A
TERM PAPER
ON
THE RELEVENT OF ACCOUNTING INFORMATION IN MERGERS AND ACQUISTIONS DECISION IN NIGERIA (BANKS)
WRITTTEN BY:
OGUNRUKU OLAWUMI OLAOYE
MATRIC NO: 020901105
DEPARTMENT: ECONOMICS
COURSE: FINANACIAL MANAGEMENT
April, 2010
TABLE OF CONTENT
ABSTRACT
Introduction
LITERATURE REVIEW
PRACTICE IN NIGERIA
DISCUSSION OF FINDINGS
SUMMARY CONCLUSION AND RECOMMENDATION
References
APPENDIX
ABSTRACT
This paper examines the relevant of accounting information in merger and acquisition decision in Nigeria. In Nigeria, mergers and acquisitions are not so common, until recently when there was reform in the financial sector, the concepts were limited to some FMCG companies. The analysis of financial statement of any business organization is useful for the evaluation of profitability position and viability of the business. Business combinations which may take forms of mergers, acquisitions, amalgamation and take-overs are important features of corporate structural changes. For the purpose of this paper consolidation of the banking industry will be examined. The empirical reports of this paper is centered around the financial statement of Diamond bank plc before and after consolidation between period 2005- 2009.
Introduction
Mergers and acquisitions represent the ultimate in change for a business and it is expected to add value to the business. No other event is more difficult, challenging, or chaotic as a merger and acquisition. It is imperative that everyone involved in the process has a clear understanding of how the process works. However, merger and acquisitions do not add value in all cases (Ajayi, 2005).
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There are cases where the synergies projected for merger and acquisition deals are not achieved. “People” problems and cultural issues are often cited as the top factors in failed integrations. While merger and acquisition activities constitute a growing area of study, there is need to examine the importance of accounting information which constitute the basis of merger and acquisition between two business entities.
MEANING OF MERGERS AND ACQUISITIONS
✓ Merger: – A merger (or an amalgamation) occurs when two or more companies transfer their businesses and assets to a new company (or to one of themselves) and in consideration, their members receive shares in the transferee company.
✓ Acquisition: – An acquisition occurs when one company acquires sufficient shares in another company so as to give it control of that other company. This may be by a take-over bid or by purchasing shares in the market.
✓ Take–Over/Take–Over Bid: – This is an offer to acquire shares of a company, whose shares are not closely held, addressed to the general body of shareholders, with a view to obtaining at least sufficient shares to give the offeror voting control of the company.
✓ Amalgamation:- The word ‘amalgamation’ is sometimes used interchangeably with the word “merger”. Like merger, an amalgamation is the fusion of the businesses of two or more companies under the ownership of one company while retaining the rights and interests of members of the fusing companies.
✓ Take–Over/Take–Over Bid: – This is an offer to acquire shares of a company, whose shares are not closely held, addressed to the general body of shareholders, with a view to obtaining at least sufficient shares to give the offeror voting control of the company.
What amounts to a ‘merger’ is not defined in the ISA No 45 of 1999. However, in the rules and regulations made there under, a merger is defined as an amalgamation of the undertakings or interest in undertakings or any part of the undertakings of one or more companies and one or more bodies corporate. A merger contemplates a transfer of properties and liabilities of one or more companies to another, such transfer does not include rights and obligations, which are not transferable such as contracts of personal service. Thus, one or more companies may merge with an existing company (through absorption) or they may merge to form a new company (through consolidation).
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Nonetheless, a fundamental characteristic of merger (either through absorption or consolidation) is that the acquiring companies (existing or new) takes over the ownership of other companies and combine their operations with its own operations.
On the other hand, the term ‘acquisition’ has not been defined in the Act but it has been said to describe an act of acquiring effective control by one company over assets or ownership and management of another company without any combination of companies. Thus, in an acquisition two or more companies may remain independent, separate legal entity, but there may be change in control of companies. In this regard, acquisition connotes a take-over, that is, the acquisition of control over the target company. And, in business and commercial terms, the expression ‘acquisition’ is properly used interchangeably with the term ‘take-over’ as distinct from a merger.
Types of Mergers and Acquisitions
The following types of business combination are easily recognizable (Famoroti, op cit; Pandey, op cit):
(a) Vertical Integration – Combination of two businesses in the same industry but at different levels in the process of producing and selling a product. For example, a company taking over the supplier of its raw materials.
