State activism and the hidden incentives behind bank acquisitions☆
Highlights
► Study of interplay of federal and state regulation on US bank acquisitions. ► Federal government uses CRA regulation to control bank acquisitions. ► States promote bank consolidation within their borders through LIHTC regulation. ► State implementation of LIHTC regulation undermines federal regulatory mechanism. ► Different regulatory agendas create opportunities for acquiring banks.
Introduction
US states must balance many, sometimes conflicting constituencies when creating social policy. On the one hand they are guardians of the public good, and on the other hand, they must encourage business expansion and growth to develop vibrant local economies. In this paper, we explore the complex and multi-layered process in which US states regulate the corporate sector and facilitate the consolidation of business and capital. Key changes in the US federal tax code over the last quarter-century have allowed states to find new ways to balance and integrate the dual missions of protecting the public good and encouraging business expansion. In the case we examine, states have been able to take advantage of a federal tax credit system to help corporations deal with an ambiguous regulatory issue that constrains their ability to acquire other firms. Thus, this case shows that one of the ways for states to consolidate business and capital is to help corporations deal with the ambiguity of federal regulations. This state activity then shapes organizations’ behaviors in this sector, and as a result, industry structure reflects variation in state activism.
Organizational theory has long been interested in how legal environments influence corporate activities. Shifts in federal laws have been shown to cause corporations to interpret their environments differently and to influence the economic decisions of organizations. Research has shown that firm structure (Fligstein, 1990, Roy, 1997, Zorn, 2004), strategy (Davis et al., 1994), and even internal policy (Dobbin et al., 1993, Edelman, 1990, Edelman, 1992, Sutton et al., 1994) are shaped by legal changes at the federal level. For example, Fligstein (1990) showed how a number of federal regulatory changes in the twentieth century drove the evolution of the corporate form. Similarly, legislation during the Reagan era led to changes in the legitimate corporate structure, which then shaped corporate acquisition and divestiture patterns (Davis et al., 1994). Some scholars have observed the effects of federal laws and regulations on organizations to be so powerful as to matter above and beyond economic efficiency (Roy, 1997).
A number of studies have examined the effects of state laws, either as microcosms to understand regulatory effects on organizations more generally (e.g. Dobbin and Dowd, 1997, Dobbin and Dowd, 2000, Haveman and Rao, 1997), or across states to show how regulatory environments differ (Guthrie and Roth, 1999a, Schneiberg and Bartley, 2001, Wade et al., 1998). An important line of research shows how US states are in economic competition; they are thus interested in promoting their own banks as a way of supporting business within their borders. Campbell and Lindberg (1990), for example, maintain that laws and regulations are a basis for competition among states to attract corporate headquarters and plant locations. Southern states, for instance, offered more relaxed and, hence, favorable property rights to consolidate industries. And New Jersey and later Delaware also passed permissive corporate laws to consolidate the headquarters of large corporations. Many legal scholars have similarly described states’ regulation and facilitation of corporate entry to and exit from their local economies (Bebchuk, 1992, Romano, 1987, Romano, 1993, Steiner, 1975).
Both these prior sets of analyses—one focused on federal regulatory effects on firms and one on state-level facilitation of business activity—are limited in that they typically only consider one side of the coin. But the relationships among federal legislation, states, and firms is considerably more complex. Research on specific cases of how these institutional and organizational levels of analysis interact illuminates important facts about the ways in which organizations and states navigate institutional change. We argue that federal and state regulatory processes are, in some cases, interdependent, and that states have an important role in how firms interpret and respond to federal law. Other researchers have shown that federal law is typically ambiguous and that firms are often interpreters and shapers of law (e.g. Dobbin et al., 1993, Dobbin and Sutton, 1998, Edelman, 1992). For instance, prior analyses suggest that firm response to law is a result of organizational trial and error or of the adoption of “best practices” (Kalev et al., 2006). We suggest that US states play an active role in helping organizations address federal mandates. We use the term state activism to describe how states are active players in the creation, maintenance, and creative appropriation of certain institutions that either consolidate or regulate businesses within their borders. By helping organizations address federal ambiguity, states thus shape organizational activity and the structure of industries.
Consolidation in the twentieth century US banking industry is a good setting to examine the intersection between organizations and their state and federal legal environments for a number of reasons. First, the banking industry is highly regulated at both levels. The influence of laws on the structure of banks and the banking industry is explored in a large literature in both economics and sociology (e.g., Berger et al., 1995, Davis and Mizruchi, 1999, Marquis and Huang, 2009, Marquis and Huang, 2010). Many other US industries including transportation, communication, utilities, health care, and agriculture that, like banking, were once highly regulated have been significantly deregulated since the 1980s (Lounsbury et al., 1998).
