially in the branch network and operations.
The rms leadership has to aim to strike the right balance between the
need for reducing personnel and the need for minimizing employee disruptions that often accompany restructurings during the integration process. As discussed, a high degree of replacement in human resources of
the acquired rm tends to negatively impact the post-acquisition performance of the combined rm through the departure of key talent and the
demoralization of the remaining employees down the chain of command.
Although empirical ndings in this area have been limited so far to senior
management replacement in U.S. commercial banking acquisitions, aggressive personnel replacement in the acquired rm is a frequent pitfall
in many mergers or acquisitions due to a strong pressure to slash costs.
This can lead to severe damage to employee morale, with negative repercussions on personnel retention, customer service, and customer retention, as well as loss of focus on possible synergies such as cross-selling.
Alternative selection approaches in human resource retention and
replacement are presented in Table 4-6. Firm-level research suggests several important methods to deal with human resources.
1. The key individuals in the acquired rm should be quickly identied for retention.
113
Table 4-6 Alternative Selection Approaches in Human Resources Retention/Replacement

Characteristics
Our team
takes
over
Advantages
Disadvantages
Examples
Loyalty to person- Trust in known and

nel of acquiring
tested managers.
rm.
Limiting, if additional First Union

talent will be re(USA)
quired to foster longterm growth.
Strong chance of demoralizing staff of
acquired rm.
Chase, Lloyds
Meritocracy Selection based on Fairness may help to Process can be timeTSB
consuming (34
push through layfairness and
months in Lloyds
offs and minimize
transparency.
TSB merger).
personnel disrupBased on view
tions. Alternative
that human talMay not be popular
could be disasent is the main
with staff of acquirtrous (best people
resource of the
ing/dominant rm,
as it may accuse
leaving to other
rm.
management of acrms with desire
tually favoring the
of revenge).
other (weaker) side.
Maintaining Maintain balance Compromise soluCould cause disrupABN/Amro,
balance/
in staff between
tion, builds contion if staff from one
BankAustria/
sensus.
side feels that their
Creditanstalt,
equality
both rms. Socounterparts from
Merita/
lution often fa- Easier to implement
if labor laws are
other side are less
Nordbanken
vored in Europe
more inexible.
talented.
and Japan.
Source: Steven Davis, Bank Mergers: Lessons for the Future (London: Macmillan Press, 2000).
2. The selection process for redundancy, replacement, or retention

should be fair and transparent. Ideally, the staff from both rms
should be placed in the same evaluation pool for selection.
3. Human resources decisions should be done quickly, for example
within the rst 100 days after the M&A announcement, in order
to avoid uncertainty, which would lead employee morale erosion and the exit of key talent.
4. The managers of the acquired rm who were opposed to the
merger or acquisition should be terminated.
These initiatives ought to help minimize future conicts and may require
the development of a process that will bring conicts to the surface and
help identify at an early stage the less-cooperative employees of the acquired rm.
An example is Swedbank, which used this approach in its integration
of acquired banks. Over a period of several days, it brought together the
114
employees of the acquired rm and exposed them to the banks vision.

Each employee was asked whether he or she agreed with the vision of
the new combined rm, and those who disagreed were either retired early
or offered help in outplacement. The approach was relatively costly, however, and did provoke some perhaps unnecessary employee disruptions.
The way in which the personnel selection, retention, and separation
process is performed needs to be effectively communicated to staff, emphasizing the degree of transparency and fairness applied, in order to
establish credibility. This credibility, along with the extent of retention
packages for the surviving staff of the acquired rm or merger partner,
need to be quickly set in order to minimize the departure of key personnel.
The need for a realignment of compensation structures between the two
rms must also be evaluated early on, especially in integrations that
attempt to bring together staff from different sectors in cross-selling initiatives.
DEALING WITH CULTURAL CHANGE
Whereas many of the factors determining whether an M&A transaction

in the nancial services sector is accretive to shareholders have been
explored extensively in the literature, little attention has been paid to
issues surrounding corporate culture. This is a soft factor that arguably
explains some of the differences observed between expected and actual
shareholder value gains and losses. In some cases, clashes of cultures
within the merged entity appear to have been the reason for M&A disasters. Corporate culture has certainly become one of the most actively
debated issues distinguishing successful from lackluster performers in the
nancial services sector.
Culture is something every nancial services rm has, even if it is
weak. It is central to the institutional environment in which people have
to work. If a nancial services rm wants to get the most out of its people,
the rst thing management has to give them is a highly desirable and
effective workplace, which is where they spend more of their time than
anywhere else. Some key ingredients are
High-quality peers and role models from whom to learn, and with
whom to compete.
A sufciently nonhierarchical, loose organizational structure that
permits ideas to rise, be taken seriously, considered carefully on
the basis of merit, acted upon quicklythat is, a structure that
protects high-potential individuals from bureaucratic stiing.
An esprit de corps that thrives on measurable competitive success
such as signicantly increasing market share or prot margins
in a business where winners and losers are not difcult to distinguish and where valuable franchises are difcult to build but easy
to lose.
115
A performance-based compensation and advancement system that

is generally respected as being fair and right not less than about
80% of the time. This must be an integral part of a benign form of
ruthless Darwinism, one that includes a reasonably high level of
involuntary turnover, in which only the best survive and progress.
In short, there has to be a climate in which bright people, if they are
found suitable, will want to spend their careers. This climate requires a
sense of continuity, admired and respected seniors, and a serious, consistent commitment to careful recruitment, management development, and
training. Qualied people who are not from the institutions home country
must be considered for high ofce. Such people cannot automatically be
deemed unworthy just because they come from a different background.
Corporate culture in a highly competitive industry like nancial services has to be regarded by management and boards as an important
competitive weapon, centered on grasping and preserving the qualities
of winning. This includes
Sound strategic direction and leadership from the topsenior
managers who know the right thing to do, then get it done
promptly by providing sufcient resources.
An overriding attention to teamwork, avoiding becoming dependent on so-called stars and stamping-out arrogance. Some apparently strong cultures are really not much more than institutionalized arrogance.
The selection of hundreds of loyal and efcient squad and platoon
leaders to carry out day-to-day activities at high levels of quality
and professionalism, to include a ne, ingrained sense of what is
unacceptable conduct, including conduct that does not violate law
or regulation but nevertheless could impair the reputation of the
rm and compromise its responsibility to clients.
A high level of adaptability by the whole organization in an industry subject to rapid changesic transit gloria. Senior management must be keenly aware of the need for adaptability and communicate it effectively by word and deed. A certain amount of
corporate angst helps keeps people on their toes.
Leadership is important. The evidence suggests that the culture of a
nancial institution can be strongly inuenced by one or two individuals
at the top of their organizations, either to push forward and improve
upon a core culture that already exists or to dramatically change it. But
most nancial services rms are run by committees on the basis of shared
responsibility and power by people, however capable, who reached their
positions largely by bureaucratic progression within the system. This may
be less true in smaller institutions than in larger ones, and less true in
investment banks than in commercial and universal banks. As products
of the system, they tend to promote the shared values and behavior
116
patterns characteristic of that system. Sometimes outsiders with quite

different perspectives are included on the top management team, often
with great catalytic effect, but other times they seem to have only limited
impact on institutions. There may be several origins of a rms culture,
which, individually or together, can form a strong competitive asset.
First, the history of an organization is often a useful cultural anchor,
particularly if that history includes a strongly positive social and political
as well as economic impact. Employees quickly identify with a proud
history and the cultural attributes associated with it, and leverage this
history in a productive way in client relationships. Business setbacks,
strategic errors, and even scandals may be more easily overcome with a
strong historical anchor embedded in the corporate culture. The problem
with a history-linked cultural identity is that it either exists or it does not,
and represents a factual basis that cannot be altered in the short-run. Most
established rms have long and honorable histories, but few are so distinguished that this provides a powerful cultural asset.
Second is the rms overall franchise, the cumulative product of its
business successes and failures in the relatively recent past. In the case of
market successes or dominance, the positive lessons can permeate the
entire rm. In the case of failures, the demoralization effect on corporate
culture can far exceed the direct impact of the failure itself. Financial
institutions that are repeatedly successful in nancial innovation, for example, often acquire resonance in the market, which can positively affect
corporate culture over a relatively short time span. People are generally
proud to be considered innovative or to be associated with innovators,
and this can pay cultural dividends. It is also well known that entrepreneurial and start-up ventures often have extremely positive cultures that
place a premium on hard work well beyond formal responsibilities, selfmotivation, attention to quality, and the like. The problem is that the
excitement can dissipate fairly quickly, after which routine takes over and
its cultural value is lost.
Third a sense of institutional self-perception. Mission statements can
be helpful in the development of strong cultures as long as they are both
realistic and alive in the sense that management walks the talk, to
use a popular phrase. Among the most useless and indeed damaging
efforts can be mission statements intended to weld together a coherent
corporate culture but that turn out to be opportunistic, unrealistic, frequently violated, and pious. These mainly serve to create a sense of cynicism, dissent, and disinterest. Many rms have a powerful corporate
culture without a mission statement, only a strong sense of vision on the
part of senior management.
Finally, there ought to be a partnership approach. In this industry,
employees are indeed the most important assets. They must be trained,
led, and given role models to emulate. They must be compensated well
and fairly, but not excessively relative to what they contribute. The question is whether certain cultural attributes specic to partnerships can be
117
synthetically introduced into corporate organizations in order to derive

some of the benets. Sometimes it can be achieved in part through welldesigned and credible management information and prot attribution
systems, which allocate earnings into pools where they are properly
generated, whether directly or indirectly. This system must then be sold
to employees as being both accurate and fair, so that those doing the
performing trust it as much as possible. Lateral information ows across
the organization and cooperative behavior intended to leave as little business on the table as possible may thus be encouraged far more effectively
than any amount of exhortation by management.
One question that constantly arises among nancial services rms is
whether a single culture is appropriate for an organization that covers a
very broad range of activities, extending from foreign exchange dealing
to mass-market retail banking to M&A advisory transactions in investment banking. But there may be some over-arching cultural attributes (a
superculture) that can be an effective umbrella covering widely different
business cultures and national cultures within an organization (see Figure
4-2). If this is considered impossible to achieve, it is likely that a holding
company form of organizationwhere unit cultures are closely aligned
to the respective businessesis superior to more integrated structural
forms among nancial services rms. However, cultural fragmentation in
such a structure has potential drawbacks, including the fragmentation of
market delivery and quality control, that are not to be taken lightly.
A decentralized federation will permit and sometimes even encourage
multiple cultures. A cultural takeover, in which the dominant partner
imposes its own culture, can be direct or indirect. In a direct cultural
Figure 4-2. Cultural Overlays.
118
imposition, the dominant rm squarely imposes its own culture (for example, Fleet Bank, Svenska Handelsbanken). This approach forces people
to focus on where they are going, not where they have come from. However, the culture of the dominant rm is itself continuously evolving. In
an indirect cultural integration, the dominant rm chooses a subculture
from within its own organization if it deems that its core culture is not
well suited to the other company. In order not to repeat the mistakes made
with the Morgan Grenfell acquisition, for example, Deutsche Bank
adopted a softer cultural approach when acquiring Bankers Trust in 1999
by handling the acquisition through its line investment bankers based in
London ofce rather than by its German-based entities.
In building a new culture, management has to focus personnel on the
future by adopting new values, most of which tend to be performancerelated. This approach (for example, as adopted by HypoVereinsbank) is
based on the assumption that behavior characteristics, rather than values,
must be changed, since the adoption of new behavior is easier than the
alteration of existing beliefs. In contrast to the performance-related approach, the soft-value approach focuses on shaping a new culture around
certain specic ideals such as integrity, collaboration, and meritocracy.
Another version of the soft-value approach is to blend the best of both
rmsfor example, the high-touch client-relationship approach of Norwest blended with the high-tech electronic and phone-banking approach
of Wells Fargo.
Senior management should not bury cultural differences, but rather
encourage open discussion of any such differences in order to raise awareness. The goal is to foster mutual understanding. The message must be
truthful. Statements to avoid include
Its a natural t. No matter how complementary the cultures of two
rms may be, it should never be assumed that they could easily
be merged into a seamless combined entity.
Nothing is going to change. All mergers and acquisitions are highly
disruptive. A false pretense will only cause unrealistic expectations
among employees, which can lead to subsequent disappointments
and disruptions.
Its a merger of equals. Such statements can lead to wholly unrealistic
expectations, resulting in turf battles and staff disruptionsas in
the NationsBankBankAmerica merger, in which case BankAmerica staff soon found out that they had, in fact, not been
merged, but simply acquired.
Persistent communication throughout the integration process is an essential ingredient of success in bridging the cultural gap, especially when
attempting to forge a new culture. Among communication vehicles available to senior management are mission statements, in-house continuing
education, and the like.
119
CONCEPTS OF FIRM LEARNING AND FINANCIAL

SERVICES M&A TRANSACTIONS
The rm is viewed as a set of so-called routinized behaviors developed

over time through knowledge accumulation that has been formed from
either direct or indirect experience (Zollo and Singh 1997; Zollo 2000).
Post-integration decisions and the learning process to implement those
decisionsintegration capabilitiesare ultimately inuenced by routines
developed by the acquiring rm and will tend to have an impact on the
rms postmerger performance. A rms learning experience from past
M&A deals is either tacit (learning by doing) or codied in manuals,
blueprints, and the like.
Knowledge codication represents the ways in which individuals involved in implementing the merger integration process discuss and share
their experience and develop process-specic tools. These tools include
the creation and updating of integration manuals, checklists and decisions
support software, the analysis of post-performance metrics, and the writing of postmortem evaluation reports. Knowledge codication should
positively affect post-acquisition performance by (1) serving as a repository of organizational memory, (2) facilitating diffusion of knowledge to
other parts of the rm, for example through manuals, (3) clarifying the
roles, responsibilities, and deadlines for those executing the integration
process, and (4) helping understand the causality between decisions taken
and performance outcomes.
A recent survey of U.S. banking M&A transactions measured the impact on post-acquisition impact of (1) preacquisition attributes, for example target rm performance, acquirer size, and market overlap, (2)
postintegration decisions, in terms of the extent of integration required
and degree of senior management replacement involved; and (3) tacit
learning and knowledge codication applied. Some of the results of the
survey are the following (Zollo 2000).
Target quality had a signicant negative impact on post-acquisition performance. This negative impact suggests that the transfer of capabilities
and resources between the acquirer and the target rm was a better way
to create shareholder value than the oppositethat is, learning from the
target. However, acquirer size did not have a signicant impact on postacquisition performance. Market overlap (dened as measured market
relatedness in terms of geographical locations and types of customers
served) also did not signicantly impact post-acquisition performance.
This seems surprising, given the greater potential for signicant economies of scale in horizontal acquisitions than in market-extension acquisitions due to the rationalization of the geographic coverage and the cost
savings of closing redundant branches. The nding suggests that the
possibilities for value creation (mainly cost efciencies) or destruction in
horizontal mergers and acquisitions are equivalent to those achieved in
120
market-extension M&A deals. Value creation in such mergers relies on

revenue-enhancing opportunities, mainly through cross-selling and organizational learning.
The degree of post-acquisition integration (dened in terms of the alignment and centralization of systems, procedures, and products) had a
signicantly positive impact on post-acquisition performance. The degree
of replacement of the target rms senior management had a signicantly
negative impact on post-acquisition performance. This nding suggests
that the replacement of the targets top management tended to destroy
shareholder value rather than enhance it. Value destruction appeared to
result from the loss of human and social capital associated with the departure of managers and from the noncooperative or antagonistic attitude
of the remaining employees due to a perception of unfair treatment in the
integration phase, thereby increasing the complexity involved in the integration process.
The amount of prior acquisition experience did not have a signicant impact on post-acquisition performance. Prior acquisition experience by itself did not seem to be sufcient to affect rm performance due to the
low frequency, high heterogeneity, and level of ambiguity (the risk of
applying the lessons in one context to a seemingly similar but very different one) inherent in the acquisition process. This nding invalidates
the benets associated with the learning by doing mechanism.
The extent of knowledge codication did have a signicantly positive impact on post-acquisition performance. The development of M&A integration capabilities seemed to have a strong positive effect on rm performance but not without costsfor example, investments in time and
energy to create and update these tools. At some point there is a risk that
the marginal costs of building and maintaining knowledge codication
may outweigh the benets of developing collective competencies for integrating M&A transactions. At higher levels of integration, the degree of
knowledge codication did have a very signicant positive impact on
performance. This nding suggests that with increasing degrees of complexity due to higher integration levels, knowledge codication is a predictor of successful post-acquisition performance.
INTERFACE MANAGEMENT IN THE INTEGRATION PROCESS
The objective of interface management depends on the integration approach that is adopted. For an absorption acquisition, only a temporary
interface management structure is likely to be necessary, whereas more
permanent structures will be needed in symbiotic and especially preservation approaches. Interface management staff can be drawn from personnel of the parent rm, the acquired rm, or from the outside. Outsiders
are valuable especially in preservation acquisitions, where objectivity and
neutrality are key issues. Important quality characteristics of an interface
121
manager include a high degree of fairness, excellent interpersonal and

cross-cultural abilities, and a good understanding of the business of the
acquired rm. Effective interface management should be capable of warding off undue interference from the parent, providing guidance, and delivering on commitments. During the interface management process, the
acquiring rm needs to refocus the attention of the targets staff on operational issues, for example by providing performance targets. It also
needs to provide a new vision and incentives to employees, for example
through realistic and coherent mission statements. As the tables in Appendix 2 suggest, the integration tasks to be performed vary in accordance
with the integration approach used.
The evidence suggests that knowledge codication does have a significant impact on postacquisition performance in certain instances. Thus, a
frequent acquirer may want to consider developing integration tools of
its own in areas such as systems conversion (conversion and training
manual), human resources integration (stafng models, training, and integration packages), sales and marketing integration (product mapping,
product training manuals), and possibly other areas as well. There appear
to be some limits to codication, however. Some U.S. non-bank nancial
rms have had apparent success in using knowledge codication in integrating their acquisitions, notably the former GE Capital Services (see
Appendix 2, Table 6). And the empirical ndings linking knowledge codication to post-acquisition performance are so far limited to acquisitions
onlythat is, no mergers of equalsmostly among U.S. commercial
banks; the data do not yet cover investment banks, asset managers, insurance companies, or other types of nancial services rms.
BENCHMARKING M&A INTEGRATION PERFORMANCE
In the end, the integration effort must be judged against a number of

benchmarks set by management and consistent with extracting maximum
shareholder value accretion from the acquisition or merger. Figure 4-3 is
one way to depict the integration process. The key questions revolve
around how it affects the following impact areas:
Client retention and extensionthat is, the rms core franchise.
Presence in major product and geographic markets achieved, as
measured by market share, industry rankings, and similar indicators
Human resources disruptions encountered, resulting in defections
of key personnel, cultural conict, and erosion of morale
Economies of scale and operating efciencies achieved as measured, for example in cost-to-income ratios
IT disruptions encountered and their impact on revenue generation and cost structures
122
Figure 4-3. The Integration Process: A Framework.
Revenue economies of scope achieved, including leveraging of

distribution channels and cross-selling gains achieved
Leveraging of knowledge and specialist expertise across the rm
The relevant integration tasks for the three major types of M&A transactionsthe absorption, preservation and symbiotic approaches identied earlierare presented in Tables 4-7, 4-8, and 4-9. Each merger or
acquisition has unique features and can easily go wrong (or leave a great
deal of value on the table) if the integration process is mishandled.
As noted, the tables in Appendix 2 summarize a series of case studies
intended to benchmark M&A integration approaches in a series of transactions based on available deal information. These include the acquisition
of a regional investment bank by a nationwide commercial bank (CIBC
Wood Gundy), a major domestic European commercial banking merger
(Banco SantanderBanco Central Hispano), a highly acquisitive serial
dealmaker in U.S. commercial banking (Banc One), acquisition of a major
wholesale bank by a European universal bank (Deutsche BankBankers
Trust), acquisition of a technology-based investment bank by a major
Table 4-7 Integration TasksAbsorption Approach

Task
Purpose
Actions and Methods
Preparing the
Work out the integration Choose a single leader [avoid a board].
Choose the management team [senior manblueprint for
plan in detail over a
agers from both sides, and involve
consolidation
precise time-line, with
them in choosing the choice of individdeadlines and targets
uals at the next level]. Selection must be
provided.
rather quick, otherwise creates employee disruptions [value destruction].
Install a transition structure with specic
tasks for key integration areas to identify
and evaluate potential synergies and
ways to achieve them. Task forces
should be used selectively using criteria
of critically and compatibility [how
compatible is integration in this area?].
Focus on critical functions, where rms
have used different approaches [high
criticality/low compatibility]. Strongly
recommended not to postpone solutions
in these areas. Second priority of task
forces is to focus on critical but compatible functions. Here the payoff will be
to demonstrate merger benets. Decisions on what trade-offs [what areas to
focus on] should be made on factual evidence/analysis not on political
grounds.
Manage to an integration calendar: announce and stick to a workable/realistic
calendar for maintaining pressure for
progress.
Communication: preparation of integration plan requires much preparation
along the way. The logic and timing
must be sold to employees, usually in a
confused and turbulent environment.
Communication must be frequent, clear,
and transparent.
Managing the Crux of the integration Weigh clear benets and costs of rationalizing a function. Sometimes the costs inrationalizaprocess, as a number
clude intangible ones of compromise
tion process
of areas must be
such as diminished moral . . .
merged within a cer A determined and fast-paced execution is
tain time span.
needed: avoid danger of slowing down
the speed because of a perceived difculty or resistance.
(continued)
123
124
Table 4-7 Integration TasksAbsorption Approach (continued)

Task
Purpose
Actions and Methods
Get acceptance of the integration: (1) focus

on real issues [what creates real improvements on results such as investments], not on principles; (2) communicate integration goals clearly and allow
debate; (3) and co-opt managers of
acquired rm [are winners as well].
Move to best
Search and adopt areas Implement a systematic program determining best practice on the basis of
practice
of best practice
technical parameters.
[aside from benets of
resource sharing, ab- Share and transfer that practice.
sorption can provide
functional skill transfers as well]. This
may be the main
source of value creation.
Ensure uniformity on some dimensions and
Harnessing the Focus also on complecomplemenmentarities [differencourage complementarity on other dimensions [allow for different brand spaces
tarity
ences] rather than just
and allocate responsibilities]. This will
similarities [resource
foster innovation and drive.
sharing benets]. Focus on cultural differences.
commercial bank (NationsBankMontgomery Securities), and a serial

non-bank nancial services acquirer (the former GE Capital Services) that
has grown rapidly in multiple niches by using both roll-ups and major
acquisitions and has arguably perfected the acquisitions process better
than any other rm.
SUMMARY
This chapter has considered key issues involved in the post-M&A integration process with specic reference to the nancial services industry.
Most of them are given by the nature and objective of the transactions
themselves and the organizational design into which they are intended
to t. Sequencing is important, as are human relations and cultural aspects. In a human capital-intensive business like nancial services, problems related to incentives, morale, and leadership have probably destroyed more shareholder value than probably any other. Each integration
Table 4-8 Integration TasksPreservation Approach

Task
Purpose
Continued
boundary
protection
Permanent need for Gatekeepers may constantly need to use

their inuence to ward off interference.
vigilance of noninterference from Gatekeepers have to also meet corporate staff
needs (deal personally with planning and
parent company.
control forms).
Create value by nur- Three key actions to be taken in nurturing process:
turing the acquisi Instilling ambition: key is not to throw retion to accelerate
sources at acquired rm but to increase horibusiness developzons, raise ambitions of acquired management. Fallacies are
ment, and change risk perceptions. The small
to think that this
size of acquired rm may have caused viis accomplished
sion blindness. This can be done by using a
by leaving it
policy statement (e.g., BP and Hendrix). The
alone and generissue is not the use of the parents resources
ous funding. This
but the fact that they are there.
is not really the
Practical support: an ambitious vision must be
case.
accompanied by practical support that vision
is strategically sound and that capabilities for
implementation are there. What is critical
here is the informal transfer of managerial
expertise (not imposition of formal systems
but one-on-one dialogue). At Hendrix, IM
staff continuously claried strategic objectives and furthered the professional development of management.
Staying vigilant: gatekeeping becomes harder
to enforce once acquired company is becoming successful or expanding (e.g., Hendrix
acquiring in Spain]. Non-interference principles should be reiterated.
Nurturing to
accelerate
business development
Accumulate
business
learning
Actions and Methods
To accumulate learn- Learning about the business: gatekeepers play a

key role in accumulating, sifting through,
ing about the busiand disseminating this knowledge (learn the
ness and from the
acquired business from an insiders perspecbusiness (justicative). However, learning must take place. For
tion of the acquisithis, there must be a restrained environment
tion). Industry
(only a few people) and also the position of
and business
the acquired rm in the overall industry conknowledge will
text must be understood.
inuence parents
decision whether Learning from the business: this learning provides long-term benets to the parents curto further move
rent domain (cultural and organizational
into an area.
change process through exposure to a very
(continued)
125
Table 4-8 Integration TasksPreservation Approach (continued)

Task
Purpose
Actions and Methods

different business, such as CIBA-Geigys entry
into household products). This is more complex than learning about a business, as the
base business can be hostile/suspicious about
this sort of transfer. Solution lies with top
management of parent to balance demands of
host structure (IM) of champion status with
that of equal treatment by base business of
parent rm. Balance is function of parent to
provide nancial support for both (equal treatment) and IM structure to attract managerial
talent to acquired rm and willingness to
maybe lose them to parent.
Organizational Due to their platform What is needed: (1) strong leadership; (2) demonstrate early control over operating perforchampioning
type, viability
within the parent is
mance; (3) ability to maintain good rapports
rarely stable (too
with corporate staff units (strategic planning), who are the friends at court.
small to represent a
Possible pitfall of expanding acquired rm
durable committhrough acquisitions: can put pressure on IM
ment). Momenstructure to focus on short-term operational
tum must come
results of acquired rm than on issues
from IM strucneeded to promote internal growth (investture, which must
ment in people).
act as champions
and persuade
parent to commit
resources.
Source: Plilippe Haspeslagh and David Jemison, Managing Acquisitions (New York: Free Press, 1991).
126
Table 4-9 Integration TasksSymbiotic Approach

Task
Purpose
Actions and Methods
Need for patience: minimize the pressure the acquired rm (due to the premiums paid
All contacts need to be channeled through
for the transaction). Allay fears by focusing managers of acquired rm on own budggatekeeping structure. However,
ets and long-term performance. Clear need for understanding between corporate
attention needs to be paid to managers
level and IM on strategic objectives, time-horizons, and type of organizational path.
of acquirer and organizational
Hold back acquirers managers: claims for involvement by acquiring rms managers
reporting of new unit.
are stronger, especially those who worked on the acquisition process and identied
the potential synergies. Will have to agree to a delay but also prepare their own
organization as a receptor of the intended capability.
Both companies are adjacent (side by side): report to a single executive, who will provide
vision and pressure both companies to prepare for change.
Achieve the capabilities transfer between both Boundary to be transformed into a semipermeable membrane: key determining success
Reaching out
sides.
factors were the style and direction of initial and subsequent contacts. Initial contacts
rather than
should originate from managers in acquired rm. To facilitate this, acquiring rm to
reaching in
put at the disposition of acquired rm experienced individuals to help to identify
resources in parent organization that would solve their problems. This will help convince acquired rm of accruing benets from early interactions.
Entrust managers of acquired rm with more responsibilities (giving product lines). At
Trading operational Overtime, need to increase the inuence of
responsibility for
operating level, both companies remain distinct.
parent.
strategic control
Yet strategy is increasingly developed to parent, as resources and people move over
to it.
Amalgamating the End-goal to become a new, unique entity,
Senior executives in both organizations assigned double roles: guardian of their own unit
and an involvement in broader strategy decisions.
organizations
without losing the character underlying
Regroup the individuals physically or geographically: for example, invest in new buildcapabilities of acquired rm.
ings, facilities. Lessening the physical distance, lessens the demand for maintaining
differences (separate compensation structure).
Starting with
preservation
127
Source: Plilippe Haspeslagh and David Jemison, Managing Acquisitions (New York: Free Press. 1991).
128
exercise presents a series of war stories that range from virtually seamless exercises to abject failure. And it appears that rms can learn to
integrate. In an industry as dynamic as nancial services, this is not a bad
skill to develop. The following chapter continues the integration story
with one of its most critical dimensions, information technology.
5
The Special Problem
of IT Integration
Information technology (IT) systems form the core of todays nancial

institutions and underpin their ability to compete in a rapidly changing
environment. Consequently, integration of information technology has
become a focal point of the mergers and acquisitions process in the nancial services sector. Sometimes considered largely a technical issue, IT
integration has proved to be a double-edged sword. IT is often a key
source of synergies that can add to the credibility of an M&A transaction.
But IT integration can also be an exceedingly frustrating and timeconsuming process that can not only endanger anticipated cost advantages but also erode the trust of shareholders, customers, employees and
other stakeholders.
KEY ISSUES
IT spending is the largest non-interest-related expense item (second only

to human resources) for most nancial service organizations (see Figure
5-1 for representative IT spend-levels). Banks must provide a consistent
customer experience across multiple distribution channels under demanding time-to-market, data distribution, and product quality conditions. There is persistent pressure to integrate proprietary and alliancebased networks with public and shared networks to improve efciency
and service quality. None of this comes cheap. For example, J.P. Morgan
was one of the most intensive private-sector user of IT for many years.
Before its acquisition by Chase Manhattan, Morgan was spending more
than $75,000 on IT per employee annually, or almost 40% of its compensation budget (Strassmann 2001). Other banks spent less on IT but still
around 1520% of total operating costs. Moreover, IT spend-levels in
many rms have tended to grow at or above general operating cost in-
129
130
0 .5
1 .5
2
Citicorp
Chase
Deutsche Bank
Credit Lyonnais
Barclays
Bank of America
NatWest
JP Morgan
UBS
Credit Agricole
Nations Bank
Bankers Trust
ABN Amro
SBC
Societe Generale
Wells Fargo
Credit Suisse
Banc One
First Chicago
Figure 5-1. Estimated Major Bank IT Spend-Levels ($ billions).