(b) Horizontal Integration – This is a combination of two or more firms in similar type of production, distribution or area of business. Examples would be combining of two luggage or two book publishers manufacturing companies to gain dominant market share.
(c) Conglomerate mergers or take-overs combination of businesses in unrelated or indirectly related industry e.g. an insurance company taking over food processing company.
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Reasons for Mergers and Acquisitions For Business Entities.
Why do business combinations take place? A number of reasons and motives give rise to business mergers and acquisitions as indicated below:
(a) Size could be a great advantage in relation to costs. It may assist, therefore, in enhancing profitability, through cost reduction resulting from economies of scale, operating efficiency and synergy. These savings could be in various areas e.g. finance, administration, capital expenditure, production and warehousing.
(b) A company with good profit record and strong position in its existing line of business, may wish to reduce risks. Through business combination the risks could be diversified, particularly when it acquires businesses whose income streams are not correlated
(c) A business with good potential may be poorly managed and the assets underutilized, thus resulting in a low return being achieved. Such a business is likely to attract a takeover bid from a more successful company, which hopes to earn higher returns.
(d) In a number of countries, a company is allowed to carry forward its accumulated loss to set-off against its future earnings for calculating its tax liability. A loss-making or sick company may not be in a position to earn sufficient profits in future to take advantage of the carry forward provision. If it combines with a profitable company, the combined company can utilize the carry forward loss and saves taxes
Accounting Information In Mergers And Acquisitions
Property (including land and real estate assets) is an essential element of many businesses. It is often used as collateral for borrowing by the owners and is one of the key “factors of production” in most businesses. The value of holding property to the business needs to be measured against the return that the equity could achieve both within the business and elsewhere. Usually, in business decisions including mergers and acquisitions, investors will usually want to review financial statements – balance sheet, profit and loss account, auditors’ and directors reports – (for the current status and a report on recent history) and a business plan. The balance sheet, which in most countries, reflect assets on historical cost concept, is a yearly snapshot of the assets and liabilities of the firm. People turn to the balance sheet for an impression of the firm’s general nature, size, and ownership structure: they look to it also for help with more detailed problems of asset strength, liquidity, etc.
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The assets of a firm on the left side of the balance sheet include both current and fixed. Fixed assets are those, which last a long time and are durable, such as buildings and plant. Some fixed assets are tangible such as machinery and equipment, others are intangible such as patents, goodwill and trademarks. The other category of assets are current assets, which have short lives and are intended to be turned into cash. A company must raise the cash to pay for the assets, Claims are sold by firm to its assets in the form of debt (loan agreements) or equity shares liabilities, like assets, are also classified as long or short-term. Short-term debt is a current liability and consists of loans and other obligations, which must be repaid in one year.
Long-term debt is that one whose repayment date is more than one year from issue. Shareholder’s equity, which represents the net worth of firm, is the difference in value between the assets and debt of the firm and is thus a residual claim. The net worth of a company consists of the capital invested and the retained profit:
Total Assets – Total Liabilities = Net Assets (Net Worth).
However, the valuation of the assets and liabilities is difficult for many reasons. The net asset position shown on the balance sheet is often based on historical costs and, therefore, does not take into account subsequent changes in the value and condition of the assets. Resources which once had value, particularly productive assets, might now be valueless because they embody automated technologies. There is also the problem that some items may be missing from the balance sheet, such as land, certain intangibles, and various liabilities such as pension benefits post-retirement health-care costs, and contingencies for environmental damage because they were not required to be recorded according to the accounting principles used in the country (United Nations, 1993; Aluko, op cit)
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Furthermore, according to Muyingo, op cit especially for property companies, some of the other information relevant to assessing their value include total rental or lettable space, annual rent, total return, and surplus ratio which expresses operating surplus as a percentage of rental revenues.
Discounted Cash Flow (DCF) Evaluation
In a merger or acquisition, the acquiring firm is buying the business of the target firm, rather than a specific asset. Thus, merger is a special type of capital budgeting technique (Pandey, op cit).
What is the value of the target firm to the acquiring firm after merger? This value should include the effect of operating efficiencies and synergy. The acquiring firm should appraise merger as a capital budgeting decision, following the DCF approach. The acquiring firm incurs a cost (in buying the business of the target firm) in the expectation of a stream of benefits (in the form of cash flows) in future. The cash flows can be determined through profit stream of the affected concern. Thus, merger will be advantageous to the acquiring company if the present value, that is, the fair value, is greater than the cost of acquisition.
