Profitability and Marketability of The Top 55 U.S. Commercial Banks
Profitability and Marketability of The Top 55 U.S. Commercial Banks
U tilizing recent developments in data envelopment analysis (DEA), this paper examines
the performance of the top 55 U.S. commercial banks via a two-stage production process
that separates profitability and marketability. Substantial performance inefficiency is uncov-
ered in both dimensions. Relatively large banks exhibit better performance on profitability,
whereas smaller banks tend to perform better with respect to marketability. New context-
dependent performance measures are defined for profitability and marketability which
employ a DEA stratification model and a DEA attractiveness measure. When combined with
the original DEA measure, the context-dependent performance measure better characterizes
the profitability and marketability of 55 U.S. commercial banks. The new approach identifies
areas for improved bank performance over the two-stage production process. The effect of
acquisition on efficiency and attractiveness is also examined.
(Data Envelopment Analysis (DEA); Profitability; Marketability; Efficiency; Banks)
0025-1909/99/4509/1270$05.00
Management Science/Vol. 45, No. 9, September 1999 Copyright © 1999, Institute for Operations Research
pp. 1270 –1288 and the Management Sciences
SEIFORD AND ZHU
Profitability and Marketability of the Top 55 U.S. Commercial Banks
of large-scale bank branch networks (Athanassopou- benchmark itself against its competitors; (ii) the mea-
los 1998). Berger and Humphrey (1997) provide a surement of the relative attractiveness in profitability
review on 130 studies of financial institution including and marketability of each bank against the back-
banks, bank branches, savings and loans, credit ground of a group of banks operating at a different
unions, and insurance companies. Finally, see Harker efficiency level; and (iii) the further study of the effect
and Zenios (1999) for recent studies on efficiency of of bank acquisitions on the performance of other
financial institutions. banks.
Most bank performance studies employ labor, inter- The remainder of the paper is organized as follows.
est (non-interest) expenses, office space, and number Section 2 defines the bank production process and its
of accounts as inputs, and number of transactions, corresponding production factors (inputs and out-
interest (non-interest) income, total loans, and depos- puts). Section 3 describes the DEA tools employed and
its as outputs. While these inputs and outputs can the resulting empirical findings for the 55 banks. Our
characterize a bank’s operational performance, they do conclusions appear in § 4 along with suggestions for
not reflect the market valuation or performance of a future investigation.
bank’s stock. To evaluate stock marketability, one may
include such additional factors as market value, earn- 2. Bank Production Process
ings per share, and return to investors in a DEA Fifty-five U.S. commercial banks appear in the Fortune
analysis. By incorporating some new factors in a 1000 (Fortune April 29, 1996). 1 Obviously, ranking by
two-stage approach, the current paper explores prof- revenue while necessary for inclusion in the Fortune
itability and (stock) marketability of 55 U.S. commer- 1000 does not adequately characterize the perfor-
cial banks in 1995. mance of these banks. Fortune also provides other
A two-stage production process is defined that factors: e.g., number of employees (employees), assets,
generates profit in the first stage, and market value in stockholders’ equity (equity), market value (MV), total
the second stage. The effect of bank size on profitabil- return to investors (TRI), and earning per share (EPS)
ity and marketability is revealed by evaluating both to further characterize the performance of the top
technical and scale efficiencies. Increasing returns to companies. 2 As pointed out by Zhu (1999), any single
scale (IRS) are found among relatively small banks— performance measure based on these eight factors will
banks with less than $2,000 million in assets in our be unsatisfactory in its performance characterization;
data set—and decreasing returns to scale (DRS) with several measures one gets conflicting reports and
among the larger banks. However, some of the larger it is difficult to determine which company exhibits a
banks exhibit IRS in profitability. An examination of better overall.
input congestion indicates that a reduction in current While Fortune’s analysis is based on each single
input levels may actually increase revenue and profit
levels. Several bank acquisitions occurred in early 1
The banks are available from the authors or from Fortune April 29,
1996. This allows a performance study on the effect of 1996.
2
bank acquisition on profitability and marketability. It Revenues are interest and non-interest revenues and are for the
fiscal year ended on or before January 31, 1996. Profits are after
is shown that marketability is, at most, slightly af-
taxes, after extraordinary credits or charges, and after cumulative
fected by bank acquisition. The present study also effects of accounting charges. Assets are the company’s year-end
indicates serious inefficiencies in both profitability total. Equity is the sum of all capital stock, paid-in capital, and
and marketability and offers a procedure to improve retained earnings at the company’s year-end. MV is obtained by
the bank production process by focusing on profitabil- multiplying the number of common shares outstanding by the price
per common share as of March 15, 1996. EPS for each company is the
ity and scale efficiency. In addition to a standard DEA
primary earnings per share that appear on the income statement.