Source: The Tower Group, 1996.
creases, as legacy systems need to be updated and new IT-intensive products and distribution channels are developed.
As a consequence, bank mergers can result in signicant IT cost savings, with the potential of contributing more than 25% of the synergies in
a nancial industry merger. McKinsey has estimated that 3050% of all
bank merger synergies depend directly on IT (Davis 2000), and The Tower
Group estimated that a large bank with an annual IT budget of $1.3 billion
could free up an extra $600 million to reinvest in new technology if it
merged, as a consequence of electronic channel savings, pressure on suppliers, mega-data centers, and best-of-breed common applications.1 However, many IT savings targets can be off by at least 50% (Bank Director
2002). Lax and undisciplined systems analysis during due diligence, together with the retention of multiple IT infrastructures, is a frequent cause
of signicant cost overruns.
Such evidence suggests that nding the right IT integration strategy is
one of the more complex subjects in a nancial industry merger. What
makes it so difcult are the legacy systems and their links to a myriad
applications. Banks and other nancial services rms were among the
rst businesses to adopt rmwide computer systems. Many continue to
use technologies that made their debut in the 1970s. Differing IT system
platforms and software packages have proven to be important constraints
on consolidation. Which IT systems are to be retained? Which are to be
abandoned? Would it be better to take an M&A opportunity to build a
1. Merger Mania Catapults Tech Spending, Bank Technology News, December 6, 1998.
The Special Problem of IT Integration
131
completely new, state-of-the-art IT infrastructure instead? What options

are feasible in terms of nancial and human resources? How can the best
legacy systems be retained without losing the benets of a standardized
IT infrastructure?
To further complicate matters, IT staff as well as end users tend to
become very exercised about the decision process. The elimination of
an IT system can mean to laying off entire IT departments. In-house end
users must get used to new applications programs, and perhaps change
work-ow practices. IT people tend to take a proprietary interest in their
systems created over the yearsthey tend to be emotionally as well intellectually attached to their past achievements. So important IT staff
might defect due to frustrations about wrong decisions made by the
new management. Even down the road, culture clashes can complicate
the integration process. Us versus them attitudes can easily develop
and fester.
Efforts are often channeled into demonstrating that one merging rms
systems and procedures is superior to those of the other and therefore
should be retained or extended to the entire organization. Such pressures
can lead to compromises that might turn out to be only a quick x for an
unpleasant integration dispute. Such IT-based power struggles during the
integration process are estimated to consume up to 40% more staff resources than in the case of straightforward harmonization of IT platforms.
(Hoffmann 1999).
At the same time, it is crucial that IT conversions remain on schedule.
Retarded IT integration has the obvious potential to delay many of the
non-IT integration efforts discussed in the previous chapter. Redundant
branches cannot be closed on time, cross-selling initiatives most be postponed, and back-ofce consolidations cannot be completed as long as the
IT infrastructure is not up to speed. In turn, this can have important
implications for the services offered by the rm and strain the relationship
to the newly combined client base.
An Accenture study, conducted in summer 2001, polled 2,000 U.S.
clients on their attitude toward bank mergers. It found, among other
things, that the respondents consider existing personal relationships and
product quality to be the most important factors in their choice of a
nancial institution. When a merger is announced, 62% of the respondents
said they were concerned about its implications and 63% expected no
improvement. Following the merger, 70% said that their experience was
worse than before the deal, with assessments of relationship and product
cost registering the biggest declines. Such bleak results can be even worse
when failures in IT intensify client distrust. The results are inevitably
reected in client defections and in the ability to attract new ones, in
market share, and in protability.
But successful IT integration can generate a wide range of positive
outcomes that support the underlying merger rationale. For instance, it
can enhance the organizations competitive position and help shape or
132
enable critical strategies (Rentch 1990; Gutek 1978). It can assure good
quality, accurate, useful, and timely information and an operating platform that combines system availability, reliability, and responsiveness. It
can enable identication and assimilation of new technologies, and it can
help recruit and retain a technically and managerially competent IT staff
(Caldwell and Medina 1990; Enz 1988) Indeed, the integration process can
be an opportunity to integrate IT planning with organizational planning
and the ability to provide rmwide, state-of-the-art information accessibility and business support.
KEY IT INTEGRATION ISSUES
As noted, information technology can be either a stumbling block or an

important success factor in a bank merger. This discussion focuses on
some general factors that are believed to be critical for the success of IT
integration in the nancial services industry M&A context. Unfortunately,
much of the available evidence so far is case-specic and anecdotal, and
concerns mainly the technical aspects treated in isolation from the underlying organizational and strategic M&A context.
Whether an IT integration process is likely to be completed on time
and create signicant cost savings or maintain and improve service quality often depends in part on the acquirers pre-merger IT setup (see Figure
5-2). The overall t between business strategies and IT developments
focuses on several questions: is the existing IT conguration sufciently
aligned to support the rms business strategy going forward? If not, is
the IT system robust enough to digest a new transformation process resulting from the contemplated merger? Given the existing state of the IT
infrastructure and its alignment with the overall business goals, which
merger objectives and integration strategies can realistically be pursued?
The answers usually center on the interdependencies between business
strategy, IT strategy, and merger strategy (Johnston and Zetton 1996).
Once an acquirer is sufciently condent about its own IT setup and
has identied an acquisition target, management needs to make one of
Acquirer needs to align

IT
Strategy
Business
Strategy
Figure 5-2. Alignment of Business

Strategy, IT Strategy, and Merger
Strategy.
Merger
Strategy
133
the most critical decisions: to what extend should the IT systems of the
target be integrated into the acquirers existing infrastructure? On the one
hand, the integration decision is very much linked to the merger goals
for example, exploit cost reductions or new revenue streams. On the other
hand, the acquirer needs to focus on the t between the two IT platforms.
In a merger, the technical as well as organizational IT congurations of
the two rms must be carefully assessed. Nor can the organizational and
stafng issues be underestimated. Several tactical options need to be considered as well: should all systems be converted at one specic and predetermined date or can the implementation occur in steps? Each approach
has its advantages and disadvantages, including the issues of userfriendliness, system reliability, and operational risk.
ALIGNMENT OF BUSINESS STRATEGY, MERGER STRATEGY,

AND IT STRATEGY
Over the years, information technology has been transformed from a

process-driven necessity to a key strategic issue. Dramatic developments
in the underlying technologies plus deregulation and strategic repositioning efforts of nancial rms have all had their IT consequences, often
requiring enormous investments in infrastructure (see Figure 5-3). Meeting new IT expectations leads to signicant operational complexity due
to large numbers of new technology options affecting both front- and
back-ofce functions (The Banker 2001). This evolution is often welcomed
by the IT groups in acquirers who are newly in charge of much larger
and more expensive operations. At the same time, however, they also face
a very unpleasant and sometimes dormant structural problemthe legacy systems.
Most European nancial rms and some U.S. rms continue to run a
patchwork of systems that were generally developed in-house over several decades. The integration of new technologies has added further to
the complexity and inexibility of IT infrastructures. What once was considered decentralized, exible, multi-product solutions became viewed as
a high-maintenance, functionally inadequate, and incompatible cost item.
The heterogeneity of IT systems became a barrier rather than an enabler
for new business developments. Business strategy and IT strategy were
no longer in balance.
This dynamic tended to deteriorate further in an M&A context. Being
a major source of purported synergy, the two existing IT systems usually
require rapid integration. For IT staff this can be a Herculean task. Bound
by tight time schedules, combined with even tighter budget constraints
and an overriding mandate not to interrupt business activities, IT staff
has to take on two challengesthe legacy systems and the integration
process. Under such high-pressure conditions, anticipated merger synergies are difcult to achieve in the short term. And reconguring the entire
134
IT infrastructure to effectively and efciently support new business strategies does not get any easier.
The misalignment of business strategy and IT strategy has been recognized as a major hindrance to the successful exploitation of competitive
advantage in the nancial services sector. (Watkins, 1992). Pressure on
management to focus on both sides of the cost-income equation has become a priority item on the agenda for most CEOs and CIOs (The Banker
2001). Some observers have argued that business strategy has both an
external view that determines the rms position in the market and an
internal view that determines how processes, people, and structures will
perform. In this conceptualization, IT strategy should have the same external and internal components, although it has traditionally focused only
on the internal IT infrastructurethe processes, the applications, the hardware, the people, and the internal capabilities (see Figure 5-3). But external
IT strategy has become increasingly indispensable.
For example, if a retail banks IT strategy is to move aggressively in
the area of Web-based distribution and marketing channels, the management must decide whether it wants to enter a strategic alliance with a
technology rm or whether all those competencies should be kept internal. If a strategic alliance is the best option, management needs to decide
with whom: a small company, a startup, a consulting rm, or perhaps
one of the big software rms? These choices do not change the business
strategy, but they can have a major impact on how that business strategy
unfolds over time. In short, organizations need to assure that IT goals and
business goals are synchronized (Henderson and Venkatraman 1992).
Once the degree of alignment between business strategy and IT strategy
has been assessed, it becomes apparent whether the existing IT infrastructure can support a potential IT merger integration. At this point, alignment with merger strategy comes into play. As noted in Figure 5-4, much
depends on whether the M&A deal involves horizontal integration (the
transaction is intended to increase the dimensions in the market), vertical
integration (the objective is to add new products to the existing production
chain), diversication (if there is a search for a broader portfolio of individual activities to generate cross-selling or reduce risk), or consolidation
(if the objective is to achieve economies of scale and operating cost reduction) (Trautwein 1990). Each of these merger objectives requires a
different degree of IT integration. Cost-driven M&A deals usually lead to
a full, in-depth IT integration.
Given the alignment of IT and business strategies, management of the
merging rms can assess whether their IT organizations are ready for the
deal. Even such a straightforward logic can become problematic for an
aggressive acquirer; while the IT integration of a previous acquisition is
still in progress, a further IT merger will add new complexity. Can the
organization handle two or more IT integrations at the same time? Shareholders and customers are critical observers of the process and may not
Business Strategy
IT Strategy
External
Business
Scope
Distinctive
Competencies
Technology
Scope
Business
Governance
Business Infrastructure and Processes
Systemic
Competencies
IT Infrastructure and Processes
135
Internal
Administrative
Infrastructure
Processes
IT
Infrastructure
Skills
Business
IT
Governance
Processes
Skills
IT
Strategic Fit
Functional Integration
Cross-Dimension Alignments
Figure 5-3. Information Technology Integration Schematic. Source: J. Henderson and N. Venkatraman,
Strategic Alignment: A Model for Organizational Transformation through Information Technology, in T.
Kochon and M. Unseem, eds., Transformation Organisations (New York: Oxford University Press, 1992).
Business Strategy
External
Business Scope: Determines where the

enterprise will compete market segmentation,
types of products, niches, customers, geography,
etc.
Distinctive Competencies: How will the firm
compete in delivering its products and services
how the firm will differentiate its products/services
(e.g. pricing strategy, focus on quality, superior
marketing channels).
Business Governance: Will the firm enter the
market as a single entity, via alliances,
partnership, or outsourcing?
136
Internal
Business Infrastructure and Processes
IT Strategy
IT Scope: Types of ITs that are critical to the
organization knowledge-based systems,
electronic imaging, robotics, multimedia, etc.
Systemic Competencies: Strengths of IT that
are critical to the creation or extension of
business strategies information, connectivity,
accessibility, reliability, responsiveness, etc.
IT Governance: Extent of ownership of ITs
(e.g. end user, executive, steering committee)
or the possibility of technology alliances (e.g.
partnerships, outsourcing), or both; application
make-or-buy decisions; etc.
IT Infrastructure and Processes
Administrative Structure: Roles, responsibilities,

and authority structure Is the firm organized
around product lines? How many management
layers are required?
IT Architecture: Choices, priorities, and

policies that enable the synthesis of
applications, data, software, and hardware via
a cohesive platform
Processes: Manner in which key business

functions will operate Determines the extent to
which work flows will be restructured, perhaps
integrated, to improve effectiveness and efficiency.
Processes: Design of major IT work functions

and practices application development
system management controls, operations, etc.
Skills: Human resource issues Experience,

competencies, values, norms of professional
required to meet the strategy? Will the business
strategy require new skills? Is outsourcing
required?
Business
Skills: Experience, competencies,

commitments, values, and norms of individuals
working to deliver IT products and services.
IT
137
Same Market
New Market
Same Product
Consolidation
or cost driven
Examples: UBS & SBC (1997),
Hypo-Bank/ Vereinsbank (1997)
Horizontal integration
or market focused
Examples: Deutsche Bank &
Bankers Trust (1998)
New Product
Vertical integration
or product driven
Examples: Credit Suisse &
Winterthur (1997),
Citicorp & Travelers (1998)
Diversification
Example: Deutsche Bank &
Morgan Grenfell (1997)
Figure 5-4. Mapping IT Integration Requirements, Products, and Markets. Source: Penzel.
H.-G., Pietig, Ch., MergerGuideHandbuch fur die Integration von Banken (Wiesbaden:
Gabler Verlag, 2000).
be convinced, so early analysis of a rms IT merger capability can be a

helpful tool in building a sensible case.
In recent years, outsourcing strategies have become increasingly popular. With the aim of signicantly reducing IT costs, network operations
and maintenance have been bundled and placed with outsourcing rms.
This has the advantage of freeing up resources to better and more efciently handle other IT issues, such as the restructuring of legacy systems.
However, critics argue that there is no evidence that nancial rms really
save as a result of outsourcing large parts of their IT operations. On the
contrary, they argue that rms need to be careful not to outsource critical
IT components that are pivotal for their business operations. Outsourcing
may also sacrice the capability of integrating other IT systems in mergers
going forward. In this case, the business and IT strategies might well be
aligned, but they may also be incompatible with further M&A transactions.
Lloyds TSB provided an example of a pending IT integration process
that made it difcult to merge with another bank. Although Lloyds and
TSB effectively became one bank in October 1995, the two banks did not
actually merge their IT systems for ve years. In fact, three years after the
announcement, the bank was still in the early stages of integrating its IT
infrastructure. The reason was not the cost involved or poor integration
planning, but rather the fact that the Act of Parliament that allowed
Lloyds to merge its customer base with TSBs was not enacted until 1999.
During the intervening period it would have been difcult for Lloyds TSB
to actively pursue any other potential M&A opportunities. The subsequent integration process would have added even more complexity to the
existing situation. Not only would the ongoing internal integration process have been disrupted, but customers might have faced further inconveniences as well. During the ve years of system integration, customers
of the combined bank experienced different levels of service, depending
138
on from which bank they originally came. For example, if a former TSB
customer deposited a check and then immediately viewed the balance at
an ATM, the deposit was shown instantly. But if a former Lloyds customer
made the same transaction at the same branch, it did not show up until
the following day.
THE CHALLENGE OF IT INTEGRATION
At the beginning of every merger or acquisition stands the evaluation of

the potential t between the acquiring rm and the potential target. This
assessment, conducted during the due diligence phase, forms the basis
for IT synergy estimates as well as IT integration strategies.
Take, for example, two Australian Banksthe Commonwealth Bank
of Australia (CBA) and the State Bank of Victoria (SBV), which CBA
acquired for A$1.6 billion in January 1991.2 CBA was one of Australias
largest, with its head ofce in Sydney and spanning some 1,400 branches
across the country with 40,000 staff and assets of A$67 billion. The bank
was owned at the time by the Australian government. SBV was the largest
bank in the State of Victoria, with its head ofce in Melbourne. It encompassed 527 branches, 2 million customer records, 12,000 staff (including
1,000 IT staff), and assets of A$24 billion.
CBA had a solid, centralized, and highly integrated organizational
setup, whereas SBV was known for its more decentralized and businessunit driven structure. CBAs IT organization was more efcient, integrated, and cost-control oriented. Its centralized structure and tight management approach were geared toward achieving performance goals,
which were reinforced by a technological emphasis on high standards and
a dominant IT architecture reecting its in-house expertise. IT stafng
was mainly through internal recruitment, training and promotion, and
rewarded for loyalty and length of service. This produced a conservative
and risk-averse management style. CBAs IT conguration was well suited
to its business environment, which was relatively stable and allowed
management to have a tight grip on IT costs within a large and formalized
IT organization that was functionally insulated from the various businesses.
SBVs IT organization, on the other hand, was focused on servicing the
needs of the organizations business units. Supported by a decentralized
IT management structure and exible, project-based management processes, the IT organization concentrated on how it could add value to
each business unit. Because it was highly responsive to multiple business
divisions, SBV ran a relatively high IT cost structure, with high stafng
levels and a proliferation of systems and platforms. The IT professional
staff was externally trained, mobile, and motivated by performance-
2. This example is taken with permission from Johnston and Zetton (1996).
139
driven pay and promotion. This structure was a good match for the banks
overall diversied, market-focused business environment. The corporate
IT unit coordinated the business divisions competing demands for IT
services in cooperation with IT staff located within the various business
divisions.
Based on its due diligence of SBV, CBA identied the integration of the
computer systems and IT operations of the two banks as a major source
of value in the merger. However, it was clear that the two banks IT setups
were very different, as is evident in Figure 5-5.
To address these differences, CBA decided as a rst step to build a
temporary technical bridge between the two banks IT systems so that
customers of either bank could access accounts at any branch of the newly
merged institution. To retain SBV customers, CBA decided to proceed
carefully rather than undertaking radical IT rationalization. Emphasis was
on keeping the existing IT shells operational until a full-scale branch
systems conversion could be undertaken. CBA decided to pursue a bestof-both-worlds approach: identify best practice in each area of the two
banks IT platforms, which could then be adopted as the basis for building
a new integrated IT structure.
Integration meetings between each banks IT specialist areas did not
Commonwealth Bank of Australia
State Bank of Victoria
Strategy
Cost focus; efficiency

IT driven
Value added focus;

effectiveness
Business unit driven
Structure
Centralized
Bureaucratic
Decentralized
Professional
Formalized
Control emphasis
Mechanistic
Position-based rewards
IT standards
Flexible
Empowerment emphasis
Organic
Performance-based rewards
IT service
Single dominating platforms

Common IT standards
Simple architecture
Multiple platforms
Incompatible system
Complex architecture
Long-serving staff
Internal recruitment and
development
Seniority emphasis
Mobile staff
External recruitment and
development
Merit emphasis
Management
Processes
System
Roles/skills
Figure 5-5. Comparing IT Integration in a Merger Situation. Source: K.D. Johnston and
P.W. Zetton, Integrating Information Technology Divisions in a Bank MergerFit,
Compatibility and Models of Change, Journal of Strategic Information Systems, 5,
1996, 189.
140
succeed for long. Agreeing on what was best practice became increasingly
difcult. Fueled by technical differences as well as by the emotional and
political atmosphere of the takeover, strategy disagreements between IT
teams mounted, and there were extensive delays in planning and implementation.
Meanwhile, CBA faced increasing pressure to complete the IT integration. Competitors were taking advantage of the paralysis while the two
banks were caught in the integration process. And it became expensive
for CBA to run dual IT structures. Shareholders were becoming concerned
whether the promised IT synergies could actually be realized and whether
the merger economics still made sense. CBA decided to replace the bestof-both-worlds approach by an absorption approach that would fully
convert all of SBVs operations into CBAs existing IT architecture. For the
IT area, this meant the rationalization and simplication of systems and
locations and the elimination of dual platforms. Indeed, the merger was
completed on time and IT synergies contributed signicantly to the anticipated value creation of the merged bank.
Traditionally, potential technical incompatibilities of two IT systems
receive most of the attention during the due diligence phase and the
subsequent merger integration process. But resolving technical incompatibilities alone usually does not take care of key integration problems
stemming from underlying dissonance among IT strategy, structure, management processes, or roles and skills in each organization. Regardless of
the technology differences, the incompatibility of two organizational cultures (which in the CBA-SBV case emerged from the particular evolution
of organizational components within each conguration) can itself be
sufcient to cause problems during integration. Each IT conguration
evolves along a different dynamic path involving the development of
organizational resources and learning specic to that path. In this case,
CBA was technology-centered and efciency-driven, whereas SBV was
business-centered and sought to add value. The two IT congurations,
while internally congruent and compatible within their own organization,
were incompatible with each other.
This incompatibility between the two IT congurations helps explain
the dynamics of the IT integration process in this particular example. The
strategic planning for IT integration after the takeover of SBV by CBA
envisaged a two-step process. First, a technical bridge was to be built
between the banks, enabling the separate IT congurations to be maintained. This was a temporary form of coexistence. Second, a new conguration based on a best-of-both-worlds model of change was developed.
Eventually that model was abandoned, and an absorption model was
adopted that integrateed the SBV platform into the CBA structure.
In a classic view, the rms choice of strategy determines the appropriate organizational design according to which the strategy is implementedstructure follows strategy (Chandler, 1962). A parallel argument
can be made in the case of IT integration. Given a sensible merger strategy
141
and the existing IT setups of the merging rms, four IT integration strategies can be distinguished (see Figure 5.6):
Full integration or absorption of one rms IT systems into the
others existing systems
Keeping systems separated and running the two IT platforms in
parallel
Combining the most efcient systems of both rms
Developing a new, state-of-the-art IT system, possibly coupled to
partial outsourcing IT operations
The difference between IT congurations might explain the shift from
a best-of-both-worlds approach to an absorption model in the CBA-SBV
case. A political view might explain the absorption of one banks IT conguration as a function of the relative power of the (usually larger) acquiring organizations IT units (Linder 1989). An alternative explanation
is that the IT conguration of the dominant rm in an M&A transaction
is a product of the established organizational t between the acquiring
organization and its IT unitsa t that supports the stated goals of the
merger. In this case SBV had a decentralized IT management structure
and exible, project-based management processes as opposed to CBAs
centralized structure that very much valued efciency, integration, and
cost control. A reverse absorption by SBV would therefore have resulted
in a mist between its IT conguration and that of its new parent orga-
IT merger strategy
IT differences between
Acquirer and Target
Synergy
Exploitation
Revenue
Exploration
Similar
IT configuration
Full Integration
Absorption
Best-of-both-worlds
Different
IT configuration
Full Integration
Absorption
Keeping system separated

Preservation
Developing a new,
state-of-the-art IT system
Figure 5-6. Schematic of Principal Drivers of IT Integration. Source: Authors diagram

based on inputs from K.D. Johnston and P.W. Zetton, Integrating Information Technology
Divisions in a Bank MergerFit, Compatibility and Models of Change, Journal of Strategic
Information Systems, 5, 1996, 189211, as well as P. Haspeslagh and D. Jeminson, Managing Acquistions (New York: Free Press, 1991) and own thoughts.
142
nization. Although SBV might have many characteristics that were attractive to CBA, the reverse takeover would have created the need for
multiple and complex changes in CBAs operations to reestablish alignment of IT and its organization. However, it might be feasible to do a
reverse takeover where there is only slight overlap or the targets IT
systems are signicantly stronger than the acquirers.
The Full Integration: The Absorption Approach
When an organizations strategy is intent on cost reductions from IT

integration, the absorption of one IT system by another is almost a foregone conclusion. In this case, all business processes are unied and all
applications standardized. Central data processing centers are combined.
Network connections are dimensioned to support data ow to and from
the centralized data-processing center. Databases may also have to be
converted to new standards as well as new software packages.
The major problems associated with the integration of two incompatible IT congurations are thus avoided. Complexity can be signicantly
reduced, as can time to completion. But this strategy is not without its
risks. One risk concerns the management of the downsizing process. The
length of downsizing initiatives becomes important when redundant IT
systems need to be maintained for a longer period in order to ensure full
service capabilities until all system components are converted onto the
dominant platform. To keep this time as short as possible and avoid any
unintended disruptions, key IT staff members need to be kept on board.
Another potential risk relates to scaling up existing systems to cover
increased transaction volumes. The platform that absorbs the redundant
IT system must be capable of handling the increased data volumes from
the outset. Obviously, the integration process will be much easier and
faster if only relatively minor adjustments are required in two systems
that are already quite similar. However, IT integration can also be a good
opportunity to improve or even extend current IT capabilities.
When Union Bank of Switzerland and Swiss Bank Corporation merged
in 1997 to form the present UBS AG, the two banks hoped to achieve
annual cost savings of some $2.3 billion by eliminating duplication in
distribution, product development, and especially IT infrastructure. SBC
had been a loyal user of IBM-compatible mainframes, supplied by Hitachi,
whereas the Union Bank of Switzerland was a long-time user of Unisys
mainframes. The two hardware platforms were incompatible. An added
complication was that both banks were using custom software to run their
respective retail banking operations (Nairn 1999).
The SBC software, called Real-Time Banking (RTB), consisted of 25,000
programs that only ran on its IBM-compatible mainframes. UBS had its
own Abacus suite of 15,000 programs that only worked on the Unisys
computers. The two banks had invested decades in the development of
their respective programs and the IT staff of each bank, naturally, claimed
their technology was superior. The conict was less about the hardware
143
platform and more a question of which was the best software application,
according to Dominic Fraymond, head of large accounts for Unisys Switzerland (Nairn 1999). The bank knew it had to make a clean choice.
To counter charges of favoritism, an external consultant was retained
to evaluate the competing systems. Unisys won the battle, and a crop of
new ClearPath servers was acquired to expand capacity at the UBS datacenter in Zurich, where IT operations for the whole group were centralized. SBCs legacy datacenter in Basle continued to support those SBC
branches that had not yet abandoned the RTB software, but the bank had
all its branches running on the common IT platform in Zurich by the end
of 1999.
In February 2001, Citigroup announced a deal to buy the $15.4 billion
(assets) European American Bank for $1.6 billion from ABN Amro Holdings NV. Observers were quick to call it a defensive move. The deal,
completed ve months later, kept a 97-branch franchise in Citis home
market, the New York City area, from the clutches of such aggressive
competitors as FleetBoston Financial Corp. and North Fork Bancorp. of
Melville, New York. Although Citigroup had gained a great deal of experience in acquisition integration, it had not been an active buyer of U.S.
banks. European American, headquartered in Uniondale, gave Citigroup
executives a chance to test their acquisition, merger, and integration skills
on an acquired branch banking system.
European American Banks earnings were almost invisible on Citigroups bottom line. But 70% of its branches were on Long Island, as were
$6.2 billion of deposits, and this gave Citigroup a 10.3% local market
share, second only to J.P. Morgan Chases 13.1%. Still, the average former
European American branch lagged other Citigroup branches by 17% in
revenue and 23% in net income, although the European American
branches were ahead in terms of growth. Citigroup intended to bring its
own consumer banking expertise to former EAB branches and focus the
latters skills on serving small and mid-size business on established Citigroup markets.
One reason for the growth in branch revenue after Citigroup bought
EAB was the use of Citiproessentially a questionnaire about customers
nancial needs that is offered as a free nancial planning tool. In addition
to helping point customers in the right direction nancially, it identied
opportunities for the bank to make salesinvestments and insurance in
addition loan and deposit accounts.
The Best-of-Both-Worlds Approach
If the strategic intent is to add value through capitalizing on mergerdriven cost synergies, the best-of-both-worlds model could be appropriate. It aims to identify each aspect of the two rms IT practices that could
be adopted as the basis for building a new integrated IT structure. At the
same time, this approach requires a lengthy process of meetings between
each rms IT teams. The best systems and processes of both need to be
144
identied, analyzed, and nally adopted. The key question is whether the
two IT platforms are compatible. Where this is the case, synergies can be
realized by incremental adjustments, capitalizing on possibilities for learning among the individual elements in the IT organization. However,
where the congurations are incompatible, high costs associated with a
long period of systems realignment are likely to be encountered.
An example of this approach was the acquisition of a Chicago derivatives boutique, OConnor & Associates, in 1994 by Swiss Bank Corporation. OConnor used very sophisticated front-end IT applications in its
derivatives business, whereas SBC used fairly standard software packages
that were not as exible and not as up-to-date with respect to the latest
business developments. As a consequence, SBC decided to keep
OConnors IT applications and progressively integrate them into the
existing SBC (later UBS) platforms. Having chosen the best-of-bothworlds approach, the bank was at the same time able to absorb knowledge
about the derivatives business and its IT implications.
Preservation: Keeping IT Systems Separate
Here the acquirers strategy does not provide for any integration of the
IT systems of the two companies. All components are intentionally kept
independent. The only linkages are those for transmission of the data
necessary for corporate management. The two organizations remain separate.
This setup is usually only selected for acquisitions of unrelated or
geographically distinct businesses. Maintaining separate IT congurations
is likely to be low risk and minimizes integration complexity. Whether
the two premerger IT congurations t or not is irrelevant. The individual
IT platforms are sustained, interdependencies minimized, and integration
limited to establishing interfaces between the systems. This avoids the
organizational complexities associated with attempting to combine the
two congurations. Although it is low-risk, the preservation option generally produces a higher overall IT cost structure, since there are few gains
from economies of scale and reduced levels of resource duplication.
When Citicorp and Travelers announced their merger in 1998, it was
clear that this was not supposed to be a cost-driven deal, but rather a
revenue-driven transaction. With relatively limited overlap in activities
and markets, there was less duplication and, as a result, less cost takeouts
that were likely to occur. Indeed, Citicorp CEO John Reed and his counterpart at Travelers, Sandy Weill, did not emphasize cost cutting in their
April 1998 announcement of the transaction. They planned on boosting
their share of wallet through cross-selling between Citibanks 40 million
U.S. customers and Travelers 20 million clients. Analysts estimated that
the greatest advantage in cross-selling would go to the former Citicorp,
which would integrate customers account information, including insurance, banking, and credit cards, onto one statement. Facing incompatible
IT congurations and the mandate to generate new revenue streams
145
through cross-selling, Citi and Travelers decided not to follow the traditional absorption approach, but rather to keep their IT systems decentralized to promote the advantage of specialized congurations.
Development of New, State-of-the-Art IT Systems
The most attractive solution following a merger sometimes seems to

be the development of a new, state-of-the-art IT platform. The rm can
then scrap all legacy systems and realize its hopes for a true world-class
system. Highly integrated IT platforms can fully support the client managers, trading oors, risk management, and top management requirements. Still, a complete buildup from scratch takes a long time and will
absorb most IT resources for an extended period. Moreover, the rm risks
being incapable of reacting to new market developments requiring an IT
response. Besides, a de novo IT platform may be difcult to manage and
to nance.
COMPARATIVE GAINS AND COSTS
The four integration options reviewed here can be seen from an IT strategy
and conguration perspective. In a merger with two incompatible IT
congurations, the implementation of a best-of-both-worlds approach is
difcult. Attempting to adopt individual components from each conguration and then blend them into a new and more powerful system can
easily fail, so the absorption model can often be more appropriate. In
contrast, in a merger with two compatible IT congurations the absorption
approach could result in large cost savings. It can also provide the opportunity for the value-added via the best-of-both-worlds approach.
Evidence shows that there is an exponential increase in resource requirements associated with moving across the spectrum from the most
economic integrated platform to the development of a new state-of-theart IT system. For example, when Bayerische Vereinsbank and Vereinsund Westbank merged in 1990, the integration team tried to calculate how
many man-years it would take to complete each IT integration approach
(Penzel and Pietig 2000). According to management estimates:
Building a completely new state-of-the-art IT network would have
absorbed about 3,000 man-years, or about seven to ten years of
implementation efforts.
An integration in which about half of the IT systems of each bank
were combined would have required about 1,000 man-years.
A straightforward absorption of the Vereins- und Westbank into
the IT conguration of Bayerische Vereinsbank would have required the least resources, with about 200 man-years.
Another solution would have been to integrate most of the Vereinsund Westbank systems into Bayerische Vereinsbank, but keep a
few peripheral systems from Vereins- und Westbank running.
146
3,000
3,000
Required man-years
2,500
2,000
~2x
1,500
>1,000
1,000
~2x
670
500
200 ~2x
100:0
Integration
360
~2x
80:20
Integration
with reduced
functionality
80:20
Integration
with full
functionality
50:50
Completely
New
IT system
Figure 5-7. Potential Resource Requirements in IT Integration. Source: Penzel.