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LITERATURE REVIEW
In Nigeria, mergers and acquisitions are not so common, until recently. For example, the first merger attempt was in 1982 between United Nigeria Insurance Company Limited and United Life Insurance Company Limited, which was, however, not consummated. The first successful merger was between AG Leventis and Company Limited, and Leventis Stores Limited in 1983 where 100 ordinary shares of 50 kobo each of Leventis Stores Limited were exchanged for 83 ordinary shares of 50 kobo each of AG Leventis and Company Limited. And, there have been a fair number of mergers and acquisitions since 1983 in the country. The increasing wave in business amalgamations started in the year 2000. And, most of the recent mergers and acquisitions are in the oil and gas, textile, insurance, banking and conglomerates sectors of the economy. And, although most recent merger and acquisition activities in Nigeria were spurred by offshore acquisitions, the ongoing reforms in the economy are expected to increase the scope.
A recent strand of the literature, exemplified by Mitchell and Mulherin (1996), has tried to address the issue of why mergers occur by building up from the two most consistent empirical features of merger activity over the last century. (1) Mergers occur in waves; and (2) within a wave, mergers strongly cluster by industry. These features suggest that mergers might occur as a reaction to unexpected shocks top industry structure. The latter feature tends to fit into the Nigerian banking industry and the related issues seem to correspond to the intuition of practitioners and analysts that industries tend to restructure and consolidate in concentrated periods of time, that these changes occur suddenly, and that they are hard to predict.
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The corporate governance structures in place before the 1980s gave the managers of large public corporations little reason to focus on shareholder concerns. Donaldson (1994), and Jensen (1988, 1993) argue that before 1980, management was loyal to the corporation, not to the shareholder. The external governance mechanisms that were formally available to shareholders were little used. External threats from raiders and takeovers were relatively few. Proxy fights were rare and didn’t have much chance to succeed. Boards tended to be cozy with management, making board oversight weak. Internal incentives from management ownership of stock and options were also modest; in 1980, only 20 percent of the compensation of chief executive officers was tied to stock market performance. Long-term performance plans were widely used, but they were based on accounting measures that tied managerial incentives much less directly to shareholder value (Holanstrom and Kaplan, 2001:123)
The Takeover Boom of The 1980s
Takeover activity began to accelerate in the early 1980s and boomed throughout much of the decade. For a long historical perspective, Golbe and White (1988) present time series evidence of US takeover activity from the late 1800s to the mid-1980s. Their findings suggest that takeover activity above 2 to 3 percent of GDP is unusual. The greatest level of merger activity occurred around 1900 with activity at roughly 10 percent of GNP for a couple of years. By those measures, takeover activity in the 1980s is historically high and the activity in the late 1990s is extraordinary. Another unique measure of merger activity is the expression of acquisition volume as a fraction of stock market capitalization. By this measure, takeover activity was substantial in the 1980s and in the second half of the 1990s, reaching roughly 10 percent of the stock market in two years in each decade. Takeovers in the 1980s were characterized by heavy use of leverage. Firms purchased other firms in leveraged takeovers by borrowing rather than by issuing new stock or using solely cash on hand. Other firms restructured themselves, borrowing to repurchase their own shares. Finally, some firms were taken private in leveraged buyouts (LBOs).
In an LBO, an investor group, often allied with incumbent management, borrows money to repurchase all of a company’s publicly owned shares and takes the company private. Kohlberg, Kravis and Roberts was one of the earliest and most prominent LBO investors (Holmstron and Kaplan 2001:124).
The use of noninvestment grade or “junk” bonds increased substantially throughout the 1980s
together with leveraged buyouts. In the mid to late 1980s, more than 50 percent of the issues were related to takeovers or mergers. Drexel Burnham and Michael Milken, who originated this novel use of noninvestment grade debt, underwrote or sold a large fraction of the junk bond issues in the 1980s. The use of junk bonds declined in the early 1990s with the credit crunch, and returned to 1980s levels in the late 1990s. The fraction used for takeovers, however, dropped to below 30 percent.
