Review of Economics & Finance Submitted on 20/03/2015 Article ID: 1923-7529-2015-03-66-17 Ralph Sonenshine, and Evan Kraft ~ 66 ~ What Motivates Banks and Other Financial Services Firms to Merge? An Empirical Analysis of Economic and Institutional Factors 1 Dr. Ralph Sonenshine (Correspondence author) American University, Department of Economics 4400 Massachusetts Avenue, NW, Washington, DC 20016, U.S.A. E-mail: Sonenshi@american.edu; Tel.: (202) 885-3733; Facsimile: (202) 885-3790 Dr. Evan Kraft American University, Department of Economics 4400 Massachusetts Avenue, NW, Washington, DC 20016, U.S.A. E-mail: kraft@american.edu; Tel.: (202) 885-3711; Facsimile: (202) 885-3790 Abstract: With globalization and deregulation, the financial services industry in many areas has consolidated significantly since the mid-1990s. What drove financial services mergers among key segments and geographic regions? This paper uses a comprehensive data set comprising 1,434 mergers in 62 countries from 1995-2011 to explore empirically the motivations behind financial services mergers, examining the factors that impact the deal premium paid to effectuate the merger. We find stronger regulatory environments, especially lower corruption, to have a positive effect on the synergies projected to arise from financial services mergers. In contrast, higher financial freedom levels were found to have a negative impact on the deal premium. Also, higher measured levels of legal protection are associated with higher deal premiums in banking mergers, though the opposite is true for insurance. Acquirers also pay higher premiums to purchase targets that are relatively small and easier to integrate. Finally, there is evidence that acquirers pay more to consummate cross-border versus domestic mergers, a result driven by cross-border, investment banking mergers. Keywords: Financial services mergers and acquisitions; Cross-border mergers and acquisitions; Foreign direct investment; Deal premium; Banking regulation JEL Classifications: G34, G14, G28 1. Introduction The past 20 years have seen remarkable merger and acquisition activity among financial service firms. Tectonic changes in regulation and technology go a long way to explaining the waves of financial sector mergers and acquisitions (M&A) activity since the 1990s. Regulatory changes such as the US Riegle-Neal Act of 1994 eliminating restrictions on interstate banking and Gramm-Leach-Bliley Act of 1999 repealing the separation of investment and commercial banking, as well as the European Union’s Single Market Act of 1988, opened up legal space for combinations. Some of the changes in the financial sector had very broad cross-sector effects, such 1 The authors would like to thank, without implicating, Dogan Tirtiroglu, and Till Stowasser at the May 2013 Industrial Organization conference for many useful comments. All remaining efforts are entirely the responsibility of the authors.