Intra-Industry Signals Resulting from Insurance Company Mergers

Abstract

ABSTRACT Given the increasing consolidation in the insurance industry, the authors' objective is to determine how the market revalues the acquirer, target, and rival insurance companies in response to merger announcements. The authors find that target and acquirer insurance companies experience favorable valuation effects at merger announcements. The authors also find positive and significant intra-industry effects in response to the announcements of insurance company mergers, which supports the signaling hypothesis. Furthermore, the authors find that the magnitude of the intra-industry effects is conditioned on the type, size, and location of the insurance companies. INTRODUCTION In recent years, the insurance industry has experienced substantial consolidation as mergers have been consummated to increase shareholder value. (1) The merger between two insurance companies may be value-enhancing for the following reasons. First, the merger may achieve economies of scale, as the combined company provides services at a lower average cost. The underlying factors that allow economies of scale include the application of technology to a larger customer base, a more efficient distribution system, and more efficient funding that reduces financing transaction costs. Second, the merging of two insurance companies may reduce redundant operations or branches, which would allow the remaining resources to work more efficiently. Third, the combination of two insurance companies that emphasize different services may allow for each entity to benefit from the expertise of the other entity. Fourth, to the extent that unsystematic risk is valued (see Harrington, 1983; Williams, 1983; and Venezian, 1984), the combination of two insurance companies may reduce the risk (see Cox and Griepentrog, 1988). Fifth, a merger may serve as a better alternative than potential insolvency for insurance companies that are experiencing financial problems (see BarNiv and Hathorn, 1997). Although there are valid value-enhancing motives for insurance company mergers, the ultimate test of the validity of mergers from a shareholder perspective is based on how shareholder wealth is affected. Many studies have measured the valuation effects of mergers. These studies have generally focused on industrial firms or commercial banks. Although virtually all related studies have found that the target firms experience positive significant valuation effects, the results for the acquiring firms are mixed. The authors' objective is to assess the valuation effects that result from large mergers between insurance companies. More specifically, the authors (1) measure the valuation effects of acquiring and target insurance companies whose stock was publicly traded, (2) measure the valuation effects of rival insurance companies (intra-industry effects) in response to announcements of mergers between insurance companies, and (3) attempt to explain the cross-sectional variation in intra-industry effects among rival insurance companies. The authors find positive and significant valuation effects for publicly traded acquirer and target insurance companies. Second, the authors find positive and significant intra-industry effects in response to the announcements of insurance company mergers, which supports the signaling hypothesis. Third, the authors find that the magnitude of the intra-industry effects is conditioned on the type of insurance company target. The authors also find that the intra-industry effects of insurance company mergers are more pronounced for insurance companies that have a similar size and are located in the same region as the target insurance company. The remainder of this article is organized as follows: the second section develops the hypotheses for intra-industry effects, the third section outlines the data and methodology, the fourth section presents the empirical results, and the final section provides conclusions and implications. …