Almost half of all major U.S companies received “hostile” takeover bids in the 1980s, where hostility is defined as bids pursued without the acquiescence of target management (Mitchell and Mulherin, 1996).
Even those firms that were not actually taken over often decided to restructure in response to hostile pressure, particularly when corporate raiders had purchase large blocks of shares.
In addition, it is reported that there were higher levels of hostility in the 1980s relative to the
1990s. In the 1980s, between 20 percent and 40 percent of tender offers were contested by incumbent management. In the 1990s, 15 percent or fewer have been contested. Andrade, et al (2001) and Sehwert (2000) report a similar decline of hostility in the 1990s for mergers overall. Again, this understates the difference between the 1980s and 1990s because it does not include hostile pressure from investors with large blocks of shares.
However, mergers and acquisitions are corporate investment decisions requiring property advice mainly at strategic level of portfolio reviews, and, at times, at operational level in space planning, allocation and efficiency evaluation (RICS, 1995b; Greenalgh, 1997; Nourse and Roulac, 1993; Evans, French and O’Roarty, 2001; Wyatt, 2001).
Strategic decision-making refers to the identification and implementation of major issues that affect the whole organization and its long-term relationship with its business environment (Greenalgh, 1997).
Property including land and real estate asset is an integral factor in many business decisions and has unique characteristics of being simultaneously a major input into production activities (agriculture, industry, and services), and into consumption by households of residential real estate and infrastructure services (Galal and Razzaz, 2001).
Thus, the property advice needs to be set in a business context. Companies regard property as an active part of the company that should be as responsive as other parts of the business. The value of holding property to the business needs to be measured against return that equity could achieve elsewhere.
However, a growing perception amongst, business occupiers is that valuations do not provide the right information to business occupiers. This has arisen partly because business occupiers do not recognize valuers in a strategic role; they see valuers providing a single valuation service, estimation of market value for purchase/sale decisions and corporate disclosure (Calborne, 1995; Wyatt, 2001; Aluko, Ajayi and Amidu, 2004).
It is also stated that valuations are asset-specific but increasingly the demand from business occupiers is for strategic property advice. And, there has also been public outcry on the poor standard of work produced by many in our calling as a result of either incompetence or (more rarely, thankfully) malfeasance (Whipple, 1990; Agbebiyi, 2000; Aluko, 2000; 2004).
Besides, the valuation profession around the world is in serious trouble. It faces growing competition, particularly for high value instructions, from other professions that have a pedigree of servicing the wider needs of business occupiers (Grasskamp, 1977; Baum, 1984; RothweU, 1984; Barnard Report, 1986; Howard, 1988; Whipple, on tit; Boyd, 1992; Aluko, 2000).
Against the foregoing, major institutional investors or business owners may not accept a single unsubstantiated figure on a signed piece of paper as the correct interpretation of market value. Much more will be expected of valuers if valuation is to be used in measuring corporate efficiency in mergers and acquisitions. Arguably, real estate markets are, also no longer defined by national borders. Businesses are now footloose on a global scale (due to the establishment of, say, for example, ECOWAS, European Union and African Union) and chose locations for their enterprises at an international level. The need for international real estate advice is increasing and the requirement to value without national boundaries is becoming implicit in international accounts and corporate real estate decisions, particularly during merger and acquisition processes where market value of fixed assets have to be estimated (Wyatt, op cit).
Consequently, valuation methods developed at the national level are under scrutiny as occupiers become more international in outlook. As a profession, it is more important to look for ways of improving our service than spend our energies attempting to justify our position. This article is intended to fill the gap so that the estate surveyor and valuer will be armed with a full set of tools when asked to provide input into a situation requiring business valuation related directly or indirectly to corporate mergers and acquisitions. This article, therefore, considers some important questions below such as: what are manager’s true motives including contextual issues driving mergers and acquisitions in Nigeria? How could valuation advice be made more responsive and relevant to merger and acquisition decisions? Is there element of marriage value in mergers, acquisitions, take-overs and conglomerate business decisions?
PRACTICE IN NIGERIA
The key regulator of mergers and acquisitions in Nigeria is the Securities and Exchange Commission (“SEC”).
Pending the passing of a competition law (a bill for the establishment of a competition commission is currently before the houses of assembly), the SEC is also responsible for reviewing mergers and acquisitions to ascertain whether the transaction would result in a substantial restraint of trade.