analysis, the paper also measures context-dependent TRI includes both price appreciation and dividend yield to an
bank performance for different efficiency levels. This investor in the company’s stock. For more detailed explanations, see
context-dependent DEA model allows (i) a bank to Fortune April 29, 1996.
measure, the current study illustrates the value of a provide data on these factors. Therefore, we restrict
performance measure that operates simultaneously our analysis to the eight Fortune factors as described in
with multiple dimensions. To fully reconcile these Figure 1. These are sufficient to illustrate our approach
eight factors and have a more complete portrayal of to explaining bank performance while attempting to
the performance of these 55 banks utilizing these disentangle marketability from profitability. Valuable
different factors, Figure 1 describes a bank production insights result from such a change in perspective.
process based on these eight factors.
The process is divided into two stages and the eight
3. Measuring Profitability and
factors are expressed as inputs and outputs in each
stage. The first stage (Stage 1) measures profitability, Marketability of Commercial
i.e., a bank’s ability to generate the revenue and profit Banks
in terms of its current labor, assets, and capital stock. In this section, we analyze the profitability and mar-
The second stage (Stage 2) measures (stock) market- ketability of 55 U.S. commercial banks. To actually
ability, i.e., a bank’s performance in the stock market characterize the performance of these 55 banks, it is
by the revenue and profit it generates. It can be seen necessary to extend the basic DEA methodology. For
that revenue and profit serve as intermediate factors in an introduction to the basic DEA models and theoret-
the sense that they are outputs from the first stage and ical extensions, readers are referred to Ali and Seiford
inputs to the second stage. (1993b) or Charnes et al. (1994).
The DEA inputs and outputs selected are based on
3.1 Characterization of Bank Performance
Fortune’s original choice of factors for performance The output-oriented (CCR) DEA model is employed
characterization. However, we will note that other to measure efficiency in profitability and marketability
factors, e.g., market value to book value, price to (Charnes et al. 1978).
冉冘 冊
earnings ratio, turnover ratio (ratio of traded value to
冘s
year-end market value), etc., may also be used to m s
⫺ ⫹
capture marketability. Unfortunately, Fortune does not max ⫹ t
o s ⫹
i r t ⫽ 1, 2
i⫽1 r⫽1
i⫽1
⫺
i
s
r⫽1
⫹
r 冊 t ⫽ 1, 2
冘 x ⫹s
n
State Corp.), and DMU54 (BayBanks), are CCR- ⫺
s.t. j ij i ⫽ x io i ⫽ 1, 2, . . . , m;
efficient in marketability. A single bank, DMU10 ex- j⫽1
hibits best practice in both dimensions. Since the
冘 y
DMUs are sorted by revenue, the first 31 banks are n
冘 ⫽1
n
profitability model are among the first 30 banks,
j
j⫽1
3
EPS data for one bank (Bank 34, Southern National Corp.) was
negative. Therefore this bank was excluded from the DEA analysis
j, s ⫺ ⫹
i , s r ⭓ 0. (2)
of Stage 2 resulting in 55 DMUs in Stage 1 and 54 DMUs in Stage 2.
