An Empirical Analysis of the Effects of Mergers and

Acquisitions on Commercial Bank Performance in Nigeria

Muktar Aliyu Abubakar

Supervisor: Dr Beat Reber

2014-2015

A Dissertation presented in part consideration for the degree of

‘MSc Finance and Investment’
 ACKNOWLEDGEMENT

I would like to express endless praises to Almighty Allah for giving me the health and

determination to successfully complete this research project.

I also want to send gratitude to my parents who gave me this wonderful opportunity to carry on

further with my studies. They gave me the required financial and emotional support to pursue this

degree in Nottingham University.

I would like to express appreciation to my supervisor, Dr. Beat Reber whose guidance proved to

be priceless over the duration of this research work. I was able to complete this dissertation

because of the support, encouragement, supervision and useful suggestions from my supervisor.

I also want to spare some words for the academic staff that helped me with my learning process

as I found it helpful in completing my dissertation.

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ABSTRACT

In recent years, merger and acquisition activities have rapidly increased among financial

institutions and it has become a very important and practical corporate tool used to pursue firm

growth. M&A activities not only can expand market shares but also create value for companies

and shareholders.

This dissertation investigates the impact of mergers and acquisitions (M&As) on Nigerian banks’

performance during the periods of 2001 to 2013. The focus is on a sample of 16 Nigerian banks

that survived after the banking reforms of 2004. Accounting based measures are used for this

research and examination of the effects of mergers and acquisitions on banks’ performances is

made using the panel data model. The analysis presents evidence that M&A activity has a

significant impact on the Nigerian banks’ performance.

The study involves comparing bank profitability ratios such as return on equity (ROE) and return

on assets (ROA) of both merged banks and non-merged banks. The results after testing for

difference shows that the profitability of Nigerian banks is different depending on M&A status.

In addition, results from the random effects regression indicates that involvement in mergers and

acquisitions improves profitability with ROA as a measure and this might be because merged

banks tends to pursue higher growth, economics of scale and greater capitalization than non-

merged banks. However, the results did not show that mergers and acquisitions have a beneficial

effect using ROE as a measure of profitability.

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 TABLE OF CONTENTS
1. INTRODUCTION ......................................................................................................................5
1.1  Background  of  Mergers  and  Acquisitions  ................................................................................................................  6  
1.2  Mergers  and  Acquisitions  in  Nigerian  banking  industry  ...................................................................................  8  
1.3  Research  objective  ............................................................................................................................................................  10  
1.4  Research  Motivation  ........................................................................................................................................................  10  
1.5  Outline  of  Dissertation  ....................................................................................................................................................  11  

2. LITERATURE REVIEW ........................................................................................................12

2.1  Definition  of  Mergers  &  Acquisitions  .......................................................................................................................  12  
2.2  Types  of  Mergers  and  Acquisitions  ...........................................................................................................................  13  
2.2.1 Horizontal M&As ...............................................................................................................13
2.2.2 Vertical M&As....................................................................................................................14
2.2.3 Conglomerate M&As ..........................................................................................................14
2.2.4 Congeneric M&As ..............................................................................................................14
2.3  Motives  for  Mergers  and  Acquisitions  .....................................................................................................................  15  
2.3.1 The Synergy Theory ...........................................................................................................15
2.3.2 Growth Theory ....................................................................................................................17
2.3.3 Market Power Theory .........................................................................................................17
2.3.4 Efficiency Theory ...............................................................................................................18
2.3.5 Shareholder Wealth Maximization .....................................................................................18
2.3.6 Managerial Hubris Theory ..................................................................................................19
2.3.7 The Agency Theory ............................................................................................................20
2.4  Review  of  Existing  Literature  on  M&A  Performance  Using  Accounting  Based  Measure  ..................  21  
2.5  Development  of  Hypothesis  .........................................................................................................................................  25  
2.5.1 Relative Bank Size ..............................................................................................................25
2.5.2 Capitalization ......................................................................................................................27
2.5.3 Liquidity ..............................................................................................................................28
2.5.4 Asset Quality .......................................................................................................................29
2.5.5 GDP and Inflation ...............................................................................................................30
3. RESEARCH DATA AND METHODOLOGY......................................................................31
3.1  Sample  size  and  data  collection  methods  ...............................................................................................................  31  
3.2  Description  of  variables  .................................................................................................................................................  31  
3.2.1 Dependent Variable: Profitability .......................................................................................32
3.2.2 Independent Variables.........................................................................................................33
3.3  Methodology  .......................................................................................................................................................................  33  
3.3.1 Data analysis procedure: Panel data....................................................................................34
3.3.2 Advantages of Panel Data ...................................................................................................34
3.4  Panel  Data  Models  ............................................................................................................................................................  35  
3.4.1 Pooled OLS Model .............................................................................................................36
3.4.2 Fixed Effect Model .............................................................................................................36
3.4.3 Random Effect Model .........................................................................................................37
3.5  Panel  Data  Estimators  .....................................................................................................................................................  38  
3.5.1 Breusch-Pagan Lagrange Multiplier ...................................................................................38

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 3.5.2 Durbin-Wu Hausman Test ..................................................................................................39
3.6  Data  Multicollinearity  .....................................................................................................................................................  39  
3.7  Regression  Model  ..............................................................................................................................................................  40  
3.8  Test  of  difference  ..............................................................................................................................................................  41  
4. EMPIRICAL RESULTS .........................................................................................................42
4.1  Tests  for  Multicollinearity  .............................................................................................................................................  42  
4.1.1 Correlation Matrix ..............................................................................................................42
4.1.2 Variance Inflation Factor ....................................................................................................43
4.2  Breusch  Pagan  LM  test  ...................................................................................................................................................  44  
4.3  Durbin-­‐Wu  Hausman  specification  test  ..................................................................................................................  45  
4.4  T-­‐test  results  .......................................................................................................................................................................  46  
4.5  Random  effects  regression  analysis  ..........................................................................................................................  48  
4.5.1 Bank Size ............................................................................................................................50
4.5.2 Capitalization ......................................................................................................................51
4.5.3 Liquidity ..............................................................................................................................52
4.5.4 Asset Quality .......................................................................................................................53
4.5.5 GDP and Inflation ...............................................................................................................53
4.6  M&A  Dummy  .......................................................................................................................................................................  54  
4.6.1 ROA as the profitability measure........................................................................................55
4.6.2 ROE as the profitability measure ........................................................................................56
5. CONCLUSION, LIMITATIONS AND FURTHER RECOMMENDATION ...................58
5.1  Conclusion  ............................................................................................................................................................................  58  
5.2  Limitations  of  study  .........................................................................................................................................................  60  
5.3  Further  Recommendation  .............................................................................................................................................  61  

BIBLIOGRAPHY ........................................................................................................................62
APPENDIX ...................................................................................................................................70

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 FIGURES AND TABLES

Figure 1 - Worldwide Bank M&A Statistics ....................................................................................7

Table 1 - Definition of Variables ...................................................................................................32

Table 2 - Correlation Matrix ..........................................................................................................42

Table 3 - Variance Inflation Factor ................................................................................................43

Table 4 - Breusch and Pagan LM test using ROA .........................................................................44

Table 5 - Breusch and Pagan LM test using ROE ..........................................................................44

Table 6 - Hausman test using ROA as dependent ..........................................................................45

Table 7 - Hausman test using ROE as dependent ..........................................................................46

Table 8 - Two group mean comparison tests for merged and non-merged banks .........................47

Table 9 - Results of Regression ......................................................................................................49

Appendix 1 - Nigerian Banks used for this research  .....................................................................................  70  

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1. INTRODUCTION

1.1 Background of Mergers and Acquisitions

 
Consolidation activities among financial institutions have been happening since the 1980s and

due to the recent crisis in the financial markets, these firms are still facing further restructuring.

As a result of these consolidations, there has been a significant decrease in the number of

financial institutions in recent years with the surviving firms being typically larger and more

diversified (DeYoung et al, 2009). As highlighted by Amel et al. (2004) and Berger et al. (1999),

the broad forces promoting this unprecedented upsurge in consolidation in the financial sector

are similar in most nations. The main reason behind consolidation among financial institutions is

to maximize shareholder wealth, however motives of other stakeholders like managers and

governments should be considered (Berger et al. 1999). Financial institutions in response to

fundamental changes in technology and regulation have made attempts at improving their

efficiency and customer base by increasing their geographical reach and offer an increased

variety of products and services. The enabling force was an upsurge of financial deregulation

that was necessary in order to fully take advantage of the innovative production processes by

banks and other financial institutions. Humphrey et al. (2006) maintain that technological

advances transformed front-office delivery systems, back-office processing and payments

systems.

Mergers and Acquisitions help to stop falling margins by attracting new customers and

increasing market share and this rapidly increases the size of financial institutions and to expand

their knowledge of new markets and products. Furthermore, mergers might help financial

institutions diversify their portfolios (Amel et al. 2004). Additionally, Berger et al. (1999)

highlight that the rapid increase in the pace of consolidation might be due to financial distress

among the weaker institutions in the industry. According to Amel et al. (2004), M&A can

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improve efficiency in several ways. Firstly, average cost can be reduced because the larger firms

resulting from a consolidation exercise can spread their fixed costs over a larger base and have

better access to cost-saving technologies. The exploitation of economies of scope may also lead

to efficiency as an M&A deal may allow the merging firms to gain entry into new markets and

reach a wider customer base with their products. Finally, managerial efficiency may be improved

as a result of consolidation. However, the magnitude of exploitable scope and scale economies

might actually be smaller than generally thought, and improved efficiency as a result of better

management practices may be subtle in larger and more complex financial institutions (Amel et

al. 2004). The statistics for the number and value of worldwide bank M&A activities is displayed

in figure 1.

 
Figure 1 - Worldwide Bank M&A Statistics

Source: Institute of Mergers, Acquisitions and Alliance

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1.2 Mergers and Acquisitions in Nigerian banking industry
 
In recent years, the Central Bank of Nigeria created restructuring programmes directed towards

resolving the problems in the Nigerian banking industry. As a result, the industry witnessed an

innovative transformation most notably the recapitalization exercise, which had a significant

impact on shaping the structure of the Nigerian banking industry (Ernest, 2012). A deliberate

policy response to correct the apparent or imminent banking sector crises and subsequent failures

resulted to the Nigerian banking sector reforms and recapitalization exercise (Adegbaju and

Olokoyo 2008). Weakness in a banking system such as weak corporate governance, insolvency,

undercapitalization, liquidity constraints and high level of non-performing loans among others

are factors that can combine to trigger a banking crisis. Similarly, Uchendu (2005) presented that

the reforms in the banking sector proceeded against the scene of banking crisis due to high rate

of undercapitalization among deposit money banks; weak management practices among banks;

defects in the corporate governance behaviour of banks and deficiencies in the supervisory and

regulatory framework.

Against this background, the governor of Central Bank of Nigeria, Prof. Charles Soludo outlined

the first phase of the banking sector reforms designed to guarantee a well diversified banking

industry ensuring the strength and reliability of banks (Soludo, 2004). According to Soludo

(2004), “Strengthening and consolidating the banking system will constitute the first phase of the

reforms designed to ensure a diversified, strong and reliable banking sector which will ensure the

safety of depositors money, play active developmental roles in the Nigerian economy, and be

competent and competitive players in the African regional and global financial system”.