A legal framework exists for mergers and acquisitions in Nigeria as in other jurisdictions. In Nigeria, mergers and acquisitions by public companies are principally regulated under the Investments and Securities Act 2007 (the “ISA”) and the Rules and Regulations made pursuant to the ISA (the “SEC Rules”).
The listing rules of the Nigerian Stock Exchange (the “Listing Rules”) also contain regulations that impact on M&A transactions.
The provisions governing schemes of arrangement are contained in the Companies and Allied Matters Act, Cap C20, Laws of the Federation of Nigeria 2004 (“CAMA”).
The ISA provides that it is not necessary for the SEC to be notified in respect of small mergers (currently defined as mergers with a value at or below NGN500,000,000 – approximately USD 3.7 million) although the SEC retains the power to require that it be notified where within 6 months of the commencement of the merger, it is of the opinion that the merger is likely to substantially prevent or lessen competition. Parties to all other mergers are required to seek the approval of the SEC.
Some industry specific regulators issue guidelines in respect of M&A transactions involving companies in their industry. Such guidelines are binding on the companies in that industry in addition to the SEC regulations.
The ISA and SEC Rules apply to all types of public companies, while the Listing Rules apply only where the target company has its securities admitted to trading on the Nigerian Stock Exchange (“NSE”).
There are generally no foreign ownership restrictions in Nigeria;
However, recently the Central Bank of Nigeria has published its policy on foreign participation in Nigerian Banks aimed at discouraging foreign companies from acquiring a controlling interest in existing local banks. The CBN has indicated that no single foreign individual/institutional investor may acquire more than the share of the single largest Nigerian individual/institutional investor and in any event the aggregate shareholding of the foreign investors should not exceed 10% of the total capital of the bank.
The CBN even restricts foreign owned banks operating in Nigeria from seeking to merge with existing Nigerian owned banks. In order to merge with a “Nigerian bank”, the CBN requires that the foreign owned bank must have branches in 2/3 of the country’s 36 States (a requirement that few, if any, of the foreign owned banks currently operating in Nigeria are able to meet); it requires also that the foreign investor shareholding in the resulting company must not
exceed 40%. Subject to meeting the requirements for application however, the CBN does not prevent a foreign investor establishing a bank in Nigeria and specifies no particular maximum
shareholding limit in that situation.
In some sectors, the prior approval of the relevant regulator is required for a change of control. These sectors include the financial sector, where the approval of the Central Bank of Nigeria (“CBN”) is required; the Insurance industry, where the approval of the National Insurance Commission (“NAICOM”) is required; the telecommunications industry, where the approval of the Nigerian Communications Commission (“NCC”) is required and broadcasting where the approval of the National BroadcastingCommission is required.
CONSOLIDATION OF THE NIGERIAN BANKING INDUSTRY
In general terms, consolidation of banking firms involves either a combination of existing banks, growth among the leading banks or exit from the industry of weak banks. The consolidation programme recently introduced and being implemented in Nigeria takes the form of mergers and acquisition. According to the Central Bank of Nigeria (CBN), the reform became necessary because of the observed fundamental problems in the industry, which include, among others:
❖ Significant asset quality problems;
❖ Undercapitalization of a number of industry players;
❖ Significant corporate governance issues;
❖ Late or non-publication of annual accounts that obviates the impact of
market discipline in ensuring banking soundness;
❖ Over-dependence on public sector deposits (accounting for over 20 percent of total deposit liabilities of deposit money banks and over 50 percent in some banks).
The implications are that the resource base of such banks are weak and volatile, rendering their operations highly vulnerable to swings in government revenue, which in turn is equally plagued by uncertainties of the international oil market;
❖ Inadequate risk management practices; and
❖ Neglect of small and medium scale enterprises by the system.
In the main, the policy aims at developing a more resilient, competitive and dynamic banking system that supports and contributes positively to the growth of the economy with a core of strong and forward looking banking institutions that are technology driven and ready to face the challenges of liberalization and globalization. The reform essentially entails the build-up of capital, size and business scale of the banking institutions, at the end of which smaller number of, but much stronger, institutions will emerge.