Although one could invoke the translation invariance property of
DEA (Ali and Seiford 1990) to allow negative values, such use is
Let ␥ o1* and ␥ o2* be the optimal values for (2) in Stage
restricted to the convex case, and some properties, e.g., returns to 1 and Stage 2, respectively. Define a scale efficiency
scale (RTS), are not translation invariant. measure by
DMU No. Bank Name CCR BCC RTS CCR BCC RTS CCR
Figure 2a CCR Efficiency Distribution in Stage 1 Figure 2b CCR Efficiency Distribution in Stage 2
Figure 2c BCC Efficiency Distribution in Stage 1 Figure 2d BCC Efficiency Distribution in Stage 2
冘s
m
twelve DRS banks in marketability (DMUs 23, 26, 28, 29, c
max i
31, 32, 33, 36, 37, 38, 39 and 41) are termed as IRS DMUs
i⫽1
for the input-oriented RTS method. These results indi-
cate that (i) in general, the RTS classification under
profitability is independent of the orientation of DEA
s.t. 冘 x ⫹s ⫽ x
j僆E
j ij
c
i
t*
io i ⫽ 1, . . . , m;
冘 y
j僆E
j rj ⭓ y ro r ⫽ 1, . . . , s; mance with Plan (b), then it may no longer be efficient
in Stage 1 profitability. In addition, a bank may not
have direct control over all Stage 2 outputs, i.e., its
j ⭓ 0, j 僆 E, (3) performance in the stock market. Thus, to improve
where E is the set of all CCR-extreme-efficient banks performance over Stage 1 and Stage 2, we focus on
and t* represents the optimal value for the input- maximizing revenue and profit. However, increases in
oriented CCR model (or, equivalently, the reciprocal revenue and profit may affect the scale efficiency in
of the optimal value ot* in (1)). If the optimal value to Stage 2. Figures 3a– b illustrate this with employees
(3) is equal to zero, input is not congested; otherwise, (input) and profit (output) in Stage 1, and profit
if the optimal value to (3) is not equal to zero, input (input) and market value (output) in Stage 2.
congestion is present. Furthermore, if a specific s ic*o If maximizing profit is a major goal, then a bank will
⫽ 0, then the i o th input is a cause of input congestion increase its current profit level to point S (Figure 3a). As
and s ic*o gives the amount of congestion. mentioned earlier, being positioned in an IRS region is
Model (3) measures input congestion for a CRS ideal for economic viability. Therefore, one should avoid
technology. If one appends the additional constraint, the situation (illustrated in Figure 3) that a profit increase
¥ j僆E j ⫽ 1, to (3), an input congestion measure for a (AS) in Stage 1 would move the bank into a DRS region
VRS technology is obtained. In this case, t* should be in Stage 2, i.e., AS should not be greater than UV. If AS
replaced by the optimal value to the input-oriented ⬎ UV, then one may wish to investigate alternative
BCC model and E should represent the set of all approaches to performance improvement in Stage 1. For
BCC-extreme-efficient banks. example, one may move the bank onto the best practice
Table 2 reports the nonzero input slacks, s ic* . It is point G by increasing the profit to P and then by
obvious from Table 2 that a serious input congestion reducing the number of employees to G.
exists in profitability. Between a third to a half of the We formalize this preference for maintaining viabil-
banks exhibited input congestion under CRS and VRS ity while improving a bank’s profitability as:
technologies. The input employee was not a factor in Process Improvement Rule: The increase in revenue
causing input congestion for the CRS technology. and profit for Stage 1 improvement should not move
Thus, labor does not appear to be overutilized under a an IRS bank in Stage 2 into a DRS region.
CRS assumption. However, for a VRS technology, the It can be seen that to implement the process im-
amount of employee congestion is 18.36% of the provement rule, we must determine an IRS stability
corresponding employee input level. region which preserves the IRS positioning of a bank.
In marketability, a very different picture is portrayed. As in Seiford and Zhu (1999b), we formulate the
With the exception of revenue congestion for four large following linear programming problem for an IRS
banks, input congestion is essentially absent. bank, DMU o , in Stage 2
冘 ˜
n
冘 ˜ y
n
scription for improvement. For example, DMU1 (Citi-
corp) was CCR-inefficient in Stage 2; however, it can j rj ⭓ o2* y ro r ⫽ 1, 2, . . . , s;
j⫽1
move its performance to best-practice by either (a)
increasing its MV, TRI, and EPS (proportionally by ˜ j ⭓ 0. (4)
123%), or (b) decreasing its revenue and profit (pro-
portionally by 55% and some additional nonzero where o2* is the optimal value to (1) for DMU o in
profit slack). If Citicorp chooses to improve its perfor- Stage 2.
