The Role of Bank Advisors in Mergers and Acquisitions

Abstract

This paper looks at the role of commercial banks and investment banks as financial advisors. Unlike some areas of investment banking, commercial banks have always been allowed to compete directly with traditional investment banks in this area. In their role as lenders and advisors, banks can be viewed as serving a certification function. However, banks acting as both lenders and advisors face a potential conflict of interest that may mitigate or offset any certification effect. Overall, we find evidence of the certification effect for target firms, but conflicts of interest for acquirers. In particular, the target earns higher abnormal returns when the target's own bank certifies the (more informationally opaque) target's value to the acquirer. In contrast, we find no certification role for acquirers. This may be due to two reasons. First, certification plays less of a role for acquirers because it is the target firm that must be priced in a merger. Second, acquirers predominantly utilize commercial bank advisors in order to obtain access to bank loans that may be used to finance the post-merger transition period. Thus, we find that acquirers tend to choose their own banks (those with prior lending relationships to the acquirer) as advisors in mergers. However, this choice weakens any certification effect and creates a potential conflict of interest because the acquirer's advisor negotiates the terms of both the merger transaction and future loan commitments. Moreover, the advisor's merger advice may be distorted by considerations related to the bank's credit exposure resulting from both past and future lending activity. The market prices these conflicts of interest; we find significantly negative abnormal returns for bank advisors when they advise their own loan customers in acquiring other firms.

Keywords: Relationship banking, investment bank advisors, commercial bank advisors, certification effect, conflict of interest effect, mergers, acquisitions