H.-G., Pietig, Ch., MergerGuideHandbuch fur die Integration von Banken (Wiesbaden: Gabler Verlag, 2000).
Some of the formers functionalities would have been lost due to

standardization. This approach was estimated to require 360 manyears, or about four years of integration time in total.
The same integration, but with the effort to preserve all the functionalities of both banks, would have increased the integration
requirements to 670 man-years (see Figure 5-7).
IMPLEMENTATION OF IT INTEGRATION
Once the integration approach has been decided, critical timing decisions
need to be made. Should the actual data conversion be gradual or in a
Big Bang? If gradual, what are the appropriate steps and sequencing?
The Big Bang approach often seems to be the most attractive on the
surface. At one pre-determined time all infrastructure systems, databases,
application software, and processing units convert and run on one common platform. Though convenient, this approach is also risky, since all
logistical, administrative, technical, and personnel issues need to be resolved in tandem. At the time of the conversion, the stress on systems
and staff can be enormous. Keeping control of the entire integration process can become difcult, especially when the IT congurations are large
and incompatible. As a consequence, major nancial rms usually avoid
the Big Bang approach.
147
In a stepwise integration, things are a bit more relaxed, but still far
from easy. Temporary links rst need to be established to allow basic data
migration. The IT congurations need to exchange high-priority information such as trading data already in the process. Once the individual
systems have been properly evaluated, conversion preparation begins and
may extend to the development of additional software. In contrast to the
Big Bang approach, data and system conversion occur in individual
steps to ensure that each system will be implemented in a timely way,
with minimal disruption for the business areas. For example, the conversion of branch networks might be undertaken regionally to reduce complexity. Individual applications within operating units might also be converted sequentially. IT management must balance the safety and reliability
of stepwise integration with the disruption and inconvenience caused for
other bank internal units, staff, and clients. New systems require extensive
training for the end-users. And all this needs to occur at a time when the
organization is already stressed by other merger integration issues.
There is little available evidence on the optimum speed of integration,
which seems to be best determined on a case-by-case basis. Functionally,
IT integration is usually best accomplished by a project manager who has
unquestioned authority and operates with minimum interference, reporting directly to the CEO and the rms executive committee. (Alternative
IT conversion choices were presented earlier in Figure 5-2.) IT integration
can easily be compromised by unnished IT conversions from prior acquisitions.
IT conversion can create a signicant operational risk for banks and
other nancial rms. If the IT congurations cannot be merged smoothly
into a stable and reliable platform, without causing major disruptions or
operational integrity, the rm could face severe consequences. Not only
can it delay the integration process as a whole, but the rm could also
become liable for damages incurred by trading partners. There could be
client defections. Regulatory concerns could also weigh heavily. Operational risks need to be incorporated into the calculation of the required
minimum equity base of a bank under revised regulatory accords. Any
major problems in a conversions process could lead to higher risk levels
and higher capital requirements.
When Wells Fargo completed its hostile takeover of First Interstate
Bank of Los Angeles in 1996 for $11 billion, it was a record deal in the
U.S. banking industry, and it drew rave reviews from Wall Street analysts.
But they soon changed their views. Stung by IT problems and what some
outsiders said was a heavy-handed approach to pushing customers into
new types of accounts, the banks saw angry business and retail clients
head out the door. The expected 7,500 job losses soon turned into nearly
13,000 as revenues dwindled. The embarrassment reached a climax in
summer 1997, when Wells Fargo admitted it incorrectly posted customer
deposits to the wrong accounts and was unable to nd the money
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although customers were quickly made good on the missing balances

(Silverstein and Vrana 1998).
Mizuho: How Not to Approach IT Integration
Mizuho Bank and Mizuho Corporate Bank were launched in April 2001
by the Mizuho Financial Group, following the groups reorganization of
its three former core banksDai-Ichi Kangyo Bank (DKB), Fuji Bank and
the Industrial Bank of Japan (IBJ)into the two Mizuho holding company
subsidiaries. After the merger Mizuho Group was the worlds largest banking company in terms of assets.
On April 1, 2000, Mizuho Bank announced that it had encountered
major IT problems, causing most of its 7,000 automated teller machines
(ATMs) to malfunction across the country (Journal of Japanese Trade and
Industry 2002). The retail banking arm was also troubled by delays in
money transfers for customers utility and other household payments.
The total number of pending money transfer orders reached 2.5 million
at the peak of the problem. Similar problems that plagued Mizuho Bank
also impacted Mizuho Corporate Bank. Customers were often doublebilled for various charges. Mizuhos ATMs had recovered by the morning
of the following day, but the backlog of money transfer orders could not
be cleared until April 18.
It was the rst time that payments systems at a major bank in Japan
had been so extensively disrupted. Some business clients using Mizuho
as their clearer for their customers bill payments had to send their clients
blank receipts or apology letters because many money transfers had not
been completed by the due dates. Although the bank reimbursed customer losses in certain cases, some corporate clients announced their
intention to seek damages from Mizuho Financial Group. The problems
were compounded because Mizuhos IT system integration coincided
with the April 1 start of a new scal year, when the volume of nancial
transactions usually spikes. There had already been payment delays at
the end of the previous scal year.
Mizuhos relay computers connecting the various operations went
down, overloaded by the massive volume of data processing. Human
errors, such as erroneous programming and false data inputs, compounded the problem. It soon became clear that the Mizuho asco was
not simply the result of an unfortunate coincidence, but was caused by a
combination of management mistakes such as insufcient computer tests,
programming defects, and human error. It also raised questions about the
role played by the Financial Services Agency (FSA) and the Bank of Japan
as nancial regulators and supervisors. And it suggested the need for
strengthened bank inspections focusing on IT operations.
One cause of the Mizuho debacle seems to have been power struggles
among the three legacy banks in anticipation of the IT integration, a
massive reorganization project stretching over three years. One of the key
challenges was how to integrate the three banks respective computer
149
systems. DKB cooperated with Fujitsu Ltd., Fuji Bank with IBM, and IBJ
with Hitachi. In December 1999, four months after the announcement of
the three-way merger, the banks decided that a merged retail bank would
adopt the DKBs Fujitsu-based computer system. That plan was rescinded
in November 2000 due to strong opposition from Fuji Bank, which was
concerned that the DKB would turn out to play the leadership role in
developing the combined retail banking platforma vital issue for any
commercial bank. As a result, the banks reached a compromise: they
would install relay computers connecting the three separate IT platforms
while keeping the existing systems for one year after the April 2000 launch
before eventually integrating them fully.
Evidently the integration plan had some fundamental problems, such
as delays in decision making and insufcient computer load tests. Mizuho
had turned down requests by Tokyo Electric Power Co. to conduct computer tests beforehand.
The series of episodes suggested that Mizuho did not seem to have a
clear information technology strategy within the framework of the overall
merger integration plan. Moreover, Mizuho management may not have
been fully aware of the associated operational risks. Japanese banks,
whose credit ratings continued to be under pressure due to slow progress
in disposals of nonperforming loans, were concerned that the Mizuho
debacle could further undermine the condence in the Japanese banking
industrys credibility. This was especially important in light of Bank for
International Settlements plans to include banks preparedness for operational risk in a new set of guidelines to be adopted in 2006 (Basel 2)
to promote operational integrity and soundness. The fallout of the Mizuho
asco developed into a political issue and ultimately led to a reprimand
from Japanese Prime Minister Koizumi, a highly unusual event.
WHY DOES IT INTEGRATION SUCCEED OR FAIL?
At the end of the 1980s, in a study conducted by the American Management Association (AMA), two-thirds of the companies involved in M&A
transactions indicated that there was an inadequate basis for making
informed decisions concerning IT issues (Bohl, 1989). Half of the respondents reported that this information was unavailable because no one
thought to inquire. IT professionals were often not involved in (or even
told of) pending structural changes until an ofcial merger announcement
was made (Bozman, 1989). With little warning, IT personnel were expected to reconcile system incompatibilities quickly so that the ow of
information was minimally disrupted.
Although this survey was conducted more than ten years ago, mergers
of IT congurations remain just as challenging today. The need to quickly
integrate new IT systems can be an extremely difcult task for a number
of reasons. First, corporate decision making still does not always systematically include IT staff in the planning process. IT integration-related
150
planning typically does not occur until the merger is over, thus delaying
the process. Second, the new corporate structure must cope with the
cultural differences (Weber and Pliskin 1996) and workforce issues involving salary structures, technical skills, work load, morale, problems of
retention and attrition, and changes in IT policies and procedures (Fiderio
1989). Third, the lack of planning results in shifting priorities relative to
the development of application projects. Fourth, technology issues relating to compatibility and redundancy of hardware and software, connectivity, and standards must be resolved. However, the integration of noncompatible systems is time consuming and cannot occur overnight if done
properly. Corporate expectations relative to IT integration during the
M&A process are often unrealistic. All of these factors can impede the
successful integration of IT during merger activities, create information
shortages and processing problems, and disrupt the normal ow of business.
In a survey of 44 CIOs of companies that had undergone corporate
mergers during 19891991, an attempt was made to examine the relationships between the measures of IT integration success and the components
that affect it (Stylianou, Jeffries, and Robbins 1996). According to the study,
the quality of merger planning appears to be an important contributor to
the success of the integration process, contributing to the ability to exploit
merger opportunities while avoiding problems in merging the IT processes. This could often be achieved by including IT personnel in premerger planning activities and performing an IT audit prior to the merger.
Data sharing across applications and programming language incompatibilities also plays a role. There seems to be greater success in the
integration process when there is a high level of cross-application datasharing. Not surprisingly, programming language incompatibilities have
a negative impact on the success of the integration process. A large number of changes in IT policies and procedures also have a negative impact
on personnel. Decreases in IT salaries or benets surely leads to a decline
in morale, and this reduces the chances of successful integration. Redundancies and defections also reduce the ability of the IS workforce to avoid
merger problems.
The results of this study indicate that in addition to past integration
experience, outcomes in the IT area following a merger or acquisition are
managerial in nature and largely controllable. Successful integration requires high-quality merger and IT integration planning, positive support
by senior management, good communications to the IT systems end
users, and a high level of end-user involvement in strategic decision
making during the process. In addition, as expected, an emphasis on IT
standardization is a positive factor.
In another study, commissioned by applications development specialist
Antares Alliance in 1997, senior IT managers from 45 U.K. organizations,
including nancial services, were surveyed. All of the organizations in
151
the survey had experienced a 25 million or larger merger or acquisition.

When it came to nancial services, the research found that banks, building
societies, and insurers appeared to suffer more from postmerger IT problems than their nonnancial counterparts. Dealing with legacy data and
the integration of IT staff following a merger or acquisition were seen as
major problemsfar more so than for nonnancial institutions. In addition, despite the inevitable change that follows mergers and acquisitions,
fewer than half of the respondents said they would use M&A as an
opportunity to review overall IT strategy. Only 20% took the opportunity
to move packaged applications, 17% to scrap legacy data, and around
12% to migrate from central mainframe computers to distributed clientserver systems. In contrast, 60% of the organizations surveyed said they
would use an M&A deal as an opportunity to review IT applications
software (Green, 1997).
Although the synergy potential of M&A deals is widely promoted,
attempts to exploit such synergy in IT are often unsuccessful. One of the
most important factors is organizational culture (Weber and Schweiger
1992). Culture clash in M&A deals is marked by negative attitudes on the
part of the acquired management toward the acquiring management.
(Pliskin et al. 1993; Romm et al. 1991). These attitudes reduce the commitment of the acquired managers to successful integration of the merging
companies and inhibit their cooperation with the acquiring rms management. Moreover, when there is intense and frequent contact, such as
under high levels of IT integration, cultural differences increase the likelihood of conict between the two top management teams involved in
the merger. Since nancial rms hope to harvest IT integration synergies,
this will most likely be associated with more contact between the two top
management cultures, setting the groundwork for culture clashes whose
negative performance effects may offset some of the potential positive
effects of IT integration.
In a study of 69 companies that completed an M&A process, 40 of
which were banks, Weber and Pliskin (1996) investigated the potential
contribution of IT integration to the effectiveness of merger and acquisitions. The ndings provide systematic evidence that organizational culture plays an important role in the effective implementation of IT integration. Specically, for banks, strong culture differences between the two
merging IT units are negatively associated with merger effectiveness. For
such rms, internal management processes associated with the level of t
between the organizational cultures may determine whether investment
in IT integration can be effectively translated into better performance. The
study found that banks, as opposed to other industries represented in the
sample, engaged in higher levels of IT integration in an attempt to realize
the potential synergy from integration. The results do not support the
view that the degree of IT integration following an M&A transaction is
associated with effectiveness of the merger.
152
WHAT ARE THE KEY LESSONS?
Information technologies represent a critical resource for the nancial

services industry. Mergers and acquisitions, and the resulting task of
integrating diverse systems, have the potential to disrupt and throw out
of alignment the smooth operation of even the best-managed IT systems.
However, an IT organization can use the opportunities offered by an M&A
event to achieve a positive net impact on its capability to perform and
contribute to the organizational objectives. Important lessons are the following.
First, nancial institutions should deal with potential IT integration
issues as early as possible, as soon as merger talks start. If a rm has not
solved its own internal IT problems, an acquisition decision will only
further complicate the situation. The underlying business strategy and IT
strategy should be aligned and not stand in sharp contrast in a potential
merger situation.
Second, IT integration is not only a technical issue. Management should
pay as much attention to questions of cultural t during premerger search
processes as they do to issues of potential synergy from IT integration.
Problems during integration can be the consequence of a more complex
organizational mist between the merging IT congurations (Johnson,
1989). The effectiveness of the strategic planning process can be enhanced
by early diagnosis of organizational and technical ts. Some of the failures
can be attributed to premerger discussions that tend to focus on the nancial components of the deal while ignoring the problems associated
with integrating the technical architecture and organizational infrastructure of the two separate entities. So IT tends to be ignored in the M&A
planning process. To minimize the disruptive nature of integrating them,
the acquirer and targets technical architecture and organizational infrastructure should be assessed prior to the acquisition. As a result, IT professionals should be fully involved in the entire process, including premerger discussions, so that potential integration problems can be
identied early (Johnson 1989; McCartney and Kelly 1984).
Third, even if an acquirer is aware of the technical and organizational
IT issues, the integration of IT following a merger must proceed carefully
in order to reap any anticipated synergies. Cultural clashes may severely
damage the cooperation and commitment of the very group that may be
instrumental in determining the success of the IT integration and ultimately the merger itself (Buck-Lew et al. 1992; Weber and Pliskin 1996).
Finally, the cost and the risk of IT integration should always be taken
into account when evaluating the feasibility of a merger or acquisition,
although it will rarely be the determining factor. Companies merge for
many reasons, and if margins are so tight that one cannot incorporate the
cost of appropriate IT integration, the deal itself might not be sustainable.
6
What Is the Evidence?
The previous ve chapters of this book have considered, in sequence (1)

reconguration of the nancial services sector and its impact on strategic
positioning and execution in nancial intermediaries, (2) the importance
of M&A transactions in that reconguration process, in terms of the structure of the global transaction ow, (3) where the gains and losses from
M&A transactions in the nancial services sector are likely to come from,
and (4) the all-important issues centering on post-merger integration.
Chapters 6 and 7 of this book seek to answer a simple question: So
what? Does all of the intense and sometimes frantic M&A activity actually
serve to benet shareholders by improving their rms competitive performance and long-term, risk-adjusted equity returns? And does it create
a leaner, more efcient, more creative, more globally competitive, and
more stable and robust nancial system? This chapter deals with the rst
of these questions, and Chapter 7 deals with the second. Neither question
is easy. To come up with defensible answers, it is necessary to come up
with plausible stories of what would have happened in the absence of the
M&A activity that occurred. Since such an exercise inevitably deals in
hypotheticals, the conclusions are always subject to further debate.
There are two approaches to this issue. One is a clinical examination
of case studies in an effort to understand the rationale and execution of
individual M&A transactions in the context of a rms overall strategy, in
order to determine whether and how they helped move that strategy
along in the achievement of improved and sustained market share and
protability. A second approach is to focus on the universe of M&A
transactions captured in a large dataset and, by using various statistical
techniques, try to separate characteristics that seem to distinguish successes from failures.
This chapter begins with three illustrative case prolesAllianz AG,
J.P. Morgan Chase, and GE Capital Servicesto ascertain what manage-
153
154
ment thought they were achieving by undertaking specic or sequential

acquisitions, how they presented the various cases to the market, and
evidence as to what was actually accomplished. This is followed by a
data-based survey of available quantitative studies on the evidence.
CASE STUDIES
In a very useful discussion based extensive interviews with senior managers at some 30 nancial services rms, Davis (2000) concludes that the
impact of mergers and acquisitions on the shareholders of acquiring rms
seems to have little bearing on the proclivity of managements to engage
in M&A deals. In 11 of 33 transactions examined, the presumed synergies
were minimal and not rigorously quantied in advance. Moreover, in
some cases potential benets were lost in excessively hasty execution of
the integration process. In other cases, the integration process was too
protracted, with much the same end result. In some cases as well, there
were nasty surprises that were not caught in the due diligence phase of
the transactions. Especially cross-border deals seemed to be problematic,
due to greater difculty in quantifying gains and extracting synergies. A
key issue in many cases appears to be overpayment, so where value was
in fact extracted from an acquisition it ended up with the shareholders of
the target rms, who have the additional benet of getting paid up-front
and escaping the downside risk.
Davis takes care to identify some exceptions. Examples include Chemical Banks acquisition of Manufacturers Hanover Trust Company under
Walter Shipley, and its subsequent acquisition of Chase Manhattan, and
Sandy Weills imaginative and opportunistic construction of Citigroup
though sequential acquisitions, each apparently well targeted and executed and creating an apparent Weill premium for a time in the Citigroup share price. Richard Kovacevichs creation of a silk purse out of a
sows ear at Wells Fargo and Angel Corcosteguis role in the shaping of
Banco Santander Centeral Hispano (BSCH) in Spain also attract praise, as
does Sir Brian Pitmans role in the creation of Lloyds TSB.
Of course, things do change, and the proof of the pudding may not
become evident for a while. Two years after these cases were examined
and positive conclusions drawn, J.P. Morgan Chase and Citigroup had
come under a massive cloud and were busy rethinking their various businesses, caught in the middle of the Argentine, telecoms, and corporate governance disasters. BSCH, too, suffered large losses in its Latin America
strategy, and Corcostegui was gone. Lloyds TSB and Wells Fargo continued
to do well, although even here observers were asking: Where next? Evidently reaching conclusions based on individual cases is a hazardous business, even without falling into the trap of trying to generalize from them.
A much more informal way of making this point is simply listing each
years winner of Banker of the Year awards in the various trade
publications (the selections usually being inuenced by recent M&A trans-
155
actions), and then tracking what happened to their rms share prices in
the ensuing period. The conclusions are rather sobering.
According to Davis (2000), the reasons for the apparent paradoxes in
management behavior in nancial-sector M&A case studies seem to be
related to preoccupation with (1) a presumed overriding industry consolidation process and the herd-like desire to be part of it, (2) the notion
that the current deal is an exception to the decidedly mixed track record
of others, based on factors such as management superiority and creativity,
and (3) the fact that managements own gains and losses are in the end
rather distinct from those of ordinary shareholders due to compensation
arrangements approved by their boardscompensation arrangements
that may not have very much to do with long-term risk adjusted total
return objectives. One could perhaps add the catalytic impact of management consultants and investment bankers, who may instill fears of being
caught in the middle, eat or be eaten, or tagged as being out of the
ow. Combined with an overreliance on external advice in the press of
daily business and the desire to tell a growth story to the market, this
kind of self-reinforcing, herd-like behavior in corporate strategic actions
among nancial rms is not too difcult to imagine.
Plenty of other case-related evidence on nancial sector M&A transactions also exists. Most of it comes from nancial analysts focusing on
the nancial services sector, who diagnose the positives and negatives of
individual M&A transactions on announcement, and then try to assess
how they are likely to contribute to the value of the franchise over a
period of time. They are, after all, supposed to be providing unbiased,
expert advice to investors. But since some of the best analyst coverage of
nancial services rms comes from the major investment banks, their
objectivity has been heavily compromised in recent years by conicts of
interest relating to their rms capital-raising and advisory businesses.
These conicts of interest arguably contribute a systematic positive bias
to their assessments of nancial services deals, as it does in other sectors.
For example, in the April 1998 announcement of the Citicorp-Travelers
merger-of-equals that formed todays Citigroup, every analyst covering
the two rms had either strong buy or buy recommendations on the
two stocks. Although a survey of the analyst coverage shows plenty of
pluses and minuses, the balance was overwhelmingly weighted in favor
of the pluses. Maybe this was objective. Maybe not. Still, many of the
recommendations looked as though they had emanated from the two
rms investor relations departments. One way to avoid this problem is
to rely more heavily on analysis emanating from buy-side rms such as
Sanford Bernstein or Prudential Securities. Another option is to review of
the work of consultants and academics that are (one hopes) distanced
from commercial relationships with parties to the deal.
Judging from anecdotal evidence reported in innumerable media reports, there are plenty of examples of nancial rms that have both succeeded and failed in M&A transactions in recent years, each of which
156
could be the subject of a clinical case study. Among the most actively
reported deals are the following:
Deutsche Banks 1989 acquisition of the U.K. merchant bank and
asset manager Morgan Grenfell & Co. at a cost of $1.5 billion. In a
transaction that many felt was overpriced, Morgan Grenfell was
allowed to pursue an independent course for years without Deutsche forcing through effective integration or leveraging its corporate nance capabilities through its own broad client base. Then
the bank was blindsided in 1996 by a Morgan Grenfell Asset Management rogue employee scandal in London that cost the bank
$600 million to restore client assets plus $330 million in client
restitution paid by Morgan Grenfell Asset Management and $1.5
million in nes to British regulators. Later, Deutsche acquired a
wounded U.S. money center bank, Bankers Trust Company, and
appeared to do a much better job of making the most of the acquisition, gradually pulling itself to within striking range of the
worlds top-tier wholesale banks.
Credit Suisse Groups acquisition of Winterthur insurance for $8.51
billion in 1997 and U.S. investment bank Donaldson Lufkin Jenrette from Groupe AXA for $12.8 billion in 2000. In the Winterthur
case, cross-selling of banking and insurance seemed to be less
successful than hoped, and as a diversication move failed miserably as crashing equity markets in 2001 and 2002 hit both the
Groups insurance and investment banking businesses simultaneously. All of this occurred against the backdrop of critical
management problems in its investment banking unit, Credit
Suisse First Boston, including a series of regulatory sanctions and
nes around the worldsymptomizing a culture that was clearly
out of control and that needed some serious reining in. These
problems came on top of overpriced, badly timed, and poorly
executed acquisition of Donaldson Lufkin Jenrette. In 2002 the
Credit Suisse Group was forced to inject $1.1 billion into its Winterthur insurance unit in order to prevent capital impairment due
to investment losses. At the same time, its CS First Boston unit was
suffering from the same revenue collapse as its investment banking
competitors and, as it was trying to right itself from its long string
of management snafus and excessive costs, CSFB found itself in
the middle of U.S. regulatory and Congressional investigations
into the role of banks in Enron and other corporate governance
scandalsas well as $100 million and $200 million settlements
over IPO practices and analyst conicts of interest, respectively.
Maybe it was bad luck. Maybe bad management. Maybe bad strategy. Maybe a bit of each. In any case, CS shares dropped by 60%
in the eight months ending December 2002, and rumors identied
the rm as a possible takeover candidate for a large international
157
group particularly interested in its private banking and investment

banking franchises.
Fortis attempted one of the more ambitious among European
M&A-driven strategies by merging Dutch and Belgian banking
and insurance groups into a nancial conglomerate that was at
once cross-functional, cross-border, and cross-cultural (and with
shares listed in both the Belgian and Dutch markets). Following
such acquisitions as the Dutch merchant bank MeesPierson from
ABN-AMRO for $1.12 billion in 1996 and the Dutch insurer ASR
from the City of Rotterdam for $3.5 billion in 2001, Fortis remained
largely a Belgian-dominated conglomerate with a massive home
market share but indifferent share price performance.
A Dutch group, AEGON NV, executed a much more focused
acquisitions-driven strategy concentrating on life insurance, serially acquiring control of Hungarian state-owned insurer Allami
Biztosito in 1992, U.K. life insurer Scottish Equitable in 1993, Providians U.S. insurance business in 1997, and in 1999 both Transamerica Corporation in the United States and the life insurance
business of Guardian Royal Exchange in the United Kingdom. In
the process it became the worlds third largest insurer in terms of
assets. The highly focused, rapid, and apparently disciplined
growth by acquisition was combined with strong protability and
impressive share price performance until the Transamerica transaction, which many regarded as overpriced and beset with difculties in unloading the targets peripheral businesses. This, together with management change and general problems in the
insurance sector, caused AEGON shareholders to give back much
of their earlier gains and required a capital increase in 2002.
UBS AG is likewise the product of a targeted strategy executed via
sequential acquisitions, large and small, mostly initiated by the
former Swiss Bank Corporation (SBC), then the countrys third
largest bank. The most important strategic acquisitions among
them include the former Union Bank of Switzerlands purchase of
U.K. fund manager Philips & Drew in 1984, SBCs creation of a
joint venture and later acquisition of the U.S. derivatives rm
OConnor & Partners in 1992, U.S. institutional asset manager Brinson in 1994, the U.K. merchant bank S.G. Warburg in 1995, the U.S.
corporate nance specialist Dillon Read in 1997, and later that year
the merger of SBC and UBSfrom a management perspective a
takeover of the larger UBS by the smaller SBCto form the new
UBS AG. Thereafter there were two more strategic acquisitions by
the combined rmGlobal Asset Management in 1999 and U.S.
retail broker PaineWebber in 2000. Looking back, the strategy appeared to be consistent and well-executed to focus on three pillars:
global private banking and asset management, wholesale and investment banking, and leadership in domestic retail banking. Most
158
of the acquisitions appeared to be carried out in a targeted and

disciplined way, especially the integration process, so that by 2002
UBS had become the largest bank in Switzerland and the worlds
largest asset manager, and was closing in on the top players in
global wholesale and investment banking.
Royal Bank of Scotland, having taken over National Westminster
Bank in a hotly contested battle with the Bank of Scotland, in 1991
acquired the retail banking operations of Mellon Bank in the
United States to supplement its 1989 acquisition of Citizens Bank,
active in New England, plus 19 smaller acquisitions. Management
argued that the banks U.S. technology platform was not fully
utilized, and that more acquisitions would be sought. Evidently
the RBS U.S. business was a well-managed, protable, stand-alone
venture capable of competing effectively against both large and
small domestic rivals in a number of regional markets.
Citigroups M&A history is probably the most dramatic of any
nancial institution in the world. Primerica Corp. (itself an amalgam of several predecessor rms under CEO Sandy Weill), acquired Smith Barney in 1987 and Travelers Corp. in 19921993,
and as Travelers Inc. acquired Shearson Lehman Brothers Inc. in
1993, the property insurance business of Aetna in 1996, Salomon,
Inc. in 1997, Citicorp in 1998, and then as Citigroup Inc. acquired
Travelers Property Casualty in 2000, Associates First Capital Corp.
in 2000, and European-American Bank, Bank Handlowy in Poland,
the investment banking business of Schroders PLC and Peoples
Bank Cards in the UK, Fubon Group in Taiwan and BanamexAccival in Mexico, all during 2001, in addition to an array of
smaller acquisitions in the United States and abroad. This remarkable track record and what by all appearances was effective and
rapid integration created a nancial conglomerate that seemed to
deliver the goods for shareholders until the U.S. nancial and
corporate governance scandals of 20012002. Given the breadth
and depth of its reach, it was a virtual certainty that Citigroup
would end up in the middle of such a problem, which cost the
rm and its shareholders dearly (on one day alone the stock lost
16% of its value). This, plus the earlier decision to spin off Citigroups property and casualty business to shareholders, raised
questions about when big is too big and broad is too broad.
It is not easy to determine success or failure from such case proles.
No doubt the rms involved would have had very different competitive
congurations if they had not engaged in extensive M&A activity, or
perhaps if they had engaged in different ones. But would the shareholder
have done any better? Who knows. Should Deutsche Bank have moved
more aggressively to integrate Morgan Grenfell? Sure, and they did just
that with the takeover of Bankers Trust. Should Credit Suisse have used
159
a premier banking franchise to fritter away resources on an investment

bank that had become semidetached? Probably not. Nor should AEGON
have violated its own return on equity hurdle rate to acquire Transamerica, which many at the time considered one step too far. And even UBS,
which seemed to go about things in a disciplined, transparent, and purposeful way, may have overstepped with PaineWebbera solid U.S. retail
brokerage rm but fully priced and with little in common with the banks
core afuent target global client base in its most important business,
private banking. Even Citigroup, amply rewarded by the market after its
1998 creation, was blindsided by events. When mistakes are made, they
are not too difcult to diagnose after the fact.
Perhaps the most dramatic M&A deal in recent years that did not
actually take place was the $30 billion merger of Deutsche Bank AG and
Dresdner Bank AG, with heavy involvement by Allianz AG, announced
in March 2000. The deal would have created the worlds largest bank,
with $1.2 trillion in assets. The idea was to merge the two banks troubled
retail businesses into a single entity, taking the name of Deutsche Banks
Bank 24. This entity would be the product of a three-way exchange of
shares under which Allianz would swap its 5% holding in Deutsche Bank
and its 21.7% holding in Dresdner Bank for a 49% stake in the new Bank
24. Initially the retail business was to be run by Deutsche Bank, but it
would also provide Allianz with a bank-based platform for the sale of
insurance products. Bank 24 would then be oated in an IPO as an independent rm, with Deutsche Bank selling its shares and Allianz reducing its stake to about one-third. As part of the deal, Deutsches mutual
fund business, DWS, would also be sold to Allianz, together with Deutsche Herold (Deutsches insurance business) for about $5.8 billion.
Meantime, the Deutsche and Dresdner retail businesses would undergo
far-reaching cost savings, estimated to be worth about $2.5 billion,
through branch closings and job cuts. The two banks remaining asset
management businesses would create one of the worlds largest fund
managers at a time when managed asset pools, notably in the pension
sector, were expected to grow rapidly in Europe. The combined investment banking operations of Deutsche and Dresdner were intended to
provide a stronger base for competing with the dominant American rms,
although the deal seemed to do little to broaden the combined rms
footprint in areas such as M&A advisory work, initial public offerings,
and some other parts of the equities business. Nor did it help create a
pan-European banking and securities platform. The plan was that RolfErnst Breuer and Bernhard Walther, heads of the two banks, would become co-heads of the combined entity and that Dresdner shareholders
would own 39% of the new rm.
Initial reactions to the announcement were highly negative. Analysts
and shareholders basically concluded that Deutsche Bank had been taken
to the cleaners by Dresdner and especially Allianz. One estimate was the
Deutsche was getting about $5.5 billion too little for asset disposals while
160
paying about $5.5 billion too much for Dresdner Bank. The announcement
that there were $2.6 billion in synergies expected beginning in 2003 was
seen as unrealistic, given that most of the cost cuts were likely to come in
Bank 24, which was to be divested. Observers also expected that restructuring charges would exceed the announced $2.7 million. And there was
concern about how the co-CEO plan would work out, particularly in light
of the very different corporate cultures of the two rms.
So both the strategy and the structure of the Deutsche-Dresdner deal
raised plenty of doubts. Shares of Deutsche Bank dropped 6% on announcement day, and Dresdner shares dropped 6% as well. The deal never
happened. Deutsches investment bankers were clearly unhappy with the
merger of the wholesale businesses, taking the view that they were making good progress in investment banking on their own after the acquisition of Bankers Trust Company and that Dresdners investment banking
operation, Dresdner Kleinwort Wasserstein, was mainly excess baggage
much of which would eventually be torched. Certainly they were unwilling to see the inevitable redundancies in the securities business come
from their own ranks. Nor did the word torch do much to boost morale
at Dresdner Kleinwort Wasserstein. Faced with insurrection among his
investment bankers, Breuer backtracked. Feeling betrayed, Walther resigned. The deal was off, with plenty of bruised egos left in its wake.
From case-based evidence, the key seems to be a well thought-through
strategy that promises sustainable risk-adjusted excess returns to shareholders under plausible market developments, which is then carefully
carried out with the help of selected corporate actions. One of the key
factors is realistically priced M&A deals. In other words: doing the right
thing, at the right price, and then doing it right. Everyone strives for this, but
some do it better than others. Here we shall look in somewhat greater
detail at three merger-intensive nancial services rms with very different
characteristics and equally different patterns in use of M&A transactions
for strategic developmentAllianz AG, J.P. Morgan Chase, and the former GE Capital Services.
Allianz AGDresdner Bank AG
Founded in 1890, the Allianz Group at the end of 2000 was the worlds
largest property and casualty insurer in terms of premium income. It was
ahead of U.S. rival AIG and was the third largest European life insurer.
Property and casualty insurance represented 55% of its total premium
income, with life/health insurance making up the remaining 45%. P&C
traditionally accounted for 8085% of total group net earnings. Moreover,
the importance and protability of its German home market, in which
Allianz was the P&C and life insurance market leader, were equally striking, with a third of Allianzs total premium income coming from Germany.
Allianz, in short, was the leading German insurer and the leading P&C
insurer worldwide. Management was determined to turn the rm into a
high-performance global supplier of a diverse set of nancial services,
161
and so several of M&A transactions were launched in order to implement

this strategic vision.
Table 6-1 shows the sequence of major Allianz acquisitions from 1984
to 2001. Announced in early April 2001, the most important of these was
the $24 billion acquisition of Dresdner Bank AG. This created a multifunctional nancial rm with a market capitalization of $98 billion and
combined revenues of about $90 billion. The merged company employed
182,000 and spanned businesses ranging from insurance to asset management, and from mass-market retail nancial services to wholesale commercial and investment banking. In terms of asset size, the Allianz Group
at the time ranked as Germanys largestand the worlds fourth largest
nancial services rm, with over $900 billion in assets.
The key justication for the Allianz acquisition of Dresdner Bank was
to position the combined rm for a capital markets windfall that German
pension reform was expected to generate. Success was dependent on
developing strong distribution (asset-gathering) capabilities, as well as
having an asset management (production) platform with sufcient scale
and expertise. The acquisition aimed to exploit cross-selling opportunities
in long-term savings products (for example, whole life insurance, annuities, and mutual funds) by using both its own agent-based insurance
distribution platform and Dresdners extensive retail branch network. In
order to tap the promising German institutional pension market, the
merged rm intended to leverage Dresdners roster of corporate banking
relationships. In asset management, Dresdner contributed about $230 billion in assets under managementraising total Allianz Group AUM to
more than $600 billion at the end of 2001 and $1.1 trillion if unit-linked
products (annuities) and the Groups own investments are included. The
merged duciary asset management platform, renamed ADAM (Allianz
Dresdner Asset Management), promised signicant scale economies and
offered a broad diversity in investment styles. Finally, Dresdners investment banking division, Dresdner Kleinwort Wasserstein (DKW), had a
good record in M&A advisory work, although it remained a mid-size
player in the industry.
At the time of announcement, Allianz management estimated the acquisition would contribute about $285 million in net synergies, starting
in 2002, to eventually reach about $1 billion by 2006 (see Figure 6-1).
Cumulative net synergies were to amount to about $3 billion during this
period, including $360 million in restructuring costs. The bulk of synergies
would be provided by distribution (46%) and asset management (33%),
and to a lesser extent by organizational restructuring and IT (21%). Most
of the identied synergies were revenue-based, rising from only 11% in
2002 to 70% by 2006.
Allianz already owned 21% of Dresdner prior to the acquisition, so the
outstanding 79% interest was valued at $24 billion, including a 25% premium of $5.8 billion. The terms of the $30 billion transaction were one
Allianz share and $185 in cash for every 10 Dresdner shares ($52 per
Table 6-1 Chronology of Key M&A Transactions of Allianz AG (19842001)
Target (100% unless

noted)
162
RAS (51%)
Cornhill Plc. (98%)
Deutsche Versicherung
(51%)
Firemans Fund
Elvia1
Lloyd Adriatico1
Vereinte Health1
Elementar1
AGF (51%)
First Life
PIMCO (70%)
Nicholas Applegate
Dresdner Bank AG
Deal
Announcement
Date
Industry Focus of
Target
Target Geographic Market
Acquired
Stake
1984
1986
1990
Insurance
Insurance
Insurance
Italy
United Kingdom
Germany (Former GDR)
51%
98%
51%
585 million
524 million
138 million
1991
1995
1995
1995
1995
1997
1999
2000
2001
2001
Insurance
Insurance
Insurance
Insurance
Insurance
Insurance
Insurance
Asset management
Asset management
Diversied Financial services
United States
Switzerland
Italy
Germany
Austria
France
South Korea
United States
United States
Germany/Global
100%
N/A
100%
N/A
N/A
51%
100%
70%
100%
80%
3.6 billion
N/A
556 million
N/A
N/A
4.6 billion
297 million
3.7 billion
1.1 billion
24.8 billion
Source: Allianz AG.