Similarly, Lemo (2005) implied that the reforms were designed to enable the Nigerian banking

system gain the strength and resources required to provide support for the support economic

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development of the country by resourcefully executing its functions as the pivot of financial

intermediation.

Two of the reforms that are constituted in the first phase generated reaction form various

stakeholders and are related to this research are; the requirement that the minimum capitalization

of banks should be N25 billion with full compliance by 31st December, 2005 and the

consolidation of banking institutions through Mergers and Acquisitions (Soludo, 2004). The

lessons from financial reform system collapse in other countries have been taken into

consideration in the formulation of this policy, according to the Central Bank of Nigeria. The

main purpose of the first phase of the Central Bank of Nigeria’s reform is to reorganize the

banking system that will lead to emergence of stronger banks that will encourage some growth in

the real sector of the economy. Additionally, this reform will result in the elimination of weaker

and unstable Nigerian banks thus renouncing the competition to stronger banks and to

simultaneously lower the problem of regulatory risks. Furthermore, capitalization is a significant

part of banking reforms in the Nigeria banking industry; this is because banks with a stronger

capital base have the higher ability to absorb the losses that arise as a result of non-performing

loans (Ezeamama et al, 2014). After the reform, Nigerian banks in operation reduced from 89

banks to 24. There are currently 21 banks operating in Nigeria because 3 banks were further

liquidated after the consolidation (Somoye, 2008).

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1.3 Research objective
 
As a result of the banking reforms in 2004, this research will aim to investigate the financial

impact of Mergers and Acquisitions on Nigerian banking performance. Theories of M&A are

often in favor of merger and acquisition deals between banks because it can create potential

synergies and attempt to strengthen the position of underperforming banks. However, the

literature reviews on M&A demonstrate a mixed outcome. The study will involve comparing

bank profitability ratios such as return on assets (ROA) and return on equity (ROE) of both

merged banks and non-merged Nigerian banks. Financial data will be obtained using BankScope

database and a total sample size of 16 Nigerian banks of out 21 (12 merged banks and 4 non-

merged banks) will be involved in this study from 2001 to 2013 (13 time periods). The main

research objective, which forms a framework for this study is to evaluate the post merger

performance of Nigerian banking sector. The specific objectives are:

1. To examine the effect of M&A on Return on assets of Nigerian Banks

2. To examine the effect of M&A on Return on equity of Nigerian Banks

1.4 Research Motivation

 
There is little consensus and correlation on the positive impact of M&As on industry

performance among researchers and practitioners alike. Several in-depth researches have shown

mixed results in whether M&A produces substantial positive benefits across industries as a

whole. The lack of consistent evidence regarding the impact of financial firm performance from

M&A creates a compelling need to look closely into the various factors that will affect a

successful M&A deal and whether bank involvement in M&A can lead to an improved

organizational effectiveness, financial performance and productivity than banks not involved in

M&A. Empirical evidence using profitability ratios in particular ROE and ROA by researchers

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such as (Focarelli et al 2002; Diaz et al 2004; Knapp et al 2006; Linder and Crane 1997; Cornett,

et, al., 2006) produced mixed results although the more recent studies show evidence of

improved performance. In the Nigerian banking industry, there is no consensus as to whether

M&A deals increased performance and this is evident as studies such as (Odetayor et al. 2013;

Umoren et al. 2007; Abdul-Rahman and Ayorinde 2013) produced mixed and inconclusive

evidence. The inconclusive evidence could be caused by the different methodologies and time

period of data used in previous studies.

In addition, according to Thomson Financial (2014) the global value for M&A deals in 2014

reached the highest annual level since 2007. The Global deal value in December hit $3.27trillion.

Therefore, this data provides evidence that M&A is an important research area and the M&A

phenomenon is particularly relevant.

1.5 Outline of Dissertation

 
This study will be divided into five chapters. The first chapter is an introduction of the research,

which includes background of M&A in Nigerian banking industry, objectives, motivations and

structure of the research. The Second chapter will present a review of previous literature on

M&A this includes the types of M&As, the motives of M&As and a summary of the empirical

literature on M&A and bank performance. The third chapter will explain details of the sample

data set and research methodology that will be used to measure the effect of M&A on Nigerian

banks. Tests of difference (T-test) will be conducted and then panel data estimators will be

conducted in order to determine the suitable regression that will be used in this research. In

chapter four, the empirical results analysis will be presented and discussed. In the final chapter, a

conclusion is reached based on the literature review and the relevant empirical analysis. In

addition, the limitations of this study will also be discussed in the final chapter.

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2. LITERATURE REVIEW

This chapter provides a basic understanding of the literature on Mergers and Acquisitions

operations and further compares it with the empirical evidence of past significant research. The

first part of this section presents the definition of M&As and highlights the similarities and

differences between Mergers and Acquisitions. The second section shows the types of M&As as

it is necessary to make a distinction between different types for a clear understanding of Mergers

and Acquisitions. Furthermore, a discussion based on previous literature, debates and verdicts on

the reasons behind M&A activity is presented. The fourth section indicates the results of M&A

activity effects and the effect it has on banking performance according to accounting based

studies. Finally, the last section presents the control variables such as size, capitalization,

liquidity, asset quality, GDP and inflation. Theories and accounting based studies are insufficient

for providing an edifying investigation of the impact of M&A performance, the hypotheses used

in the studies are developed.

2.1 Definition of Mergers & Acquisitions

 
Mergers and acquisitions, also known as M&A involve the process of combination of

management, finance and strategy among firms with the goal of achieving corporate growth or

expansion (Sudarsanam, 1995). However, the terms of mergers and acquisitions are two different

phenomena of business activities. Therefore, it is important to distinguish the differences and

similarities between Mergers and Acquisitions.

In an acquisition deal, the ‘acquirer’ company purchases all or majority of the shares of the

‘target’ company in order to take over the management and ownership of the business

organization. The acquirer will usually offer stocks of the new combined business or cash to buy

over the stocks from the target company. This can be either through a deal that was agreed upon or

a hostile takeover. Acquisitions are essentially takeovers, which mean one bigger firm buys out

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the smaller firms (Fiordelsi, 2009).

In a merger deal, there is a mutual agreement by two or more separate companies to combine

with each other to form a single organization and share their resources with the aim of achieving

a common objective (Sudarsanam, 1995). In cases of a merger, the companies involved are

usually of similar size and therefore no one company can actually dominate the other after the

merger exercise (Fiordelisi, 2009).

In general, Coyle (2000) maintains that Mergers and Acquisitions can be stated as when two or

more companies join together partially or completely. If the combining firms are similar in size

and subsequently no one company is controlling the ownership after combination this transaction

is called a merger. Where in the case of acquisition, one bigger company takes over the smaller

company and the target company becomes the subsidiary of the acquirer.

2.2 Types of Mergers and Acquisitions

2.2.1 Horizontal M&As
 
Horizontal M&A occurs when the acquiring firm and target firm are in the same industry with the

same business. This means the acquiring company and target company are competitors in the

same market. The motive for banks to pursue horizontal M&A deals might be in order to gain

competitive advantages and market power over their rivals as well as seeking economies of scale

to increase capital and profit (Gaughan, 2013). Horizontal M&A is experienced in the banking

industry for example, Access bank PLC acquisition of Intercontinental bank (Punch, 2012) and

the merger between Lloyds TSB and HBOS (Murray-West, 2008).

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2.2.2 Vertical M&As
 
Vertical M&A is when the acquiring firm and target firm are in different positions of the value

chain. Most companies are usually in buyer-seller, client-supplier and value chain linkages

(Gaughan, 1999). Specifically, the target company could be the supplier or customer of the

acquiring company. Vertical M&A consists of forward integration and backward integration.

Forward integration means acquiring firm merges into the direction of its retailer (for example,

customers); whereas backward integration means acquiring firm merges into the direction of its

suppliers (Watson and Head, 2010). There is a cost saving through synergies merger. For

example, HSBC acquired JP Morgan’s dollar clearing business in 1996 (Business Day, 1996).

2.2.3 Conglomerate M&As

 
The conglomerate M&A occurs when the target and acquiring firm operate in unrelated business

areas. There are different reasons and motivations behind conglomerate M&A and these can be

for the pursuit of risk reduction by diversification and cost reduction or other more complex

motivations (Gaughan, 2007). In addition, Conglomerate M&A makes the allocation of resources

more efficiently (Bruner, 2002). Example of conglomerate M&A is when ITT a multinational

telephone service company acquired car rental company Avis Inc., hotel chain Sheraton Corp. of

America and Ceasers world, a gaming company (Newsweek, 1995).

2.2.4 Congeneric M&As

Congeneric M&A occurs when the acquiring firm and target firms are in related business field

but not of the same products (as in horizontal merger) or the companies are not in a manufacturer

& supplier relationship (as in the case of vertical merger) (Gaughan, 2007). For instance, Lloyds

Bank in 1995 acquired the mortgage business of Cheltenham and Gloucester. The mortgage

business is related but is different from Lloyds Banks’ retail banking business.

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2.3 Motives for Mergers and Acquisitions
 
There have been previous studies and investigations regarding the motives for mergers and

acquisitions. A summary of reasons companies get involved in merger and acquisition activity

was provided by (Andrade et al. 2001) “efficiency-related reasons that often involve economies

of scale or other synergies; attempts to create market power, perhaps by forming monopolies or

oligopolies; market discipline, as in the case of the removal of incompetent target management;

self-serving attempts by acquirer management to over-expand and other agency costs; and to take

advantage of opportunities for diversification, like by exploiting internal capital markets and

managing risk for undiversified managers”. The theories with respect to mergers and acquisitions

can majorly be classified into two groups of neoclassical theories and behavioural theories. The

assumption that managers are rational and make sensible choices to represent the interest of the

shareholders is classified under the neoclassical theory, whereas behavioural theory focuses on

the notion that managers are not rational and their choices do not maximize shareholder wealth

(Dilshad, 2013). It is necessary to understand the impact of each motivation and these will be

discussed in the following subsections.

2.3.1 The Synergy Theory

 
Merger and Acquisition is basically a technique of creating synergies through the combination of

two lines of business complements. According to Gaughan (1999), the operations of banks

through M&A are a more profitable combination of assets as the mergers translate to cost

efficiency, increased service and liquidity. The synergy theory suggests that the value of the

combined firms is greater than the sum of the value of the individual firms (Bradley et al., 1988).

The occurrence of takeovers only happens when the shareholders of both target and acquirer will

gain values (Berkovitch and Narayanan, 1993). Empirical studies like (Berkovitch & Narayanan,

1993 and Bradley et al., 1988) provide evidence of value gains of target firm, acquiring firm and

the total value of the combined firms. Generally, firms can obtain synergies from the

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achievement operating efficiency, financial synergy and managerial efficiency.