Because DMU o exhibits IRS in Stage 2, the optimal tion continues to hold for 僆 { : 1 聿 ⬍ *o }, where
value to (4) must be less than one, i.e., *o ⬎ 1. As represents the proportional increase of all inputs, x̂ io
shown in Seiford and Zhu (1999b), the IRS classifica- ⫽ x io (i ⫽ 1, . . . , m) and *o is defined by (4). (See
Appendix A for the proof.) Table 3 reports the value of Table 3 RTS Sensitivity Results for IRS Banks in Stage 2
*o for the 11 IRS banks in Stage 2.
DMU No. Bank Name Change Rate
By this sensitivity analysis of RTS classification, we
can implement the process improvement rule as follows. 35 Firstar Corp. 1.01630
Step 1. For an IRS bank, DMU o , in Stage 2 which is 43 Marshall & Ilsley Corp. 1.12606
CCR-inefficient in Stage 1, calculate (4). First Tennessee National
(i) If o1* 聿 *o , improve profitability performance by 44 Corp. 1.00675
45 Banponce Corp. 1.15406
setting
46 UJB Financial 1.01941
冦
⫺*
Employees Stage1 ⫽ employees ⫺ s employees 47 Integra Financial 1.36827
⫺*
Assets Stage1 ⫽ assets ⫺ s assets 49 Regions Financial 1.14642
⫺* 50 Signet Banking Corp. 1.51128
Stage 1 Equity Stage1
⫽ equity ⫺ s equity
⫹* 51 Old Kent Financial Corp. 1.25299
Revenue Stage1
⫽ o revenue ⫹ s revenue
1*
53 Bancorp Hawaii 1.29549
⫹*
Profit Stage1
⫽ o profit ⫹ s profit
1*
55 Union Planters Corp. 1.03753
冘 Assets ⫹ s
oriented CCR model 55
⫺
⫽ o Assets o
*o ⫽ min o
j j assets
j⫽1
冘 Employees ⫹ s 冘 Equity ⫹ s
55 55
⫺
s.t. j j employees ⫽ o Employees o j j
⫺
equity ⫽ o Equity o
j⫽1 j⫽1
冘 Profit ⫺ s
55
⫹
the adjusted CCR scores in Stage 2 after all banks
j j profit ⫽ *o Profit o
become CCR-efficient in Stage 1.
j⫽1
Table 4 reports the adjusted efficient input-output
j ⭓ 0, j ⫽ 1, . . . , 55. levels for three selected banks. DMU2 is a DRS bank in
Stage 2, therefore we use the original CCR results to
In effect, we first increase DMU o ’s current output project the current levels of employees, assets, equity,
levels by *o (moving the bank onto point P as in Figure revenue, and profit in Stage 1. Then, in Stage 2, we use
3a), then decrease the three input levels by an input- the new CCR results to adjust the levels of MV, TRI, and
oriented CCR model (moving the bank onto point G in EPS. Because no input slack is detected during CCR
Figure 3a). analysis in Stage 2, the adjusted revenue and profit levels
Finally, we obtain an efficient input-output level in in Stage 2 are the same as those in Stage 1.
Stage 1 by setting DMU35 is an IRS bank in Stage 2, and the sensi-
tivity analysis of RTS classification indicates that the
冦
⫺*
Employees Stage1 ⫽ *o employees ⫺ s employees
⫺* original CCR score is greater than *o (1.51298
Assets Stage1
⫽ *o assets ⫺ s assets
⫺*
Equity Stage1 ⫽ *o equity ⫺ s equity ⬎ 0.01630). Therefore the levels of revenue and
Stage 1
Revenue Stage1 ⫹*
⫽ *o revenue ⫹ s revenue profit are increased proportionally by 0.01630, and
Profit Stage1 ⫹*
⫽ *o profit ⫹ s profit we use the input-oriented CCR model to move
DMU35 onto the best-practice frontier in Stage 1.
Step 2. Apply case (i) to other banks and obtain the Finally, we move this Stage 1 frontier bank onto the
corresponding efficient input-output levels. best-practice frontier in Stage 2.