1
These acquisitions were part of the same transaction with Swiss Re.
Acquisition Price
Price (In i)
163
Figure 6-1. Allianz-Dresdner, Expected Annual Net Synergies from Business Segments
and Functional Areas (20022006).
Dresdner share). In structuring the deal, Allianz intended to unwind its

cross-shareholdings in a tax-efcient way (see Figure 2-6 in Chapter 2),
minimize new debt, and avoid the dilutive effects of net capital increases.
As part of the agreement to reduce its cross-holdings with Munich Re,
Allianz also planned to restructure its joint holdings in their German
insurance enterprises. This step allowed Allianz to redeploy the released
capital in its core businesses.
Upon announcement, Allianz projected the deal to be earningsaccretive starting in 2001 even without synergies. The insurer was then
forecasting a combined 2001 net income of $2.7 billion after deducting
$540 million in goodwill and nancing chargesan increase in earning
per share of 13%. Allianz also anticipated that the reduction in crossshareholdings would increase the rms free-oat from 65% to 80% and
would positively inuence its share price. The Allianz shareholding structure after the Dresdner Bank acquisition is shown in Figure 6-2.
The main Allianz objectives in the Dresdner transaction included the
achievement of better competitive positioning in both production and
distribution of a broad array of nancial services, particularly at the retail
level. Scale (driven by market share) and scope (range of products) increasingly mattered. Larger market share not only seemed to allow lower
fees due to scale economies, but also fed the perception of better reliability
(brand awareness). Wider product choice was important to enhance client
share-of-wallet, business volume, and premium pricing. Moreover, due
to low barriers to entry, production of nancial services represented the
commoditized end of the value chain, in which branding and performance were key competitive advantages. Financial services rms relying
mainly on production operations were likely to be increasingly vulnerable
164

Private Investors
10%
Munich Re
21%
Investment Companies
22%
HypoVereinsbank
7%
Other Institutional Investors

40%
Figure 6-2. Allianz AG Shareholder Structure (Dec. 31, 2001)Free Float 72%, Major LongTerm Investors, 28%.
to margin pressure. In contrast, margins were thought to be increasingly

attractive in distribution and advice. The combination with Dresdner
would create a exible multichannel distribution platform, leveraging the
complementary distribution strengths of both rms in each of the principal target markets.
Allianz believed that this model could only work through an actual
merger or acquisition, as opposed to relying on cooperative distribution
agreements. Owning was perceived better than renting, since it allowed in-house retention of production and distribution and a better
realization of synergies through business integration. Management felt
that prior distribution agreements for long-term savings products with
banks in which it held minority stakes (for example, Dresdner Bank and
HypoVereinsbank) had been ineffective. These banks were often competitors as both distributors and producers in this same segment. For its part,
Dresdner viewed the acquisition by Allianz as an opportunity to restructure its retail banking business. The potential generation of fee income
from cross-selling life and P&C insurance and the intensied culling of
branches and staff planned by Allianz was seen to help improve the retail
segments high cost-to-income ratio and its overall protability.
By creating a multichannel distribution platform, the merged rm
would be well positioned across three retail channels and one institutional
distribution channel (see Figure 6-3). The key attraction of this model was
extensive access to both German institutional and individual clients. In
addition to a broad corporate reach, the combined entity would have the
second largest nancial services retail customer base in Germany, with 20
million clients. The other main justication for the Allianz-Dresdner deal
was to build its combined fund management business, ADAM, into a
world-class asset management platform serving as an in-house factory
of diverse, high-performance nancial products.
As expected, a great deal of speculation followed the Allianz acquisition of Dresdner Bank about the future of its investment banking business,
Dresdner Kleinwort Wasserstein.
165
Dresdner
Bank
Dresdner
Vermgensberatung
Advance
Bank
Figure 6-3. Allianz-Dresdner Multichannel Distribution (Germany).
On the one hand, it was argued that an investment banking business

could be a useful part of the kind of multifunctional nancial conglomerate the Allianz Group had becomeas a potentially protable unit to
serve corporate and institutional investor clients (and with low correlations of returns with the remaining Allianz businesses) and as an in-house
source of superior products and investment ideas for Allianz clients. Conversely, the Allianz capital base and distribution platform would make
Dresdner Kleinwort Wasserstein a rm to be taken much more seriously
in the world of global investment banking.
On the other hand, having an investment bank as part of the Allianz
Group could add substantially to earnings volatility. In addition, building Dresdner Kleinwort Wasserstein into one of the top ve or six rms
globally would require massive doses of capital, talent, risk tolerance,
and endurance. Furthermore, most investment banking businesses were
enormously competitive, without particularly attractive sustained profitability for most of the players. Besides, after the merger Allianz had
become such an important asset manager that the best ideas and execution were likely to ow from just about all of the major investment
banks. So the value of an in-house investment banking rm could be
quite limited.
In the fall of 2001 Allianz announced that Dresdner Kleinwort Wasserstein was not for sale. The decision was probably facilitated by the low
value of investment banking franchises at the time. Co-CEO Bruce Wasserstein subsequently resigned to become head of Lazard Fre`res and took
with him several talented senior bankers. Allianz reiterated publicly that
Dresdner Kleinwort Wasserstein would remain part of the Group.
166
Allianz management style was largely decentralized, reecting the

leaderships view of the rm as a nancial holding with a reserved right
of intervention. This meant that senior managers of acquired businesses
usually kept their positions, and subsidiaries retained considerable latitude in their own operations, for example product design, underwriting,
and distribution. Allianz only intervened directly in the activities of subsidiaries when they underperformed and required management changes
or restructuring. The Group also provided various levels of centralized
support, notably in the areas of nancial and strategic planning, investment management, rmwide marketing initiatives and information technology, and management training. Given the diversity of its operations,
the culture of Allianz was not monolithic. Instead, it represented a loosely
dened umbrella for an array of subcultures associated with very different
businesses, ranging from insurance to investment banking. As with other
large nancial services rms that grew rapidly through acquisitions, Allianz faced the challenge of moving to a common corporate superculture,
discussed in Chapter 4.
Following the Dresdner acquisition, Allianz made a number of adjustments to its long-term strategic goals. Senior management emphasized
ve strategic objectives: (1) optimize the economic value added (EVA) of
the Group, (2) capitalize on high-growth property and casualty insurance
(P&C) market opportunities by leveraging the Groups risk management
expertise, (3) build on the Groups leading position in long-term savings
and protection products by focusing on its clients old age provision
(pension) requirements, (4) expand the rms asset gathering capabilities
by building customer-specic, multichannel distribution platforms; and
(5) continue to strengthen the rms capital markets expertise.
Figure 6-4 provides the pro-forma Allianz Group revenue breakdown
by businesses for 2000, the year prior to the Allianz-Dresdner deal. Allianz
seemed to be in a position to challenge some of its principal rivals such
as Groupe AXA, AIG, and Citigroup, each of which had a global footprint
but exhibited signicant differences in strategic targeting and execution.
The question remained whether management could translate this impressive platform into a seamless global nancial services player that would
be able to combine exploitation of both revenue and cost synergies with
sufciently large market shares to create durable excess returns. The stock
market seemed to be unconvinced, as Figure 6-5 suggests. At a time when
all insurance companies were under substantial performance pressure due
to sinking equity returns and serious losses related to the terrorist attacks
of September 11, 2001, in New York, Allianz shares signicantly underperformed what was arguably its closest peer, the U.S.-based global insurer AIG.
A year after the Dresdner Bank acquisition many of the Allianzs expectations had not yet materialized. Revenues had indeed grown, although Dresdner Bank alone was estimated to have lost more than $2
billion in 2002 (loan losses of $600 million plus investment banking losses
Life & Health Insurance (A)

15.1%
Corporate Banking (D)

4.4%
Retail & Private Banking (D)
4.7%
Property & Casualty
Insurance (A)
50.9%
Asset Management (A&D)

5.9%
Other
5.0%
Investment Banking (D)

14.0%
Figure 6-4. AllianzDresdner Pro Forma Earnings Distribution, 2000 (total $6.1 billion). Source: Wall Street Journal, April 2, 2001.
Figure 6-5. Allianz AG Share Price 20012002 (compared to AIG and S&P 500 Index).
167
168
of $1.4 billion at DKW). In addition, investment losses in the insurance

business were encountered owing to weak stock markets. In March of
2003 Allianz announced its rst annual loss since 1945, totaling EUR 1.2
billion after tax for 2002 (dropping from net earnings of EUR 3.5 billion
in 2000 and EUR 1.6 billion in 2001), while the share price dropped
roughly 70% from the announcement of the Dresdner acquisitiona decline of roughtly 50% against the German Xetra Dax index. Management
continued to defend the competitive model, however, although the future
of DKW as part of the Group was increasingly called into question.
J.P. Morgan Chase & Co.
In January 1995, the share price of Chase Manhattan Corp. was $34, with
a return on assets a bit under 1%, a return on equity of about 15%, a priceto-book ratio of about 1.2 and a price-to-earnings multiple of 7.0. In the
view of some at the time, this was decidedly mediocre for a nancial
services rm that incorporated a number of rst-rate business franchises
in areas such as New York retail banking, custody, private banking, credit
cards, corporate lending, and a number of others, as well as a global
presence that seemed to embody numerous unrealized possibilities.
In April 1995, investment manager Michael Price, Chairman of Mutual
Series Fund, Inc., announced that funds under his management had purchased 6.1% of Chases stock, and that he believed the Chase board should
take steps to realize the inherent values in its businesses in a manner
designed to maximize shareholder value. At the banks subsequent annual
meeting, Price aggressively challenged the banks management efforts:
Dramatic change is required. It is clear that the sale of the bank is superior
to the companys current strategy . . . unlock the value, or let someone
else do it for you.1 Chases chairman at the time, Thomas Labreque,
responded that Prices assertions were unfounded and that he had no
intention of selling or breaking up the bank. By mid-June 1995, Michael
Price and other institutional investors, convinced that Chase stock was
undervalued, were thought to have accumulated approximately 30% of
the banks outstanding shares, and the stock price had climbed to about
$47. Labreque announced that the bank was continuing its efforts to refocus its businesses and to reduce costs going forward.
During June and July of 1995, Chase and BankAmerica talked seriously
about a merger in which the BankAmerica name would be retained. Then
BankAmerica suddenly backed out for reasons that were not totally clear.
Chemical Bank followed quickly with a proposal for a merger of equals.
According to Chemicals then CEO, Walter Shipley, This combined company has the capacity to perform at benchmark standards. And when we
say benchmark standards, we mean the best in the industry.2 Labreque
agreed, and the negotiations were completed on August 28, 1995. Chem1.. The Wall Street Journal, May 19, 1995.
2. ABC Evening News, August 28, 1995.
169
ical would exchange 1.04 shares of its stock for every Chase share outstanding, an offer reecting a 7% premium over the closing price of Chase
shares on the day before the announcement.
The combined bank, retaining the Chase name, thus became the largest
bank in the United States and thirteenth largest in the world in terms of
assets. The new Chase also became the largest U.S. corporate lending
bank, one of the largest credit card lenders, and the largest player in trust,
custody, and mortgage servicing. Shipley became chief executive, and
Labreque became president. Substantial cost-reduction efforts were
quickly launched (including large-scale layoffs and branch closings)
aimed at reducing the combined overhead of the two banks within three
years by 16%. In the month following the announcement of the merger,
Chemical Banks stock rose 12%.
Labreque denied that shareholder pressure had anything to do with
the merger. Michael Price asserted that he had not played a major role,
but was happy to have been in the right place at the right time. Nevertheless, adjusting for the exchange offer and the postmerger run-up in
Chemicals share price, Chase shares more than doubled in a little over
six months based on the markets assessment of the potential value embedded in the merger (see Figure 6-6).
Following Chemical Banks acquisition of Chase, the new Chase (CMB)
had become a broadly diversied global banking and nancial services
company, and conducted its business through various bank and non-bank
Figure 6-6. Comparative Return Analysis: Chase Manhattan Bank, 19911995. Source: Bloomberg.
170
subsidiaries, including Chase Manhattan Bank, a New York bank holding

corporation, Chase Manhattan Bank USA National Association, a national
bank, and Chase Securities Inc., a securities broker-dealer engaged in all
aspects of investment banking. Chases activities were internally organized into ve major business franchises: (1) national consumer services
(retail banking and credit cards), (2) investment banking, (3) private equity
investments through Chase Capital Partners, (4) global services (information and transaction processing), and (5) wealth management and private banking.
By 2000, Chases wholesale banking competitor J.P. Morgan (JPM) was
a leading global nancial services rm that operated mainly in corporate
and institutional business segments: syndicated bank credits, corporate
nance, equities and equity investments, interest rate and currency markets, asset management services, and proprietary trading. As the commercial banking product of the 1930s breakup of the House of Morgan
due to the Glass-Steagall Act, many long considered J.P. Morgan the best
bank in the United States.
Both JPM and CMB had been struggling to establish themselves in the
securities underwriting and M&A advisory businesses, areas that were
much more protable than traditional commercial banking. For its part,
Chase had never made a secret of its desire to buy an equities franchise
to complete the lineup of its wholesale and investment banking operations. In a bid to strengthen equities underwriting, Chase chose a path of
successive acquisitions (Hambrecht & Quist in 1998, the Beacon Group
and Robert Fleming in 2000) to strengthen its investment banking capabilities. But although it made some progress off the back of its enormous
wholesale lending and loan syndication business, Chase had been unable
to break into the top-10 ranks of key corporate nance areas such as equity
underwriting and M&A advisories.
According to many observers, J.P. Morgans future had become increasingly uncertain. Starting from an enviable base as the top U.S. corporate
bank in the 1980s, its costly transformation from a wholesale commercial
bank into a leading investment bank failed to bear as much fruit as intended. Despite a stellar client list and good progress in building market
share in a number of areas (including mergers and acquisitions), Morgan
found it very difcult to compete in critical areas such as equity originations and non-investment grade bondsespecially given its tradition of
wholesale banking for top corporates, its lack of relationships with smaller
companies in hot sectors, and its insignicant presence in retail banking
or securities distribution. With the benet of hindsight, a merger with one
of the major securities houses or even one or two targeted acquisitions
along the way could have made Morgan a viable and indeed formidable
competitor. Perhaps the terms would have been unattractive. Or an unwillingness to contaminate the banks strong culture, together with a
certain degree of arrogance, may have precluded this. It is difcult to
171
Table 6-2 J.P. MorganChase Pro-forma Revenues and Pretax

Cash-ow, 1999 ($ billions)1
Investment banking
Wealth management
Private equity
Operating services
U.S. consumer services
Revenues
Pretax Cash
Earnings
$15.9
3.7
3.4
3.3
9.9
$5.9
1.0
3.0
0.9
2.6
Last twelve months (LTM) ending June 30, 2000; pro forma, including Robert
Fleming.
judge from the outside. But by 2000 Morgan seemed to be oundering,

and this was clearly reected in the share price.
Together with a cost structure that was stubbornly high for an investment bank, J.P. Morgans stock price reected the rms disappointing
performance. Once the most valuable bank in America, its capitalization
fell to the $30 billion range, far short of its one-time peers such as Citigroup ($247 billion in December 2000). Rumors intensied that Morgan
was nished as an independent rm. Amidst takeover speculation, its
stock had already seen a gain from about $110 in early July to $177.75 on
September 12, 2000, the day of the Chase-Morgan merger announcement.
From that perspective, J.P. Morgans sellout was not surprising. Still, one
of the greatest institutions in American nance was gone, and many
thought that it did not necessarily have to turn out this way.
The merger took the form of an all-stock offer by Chase of 3.7 shares
of the new rm for each share of JPM, which valued each JPM share at
$207 based on the pre-announcement CMB share price of $56.06a premium of about 16%. The deal cost Chase shareholders $30.9 billion. According to Chase CEO William B. Harrison at the time of the merger
announcement, Its a very fair deal. . . . And most importantly, when we
look at the overall transaction two years from now, it should be accretive
to shareholders.3
The J.P. MorganChase (JPMC) combination, said the press release issued jointly by the companies, would create an organization with unparalleled client base, global capabilities, and product leadership in
growth markets. The purported strategic considerations centered around
complementary strengths in clients, geographies, and services (see Tables
6-2 and 6-3, Figure 6-7). This included the addition of Chases noninvestment grade clients, middle-market clients, and clients engaged in
3. As quoted in Andrew Ross Sorkin, Those Sweet Trips to the Merger Mall, New York Times, April
7, 2002.
172
Table 6-3 J.P. MorganChase Comparative Product Strengths

J.P. Morgan
Chase
Equity underwriting
Equity & structured derivatives
Global M&AEurope
Europe xed income
U.S. asset management
LabMorgan (e-banking applications)
New economy and Asian equities

FX & interest rate derivatives
Global M&A
Syndicated & leveraged nance
European & Asian asset mgmt.
Chase.com (e-banking)
Operating services
new-economy businesses to J.P. Morgans rst-rate client base comprising mainly large, blue-chip, investment grade companies. The combination was to provide increased opportunities for cross-marketing the companys full product array. The new rm would be a massive, globally
balanced wholesale nancial services company focusing on corporations
and institutions.
The combined company would in addition have a total of $720 billion
of duciary assets under management, making JPMC the second largest
active asset manager in the United States, behind Fidelity Investments.
These assets were well diversied in terms of major categories (equities
52%, xed income 25%, cash and other classes 23%), by geographic region
(U.S. 65%, non-U.S. 35%), and by client type (institutional investors 60%,
private clients 40%).
The merger thus created a very broad rm with leading positions in
xed income underwriting and trading, syndicated lending, risk management, private equity, asset management and private banking, custody,
North America
52%
Europe 30%
Asia Pacific
12%
Latin America
6%
Figure 6-7. J.P. Morgan Chase pro forma 1999 global revenue distribution. Source: Company lings.
173
and several key areas of retail banking. The core value propositions at the
time of the merger were purported to be the following:
Greater diversication of business lines. The combined company
would be broadly diversied to encompass an array of nancial
services businesses, which could be expected to provide a more
stable revenue stream than those experienced by a pure wholesale
bank.
Enhanced scale and global reach. The combined company would
be among the top ve global nancial institutions in terms of
market capitalization (about $95 billion) at the time of the merger
announcement, ranking third in the United States after Citigroup
and Morgan Stanley Dean Witter, respectively.
Synergies and cost savings. On a pretax basis, the cost savings and
incremental revenue accruing to the combined entity, by the end
of the second year, was estimated at $1.5 billion and $400 million,
respectively. The two merging banks had already made signicant
progress on their own. Fee income had attained almost 70% of
total earnings, while efciency and credit problems of both banks
had improved substantially. This progress had contributed to
pushing combined pro forma return on equity above 20%.
In addition, the deal was intended to leverage Chases integration track
record. While J.P. Morgan had mainly pursued a build strategy, Chase
had an array of acquisitions under its belt carried out by the legacy
Chemical Bank team, including difcult ones like Manufacturers Hanover
and the old Chase itself, and people-sensitive ones like Hambrecht &
Quist and Robert Fleming.
Despite the track record, purported common cultural attributes, and
inclusive approach to integration (see Table 6-4), the deal soon turned
into an outright Chase takeover of J.P. Morgan. Within two years most of
the key Morgan managers were gone, as were many of the important line
bankers and specialists. Divisions of responsibility in various units between people from the two predecessor banks were usually short-lived,
with the ex-Chase individuals winning most of the time. This was foreseeable, perhaps inevitable, in the light of experience with most nancial
Table 6-4 J.P. Morgan Chase: Purported Capacity to

Integrate
Track record of successful integrations
Inclusive approach to integration
Common cultural elements
More focused, less complex than prior mergers
Staff retention driven by opportunity and incentives
174
industry mergers, but it might have been disproportionately important

here because of the unusually high quality of the J.P. Morgan staff and its
teamwork-oriented culture. That culture itself was a powerful attribute of
J.P. Morgan. The Chase culture was also strong, but very different. The
two evidently did not mix well.
From a cost standpoint the deal was a disappointment as well. A $3.2
billion restructuring charge indicated by management on announcement
of the deal in September 2000 was intended to make possible $1.5 billion
in annual savings. In fact, the restructuring charge later turned into $4.5
billion in order to right-size the business given the weaker than expected economic conditions.
The Chase-Morgan merger is often compared with the TravelersCiticorp merger two years earlier. Analysts were universally bullish on Citigroup based on possible revenue synergies, efciency gains, and the expectation of a ruthless integration process in the Sandy Weill tradition
integration that would nevertheless retain and motivate the best people.
They were much more cautious about the J.P. MorganChase deal, less
about the strategy itself than about managements ability to pull it off and
the persistence of missing resources in important areas of investment
banking.
The JPMC board, however, had no such doubts and awarded special
bonus payments of some $50 million to senior managers for getting the
deal done. Shareholders of both rms did less well, as roughly 40% of the
stocks value disappeared in the two years following the deals announcement in September 2000. By late 2002 the combined rm was worth little
Figure 6-8. Share Prices of Citigroup and J.P. Morgan Chase in the Two Years Following the JPMC Merger.
175
more than Chase alone prior to the merger. It was perhaps a hallmark of
the times that managers got paid for doing deals rather than delivering
value to shareholders.
Figure 6-8 describes the stock prices of J.P. Morgan Chase and Citigroup
against the S&P 500 index during this period. Both companies suffered
from adverse developments in the equity market, as reected in the S&P
500 index, as well as emerging market problems, and nancial distress
and bankruptcies during this period. Both found themselves in the middle
of Enron and other corporate scandals. But the market seemed to persist
in its differentiation between the two stories.
General Electric Capital Services
Few nancial services organizations demonstrated as consistent a degree

of success in sustaining high rates of risk-adjusted prot growth as did
General Electric Capital Services (GECS), the nancial services subsidiary
of GE, until its dissolution in 2002.
Formed over 70 years ago to nance customers of GE household appliances, GECS had assets of $490 billion at the end of 2001the largest
non-bank nancial institution in the world. It contributed net income of
$3.6 billion on revenues of $58.2 billion to GEs 2002 total of $134 billion
almost half of GEs total revenues and (in a bad year) about 20% of its
prots (see Figure 6-9). With about 91,000 employees worldwide, it produced after tax returns on invested capital between 20% and 25% for over
20 years, a consistent record of growth and protability that very few
other nancial rms could match. GECS was, in effect, a nancial conglomerate within a conglomerate. It was also the highest-growth business
Segment Revenues $131,698 million

Industrial Products
& Systems
$9,755
NBC
$7,149
Materials
Segment Pre-Tax Profit

$18,780 million
(after-tax ROE 25.8%)
Consumer Products
$8,456
Industrial Products
& Systems
NBC
Aircraft Engines
$7,651
Equipment
Management
Equipment
Management
Power Systems
$4,254
$1
Materials
$11,141
$1
,12
,65
$999
Consumer
Products
$495
Aircraft Engines
$2,060
$311
$22,926
Consumer Finance
$1,930
Insurance
Power Systems
$6,255
$23,296
Technical Products &
Services
Other GECS
$4,331
$9,266
Commercial Finance
$16,040
Consumer Finance
$10,266
Figure 6-9. General Electric, 2002.

Note: Insurance (loss $509), other GECS (loss $291).
Commercial
Finance
$3,185
Technical Products
& Services
$1,562
176
among GEs stable of businesses. To the extent that GE was a growth story
for investors over the years, GECS played a disproportionately important
role in that process.
Shareholders of General Electric in effect own a closed-end mutual
fund. The fund consisted of aircraft engines, plastics, power generation
and distribution equipment, broadcasting, diesel locomotives, large
household appliances, medial equipment, and a variety of other industrial
activities, plus one of the worlds largest nancial services businesses.
They are therefore confronted with all the pluses and minuses associated
with conglomerates, including, most important, the evidence of a conglomerate discount that is almost always embedded in the share price, as
discussed in Chapter 2. Even if GECS had been an independent company,
it would still have been a massive nancial conglomerate. So how did GE
and GECS produce both impressive and consistent returns, which in the
end made GE the most valuable company in the world?
The classic GE management principles appeared to account for this
apparent anomaly. To rephrase Jack Welchs insistent messages: seek to
dominate fast-growing but highly concentrated markets and combine that
with six-sigma targets in quality control and erce attention to costs,
leadership development, and leveraging know-how. In short, try to create
an internal market for capital that functions more efciently than the
external marketsomething most economists would deny can be done
on a sustained basis. No doubt Jack Welch would have argued that the
same thing applies to the market for human capital, where the legendary
GE approach to promoting and optimizing the use of talent seemed to
operate in tandem with the highly disciplined pattern of in nancial
optimization.
Tables 6-5 and 6-6 reproduce two pages out of the GE playbook designed to highlight not only the purposeful way GE went about its business but also the notion that these are real businesses that carry the rm
protably through economic cycles and produce real returns without
Table 6-5 GE Leadership Based on Financial Visibility and Accountability

Diverse set of #1 franchises in global markets
Business initiatives
with visible nancial benets
Strong balance sheet to

capitalize on change
and opportunity
Every business executes

and contributes
Accelerating impact
from Digitization
Disciplined approach to
investment and risk
Portfolio produces
growth through every
cycle
All initiatives deliver operational

improvements
Core competence in acquisition and integration
Source: General Electric Company, Annual Report 2001.
177
Table 6-6 Key GE Operating Principles

[We] are passionately focused on driving customer success.
Live Six Sigma quality . . . ensure that the customer is always its rst beneciary . . .
and use it to accelerate growth.
Insist on excellence and be intolerant of bureaucracy.
Act in a boundaryless fashion . . . always search for and apply the best ideas
regardless of their source.
Prize global intellectual capital and the people who provide it . . . build diverse teams
to maximize it.
Create a clear, simple, customer-centered vision . . . and continually renew and
refresh its execution.
Create an environment of stretch, excitement, informality, and trust . . . reward
improvements . . . and celebrate results.
Source: General Electric Company, Annual Report 2001.
smoke and mirrors. Ultimately the story has to be effectively sold to the
market. Of course, the devil is in the details. Yet the results suggest that
the broad objective was largely achieved for many years.
What about GECS? Figure 6-10 shows the organizational structure of
GEs nancial services activities at the beginning of 2002representing
28 independent businesses, of which 11 were considered global leaders.
Each was managed according to the GE principles of growth, market
concentration, service quality, and attention to costs. There were relatively
few cross-links between these businesses, so the structure and its sustained protability did not depend heavily on cross selling, as would
usually be true in universal banking or other nancial conglomerate structures. The key linkages between GECS and its parent were managerial
and nancial. The GE management philosophy was clearly manifest in
the development and success of GECS, and GEs deep pool of talent was
used to support GECSs rapid growth.
That growth was itself the result of a rapid-re series of acquisitions
(Ashkenas, DeMonaco and Francis 1998). Those over $100 million completed during 19992002 in the United States and internationally are listed
in Table 6-7. During the 19922001 decade, GECS completed a total of
over 400 acquisitions, and in the year 2001 alone closed 27 deals worth
$42 billion, including its largest single acquisition, Heller Financial at a
cost of $ 5.3 billion.
The rms acquisition process has been a topic of interest for years.
The GECS structure of high-performance specialists evidently allowed the
rm to be extremely opportunistic and aggressive in actively soliciting
acquisitions. The managers of each of the relatively narrow nancial businesses knew that particular part of the industry and the key players very
178
Equipment
Management
Penske
Truck
Leasing
Computer
Services
Commercial
Air Leasing
Container
Leasing
Railcar
Services
Specialized
Financing
Modular
Structure
Leasing
Satellite
Leasing
Equity
Group
Projects &
Structured
Finance
Commercial
Finance
Trailer
Leasing
Fleet
Leasing
Commercial
Real Estate
GE Capital Services
Credit
Insurance
Employers
Reinsurance
Mid-Market
Equipment
Global
Consumer
Finance
Mortgage
Insurance
Municipal
Bond
Insurance
Specialty
Insurance
Vendor
Annuities
Auto
Financing
Retailer
Financial
Services
Mortgage
Services
Consumer
Financial
Services
Hawaiian
Operations
Consumer
Services
Mid-Market
Financing
Figure 6-10. GE Capital Services Legacy Structure.
well, and knew them globally. So when acquisitions opportunities presented themselves, perhaps resulting from economic or nancial developments, management could move quickly and decisively. Management
was able to understand the target, value it, undertake due diligence with
the help of GE teams who were expert in the process, and conclude
transactions that were highly favorable to the rm. The opportunistic $2.3
billion acquisition of most of beleaguered ABBs structured nance arm
in September 2002 was a case in point.
Figure 6-11 presents a stylized version of the highly disciplined, logical,
and codied GECS acquisition processsome have called it a virtual
acquisition machine. Done right at the right prices and integrated
quickly and well, it is clear how this machine could fuel both top-line
growth and bottom-line protability. GECS acquisition activities in Japan
in the late 1990s, depicted in Figure 6-12, constitute a good example of
this unique institutional skill, executed through highly focused business
units within the GECS group. All of this clearly came at a cost, however,
in terms of the transparency of GE nancials. GEs legendary internal
nancial discipline and audit process may have understood things, but it
was certainly difcult for outsidersprofessional analysts and fund managers, as well as ordinary investorsto follow along. So the Jack Welch,
GE, and GECS mystique probably became a major factor driving the
Table 6-7 GE Financial Services Acquisitions Exceeding $100 Million in The United States, 19902002
179
Date
Announced
Date
Effective
Value
($mil)
01/02/90
03/30/90
10/11/90
06/02/92
01/06/93
02/04/93
04/05/93
05/27/93
06/30/94
12/27/94
11/13/95
12/26/95
05/20/96
08/02/96
01/23/97
06/30/97
07/31/98
10/12/98
05/17/99
09/15/99
03/30/01
06/29/01
07/30/01
08/01/01
12/14/01
01/31/90
04/30/90
05/10/91
06/02/92
04/15/93
12/31/93
07/14/93
07/16/93
11/01/94
04/03/95
04/03/96
04/03/96
07/23/96
11/29/96
05/30/97
11/04/97
10/29/98
12/31/98
10/29/99
11/19/99
08/01/01
06/29/01
10/25/01
08/01/01
05/14/02
350.00
1193.60
1600.00
560.00
750.00
500.00
550.00
215.00
400.00
1800.00
400.00
960.00
454.785
1799.24
450.00
1081.10
500.00
800.00
3961.00
200.00
2118.663
100.00
5321.532
120.00
5541.921
Target Name
Target Business Description
McCullagh Leasing Inc.