Operating Synergy

The operating synergy can be achieved by either enhancing the revenue or by reducing costs

(Gaughan, 1999). The combined firm generates resources such as cash flows and revenues that

are much bigger than those of individual firm itself. The costs reduction can be achieved by

sharing fixed costs through larger economies of scale and the combined firm will generate more

efficiency through using a more efficient production line employed by one of the individual

firms. In fact, the achievement of economies of scale is the goal of horizontal mergers. For

example, in the 1970s small banks in the United States experienced growth as a result of buying

up smaller banks and then streamlining their operations (Pasiouras, et al., 2005). Most cost

savings were achieved through closing redundant branches, consolidating systems, processing

checks and credit-card transactions (Brealey, et al., 2011).

Financial Synergy

Financial synergy refers to the gaining of financial benefits by lowering capital cost because of

the combination of banks (Gaughan, 1999). Financial synergy is comparatively a nominal motive

in comparison to economic, operational and managerial synergies. Financial synergy can be

generated as internal financing costs are economical in comparison to external financing and

additionally it increases the debt capacity of the combined banks. It will be cheaper for the new

combined firm to access capital market because of increased borrowing capacity (Sudarsanam,

2003). Empirical evidence supports this theory as Rathinasamy et al (1991) suggests, “the post-

merger actual debt ratios are significantly higher than the potential theoretical ratios”. This also

provides tax savings on investments (Copeland, 2005).

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Managerial efficiency

Managerial efficiency in the areas of production, research, finance and marketing are referred to

as economies in the particular management systems. Through the M&A operation, banks have

restriction on the number of employees working for them. Thus, those underutilized employees

or duplicated function jobs, would be cut to reduce the cost of human capital and maximize the

profitability (Copeland, 2005).

2.3.2 Growth Theory

 
Mergers and acquisitions are also motivated by a firm’s willingness to grow and expand its

market share and also to obtain more market power. Therefore, faster growth is an important

motive that encourages banks to participate in M&A activities. Through the immediate

acquisition of another bank, banks exploit a new growth opportunity (Sudarsanam, 1995). Banks

generally experience an immediate increase in market share and assets in a short period of time

after acquisitions of insolvent banks at a bargain price. Acquired banks in a particular geographic

area can also be a quicker way to expand instead of organic growth from scratch through internal

expansion. According to (Economy Watch, 2010), most banks in the US banking industry pursue

great opportunities like development of new products through financial engineering, new markets

and new delivery channels through M&A operation.

2.3.3 Market Power Theory

 
Through economies of scale, it is possible to increase the revenue, market share and market

power on financial services of two banks involved in a horizontal merger. Although each

participant in an M&A activity has different goals, there is consistency on the evidence of M&A

activities aiming at the increase of market power. It is also recognized that in addition to M&A

improving the market power, it also increase the market share. Subsequently, those merged banks

become the main players for setting the price on certain financial retail services (Berger et al

1999).

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2.3.4 Efficiency Theory

The efficiency theory states that there is motivation for mergers and acquisitions because of the

potential improvement in the combined bank’s operation (Berger and Humphrey 1997). For

example, the superior manager is able to take up responsibility in the control of operations,

exploit cost reduction “synergies” or the complementarities resulting from the partners’

operations, or taking advantage of the economies of scale and risk spreading opportunities and

the securing of capital (Berger and Humphrey, 1997). In other words, the enhancement of

existing assets and achievement of lower cost efficiency in producing a given quantity and

quality of goods and services can be achieved by the combination of banks.

2.3.5 Shareholder Wealth Maximization

 
The modern finance theory states that shareholders wealth maximization is the most important

criterion in investment and financial decisions (Gaughan, 1999). In other words, the improved

cash flows from such activity, after taking into account the appropriate discount rate, should yield

at least zero or a positive value (Sudarsanam, 1995). The criterion of shareholders’ wealth

maximization is realized if the added value resulting from merger and acquisition activity

exceeds the cost of acquisition. According to Fiordelisi (2009), banks might seek to improve

shareholders’ wealth in a competitive environment by expansion through internally generated

growth or through Mergers and Acquisitions.

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2.3.6 Managerial Hubris Theory
 
Managerial Hubris is a major reason for inefficient performance after a merger and acquisition

deal. This mainly leads to the reduction in wealth of both acquiring and acquired firm. As

supported by many scholars in their research, Roll (1986) summarizes that managers from

acquiring companies tend to make combination decisions according to their own benefits firstly

rather than the future benefits of the firm. Furthermore, Roll (1986) even considered managerial

hubris as the major reason that managers try to combine companies for the sake of own benefits.

Additionally, Berkovitch and Narayanan (1993) recognize that managers tend to make errors in

the evaluation process of the target firm and some target firms are still acquired even they could

not bring synergy effect. In recent years, there are still arguments against M&As. For example,

Malmendier and Tate (2008) believes that the high premium of acquiring a target company could

be attributed to the overconfidence of managers and further pointed out that the arrogance is a

catalyst for mistakes in evaluating the true value of a target company. Therefore, acquiring

company often spends a larger price on acquired company than the current price. Berkovitch and

Narayanan (1993) pointed out that managers are often too confident to make appropriate

decisions in value estimation from an investment. As a result, the firm has to pay a high premium

for a combination. Moreover, evidence shows that managers from acquiring companies tend to

overestimate acquired company’s value rather than underestimating it. There are some possible

results because of managerial hubris according to Roll (1986), one is the value of new company

(after acquiring a target company) begins to decrease; the value of acquiring firm decreases; the

value of target firm increases. Of all the perspectives considered, managerial hubris is a reason

for M&A to have a negative effect on a company.

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2.3.7 The Agency Theory
 
The agency theory is defined as a contract in which the agent implements some services on the

shareholders’ behalf. This involves delegating some decision making power to the agent

(Meckling, 1976). Some Mergers and acquisitions occur as a result of agency problem

(Berkovitch and Narayanan, 1993). Existing agency problems are potential conflicts between

shareholders and managers; because the acquirer’s managers pursue their own welfare rather than

the interest of the company as a whole (Meckling 1976). Therefore, the managers may prefer

taking acquisitions despite of the decrease of firm’s total value because some Managers are of the

belief that the larger the organization the less likely another bank can acquire it and this would

make their jobs more secure. The acquisitions motivated on these grounds have no justification

for shareholders wealth instead managers are more likely enjoy their own benefits at the expense

of shareholders (Meckling 1976). The agency problem might lead to a decrease in the firm’s

total value and this might be a reason why mergers and acquisitions have a negative impact on

the post-merger performances. However, Sharma and Ho (2002) suggest the agency problem

may lead to positive post-merger performance. Their arguments are based on Jensen’s (1986)

theory that managers tend to invest free cash flow in negative net present value projects. They

suggest takeovers paid in cash have better post-merger performance because the reduction of

cash limits the possibility that managers misuse free cash flows.

  20  
2.4 Review of Existing Literature on M&A Performance Using Accounting
Based Measure
Accounting based measures use accounting data, which form the main part of the banking

literature to examine the impact of M&A on the operating performance of banks. The accounting

based measures include but are not limited to return on equity (ROE), return on investment (ROI)

and return on assets (ROA) (Van Ees et al, 2003). According to Faulkner et al (2012), there are

two main advantages of using accounting based measures as a proxy for measuring M&A

performance. Firstly, the measure the actual performance as reported in the annual financial

statements. Secondly, long term accounting ratios such as return on asset (ROA) and return on

equity (ROE) best show potential synergies from M&A activity. Usually, operating performance

of acquiring banks is analyzed for a period of one year prior to deal to a 3-5 years after

acquisition as the potential synergies can be reflected in this time period (Beitel and Schiereck,

2001). This is consistent with Healy et al. (1992) that assert operating performance of firms

improve 5 years after an M&A exercise.

On one hand, existing literature on accounting based measures by Linder and Crane (1992),

Rhoades (1993), Odetayor et al. (2013), Focarelli et al (2002), Kwan and Wilcox (2002) provide

evidence that M&A activities do not affect bank’s performance positively. There are as follows:

Linder and Crane (1992) investigated 47 US banks in order to compare their operating

performances between pre-merger and post-merger for 6 time periods from 1982 to 1987. Their

results suggested that there is no significant increase in profitability two years after merger.

Similar studies carried out by Rhoades (1993) and Kwan and Wilcox (2002), discovered that

M&A deals are not considerably related to cost reduction and efficiency improvements. In the

study by Kwan and Wilcox (2002) states that the X-efficiency of 4,900 US merged banks

  21  
between 1980 and 1990 were determined and the study concluded a significant decline in X-

efficiency in the year following the mergers.

Rhoades (1993) considered thirty-nine empirical studies of bank consolidation and efficiency that

between 1980 and 1993. About 50% of these studies assess the financial performance of banks

after a merger or acquisition exercise. The findings of these financial performances revealed that

mergers and acquisitions failed to improve the efficiency and profitability of banks.

Odetayor et al. (2013) examined the post-merger profitability of two selected Nigerian banks

(Access bank and UBA) for 8 time periods (2005-2012). To measure performance, this study

used Net Profit as the dependent variable and net assets and shareholder funds as independent

variables and the method of estimation was OLS regression. The result showed that there is no

significant increase in profitability after the merger.

Focarelli et al., (2002) conducted a study of 66 acquisitions and 135 mergers of Italian banks for

periods from 1985 to 1996. In order to distinguish between merges and acquisitions impact on

bank performance, the authors analyzed both pre-merger and post-merger periods. The study uses

operating cash flows returns on assets (ROA), return on equity (ROE), profit efficiency and

various dummy variables representing different forms of M&As and time periods. Findings from

the study concluded that mergers deals fail to improve financial performance and the cost

efficiency declines due to characteristics and rigidity of Italian labour market, there are poor

ROA levels and ROE decreases. Acquisitions deals lead banks to experience an increase in

revenue as well as ROE and ROA for three periods after the deal. The authors suggest that the

reason for this is because of an enhanced loan portfolio quality. Substantial benefits on cost

efficiency and profit efficiency of the involved banks were not found. In general, the authors do

not report substantial cost efficiency and profit efficiency increases for banks involved in M&As.

  22  
On the other hand, using accounting based measures, Díaz, et al., (2004), Knapp, et al., (2006),

Umoren et al. (2007), Abdul-Rahman and Ayorinde (2013), Spindt and Tarhan (1993), Cornett,

et, al., (2006), Campa and Hernando (2006) revealed that M&As deals have brought a positive

impact on banks long-term profitability and have significantly improved the firm efficiency.

There are as follows:

Diaz, et al., (2004) used a panel data method and a sample of 1629 banks to investigate the effect

on banks’ performance of financial acquisitions during periods from 1993 to 2000. The findings

from the research revealed that M&A deals do actually contribute to an increase in the acquirer’s

long-term profitability.

Knapp et al., (2006) investigated 80 US banks with a value in excess of $25 million during

periods from 1987 to 1998 in order to determine the impact of mergers on the bank’s

performance. The authors use ROA, ROE, cash flow and cash flow ROE. The research findings

suggest that mergers create substantial profit gains up to five years in the post-merger period.

Spindt and Tarhan (1993) used a sample of 192 mergers of small banks in 1996 through running

several non-parametric tests. These researchers found out that banks involved in M&A increase

the operational income by of gaining in economics of scale. In addition, this result was confirmed

by Pilloff and Santomero (1997) who found that scale economics exist for banks with total assets

smaller than 100 USD million. In fact, Spindt and Tarhan (1993) mainly focus on M&As of

smaller banks.