At this juncture, it is important to indicate that the announcement and the implementation of the policy have induced a shake-out in the industry, which has posed a new set of challenges to the NDIC. For example, following the announcement, the inter-bank market was adversely affected as inter-bank placements by the big players in the market were withdrawn from smaller banks as a precautionary measure. There was also a wave of flight to safety by depositors who were apprehensive of the survival of their banks. The development coupled with the planned phased withdrawal of public-sector funds from the universal banks made the liquidity position of some banks precarious.
Apart from the shock-induced problems, the fact remains that some of the banks, particularly the marginal ones, may be unable to get a merger partner and/or be acquired by a stronger bank before the end of 2005 and that would compound the problems of such banks and could lead to their eventual demise post December 2005. These and other emerging challenges would put severe pressure on the Corporation’s financial and human resources.
Pre-consolidation Challenges
a. Liquidity Problems
The new minimum capital requirement of N25 billion, which prompted the on going consolidation exercise, has led to panic in the inter-bank market. Following the new policy direction of the CBN, particularly as it relates to consolidation and increase in banks’ capital base, the big players in the inter-bank market withdrew their funds in the market with the attendant liquidity problem for the marginal banks. Currently, some banks have been thrown out of the clearing system as a result of their weak liquidity position. This situation becomes a concern for the NDIC as a few banks are currently unable to meet their obligations to their depositors. If the development is not properly managed, what begins as a mere liquidity problem may cause runs on these banks and other banks and may well lead to the failure of some banks. The situation may warrant the provision of financial assistance by the Corporation to eligible banks. Eligibility criteria for accessing financial assistance from the NDIC include, among others, the following:
• Solvency;
• Good corporate governance;
• Credible turn-around plan;
• Credible repayment plan; and
• Acceptable collateral.
b. Raising of Bank Capital Using Laundered Financial Resources
With the minimum capitalization of N25 billion, banks are continually flooding the capital market to raise additional capital funds – either to meet up with the minimum requirement or to position themselves for mergers and acquisition. To date, all the banks that were in the capital market to source funds have been reporting over-subscription. The regulatory challenge here relates to money laundering. How can the Regulatory Authorities prevent massive money laundering in banks during consolidation period, especially when the instruments for payment for such investments might have been “coloured” beyond recognition by the various issuing houses and receiving agents? This may lead to another concern which relates to compatibility of co-investors. To what extent are co-investors compatible? The on-going process may create
ownership structures that may make management of emerging banks very complex as it may be difficult to identify “fit and proper persons” and/or compatible partners during the process of consolidation. Therefore, all banks should adopt the “Know-Your-Co-investors” (KYC) principle in pursuing the consolidation programme.
c. Raising Capital Using Depositors’ Fund
There are indications that depositors’ funds have been utilised to grant loans for share acquisition in the pursuit of the consolidation programme. Such a practice, apart from being a violation of CBN guidelines, may lead to asset/liability mis-match if depositors’ funds are locked into equity investment. Such risks could threaten the safety of depositors’ fund and it is an issue of serious concern to the NDIC because of its role as deposit insurer. It is hoped that such share acquisitions will be identified and disqualified by the CBN through its capital verification exercise.
d. Increased Level of Risk during the Integration Process
During the consolidation process, the overall risk profile of the new entity could increase because of the integration risk and the complexity of the rationalization process. Common reasons for possible escalation of the risk profile of the merged entity, especially initially, include failure of control system, lack of management focus and poor understanding ofm‘adopted” risks. The degree of escalation will depend upon the circumstances surrounding the merger, in particular whether the merger is friendly or hostile. This situation poses a challenge to the Corporation to the extent that the safety of depositors’ funds could be adversely affected.
Post-Consolidation Challenges
a. Inadequate Executive Capacity
Management of banks should be fit and proper, competent, properly skilled and prudent. The ability of executive management to build and mould a management team that is able to lead the merged banking entity through the painful process of merging IT systems, business lines and products, cultures and people is of critical importance and particular concern to NDIC. In that regard, the management of the merged entity needs to have the ability to identify the integration risks at an early stage and manage them effectively in the shortest possible time. Given that banking is all about risk management, whatever circumstance that adversely affects the ability of any bank management to effectively manage risks facing it, would inadvertently constitute a challenge to the Corporation given its primary function of deposit insurance.
