Abstract

ABSTRACT This study’s main objective is to present the circumstances that signal an imminent commercial bank liquidation and the conditions in which mergers are advantageous for a potential acquirer. In addition, it applies the method in an empirical investigation within the context of the domestic banking industry. The research reveals new explanatory factors for liquidations and mergers between robust and insolvent banking institutions, such as bankruptcy costs and tax credits derived from a corporate union. The framework stands out for highlighting the role of creditor financial institutions participating in the open and interbank markets, which in the search to maximize their utility together with that of the shareholders have a decisive influence over the continuity or closure of the bank in crisis. The soundness of the financial system is an essential public good for society. Systemic financial crises cause significant costs for economic agents, such as a fall in production, increased unemployment, a rise in the fiscal deficit, and asset price instability. Efforts to achieve stability involve the regular functioning of banks. In this context, it is important to understand the circumstances under which banking institution distress can be solved by alternatives that are less costly for the treasury. Often, the research indicates the causes of disruptions to corporate activities; however, the explanatory variables and the tools used by bankruptcy prediction models are constantly being evaluated. Theories that elucidate the phenomenon are even scarcer. The paper’s result suggests the effectiveness of the method developed from the paradigmatic perspective of the field of economics and management, corroborating agency theory. The explanatory variables of bankruptcy and bank merger highlighted in this research can contribute to the elaboration of robust models to predict financial distress. The mathematical model of liquidation and merger was constructed from the viewpoint of an imperfect world where informational asymmetry and conflict of interests among shareholders, open and interbank market creditors, and bondholders (which includes depositors and holders of bonds issued by the bank) prevail. Bankruptcy maximizes shareholder and creditor utility if liquidation costs plus the value payable to the bondholders after liquidation are lower than the value they receive in the event of continuity. A merger is feasible for an acquirer if expected return plus tax benefits minus bondholder expenses is greater than the value payable to interbank market creditors. The method is applied to the merger between Itaú and Unibanco, considered a milestone in the process of consolidating the banking market in Brazil. This paper suggests the use of an algebraic model, based on agency theory, as an indicator of conditions for liquidations and bank mergers. The proposed approach was adequate for explaining the union between Unibanco and Itaú, which culminated in the largest private financial conglomerate in the Southern Hemisphere. Unibanco experienced the bankruptcy circumstances and there was evidence that Itaú’s tax benefits encouraged the merger. This article contributes to academic epistemology because it revisits the classical model, characterized by mathematical and theoretical robustness, and adjusts it to the specificities of banks. In addition to this methodological novelty, it applies it to an emblematic case, making it a useful tool for corporate decision-making and bank supervision, especially with regards to actions focused on financial stability.

Highlights

  • The literature in the field of corporate finance highlights the trade-off between the tax benefits and risk of corporate default derived from financial leverage

  • This study considers that operations classified in current assets and liabilities on the Balance Sheet (BS) refer to t1 and those recorded in realizable assets and long-term liabilities refer to t2

  • The theoretical-algebraic model proposed by Bulow and Shoven (1978), supported by agency theory, was adjusted to the idiosyncrasies of commercial banks and proved adequate for explaining the merger occurring between Unibanco and Itaú

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Summary

Introduction

The literature in the field of corporate finance highlights the trade-off between the tax benefits and risk of corporate default derived from financial leverage. Depending on the level and speed of indebtedness, insolvency costs tend to increase and, bankruptcy may become feasible. The interest on third-party capital is tax deductible, while the dividends paid to shareholders do not enjoy this advantage. As an organization takes out loans, its risk of defaulting rises due to the new amortization and interest-payment obligations. Despite the obstacles to measuring the expenses associated with bankruptcy, studies support their relevance to the firm’s capital structure (Baxter, 1967; Kraus & Litzenberger, 1973). Several studies indicate their impacts on the strategies used in relation to the continuity or interruption of company activities (Bulow & Shoven, 1978; White, 1983, 1989)

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