  23  
Umoren et al. (2007) considered a sample of 7 Nigerian merged banks and used ROE as the

dependent variable to measure change of performance of the banks pre and post merger. The

paper used ROA as an independent variable and as a measure of profitability. This study

considered 3 time periods from 2004 to 2006 (two years pre-merger and a year post-merger).

Results from this study found that mergers lead to improved bank performance.

Abdul-Rahman and Ayorinde (2013) examined the pre and post-consolidation performance of

Nigerian banks. The paper considered a sample of 15 banks and used Return on equity, Return on

asset and Net profit margin as proxies for performance. The study considered 10 time periods (5

years pre-consolidation and 5 years post-consolidation). Regression analysis was used to analyze

post merger performance and the results revealed that Mergers and Acquisition activity positively

influenced bank performance and that on average, bank consolidation resulted into improved

performance.

Cornett, et al., (2006) studied a sample of 134 mergers made in the US between 1990 and 2000 to

estimate changes in the long-term operating performance for both large and small banks. The

authors’ measure operating performance change in the two years after the banks merger

compared to the same value in the two years before the merger. The results suggest that there are

revenue efficiency improvements for large mergers and for product and geographical focused

mergers.

Campa and Hernando (2006) investigated 66 European banks to determine the impact of mergers

on the firm’s operating performance for periods from 1998 to 2002. The results suggested that

mergers significantly improve the firm efficiency and the target bank’s performance.

  24  
2.5 Development of Hypothesis
The purpose of the study is to investigate the effect of Mergers and Acquisitions on Nigeria

bank’s performance. Concentrating only on the theories of M&As and results of accounting

based studies are not enough to achieve this objective. Therefore, the study further scrutinizes the

impact of M&As on profitability based on characteristics involving bank size, capitalization,

liquidity, asset quality as well as macroeconomic factors such as GDP and inflation. The

following section discusses the existing literature and assesses the results related to these

characteristics for the development of the hypothesis for this study.

 2.5.1 Relative Bank Size

 
There is empirical evidence to suggest that firm size is highly related with firm profitability

(Dickerson et al 1997; Ramaswamy and Waegelein 2003). In terms of size, the studies of Berger,

et al., (1999) claim that smaller and less efficient banks usually tend to merge with larger and

more efficient banks. This is ideally aimed to transfer the expertise and operating policies and

procedures of a more efficient firm over its less efficient operation in order to exploit the hidden

synergies for increased profitability. According to Niresh and Velnampy (2014), this is

corresponded with the theory of economies of scale and scope, which indicates that a large

company will in general be more profitable than a smaller one. In accordance with this concept, a

positive relationship between firm size and profitability is expected. There are different ways to

measure a firm’s size. In this research, a firm’s size is measured by the logarithm of the bank’s

total assets and this is consistent with (Subramanyam and Wind, 2010). Frensch (2007) observes

that the target characteristics to impact M&As success is the combination potential and the

relative size. Specifically, if the target is a small one, all the structures of the acquirer are

enforced it and the change requirements are very asymmetrical. The danger is that such change in

organizational structure could create unnecessary confusion in the subsidiary and brings about a

  25  
lack of knowledge at the parent company level (Frensch 2007). Moeller et al. (2004) claim that

acquiring larger targets instead of smaller ones results into more success. The views of Shelton

(1998) are consistent with this and claim that higher value is created for acquirers with an

increase in relative size.

However, too large or too small acquisitions can affect performance negatively. Therefore,

effects from larger acquisitions may be complicated, while smaller acquisitions may not be worth

the effects (Kusewitt, 1985). The conclusion is thus as DePamphilis (2010) states that the average

target size therefore would perform the best role in determining acquirer’s shareholders’ returns.

Gupta and Misra (2007) investigate the size influence of size M&A of US publicly listed banks

during the period 1980 and 2004. The authors find evidence of irregular effects on shareholder

returns. Furthermore, Agrawal et al. (1992) demonstrate no correlation for size related

performance effects. Similarly, Sirower (1997) concludes there is no evidence that the relative

size of the target has effects on the performance. The findings of a study carried out by

Velnampy and Nimalathasan (2010) on the relationship between firm size and profitability of

Commercial Bank and Bank of Ceylon in Sri Lanka over a 10-year period was mixed. For

Commercial bank, a positive relationship between firm size and profitability was found. In

contrast, for Bank of Ceylon, no relationship between firm size and profitability was found.

HYPOTHESIS 1: According to the review of the existing literature, an unclear effect of size on

bank performance is expected in the Nigerian banking sector.

  26  
2.5.2 Capitalization
 
Capitalization is measured by total equities over total assets (Subramanyam and Wind, 2010).

Capital structure is essentially how a firm separates the proportion of its cost of finance between

debt and equity (Emery, et al., 2007). The purpose of bank capitalization is to find a resolute

solution to the problem of unstable banking and to improve the efficiency of management in the

banking system (Clementina and Isu, 2013). Aderinokun (2004) maintains that “increasing the

capital base of banks in Nigeria would strengthen them and, in the process, deepen activities

within the industry, provide better funding for banks lending activities and increase profitability”.

Capitalization has become a focal point of banking, as it is an indicator of a bank’s ability to

compete with the banking industry. The study by Holmstrom and Tirole (1997), revealed that

increased level of borrower monitoring is induced by higher bank capital and this indirectly

results into a higher chance of survival for the bank due to a reduced probability of default by

increasing the surplus generated by the bank-borrower relationship. The conceptual framework is

to check the risk-taking of banking operation and its capital requirements with appropriate

supervision (Vivies, 2000). Existing literature offers conflicting views on how capital can affect

bank performance. On one hand, Naceur (2003) revealed that there is less need for external

funding with a higher equity-to-asset ratio, and therefore there is higher profitability. Holmstrom

and Tirole (1997) show that high bank capital increases the total surplus generated in the

relationship between bank and borrower and predicted that higher capital will lead to higher bank

profitability banks. In addition, Janson (2005) suggests that there exist a positive correlation

between holding capital and performance because it enables banks to attract more depositors and

also be ready to pay dividend and interest on deposit.

  27  
HYPOTHESIS 2.(a): Banks with larger capital ratio show higher profitability and a stronger
ability to compete in the banking industry. Therefore a positive correlation between
capitalization and performance is expected in the Nigerian Banking industry.

On the other hand, Ross (1997)’s view was completely on the contrary. Ross indicates that lower

capital ratio signals positive information. In addition, Modigliani and Miller (1963), show that

higher capital mechanically leads to a lower ROE. Altunbas and Ibanez (2008) claim that

changing the capital structure or performance of firms brings about agency problems between

shareholders and managers. Nevertheless, Jensen (1986) argues that cumulative financial

leverage might diminish this type of agency problem because it can pressure the banks’ managers

to work toward as efficiency due to short-term stresses resulting from the needs of servicing the

debt.

HYPOTHESIS 2.(b): Bank with larger capital ratio may cause agency problems as the

managers are likely enjoying their own benefits at the expense of the stockholders. Under this

theory, the relationship between capital structure and performance is expected to be negative in

the Nigerian banking industry.

2.5.3 Liquidity

Liquidity indicates the short-term solvency of a firm and it demonstrates how quickly a bank to is

able to convert its assets into cash to pay its short-term debts (Subramanyam and Wind, 2010).

According to Altunbas and Ibanez (2008), the merged banks with better liquidity management

show a better performance. Since the primary essential business for banks is liquidity, the more

liquid the bank and the less likely the firm experience financial distress on a short-term basis.

This is supported by Marozva (2015), who asserts “insufficient liquidity is one of the major

reasons for bank failures, holding liquid assets have an opportunity cost of higher returns”.

Bourke (1989) finds a positive significant relationship between bank liquidity and profitability.

  28  
HYPOTHESIS 3. According to the existing literature banks with high liquidity experience good

performance. Thus, the relationship between liquidity and performance of Nigerian banks is expected

to be positive.

2.5.4 Asset Quality

 
Asset quality is an aspect of bank management that involves the assessment of a firm’s assets to

determine the level and size of credit risk associated with the firms operations (Adeolu, 2014). In

other words, asset quality refers to banks’ credit risk position. Asset quality can be measured as a

ratio of the level of non-performing loans divided by total loan. According to Altunbas and

Ibanez (2008), a low asset quality may cause deteriorating in post-merger performance of a firm.

(Demirguc-Kunt, 1989 and Whalen, 1991) declared that bank asset quality is an important issue

in banking because before a bank can be declared bankrupt, a sizeable amount of non-performing

loans must be in existence since bank asset quality is an indicator for the liquidation of banks.

According to the Basle Committee on Banking Supervision, the main principles for efficient

banking supervision covered twenty-five fundamental principles and seven are designed to tackle

the relevant issues of credit risk management or bank asset quality (Basle, 1997). This indicates

that asset quality is of general concern and importance to financial supervisory authorities in

every nation throughout the world. The healthiness of a bank depends mainly on asset quality;

banks with good assets are able to attract and retain deposits, for continued liquidity (Garten

1991). The deterioration in the asset quality of a bank affects its operating and financial

performance as well as the general reliability of the financial system in which it is an entity

(Adeolu, 2014).

HYPOTHESIS 4. Banks with good asset quality implies low loan risk. Therefore, bank asset

quality and profitability should be positively related in the Nigerian banking industry.

  29  
2.5.5 GDP and Inflation

GDP:

In a study by Kiymaz (2004) a sample of 227 US financial institutions that were involved in

M&A activity during the periods of 1989 to 1999 were observed. The author reveals that

macroeconomic factors are very important to explain the value creation within M&A activities.

Similarly, Pasiouras, et al (2005) suggest that macroeconomic conditions could have an indirect

effect on the profitability of banks. GDP Growth is expected to have a positive effect on banks’

performance, according (Rajan and Zingales 1998).

HYPOTHESIS 5(a). The growth of GDP has a positive effect on banks’ performance, therefore

a positive relationship between GDP and Nigerian banks’ performance is expected.

Inflation:

Inflation might have an effect on the revenues and costs of financial institutions (Pasiouras and

Kosmidou, 2005). This is because inflation is a macroeconomic indicator of market risk and high

levels of inflation indicate a negative economic view (Vencatachellum and Wilson, 2013). As

such, the high level of inflation could affect the high cost of capital and therefore impact

profitability and bank performance and profitability. Perry (1992) suggests that the effect of

inflation on bank performance is dependent on whether the inflation is anticipated or

unanticipated. Empirical studies like Abreu and Mendes (2001) have examined some

determinants of profitability of US banks and reported that there is a significant relationship

between profits and different macroeconomic factors.

HYPOTHESIS 5(b). The high inflation ratio causes a high cost of capital. Therefore, it has a

negative impact on banks performance. Thus, a negative relationship between inflation and

performances are expected for Nigerian Banks.