The foregoing implies a change of orientation, attitudes, value system and above all, capacity building by the operators at all levels particularly, at the top management level, in order to address the issue.
b. Weak Corporate Governance
Responsive corporate governance is always an aspect that is closely monitored by the regulatory authority in order to ensure the transparency and accountability of management of banking institutions and the curtailment of their risk appetite. Responsive corporate governance involves the enthronement of mechanisms, processes and systems for ensuring that:
• There is appropriate direction and oversight by directors and senior management
• There is transparency and accountability to the various stakeholders;
• The organisation complies with the applicable legal and regulatory requirements;
• There is disclosure of all material information to stakeholders such as investors, depositors, regulatory authorities, etc; and
• The organisation’s viability and solvency is sustainable through adequate internal controls and audits as well as appropriate risk management framework.
Good corporate governance requires probity, transparency and accountability. It often helps to assure that business strategies are consistent with safe and sound operations and thus can act as the first line of defence against excessive risk – taking.
d. The Establishment of Asset Management Company
A key element of the 13-point agenda of the on-going banking reform programme is an establishment of the Asset Management Company (AMC).
While the idea is good, its success is hinged on the adequacy of the legal system and responsiveness of the judicial process. For as long as the abuse of the court processes, which has made the foreclosure of collaterals an herculean task, remains unchecked, the effectiveness of AMC will remain a challenge. The NDIC as a liquidator of banks has not had any appreciable success in the courts since the scrapping of the Failed Banks Tribunals. Besides, issues pertaining to Savannah Bank Plc have been in the courts for over three years while the depositors of the bank are unable to retrieve their trapped funds. The NDIC, on its part has not been able to discharge its obligations to the depositors because of the protracted litigations. This is a challenge that must be resolved for the entire nation in general and the banking system in particular. In many countries, including the United States of America (USA) where similar intervention institutions were established, they were given some special emergency powers to enable them discharge their mandates effectively. There is the need for similar powers for our AMC in order for it to realize the objectives of its establishment. With the recent development that led to AMC bill to be passed into law in Nigeria, the process of financial intermediation will be strengthening anomg the operators.
METHOD OF ANALYSIS
This Chapter entails the methodology that forms the basis of our analysis. For the purpose of the work our data will be revolve around Diamond Bank Financial. Basically, the theoretical framework of this paper is specified along side with the model specification. Also, a priori expectation of each independent variables with respect to dependent variable is stated therein.
The methodology of this paper revolves around the collection, computation and analysis of secondary time series data (this includes papers, journals, official bulletins; reports on merger and acquisition. Econometric tools will be employed in the specification of relevant model in estimating the various variables and testing of relevant hypothesis. Due to limitation of data, the use of ordinary least square (OLS) covering 2005-2009 for Diamond bank Plc will be used.
MODEL SPECIFICATION
The model is thus specified;
ROCE = F (DEPOSIT LIABILITIES, ASSETS)
Stating it explicitly,
ROCE =α0 +α1DEP + α2ASS + Ui
Where,
ROCE = Return on capital employed
DEP = Deposit liabilities as a percentage of assets
ASS = Assets of the bank as a percentage of net earnings
Ui = Stochastic error term
Theoretical/ A priori Expectation
This model assumes the profitability of the banks using ROCE is determined by deposit liabilities and assets. The model thus shows the ROCE as the dependent variable and deposit liabilities and Assets as the independent variables. Therefore, it is expected that assets of the company will be positively related to the return on capital employed while it is assumed that deposit liabilities will be negatively related to the return of capital employed.
Empirical Results and data Interpretation
This part involves the presentation of data and empirical results. The equation of the model will estimated using familiar ordinary least square technique. Accordingly, the data sets that have been assembled so far have been used in estimating the equation and the results are presented.
Table 1
|YEAR |RETURN ON CAPITAL EMPLOYED (%) |DEPOSIT LIABILITIES (%) |ASSETS (%) |
|2005 |12.19 |59.82 |16.57 |
|2006 |1.08 |66.05 |14.07 |
|2007 |12.86 |67.68 |17.26 |
|2008 |10.11 |66.19 |19.89 |
|2009 |5.94 |68.34 |17.91 |
SOURCE: 5 Year Financial Summary Of DIAMOND BANK PLC
Emprical Results
ROCE = 26.07461 -0.671337DEP+ 1.540946ASS
T-Statistic (0.548567)* (-0.928849)* (1.333715)*
R2=0.53
R2=0.0534 (adjusted r-square)
Interpretation
The normal values above show the effect of one unit change in each of the variables on the dependent variables. From the result, for R2, it shows that about 53% variation in return on average equity is explained by both the assets and deposit liabilities of the bank. The adjusted R2 tells us that, after talking into account the number of repressors, the model explains only 5.34% of the variation in ROCE. Even the adjusted R2 of 0.0534 seems low due to data this might statistically significant.