Ellco Leasing Corp
Macy Credit, Macy Receivables
Chrysler Capital-Diversied
GNA Corp (GE Capital Corp)
First Chicago Corp-Commercial
United Pacic Life Insurance
Verex Corp (GFC Financial)
Harcourt General Inc-Insurance
ITT-Equip Fin, Small Bus Fin
Union Fidelity Life Insurance
Life Insurance Co of Virginia
AmeriData Technologies Inc
First Colony Corp
Coregis Insurance
Colonial Penn P&C Group
Kemper Reinsurance Co
Colonial Pacic Leasing
LTCB-US Loan Assets Portfolio
Crown Castle International
Franchise Finance Corp of Amer
NTL Inc
Heller Financial Inc
Crescent Real Estate Equities
Security Capital Group Inc
Provide vehicle leasing services

Provide commercial leasing services
Provide personal credit services
Provide business credit services
Life insurance company
Real estate loan portfolio
Insurance company
Insurance company
Mnfr communications equip
Insurance holding company
Life, health insurance company
Whl computers, peripherals
Insurance holding company
Insurance company
Insurance company
Fire, marine, casualty insurance company
Provide external nancing services
Mortgage security nance co
Provide wireless transmission services
Real estate investment trust
Provide communications services
Provide business nance services
Real estate investment trust
Provide real estate research services
Target Country
(continued)
180
02/26/90
07/18/90
05/17/91
07/23/91
04/06/93
04/06/93
08/16/93
01/23/95
02/03/95
02/28/95
07/28/95
10/12/95
08/21/96
07/29/97
09/22/97
11/03/97
02/18/98
05/29/98
06/08/98
06/25/98
01/26/99
05/21/99
12/20/99
05/26/00
05/29/01
06/22/01
04/27/90
07/18/90
07/02/91
05/08/92
11/01/93
08/31/93
02/28/95
02/04/95
02/28/95
08/31/95
12/13/95
09/02/96
11/24/97
01/09/98
11/03/97
04/01/98
05/29/98
11/23/98
06/25/98
03/05/99
06/30/99
03/01/00
10/20/00
06/12/01
04/08/02
239.98
331.692
450.125
140.00
1350.018
107.227
385.64
145.424
140.054
162.269
132.624
1515.085
277.14
192.175
815.182
502.71
593.871
599.899
273.999
497.029
6565.60
493.00
2323.68
269.034
312.51
522.44
Wang International Finl Ltd

Burton Group Financial Svcs
Mercantile Cred-Vehicle Loans
Banco Bilbao Vizcaya SA
GPA Group PLC-43 Planes
TIP Europe PLC
Finax
Credit de lEst
United Merchants Finance Ltd
Societe Gestion Financiere et
Australian Retail Finl Network
Sovac(Eurafrance)
Marubeni Car System Co
Central Transport Rental Group
Woodchester Investments PLC
MEPC PLC-Small Commercial(191)
Toho Mutual-New Bus Op & Sales
UIS
GPA Group-9 Aircrafts
Financial Sector-Tranche ABCD
Japan Leasing Corp
Avco Financial Services Ltd
Toho Mutual Life
Nissen-Consurmer Credit Bus
Malvern House Acquisition Ltd
National Mutual Life Assurance
Provide computer leasing services

Provide nancial services
Provide vehicle credit services
Bank
Manufacture airplanes
Provide trailer rental services
Provide credit card services
Bank
Provide nancing services
Investment holding company
Provide credit card nl services
Bank; holding company
Provide car leasing services
Provide RR car rental services
Investment bank
Own, operate ofce property
Insurance company
Own and operate buildings
Provide aircraft leasing services
Provide business credit services
Provide consumer credit services
Investment company
Provide insurance services
Ireland-Rep
United Kingdom
United Kingdom
Spain
Ireland-Rep
United Kingdom
Sweden
France
Hong Kong
France
Australia
France
Japan
United Kingdom
Ireland-Rep
United Kingdom
Japan
France
Ireland-Rep
Thailand
Japan
Australia
Japan
Japan
United Kingdom
United Kingdom
181
Figure 6-11. The GECS Acquisition Process. Source: Ronald Ashkenas, Lawrence J. DeMonaco, and
Suzanne C. Francis, Making the Dean: How GE Capital Integrates Acquisitions, Harvard Business
Review, JanuaryFebruary 1998, p. 167.
GE share price to what some argued were improbable levels over a long
period of time.
In nancial matters, the various GECS units clearly beneted from the
low cost of capital associated with a high corporate share price and a
AAA GE debt ratingfrom which GECS beneted through a comfort
letter from the parent to its nance subsidiary, which covered GECSs
capital market issues. GECS borrowings in 1999 were $200 billion, for
example, most of which were involved in nancing receivables. In this
sense there was a cross-subsidy that GECS received from its parent,
whose value would be eroded if GECSs weight in GEs overall business
became sufciently large to endanger the corporations overall credit quality. This weight (in terms of revenues) increased steadily from about 37%
in 1995 to over 45% in 2001.
182
GE Capital Consumer Finance

Capital: 12bn
Employees: 750
Business: consumer finance, such as credit
cards
History: formed in 1994, after GE Capital
bought Minebea Shinban and Shin Kyoto
Shinban, two small consumer finance
groups
Koei Credit
Capital: 50m
Employees: 427
Business: unsecured consumer loans
History: bought by GE Capital in 1998
Lake Corporation
Capital: 34bn
Employees: 2,800
Business: unsecured consumer loans
History: formed in 1998 after GE Capital
bought Lake
Investment
income
$5.51bn
Financing
leases
$3.50bn
Operating
lease
rentals
$4.82bn
GE Capital Car System Corporation

Capital: 1.2bn
Employees: 150
Business: car leasing
History: formed in 1998 when GE Capital
bought 80 per cent of Marubeni Car
Systems
Premium
and
commission
income of
insurance
affiliates
$9.27bn
Time sales,
loan and
other
income
$12.21bn
GE Edison Life Assurance

Capital: 72bn
Employees: 6,900
Business: life assurance
History: formed in 1998 as a joint venture
with Toho Mutual, but 90% owned
by GE Capital
Japan Leasing Corporation

Capital: currently unclear
Employees: 1,300
Business: car and equipment leasing
History: GE Capital bought the group from
LTCB in 1999. Total assets are believed
to exceed 900bn
Figure 6-12. GE Capital Services Acquisitions in Japan in the 1990s. Source: General Electric (the
chart shows Japan revenues for 1998).
Although it was clearly a nancial services conglomerate embedded

within a parent that was itself a conglomerate, GECS was almost the
antithesis of the way the major banks and nancial conglomerates have
traditionally been managedoften operating in highly competitive markets with bloated costs, bureaucratic organizations structured as generalists not specialists, and often with mediocre or poor service quality.
Overall, the top 10 global banks have produced about one-half the growth
and operating performance of GECS during the decade of the 1990s and
beyond. And although it is impossible to determine total returns to shareholders (since GECS is not a listed company), those returns would no
doubt reect this fact. GECS was considerably smaller than the worlds
largest banks but would certainly qualify as one of the most valuable
nancial services franchises.
A comparison of GECS and Citigroup is instructive in this regard (see
Table 6-8). Citigroup in 2001 was much larger in terms of assets and
somewhat ahead in terms of return on assets, but GECS was ahead in
terms of return on equity, assuming comparable accounting. Although
GECS was not a bank, its leverage actually exceeded that of Citigroup,
yet it beneted from a higher debt rating. Although they are similar only
to the extent that they are conglomerates, the similarity in stock price
performance after the 1998 formation of Citigroup is striking. Both dramatically outperformed the market (for example, the S&P 500 index) for
an extended period, although Citigroup shares appeared more volatile.
Both were hard-hit by the equity market declines of 2001 and 2002 and
(for somewhat different reasons) by the corporate scandals and loss of
183
Table 6-8 GE Capital Versus Citigroup 2001
Total Assets
Total Debt
Return on Assets
Return on Equity
Debt to Capital Ratio
LT Debt Rating
GE Capital
Citigroup
$426 billion
$240 billion
1.36%
21.0%
87.96%
AAA
$1.05 trillion
$399 billion
1.43%
20.4%
81.87%
AAA
Date: Bloomberg Financial Markets, Standard & Poors, company reports.
market credibility that began with the 1991 Enron disaster (as depicted in
(Figure 6-13). Although the GE share price lagged somewhat.
As noted, concerns in the case of GE had long centered on the growing
importance of GECS within the GE structure and the potential threats it
posed for the parents AAA debt rating, as well as the massive exposure
of GECS to the commercial paper marketthat is, allegedly using uncommitted short-term nancing for long-term funding requirements. Together
with lack of transparency and the retirement of Jack Welch, this may help
explain the rapid erosion of GEs extraordinary valuation multiples that
had prevailed for such a long time. In response, GE moved quickly in
2002 to add committed bank lines to its nancing armory, signicantly
increased disclosure of the internal nancial affairs, and broke GECS into
four separate businesses that were, according to GE CEO Jeffrey Immelt,
easier to understand and easier to manage from the corporate center (see
Figure 6-14 for detail on the four businesses). It was the end of a rather
Figure 6-13. General Electric versus Citigroup (share prices after the Citigroup
merger on April 6, 1998).
184
Figure 6-14. Breakup of GE Capital Services, July 2002 (August 2002total assets
$445 billion).
impressive chapter in the annals of the nancial services industry.

Whether the breakup of GECS will make a difference in the remarkable
returns achieved by GEs nancial businesses remains to be seen. If the
disciplined GE approach to capital allocation and risk management can
be sustained, there is reason for optimism.
As indicated earlier, case studies and clinical analyses all suffer from
the unobservable counterfactual, as well as possible biases in the analysis.
So case-based conclusions are basically impossible to generalize. Sooner
or later one has to proceed to statistical studies that are based either on
cross-sectional or time-series data. Assuming the availability of reliable
data, denitive conclusions are at least in the realm of the possible, and
in some cases may be highly instructive.
WHAT DOES THE EMPIRICAL EVIDENCE SHOW?
Most studies of nancial sector mergers examine either market reaction

to merger announcements or long-term performance measures against
various kinds of benchmarks. Market reaction studies attempt to gauge
whether the market sees the announcement of a merger as a positive or
negative event. In general, market reaction to the announcements of
nancial-sector mergers is neutral or slightly negative for the acquirer but
highly positive for merger targets. Combined returns to both partners are
usually around zero. Conditions in the M&A market can inuence those
returns, however. For example, James and Weir (1987) nd that acquirer
returns go up when acquirers have more potential targets, but go down
when more potential acquirers exist.
Studies evaluating the long-term performance of merged banks produce mixed results. Cornett and Tehranian (1992) found that merged
185
banks outperformed the industry in terms of return on equity but not

return on assets. They concluded that better performance appears to be
the result of attracting more loans and deposits to a given equity base, as
well as employee productivity and asset growth. DeLong (2001a) found
that average return on assets does not improve as a result of M&A transactions, but industry-adjusted efciency increases.
An examination of the worlds 200 largest banks during the 1980s
(Saunders and Walter 1994) found evidence that the very largest banks
grew more slowly than the smaller banks in the sample. Limited economies of scale did appear to exist among the banks included in the study.
A study of 72 nancial services M&A deals exceeding $500 million
during 19901999 conducted by Accenture (2000) found that one third of
the deals created signicant shareholder value during the two years after
merger completion. Top deals were HSBC-Midland Bank, Lloyds-TSB,
and Morgan Stanley- Dean Witter (see Figure 6-15). Two-thirds of nancial
services M&A deals destroyed shareholder value within two years against
local benchmarks. However, the best-performing one-third of the deals
outweighed the rest to produce a 7% two-year excess return. Important
factors in the Accenture study included a premerger integration plan, a
premerger succession plan, top-line (revenue) focus, and an emphasis on
consistent and effective branding. Less important factors were found to
Figure 6-15. Long-Term Performance in Financial Services M&A Transactions (cumulative total return to shareholders from 72 deals exceeding $500m each, 19901998). Data: Accenture, 2000.
186
Table 6-9 Post-Acquisition Returns in Selected U.S. Financial Sector Mergers

Returns
Seller
Buyer
Buyer
Acquirer
Target
Date
Value
Premium #
1 wk*
1 wk*
1 year**
Travelers
NationsBank
Chase
Norwest
Conseco
M&T Bank
Star Banc
NY Community
Citicorp
B of A
Morgan
Wells Fargo
Greentree
Keystone
Firstar
Richmond
4/98
4/98
9/00
6/98
4/98
5/00
7/98
3/01
70.0
59.3
36.3
33.6
7.1
1.0
7.0
0.8
10.4%
48.4%
59.7%
0.9%
85.9%
41.6%
44.1%
7.2%
8%
2%
24%
3%
35%
29%
44.1%
11%
6%
4%
19%
11%
15%
4%
2%
7%
2%
4%
14%
10%
55%
54%
44%
43%
* Price change one week pre- and post-announcement. ** Price change one week pre-announcement to one
year post-announcement. Value of offer when announced. # Difference between offer price and market
price one week before offer. Percentage point differences over specied periods relative to S&P 500 peers.
Data: Standard & Poors, Mergerstat, Boston Consulting Group, Thomson Financial.
be cost takeout and IT integration. This mixed record is reected in Table

6-9, which depicts deal premiums and returns to buyers and sellers over
a one-week and one-year period following announcement of each transaction in the case of a number of American deals during the 19982001
period.
A few empirical studies look at both market reaction and long-term
performance to determine whether the market can correctly predict successful bank mergers. Evidence from these studies is mixed. Pilloff (1996)
found no relationship between abnormal returns upon the announcement
of a merger and subsequent performance of the publicly traded banks
examined. That is, the market does not seem to be able to predict which
bank mergers will improve performance. However, Cornett and Tehranian (1992) found signicant correspondence between market reaction and
several more indicators (operating efciency, pretax cash ow, ROE,
deposits-to-equity, loans-to-assets, and asset growth).
As noted in Chapter 2, active debate has persisted in banking concerning the benets and costs of universal banking and nancial conglomerates (Saunders and Walter 1994). Proponents suggest that banks that are
permitted to serve all the nancial needs of individuals and companies
are more efcient than institutions that provide only one or a few of the
services. Arguments against universal banks and conglomerates suggest
that such institutions tend to be less innovative than segmented nancial
rms. With regard to mergers, the pertinent question is, should a merger
combine two entities engaged in the same activity, or should it extend the
product line of the acquirer? Intra-industry mergers are those where the
acquirer targets a rm that is engaged in similar activities. The main
187
advantages of intra-industry mergers are that they could improve efciency as well as enjoy economies of scale. Inter-industry mergers, or
mergers where the partners are engaged in different activities, allow the
acquirer to realize economies of scope as well as lower the risk and cost
of bankruptcy.
DeLong (2001a) found that the market reacts positively to bank mergers
that focus activities and geography but that different facets of focusing
actually improve long-term performance. The study concluded that inefcient acquirers tend to improve the efciency of the merged entity more
than other acquirers. This nding suggests that acquirers use mergers as
an excuse to improve efciency within their current organizations by
eliminating unprotable activities or letting go less productive staff. Indeed, in an early study Jensen and Ruback (1983) suggested that in-market
or focusing mergers are a good mechanism to replace inefcient managers
with efcient ones. In a later work, Jensen [1986] contended that this could
enhance value only if partners come from the same industry, since managerial skills are not transferable between industries.
Focusing Mergers: Improved Efciency and Scale-Effects
Extensive research has shown that activity-focusing mergers could improve efciencies either through the transfer of skills or changing the mix
of outputs. Berger and Humphrey (1992b) found that acquiring banks
tend to be signicantly more efcient than the acquired banks, suggesting
that the acquirer may potentially improve the efciency of the target.
Akhavein, Berger, and Humphrey (1997) found that megamergers between U.S. banks increase revenues by improving efciency rather than
increasing prices. They found that increased revenues come in part from
a shift in asset allocation after the merger from government securities to
loans, which earn more for the bank. They also found evidence consistent
with both partners being inefcient. This low-efciency hypothesis again
suggests that acquiring banks use mergers as an excuse to improve efciency within their own organizations.
Findings on merger-related improvements in return on equity are contradictory. Linder and Crane (1992) and Pilloff (1996) found that return
on equity (ROE) does not improve for merged banks. Cornett and Tehranian (1992) did nd a signicant increase in industry-adjusted ROE (but
not in industry-adjusted return on assets). Berger and Humphrey (1992b)
pointed out that Cornett and Tehranian looked at mergers that occurred
from 1982 to 1987. The nal year of their study, however, was an unusual
one for the banking industry; most large banks made sizable loss provisions for their loans to developing countries. Such provisions greatly
reduced equity and thus increased ROE. Perhaps their nding was mainly
a result of unusual circumstances and not robust with regard to other
periods.
188
In-market mergers seem to allow the acquirer to reduce redundant

operations that both partners were performing before the merger. Houston and Ryngaert (1994) and DeLong (2001) found that the market rewards
mergers where geographic overlap exists between acquirer and target.
Houston, James, and Ryngaert (1999) found that geographic overlap is
positively related to the estimated present value of mergers, as well as
estimated cost savings. Cornett, Hovakimian, Palia, and Tehranian (1998)
found that mergers of partners headquartered in the same U.S. state earn
higher returns than mergers with partners in different U.S. states. Furthermore, corporate governance mechanisms appear to work better for
in-market mergers than market-extending ones. For example, CEO equity
ownership tends to align CEO and shareholder interests in intrastate
mergers but less so for interstate mergers.
Evidence on long-term performance of focusing mergers is mixed. Cornett and Tehranian (1992) found that improvement is greater for bank
mergers within U.S. states than between U.S. states. However, using a
more specic measure of geographic overlap, DeLong (2001) found that
common geography does not lead to long-term performance enhancement.
As noted in Chapter 2, most empirical studies of nancial services
mergers do not nd evidence of economies of scale. Some studies of bank
scale economies (see Berger and Humphrey [1993] for an overview) have
found economies of scale in banking in small banks. Other studies (see
Clark [1988] and Berger, Hunter, and Timme [1993]) found the relationship
between size and average cost to be U-shaped. This suggests that small
banks can benet from economies of scale, but that large banks seem to
suffer from diseconomies of scale, resulting in higher average costs as
they increase in size. Although Kane (2000) found that the stock market
reacts positively when big banks merge, he suggested that the merged
entity was taking greater advantage of government guarantees, not taking
advantage of economies of scale.
Despite the lack of much empirical evidence showing the existence of
signicant scale economies in banking based on overall rms size, the
argument is so pervasive in the nancial community and the media that
the market may believe scale economies actually do exist. If so, it will
reward bank mergers that it considers more likely to reduce average costs
by virtue of size, and thereby enhance equity values upon announcement.
Long-term realization of economies of scale, however, could be elusive.
Focusing Mergers: Monopoly Power
Geographically broadening mergers could also take advantage of monopoly rents by entering areas that are protected from competition. To create
new value from the target, the acquirer must employ resources to increase
the market share, introduce new activities, or change the mix of activities
to include those that extract the most rents of the rm in the protected
market. Empirically, banks seem to seek out monopolistic or oligopolistic
189
markets. Beatty, Santomero, and Smirlock (1987) found that the higher the
market concentration of the banking industry in a given area (as reected
by the Herndahl-Hirschman index), the higher the premium paid to
acquire a bank in that area; the higher concentration is a proxy for regulatory protection.
Although various studies nd that banks in concentrated markets tend
to charge higher interest rates or pay lower deposit rates than banks in
less concentrated markets, antitrust policy seems to prevent banks that
merge from taking advantage of their increased market power. Berger and
Hannan (1996) found that loan rates were higher and deposit rates were
lower when banks operated in concentrated markets. These increased
revenues, however, did not result in higher prots. The study also showed
evidence consistent with managers pursing a quiet life and incurring
higher costs than their counterparts in less concentrated markets.
Akhavein, Berger, and Humphrey (1997) found that banks that merge
charge more for loans and pay less on deposits before they merge than
other large banks. Specically, they found that banks that merged charged
17 basis points more for loans than the average large bank prior to merging. After the merger, however, this difference fell to about 10 basis points.
This suggests that merging banks do not tend to take advantage of their
increased market power. The authors contend that antitrust policy is effective in preventing mergers that would create market power problems.
Siems (1996) reached a similar conclusion. In his study of 19 bank
megamergers (partners valued over $500 million) in 1995, he rejected the
market power hypothesis, although he found that in-market mergers create positive value for both the acquirer and the target upon announcement. He found no relationship between the abnormal returns and the
change in the Herndahl-Hirschman index that measures market concentration.
Diversifying Mergers: Economies of Scope
As noted in Chapter 3, there is very little empirical evidence regarding

cost economies of scopewhether unit costs of nancial services rms
go down or up, all else equal, in response to a broader product range
achieved, for example, through mergers or acquisitions.
Giddy (1984) showed how underwriting and commercial lending risks
are similar in that both are comparable to put options. Both incur limited
upside gains: in the case of underwriting, it is the difference between the
offer price and the net cost; and in commercial lending the gains come
from the spread between the cost of funds and the interest rate on the
loan. Both also incur substantial downside risks: if the market price of a
security is below the offer price, buyers will be scarce and the underwriter
might have to sell at a price below the net price. The risk in commercial
lending is that some or the entire loan will not be repaid. The limited
upside gain coupled with substantial downside risks is similar to writing
puts on stocks. Having learned to assess and price this risk, commercial
190
bankers could transfer some of the knowledge and experience they have
to underwriting securities. Furthermore, banks offering both commercial
and investment banking services minimize not only informationgathering costs but also monitoring costs. The monitoring of a bank loan,
for example, is similar to the monitoring of a corporate investment.
In his survey of the literature on economies of scope in banking, Clark
(1988) found no consistent evidence. Of the 11 studies that examined
global economies of scope, only one presented signicant evidence of
scope economies when it examined the relationship among several products. Berger and Humphrey (1992a) found scope economies could lower
the costs of a commercial bank by 10 to 20%. Moreover, Mitchell and
Onvural (1995) examined the cost structure of over 300 large bankswith
assets between $0.5 and $100 billionin both 1986 and 1991 and found
extremely weak evidence for the existence of economies of scope.
Empirical evidence concerning the existence of certain product-specic
economies of scope is more substantial. Yu (2001) provided interesting
support for the economies of scope argument. The U.S. equity market
responded favorably to stocks in the nancial services sector as a whole
with the Financial Services Modernization Act (the Gramm-Leach-Bliley
Act) of 1999. This allowed U.S. commercial banks to engage in securities
and insurance activities and vice versa. Among other things, the legislation repealed the Glass-Steagall Act of 1933 that separated commercial
from investment banks in the United States. The Act allowed Citigroupa
rm created from the commercial bank holding company of Citicorp and
the Travelers insurance and nancial services company, which also owned
the Salomon Smith Barney securities rmto stay in business. Yus study
found that the market reacted most favorably to large securities rms,
large insurance companies, and bank holding companies already engaged
in some securities businesses (those with Section 20 subsidiaries allowing
limited investment banking activities). The study suggested that the market expected gains from product diversication, possibly arising from
cross-product synergies or perhaps extension of too-big-to-fail guarantees. Another study by Lown et al. (2000) similarly found that both
commercial and investment bank stocks rose on announcement by President Clinton on October 22, 1999, that passage of the Gramm-LeachBliley Act was imminent.
A study of U.S. bank mergers in the 1990s by Brewer et al. (2001) found
that merger premiums increased by about 35% as a result of deregulationspecically, the passage of the 1997 Riegle-Neal Act, which eliminated geographic restrictions for U.S. bank operations. The study found
that bid premiums were higher, and the better-performing were the targets as measured by return on average assets, the lower the embedded
risk of the targets, the greater the diversication represented by the acquisition, and the larger the representation of independent directors on
the boards of the target banks. The latter observation is consistent with
other research in nance, which suggests that independent directors con-
191
tribute materially to obtaining the best possible price for the shareholders
of target rms.
Other examples of economies of scope exist in history. During the 1920s,
U.S. commercial banks were permitted to have securities afliates. Kroszner and Rajan (1994) found that U.S. bank afliates typically underwrote
better-performing securities than specialized investment banks. Perhaps
commercial banks obtained knowledge about rms contemplating selling
securities through the deposit and borrowing history of the rm. If so,
commercial banks could then select the best risks to bring to market.
Investors seem to take such arrangements into consideration: Puri (1996)
found that securities underwritten by commercial banks generated higher
prices than similar securities underwritten by investment banks. This
suggests lower ex ante risk for those underwritten by commercial banks.
What little empirical evidence there is suggests that economies of scope
seem to exist for specic combinations of products in the realm of commercial and investment banking as well as insurance. However, they are
often difcult to extract and require well-designed, incentive-compatible,
cross-selling approaches.
Diversifying Mergers: Tax-Efciency
Geographically diversifying mergers may reduce taxes by lowering both

the expected and actual tax burden of the combined entity. If effective
marginal tax rates increase with the value of rms pretax revenue, Smith
and Stulz (1985) showed that lowering the variability of a rms pretax
value can reduce the expected tax burden and thereby increase the expected value of the rm. For example, if there are two rms with expected
earnings of $600, one with certain earnings of $600 and one with expected
earnings of $600, it has a 50% chance of earning $1,200 and a 50% chance
of earning nothing. Assume an increasing tax rate: the tax rate is 10% for
the rst $750; for larger earnings it climbs to 12%. The expected taxes of
the rst rm are $60; for the second rm, they are $64.50 (0.5 (0.10
$750 0.12 $450 0). Even though the rms have the same expected
earnings ($600), the one with the less volatile earnings has lower expected
taxes. Over time, rms can lower their actual tax burdens by lowering the
volatility of their earnings.
Not much empirical evidence, however, exists to support the taxreduction argument. Santomero (1995) pointed out that if the tax argument holds, American rms would be less interested in reducing the
volatility of their earnings as a result of lower marginal U.S. corporate tax
rates. But he found no evidence to support this contention. He also
pointed out that tax reduction depends on taxable income, not reported
book income. Since discretion exists concerning the reporting book prot,
real economic decisions, such as the decision to merge, would tend not to
depend on prots reported to the market. The more discretion exists
concerning the reporting book prots, the less valid the tax reason for
wanting to reduce earnings volatility.
192
Diversifying Mergers: Financial Stability
As noted in Chapter 2, diversication can reduce the risk embedded in a

rms share price and therefore improve value. Bankruptcy costs include
the direct costs of legal, accounting, and administrative fees, as well as
the indirect costs of lower sales, worse terms for purchasing supplies or
obtaining credit, reduced employee morale, and other opportunity costs.
James (1991) nds banks lose about 30% of the value of their assets when
they declare bankruptcy. Since bankruptcy costs can be high, lowering
expected default would be benecial to a nancial rm. By reducing the
volatility of a banks share value, activity diversication could reduce the
expected risk of failure and thereby reduce the expected costs associated
with bankruptcy. The lower the correlation between cash ows from different businesses, the greater the benets of diversication. That is, the
more differently the activities react to an external and internal shocks, the
more benecial is diversication.
A drawback to stockholders of reducing the probability of bankruptcy
is that the value of current debt increases at the expense of equity holders.
This wealth redistribution occurs because bond-holders receive payment
with greater probability and the market value of the current debt increases. Israel (1991) presented a model that shows that higher debt levels
of potential merger targets result in lower protability for the acquirer.
Billett (1996) tested this theory and nds evidence to support the existence
of a wealth transfer from bidder and target-equity holders to target-debt
holders. He found that the more noninvestment grade debt a rm has,
the less likely it is to be acquired. Acquirers seem to want to avoid coinsuring debt.
Studies that test the risk reduction hypothesis often look at how hypothetical combinations could have reduced risk by using actual industry
averages. Using accounting and market data, Boyd, Graham, and Hewitt
(1993) tested whether hypothetical mergers between bank holding companies and non-bank nancial rms decrease risk. In a sample of data
from 1971 to 1987, they found that mergers between bank holding companies and insurance rms could have reduced risk, whereas mergers
between bank holding companies and securities rms or real estate rms
could have increased risk.
There is some additional evidence that a positive link exists between
diversication and nancial stability. Saunders and Walter (1994) carried
out a series of simulated mergers between U.S. banks, securities rms,
and insurance companies in order to test the stability of earnings of the
pro-forma merged rm as opposed to separate institutions. The
opportunity-set of potential mergers between existing rms and the riskcharacteristics of each possible combination were examined. The ndings
suggest that there are indeed potential risk-reduction gains from diversication in multi-activity nancial services organizations, and that these
gains increase with the number of activities undertaken. The main risk-
193
reduction gains appear to arise from combining commercial banking with

insurance activities, rather than with securities activities. These studies
may exaggerate the risk-reduction benets of cross-market mergers because they ignore many of the operational costs involved in setting up
and managing these activitiesthat is, only the nancial rms in existence
for the full 19841988 period are considered.
Santomero and Chung (1992) likewise created hypothetical bank holding companies comprising of various combinations of banking, insurance,
and securities rms to test whether activity diversication could reduce
risk. The authors found that bank holding companies that existed from
1985 to 1989 could have reduced their probability of failure had they been
permitted to diversify into insurance and securities. Of the ten combinations the authors examined, the best combination was the bank holding
company with both insurance and securities rms. The only combination
that would have increased the probability of bankruptcy over the standalone bank holding company was one encompassing a large securities
rm. The ndings are particularly interesting in light of the turbulence
during the late 1980s in both the securities and insurance industries. That
is, volatility should have increased as a result of the macroeconomic environment.
CROSS-BORDER MERGERS AND ACQUISITIONS
A special case of market-extending mergers involves crossing borders.

Examples cited earlier include UBSPaineWebber, Deutsche BankBankers Trust, and HSBCRepublicCCF in banking and securities and a large
number of transactions in insurance and asset management. Interest in
cross-border deals presumably responded to the EUs 1988 Second Banking Directive and the U.S. 1999 Gramm-Leach Bliley Act, which made
such mergers easier.
In a very early study Grubel (1977) examined the phenomenon of
multinational banks in an attempt to nd the advantages banks have by
locating in a foreign country that enables them to overcome the inherent
disadvantages they face vis-a`-vis indigenous nancial institutions. Product differentiation, he suggested, is not an advantage, since products can
be copied. Foreign banks main advantage is knowledge of operations
and needs of clients from their home countries. This information is difcult for host country banks to acquire, unless the local banks work with
the multinational rms. Even then, the banks do not know entire operations. When banks move abroad, therefore, they do so defensively so that
the host country banks do not have the opportunity to obtain this special
knowledge.
In another early study, Gray and Gray (1981) observed that multinational banks gain their comparative advantage from market imperfections. The two most important raw materials of banks were found to
be funds and knowledge; by expanding their presence abroad, banks were
194
able to enhance both. A stay-at-home bank was constrained by the need

to obtain global funds through correspondent banks, which means that
the information such a bank receives is second-hand. When banks were
able to obtain funds more cheaply by cutting out the middleman and
obtain information less expensively by being there, they may have had a
comparative advantage. So, as clients expand their operations, banks may
want to follow them to provide all the services they need. Although
DeLong (1993) nds that foreign banks tend to locate in countries where
there is a great deal of direct investment, the study was unable to show
whether banks were leading or following their clients.
A study by Buch and DeLong (2001) found that cross-border bank
mergers are in fact still quite rare. When they did occur, how did they
perform? In a paper that comprehensively examines theory and evidence
about cross-border bank mergers, Berger, DeYoung, Genay, and Udell
(2000) explored the causes and consequences. Managerial motives seem
to play an important role in cross-border bank mergers, as does deregulation that allows such mergers. Although the authors nd that foreign
institutions tend to be less efcient than their local counterparts on average, banks from certain countries are able to overcome the local market
advantage of their domestic rivals. Banks from some countries such as
Spain are as efcient as their local counterparts, and banks from one
country, the United States, are more efcient than their domestic counterparts. The results suggest that domestic institutions will continue to be
important for the provision of nancial services despite foreign competition. However, banks that provide services as well as, or more efciently
than, their local counterparts may work to increase global consolidation.
The study does not explore why U.S. banks tend to be successful internationally. The authors cautioned that they looked only at developed
countries, that the results may differ for emerging markets, and that nancial institutions could alternatively provide international services
through means other than acquisitions. Furthermore, the study involved
accounting data, which are very difcult to compare internationally and
may not accurately reect the condition of the banks. What is interesting,
the authors found that banks that perform well at home tend to perform
well outside their home countries, and those that do not perform well at
home tend to be international laggards as well.
The nding that competitive efciency in a banks home market inuences efciency in the afliate is supported by Berger and DeYoung (2001),
who examined the effects of geographic expansion on bank efciency.
They found that parent organizations have a great inuence on the efciency of their afliates. Control by headquarters appears to be more
difcult as distance increases, but well-run parents seem to have well-run
afliates regardless of distance.
Buch (2002) found that regulations, as well as information costs (measured by distance), common language, and common legal systems, induce
banks to engage in international investments. The importance of each of
195
these factors varies from country to country. The results suggest that banks
may choose different paths for internationalization. Banks from some
countries, such as Spain, prefer markets that are similar to their own,
whereas others want markets with low entry barriers.
Most of the empirical works on cross-border M&A deals in the nancial
services industry have focused on banks. There is virtually no empirical
work available on securities rms, asset managers, or insurance companies. In the rst two industries, there have arguably been too few deals
to devise a large enough dataset suitable for analysis, although this is
hardly the case in the insurance sector, as discussed in Chapter 2.
Event Studies
Event study methodology (Brown and Warner 1985) can be used to determine investor reaction to events such as the announcement of a merger
or an earnings report. The technique controls for conditions in the general
market. For example, if the market is doing poorly (well), a stock may do
poorly (well) because of the market environment and not because of the
event. Therefore, one needs to determine the relationship a particular
stock has with the market during normal timesthat is, before the
event occurs. This relationship can be determined by regressing the returns of the stock on the market index and a constant.4 One then determines what the stock should have earned (total returns) given the state
of the general market, as well as the stocks past relationship with the
general market. These hypothetical returns are compared with actual returns to determine the abnormal returns, that is, how much more or less
the stock earns as a result of the announcement.5
Abnormal returns are added together over various periods, usually
several days before the announcement to several days after. It is important
to look at a few days before the event in case any news about the event
itself has leaked and has already affected the value of the stock. Looking
at the abnormal returns for a few days after the announcement allows
event studies to take second thoughts into account. The market may be
so surprised about an announcement that it may need a few days to digest
the news. One cannot know with certainty the ideal length of the pre-or
post-event periods. Extending either period leads to problems, since other
events, such as earnings reports or changes in management, could occur
and the market could be reacting to those events instead.
As an example of how the event study approach can be used, we
applied it to the seven strategic M&A deals, cited earlier, that were undertaken by UBS AG and its predecessor organizations during the period
19842000. These include the Swiss Bank Corporation acquisition of
4. We obtain the following relationship: Ri ai bi RMt where RMt the return on the market at time
t; ai regression result on the constant; bi relationship between the market and stock i, also known as
the beta of stock i.
5. That is, ARit Rit (ai bi RMt), where ARit abnormal return for stock i at time t; Rit return
on stock i at time t; and RMt the return on the market at time t.
196
OConnor (January 9, 1992), the SBC acquisition of Brinson (August 31,

1994), the SBC acquisition of S.G. Warburg (May 2, 1995), the SBC takeover
of Dillon Read (May 15, 1997), the merger of Swiss Bank Corporation and
Union Bank of Switzerland to form the present UBS AG (December 8,
1997), the UBS acquisition of Global Asset Management (GAM) announced in September 13, 1999, and the UBS acquisition of PaineWebber
announced on July 11, 2000. The rst four deals were undertaken by Swiss
Bank Corporation and can therefore be viewed in terms of SBC share price
impacts; the SBC-UBS merger in 1997 can be examined in terms of both
the SBC and UBS cumulative abnormal returns, and the GAM and
PaineWebber deals would have affected the shares of the new UBS AG.
We estimated alpha and beta using daily returns from 500 to 10 days
before the merger announcement by regressing the returns of the stock
on the returns of the Swiss SMI index. To determine the extent to which
a particular merger was perceived by the market to have created or destroyed value, we cumulated the abnormal returns for various event windows for each SBC and UBS transaction beginning with OConnor in 1992
and ending with PaineWebber in 2000. As mentioned above, no scientic
way of determining the ideal event window exists, although no confounding events (earnings reports, changes in management, other major mergers) occurred around the time of the various merger announcements. We
therefore conclude that the market was reacting only to the announcement
of the particular merger. Table 6-10 summarizes the respective calculated
abnormal returns.
No regularity is obvious from the markets reactions to SBC or UBS
merger or acquisition announcements based on the seven cases examined
here. That is, the market appears to judge each merger on its own merits.
Market reaction to the merger of UBS and SBC, for example, was highly
positive for shareholders of both rms, possibly reecting expected cost
cuts (especially in their domestic banking businesses) that could be made
Table 6-10 Abnormal Returns Associated With Selected UBS Transactions