  30  
3. RESEARCH DATA AND METHODOLOGY

3.1 Sample size and data collection methods

 
The population of this research is the Nigerian banking industry. The entire banking industry in

Nigeria had 89 banks as at end of 2005. After the consolidation exercises the number of banks in

Nigeria came to 24. The sampling technique that was used is judgmental and 16 listed banks out

of the 24 banks that made the consolidation deadline of 2005 were selected. The easier

accessibility to their financial statements was considered and the selected banks were considered

because they are listed in the Nigerian Stock Exchange market and therefore financial statements

were accessible.

This study primarily uses secondary data such as information from academic journals, textbooks,

magazines, newspapers, companies’ annual reports, and Internet sources will be utilized. The

financial statements of banks used in this study were obtained from the BankScope database of

Bureau Van Dijk’s company. The samples used are banks operation in Nigeria from 01/01/2001

to 31/12/2013. The selection process yielded a total of 16 banks of which 4 were not involved in

M&A activity and 12 involved in M&A. In addition, Macroeconomic indicators GDP and

Inflation were obtained from the World Bank database.

3.2 Description of variables

This paper uses a series of financial indicators to access the financial performance of banks in the

Nigerian banking sector. The dependent variables are Return on Assets (ROA), Return on Equity

(ROE) and the control variables are bank size, capitalization, liquidity and asset Quality. In

addition, GDP and Inflation are also considered as variables in order to analysis the trend over

time. Table 1 shows the formulas for the variables.

  31  
Table 1 - Definition of Variables

Variables Acronym Formula

Return on Asset ROA Net Income/ Total Asset
Return on Equity ROE Net Income/ Equity
Size SIZE Natural Logarithm of Total Asset
Capitalization CAP Equity/ Total Asset
Asset Quality ASSETQ Impaired Loans/ Gross Loans
Liquidity LIQD Net Loans/ Total Asset
Gross Domestic Product GDP GDP Growth Rate
Inflation INFL Inflation Rate

3.2.1 Dependent Variable: Profitability

 
Return on equity (ROE) is one of the most important ratios that investors consider. ROE is

calculated as the ratio of annual net income over total shareholders equity and this indicates a

company’s profitability by revealing the amount of profit generated through capital that the

shareholders have invested. In other words, it shows how much profit a company generates with

the money that shareholder have invested. It assesses the financial performance from the

shareholder’s perspective and reflects the return on owners’ investment. However, the

denominator might be different across banks and therefore this is a shortcoming of using the

ROE as a measure of profitability (Subramanyam and Wind, 2010).

Return on asset (ROA) is an alternative measure of a firm’s profitability by showing how well a

bank’s funds were used, irrespective of the relative magnitudes of the sources of these funds.

ROA is calculated as the ratio of net income over total asset. Return on Assets is generally

referred to as an overall indicator of the performance of a financial institution. It shows a bank’s

ability in generating profits from its disposable assets. In other words, ROA reflects how efficient

a firm generates profit by using its assets. However, ROA fails take into account the profits

  32  
generated by off-balance sheets operations and this is a limitation of using this ratio

(Subramanyam and Wind, 2010).

3.2.2 Independent Variables

 
The independent variables will be Size, which for this research will be the Natural Logarithm of

total assets the banks. Capital structure, Liquidity and Asset quality. In addition, Macroeconomic

variables such as GDP and Inflation are included in order to capture time effect and they act as

time dummies as they have the same value across all individuals within a year. The remaining

explanatory variables consist of dummy variable (M&A dummy), which tries to quantify the

effect of mergers on profitability.

3.3 Methodology
 
There are different methods of measuring M&A Performance. According to Wang and Hamid

(2012), these are event studies, accounting based measures, managers’ perceived performance,

experts informants assessment and divestment measure. In this research, accounting based

measures is the approach that will be used to measure M&A performance in order to find out if

Nigerian banks experienced better performance as a result of M&A activity. Accounting studies

involve financial ratios, and their analyses to assess a bank’s performance. This study focuses

solely on the Nigerian banking industry by using a combination of quantitative techniques. Some

existing literature use accounting ratios to investigate the performance of banks involved in

M&A. These studies examine the financial performance of acquirers before and after

acquisitions. However, using this approach might not be accurate as other factors such as

economic conditions could also affect the M&A performance of banks. This study uses Ordinary

Least Squares (OLS) regression method and this method can be used describe and evaluate the

relationship between two or more variables (Brooks, 2014).

  33  
3.3.1 Data analysis procedure: Panel data
 
The data is constructed as a panel dataset; therefore panel data regression analysis is employed in

this research. The characteristic of panel data provides information on individual behavior and

across individuals over time, as they have cross-sectional and time series dimensions. According

to Wooldridge (2013), panel data can be balanced when all individuals are observed in all time

periods or unbalanced when individuals are not observed in all time periods. The accounting data

for some banks used in this research are not available for each year and thus the time series

observation is different across individuals therefore this study uses an unbalanced panel data.

Thus, each individual bank may have different numbers of time observations. The panel data set

for this project has 197 observations from 16 Nigerian banks observed across a period of 13 years

using annual time-series data from 2001 to 2013.

3.3.2 Advantages of Panel Data

 
Some of the benefits of using panel data sets are explained in Hsiao (2013). Panel data sets are

much larger data sets than cross sectional or times series data, which offer higher variability and

less possibility of multicollinearity among variables. Panel data possesses additional and more

informative data, which enables the researcher to test more sophisticated behavioural models and

get more reliable results. In addition, another good characteristic of panel data set is the ability to

control for individual heterogeneity. In other words, the researcher can have control over certain

types of omitted variables and this will result into more consistent estimates. There is a bias in

resulting estimates when these unobserved individual specific effects are not controlled. Complex

issues of dynamic data sets are better-studied using panel data. And this is because of the ability

to recognize and estimate effects that cross sectional and time series data may not be able to

detect (Hsiao, 2013).

  34  
3.4 Panel Data Models
 
Panel data set has both time series and cross-sectional dimensions as already explained in this

research paper. According to Wooldridge (2013), pooled OLS, fixed effects model and random

effects model can be used to estimate a panel data regression model. The different methods will

be explained in the next section. According to Greene (2012) panel data can be denoted by:

𝑦!" = 𝑥!" 𝛽 +   𝑧! 𝛿 + 𝑢! + 𝜀!" (3.01)

𝑖 is individuals (𝑖=1,2,…N) which is the quantity of cross-sectional units over 𝑡 period of time,

(𝑡=1,2,…N);

𝑦!" is observation of dependent variable for individual 𝑖 at time 𝑡;

𝑥!" is observation of the independent variable for individual 𝑖  at time 𝑡;

𝛽  represents the coefficient on 𝑥!" ;

𝑧!  is the time-invariant apparent variables that differs between individuals;

𝛿  is the coefficients on 𝑧;

𝑢!  is unobserved individual-level effect;

𝜀!"  is the stochastic error term.

  35  
3.4.1 Pooled OLS Model
 
A pooled model is when the data on different individuals are simply pooled together with no

provision for individual differences hat might lead to different coefficients (Hill et al., 2014).

Pooled OLS model is the simplest estimation method since the approach allows the pooling of all

observations in OLS regression without reasonable and supportable assumptions and this has

severe limitations (Brooks, 2014). According to Hill et al. (2014) and Wooldridge (2013), pooled

OLS ignores the panel nature of the data and treats individual effects as constant and common.

The result of applying pooled OLS might indicate extreme limitations. As a consequence, it may

cause complicated error processing, such as heteroskedasticity through individuals and serial

correlation for all individuals (Hill et al., 2012). The estimates from pooled OLS regression may

be biased and inconsistent (Wooldridge, 2013). Thus, pooled OLS is the most restrictive panel

data model and is not often used in practice (Brooks, 2014).

As an alternative to pooled OLS, the fixed effect and random effect models are considered more

appropriate estimation methods for panel data regression because the presence of individual-

specific effects in the panel data are recognized by both methods. However, the two models differ

in their assumption of the relationship between these individual-specific effects and the

explanatory variables in a model (Brooks, 2014).

3.4.2 Fixed Effect Model

 
The fixed effects model is based on the assumption that the individual-specific effects are

correlated with each independent variable 𝛸!" in the regression model and that there is different

intercept term with the same slope parameters for each individual (Wooldridge, 2013). Hence, the

emphasis is on removing the bias 𝑢! from the estimation model. It is not possible to measure this

in the OLS model, making it biased and inconsistent because of the omitted variable. In addition,

the correlation of 𝑢! within the regression model requires a strategy that is not feasible.

  36  
Therefore, in order to achieve consistent 𝛽 estimates, the model omits 𝑢! from the regression

model. This is known as fixed effect estimators, 𝛽!"  (Wooldridge 2013). This means that to

remove 𝑢! , the model needs to be considered as follows:

𝑦! = 𝑥!" 𝛽 + 𝑧! 𝛿 + 𝑢! + 𝜀!" (3.02)

! ! !
Denote 𝑦! =   ! ∑!!!! 𝑦!" ;  𝑥! = !  ∑!!!! 𝑥!" ; 𝜀! = !  ∑!!!! 𝜀!" , as well 𝑧! and 𝑢! are time invariant,

𝑧! =   𝑧! And 𝑢! = 𝑢! , hence, equation (3.02) applies

𝑦!" −   𝑦! = 𝑥!" − 𝑥! 𝛽 + 𝑧! − 𝑧! 𝛿 + 𝑢! − 𝑢! + (𝜀!" − 𝜀! ) (3.03)

Which implies that

𝑦!" = 𝑥!" 𝛽 + 𝜀!" (3.04) and this satisfies all the OLS conditions. Therefore, 𝛽  and 𝛽!" can be

estimated using standard OLS.

3.4.3 Random Effect Model

 
The random effects model is based on the assumption that the individual-specific effects 𝑢! are

uncorrelated with the independent variables  𝛸!" (Wooldridge, 2013). The assumptions of the

random effects model are inclusive of all the assumptions of the fixed effects model with the

additional requirement that is independent of all independent variables in all time periods

(Wooldridge, 2013).

As shown in Equation (3.01), the (𝑢! +   𝜀!" ) becomes known composite-error or disturbances by

assuming that u and ε characterized as mean-zero processes; that they are uncorrelated with each

other, they are each homoskedastic; and they do not have correlations among individuals or over

time (Greene, 2012). The composite error process is defined as

𝑣!" = 𝑢! + 𝜀!" (3.05)

  37  
E 𝑣!" =    0 is the mean zero process.

E 𝑣!"! = 𝜎!! + 𝜎!! is the variance between 𝑢 and 𝜀

!
E 𝑣!" 𝑣!" = 𝜎  !   , t  ≠ 𝑠 is the covariance within unite and ∑ =   𝜎!! 𝐼! + 𝜎!! 𝐼! as the covariance

matrix of the T errors. Therefore, the equation (3.01) can be written as

𝑦!" = 𝛽! + 𝛽𝑋!" + 𝛿𝑍!" + 𝑣!" (3.06)

Because 𝑢! has the composite error in each time period, therefore the 𝑣!" is serially correlated

over time. Wooldridge (2013) claims that this issue can be solved by using the generalized least

square (GLS) transformation.

