Estimation of the Impact of Mergers in the Banking Industry with Historical Data on Mergers

Abstract

The standard merger simulation methods, which measure the effect of the change in ownership on unilateral pricing incentives, solely focus on price but do not generally provide an accurate forecast of price (Peters, 2006; Weinberg and Hosken, 2008). The prediction errors on price can come from the postmerger change in product quality, entry, change in supply, shifts in demand or model misspecification. With historical data on mergers, this paper develops a methodology of merger simulation that extends merger prediction from price to product quality and entry, and improves postmerger prediction of price by incorporating merger synergies (change in supply), postmerger change in product quality and entry. The historical data on mergers reveal the degree of merger synergies in a given industry, allow us to estimate the pattern of postmerger change in product quality and help us select reasonable assumptions in merger simulation. I apply the methodology to analyze seven within-market bank mergers in the U.S., and compare the prediction with postmerger observations.

Keywords: Merger simulation, Merger synergies, Endogenous product quality, Entry

JEL Classification: L11, L13, L44, G21, G34