The estimation results revealed that ROCE of Diamond Bank Plc is statistically determined by the assets and deposit liabilities of the bank. The variables are significant at 25% level. With respect to direction of impact, assets impinged positively on return capital employed which conforms with theoretical expectation. Also, on the other hand, deposit liability is negatively to ROCE which not conform with a priori expectation.
The estimation reveals that the joint influence of the net income and operating expenses on return on equity cannot be ignored. We therefore reject the null hypothesis (HO) while accepting the alternative (H1) and conclude that the parameters (α0 α1 & α2) taken as a whole are jointly significant.
SUMMARY RECOMMENDATION AND CONCLUSION
Summary
This study is carried out using ordinary least square (OLS) on time series data covering period 2005-2009. The results showed that, the two variables are statistically significant in explaining variation in return on capital employed. The result showed that assets base and deposit liabilities as a percentage of total assets conform to expectation of the theory. This implies that a good quality assets base will generate returns on the investment of public investors but high deposit liabilities erode the gross earnings of the bank.
Recommendation
Based on the findings this paper, the following policy suggestions are highlighted below;
• The Use of Information and Communication Technology is very important in M&A. Take for example the banking industry in Nigeria. The experience of banking system consolidation in other countries, particularly the USA and Japan shows that diseconomies of scale do occur at high levels of output. Studies in those countries also show that the mega banks were able to enjoy economies of scale at all levels of output using state-of-the-art ICT. Thus, given that mega banks would emerge from the consolidation process, the time is ripe for banks to begin to think of the appropriate ICT to employ to ensure efficient service delivery and cost effectiveness while forestalling the creeping in of diseconomies of scale.
• The estimation result shows that an increase in asset will increase the return on capital employed, therefore companies in merger and acquisition should focus on increasing the level of assets so that the return on capital employed may be improved.
• With the increased capital base of banks and the enlarged shareholder base, the management of banks are faced with the challenge of fashioning out profitable investment opportunities to maximize the use of the huge assets at their disposal. One of the areas recommended for exploration is cross-border merger. Thus, the emerging mega banks need to spread out to the West African sub-region and the rest of Africa to become more visible players in the sub-regional and regional financial markets.
• Also, as part of measure to improve profitability, the level of turnover made during the year must be able to cover up for total deposit liabilities.
Conclusion
I would like to stress that the financial services sector has proved to be extremely dynamic in recent years. Many factors are combining to create conditions for change in banking markets – new technology, globalisation of markets, the introduction of far reaching regulatory reforms, changes in consumer behaviour and the emergence of new products and industry players. In any merger analysis, the Commission relies heavily on objective data and in this context there is suggestion that analysis is a two way street. Industry assistance in the provision of meaningful data will enable the Commission to make informed decisions about the outcome of any merger and acquisition proposal. The paper provides relevant information on how corporate business entity can be valued for mergers and acquisitions. It examines valuation concepts (based on accounting concepts), the need to incorporate marriage values and some financial accounting ratios in the analysis of merger and acquisition.
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APPENDIX 1
|Dependent Variable: ROCE |
|Method: Least Squares |
|Date: 04/07/10 Time: 13:04 |
|Sample: 2005 2009 |
|Included observations: 5 |
|Variable |Coefficient |Std. Error |t-Statistic |Prob. |
|C |26.07461 |47.53221 |0.548567 |0.6384 |
|DEP |-0.671337 |0.722762 |-0.928849 |0.4510 |
|ASS |1.540946 |1.155379 |1.333715 |0.3139 |
|R-squared |0.526733 | Mean dependent var |8.436000 |
|Adjusted R-squared |0.053467 | S.D. dependent var |4.919536 |
|S.E. of regression |4.786213 | Akaike info criterion |6.253065 |
|Sum squared resid |45.81567 | Schwarz criterion |6.018728 |
|Log likelihood |-12.63266 | F-statistic |1.112974 |
|Durbin-Watson stat |2.920157 | Prob(F-statistic) |0.473267 |