𝑦!" − 𝜆𝑦! = 𝛽! 1 − 𝜆 + 𝛽! 𝑥!" − 𝜆𝑥!" + 𝛿 𝑧! − 𝜆𝑍! + (𝑣!" − 𝜆𝑣! ) (3.07)

Where
! ! !
𝑦! = ! ∑!!!! 𝑦!" ; 𝑥! = ! ∑!!!! 𝑥!" ; 𝑣! = ! ∑!!!! 𝑣!" , the overbar identifies the time average of the

consistent variables.

3.5 Panel Data Estimators

 
Two tests will be applied to determine which model should be used for the regression in this

research. The Breusch-Pagan Lagrange Multiplier and the Durbin-Wu Hausman test will be

conducted.

3.5.1 Breusch-Pagan Lagrange Multiplier

 
Breusch-Pagan LM test is used to determine whether individual specific effects are in existence.

According to Wooldridge (2013), this test helps the researcher decide between Random effects

model and the pooled OLS regression. The null hypothesis in the Breusch-Pagan Lagrange

Multiplier test is that variance across entities is zero. This means there are individual effects in

the data.

  38  
The specific hypothesis under investigation is:

• H0 : σ2 α = 0, Variance across entities is zero

• H1 : σ2 α ≠ 0, Variance across entities is in existence

3.5.2 Durbin-Wu Hausman Test

 
The Durbin-Wu-Hausman Test is used when the unobserved effect shows an independent

distribution of the other explanatory variables. The Hausman test is useful when a researcher is

deciding between the fixed effects model and the random effects model in panel data. When the

individual specific effects are correlated with the regressors it adopts the fixed effects model in

panel data. Conversely, it applies the random effects model in panel data if the individual effects

are uncorrelated with the regressors (Wooldridge, 2013).

The specific hypothesis under investigation is:

• H0: αi, individual effects uncorrelated with regressors

• H1: αi, individual effects correlated with regressors

3.6 Data Multicollinearity

Data multicollinearity is a common problem that exists in panel data. Multicollinearity occurs

when predictors in a regression model are strongly correlated with each other. In other words,

Multicollinearity exists when explanators vary closely together (Hill et al., 2012). As a

consequence, the estimator standard errors tend to be large and it will become possible that the t-

statistics will indicate that there is no significant difference between the parameter estimates and

zero. A major issue is that when multicollinearity exists among variables, their separate effects

are hard to determine. Furthermore, estimators tend to be highly sensitive to the deletion and

addition of a few observations or even the deletion of a variable that is not significant (Hill et al.,

2012). Nevertheless, multicollinearity does not have an adverse impact on the predictive power

  39  
of the regression model as a whole. This occurrence is common in time-series data due to the

presence of lagged variables and common time trends among the explanatory variables. If the

nature of multicollinearity among variables remains the same within the out-of-sample

observations, there is possibility of accurate forecasts (Hill et al., 2012).

If there is a poorly estimated equation, it might be useful to detect collinear relationships and

Brooks (2014) suggests using Correlation Matrix and Variance Inflator Factor (VIF) to measure

the possibility of multicollinearity among variables. In multiple regressions, the correlation

matrix describes the correlation between the explanatory variables. A high correlation means that

the correlation between the dependent and independent variables will also be high and vice versa.

Generally, a correlation of 0.7 and above suggests the likelihood of multicollinearity (Hair, et al.,

2014). On the other hand, VIF can be defined as the reciprocal of tolerance that indicates the

degree of the inflation in the standard errors related to a particular beta weight that is as a

consequence of multicollinearity. VIF offers a rational and instinctive indication of the effects of

multicollinearity on the variance of the estimated regression coefficient (O’Brien, 2007).

Generally, the recommendation for acceptable levels of VIF is 10 (Hair, et al., 2014).

3.7 Regression Model

𝑌!"# = 𝑎!" + 𝛽! 𝑆𝐼𝑍𝐸!" + 𝛽! 𝐶𝐴𝑃!" + 𝛽! 𝐴𝑆𝑆𝐸𝑇𝑄!" + 𝛽! 𝐿𝐼𝑄𝐷!" + 𝛽! 𝐺𝐷𝑃!" +   𝛽! 𝐼𝑁𝐹𝐿!" + 𝑀&𝐴 + 𝜀!"

𝑌!"# = 𝑎!" + 𝛽! 𝑆𝐼𝑍𝐸!" + 𝛽! 𝐶𝐴𝑃!" + 𝛽! 𝐴𝑆𝑆𝐸𝑇𝑄!" + 𝛽! 𝐿𝐼𝑄𝐷!" + 𝛽! 𝐺𝐷𝑃!" +   𝛽! 𝐼𝑁𝐹𝐿!" + 𝑀&𝐴 + 𝜀!"

Where:

𝑎 is a constant

𝜀 is the standard error

ROA and ROE are the dependent variables in the two models and used as the measures of

profitability in this research. The independent variables are size, capitalization, liquidity, asset

quality, GDP, inflation and M&A dummy. The error term of the model is 𝜀 and this represents all

other unobservable or non-measureable factors that may affect Y (which represents the dependent
  40  
variable) because observed X (which represent the independent variables) cannot fully explain Y

and 𝛽 represents the regression coefficient. Through regression analysis, this research aims to

understand how X affects Y and to quantify the magnitude of the effect. If it is stated that Y and

X are negatively correlated, it means that the relationship between Y and X is negative, and vice

versa. Thus, applying for correlation between dependent factor and independent factors enable an

analysis of significant or insignificant relationship on assessing M&A effects on banking

performance.

3.8 Test of difference

 
The reason for this is to test whether differences in profitability exist between Nigerian banks

depending on their M&A status by using the measures of profitability ROA and ROE. A t-test

will be carried out, which is a two-group mean comparison test to see if two means are different

from each other. T-test can tell whether two groups have different average values by accepting or

rejecting the null hypothesis (Neideen, et al., 2007). The null hypothesis of the independent t-test

assumes the profit means are equal for merged and non-merged banks, in line with the approach

used by Cassidy (2005). A two-sample t-test will be performed on the two sets of data to test for

significance at the 5% level. It is a test of the 2 sets of data (merger and non-merger) through

accounting based measure.

The null hypothesis under investigation is:

• H0 : There is no difference in profitability (ROA and ROE) between merged and

non-merged banks

The alternative hypothesis is:

• H1 : There is difference in profitability (ROA and ROE) between merged and non

merged banks

  41  
4. EMPIRICAL RESULTS

This section of the dissertation will present the empirical analysis and discuss the results.

4.1 Tests for Multicollinearity

4.1.1 Correlation Matrix
 
The results from the correlation matrix indicate that there is a low degree of correlation among

the variables. After observing the correlation matrix, it can be reported that there are varying

relations among the size, capitalization, liquidity, asset quality, GDP and inflation variables and

their relationship with the profitability measures ROA and ROE. There should not be a problem

when trying to estimate the regression models because the correlation among variables is very

small. The correlation among these variables should not cause data multicollinearity problems as

there are all below 0.7 as suggested by (Hair, et al., 2014). The correlation matrix is presented in

table 2.

Table 2 - Correlation Matrix

Asset
ROA ROE Size Capitalisation Liquidity GDP Inflation
Quality

ROA 1.0000
ROE 0.0971 1.0000
Size -0.0265 0.0101 1.0000
Capitalisation 0.2409 -0.1648 -0.0726 1.0000
Liquidity -0.0684 0.0337 0.1493 0.2553 1.0000
Asset Quality -0.2972 -0.0723 -0.2194 -0.3242 -0.2473 1.0000
GDP 0.0972 0.0675 -0.2470 0.0738 -0.0915 0.0267 1.0000
Inflation 0.0928 -0.0849 0.0367 0.0570 0.1666 0.0810 -0.1484 1.0000

  42  
4.1.2 Variance Inflation Factor
 
In addition to checking the data multicollinearity using the correlation matrix, the variance

inflation factor (VIF) was used to check the consistency of the result. This was used because it is

generally a better method of checking data multicollinearity than the correlation matrix. The

results show a VIF of 1.20 and this is below the highest acceptable level of 10 as suggested by

(Hair, et al., 2014). In view of this, multicollinearity does not exist in the data. The result of using

the VIF method is presented in table 3.

Table 3 - Variance Inflation Factor

Variable VIF 1/VIF

ROA 1.27 0.788838

ROE 1.09 0.917716

Size 1.18 0.848282

Capitalisation 1.35 0.739968

Liquidity 1.22 0.821156

Asset Quality 1.41 0.709777

GDP 1.11 0.901379

Inflation 1.11 0.902009

M&A Dummy 1.09 0.921506

Mean VIF 1.20

  43  
4.2 Breusch Pagan LM test
 
The Breusch-Pagan test was carried out to in order to determine whether to use the Pooled OLS

model or the random effects model. The results of the test are presented in tables 4 and 5. From

the results, it can be seen that the chi squared in very small at 1% level for both ROA and ROE.

In addition, both results show variance (𝑢)=0 and P-values are both equal to zero. As a basis of

this method used, the null hypothesis should be rejected which means that there is existence of

individual specific effects and the random effects model should be used for the panel data

regression instead of Pooled OLS.

Table 4 - Breusch and Pagan LM test using ROA

Var sd = sqrt (Var)

roa 24.1358 4.912820
e 19.57727 4.424621
u 1.01024 1.005107
Var (u) =0
chibar2 (01) =17.41
Prob > chibar2 =0.0000

Table 5 - Breusch and Pagan LM test using ROE

Var sd = sqrt (Var)

roe 2305.181 48.0123
e 2160.819 46.48461
u 210.432 14.5063
Var (u) =0
chibar2(01) =14.52
Prob > chibar2 =0.0000

  44  
4.3 Durbin-Wu Hausman specification test
 
Further to using the Breusch-Pagan LM test which suggested the existence of individual effects

and random effects should be a better estimator than pooled OLS. The Durbin-Wu Hausman test

was carried out to check if the individual effects are correlated with the regressors. According to

Clark and Linzer (2012), the Hausman test will reject the random effects model when the P-value

is less than 0.05. Table 6 shows the result using return on assets and the P-value is 0.5814, which

means the test failed to reject the random effects model. In addition, table 7 shows the results for

the return on equity and the P-value is 0.0019, this suggests rejecting the random effects model

however (V_b-V_B is not positive definite) therefore the random effects should not be rejected.

As a result of this, random effects regression will be used for both measures of profitability ROA

and ROE.