Second, both types of regulators have been focused on the issue of bank consolidation. Regulatory limits on bank expansion that grew out of an historical fear of concentrated capital and banking persisted for much of US history (Roe, 1994). Communities resisted the consolidation of banks in their area, since larger banks were perceived as invaders beholden to the economic interests of distant corporations, and were less responsive than smaller local banks to the needs of communities (Marquis and Lounsbury, 2007). Yet states’ economies and economic growth hinge on a large and vibrant banking sector (Dehejia and Lleras-Muney, 2003). Economies of scale allow consolidated banks to provide a much wider array of services at lower rates to local businesses; therefore, states bent on promoting local economic growth have an interest in promoting bank consolidation within their borders.
Third, regulations of the banking industry, especially those at the federal level connecting acquisition activity and underserved community lending, were ambiguous and complex, which gave state regulators some leverage to intervene in the way banks interpreted and responded to those regulations. Our empirical analysis begins with a complex institutional history of a wave of bank regulation that began in the 1970s that we later quantitatively show has influenced the bank acquisition wave of the 1990s. Corporate acquisitions have long held the interest of organizational scholars (Davis and Stout, 1992, Palmer et al., 1995, Stearns and Allan, 1996, Marquis and Huang, 2010). The banking case is unique, however, because government approval of acquisitions is contingent on whether banks serve their local communities as mandated by the Community Reinvestment Act (CRA), which was passed in 1977 to compel banks to bring banking services and resources to low-income communities. The CRA is a classic example of an ambiguous law in that specific criteria for compliance are not specified, but there are many ways banks can get credit for “serving” low-income communities. Traditionally these have included philanthropy, charitable activities, and access to services such as everyday consumer banking and personal and commercial loans. While prior research on legal ambiguity has highlighted how such laws can provide opportunities for organizations, we show how ambiguous CRA regulations provide a constraint on bank acquisition activities.
A new approach for banks to fulfill CRA requirements emerged in the late 1980s, providing an important tool for state regulators to assist banks in their acquisition activities. It was a small, experimental provision of the Tax Reform Act of 1986 called the Low-Income Housing Tax Credit (LIHTC). Legislators did not realize at the time (because the LIHTC was not originally intended for corporate use) that the LIHTC would by 1990 prove to be an extremely lucrative way to fulfill CRA obligations because it also afforded banks a double tax break that was previously unheard of in corporate and individual tax history (Guthrie, 2004, Guthrie and McQuarrie, 2005, Guthrie and McQuarrie, 2006). Although the CRA and LIHTC are both federal laws, states control how active the LIHTC market is within their borders. States make available to banks LIHTC opportunities, which help them meet their CRA requirements in a cost-effective manner, and concurrently consolidate capital within their local economies. In the case of the CRA and LIHTC, regulatory action began at the federal level and state-level activism emerged, as an unintended consequence, to help corporations navigate the regulatory environment. We show that because they are ambiguous, federal CRA judgments constrain bank acquisitions; however activist states are able to use the LIHTC to help banks navigate the federal CRA requirements and as a result consolidate capital within their borders.
In the following section we review the literature in organizational theory on business-state relationships and on competition among states to attract business by creating a favorable economic environment. After that theoretical overview, we discuss the particular case of banking regulation, showing empirically the interplay of federal and state actors governing, and facilitating, bank acquisitions. The hypotheses proposed are informed by archival research of banking regulation over the last 30 years, including the congressional record, government and academic studies, and press accounts, accompanied by in-depth interviews with individuals working in this sector. We conclude with a discussion of our primary theoretical point—because federal regulations of corporations are ambiguous, in situations when states interests are in-line with corporations, activist states can find solutions that allow corporations to comply with the federal law in ways that may controvert the intended federal regulatory mechanisms.
Section snippets
Theory and hypotheses
Institutional theory, one of the most active areas of organizational research (e.g. see Mizruchi and Fein, 1999, Powell and DiMaggio, 1991), has shown that there are many ways that the state and law affect organizations. Investigators have assessed how public policy influences organizational structures, strategies, and competitive conditions (e.g., Davis et al., 1994, Dobbin and Dowd, 1997, Fligstein, 1990). Law within this framework has been categorized as having both coercive and normative
Data and methods
We test our predictions on all commercial banks in the 48 contiguous United States that received a CRA rating between 1990 and 2000.7 The resulting database has 91,905 bank-year observations across the approximately 13,000 banks that existed during this period. CRA performance data became publicly available in 1990, and
Results
Table 1 presents the descriptive statistics and correlations. The correlations between state LIHTC activity and CRA ratings are low: −.068 for high rating banks, and .048 and .045 for moderate and low CRA ratings, respectively. Table 2, Table 3 present the regression models for bank acquisitions within state of headquarters and outside state of headquarters, respectively. The latter tables are similar in format. Model I has all control variables. Model II adds the LIHTC variable, models III and
Discussion and conclusions
After a century of progressive deregulation of banking markets, one significant remaining impediment to bank expansion is the Community Reinvestment Act (CRA), which is dependent upon how well banks serve low-income communities. A response to public umbrage over banks’ unfair treatment of low-income communities, the CRA has become one of the key ways the federal government assesses whether banks are meeting their social obligations by treating all communities fairly. It has also become one of
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We thank Mark Mizruchi for his comments on a prior version of this paper.