Step 3. Calculate (1) again with the new Revenue Stage1 DMU50 is an IRS bank in Stage 2 with o1* ⬍ *o .
and Profit Stage1 levels obtained from Steps 1 and 2 as Therefore we apply the same procedure as for
new input levels in Stage 2. We then obtain the DMU2.
following efficient input-output levels for DMU o in
3.4 The Effect of Acquisition on Profitability and
Stage 2:
Marketability
冦
⫹*
MV Stage2 ⫽ o2* MV ⫹ s MV Chase Manhattan Corp. (DMU6) and First Interstate
⫹*
TRI Stage2
⫽ o TRI ⫹ s TRI
2*
Bancorp (DMU18) were acquired by Chemical Banking
⫹*
Stage 2 EPS Stage2
⫽ o EPS ⫹ s EPS
2*
Corp. (DMU4) (March 31, 1996) and Wells Fargo & Co.
⫺*
Revenue Stage2
⫽ Revenue Stage1
⫺ s revenue (DMU16) (April 1, 1996), respectively.7 Employing vari-
⫺*
Profit Stage2
⫽ Profit Stage1
⫺ s profit ous expense ratios, Rhoades (1993) shows that during
The above steps improve the profitability and 1981–1986, horizontal bank mergers did not yield effi-
marketability and satisfy the process improvement ciency gains. For our current empirical study, we exam-
rule. Note that the only difference between the ine the potential effect of acquisitions on these banks’
Revenue Stage1 (Profit Stage1 ) and Revenue Stage2 (Profit Stage2 ) performance over profitability and marketability.
is possible nonzero input slacks in Stage 2. How- Two hypothetical DMUs, namely Bank A (DMU4
ever, on the basis of complementary slackness, only ⫹ DMU6) and Bank B (DMU16 ⫹ DMU18), are
one of revenue and profit has a possible nonzero 7
NBD Bancorp acquired First Chicago Corp. and changed its name
slack for each bank in Stage 2. From our empirical
to First Chicago NBD Corp. Also, First Union Corp., Fleet Financial
application, only a nonzero revenue slack of $53 Group, and PNC Bank Corp. acquired First Fidelity Bancorp,
million was found for DMU13 (PNC Bank Corp.). Shawmut National Corp., and Midlantic Corp., respectively. How-
From Table 3, we observe that the condition of o1* ever, data before acquisition are not available for the current study.
Table 4 Adjusted Efficiency Levels for Selected Banks respectively. For example, the number of employees in
Bank A (72443) is the summation of number of em-
Adjusted Level
ployees in DMU4 (39078) and DMU6 (33365). TRI and
DMU2 BankAmerica Corp. Original Level Stage 1 Stage 2 EPS are relative numbers. To obtain an aggregated
number for TRI or EPS, we need information on total
DRS in investment and profit after taxes. Unfortunately, the
Stage current study does not have access to data on total
2 Employees 95288.00 95288.00
investment. Therefore, we use the profit levels to
Assets ($ millions) 232446.00 229124.67
Equity ($ millions) 20222.00 19923.33
combine the TRIs and EPSs respectively.
Revenue ($ millions) 20386.00 29880.00 29880.00
Profit ($ millions) 2664.00 3904.68 3904.68
TRI acquisition
j ⫽ 1j TRI j1 ⫹ 2j TRI j2 , j ⫽ A and B.
Market Value ($ millions) 27148.60 72620.33
Total Returns to Investors (%) 69.40 190.48 where 1j ⫽ (Profit j1/Profit j1 ⫹ Profit j2) and 2j ⫽ (Profit j2/
Earning per share ($) 6.49 17.36 Profit j1 ⫹ Profit j2). Specifically, we consider the convex
combination of the levels of TRIs for the acquired banks.
Adjusted Level
In this case, we have 1A ⫽ 0.61, 2A ⫽ 0.39, and 1B ⫽ 0.54,
DMU35 Firstar Corp. Original Level Stage 1 Stage 2 2B ⫽ 0.46. Note that the profit levels are “profits after
taxes.” Thus, we may derive the EPS for banks A and B
IRS in by
Stage
2 Employees 9263.00 6222.16 Profit j1 ⫹ Profit j2
Assets ($ millions) 19168.30 12875.76 EPS acquisition
j ⫽ , j ⫽ A and B
Profit j1 Profit j2
Equity ($ millions) 1524.80 1024.24 ⫹
Revenue ($ millions) 1740.00 1768.36 1768.36 EPS j1 EPS j2
Profit ($ millions) 228.90 232.63 232.63
Market Value ($ millions) 3393.4 3662.74
Table 5 provides the input and output data on the
Total Returns to Investors (%) 53.50 57.75 two hypothetical banks.