Table 6 - Hausman test using ROA as dependent

Coefficients
(b) (B) (b-B) Sqrt (diag (V_b-V_B))
Fixed . Difference S.E.
Size 0.1817268 -0.0260843 0.2078111 0.1769857
Capitalization 0.0906423 0.108186 -0.0175437 0.0197008
Liquid -0.140352 -0.1077933 -0.0325587 0.021801
Asset Quality -0.0986426 -0.1104622 0.0118196 0.0150408
GDP 0.0698187 0.0606287 0.0091899 0.0085894
Inflation 0.0290692 0.0273151 0.001754 0.0015454
b = consistent under Ho and Ha;
B = inconsistent under Ha, efficient under Ho;
Test: Ho: difference in coefficients not systematic
chi2(6) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 4.71
Prob>chi2 = 0.5814

  45  
Table 7 - Hausman test using ROE as dependent

Coefficients
(b) (B) (b-B) Sqrt (diag (V_b-V_B))
Fixed . Difference S.E.
Size -4.993717 -1.078838 -3.914879 2.04495
Capitalization -1.864691 -1.282037 -0.5826539 0.2247859
Liquid 0.9645048 0.3449016 0.6196031 0.2532133
Asset Quality -0.0096672 -0.4907251 0.4810579 0.1731623
GDP 0.3746416 0.4756477 -0.1010061 0.012102
Inflation -0.1328134 -0.0965014 -0.036312 .
b = consistent under Ho and Ha;
B = inconsistent under Ha, efficient under Ho;
Test: Ho: difference in coefficients not systematic
chi2(6) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 20.89
Prob>chi2 = 0.0019 (V_b-V_B is not positive definite)

4.4 T-test results

 
Firstly, a Variance ratio test was performed because of the need to see whether the variances

between profitability, depending on firm’s M&A status, are equal or unequal. This is a

conventional method used in statistical texts like Moore and McCabe (2006), which suggest

always testing for unequal variances unless there is clear evidence that variances are equal. The

results suggest the null should be rejected at 1% showing variances are unequal; hence the t-test

with unequal variance was carried out. For both of our profitability measures (ROA and ROE),

the t-test results show that we reject the null hypothesis because the p-value is less than our

significance level of 5%. Hence, it can be concluded that there are differences in profitability

between Nigerian banks involved in M&A and banks not involved in M&A. Table 8 presents the

results from the t-tests.

  46  
Table 8 - Two group mean comparison tests for merged and non-merged banks

Merged Observations Mean Std. Err. Std. Dev. T-statistic P-value

ROA NO 51 3.308 0.225 1.607
YES 146 1.158 0.447 5.397 4.298 0.006
Total 197
ROE NO 51 21.439 1.625 11.605
YES 146 9.510 4.431 53.546 2.527 0.012
Total 197

  47  
4.5 Random effects regression analysis
 
The t-test results show that there is difference in profitability between Nigerian banks that were

involved in mergers and acquisitions and banks that were not involved with two measures of

performance (dependent variables) taken into account return on equities (ROE) and return on

assets (ROA). In order to achieve the objective of this dissertation, further investigation is

necessary. Therefore, two further regression methods were performed and their results would be

analyzed hereafter.

Two regressions were carried out and have been designed to estimate the impact of Nigerian

banks on the profitability while incorporating an M&A variable to assess M&A effects on

performance. These determinants or the independent variables in the regressions include bank

size, capitalization, liquidity, asset quality, GDP, inflation, M&A dummy variable (i.e. whether a

bank has merged or not). As the purpose of this study is to look at the impact of mergers and

acquisitions on the Nigerian bank performance the last determinant which is the M&A dummy

will form an important part of the analysis.

The Evaluation will involve looking at the corresponding beta-coefficients for each determinant

of their size, sign and significance in order to reach conclusions on the main factors that crucially

influence Nigerian bank performance; precisely to check if mergers substantially improve the

wealth of banks. Table 9 displays the regression results and it shows R2 is high at 0.609 and

0.594 for ROA and ROE respectively which indicates that the model might be appropriate and

60.9% and 59.4% of changes in ROA and ROE can be explained. The remaining 39.1% and

40.6% unexplained variables is largely due to variation in other variables outside the regression

model, which are otherwise included in the stochastic error term.

  48  
Table 9 - Results of Regression

(1) (2)
VARIABLES ROA ROE

Size -0.0257** 1.126***

(0.275) (2.748)
Capitalization 0.102** -1.354***
(0.0459) (0.474)
Liquidity -0.107*** 0.359
(0.0359) (0.359)
Asset Quality -0.104*** -0.415
(0.0288) (0.293)
GDP 0.0621 0.495
(0.0450) (0.481)
Inflation 0.0272** -0.0979
(0.0118) (0.127)
M&A Dummy 1.400** -13.30**
(0.981) (8.246)
Constant 5.756 48.05
(4.328) (44.57)

Observations 186 186

R-squared 0.609 0.594
Standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1

  49  
4.5.1 Bank Size
 
The results from the empirical test are consistent with the literature reviewed as (Agrawal et al.,

1992; Gupta and Misra, 2007; Velnampy and Nimalathasan; Sirower, 1997) expected that size

variable would have an ambiguous and varying evidence relationship with profitability.

The results from the first regression indicate that the independent size variable has a significant

negative relationship with ROA as measure of profitability. The coefficient of size in the ROA

regression is -0.0257 and is significant at 5%. The coefficient on the size variable simply explains

that if a bank grows in size by 1%, this would lead to a 0.0257% decrease in Nigerian banks

profitability with all things being equal. Goddard et al (2004) found similar evidence of negative

relation, which indicates that the size of bank does not necessarily imply for better performance.

A possible explanation for this could be the fact that bank expansion leads to diseconomies of

scale, which deters performance. Therefore, this results shows that size is not a determinant of

bank profitability when ROA is the profitability measure.

On the other hand, size variable indicates a positive significant relationship with profitability in

the ROE regression. This observation is consistent with the finding of French (2007) and Berger

et al (1999). In term of size, big banks are expected to take advantage of scale economics and

scope to increase their earnings. Hence, it is able to gain high profits (Glancey, 1998), and the

size may be an inverse proxy for the profitability.

Results from regression are consistent with study by Velnampy and Nimalathasan (2010) who

found mixed results after testing the relationship between firm size and profitability. The results

therefore support hypothesis 1 that size has an ambiguous effect on Nigerian bank performance

bank performance.

  50  
4.5.2 Capitalization
 
The first hypothesis asserts a positive relationship between capitalization and bank performance

in the Nigerian banking industry. The result of the ROA regression reveals that the capitalization

beta coefficient 0.102 is significant at the 5% level. This positive association of capitalization

ratio and performance demonstrates that, as capitalization increases, the bank improves its

performance. The reason is that an increase in the level of capitalization tends to favor the banks’

ability to compete within the banking industry and increase the risk-taking ability of the banking

operation as its lending power rises. This finding supports the evidence from Holmstrom and

Tirole (1997), Naceur (2003) and Acharya (1988) which all suggest a positive correlation

between capital structure and performance. Furthermore, the research results are in line with

growth theory, synergy theory, market power theory and efficiency theory in term of ROA

measurement. Hence, the results support hypothesis 2a that banks with higher capital ratio are in

a stronger position to compete than banks with smaller capital ratio.

The second hypothesis predicts a negative relationship between capital structure and performance

in the Nigerian banking industry. Indeed, as far as shareholders are concerned, looking at the

results of ROE regression, it is worth to note that capitalization has exhibited a highly negative

correlation with performance. The coefficient of capitalization is -1.354 and is significant at 1%

level. The negative coefficient of capitalization simply explains that an increase of 1% in

capitalization would lead to 1.354 % decrease in profitability with all things being equal. This

result specifically supports Modigliani and Miller (1963) assertion that higher capital ratio leads

to lower ROE. In addition this is consistent with the observation of Ross (1997) and Altunbas and

Ibanez (2008) who assert that acquisitions serve to increase capitalization for banks yet it might

not create positive relationship with shareholder value because of agency problems existing

between shareholder and managers. The results therefore support hypothesis 2b, which predicts a

  51  
negative relationship between capital ratio and Nigerian bank performance and that larger capital

ratio does not necessarily mean higher wealth for shareholders.

4.5.3 Liquidity
 
According to review of the existing literature, liquidity is expected a positive influence on banks’

performance. Indeed, similar result is found after empirical testing. A positive relationship

between liquidity and ROE was found however this relationship is insignificant. On the other

hand, liquidity has a negative impact on bank profitability at 1% significant level when ROA is

the profitability indicator. This result is not consistent with Altunbas and Ibanez (2008) and

Bourke (1989) that liquidity is one of key factor driving successful bank’s performances in

financial systems which bank needs to rationalize its exercising of asset quality.

In reality, it is obvious that banks with high liquidity would be performing well which would lead

to improved banks performance. For example, during the financial crisis in 2008, some banks had

experienced liquidity problems such as loose credit availability and this may have resulted in the

crisis, and were thus were acquired by banks in a greater financial position. The crisis of US

subprime market and the associated liquidity squeeze had a major impact on financial institutions

and banks worldwide. The crisis intensified in the third quarter of 2008 with many banks and

financial institutions witnessing a collapse (Ramlall, 2013). However, findings from this research

lead to rejection of hypothesis 3 because of a significant negative relationship.

  52  
4.5.4 Asset Quality
 
Turning to the results for asset quality, prior literature reveals that asset quality plays a key role in

banks performance. From the ROA regression results, there is a negative relationship between the

asset quality variable and profitability and this is significant at the 1%. The ROE regression also

shows a negative relationship however this is insignificant. The negative coefficient on asset

quality variable simply illustrates that if the non-performing loans of a bank increase, its

profitability would decrease. This observation is not consistent with the findings of Altunbas and

Ibanez (2008) and Garten (1991) who disclose that low asset quality is more likely to have a

negative effect on the performance of banks. Therefore, the results reject hypothesis 4 that higher

asset quality will improve profitability of Nigerian banks.

4.5.5 GDP and Inflation

 
GDP:

GDP is measured by the percentage of gross domestic product growth. The hypothesis predicts a

positive association between GDP and banks’ performance. Similar to the regression results, the

coefficient of GDP has a positive relationship with both ROA and ROE. This demonstrates that

GDP has essentially impacted the banking performance. The research results are in line with the

finding of Kiymaz (2004), Levine (1998) and Rajan and Zingales (1998) who claim that the

growth of GDP have a positive impact on banks’ performance and it can be seen that the decrease

of GDP is expected to have a negative influence on the Nigerian banking performance. However,

for this study the positive relationship between the measures of profitability ROA and ROE and

the coefficient are both insignificant. Overall, good macroeconomic condition implies better

banks performance, and vice versa. The results fail to support hypothesis 5a because of the

insignificant relationship.

  53  
Inflation:

Reviews of the existing literature in the banking industry expected that inflation variables would

have a negative relationship with profitability (Abreu and Mendes, 2001; Vencatachellum and

Wilson (2013). In terms of economic market, high inflation might cause high cost of capital since

the results of decreased profits. Varying results were found after empirical testing and the results

indicate that the coefficient of inflation is 0.0272 and is significant at 1% level in ROA

regression. In the ROE regression an insignificant negative beta coefficient was found. The

positive coefficient in the ROA regression contradicts the hypothesis, because of the significance

of its positive effect on performance. Therefore this is not consistent with empirical studies like

Vencatachellum and Wilson (2013) and Abreu and Mendes (2001). The results point towards a

positive relationship between inflation and bank performance in the Nigerian banking industry. In

view of this, hypothesis 5b is rejected.

4.6 M&A Dummy

 
The remaining explanatory variables consist of dummy variable that tries to quantify the effect of

mergers on profitability (“Merged” variable). Crucially, the findings of these explanatory

variables should enlighten on the impact of mergers on Nigerian bank performances. Regarding

the dummy “M&A Dummy”, this is independent of the Nigerian banking industry specific effect.

