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Abstract:
The Financial Services Modernization Act of 1999 repeals the Depression-era Glass-Steagall Act (1933) and the Bank Holding Company Act (1956) and allows insurance firms for the first time to merge with banks and cross sell non-traditional insurance products. Previous studies suggest that such an opportunity will lead to consolidation in the financial services industry. In this study we investigate whether the FSMA will lead to mergers between insurance companies and other firms in the financial services industry by analyzing the announcements leading to the FSMA. Our study shows that relaxation of merger barriers creates a wealth effect for firms in the industry. We also find a larger wealth effect for life and property/casualty insurers, which are predicted to generate the highest diversification benefit when combined with bank holding companies. Cross-industry merger opportunities and regulatory changes also reduce the systematic risk of firms in the insurance industry. The cross-sectional variation of the wealth effect can be explained by the type of insurance, size, and performance as well as the diversification benefit. As predicted by merger literature, larger and poorly performing firms a have higher wealth effect.
[Keywords: insurance industry, wealth effects, Financial Modernization Act, cross-industry merger, systematic risk]
INTRODUCTION
The Financial Services Modernization Act (FSMA) is the most sweeping deregulation of the U.S. financial services industry in the last century. The FSMA repeals both the Depression-era Glass-Steagall Act of 1933, which separated banking and securities activities, and the Bank Holding Company Act of 1956, which prohibited bank holding companies from engaging in insurance-related activities. Gradual erosion of the Glass-Steagall Act has given U.S. banks increasing access to traditional insurance1 and securities2 business. The insurance industry has largely been regulated by the Depression-era regulations, and has thus been restricted to traditional insurance business and restricted from merging with other types of financial services firms. The FSMA allows cross-selling of non-traditional insurance products by insurance firms, and it also allows them to merge with banks. Thus, the FSMA gives us the unique opportunity to test whether these new deregulations are going to create value (wealth effects) for firms in the insurance industry. We are especially interested to know whether the FSMA will encourage cross-industry mergers. Previous studies (see Cyree, 2000; Ely and Robinson, 1998; Carow,...