| Over the past two decades, significant research effort has been devoted into measuring the efficiency of financial institutions, especially commercial banks. Even though many studies found that measured inefficiencies in these financial studies were high (at least 20% of the total banking industry cost and about half of the industry's potential profits), there is still no consensus about the sources of the differences in measured efficiencies. Differences might be due to various efficiency concept employed, and different measurement methods used to estimate efficiency within each concept. There is also not an agreed theory as to the potential efficiency correlates.; A stochastic frontier alternative profit function is defined for cross-sectional data on merged U.S. commercial banks (during 1997), in which the non-negative technical inefficiency effects are assumed to be a function of firm-specific variables. The inefficiency effects are assumed to be independently distributed as truncations of the normal distributions with constant variance, but means that are linear functions of observable firm-specific variables. We employ the maximum likelihood method to estimate the parameters of the frontier model and the prediction of the technical efficiencies of the firms. The generalized likelihood-ratio test is considered for testing the null hypotheses that the inefficiency effects are absent; are not stochastic; and they do not depend on the firm-specific variables. We found that inefficiencies are present, and the measured efficiencies were higher than those presented in earlier banking studies. The approach adopted in this study differs from the usual practice of predicting firm-level inefficiency effects and then regressing these effects upon various factors in a second-stage of modeling. Testing for the functional form, we found that the flexible translog is an adequate representation of the banking data. We also found that the truncated normal distribution better represents the data than the half-normal distribution frequently applied in other studies. We found that merged banks showed an improved risk-adjusted performance due to better diversification opportunities. Overall, a merger improves bank efficiencies to an extent that banks take advantage of better and more diversification opportunities following the merger, and diversify into activities that add value into the firm. |
