This paper utilizes a new flow measure of the true
output of bank services to analyze the
impact of mergers on the cost and productivity of Bank
Holding Companies (BHCs) over the period 1987–1999.
It shows that there are conceptual problems in the output
measures used in previous studies, which may be the
reason for their paradoxical findings: Bank mergers
are estimated to lead to significant increases in profit,
without cost savings or increases in market power. This
paper also points out the problematic understanding
of diversification in previous studies. To remedy these
problems, this paper uses a new measure that accounts
coherently for risk in measuring bank service output
and recognizes that the funds banks borrow and lend
are a special intermediate input. Once one accounts
for the better diversification resulting naturally from
mergers, the commonly used, book-value-based output
measure shows little improvement in cost productivity.
In contrast, the new flow measure of bank output shows
more improvement, although it is still insignificant—partly
because the sample size is relatively small. The gap
widens further when one corrects for possible bias in
the new output estimate. Thus, the new measure of bank
output has the potential to resolve the paradox found
in the existing literature, by showing that mergers
do lead to cost savings.
JEL classification codes: G21, D24, G34, O47
Keywords: bank holding company, service output, mergers and acquisitions, cost savings, returns to scale, productivity