Earning per share ($) 3.00 3.24 We examine the effect of acquisition on profitability
and marketability for two cases. (Note that DMU16 is
Adjusted Level
a CCR-efficient bank in Stage 1.) In Case I, we keep the
DMU50 Signet Banking Corp. Original Level Stage 1 Stage 2
original CCR-frontier fixed, i.e., we keep the CCR-
efficient DMUs (including DMU16) in the reference
IRS in set. In Case II, we exclude DMU16 from the reference
Stage set. This affects the CCR-frontier in Stage 1 but not in
2 Employees 4485.00 4485.00 Stage 2, since DMU16 is a CCR-inefficient DMU in
Assets ($ millions) 11012.90 11012.90
Stage 2. Thus, for marketability, we only need to
Equity ($ millions) 886.70 870.90
Revenue ($ millions) 1145.30 1472.71 1472.71 consider Case I. Table 5 reports the results. In Case I,
Profit ($ millions) 114.30 169.85 169.85 the CCR scores of the two hypothetical banks are
Market Value ($ millions) 1454.50 2387.02 almost the same. In both stages, no obvious efficiency
Total Returns to Investors (%) 31.00 50.88 gain results from the acquisition. (Note DMU16 is one
Earning per share ($) 0.53 1.80
of the referent banks.)
In Case II, removal of DMU16 results in better profit-
ability for both banks A and B. In both cases, DMU30 is
created to represent the result of the two acquisitions.
in the reference set for the evaluation of Banks A and B.
Additivity is assumed in acquisition, i.e., the input
and output levels in Bank A and Bank B are the 3.5 Context-Dependent Performance
summations of the associated input and output levels We have identified best-practice/performance for
for DMU4 and DMU6, and DMU16 and DMU18, profitability and marketability and examined/pre-
Case I Case II
BANK Chemical Banking Corp.
A (plus) Chase Manhattan Corp. New Level Stage 1 Stage 2 Stage 1
Employees 72443.00
Assets ($ millions) 304099.00 CCR Efficiency CCR Efficiency CCR Efficiency
Equity ($ millions) 21046.00 ⫽ 1.19712 ⫽ 2.12843 ⫽ 1.18188
Case I Case II
BANK Wells Fargo & Co. (plus) First
B Interstate Bancorp New Level Stage 1 Stage 2 Stage 1
Employees 46900.00
Assets ($ millions) 108387.00 CCR Efficiency CCR Efficiency CCR Efficiency
Equity ($ millions) 8209.00 ⫽ 1.19137 ⫽ 1.58192 ⫽ 1.09935
scribed improvements for individual banks. Our sug- pared to bank y depends on the presence or absence of
gestions for improvement addressed the radial dis- a third option, say bank z (or a group of banks).
tance from an inefficient bank to the best-practice Relative attractiveness is dependent upon the back-
frontier. However, we have not examined the influ- grounds constructed from alternative options (banks).
ence of similar or closely performing banks. Research- We first develop the following DEA technique to
ers of consumer choice theory point out that consumer construct these different backgrounds for measuring
choice is often influenced by context. For example, a the attractiveness of a particular bank.
circle appears large when surrounded by small circles Define J 1 ⫽ {DMU j , j ⫽ 1, . . . , n} (the set of all n
and small when surrounded by larger ones. Similarly DMUs (banks)) and interactively define J l⫹1 ⫽ J l ⫺ E l
a product may appear attractive against a background where E l ⫽ {DMU k 僆 J l 兩 *(l, k) ⫽ 1, and all slacks on
of less attractive alternatives and unattractive when inputs and outputs are zero}, where *(l, k) is the
compared to more attractive alternatives (Tversky and optimal value to the following linear programming
Simonson 1993). Considering this influence within the problem:
framework of the current study, one would ask “what
is the relative attractiveness of a particular bank when *共l, k兲 ⫽ max 共l, k兲
j , ,共l,k兲
compared to others in terms of profitability and mar-
ketability?” As in Tversky and Simonson (1993), one
agrees that the relative attractiveness of bank x , com-
s.t. 冘
j僆f共J l 兲
j y rj ⭓ 共l, k兲y rk r ⫽ 1, . . . , s;
冘
j僆f共J l 兲
j x ij ⭐ x ik i ⫽ 1, . . . , m; in E l⬘ , where l⬘ ⬍ l. The attractiveness score of a
specific DMU q ⫽ ( x q , y q ) in a specific level E l o , l o
僆 {1, . . . , L ⫺ 1} is defined as the optimal value to the
j ⭓ 0 j 僆 f共J l 兲, (5)
following linear programming problem
where x ik and y rk represent the amounts of the ith
⍀ qlo共 ␣ 兲 ⫽ max ⍀ q 共 ␣ 兲 ␣ ⫽ 1, . . . , L ⫺ l o
input and the ith output of DMU k , and j 僆 f(J l ) means j ,⍀ q 共 ␣ 兲
冘
DMU j 僆 J l , i.e., f represents the correspondence
from a DMU set to the corresponding subscript index s.t. j y rj ⭓ ⍀ q 共 ␣ 兲y rq r ⫽ 1, . . . , s;
j僆f共E l o⫹ ␣ 兲
set.