Abnormal Returns for Acquirer
Merger
SBC OConnor
SBC Brinson
SBC Warburg
SBC Dillon Read
SBC-UBS (for SBC)
SBC-UBS (for SBC)
UBS-GAM
UBS-PaineWebber
Date
Event Date
[1,1]
window
[3,3]
window
[5,5]
window
9-Jan-92
31-Aug-94
2-May-95
15-May-97
8-Dec-97
8-Dec-97
13-Sep-99
11-Jul-00
0.444%
0.713%
0.012%
0.413%
4.108%
9.368%
0.082%
0.244%
0.930%
1.084%
2.515%
1.551%
7.756%
13.133%
0.977%
7.306%
2.587%
3.704%
5.170%
1.842%
5.929%
12.813%
1.452%
2.795%
0.902%
5.205%
7.127%
5.231%
4.936%
10.256%
0.899%
3.509%
197
possible by the mergerstogether with the presumably stronger competitive position of the new UBS AG in its various areas of activity (notably
private banking and investment banking). However, market reaction to
the UBS acquisition of PaineWebber was strongly negative, possibly a
reaction to of the high price paid, the absence of short-term cost reductions, lack of major PaineWebber contributions to strengthening the UBS
investment banking platform in the United States, and uncertainly about
how the PaineWebber capabilities would be leveraged into UBS operations outside the United Statesthe latter uncertainty was noted in a
subsequent Moodys downgrade of UBS debt in 2001.
Specically in the positive market reaction to the announcement of the
SBC-UBS merger, the good reputation of SBC as a serial acquirer may
have had a positive inuence. By mid-1997, SBC had cultivated a strong
reputation concerning its ability to target acquisitions, integrate them
successfully, and ultimately extract value for its shareholders. For example, The Economist (1999) had noted that SBCs handling of its previous
i.e., prior to the UBS mergeracquisitions had been hard to fault, and
Davis (2000) wrote that SBC had a track record of successfully blending
and shaping different cultures in a meritocractic environment (p. 105).
Market reaction to the announcement of the SBC merger with UBS was
also in line with conclusions from the empirical M&A literature cited
earlier.
EUROPEAN VERSUS U.S. FINANCIAL SECTOR MERGERS
Event studies in the empirical M&A literature have been heavily concentrated U.S.-based transactions. Among the reasons for this bias are limitations in international data availability, consistency, and equity market
characteristics in various countries such as large, concentrated blocks of
shareholdings, multiple share classes, slowness in dissemination of M&A
information, the role of governments as regulators, and holders of golden
shares.
Nevertheless, research concerning European bank mergers has been
growing. Cybo-Ottone and Murgia (1997) examined market reactions to
European nancial-sector mergers while Vander Vennet (1998) examined
at long-term performance.
Cybo-Ottone and Murgia (1997) assessed stock market reaction to the
announcement of several bank mergers in Europe. Contrary to studies of
U.S. mergers that nd neither positive nor negative reaction on average,
their study found that the combined return to bidders and targets is
positive, and also found weak evidence of a positive response to acquirers.
The authors suggest that their results could be capturing possible economies of super-scale (European mergers on average tend to be much larger
than U.S. mergers), as well as a regulatory environment that was historically friendlier to universal banking. European bank mergers could thus
take advantage of more revenue synergies than U.S. mergers.
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Vander Vennet (1998) attempted to determine which European banks

were more likely to be active in their domestic takeover markets and why,
and further investigated long-term performance to understand whether
the banks expectations were fullled. For mergers of equals, both partners
tend to be underperformers, in terms of operational efciency and profitability. This nding suggests that acquirers want to merge to in order
take advantage of presumed synergies. Operational efciency and, to a
lesser extent, protability improve in the three years after the merger. The
long-term performance of merged European banks suggests that the synergies were to a large extent realized.
Although DeLong (2001b) and Houston, James, and Ryngaert (1999)
found that in-market mergers tend to create value upon announcement
based on the U.S. nancial services deal ow, such ndings may not be
true for non-U.S. mergers, since in-market takeovers are expected to cut
costs faster and more dramatically than market-extending acquisitions,
and in addition may do so more dramatically in the United States than
elsewhere. Especially in Europe, where strong unions and social legislation prevent large-scale personnel layoffs, even in-market mergers may
not be able to cut costs as effectively as in the United States.
Moreover, according to Vander Vennet (1998), event studies are seldom
used to study European bank mergers because many European banks
involved in takeovers are not publicly traded in liquid equity markets.
One comprehensive study (Cybo-Ottone and Murgia 1997) nds that the
announcements of European bank mergers, like U.S. bank mergers,
generally result in no gains or losses to combined stockholders of
the partners. However, U.S. acquirers tend to lose value slightly, whereas
U.S. targets gain 7 to 14 percent (Cornett and Tehranian 1992; Houston
and Ryngaert 1994). European acquirers tend not to lose value, but
European targets do not appear to make great gains. Although mergers
of equals surveyed in the latter study range from megamergers to combinations of small banks, a common problem exists in blending the dissimilar corporate philosophies. Results for takeovers, dened as a larger
institution acquiring a smaller one, are different. Market power and increasing size appear to be the driving forces. Large universal banks tend
to acquire targets that are relatively small and inefcient. Takeovers do
not lead to long-term improvement in return on assets or efciency, perhaps because the targets are too small to have much inuence on the large
organization.
In a study of Dutch and Belgian nancial services rms, Verweire and
Van den Berghe (2002) found a negative and linear relationship between
the degree of diversication of business streams and performance in terms
of total returns to shareholders. This is attributed to the costs of integration
complexity carried by the rms involved, which more than outweighed
the positive scope economies that tend to appear mainly on the revenue
side. Davis (2000) points out several ways that European bank mergers
differ from U.S. mergers. In a series of case studies, he nds Europeans
199
are much more concerned about unions, and that cost-cutting is a much
smaller source of any joint gains than in the United States.
SUMMARY
The empirical literature on mergers and acquisitions in the nancial services sector surveyed in this chapter broadly validates the conclusions
suggested in the conceptual discussion that preceded it. Mergers and
acquisitions that work tend to focus the activities of the acquiring rm,
either geographically or by product or by client, which allows the realization of operating efciencies and maximizes the rms market footprint.
Those gains in market share and cost-cutting efforts may then translate
into improved returns on capital invested. How the transaction is implemented is as important as the transaction itself, notably the price, the
integration process, and persistent careful attention to quality and service.
An overpriced acquisition can be hard to overcome. And merger integration in this industry has to be rapid and transparent: people need to know
where they stand, and those who remain on board have to be enthusiastic
about their own and the rms prospects going forward. Not least, clients
have to be convinced that the transaction is in their interest as well, either
by delivering better pricing or better service. Still, a 1999 report by the
Bank for International Settlements (1999) concluded: Studies continue to
indicate that the experience of a majority of mergers is disappointing, as
organizational problems are systematically underestimated and acquirers
tend to overpay for targets.
The same lessons hold when rms pursue mergers in other regions or
try to broaden the client base or scope of activity through acquisitions.
Such transactions have to be conducted according to the same rulebook
that applies to focusing transactions. GECS has been noted as one rm
that has tried to do this, often with impressive success. And some nancial
rms, such as National Australia Bank and HSBC, have shown that close
attention to the rulebook can lead to a portfolio of protable stand-alone
businesses in some very diverse markets. This does not deny that scope
economies are achievable, notably on the demand side through crossselling. But in such cases the incentives to cross-sell have to be examined
at an extremely granular level. Employees and clients need to believe that
cross-selling is in their own interests. Anything else tends to be just exhortation.
It is worthwhile to note that determining whether the mergers and
acquisitions in the nancial services sector were successful, partially successful, or failed might be difcult to assess in terms of shareholders
value creation in the early 2000s. One needs to distinguish between the
company-related implications (that is, unsystematic implications) and the
effects of the market at large (that is, the systematic implications). There
are numerous instances of successful mergers and acquisitions in nancial
services, but unfavorable business cycles and other adverse circumstances
200
could render the best-conceived deal economically unfeasible. Apparently,

the jury is still out on the merits of mergers in the industry, but they
nevertheless go on, albeit a slower rate due to a lackluster economy in
the early 2000s as well as declines in share prices that limited the attractiveness of stock-for-stock swaps.
In a survey paper written at the peak of the U.S. nancial M&A wave,
Pilloff and Santomero (1997), point out the paradox that there appeared
to be no net economic gain from all of this activity. Self-delusion and selfenrichment by management were rejected as implausible over the long
term. The devil, in fact, seems to be in the details. How effectively is the
integration if carried out, and how disciplined is the internal capitalallocation process applied going forward?
7
Mergers, Acquisitions, and the
Financial Architecture
Merger and acquisitions activity in the nancial sector has been one of
the major vehicles in the transformation of a key set of economic activities that stand at the center of the national and global capital allocation
and payments system. It can therefore be argued that the outcome of
the M&A process in terms of the structure, conduct, and performance of
the nancial sector has a disproportionate impact on the economy as a
whole.
There are three issues here. The rst relates to how well the nancial
system contributes to economic efciency in the allocation of resources,
thereby promoting a maximum level of income and output. The second
relates to how it affects the rate of growth of income and output by inuencing the various components of economic growththe labor force, the
capital stock, the contribution of national resources to growth, as well as
efciency in the use of the factors of production. The third issue concerns
the safety and stability of the nancial system, notably systemic risk associated with crises among nancial institutions and their propagation to
the nancial system as a whole and the real sector of the economy.
A nancial structure that maximizes income and wealth, and promotes
the rate of economic growth together with continuous market-driven economic reconguration, and achieves both of these with a tolerable level
of institutional and systemic stability would have to be considered a
benchmark system.
The condition and evolution of the nancial sector is therefore a matter
of public interest. Outcomes of the nancial-sector restructuring process
through M&A activity or in other ways that detract from its contribution
to efciency, growth, and stability can therefore be expected to attract the
attention of policymakers. For example, nobody seriously believes that a
dynamic market-driven economy that hopes to be competitive on a global
scale can long afford a nancial services industry that is dominated by
201
202
one or two mega-conglomerates that are able to extract monopoly rents

from their clients and shield themselves from competition by new entrants. Long before that happens, the high political prole of the nancial
industry and its institutions would trigger a backlash felt in legislative
initiatives, judicial decisions, and regulatory changes, reecting efforts to
restore higher levels of competitive discipline to the industry.
This chapter examines the public policy issues affecting the structure
of the nancial system and therefore the M&A process, and vice versa.
The issues range from competition policy to the design of the nancial
safety net and the potentially intractable problems of assuring the safety
and soundness of massive nancial conglomerates that are active in a
wide range of nancial businesses and sometimes extend across the
world.
IMPACT ON THE STRUCTURE OF THE FINANCIAL SYSTEM
One way to calibrate the so-called static efciency properties of a nancial system is to use the all-in, weighted average spread (differential)
between (1) rates of return provided to ultimate savers and investors and
(2) the cost of funds to the ultimate users of nance. This stylized gross
spread can be viewed as a measure of the total cost of nancial intermediation, and is reected in the monetary value of resources consumed in
the nancial intermediation process. In particular, it reects direct costs
of nancial intermediation (operating costs, cost of capital, and so on). It
also reects losses incurred in the nancial process that may ultimately
be passed on to end users, as well as liquidity premiums and any excess
prots earned. In this framework, nancial processes that are considered
statically inefcient are usually characterized by high all-in margins due to
high overhead costs, high losses not ultimately borne by shareholders of
the nancial intermediaries themselves, excess prots due to concentrated
markets and barriers to entry, and the like.
Dynamic efciency is characterized by high rates of nancial product
and process innovation through time. Product innovations usually involve creation of new nancial instruments along with the ability to replicate certain nancial instruments by bundling or rebundling existing
ones (synthetics). There are also new approaches to contract pricing, new
investment techniques, and other innovations that fall under this rubric.
Process innovations include contract design and methods of trading,
clearance and settlement, transactions processing, custody, techniques for
efcient margin calculation, application of new distribution and clientinterface technologies such as the Internet, and so on. Successful product
and process innovation broadens the menu of nancial information and
services available to ultimate borrowers and issuers, ultimate savers, and
various other participants in the nancial system.
A healthy nancial system exerts continuous pressure on all kinds of
nancial intermediaries for improved static and dynamic efciency. Struc-
Mergers, Acquisitions, and the Financial Architecture
203
tures better able to deliver these attributes eventually supplant those

that do not, and this is how nancial markets and institutions have
evolved and converged through time. For example, global nancial markets for foreign exchange, debt instruments, and to a lesser extent equities
have already developed various degrees of seamlessness. It is arguable
that the most advanced of the worlds nancial markets are approaching
a theoretical, complete optimum where there are sufcient nancial
instruments and markets, and combinations, thereof, to span the whole
state-space of risk and return outcomes. Conversely, nancial systems
that are deemed inefcient or incomplete tend to be characterized by
a high degree of fragmentation and incompleteness that takes the form
of a limited range of nancial services and obsolescent nancial processes.
Both static and dynamic efciency in nancial intermediation are of
obvious importance from the standpoint of national and global resource
allocation. That is, since many kinds of nancial services can be viewed
as inputs into real economic processes, the level of national output and
incomeas well as its rate of economic growthare directly or indirectly
affected, so that a retarded nancial services sector can represent a
major impediment to an economys overall economic performance. Financial system retardation represents a burden on the nal consumers of
nancial services and potentially reduces the level of private and social
welfare; it reduces what economists call consumer surplus, an accepted
measure of consumer welfare.1 It also represents a burden on producers
by raising their cost of capital and eroding their competitive performance
in domestic and global markets. These inefciencies ultimately distort the
allocation of labor as well as capital and affect both the level of income
and output, as well as the rate of economic growth, by impeding capital
formation and other elements of the growth process.
As noted in earlier chapters, in retail nancial services extensive banking overcapacity in many countries has led to substantial consolidation
often involving the kind of M&A activity detailed in the tables found in
the Appendix 1. Excess retail production and distribution capacity in
banking has been slimmed down in ways that usually release redundant
labor and capital. This is a key objective of consolidation in nancial
services generally, as it is in any industry. If effective, surviving rms tend
to be more efcient and innovative than those that do not survive. In
some cases this process is retarded by restrictive regulation, by cartels, or
by large-scale involvement of public sector nancial institutions that operate under less rigorous nancial discipline or are beneciaries of public
subsidies.
Also at the retail level, commercial banking activity has been linked
1. Consumer surplus is the difference between what consumers would have paid for a given product
or service according to the relevant demand function and what they actually have to pay at the prevailing
market price. The higher that price, the lower will be consumer surplus.
204
strategically to retail brokerage, retail insurance (especially life insurance),

and retail asset management through mutual funds, retirement products,
and private-client relationships. At the same time, relatively small and
focused rms have sometimes continued to prosper in each of the retail
businesses, especially where they have been able to provide superior
service or client proximity while taking advantage of outsourcing and
strategic alliances where appropriate. Competitive market economics
should be free to separate the winners and the losers. Signicant departures from this logic need to be carefully watched and, if necessary, redressed by public policy.
In wholesale nancial services, similar links have emerged. Wholesale
commercial banking activities such as syndicated lending and project
nancing have often been shifted toward a greater investment banking
focus, whereas investment banking rms have placed growing emphasis
on developing institutional asset management businesses in part to benet
from vertical integration and in part to gain some degree of stability in a
notoriously volatile industry. Vigorous debates have raged about the need
to lend in order to obtain valuable advisory business and whether specialized monoline investment banks will eventually be driven from the
market by nancial conglomerates with massive capital and risk-bearing
ability. Here the jury is still out, and there is ample evidence that can be
cited on both sides of the argument.
The United States is a good case in point. Financial intermediation was
long distorted by regulation. Banks and bank holding companies were
prohibited from expanding geographically and from moving into insurance businesses and into large areas of the securities business under the
Glass-Steagall provisions of the Banking Act of 1933. Consequently banks
half a century ago dominated classic banking functions, independent
broker-dealers dominated capital market services, and insurance companies dominated most of the generic risk management functions, as shown
in Figure 7-1. Cross-penetration between different types of nancial intermediaries existed mainly in the realm of retail savings products.
A half century later this functional segmentation had changed almost
beyond recognition, despite the fact that full de jure deregulation was not
fully implemented until the end of the period with passage of the GrammLeach-Bliley Act of 1999. Figure 7-2 shows a virtual doubling of strategic
groups competing for the various nancial intermediation functions. Today there is vigorous cross-penetration among all kinds of strategic
groups in the U.S. nancial system. Most nancial services can be obtained
in one form or another from virtually every strategic group, each of which
is, in turn, involved in a broad array of nancial intermediation services.
The system is populated by mega-banks, nancial conglomerates, credit
unions, savings banks, saving and loan institutions, community banks,
life insurers, general insurers, property and casualty insurers, insurance
brokers, securities broker-dealers, asset managers, and nancial advisers
Figure 7-1. The U.S. Financial Services Sector, 1950. Figures 7-1 and 7-2 courtesy of
Richard Herring, The Wharton School, University of Pennsylvania.
Figure 7-2. The U.S. Financial Services Sector, 2003.
205
206
mixing and matching capabilities in ways the market seems to demand.

It remains a highly heterogeneous system today, confounding earlier conventional wisdom that the early part of the twenty-rst century would
herald the dominance of the European style universal bank or nancial
conglomerate in the United States. Evidently their time has not yet come,
if it ever will.
If cross-competition among strategic groups promotes both static and
dynamic efciencies in the nancial system, the evolutionary path of the
U.S. nancial structure has probably served macroeconomic objectives
particularly growth and continuous economic restructuringvery well
indeed. Paradoxically, the Glass-Steagall limits in force from 1933 to 1999
may have contributed, as an unintended consequence, to a much more
heterogeneous nancial system than otherwise might have existedcertainly more heterogeneous than prevailed in the United States of the 1920s
or that prevail in most other countries today.
Specically, Glass-Steagall provisions of the Banking Act of 1933 were
justied for three reasons: (1) the 8,000-plus bank failures of 19301933
had much to do with the collapse in aggregate demand (depression) and
asset deation that took hold during this period, (2) the nancial-sector
failures were related to inappropriate activities of major banks, notably
underwriting and dealing in corporate stocks, corporate bonds, and municipal revenue bonds, and (3) these failures were in turn related to the
severity of the 1929 stock market crash, which, through asset deation,
helped trigger the devastating economic collapse of the 1930s. The available empirical evidence generally rejects the second of these arguments,
and so nancial economists today usually conclude that the Glass-Steagall
legislation was a mistakethe wrong remedy implemented for the wrong
reasons.
Political economists tend to be more forgiving, observing that Congress
only knew what it thought it understood at the time and had to do
something dramatic to deal with a major national crisis. The argumentation presented in the 1930s seemed compelling. So the Glass-Steagall
provisions became part of the legislative response to the crisis, along with
the 1933 and 1934 Securities Acts, the advent of deposit insurance, and
other very positive dimensions of the regulatory system that continue to
evolve today.
The Glass-Steagall legislation remained on the books for 66 years, reconguring the structure of the nancial system into functional separation
between investment banking and securities, commercial banking, and
commerce (which included insurance) was later cemented in the Bank
Holding Company Act of 1956. European-type universal banking became
impossible, although some restrictions were later eased by allowing
Section-20 investment banking banking subsidiaries of commercial bank
holding companies to be created with progressively broader underwriting
and dealing powers and 10% (later 25%) illegal-activity revenue limits.
207
Very few nancial institutions actually took advantage of this liberalization, however.
What happened next? Independent securities rms obtained a longlasting monopoly on Glass-Steagall-restricted nancial intermediation activitiesmainly underwriting and dealing in corporate debt and equity
securities and municipal revenue bondswhich they fought to retain
through the 1990s via a wide range of vigorous rear-guard political lobbying and legal tactics. Firms in the securities industry included legacy
players like Lehman Brothers and Goldman Sachs, as well as rms forcibly
spun off from what had been universal banks, such as Morgan Stanley.
All of the U.S. securities rms were long organized as partnerships,
initially with unlimited liabilitythus fusing their ownership and management. This did not change until almost a half-century later, when many
converted to limited liability companies and later incorporated themselvesthe last being Goldman Sachs in 1999. Arguably, the industrys
legacy ownership-management structure caused these rms to pay extraordinary attention to revenue generation, risk control, cost control, and
nancial innovation under high levels of teamwork and discipline. Some
of this may have been lost after their incorporation, which the majority
of the partners ultimately deemed necessary in order to gain access to
permanent capital and strategic exibility.
Unlike banks, independent U.S. securities rms operate under relatively transparent mark-to-market accounting rules, a fact that placed
management under strict market discipline and constant threat of capital
impairment. There was also in many rms a focus on light strategic
commitments and opportunism and equally light management structures that made them highly adaptable and efcient. This was combined
with the regulatory authorities presumed reluctance to bail out commercial enterprises whose failure (unlike banks) did not pose an immediate threat to the nancial system.
When Drexel Burnham Lambert failed in 1990 it was the seventh largest
nancial rm in the United States in terms of assets. The Federal Reserve
supplied liquidity to the market to help limit the systemic effects but did
nothing to save Drexel Burnham. When Continental Illinois failed in 1984
it was immediately bailed out by the Federal Deposit Insurance Corporationincluding all uninsured depositors. In effect, the bank was nationalized and relaunched after restructuring under government auspices.
Shareholders, the board, managers, and employees lost out, but depositors
were made whole. The lack of a safety net for U.S. securities rms arguably reinforced large management ownership stakes in their traditional
attention to risk control.
The abrupt shake-out of the securities industry started in 1974. The
independent securities rms themselves were profoundly affected by deregulation (notably elimination of xed commissions, intended to improve the efciency of the U.S. equity market). Surviving rms in the end
208
proved to be highly efcient and creative under extreme competitive

pressure (despite lack of capital market competition from commercial
banks), dominating their home market (which accounted for around 60%
of global capital-raising volume and on average about the same percentage of M&A activity) and later pushing that home-court advantage into
the international arena as well. Alongside the independent securities rms
grew a broad array of independent retail and institutional fund managers,
both generalists and specialists, and brokers with strong franchises that
were not full-service investment banks, such as like Charles Schwab and
A.G. Edwards, as well as custodians such as State Street, Bank of New
York, and Northern Trust Company.
The regulation-driven structure of independent U.S. capital market
intermediaries may have had something to do with limiting conict of
interest and other problems associated with involvement of nancial rms
in multiple parts of the nancial services business. There was also a
general absence of investment bankers (but not commercial bankers) on
corporate boards. There were few long-term holdings of corporate shares
by nancial intermediaries. That is, there were few of the hallmarks of
universal banking relationships that existed elsewhere in the world.
The structure also had much to do with the process of U.S. nancial
disintermediation on the borrower-issuer side as well as the savings and
asset management side of the ow of funds, with nancial ows through
the capital markets showing better static and dynamic efciency properties and drawing off nancial activities from banks and thrifts. Nonetheless, many small community banks and thrifts continued to thrive by
virtue of client proximity, better information, better service, or some combination of these.
Finally, legacy effects of the Glass-Steagall provisions, through the resulting nancial intermediation structure, also had much to do with U.S.
reliance in matters of corporate governance on a highly contestable market
for corporate control. For better or worse, in the absence of Glass-Steagall
the U.S. economic performance story though the end of the twentieth
century might have been very different from what it actually was. It
proved to be very good at producing sustained economic dynamism compared with most other parts of the world. It did not, however, prove to
be a good guardian against the kinds of duciary violations, corporate
governance failures, and outright fraud that emerged in the U.S. nancial
scandals in 2002.
Still, consolidation has proceeded apace in the United States, although
the 1999 deregulation did not in fact produce a near-term collapse of the
highly diversied nancial structure depicted in Figure 7-2. However,
consolidation has been accompanied in recent years by higher concentration ratios in various types of nancial services, except in retail banking,
where concentration ratios have actually fallen. None of these concentrations seem troublesome yet in terms of preserving vigorous competition
and avoiding monopoly pricing, as suggested in Figure 3-9 in Chapter 3.
209
A similar framework for discussing the nancial structure of Europe is

not particularly credible because of the wide structural variations among
countries. One common thread, however, given the long history of universal banking, is that banks dominate most nancial intermediation functions in much of Europe. Insurance is an exception, but given European
bancassurance initiatives that seem to be reasonably successful in many
cases, some observers still think a broad-gauge banking-insurance convergence is likely.
Except for the penetration of continental Europe by U.K. and U.S.
specialists in the investment banking and fund management businesses,
many of the relatively narrowly focused continental nancial rms seem
to have found themselves sooner or later acquired by major banking
groups. Examples include Banque Indosuez and Banque Paribas in
France, MeesPierson and Robeco in the Netherlands, Consors in Germany,
and Schroders, Flemings, Warburgs, and Gartmore in the United Kingdom. Figure 7-3 may be a reasonable approximation of the European
nancial services industry structure, with substantially less density of
functional coverage by specic strategic groups than in the United States
and correspondingly greater dominance of major nancial rms that include commercial banking as a core business.
It is interesting to speculate what the European nancial services
industry-structure matrix in Figure 7-3 will look like in ten or twenty
years. Some argue that the impact of size and scope is so powerful that
the nancial industry will be dominated by large, complex nancial institutions in Europe, especially in the euro-zone. Others argue that a rich
array of players, stretching across a broad spectrum of strategic groups,
Figure 7-3. The European Financial Services Sector, 2003.
210
will serve the European nancial system and its economic future better
than a strategic monoculture based on massive universal banking organizations and nancial conglomerates. Consolidation is often to the good,
but it has its limits.
Besides the United States and Europe, there is the perennial issue of
the role of Japans nancial system. Like the United States, it was long
distorted by competitive barriers such as Article 65 of the Japan Financial
Law, promulgated during U.S. occupation after World War II. But it also
had distinctive Japanese attributes, such as the equity crossholdings between banks and industrial companies in keiretsu structures. Major Japanese City banks such as Sumitomo and Bank of Tokyo existed alongside
four major and numerous minor securities rms, trust companies, nance
companies, and the like. Competitive dynamics were hardly transparent,
and government ministriesnotably the Ministry of Finance and the Ministry of International Trade and Industrywielded extraordinary inuence.
The good years of the 1970s and 1980s covered up myriad inefciencies
and inequities in Japans nancial system until they ended abruptly in
the early 1990s. The required Japanese nancial-sector reconguration
was not impossible to gure out (see for example Walter and Hiraki 1994).
Mustering the political will to carry it out was another matter altogether,
so that a decade later the failed Japanese system still awaited a new,
permanent structural footing. Meanwhile, life goes on, and some of the
key Japanese nancial business in investment banking, private banking,
and institutional fund management have seen substantial incursions by
foreign rms. In other sectors, such as retail brokerage, foreign rms have
had a much more difcult time.
Structural discussions of Canada, Australia, and the emerging market
economies, as well as the transition economies of eastern Europe, have
been intensive over the years, particularly focusing on eastern Europe in
the 1990s and the Asian economies after the debt crisis of 19971998 (see
Claessens 2000; Smith and Walter 2000). Regardless of the geographic
venue, some argue that the disappearance of small local banks, independent insurance companies in both the life and nonlife sectors, and a broad
array of nancial specialists is probably not in the public interest, especially if, at the end of the day, there are serious antitrust concerns in this
key sector of the economy. And as suggested in Figure 7-4, the disappearance of competitors can have signicant transactions cost and liquidity consequences for nancial marketsin this case non-investment grade
securities.
At the top of the nancial industry food-chain, at least so far, the most
valuable nancial services franchises in the United States and Europe in
terms of market capitalization seem far removed from a nancialintermediation monoculture (see Tables 2-12 and 2-13 in Chapter 2). In
fact, each presents a rich mixture of banks, asset managers, insurance
companies, and specialized players.
211
Figure 7-4. Active underwriters and dealers: high-yield bonds. The consolidation of many securities rms combined with the dealers reduced willingness to take risk have drastically reduced all
rms market-making activities. Source: J.P. Morgan Chase.
An interesting facet of Tables 2-12 and 2-13 is that no single strategic

group seems to have come to dominate the playing eld. Some of the
most valuable rms in the business are generalists, even nancial conglomerates. Some are international, even global, while others are mainly
domestic or regional. And some are specialists, focusing on only part of
the nancial services spectrum but obviously doing something right. So
far it does not seem that multifunctional nancial conglomerates, most
created through extended periods of M&A activity, have been successful
in driving the more specialized rms from the playing eld. Nor does the
reverse seem to be the case, although creation of todays cohort of specialists has usually involved equally intense M&A activity. And so it
seems that in terms of structural survivorship and dominance, the jury
remains out.
How the institutional structure of the nancial services sector will
evolve is anybodys guess. Those who claim to know often end up being
wrong. As noted in the previous chapter, inuential consultants sometimes convince multiple clients to do the same thing at the same time,
and this spike in strategic correlation can contribute to the wrongness of
their vision. What is clear is that the underlying economics of the industrys competitive structure will ultimately prevail, and nance will ow
along conduits that are in the best interests of the end users of the nancial
system. The rms that constitute the nancial services industry will have
to adapt and readapt to this dynamic in ways that protably sustain their
raison detre.
212
THE REGULATORY OVERLAY
This discussion has argued that on the whole, M&A activity in the nancial services industry is driven by straightforward, underlying economic
factors in the nancial intermediation process dominated by a constant
search for static and dynamic efciency. If bigger is better, restructuring
will produce larger nancial services organizations. If broader is better, it
will give rise to multifunctional rms and nancial conglomerates. If not,
then further restructuring activity will eventually lead to spin-offs and
possibly breakups once it becomes clear that the composite value of a
rms individual businesses exceeds its market capitalization. Along the
way, it is natural that mistakes are made and a certain herd mentality that
exists in banking and nancial services seems to cause multiple rms to
get carried away strategically at the same time. Still, in the end, the
economic fundamentals tend to win out.
At the same time, the nancial services industry is and always will be
subject to regulation by government. First, as noted earlier, problems at
nancial institutionsespecially commercial bankscan create impacts
that broadly affect the entire nancial system. These problems, in turn,
can easily have an impact on the economy as a whole. The risks of such
negative externalities are a legitimate matter of public interest and justify regulation. If the taxpayer is obliged to stand by to provide safeguards
against systemic risks, the taxpayer gets to have a say in the rules of the
game.
Additionally, nancial services rms are dealing with other peoples
money and therefore have strong duciary obligations. Governments
therefore try to make sure that business practices are as transparent and
equitable as possible. Besides basic fairness, there is a link to nancial
system efciency as well in that people tend to desert rigged markets and
inequitable business practices for those deemed more fair. Regulators
must therefore keep the three goalsefciency, stability, and equityin
mind at all times as the core of their mandate. This is not a simple matter,
and mistakes are made, especially when the nancial landscape is constantly changing, as are the institutions themselves.
Markets and institutions tend, perhaps more often than not, to run
ahead of the regulators. Regulatory initiatives sometimes have consequences that were not and perhaps could not have been foreseen. The
regulatory dialectic in the nancial services sector is both sophisticated
and complex, and often confronts both heavily entrenched and politically
well-connected interests (as well as some of the brightest minds in business). The more complex the industryperhaps most dramatically in the
case of massive, global nancial services conglomerates where comprehensive regulatory insight (and perhaps even comprehensive management oversight) is implausiblethe greater the challenge to sensible regulation (Cumming and Hirtle 2001). Here the discussion will be limited
to some of the basic regulatory parameters that are consistent with the
213
nancial services industry dynamicsleaving aside the question whether

of a small country is in fact capable of bailing out a major global bank
under its regulatory jurisdiction.
As noted, we presuppose that the nancial services industry worldwide has been, and will continue to be, subject to signicant public authority regulation and supervision due to the duciary nature of the
business, the key role of nancial systems in driving economic performance, the potential for nancial fraud, and the possibility of serious
social costs associated with nancial failure. Indeed, we know from experience that even small changes in nancial regulation can bring about
large changes in nancial system activity. We also know that, to the extent
information ows among counterparties in nancial activities are imperfect, regulation can signicantly improve the operation of nancial systems. The greater the information asymmetries and transaction-cost inefciencies that exist, the greater will be the value of regulation quite
apart from its benets in terms of safety and soundness. And it sometimes
seems that the more the nancial intermediaries complain, the better the
regulators are doing their jobs.
Edward Kane (1987) is one of the pioneers in thinking about nancial
regulation and supervision as imposing a set of taxes and subsidies
on the operations of nancial rms exposed to them. On the one hand,
the imposition of reserve requirements, capital adequacy rules and certain
nancial disclosure requirements can be viewed as imposing taxes on
a nancial rms activities in the sense that they increase intermediation
costs. On the other hand, regulator-supplied deposit insurance, information production and dissemination, and lender-of-last resort facilities
serve to stabilize nancial markets, reduce information and transaction
inefciencies, improve liquidity, and lower the risk of systemic failure
thereby improving the process of nancial intermediation. They can
therefore be viewed as implicit subsidies provided by taxpayers.
The difference between these tax and subsidy elements of regulation
can be viewed as the net regulatory burden (NRB) faced by particular
types of nancial rms in any given jurisdiction. All else equal, nancial
ows tend to migrate toward those regulatory domains where NRB is
lowest. NRB differences can induce nancial-intermediation migration
when the savings realized exceed the transaction, communication, information and other economic costs of migrating. Indeed, it has been argued
that a signicant part of the nancial disintermediation discussed in
Chapter 1and its impact on various types of nancial rmshas been
due to differences in NRB, which is arguably highest in the case of commercial banks. Competition triggers a dynamic interplay between demanders and suppliers of nancial services, as nancial rms seek to
reduce their NRB and increase their protability. If they can do so at
acceptable cost, they will actively seek product innovations and new avenues that avoid cumbersome and costly regulations by shifting them
either functionally or geographically.
214
REGULATORY TRADEOFFS
The right side of Figure 7-5 identies the policy tradeoffs that invariably
confront those charged with designing and implementing a properly
structured nancial system. On the one hand, they must strive to achieve
maximum static and dynamic efciency with respect to the nancial system as a whole, as dened earlier, as well as promote the competitive
viability of the nancial industry. On the other hand, they must safeguard
the stability of institutions and the nancial system, in addition to helping
to assure what is considered acceptable market conductincluding the
politically sensitive implied social contract between nancial institutions
and unsophisticated clients. The rst problem, safety-net design, is beset
with difculties such as moral hazard and adverse selection, and becomes
especially problematic when products and activities shade into one another, when on- and off-balance sheet activities are involved, and when
domestic and foreign business is conducted by nancial rms for which
the regulator is responsible. The second problem, market conduct, is no
less difcult when end users of the system range across a broad spectrum
of nancial sophistication from mass-market retail clients to highly sophisticated trading counterparties.
In going about their business, regulators continuously face a dilemma.
On the one hand, there is the possibility that inadequate regulation will
result in costly failures. On the other hand, there is the possibility that
overregulation will create opportunity costs in the form of nancial
efciencies not achieved, or in the relocation of rms and nancial transactions to other regulatory regimes offering a lower NRB. Since any improvements in nancial stability can only be measured in terms of damage
that did not occur and costs that were successfully avoided, the argumentation
surrounding nancial regulation is invariably based on what if hypotheticals. In effect, regulators are constantly compelled to rethink the balance
between nancial efciency and creativity on the one hand, and safety,
stability and suitable market conduct in the nancial system on the other.
They face the daunting task of designing an optimum regulatory and
supervisory structure that provides the desired degree of stability at minimum cost to efciency, innovation, and competitivenessand to do so
in a way that effectively aligns such policies among regulatory authorities
functionally and internationally and avoids fault lines across regulatory
regimes. There are no easy answers. There are only better and worse
solutions as perceived by the constituents to whom the regulators are
ultimately accountable.
Regulators have a number of options at their disposal. These range
from tness and properness criteria under which a nancial institution
may be established, continue to operate, or be shut-down to line-ofbusiness regulation as to what types business nancial institutions may
engage in, adequacy of capital and liquidity, limits on various types of
exposures, and the like, as well as policies governing marking-to-market
215
Figure 7-5. Regulatory Tradeoffs, Techniques, and Control.
of assets and liabilities (see Figure 7-6). Application of regulatory techniques can also have unintended consequences, as discussed in the rst
part of this chapter, which may not all be bad. And as noted, regulatory
initiatives can create nancial market distortions of their own, which
become especially problematic when nancial products and processes
evolve rapidly and the regulator can easily get one or two steps behind.
A third element involves the regulatory machinery itself. Here the
options range from reliance on self-control on the part of boards and
senior managements of nancial rms concerned with protecting the
value of their franchises through nancial services industry self-
216
regulation via so-called self-regulatory organizations (SROs) to public

oversight by regulators with teethincluding civil suits and criminal
prosecution. The options are listed in Figure 7-7
Self-regulation remains controversial, since nancial rms seem to persistently suffer from incidents of business losses and misconductdespite
the often devastating effects on the value of their franchises. Management
usually responds with expensive compliance infrastructures. But nothing
is perfect, and serious problems continue to slip through the cracks. And
ethics programs intended to assure appropriate professional conduct
are often pursued with lack of seriousness, at worst creating a general
sense of cynicism. People have to be convinced that a good defense is as
important as a good offence in determining sustainable competitive success. This is something that is extraordinarily difcult to put into practice
in a highly competitive environment and requires an unusual degree of
senior management leadership and commitment (Smith and Walter 1997).
Control through self-regulatory organizations (SROs) is likewise subject to dispute. Private sector entities that have been certied as part of
the regulatory infrastructure in the United States, for example, have repeatedly encountered problems. For instance, in 1996 one of the key U.S.
SROs, the National Association of Security Dealers (NASD), and some of
its member rms were assessed heavy monetary penalties in connection
with member rms rigging over-the-counter (OTC) equity markets. A
vigorous attempt to refute empirical evidence of improprieties eventually
yielded to major changes in regulatory and market practices. The Financial Accounting Standards Board, an SRO populated with accountants
and dependent on the major accounting rms for funding, was clearly
incapable of preventing audit disasters and the collapse of Arthur Andersen. Nor did the New York Stock Exchange, the American Stock
Exchange, the NASD, the Investment Company Institute (covering mutual
funds), the Securities Industry Association (representing investment
217
banks), and broad-gauge business organizations such as the Business

