The use of efficiency measures to compute welfare improving: an application for competition policy

Author:Gustavo Ferro, Sonia León
Position:Universidad del Centro de Estudios Macroeconomicos de Argentina, Buenos Aires, Argentina and Consejo Nacional de Investigaciones Cientificas y Tecnicas, Buenos Aires, Argentina
Pages:227-245
SUMMARY

Purpose Merger approving focuses on both market power and welfare gains. In general, the approval process does not include a comparative efficiency analysis. This paper aims to introduce this dimension and show its potential. Design/methodology/approach Based on the analysis of past bank mergers, the authors examine expected and actual efficiency gains. This paper measures the... (see full summary)

 
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The use of eciency measures to
compute welfare improving: an
application for competition policy
Gustavo Ferro
Universidad del Centro de Estudios Macroeconomicos de Argentina, Buenos Aires,
Argentina and Consejo Nacional de Investigaciones Cienticas y Tecnicas,
Buenos Aires, Argentina, and
Sonia Le
on
Instituto de Economía, Universidad Argentina de la Empresa (UADE),
Buenos Aires, Argentina
Abstract
Purpose Merger approving focuses on both market power and welfare gains. In general, the approval
process does not include a comparative efciency analysis. This paper aims to introduce this dimension and
show its potential.
Design/methodology/approach Based on the analysis of past bank mergers, the authors examine
expected and actual efciency gains. This paper measures the potential (ex ante) and ex post efciency gains
of bank mergers by using data envelopment analysis (DEA).
Findings The authors nd some (approved) mergers were promised and yielded efciency gains while
others did not.
Research limitations/implications DEA does not allow testing statistically the signicance of the
presumed relationship between variables.
Practical implications The authors conclude that some mergers that took place would not have been
approved had an efciency analysis been made.
Social implications Regulators and/or competition authorities could approve mergers which do not
increase efciency.
Originality/value To date, efciency frontier analysis has not been performed for merger approval. It
implies that the regulator or competition authority could allow mergers with no clear social gains.
Keywords Efciency, Mergers and acquisitions, Banking regulation, Competition policy
Paper type Research paper
1. Introduction
Merger approval in competition policy focuses on two important issues once the relevant
market has been dened: rst, whether the merger increases market power (and the condition
of price setter for the merged rms), and second, whether the merger can increase social welfare
through cost savings. Mergers are customarily justied as their (potential) efciency gains are
passed on to consumers, but they usually face objections for their effects on concentration in the
market under analysis. Welfare gains are usually estimated by means of the incremental
consumer plus producer surpluses in a partial equilibrium analysis, before and after the
merger. The use of an efciency frontier analysis can potentially improve the understanding of
the efciency gains owing to the merger, comparing both ex ante and ex post efciency gains.
The efciency frontier analysis can also prevent a merger if efciency gains are not expected.
Welfare
improving
227
Journal of Financial Regulation
and Compliance
Vol. 26 No. 2, 2018
pp. 227-245
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-09-2016-0072
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm
Bank mergers can roughly be classied as those with a macroeconomic origin and those
with a microeconomic motivation. The former is common during nancial crises, when the
objective to absorb insolvent entities facing bankruptcy is to save the integrity of the market
from systemic risks. The latter, occurring in normal times, is to achieve market and cost
synergies.
Macroeconomic-type mergers of banks could be linked to the standard failing rm
defence argument. During economic crises, some nancially distressed companies will seek
to improve their condition by merging with healthier competitors. Competition agencies
may therefore face an increasing number of merger reviews involving nancially troubled
rms, some of which may be true failing rms while others may simply be weak
competitors. In some of the cases, parties may put the failing rm defence forward as an
argument in favour of approving their transaction. Some countries do not consider that
mergers involving failing nancial institutions should be treated differently. Others,
however, do treat mergers different amongst nancial institutions when bank failure is a
possibility (OECD, 2010). As Norris (2010) highlights, referring to merger guidelines in the
USA, the rationale behind the defence argument is that “a merger is not likely to create or
enhance market power or to facilitate its exercise (our Italics), if imminent failure [. . .] of one
of the merging rms would cause the assets of that rm to exit the relevant market.” The
failing rm defence argument originated in the 1930s; nevertheless, its practical application
has been limited to selected cases (Fina and Mehta (2011).
We have analyzed microeconomic-type mergers in the Argentine banking system in
recent years. This paper measures the potential (ex ante) and actual (ex post) efciency
gains of bank mergers by using data envelopment analysis (DEA) in the period of 2005-11.
We apply DEA to the nancial system and decompose the potential efciency gains in pure
technical efciency, scope and scale gains. We nd mergers that improved (ex post)
efciency and some that did not. Of the latter groups, some did not even assure potential (ex
ante) efciency gains.
The Argentine nancial system has a stable number of entities following a consolidation
via some mergers that reduced the total number of entities by 10 per cent after the 2001-02
nancial crisis. The industry – as in the rest of the world – is heavily regulated and mergers
have to be approved both by the Central Bank and the National Competition Authority
(CNDC). Following the procedure established by Law 25,156, the entities under study
reported their operations for economic concentration, and the Secretary of Trade concluded
that they did not intend to or have the effect of “restricting or distorting competition so as to
harm general economic interests”. This nding, in turn, enabled them to merge. Opinions
issued by the CNDC, which is a dependence of the Secretary of Trade, are an integral part of
the approval document.
Following this introduction, Section II reviews the literature on bank mergers and their
relationship to efciency. Section III presents the mergers under review. Section IV describes
the methodology and data, and Sections V and VI present the results and conclusions,
respectively.
2. Literature on banking mergers and their relationship with eciency
2.1 Context of the discussion
To contextualize the performance of the Argentine banking system in recent years, we
present a brief historical review of the past four decades. Summarizing, as in other
developing countries, local nancial system followed a nancial repression type of
organization after the Second World War. Financial liberalization in the 1970s was followed
by 1980 idiosyncratic nancial crack, and macroeconomic shocks impacting on the sector,
JFRC
26,2
228

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