When l ⫽ 1, Model (5) becomes the original output-
oriented CCR model and E 1 consists of all the efficient
冘
j僆f共E l o⫹ ␣ 兲
j x ij ⭐ x iq i ⫽ 1, . . . , m;
Bank Score Bank Score Bank Score Bank Score Bank Score
Bank Score Bank Score Bank Score Bank Score Bank Score Bank Score Bank Score Bank Score Bank Score
DMU48, with a CCR score of 1.65955, is in Level 5, tiveness score for DMU29 indicates a large difference
whereas, DMU2, with a CCR score of 1.46572, is in relative to the other banks in Level 2 BPF.
the last level. We observe that CCR scores alone do Similarly, for marketability, DMU52, DMU42,
not entirely characterize the performance of these DMU45, DMU41, DMU37, DMU22, DMU15, DMU23,
banks. The stratification which results from DEA and DMU7 are the most attractive banks in each of the
Model (5) provides a better indication of the struc- first 9 levels of BPF. Among the original CCR-efficient
ture of the set of banks. DMUs, DMU52 has the lowest first-degree attractiveness
For profitability, DMU30, DMU29, DMU6, DMU33, score—almost one third of the average. Relative to the
and DMU37 are the most attractive banks for each of the banks in the Level 2 BPF (evaluation background),
first 5 levels of BPF. However, the first-degree attractive- DMU52 exhibits distinctive performance on marketabil-
ness scores for the banks in Level 3, Level 4, and Level 5 ity, compared to the other CCR-efficient banks.
BPFs are very similar. In contrast, the first-degree attrac- The average first-degree attractiveness scores in
Notes. 1. Bank 24 becomes the new CCR efficient DMU due to the removal of Bank 16. The 1st-degree attractiveness score for Bank 24 is 0.86337.
2. The banks in level 2 BPF (with acquisition) are DMUs A, B, 15, 19, 28, 29, 31, 40, and 44.
3. The numbers in parentheses represent the optimal lambda values in the attractiveness measure (6).
Table 7b Effect of Acquisition on Attractiveness Measure for Marketability
Notes. 1. The banks in Level 3 BPF (with acquisition) are DMUs B, 11, 21, 31, 35, 38, 39, 41, 49, 51, and 53.
2. The numbers in parentheses represent the optimal lambda values in the attractiveness measure (6).
each level may be used as a measure of average radial BPF is chosen as evaluation background, we obtain the
distance between successive BPFs. For example, the opposite result on DMUs 5 and 30, i.e., DMU30 is the
average value of 0.72999 for Level 1 in Table 6a most attractive bank, and then DMU5. This indicates
indicates that on average, the two output levels (rev- that different evaluation backgrounds may yield dif-
enue and profit) may be decreased approximately by ferent results on context-dependent performance.
73% before the Level 1 BPF reaches the Level 2 BPF. Note that in Model (1), deleting or adding some
Thus the averages in Tables 6a and 6b portray average inefficient DMUs does not alter the efficiencies of the
performance differences of profitability and market- existing DMUs. However, such actions will obviously
ability between successive BPFs. affect the results from the attractiveness measure (6).
If we consider the second-degree attractiveness for In § 3.3, we examined the effect of acquisition on the
banks in Level 1 BPF (Stage 1), i.e., we set l 0 ⫽ 1 and performance of the banks involved in the acquisition.
