Innovative Applications of O.R. An integrated performance evaluation of financial holding companies in Taiwan Shih-Fang Lo a , Wen-Min Lu b, * a International Division, Chung-Hua Institution for Economic Research, Room 531, 75 Chang-Hsing Street, Taipei 106, Taiwan b Department and Graduate Institute of Finance, National Defense University, No. 70, Sec. 2, Zhongyang North Road, Beitou, Taipei 112, Taiwan article info Article history: Received 12 July 2007 Accepted 3 September 2008 Available online 12 September 2008 Keywords: FHCs Data envelopment analysis Efficiency Slacks Slacks-based measure Super efficiency Malmquist index Negative output data abstract There has been a worldwide trend for financial institutions to become larger in scale and more diversified in scope, with Taiwan being no exception. Fourteen financial holding companies (FHCs) have each begun to function as a management umbrella in Taiwan by investing in different types of financial services such as banking, insurance, and securities. This paper focuses on this local financing issue from an integrated methodological perspective by model innovations proposed in several earlier studies. For example, the efficiency of profitability and marketability are combined to evaluate the FHCs’ performance. To conduct a valid and reliable evaluation process while applying the FHC’s case in Taiwan, we integrate the slacks- based measure (SBM) and slacks-based measure of super efficiency (super-SBM) models in order to directly handle the slacks and identify the best performers. A new scheme that deals with the negative output data in the SBM/super-SBM is also introduced. Inter-temporal efficiency change, which is decom- posed into ‘catch-up’ and ‘frontier-shift’ effects, is analyzed by means of the SBM-based Malmquist index. A decision-making matrix is also presented to help the FHCs’ managerial authorities position themselves in the industry. The above techniques show with a high degree of consistency that large-sized FHCs per- form better than small-sized ones. Crown Copyright Ó 2008 Published by Elsevier B.V. All rights reserved. 1. Introduction There has been a worldwide trend for financial institutions to become larger in scale and more diversified in terms of their scope. The emergence of the financial holding company (FHC), which has already become popular in the United States, Europe, and Japan, 1 is one of the classic ways in which financial service institutions have begun to operate across industries. In referring to the financial reform experiences of other countries, the Taiwan government successively passed legislation to enable local financial institutions to merge with or acquire other financial institutions in order to cope with the prob- lems of over-competition in this small economy. Fourteen financial holding companies in Taiwan have begun operating since 2001. The holding company serves as a management umbrella and invests in subsidiary institutions that are engaged in different kinds of financial services such as banking, insurance, and securities. A FHC is estab- lished as a pure financial holding company with more than two other financial subsidiaries. The 14 FHCs currently in operation are divided into the following types: (1) those with banks as the main part: Hua Nan, China Development, E.SUN, Mega, Taishin, Sinopac, Chinatrust, and First; (2) those with insurance as the main part: Cathay, Fubon, and Shin Kong; and finally (3) those with securities as the main part: Fuhwa, Waterland, and Jihsun. It is generally believed that the estab- lishment of FHCs will promote economies of scale and help the bank- ing sector compete more efficiently internationally. Even though the legislation allows for expansion across indus- tries, the FHCs in Taiwan are still ‘too many in number, and too small in size’ compared to those in other Asian countries. The three largest banks in both Hong Kong and Singapore have a total market share of more than 88% and 80%, respectively. However, none of the 14 FHCs in Taiwan have a market share of more than 10%. Faced with a highly saturated and competitive market, the major mission of the FHCs is to operate efficiently to secure their survival. Although the history of FHCs in Taiwan is quite short compared with that in other industrialized countries, investigating the per- formance of FHCs is important since this small economy is vulner- able to the existence of a handful of large and inefficient financial institutions. This paper therefore focuses on the local financing issue from an integrated methodological perspective by model innovation with managerial implications in the field of the financial service industries. It is hoped that the proposed model and techniques can be used in relation to the financial industries of other countries that face a similar environment. 0377-2217/$ - see front matter Crown Copyright Ó 2008 Published by Elsevier B.V. All rights reserved. doi:10.1016/j.ejor.2008.09.006 * Corresponding author. Tel.: +886 2 2898 6600x604981; fax: +886 2 2898 5927. E-mail address: wenmin.lu@gmail.com (W.-M. Lu). 1 The government of the United States passed the Financial Services Modernization Act in 1999, known as the Gramm–Leach–Bliley Act, thereby abolishing both the Banking Law and the Glass–Steagall Act, which had demanded that the activities of commercial banks, investment banks, and insurance companies be kept separate. In 1997, Japan reformed its Anti-Monopoly Law and passed the Financial System Reform Law and the Bank Holding Company Act. These new laws were implemented in 1998. Europe has had a long history of ‘universal banking’ where financial institutions offer a broad range of financial services. European Journal of Operational Research 198 (2009) 341–350 Contents lists available at ScienceDirect European Journal of Operational Research journal homepage: www.elsevier.com/locate/ejor