It can be seen that the results of M&A dummy indicate significant relationship with profitability

in both ROA and ROE regressions. This result supports early indication from the t-tests that

differences exist in the profitability of banks involved in M&As and those not involved.

  54  
4.6.1 ROA as the profitability measure
 
Considering ROA as the profitability measure, the result of M&A dummy shows highly

significant positive relationship with profitability. This means that merged banks are more likely

to make higher profits than non-merged banks. This outcome is consistent with results found by

Knapp, et al., (2006) and Cornett, et, al., (2006) who suggest that M&A activities have positive

influences of bank performance.

This result may be due to the notion that banks engaged in mergers and acquisitions tend to

generate more effective and more profitable combination of asset operations through M&As.

This finding or assumption also supports some theories of M&As, such as growth theory,

synergy theory and market power theory; which identify that banks exploit a growth opportunity

through the immediate acquisition of another bank, especially for acquiring a bank in a line of

business (Horizontal M&As), which can be a quick way to expand (Gaughan, 1999). Also, some

banks may provide certain synergistic benefits through an acquisition, banks would be able to

alter their capital structure, enhance their liquidity and reduce their cost of capital. Yet, merged

banks have priority to expand to gain the market share and thus increase their market power,

followed by great gains on banks’ revenues. On the other hand, when two small banks merged

with each other, the cost of capital would be significantly reduced compared non-merged small

banks. Also, merged banks can create more liquidity and increase the loans to the borrowers

while running more efficiently than previous period.

  55  
4.6.2 ROE as the profitability measure
 
Turning to ROE as the profitability measure, the regression result gives a positive relationship

with the M&A dummy with a negative coefficient of 13.30 and this is highly significant at the

5% level. This result means merger and acquisition deals fail to improve bank profitability. The

implication of this result is that, merged banks do negatively influence bank performance in the

Nigerian banking industry. The results here are consistent with studies by Focarelli et al (2002),

Linder and Crane (1992), and Rhoades (1993) who found similar evidence of negative

relationship between M&A activity and profitability. Probably, a reason for such a finding may

be that banks involved in M&A generate more profits. Nevertheless, this does not create or

translate into higher shareholder value. If this finding is to be relied upon, then mergers are rather

detrimental to Nigerian bank performance as they are very costly activities (in terms of funding,

resources and time), which do not add any value to bank performance. More specifically, the

costs of M&A transaction are paid either by share and cash or combine both share and cash. This

cost can affect the financial performance as banks’ future cash outflows can have a great

influence on future financial performance.

Furthermore, M&A activity may also create organization culture conflict between different banks

since the operation combine two or more banks together. People find difficulties in changing

their corporate culture (Gaughan, 1999). The culture differences include the management style,

the business goals, thinking attitudes, behaviours, the way of making business and the philosophy

in business. Fiordelisi (2009) claims that the corporation culture can influence the workforce

motivation and ability to perform.

  56  
On the other hand, due to the agency problem existing, managers may also follow their own

objective rather than shareholders’ concern. Managers may be motivated to increase their pay and

power through the M&A activity which may impact shareholders’ value. The results are

consistent with the arguments by Meckling (1976). Therefore, it can be concluded that there is no

added shareholders’ value resulting from M&As.

Such contrary findings between the two profitability indicators may be due to the adopted

methodology. It has been noted previously that operating profits usually influences potential buy-

outs; hence, the ratio of ROE or ROA to total income is more effective in measuring bank

performance. Using such a measure to assess the impact of M&A alongside the normal

profitability ratios of ROE and ROA may provide more consistent results. Interestingly, a look at

the two contradictory findings above may reveal why previous literature provides inconsistent

results regarding the impact of M&A on bank performance. This may simply be due to

methodological differences and the profitability measure used as illustrated in this research.

While ROA as profitability measure shows that M&A strongly and positively influences bank

performance, ROE shows a significant relationship of a negative impact on bank performance.

Although both methods conclude the contradictory finding, if these findings are accurate, then

mergers and acquisitions play a significant role in influencing the Nigerian banking industry.

  57  
5. CONCLUSION, LIMITATIONS AND FURTHER RECOMMENDATION

5.1 Conclusion
 
This study examined the impact of mergers and acquisitions on profitability of Nigerian banks

listed in the Nigerian stock exchange from 2001 to 2013. A panel data of 16 banks in Nigeria are

used as the sample and 11 banks were involved in mergers and acquisitions. The random effects

regression model is employed to test differences of profitability among the merged and non-

merged bank by controlling firm-specified effects and time-specific factors. The measures of

profitability used were return on assets and return on equity and are employed as the dependent

variables in the models. In addition, to get a picture of bank’s financial health, selected control

variables such as bank size, capitalization, liquidity, asset quality as well as adding

macroeconomic conditions (GDP and inflation) were considered. The findings of control

variables are consistent with the most hypotheses, which were set in the earlier texts.

In addition, the M&A dummy variable played a major determinant role in this research because

the purpose of this dissertation is to compare the performance between merged and non-merged

Nigerian banks. The results from analysis using random effects regression for both return ROA

and ROE and t-tests suggest that banks involved in M&A activity have experienced changing

performances. The performed t-tests demonstrated that there are differences in profitability

between merged banks and non-merged banks. Furthermore, the random effect regression

showed that M&A dummy variable has significant relationship with profitability in both ROA

and ROE regressions. However, these findings were mixed just like the results from previous

studies are also mixed. Studies investigate company’s post-merger performances in different

countries using various methodologies.

  58  
From the random effects regression, the result shows a significant positive relationship between

ROA and M&A dummy variable. This means that merged banks experience an increase in

profitability. The outcomes are in line with some of the existing findings on mergers and

acquisitions. Díaz, et al., (2004), Knapp, et al., (2006), Umoren et al. (2007), Abdul-Rahman and

Ayorinde (2013), Cornett, et, al., (2006), Campa and Hernando (2006) found significant

performance differences between merged and non-merged companies. They reported that

Mergers and acquisitions deals have brought a positive impact on banks long-term profitability

and significantly improve the banks’ efficiency. Additionally, the results from this research are

consistent with growth theory, synergy theory, market power theory and efficiency theory as

banks took advantage of economies of scale and scope to increase their earnings. Hence, there is

an ability to gain high profits (Glancey, 1998).

In contrast, the regression results revealed that M&A dummy had a significant negative

relationship with profitability in ROE. This result suggests that mergers and acquisitions do not

improve the bank performance in Nigerian banking industry. This finding is consistent with some

other studies that found evidence of under-performance of merged. Linder   and   Crane   (1992),  

Rhoades   (1993),   Odetayor   et   al.   (2013),   Focarelli   et   al   (2002),   Kwan   and   Wilcox   (2002)  

reported that mergers and acquisitions have a negative impact on the profitability of banks. The

findings from this research suggest that M&A activities do not help banks in using shareholder

funds to generate value.

There are inconsistent results obtained in this research based on the results of M&A dummy,

since ROA as a profitability measure indicates that M&A strongly and positively impacts bank

performance in Nigerian banking industry; whereas ROE displays a significant negative

relationship. Therefore it can be concluded that M&A may positively or negatively influence

  59  
bank performance as a result of the indicators used in the research. Researchers must therefore

critically assess indicators to be used in order to obtain consistent and reliable findings.

5.2 Limitations of study

 
A major limitation of this study is the sample size. Unlike most of the previous empirical studies

in this area where researchers normally used a sample with a large number of firms, this study

uses only 16 banks to examine the impact of M&A on profitability. While some of regression

results are consistent with past findings, there are results in this research that are not statistically

significant especially for the ROE regression. As a result of the small sample size, t-tests to test

differences in profits may result in biased results as larger sample size will result in more

accurate results than a small sample and the result would be more representative. The reason for

this small sample is that this dissertation specifically tests Nigerian banks and there are a total of

21 banks currently operating. Therefore, it is possible that the selected sample might be able to

explain the industry accurately.

In addition to the limitation of sample size, this research fails to provide a distinction between

mergers and acquisitions, i.e. the sample of data does not highlight the difference amongst

consolidation activities whether a bank is an acquirer or a target or where there is a combination

of banks to form a new entity.

Another limitation is that collecting the secondary data was limited and not in depth or in detail.

Based on the data available, this research only examined the limited variable factors or accounting

ratios to determinate the banks performance. It only included bank size, capitalization, liquidity, asset

quality, GDP and inflation. This research was unable to examine other observable factors such as

country regulation, geography and payment methods.

  60  
5.3 Further Recommendation

The limitations of this study that are earlier indicated should be considered. Firstly, The

inclusion of more control variables to a research may create more accurate results, as there will

be less unexplained variables, which may lead to a higher R2 in the regression model. In addition,

a distinction between mergers and acquisitions activities should also be made since mergers and

acquisitions are different business activities and a distinction between the different consolidation

activities is needed so that more accurate results may be obtained.

A further research could be a study of the impact of the consolidation reform exercise on

marketing challenges. Most of these challenges were equally occasioned by the fact that the

reform was policy rather than market driven. These marketing challenges include the need to

reposition corporate identities of the emerging banks; fabricate and deliver quality services;

expansion of bank branches; determine the shares valuation formula for the merger candidates;

loss of job commitment; job insecurity; service encounters management and structural and

cultural discrepancies. Against these backdrop challenges, Ernest (2012) advises other

developing nations wishing to embark on a similar exercise should predetermine these challenges

and sensibly device ways of managing it and a market induced consolidation exercise should be a

superior decision to a policy driven exercise.

  61  
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APPENDIX

Appendix 1 - Nigerian Banks used for this research

Consolidated Bank Capital Base Constituent Bank(s)

(N Billion)

1 Access Bank Plc. 28.5 Access Bank, Marina International Bank

& Capital Bank

2 Diamond Bank 29 Diamond Bank & Lion Bank

3 EcoBank Nigeria 25+ EcoBank Nigeria
4 Fidelity Bank Plc. 29 Fidelity Bank, FSB International Bank &
Manny Bank
5 First Bank Plc. 44.62 First Bank of Nigeria, FBN Merchant
Bankers, & MBC International Bank

6 First City Monument Bank 30 FCMB, Cop. Development Bank &

NAMB Limited
7 Guaranty Trust Bank 34 Guaranty Trust Bank

8 Skye Bank 37 Prudent Bank, EIB International,

Cooperative Bank, Bond Bank &
Reliance Bank
9 Stanbic IBTC Bank 25 Stanbic Bank, IBTC, Chartered Plc. &
Regent Bank Plc.
10 Standard Chartered Bank 26 Standard Chartered Bank
11 Sterling Bank 25 Magnum Trust Bank, NAL Bank,
IndoNigeria Bank & Trust Bank of
Africa

12 Union Bank 58 Union Bank, Union Merchant Bank,

Universal Trust Bank & Broad Bank
13 United Bank of Africa 50 United Bank of Africa & Standard Trust
Bank

14 Unity Bank 30 Intercity Bank, First Interstate Bank,

Tropical Commercial Bank, Pacific
Bank, Centre Point Bank, NNB
International Bank, Bank of the North,
Societe Bancaire & New Africa Bank
15 Wema Bank 26.2 Wema & National Bank
16 Zenith Bank 38 Zenith Bank
Source: Ernest (2008)

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   71