Round Table do much to head off the widespread governance failures in
the early 2000s that called into question some of the basic precepts of U.S.
market capitalism.
The U.S. corporate scandals hardly speak well of either rm or industry
self-regulation, with systematic failures across the entire governance
chain ranging from corporate management along with boards of directors and their various committees to the external control process including
commercial banks, investment banks, public accountants, rating agencies,
institutional investors, and government regulators. In some cases the regulators seem to have been co-opted by those they were supposed to
regulate, and in others (especially banks and accounting rms) they actively facilitated and promoted some of the questionable activities of
management at the expense of shareholders and employees.
Commercial and investment banks were right in the middle of the
mess, actively facilitating some of the most egregious shenanigans. It was
not until the launching of legal proceedings by the Attorney General of
the State of New York, Congressional hearings, and belated enforcement
action by the Securities and Exchange Commission that the various SROs
and industry associations were stirred into action. Probably the equity
market collapse in 20002002, and the view that this had become a major
political issue did as much as anything to get serious corrective action
underway.
Other well-known examples occurred in the United Kingdom, which
relied heavily on the SRO approach. In 1994, the self-regulatory body
governing pension funds, The Investment Management Regulatory Organization (IMRO), failed to catch the disappearance of pension assets
from Robert Maxwells Mirror Group Newspapers, and the Personal Investment Authority (PIA) for years failed to act against deceptive insurance sales practices at the retail level. In the Maxwell case, a 2001 report
of the Department of Trade and Industry (DTI) described the conduct of
the rms involved as beset with cliquishness, greed and amateurism.
Inevitable in self-regulation are charges of the fox watching the henhouse. As in the Maxwell case, the City of London came in for a good
deal of criticism for the easygoing ways that did much to contribute to
its competitive success in the global marketplace. And Americans have
cut down on lecturing others about the superiority of the market-driven
U.S. corporate governance system.
But reliance on public oversight for nancial regulation has its own
problems, since virtually any regulatory initiative is likely to confront
powerful vested interests that would like nothing better than to bend the
rules in their favor (Kane 1987). The political manipulation of the savings
and loan regulators in the United States during the 1980s is a classic
example and created massive incremental losses for taxpayers. So were
the efforts by Enron and other corporations, as well as some of the nancial rms, to use their government contacts to further their causes. Even
218
the judicial process, which is supposed to arbitrate or adjudicate matters

of regulatory policy, may not always be entirely free of political inuence
or popular opinion.
Just as there are tradeoffs implicit in Figure 7-6 between nancial system performance and stability, there are also tradeoffs between regulation
and supervision. Some regulatory options (for example capital adequacy
rules) are fairly easy to supervise but full of distortion potential due to
their broad-gauge nature. Others (for example tness and properness
criteria) may be highly cost-effective but devilishly difculty to supervise.
Finally, there are tradeoffs between supervision and performance, with
some supervisory techniques far more costly to comply with than others.
Regulators must try to optimize across this three-dimensional set of tradeoffs under conditions of rapid market and industry change, blurred institutional and activity demarcations, and functional as well as international regulatory fault lines.
THE AMERICAN APPROACH
One observation from U.S. experience is that, on balance, commercial

banks clearly carry a net regulatory burden, which, in terms of the actual
requirements and costs of compliance, has been substantially greater than
that which applies to the securities industry and other nonbank intermediaries. This has arguably had much to do with the evolution of the
countrys nancial structure, generally to the detriment of commercial
banking. Institutional regulation of nonbank intermediaries is relatively
light, but regulation of business conduct is relatively heavy and sometimes not particularly successful, as the nancial scandals of 20012002
demonstrated.
For example, when Congress passed the Securities Act of 1933 it focused on truth in new issues, requiring prospectuses and creating underwriting liabilities to be shared by both companies and their investment
bankers. It then passed the Securities Act of 1934, which set up the Securities and Exchange Commission and focused on the conduct of secondary markets. Later on, in the 1960s, it passed the Securities Investor
Protection Act, which provided for a guarantee fund (paid in by the
securities industry and supported by a line of credit from the U.S. Treasury) to protect investors who maintain brokerage accounts from losses
associated with the failure of the securities rms involved. None of these
measures, however, provided for the government to guarantee deposits
with securities dealers, nor did it in any way guarantee investment results.
So there was less need to get inside the securities rmsthe taxpayer
was not at risk. Where the taxpayers were at risk, in commercial banking
and savings institutions, regulation was much more onerous and compliance much more costly, ultimately damaging these institutions market
shares in the nancial evolution process.
219
Although the SEC developed into a forthright regulator, often willing

to use its powers to protect individual investors and ensure the integrity
of the markets, most of the discipline to which U.S. nonbank nancial
rms have been subject since 1934 is provided by the market itself. Prices
have risen and fallen. Investors have often lost money. Many securities
rms have failed or have been taken over by competitors. Others have
entered the industry with a modest capital investment and succeeded.
Firms are in fact regulated by the requirements of their customers, their
creditors, and their ownersrequirements demanding marked-to-market
accounting, adequate capitalization, and disclosure of all liabilities. Customers presumably require good service and honest dealings or they will
change vendors.
Together with the ever-present threat of massive class-action civil suits,
these market-driven disciplines, many would argue, have proven to be as
effective regulators of business conduct as any body established by government, particularly in the securities industry. The approach forces independent securities rms (or separately capitalized securities rms that
are part of bank holding companies) to pay great attention to managing
risks, managing costs, and ensuring protability. There is no lender of last
resort for the individual rm. In addition, they are subject to the costs of
maintaining expensive compliance systems, and since they are dependent
on banks for much of their funding, they have to meet acceptable credit
standards. Even in the case of massive failures like Drexel Burnham Lambert, regulators allowed the failure to run its course, taking care only to
provide sufcient liquidity to the market during the crisis period.
Since multifunctional nancial rms began to emerge in the United
States during the 1990s and particularly after 1999, the basic approach
has been regulation by function, requiring holding company structures
with separately capitalized banking and non-banking afliates and a lead
regulator, the Federal Reserve, responsible for the holding company as a
whole.
Functional regulation in the United States has been carried out through
a crazy-quilt of agencies, including the Federal Reserve, Federal Deposit
Insurance Corporation, Ofce of the Comptroller of the Currency, and
Securities and Exchange Commission, plus SROs such as the NASD,
FASB, CFTC, and the major nancial exchanges. Sometimes nonnancial
regulators get involved, such as the Department of Labor, the Special
Trade Representative, the antitrust and consumer protection agencies, and
various Congressional committees. In addition there are the courts, with
particular importance accorded the Chancery Court of the State of Delaware.2 The whole regulatory structure is replicated to some extent at the
state level, with state banking and securities commissions as well as insurance regulation, which rests entirely with the states.
2. See for example Top Business Court Under Fire, New York Times, 23 May 1995.
220
The system is certainly subject to unnecessary complexity and excessive

regulatory costs. In recognition of this, it was partially streamlined in the
1999 Gramm-Leach-Bliley deregulation. However, there is a sense that
regulatory competition may not be so bad in fostering vigorous competition and nancial innovation. Regulator shopping in search of lower
NRBs can sometimes pay economic dividends. And some of the major
regulatory problems of the pastnotably the BCCI debacle in 1991, theft
of client assets in the custody unit of Bankers Trust Company in 1998, and
evasion of banking regulations in the case of the Credit LyonnaisExecutive Life scandal in 2001were all uncovered at the state, not federal,
level. Similarly, conicts of interest involving sell-side research analysts
among investment banks in 2002 were pursued aggressively by the Attorney General of the State of New York, with the SEC becoming active
only when the political heat was turned up. This suggests that sometimes
more eyes are better than fewer.
Mistakes have certainly been made in U.S. nancial regulation, and
there have doubtless been signicant opportunity costs associated with
overregulation. A possible example is the self-dealing prohibition under
the Employee Retirement Income Security Act of 1974 (ERISA), which
prohibits transactions between the investment banking and pension fund
management units of the same nancial rm. The prohibition is designed
to prevent conicts of interest in multifunctional nancial rms handling
retirement funds, but at the cost of less-than-best execution in securities
transactions (Srinivasan, Saunders and Walter, 2002). Furthermore, the
way the LTCM collapse was handled by the Federal Reserve in 1998
continues to be widely debated. And as noted, few of the regulatory and
quasiregulatory organizations covered themselves with glory during the
nancial scandals of 2002.
But by and large, the system has delivered a reasonably efcient and
creative nancial structure that has been supportive of U.S. growth and
development and at the same time has been tolerably stable. Maybe this
is as good as can be expected. If there are lessons, they are that regulatory
messiness and competition are not always bad and can lead to unexpected
dynamism as solutions are left to the market instead of the regulators.
There are accidents embedded in this approach, but so far they have been
reasonably tolerable.
EUROPE IS DIFFERENT
As discussed earlier, in Europe there has been no tradition of separation

of commercial banking, investment banking, and insurance of the type
that existed in the United States from 1933 to 1999. Instead, the universal
banking model predominated from Finland to Portugal, and banks have
for the most part been able to engage in all types of nancial services
retail and wholesale, commercial banking, investment banking, asset
management, as well as insurance underwriting and distribution. Savings
221
banks, cooperative banks, state-owned banks, private banks and in a few

cases more or less independent investment banks have also been important elements in some of the national markets. Reecting this structure,
bank regulation and supervision has generally been in the domain of the
national central banks or independent supervisory agencies working in
cooperation with the central banks, responsible for all aspects of universal
bank regulation. The exception is usually insurance, and in some cases
specialized activities such as mortgage banking, placed under separate
regulatory authorities. And in contrast to the United States, there was
little history or tradition of regulatory competition within national nancial systems, with some exceptions, such as Germany and its regional
stock exchanges.3
Given their multiple areas of activity centered around core commercial
banking functions, the major European players in the nancial markets
can reasonably be considered too big to fail in the context of their national
regulatory domains. This means that, unlike the United States or Japan,
signicant losses incurred in the securities or insurance business could
bring down a bank that, in turn, is likely to be bailed out by taxpayers
through a government takeover, recapitalization, forced merger with a
government capital injection, or a number other techniques. This means
that European nancial regulators may nd it necessary to safeguard
those businesses in order to safeguard the banking business. Failure to
provide this kind of symmetry in regulation could end in disaster. No
bank failure in Europe has so far been triggered by securities or insurance
losses. But it can easily happen. Despite the disastrous trading activities,
which ultimately brought it down, it was the responsibility of the Bank
of England, as home country regulator, to supervise Barings global activities, a case that was an object lesson in how difcult such oversight can
be.
The European regulatory overlay anchored in EU directives cover the
right of banks, securities rms, asset managers, and insurers to engage in
business throughout the region, the adequacy of capital, as well as the
establishment and marketing of collective investment vehicles such as
mutual funds. One can argue that the single passport provisions and
home-country responsibility for institutional tness and properness were
a necessary response to reconciling the single-market objectives in the
European Union with appropriate regulation of the nancial services sector.
All EU regulation was supposed to be in place at the beginning of 1993.
But delays and selective implementation by member governments
dragged out the process so that, almost a decade later, the benets of the
single-market initiatives in this sector were probably a fraction of what
they might have been. There remain important problems with respect to
regulatory symmetry between banks and non-bank nancial services
3. See for example A Ragbag of Reform, The Economist, March, 1 2001.
222
rms. Perhaps most seriously, there remain persistent dissonance in

conduct-of-business rules across the European Union.
The latter continue to be the exclusive responsibility of host-country
authorities. Financial institutions doing business in the European Union
must deal with 16 sets of rules (if the offshore Eurobond market is included)26 after enlargement in 2005. These have gradually converged
toward a consensus on minimum acceptable conduct-of-business standards, although they remain far apart in detail. Areas of particular interest
include insider trading and information disclosure. For example, the view
that insider trading is a crime, rather than a professional indiscretion, has
been new in most of Europe. Few have been jailed for insider trading,
and in several EU countries it is still not a criminal offense. On information
disclosure in securities new issues, there has been only limited standardization of the content and distribution of prospectuses covering equity,
bond, and Eurobond issues for sale to individuals and institutions in the
member countries. The devil is in the details.
If a sound regulatory balance is difcult to strike within a single sovereign state, it is even more difcult to achieve in a regional or global
environment where differences in regulation and its implementation can
lead to migration of nancial activities in accordance with relative net
regulatory burdens. In a federal state like the United States, there are
limits to NRB differences that can emergealthough there are some. A
confederation of sovereign states like the European Union obviously has
much greater scope for NRB differences, despite the harmonization embedded in the EUs various nancial services directives. Each of these
represents an appropriate response to the regulatory issues involved. But
each leaves open at least some prospect for regulatory arbitrage among
the participating countries and fault lines across national regulatory
systemsparticularly as countries strive for a share of nancial valueadded. Players based in the more heavily regulated countries will successfully lobby for liberalization, and the view that there ultimately has
to be a broad-gauge consensus on common sense, minimum acceptable
standards has gained momentum (Dermine and Hillion, 1999; Walter and
Smith 2000).
So far, progress in Europe on nancial market practices has been painfully slow. As a result, the cost and availability of capital to end users of
the nancial system (notably in the business sector) has remained unnecessarily high, and the returns to capital for end users (notably households
and most importantly pension investors) remains unnecessarily low. This
has doubtless had an adverse overall impact on Europes economic performance, both in terms of static welfare losses to consumers and producers and dynamic underperformance reected in the process of structural adjustment and the rate of growth.
The most promising European response to this regulatory drag on
economic welfare was the Lamfalussy Committees nal report (2001). Its
goals were straightforward and essentially performance-driven: (1) mod-
223
ernizing nancial market regulations, (2) creating open and transparent

markets that facilitate achieving investor objectives and capital-raising,
(3) encouraging the development of pan-European nancial products that
are easily and cheaply traded in liquid markets, and (4) developing appropriate standards of consumer protection.
Judging from the Lamfalussy Committees report, European convergence is likely to involve centralized regulatory structures at the national
level. Emphasizing efciency and accountability, the structure is similar
to that of the U.K. Financial Services Authority (FSA), which was created
in 2000 as a result of reforms that began in 1997. It covers both institutions
and market practices. The idea is that national regulatory convergence
along these lines will contribute to reducing fragmentation of nancial
markets. Denmark, Sweden, Belgium, Luxembourg, and Finland are reportedly moving in this direction. In Germany, a debate persisted about
regulatory domains of the federal and state level. France has apparently
focused on the merits of separate regulators, one for wholesale business
and institutional soundness and the other for retail activities. The French
approach tries to be responsive to consumer protection and potential
conict of interest problems, as well as to the criticism that omnibus
market regulators like the SEC lean too heavily to the retail side and that
this can lead to overregulation of interprofessional wholesale markets.
This general convergence on a more or less consistent regulatory approach at the national level still leaves open the question of pan-European
regulation, with wide differences of opinion as to necessity and timing.
The Lamfalussy Report simply recommended a fast-track securities
committee intended to accelerate the process of convergence based on a
framework agreed by the EU Commission, Council of Ministers, and
European Parliament. As noted earlier, small changes in regulation tend
to trigger big changes in the playing eld. Some win and some lose, and
the losers political clout can postpone the day of reckoningespecially
if the common interest is hard to document. So the Lamfalussy Committee also had more concrete recommendations on investment rules for
pension funds, uniformity in accounting standards, access to equity markets for nancial intermediaries on a single passport basis, the denition
of investment professionals, mutual recognition of wholesale nancial
markets, improvements in listing requirements for the various exchanges,
a single prospectus for issuers throughout the European Union, and improvements in information disclosure by corporations.
This led to proposals for a single nancial passport that would let
companies raise capital in any of the EU debt and equity markets via a
single prospectus approved by regulators in the rms home country in
most cases (in any EU country for large-denomination issues), and a
uniform, simplied prospectus for smaller companies. Individual exchanges would retain the power to reject prospectuses. The plan remained
controversial because of its reliance on home-country approval even when
the necessary level of regulatory competence may not exist, as well as the
224
decision to classify as wholesale investments exceeding i50,000 with a

simplied prospectus, although many institutional investors often buy
less than that amount.
Many of the Lamfalussy recommendations were already incorporated
in the EUs 1992 Investment Services Directive but were implemented
unevenly or sometimes not at all. The Committee made a compelling case
for accelerated and forthright implementation, hardly too much to ask a
decade after launch. So a regulators committee was foreseen in order
to assure that enabling legislation and market rules are actually implemented. The European Securities Committee (ESC) was created in June
2001 to accelerate progress in line with the Lamfalussy Reports end-2003
target. Made up of representatives of the member states, the ESC was
ultimately to be transformed into a pan-EU regulatory body charged with
implementing securities legislation.4 The European Parliament immediately demanded the power to review decisions of the ESC. In June 2001
the draft single-prospectus directive was generally welcomed, although
the market abuse draft directive was highly criticized for being excessively broad. The reception of both suffered from a lack of consultation
by the Commission with national nancial regulators and the nancial
community.
All of the Lamfalussy recommendations made a great deal of sense. The
best features of the Anglo-American approach are adopted and those that
might not work well in the European context (including perhaps a central
SEC with substantial enforcement powers) are de-emphasized. The proposals, if vigorously implemented, will go a long way toward achieving the
efciency and growth objectives that the Committee targeted in its initial
report. Within the nancial sector itself, if European rms are eventually
to gain on the current American market share of roughly 65% in global
capital raising and corporate advisory revenues, who could disagree?
JOINING THE PUBLIC POLICY ISSUES
Mergers and acquisitions in the nancial sector are driven by the strategies
of individual management teams who believe it is in their organizations
best interests to recongure their businesses, hoping to achieve greater
market share and protability and therefore higher valuations of their
rms. As discussed in previous chapters, they believe that these gains
will come from economies of scale, improved operating efciencies, better
risk control, the ability to take advantage of revenue synergies and other
considerations, and are convinced they can overcome whatever economic
and managerial disadvantages may arise. Sometimes they are right. Sometimes they are wrong, and net gains may turn out to be illusory or the
4. The Economist (ibid.) quotes the case of Lernout & Hauspie, a Belgian tech rm under investigation
for fraudulent accounting, where local investigators had to rely on the US SECs EDGAR system for
nancial reports on the company.
225
integration process may be botched. In the end, the market will decide.
And when the markets are subject to shocks, such as changes in economic
fundamentals or technologies, they usually trigger a spate of M&A transactions that often seem to be amplied by herd-like behavior among
managements of nancial rms. Public policy comes into the picture in
several more or less distinct ways.
First, policy changes represent one of the key external drivers of the
M&A process. These may be broad-gauge, such as the end of the Bretton
Woods xed exchange rate regime in 1971, or the advent of the euro in
1999, or the liberalization of markets through the European Union or
NAFTA or trade negotiations covering nancial services under the auspices of the World Trade Organization. Other general policies designed
to improve economic performance, ranging from macroeconomic policy
initiatives to structural measures affecting specic sectors, can have profound effects on M&A activity in the nancial services industry by affecting market activity and the client base.
In addition, there are specic policy initiatives at the level of nancial
institutional and markets that can have equally dramatic effects. U.S.
examples mentioned earlier include the 1933 Glass-Steagall Act, the 1956
Bank Holding Company Act, the McFadden Act (limiting geographic
scope) among regulatory constraints, or the 1974 U.S. Mayday introduction of negotiated brokerage commissions and the 1999 GrammLeach-Bliley Act, among the important regulatory initiatives. European
examples include the EUs banking, insurance, and investment services
directives, the 1986 U.K. Big Bang deregulation and a host of minibangs that followed on the Continent in efforts to improve the efciency
and competitiveness of national nancial systems. Japan followed the
deregulation trend in its unique way, creating substantial opportunities
(and some risks) for strategic moves by domestic as well as foreign-based
nancial rms.
In short, changes in public policies at the broad-gauge and nancialsector levels have been among the most important drivers of M&A activity
among nancial rmswhether they are based in legislation, judicial
decisions, or actions of regulatory agencies. As noted, even small changes
in the policy environment can have large effects on nancial markets and
the nancial services industry and trigger M&A activity.
Conversely, the general public is vitally concerned with the results of
nancial services M&A activities. We have identied static and dynamic
efciency of the nancial sector alongside safely and soundness as the
twin public-interest objectives, and M&A activity affects both.
Deals that threaten to monopolize markets are sure to trigger public
policy reactions sooner or later. A managers nirvana of comfortable oligopolies with large excess returns is unlikely to be sustained for long as
a matter of public interestor as a result of market reactions, as clients
ee to other forms of nancial intermediation or other geographic venues
where they can get a better deal. What the public needs is a highly creative
226
and vigorously competitive and perhaps diverse set of nancial intermediaries that earn normal risk-adjusted returns for their shareholders
and generate minimum all-in nancing costs for the business sector and
maximum consumer surplus for the household sector, all the while contributing to continuous market-driven economic restructuring in accordance with global competitive advantage. A tall order. But M&A transactions in the nancial services sector that hold promise of moving things
in that direction are clearly in the public interest.
At the same time, we have discussed safety and soundness of the
nancial system as a second public interest objective, one that often requires a delicate balancing against the aforementioned efciency objective.
Normally safety and soundness is dened in terms of the stability of the
nancial system. But it has been dened more broadly in this chapter to
encompass market conduct, transparency, governance and corporate control, fairness, and even safeguarding of the stability of individual institutions when that involves explicit or implicit backstops borne by taxpayers. M&A transactions that alter the nancial landscape can clearly affect
this broad denition of safety and soundness. Deals can easily create rms
that are in fact too big to fail. Or the resulting entities are so broad and
complex as to defy managerial oversight, much less regulatory insight.
Or they become so politically connected that they coopt the regulators.
Or the M&A deals are driven by the regulations themselves, triggering
unintended consequences or moral hazard.
There may be concerns that regulatory arbitrage internationally could
cause rms to exploit regulatory fault lines or perhaps exceed the ability
of the home-country regulator and its central bank to assure nancial
stability. This puts a premium on international coordination in the regulatory overlay. A great deal of progress has been made in this regard
through the Bank for International Settlements (BIS)notably with respect to consolidated nancials and capital adequacyalthough often in
ts and starts, accompanied by a great deal of debate and disagreement.
Less dramatic international policy alignment has occurred in insurance,
asset management and securities, and certainly in general issues such as
transparency and corporate governance. So the emergence through the
acquisitions process of massive multinational, multifunctional nancial
rms like Citigroup, HSBC, J.P. Morgan Chase, Deutsche Bank AG, Allianz AG, BNP Paribas, Credit Suisse Group, and a host of others presents
special public policy challenges. Appropriate responses are not always
easy to identify or implement.
The point is that mergers and acquisitions in the nancial sector carry
with them a substantial public interest element. Sometimes they are driven
by measures taken in the public interest. Sometimes they themselves drive
those measures. It is an unstable equilibrium that will surely persist as a
key facet of the national and global nancial environment in the years
ahead.
8
The Key Lessons
This book has portrayed the contours of the mergers and acquisitions
landscape in nancial services. It identied (1) what drives the broad
structure of the industry, (2) how the patterns of nancial takeovers have
transformed it and are likely to continue reshaping the industry going
forward, (3) what motivates nancial sector M&A deals and what they
are supposed to achieve, (4) what it takes to execute them successfully,
(5) whether they actually work in terms of market share and shareholder value, and (6) whether the outcomes are good for the efciency
and stability of the nancial system. An effort was made to link the basic
underpinnings of competitive advantage in this unique industry to the
observed outcomes based on available performance data and individual
case studies. So what have we learned?
HOW DO SHAREHOLDERS FARE?
As in most other industries, shareholders of target companies in the nancial services industry consistently do well. They normally receive a
premium to the premerger market price of their stock (or the intrinsic
value of the rm if it is not publicly traded) and usually have the option
to cash out quickly if they dont like the prospects of the combined rm.
This option is valuable, as shareholders who have held their shares in
merged nancial rms too long can painfully attest.
On the other hand, shareholders of nancial services acquirers on average do far less well. They can gain if the strategic rationale behind the
acquisition makes sense, if the price is right, and if the integration is
handled effectively. Unless they bail out on announcement, they can risk
losing heavily if the underlying rationale of the deal is awed, the acquisition is overpriced, or the process of integration ends up destroying much
of the value of the deal.
227
228
On balance, restructuring of the nancial services industry through

mergers and acquisitions tends to redistribute wealth among shareholders
of acquiring and target rms. But it is not necessarily a zero-sum game.
Indeed, market-driven restructuring in the nancial services sector
should, as in other industries, increase both the efciency and dynamism
of the sector as a whole. In some transactions two plus two does equal
veor even morein which case both buyers and sellers get to carve
up the joint gains. So on balance, nancial industry restructuring through
M&A transactions should throw off plenty of net benets, which makes
it all the more curious that shareholders of acquiring rms tend to do so
poorly. It seems that the owners of targets in many mergers tend to get
the lions share of the joint gains. But in well conceived and well executed
deals stockholders of the buying rms do in fact share in the bounty. As
always, the devil is in the details.
COMPETITIVE GAINS AND LOSSES: COST AND EFFICIENCY
The evidence suggests that the net gains from M&A transactions, come
either on the cost and efciency side or the revenue side of the combined
businesses. The key lessons from the evidence, on the cost side, appear to
be the following.
For entire nancial rms there appear to be few economies of scale (unit
cost reductions associated with larger size, all else remaining the same)
to be harvested in the banking, insurance, and securities industries beyond relatively small rm size. Moreover, cost differences attributable to
economies of scale tend to be relatively small compared to total costs and
compared to cost differences between the most and least efcient rms in
these sectors. Nor is there much evidence of diseconomies of scale beyond
optimum-size rms. So cost economies of scale are not likely to be an
appropriate motivation for M&A deals, especially large ones, nor is the
possibility of diseconomies of scale likely to represent a compelling argument against them.1
However, since nancial rms usually consist of an amalgam of scalesensitive and non-scale-sensitive activities, M&A transactions can add
signicant value if product-level scale economies are aggressively exploited. Obvious candidates include various kinds of mass-market
consumer nancial services, securities custody, trade nancing, and the
like.
Besides economies of scale, there is plenty of evidence that operating
efciencies can be harvested as a result of M&A transactions. It has been
noted repeatedly that nancial services rms of roughly the same size can
have very different efciency levels, as measured for example by cost-toincome ratios, and that the largest observed rmwide economies of scale
1. A possible exception is asset management specialists, where economies of scale in production and
distribution of duciary services may be substantial over broad levels of assets under management.
The Key Lessons
229
seem to pale by comparison to operating efciency differencesperhaps

by a factor of four or ve. So M&A transactions can lead to major gains
in operating efciency regardless of size, particularly where there are
signicant overlaps in production or distribution infrastructures (for example, branch ofces, IT systems) that permit signicant downsizing of
the workforce and more productive redeployment of capital. Improved
operating efciencies mean a great deal to shareholders of acquiring rms
because, after the necessary restructuring charges, they show up early in
the evolution and their risk-adjusted net present value can be very high
indeedthe so-called low-hanging fruit in M&A deals.
IT has clearly grown in importance as a focus of operating economics
in nancial services rms over the years, as have annual IT budgets. If
those budgets are lumpy in terms of minimum critical mass in order to
achieve state-of-the-art platforms, and if only large nancial rms can
support the spend-levels required, it could be that the IT channel provides
a link to improved operating efciencyso that mergers or acquisitions
that generate greater size may also generate larger operating efciency.
However, outsourcing and pooling of IT capabilities may help smaller
rms limit this potentially adverse effect on their competitive performance.
Working against possible scale and efciency gains in mergers and
acquisitions are costs associated with complexity. Larger rms are harder
to manage than smaller ones. It is not easy to instill compelling cost
discipline, teamwork and a common culture in a rm with several hundred thousand people scattered across hundreds of locations, possibly
globally. While this may be possible at the worlds largest employer, WalMart, banking and nancial services are another matter altogether. It
means a high degree of complexity, and complexity usually means increased costs.
Also in the realm of costs are conicts of interest between the rm and
its clients, as well as between clients. Regardless of size, a greater range
of products, clients, and locations spell greater potential for conicts of
interest. Exploitation of these conicts must be prevented by means of
conduct guidelines and effective Chinese walls that limit some of the
hoped-for synergies. But the costs of dealing with conicts of interest after
they occur can be horrendous, as banks involvement in corporate nancial scandals has demonstrated. Revenues may collapse as the rms reputation takes a serious hit. Or costs may balloon as the rm scrambles to
rescue its good name or deals with class-action litigation. Either way,
preventing and managing conicts of interest can and do show up on
both the cost and revenue sides of the ledger in scoping out the possible
effects of an M&A deal.
In short, on the cost side, the managerial lessons are dont expect too
much from economies of scale on a rmwide basis, but work to exploit
them in scale-sensitive businesses while aggressively pursuing operating
efciencies by shedding redundant resources as quickly as possible for an
230
early harvest in the value of the transaction to shareholders. At the

same time, create incentive-compatible managerial structures that help
immunize the rm from the costs of complexity and exploitation of conicts of interest, especially those creating potential franchise risks for the
business.
COMPETITIVE GAINS AND LOSSES: REVENUES
In addition to cost and efciency effects on competitive performance,

M&A transactions in the nancial services sector are also driven by revenue effects. Top-line gains resulting from M&A transactions can come
from several sources.
The combined rms market footprint tends to be greater as a result
of a merger or acquisition, and this can generate disproportionate gains
in revenues, for example by enabling the rm to credibly bid for larger
transactions or build distribution channels to a level required by critical
mass, or by extending that footprint over greater geographies or broader
sets of clients. A related revenue-based benet may be achieved if the
rm is able to diversify across additional distribution channels acquired
in the M&A transaction, and thereby broaden or deepen access to important market segments. Bigger rms often have more strategic options.
The most important revenue-related gain tends to be revenue economies
of scope associated with cross-selling if the M&A transaction broadens the
product range. Here the key is to examine the potential for cross-selling
in each of the feasible product linkages and designing incentivecompatible reward systems to get it done. Because insufcient effort and
care are often devoted to the detailed work required to extract signicant
revenue economies of scope, management and shareholders are frequently disappointed by the results.
In terms of top-line gains from M&A transactions, the key lessons are
to identify them early, as part of the due diligence processwhich itself
will play an important part in dening the terms of the transaction.
Once the deal is done, the revenue synergies need to be targeted at a
sufciently granular level to be exploitable in the real world, and then
incentive-compatible approaches to compensation have to be carefully
designed at the grass roots to make them happen. Nothing works in
making cross-selling work like compensation that is transparent, fair, and
reliable. In addition, absence of perceived best-in-class services will encourage clients to defecta process made easier by modern technologies
that reduce information and transactions costs. With increasingly promiscuous nancial services clients, it usually pays to adopt an open architecture approach that extends the boundaries of the rm. Even after
successfully identifying and getting to work on extracting revenue gains,
doing so in a sensible way usually takes time. This pushes the top-line
benets into the future, where they are worth less to shareholders, so
The Key Lessons
231
opportunities to take early harvests on the revenue side are especially

valuable.
COMPETITIVE MARKET STRUCTURE
Whatever the cost and revenue gains that can be extracted from a merger
or acquisition, neither are worth much if the market structure in which
the rm nds itself turns out to be highly competitive. Like the dog who
caught the bus, sometimes managements get what they wish for but may
not in the end enjoy the fruits of all their efforts. In highly competitive
markets, even the most promising cost and revenue gains tend to be
eroded before long. This is how competitive markets are supposed to
work, after all. The consequence is that the results of managements exertions end up benetting mainly clients, with very little left over for
shareholders in terms of returns on invested capital. So it is important
from the outset to identify the rms sources of sustainable competitive
advantage and align them with the target markets where this competitive
advantage can be brought to bear in a way that provides signicant
margins and resistance to prot-erosion. This can involve sustainable
product differentiation, rst-mover advantages, massive and lumpy
capital investments, dominant positions in highly concentrated markets,
regulatory barriers to competition, and a host of other factors. People
usually do better owning shares in Microsoft than growing wheat. The
evidence that M&A transactions which focus nancial services activities
do better than transactions which disperse activities is hardly surprising.
So astute assessment of the future competitive structures of target markets
is a prerequisite for shareholder-value gains in mergers or acquisitions.
DOING IT RIGHT
Even if they are well-targeted in terms of cost and revenue gains, successes
and failures in nancial services M&A transactions depend heavily on the
effectiveness of post-merger integration.
It is important to be absolutely clear what the merger or acquisition is
about. Are the incremental resources to be absorbed, are they to be preserved pretty much intact and perhaps leveraged into the acquirers operating platform, or are they destined to complement and ll in existing
resources, markets, or clients? As in other industries, M&A transactions
represent one tool in corporate development, growth, and protability,
and a great deal of value can be destroyed if this tool is abused or misused.
The integration process has to be driven by the underlying transaction
rationale.
How people react to the transaction, before and after the fact, is perhaps
the most important issue. Those who will be asked to leave should know
it as quickly as possible after the announcement, receive clear severance
232
terms, and be able to get on with their lives. Those who will be asked to
stay should be equally clear about the incentives, functions, reporting
lines, and related dimensions of the professional environment. They
should end up thinking of the transaction as an important and rewarding
professional opportunity that doesnt come along too frequently in life.
They should want to get with the program with energy and imagination. Some of the most visible disasters in the history of nancial services
merger integration can be ascribed to people problems, sometimes with
the result that the combined rm is worth little more than the acquirer
was worth prior to the transactions. And it is useful to keep in mind that
competitors are always circling, eager to pick up rst-rate talent that is
mauled in the merger process.
Information technology integration in the nancial services sector is
unusually importantand mistakes tend to be unusually damaging
because of the key role of information and transactions processing. IT
issues need to be brought into the M&A planning early in the process,
including the due diligence process, and driven by the underlying strategy. Critical issues include misalignments in IT congurations, choice of
dominance of IT platforms and technical architectures, organizational infrastructure and leadership, and the costs of IT integration. Failure to deal
with these issues as an integral part of the merger process has led to more
than their share of value destructionparticularly in the case of clientfacing IT dimensions. And IT integration is never cheap, as it involves
capital and operating outlays that come soon after the completion of deals,
so its earnings impact will be felt early in the game.
Culture can cut several ways in merger situations. On the one hand, a
cohesive culture can be an asset for an acquirer by making clear what
behavioral norms and working conditions will prevail in the combined
rm. Those who are unlikely to do well under those norms can be more
easily ltered out, which may help limit problems down the road. And
clarity about the way things are done helps those who remain to coalesce
and to move ahead. On the other hand, a powerful and exclusive culture
on the side of the acquirer, as against a looser and more receptive one,
may make it more difcult to achieve easy buy-in on the part of the
acquired teamespecially if it, too, had a strong culture. This issue may
be especially problematic if the acquired resources are critical for future
competitive success and, for all intents and purposes, requires what is in
effect a reverse takeover.
Branding is another key aspect of merger integration. A decision has
to be made at some point what the branding strategy is to be. This itself
is driven by the nancial services and markets that form the activity
portfolio of the combined rm, which may push the decision either toward multiple sub-brands or toward brand uniformity. Other issues include the equity already embedded in the legacy brands, the need for the
appearance of uniformity and seamlessness across client-segments and
geographies, and the potential for conicts of interest that may arise in
The Key Lessons
233
the minds of clients when confronted by a single brand covering highly

diverse activities. Timing also important. Re-branding being delayed until
after the dust settles from the M&A transaction often makes a lot of sense.
Finally, there is increasing evidence that nancial rms can learn to
integratethat codied procedures which identify things that need to
get done, in what sequence of priority, and what works and what doesnt
can actually help ease the integration process in subsequent acquisitions.
For rms that have a successful acquisitions track record and that are
most likely to grow by acquisitions in the future, such learning by doing
and codication appear to explain some of the acquisitions success stories
in this industry. Conversely, institutional forgetfulness, underestimating
the integration problems, and playing by ear have clearly been disastrous
in more than a few high-prole cases.
In short, we have emphasized a number of times the importance of
strategic execution in connection with M&A transaction in nancial services, and post-merger integration is at the heart of this process. No matter
how well founded the overall master plan is or how well a given deal
ts, integration problems have an inordinate ability to derail the best laid
plans.
DOES ORGANIZATIONAL STRUCTURE MATTER?
The structural prole of the nancial services rm that results from its
strategic developmentand the use of M&A transactions as a tool in that
developmentcarries important lessons as well.
Depending on the applicable tax regime, multifunctional rms may be
more tax-efcient than specialist rms because they carry out a greater
share of transactions within the rm rather than between rms. In addition, by diversifying earnings across business streams and reducing earnings volatility, overall tax liabilities may be reduced under certain tax
regimes. This may also be the case when there is a difference in the tax
treatment of foreign earnings and M&A transactions have produced an
international or global business prole.
The evidence shows that diversied nancial rms tend to have more
stable cash-ows than rms that are more narrowly dened in terms of
geographies, product range, or client groups to the extent that the individual earnings streams are not perfectly correlated. The result ought to
be a more stable rm, which should pay dividends in cost-of-capital
considerations such as debt ratings and share prices. This attribute should
also be of interest to banking and nancial regulators in that it makes
invocation of lender-of-last-resort facilities and taxpayer bailouts less
likely. However, some of the complex multifunctional nancial rms that
are the result of sequential mergers and acquisitions are awfully hard to
understand and regulate, and it seems unlikely that management itself
fully understands and controls the risks embedded in the business
especially correlations among different types of risks.
234
A related issueimplicit too-big-to-fail (TBTF) guarantees through

likely taxpayer-nanced bailouts in the event of difcultiescan be a side
benet of M&A transactions that move a rm closer to that status, including cost of capital benets. Still, TBTF status invariably comes with
strings attached, including more intrusive regulation. And there is always
the question of what lender-of-last-resort facilities are actually worth,
especially in the case of very large institutions based in small countries.
An institutional prole that is international or global, which almost
always involves substantial M&A activity, has to be part of a strategy that
makes sense in terms of the business conducted. Retail customers could
care less whether they are dealing with an international or global rm
unless, as a consequence, they benet from better products or better pricingwhich is not always the case. So these are essentially multilocal
businesses. At the other extreme, institutional investors and major corporate clients depend on global nancial rms to provide the best ideas
and seamless execution in all relevant nancial markets to help them
achieve their own objectives.
In the case of multilocal businesses, questions must be asked about
what a foreign acquirer is bringing to the party that will make the target
more competitive in its own market, how some of the resources of the
target can be leveraged in the acquirers home market or in third markets,
or whether the acquisition is a pure portfolio investment. In the case of
global businesses, how to weld the target into an integrated business
structure, how to deal with intercultural issues, and how to bridge regulatory systems are among the key questions. So far at least, rms that
bridge a wide range of clients, products, and geographies in a way that
produces abnormally high sustained returns to their shareholders are few
and far between.
Like rms in general, the evidence suggests that the broader the range
of activities engaged in by nancial services players, the more likely it is
that the shares will be subject to a conglomerate discount. The reasons
appear to be related to weaker internal disciplines in avoiding low net
present value projects in particular parts of the business and in avoiding
cross-subsidization between the constituent businessesin addition to
the fact that investors may avoid the shares because of the impossibility
of clean plays in exposures to specic types of nancial services activities. If shares of nonnancial conglomerates tend to suffer from a conglomerate discount, there is no reason that highly diverse rms covering
banking, securities, insurance, and asset management should not be similarly affected.
SOLID MANAGEMENT AND LEADERSHIP
All things considered, there is no substitute for good management in the

strategic positioning and implementation process of nancial services
rms. That means (1) targeting markets that are large and growing and
The Key Lessons
235
increasingly concentrated, where the rm has a shot at being one of the

dominant players, and (2) knitting together those markets that extract the
maximum value from scale and scope linkages that may exist. The evidence shows that the rst of these is substantially more important than
the second. It also means paying careful attention to operating costs and
risk control, both of which allow plenty of room for excellence as well as
for errorespecially with regard to developing and executing an integrated approach to the management of risk. And nally, it means intense
and persistent attention to product quality and innovation. What shareholders are looking for is a highly disciplined and creative approach to
the internal allocation of productive resources that appears to be more
efcient than external markets and is likely to deliver sustainable excess
returns on share capital.
Leadership of nancial rms that is driven by these core objectives will
nd that the use of mergers and acquisitions as a strategic tool can be
very rewarding indeedthe tendency to do the right thing and to do it
right in an M&A context tends to grow out of the basic way the business
is run. Everything else follows from that. The objective, after all, is to
deliver sustainable value to the rms owners. If not, then what is the
point? Firms whose leaders take their eyes off the ball or fall victim to
hubris, which is not uncommon in strategic corporate actions such as
mergers and acquisitions, usually nd that the market takes rather little
time to signal its response.
And what about the public interest? Policymakers should support the
creation of a leaner and more creative nancial system as a matter of
general economic policyone that fosters capital formation and efciency
in the use of capital as well as lower information and transaction costs.
Efciency and growth are ubiquitous public policy goals, and a highperformance nancial system is a sine qua non for achieving them. At the
same time, nancial instability can do massive and long-lasting damage
to the economy and society. Mergers and acquisitions in the nancial
services sector clearly affect both sets of objectives and invariably attract
keen interest on the part of regulators, who in turn tend to respond in
ways that are of material interest to the nancial rms themselves.
APPENDIX 1
Financial Service Sector Acquisitions
Note: Transactions in excess of $500 million were completed
during 19852002. Data: Thomson Financial Securities Data.
238
239
240
241
242
243
244
245
246
247
248
249
250
251
252
253
254
255
256
257
258
259
260
261
262
APPENDIX 2
Case Studies
264
265
266
267
268
269
270
271
272
273
274
275
276
277
278
279
280
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Index
Abnormal returns, 195, 196

Absorption approach to IT integration, 141
143, 145, 146
Absorption approach to merger integration,
106110, 120, 123124
Acquirer size, post-acquisition impact of,
119
Adaptability, 115
Adjusted book value of equity (ABVE), 94
95
Advisors, investment bank, 93
Advisory services, 2425
AEGON NV, 39, 157, 159
Agency business, 23
AIG, 39
Allnanz, 9, 40, 72
Allianz AG, 52, 55, 70, 159162
Allianz AG-Dresdner Bank AG case
study, 160168
American Stock Exchange, 216217
Antares Alliance, 150
Antitrust constraints, 76
Aon Limited, 39
Asset managers, 6, 9
cross-market transactions and, 38, 39,
42
in-market transactions and, 39
key attributes of, 2634
largest, worldwide, 4849
market power and, 79, 81
merger volume, 43
pattern of M&A activity, 49, 50
pension fund activities, 31
technical know-how and, 82
Asymmetric information, 82
Australia:
regulatory change, 36, 37
securities markets, 20
Balance/equality approach, 113

Bancassurance, 6, 40, 72, 209
BancOne, 68, 110, 111
Banco Santander-Central Hispano BSCH,
56, 104, 110, 111, 154
BankAmerica, 68, 168
Bankers Trust Company, 156, 158, 160, 220
Bank for International Settlements, 199, 226
Bank Holding Company Act of 1956, 37,
206, 225
Banking Act of 1933, Glass-Steagall
provisions of, 37, 43, 101, 206, 208,
225
Banking type services, mutual fund
company, 30
Bank of America, 37, 56, 68
Bank of Montreal, 77
Baseline market value of equity (BMVE),
94, 95
Bayerische Vereinsbank, 145146
BBVA, 56
Benchmarking integration performance,
121127
Best-of-both-worlds approach to IT
integration, 141, 143146
Big Bang approach, 36, 146, 225
Bonds, 20, 27
Book value of equity (BVE), 9396
Borrowing, total net (U.S.), 78
Bought deals, 22
Branding, 232233
Breuer, Rolf-Ernst, 159, 160
Brokerage, 23
Business Round Table, 217
Business strategy, alignment with merger
strategy and IT strategy, 132138,
152
Business streams, diversication of, 83
301
302
Canadian Finance Ministry, 77
Canadian Imperial Bank of Commerce, 77
Canadian securities markets, 20
Capital adequacy rules, 218
Captiva Finance Ltd., 87
Cash management, 15
Central securities depositories (CSDs), 25
CFOWeb.com, 11
Chancery Court of the State of Delaware,
219
Chase Manhattan Bank, 168170
J. P. Morgan Chase & Co. case study, 168
175
Chemical Bank, 154, 168169
Citibank, 87
Citicorp, 85, 158
Citicorp-Travelers Group, 85, 155
Citigroup, 37, 56, 68, 70, 72, 88, 154, 155,
158, 182, 183
Civil suits, 216, 219
Client-driven linkages, 63
Client retention and extension, 121
Collective investment vehicles, 4, 6
Commercial banks:
corporate scandals of 2002, 217
cross-market transactions and, 3842
cross-selling and, 6972
ow of funds and, 46
largest, worldwide, 47, 48
merger volume, 43
mutual fund activities, 30
net regulatory burden (NRB) of, 218
nonnancial shareholdings issue, 9092
operating efciencies, 6768
overcapacity and, 1516, 38, 203
regulatory change and, 37, 204207
shifts in market shares, 11, 12
too-big-to-fail (TBTF) guarantees and, 84
85
Type-C nancial rms, 100, 101
Commercial paper, 22, 27
Commonwealth Bank of Australia (CBA),
138140
Communication, 118
Compensation structures, 114, 115
Competition policy, 204207
Complementarity, 104
Complexity, costs of, 229, 230
Concentration ratios, 82
Condentiality, 32
Conicts of interest, 8588, 208, 229, 232
233
Conglomerate discount, 8990
Congressional committees, 219
Continental Illinois, 207
Index
Control premium, 95
Corcostegui, Angel, 154
Corporate bonds, 20
Corporate culture, 232
dealing with change, 104, 114118
fragmentation of, 117
IT integration and, 150152
takeovers, 117118
Corporate decision making, IT integration
and, 149150
Corporations:
common stocks, 2022
ow of funds and, 4, 5
search for nancial efciency, 9
Cost economies of scale, 6466, 121, 228
230
Cost economies of scope, 6667
Credibility, 114
Credit Lyonnais-Executive Life scandal, 220
Credit quality, 83
Credit Suisse Group, 39, 70, 156159
Criminal prosecution, 216
Cross-border transactions, 43, 44, 46, 47,
193197
Cross-holdings, 5255
Crossholding structures, equity, 9192
Cross-market transactions, 3842
Cross-purchasing, 74
Cross-selling, 6976, 120
Culture, corporate (see Corporate culture)
Currency swaps, 22
Data sharing, 150
Deal ow, global nancial services M&A,
3559
cross-border transactions, 43, 44, 46, 47
cross-holdings, 5255
cross-market transactions, 3842
domestic transactions, 43, 44, 47
forces driving:
regulatory change, 3637
strategy, 3738
technology changes, 3536
global M&A transactions, 42
in-market transactions, 3839, 4345
merger intensity rankings, 44
nonnancial shareholdings, 5556
survivorship, 4752
top nancial rms by market
capitalization, 56, 58
worldwide merger volume, 43
Dened-contribution plans, 31
Demand-side economies of scope, 6976
Demutualization, 18
Den Danske Bank, 8586
Deposit taking, 14
Deutsche Bank, 106, 118, 156, 158160, 160
Direct-connect mechanisms, 4, 5
Index
Distribution infrastructures, high-cost, 15
Diversifying mergers, evidence on, 189193
DKB, 149
Domestic transactions, 43, 44, 47
Donaldson Lufkin Jenrette, Inc., 39, 156
Dresdner Bank AG, 52, 55, 70, 159, 160
Allianz AG-Dresdner Bank AG case
study, 160168
Dresdner Kleinwort Wasserstein, 160, 161,
164165
Drexel Burnham Lambert, Inc., 207, 219
Dutch Auction Initial Public Offering (IPO)
platforms, 35
Dynamic efciency, 9, 11, 202203, 212, 214,
225
E-applications in nancial services, 10, 36
Economic drivers of mergers and
acquisitions (see Value of mergers
and acquisitions)
Economies of scale, 6466, 121, 228230
Economies of scope, 6567
cost-related, 6667
revenue-related, 6976, 122, 230
Efciency:
nancial system, 911, 201204, 212, 214,
215, 225
operating, 6769, 228229
Electronic communications networks
(ECNs), 36
Embedded human capital, 83
Empirical evidence (see Evidence)
Employee Retirement Income Security Act
of 1974 (ERISA), 220
Enron Corporation, 217
Equity, regulation and, 212, 214
Equity analyst conicts of interest, 88
Equity market system of nonnancial
shareholdings, 90, 91
Equity securities, 2022, 27
Esprit de corps, 114
Euroclear, 25
Europe:
cross-holdings, 5255
cross-selling, 73
demutualization, 18
evidence on mergers, 197199
nancial structure, 209210, 220224
in-market transactions, 4344
multifunctional nancial rms, 102
mutual funds, 29
regulation, 220224
European banks, 11
European Securities Committee (ESC), 224
European Union, 222224
Euro-zone, 19, 20
Event studies, 195197
303
Evidence, 153199
case studies, 153184
Allianz AG-Dresdner Bank AG, 160
168
General Electric Capital Services
(GECS), 175184, 199
J. P. Morgan Chase & Co., 168175
review of, 154160
empirical, 153, 184199
cross-border mergers, 193197
diversifying mergers, 189193
European vs. U.S. mergers, 197199
focusing mergers, 187189
Federal Deposit Insurance Corporation
(FDIC), 207, 219
Federal Reserve, 207, 219, 220
Fiduciaries, 4, 5
Fiduciary asset management, 6, 16
Financial Accounting Standards Board
(FASB), 216, 219
Financial architecture, 201226
impact of M&A process on nancial
system, 202211
joining the public policy issues, 224226
regulation and, 204208, 212226
European approach, 220224
net regulatory burden (NRB), 213, 214,
218, 220, 222
tax and subsidy elements, 213
tradeoffs, 214218
U.S. approach, 218220
Financial-industrial crossholding system of
Financial intermediary-based system of
nonnancial shareholdings, 90, 91
Financial Services Authority (FSA), 223
Firm learning and M&A transactions,
119120
Fitness and properness criteria, 214, 218
Fleet Financial Group, Inc., 40
Focusing mergers, evidence on, 187189
Foreign exchange, 1920
Fortis, Inc., 157
Fortis Group, 70
Franchise, overall, 116
Franchise value of rm, 95
Fuji Bank, 149
Fully integrated nancial rms, 100102
Fully intermediated nancial ows, 4
Fund-rating services, 29
Gains from M&A transactions:
cost and efciency, 228230
revenue, 230231
General Electric Capital Services (GECS)
case study, 175184, 199
Geographic linkages, 6364
304
German households, private asset
allocation in, 13
Global nancial services reconguration, 3
34
nancial efciency, 911
key attributes of four pillars:
asset management, 2634
commercial banking, 1416
insurance, 1619
securities services, 1926
shifts in intermediary market shares, 11
13
stylized process of nancial
intermediation, 39
Global issues, 22
Goldman Sachs Group, Inc., 56, 207
Gramm-Leach-Bliley Act of 1999, 37, 96,
101, 193, 204, 220, 225
Grupo Financerio Sern, 56
Hafnia Insurance Group, 8586
Hedging, 24
Herndahl-Hirshman Index (HHI), 7779,
81
History of organization, 116
Holding companies, 100, 101, 204
Households:
search for nancial efciency, 9
HSBC, 56, 185, 199
Human capital, embedded, 83
Human resources (see Personnel)
Immelt, Jeffrey, 183
Impact area, deciding on integration level
by, 110112
Information ows, internal, 82
Information technology (IT) integration,
121, 129152
alignment of business strategy, merger
strategy, and IT strategy, 132138,
152
challenge of, 138145
absorption approach, 141143, 145, 146
best-of-both-worlds approach, 141, 143
146
preservation approach, 141, 144146
state-of-the-art system approach, 141,
145, 146
implementation of, 146149
importance of, 232233
key issues, 129132
key lessons, 152
success vs. failure in, 149151
ING, 70
In-market transactions, 3839, 4345, 112
Insurance companies:
cross-market transactions and, 3840, 42
Index
cross-selling and, 6970, 72
ow of funds and, 4, 6, 9
largest, worldwide, 4748
merger volume, 43
regulation and, 204206
shifts in market shares, 12, 13
Integration, 99152
alignment of merger strategy with
business strategy and IT strategy,
132138
alternative approaches to, 106110
benchmarking performance, 121127
dealing with cultural change, 104, 114
118
deciding on levels by impact area, 110
112
rm learning and M&A transactions,
119120
importance of, 231233
information technology (IT) (see
Information technology (IT)
integration)
interface management, 120121
organizational structure, 99102
personnel retention issue, 112114
pre-merger issues, 104106
typology of, 102104
Integration capabilities, 119
Interest-rate swaps, 22
Interface management, 120121
Intermediary market shares, shifts in, 1113
Internet-based technology, 911
Invested premiums, earnings on, 16
Investment banks, 19
corporate scandals of 2002, 217
cross-market transactions and, 3840, 42
disappearance of, 40, 50, 210, 211
evolution of major rms, 5053
lending by, 15
market power and, 7981
merger volume, 43
underwriting, 22
Investment Company Institute, 216217
Investment funds, 49, 1113
Investment Management Regulatory
Organization (IMRO), 217
Investment research, 2324
Investor services, 2526
Index
J. P. Morgan, Inc., 35, 88, 129, 170
J. P. Morgan Chase & Co., 37, 160
case study, 168175
Japan:
nancial intermediation ows controlled
by banks, 11
nancial system, 209210
keiretsu networks, 91, 210
Mizuho Bank debacle and, 148149
regulatory change, 37, 225
underwriting of securities, 22
Knowledge-based view, 103104
Knowledge codication, 119121
Koizumi, Junichiro, 149
Kovacevich, Richard, 154
Labreque, Thomas, 168, 169
Lamfalussy Committee, 222224
Leadership, 104, 105, 115116, 234235
Lending:
commercial bank, 1415
syndicated, 204
total net (U.S.), 78
Life insurance, 1618, 47
Line-of-business regulation, 37, 47, 214
Lloyds TSB, 137138, 154, 185
Loan syndication, 14
Local bonds, 20
Long-Term Capital Management, Inc., 84
Losses from M&A transactions:
cost and efciency, 228230
revenue, 230231
revenues, 230231
Managers, overinvestment by, 9293
Market access, securities rm, 22
Market capitalization, top nancial rms
by, 56, 58
Market conduct, 214
Market extension, 6264
Market-making, 23
Market overlap, post-acquisition impact of,
119
Market power, 7682
Market structure, competitive, 231
Market value of equity, 9396
Marsh & McLennan Companies, 39
Maxwell, Robert, 217
Mayday, 36, 225
McFadden Act of 1927, 37, 225
Medium-term note (MTN) programs, 22
Mega mergers, 65
Mellon Bank, 158
Merchant banking, 25, 39, 41
Merger integration (see Integration)
Meritocracy approach, 113
305
Merrill Lynch, 35, 36, 88
Mirror Group Newspapers, 217
Mixed bundling, 71
Mizuho Bank, 148149
Mizuho Corporate Bank, 148
Money markets, 1920
Morgan Grenfell & Co., 156, 158
Morgan Stanley-Dean Witter & Company,
185
Morningstar, Inc., 29
Multinational banks, 193197
Mutual fund companies:
banking type services, 30
Mutual funds, 6, 27, 2930
linkages between pension funds and, 31
regulation change and, 205
shifts in market shares, 12
National Association of Securities Dealers
(NASD), 216, 219
National Australia Bank, 199
Net regulatory burden (NRB), 213, 214, 218,
220, 222
Network economies, 75
New York Stock Exchange, 216217
Nonnancial shareholdings, 5556, 9092
Non-life insurance, 1617, 19, 48
North American Free Trade Agreement
(NAFTA), 77
OConnor Partners, 36
Oligopoly, 77
On-line distribution of nancial
instruments, 911
On-line personal nance platforms, 74, 75
Operating efciencies, 6769, 228229
Organizational t view, 102103, 106
Organizational structure, 99102, 114, 233
234
Our team takes over approach, 113
Outsourcing, 137
Overcapacity, 1517, 38, 203
Overinvestment, 9293
Overpayment, 154
Partially integrated nancial rms, 100, 101
Partnership approach, 116117
Pension funds, 6, 2829, 31
regulation change and, 205
shifts in market shares, 12
Personal interactions, 104
Personal Investment Authority (PIA), 217
Personnel:
disruptions encountered, 121
retention issue, 112114
Pitman, Sir Brian, 154
Planning, IT integration success and, 150
306
Post-acquisition integration, 119120
Potential market value of equity (PMVE),
96
Preservation approach to IT integration,
141, 144146
Preservation approach to merger
integration, 106110, 120, 125126
Price, Michael, 168, 169
Price-to-book value ratios, 9596
Principal investing, 25
Prior acquisition experience, 120
Private client asset management, 3133
Private equity, 21, 25, 27
Product-driven linkages, 63
Program trading, 23
Proprietary trading, 23
Prudential Financial, 39
Prudential Securities, 3940
Public policy, 235
changes in, 60, 76, 225
See also Regulation
Quicken 2003, 11
Regulation:
as driver of M&A deals, 60
nancial architecture and, 204208, 212
226
European approach, 220224
net regulatory burden (NRB), 213, 214,
218, 220, 222
tax and subsidy elements, 213
tradeoffs, 214218
U.S. approach, 218220
M&A deal ow and, 3637
organizational structure and, 101
ReliaStar Life Insurance Company, 70
Resource-based view, 103
Return on invested capital, global levels of
concentration and, 78
Revenue economies of scope, 6976, 122,
230
Risk arbitrage, 23
Risk management, 24
Risk mitigation, 63, 64
Robertson Stephens, Inc., 40
Role models, 114
Royal Bank of Canada, 77
Royal Bank of Scotland, 158
Safety net, nancial, 202, 207208, 214
Savings, 45
Savings banks, 4, 6, 204
Savings organizations, 4
Scale economies, 6466, 121, 228230
Scope economies (see Economies of scope)
Scotiabank, 77
Secondary market trading, 23
Index
Second Banking Directive (EU), 193
Securities Act of 1933, 218
Securities Act of 1934, 218
Securities and Exchange Commission
(SEC), 217220, 223
Securities rms:
regulation and, 204208, 218, 219
See also Investment banks
Securities Industry Association, 216217
Securities infrastructure services, 2526
Securities Investor Protection Act, 218
Securitized intermediation, 4
Self-perception, institutional, 116
Self-regulation, 215217
Self-regulatory organizations (SROs), 216
217, 219
Sell-side research, 23
Shareholders, benets to, 227228
Shareholdings, nonnancial, 5556
Shipley, Walter, 168
Single nancial passport, 223
SNS Bank NV, 87
Sovereign debt instruments, 20, 22
Special Trade Representative, 219
Stability, regulation and, 212, 214
State Bank of Victoria (SBV), 138140
State bonds, 20
State-centered approach to nonnancial
shareholdings, 9092
State-of-the-art IT system approach to IT
integration, 141, 145, 146
State-owned enterprises (SOEs), 2425
Static efciency, 9, 11, 202203, 212, 214,
225
Stepwise approach to IT integration, 146
Strategic capabilities, 103
Strategic t view, 102, 106
Strategic integrity, 75
Strategic motivation, 103
Subsidy elements of regulation, 213
Supercultures, 117
Survivorship, 4752
Swedbank, 113114
Swiss Bank Corporation, 36, 195197
Switzerland:
underwriting of securities, 22
Symbiotic approach to merger integration,
106110, 120, 127
Synergies, 63
Target quality, post-acquisition impact of,
119
Taxation:
high-net-worth investors and, 32
Tax elements of regulation, 213
Index
Teamwork, 115
Technical incompatibilities, 140, 150
Technical know-how, 8283
Technical prots and losses, 16
Technical reserve, 16
Technology changes, 3536, 60
Third-party business (see Fiduciary asset
management)
Tobins Q, 95
Too-big-to-fail (TBTF) guarantees, 8485,
234
Toronto Dominion Bank, 77
Trading, 23
Transactions nancing, 15
Transactions infrastructures, high-cost, 15
Transamerica Corporation, 157
Treasury activities, commercial bank, 15
Treasury bonds, 20
Type-A nancial rms, 100102
Type-B nancial rms, 100, 101
Type-C nancial rms, 100102
Type-D nancial rms, 100, 101
UBS AG, 33, 157158, 159, 195197
Underwriting of securities, 22
United Kingdom:
evolution of merchant banks, 41
market and book value of bank assets,
18931993, 78, 79
multifunctional nancial rms, 101102
mutual funds, 29
regulatory change, 36
self-regulatory organizations (SROs), 217
Unit-linked products, 1718
Universal banking model, 220221
U.S. Comptroller of the Currency, 84, 219
U.S. Department of Labor, 219
U.S. Federal Reserve, 84
Users of funds, ultimate, 5
Value of mergers and acquisitions, 6098,
227235
asymmetric information, 82
307
from book value of equity to market
value equity, 9396
competitive gains and losses, 228231
competitive market structure and, 231
conicts of interest, 8588
conglomerate discount, 8990
cost economies of scope, 6667
credit quality, nancial stability, and
diversication of business streams,
8384
economies of scale, 6466, 228230
embedded human capital, 83
integration and, 231233
leadership and, 233234
management and advisor interests, 9293
market extension, 6264
market power, 7682
operating efciencies, 6769, 228229
revenue economies of scope, 6976
to shareholders, 227228
technical know-how, 8283
theory, 6162
too-big-to-fail (TBTF) guarantees, 8485
weighing the pluses and minuses, 93
Venture capital, 21, 25, 27
Vereinsund Westbank, 145146
W. R. Hambrecht & Co., 35
Walther, Bernhard, 159, 160
Wasserstein, Bruce, 165
Welch, Jack, 176, 178, 183
Wholesale nancial services, 39, 7172, 79,
80, 82, 204
Wholesale loans, 15
Winterthur Group, 70, 156
Wit Soundview Corporation, 35
X-efciencies, 6769
Yield pinch, 17
Zurich Financial Services, 56

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