␣ ⫽ 2, then we have the optimal values to (5), 0.77653 Now, by (6), one is able to study the effect of acquisi-
(DMU1), 0.38302 (DMU5), 0.55309 (DMU10), 0.67744 tion on the relative attractiveness of the other banks.
(DMU16), 0.65317 (DMU17), and 0.54656 (DMU30). As described in § 3.3, Banks 4 and 6, and Banks 16
Therefore, if Level 3 BPF is chosen as evaluation and 18, are respectively replaced by two hypothetical
background, DMU5 is the most attractive one in banks, A and B. From Model (5), we obtain that, in
profitability, and then DMU30. Whereas if the Level 2 Stage 1, A and B are two new members in the Level 2
BPF. The second and third columns in Table 7a market level, the current study develops a procedure
respectively report the first-degree attractiveness to improve a bank’s profitability and marketability,
scores and the referent banks in the Level 2 BPF for the moving it onto the best-practice frontier while main-
banks in Level 1 BPF after the acquisition. For conve- taining a viable IRS positioning across both stages.
nience, Table 7a also reports the corresponding infor- Our newly developed context-dependent DEA model
mation in Columns 4 and 5 when there is no acquisi- allows one to measure the attractiveness of a bank
tion. The last column in Table 7a gives the change in against the background of its competitors. Finally, our
the attractiveness scores. It can be seen that the attrac- examination of bank acquisition for the data set indi-
tiveness scores for DMUs 5, 10, and 30 remain un- cates that such activity did not affect the performance
changed, while scores for DMUs 1 and 17 are slightly of the banks involved in the acquisition, but did affect
decreased. Note also that the difference between
the attractiveness of other banks.
DMU1’s and DMU17’s scores becomes smaller after
The current study does not attempt to incorporate
the acquisitions. The acquisitions alter the context and
judgment as was done in Charnes et al. (1990). The
cause the performances of DMUs 1 and 17 to be less
incorporation of value judgment, e.g., introduction of
distinct from each other.
weight bounds into the dual of (1), will sharpen DEA
In Stage 2, Model (5) concludes that Bank A belongs
scores and rule out possibly unreasonable values.
to the Level 3 BPF. Therefore we use (6) to measure the
second-degree attractiveness of the banks in the Level Since the current study did not have access to such a
1 BPF, i.e., the banks in the Level 3 BPF serve as the priori information and the number of efficient banks is
referent set. Table 7b reports the results. It can be seen very small (only six out of fifty-five), we did not
that the second-degree attractiveness scores for DMUs employ a cone ratio or assurance region approach.
10, 13, and 48 remain unchanged while the scores for However, with the appropriate information, such an
DMUs 40, 52, and 54 are decreased. Our interpretation approach would be possible. For example, one would
is that the acquisition of Bank 18 by Bank 16 resulted employ the DEA/preference structure model of Zhu
in an increase in the attractiveness of these banks in (1996b) for the two-stage bank production process
terms of marketability. improvement procedure if a preference structure over
Finally, we point out that because of the acquisition, various production factors is available. This method
i.e., deleting and adding of DMUs, the structure of the has improved flexibility for target setting since it
BPFs is changed. For example, in Stage 2, DMUs 24 allows increases on inputs and decreases on outputs.
and 45, which were originally in Level 3 BPF, are now As an alternative approach to performance evalua-
members of the Level 2 BPF. As a result, the first- tion, the current paper employs DEA to analyze the
degree attractiveness score for DMUs 40, 52, and 54 financial performance for the Fortune 1000 (banking)
decreases, i.e., these banks become more attractive data as published by Fortune magazine. The current
compared to the other banks in the Level 1 BPF. study did not have access to such additional factors as
asset quality, capital adequacy, and liquidity which
4. Conclusions and Future Research could provide additional insight into the financial
The paper analyzes the profitability and (stock) mar- performance of commercial banks. The relationships
ketability of the top 55 U.S. commercial banks in 1995 of these dimensions to the profitability and market-
using an innovative two-stage DEA model. Close to ability of banks deserves to be further studied.
90% of the banks were inefficient in both profitability In addition, at the time of this study, data for
and marketability. Further, most large banks exhibited succeeding years had not been published and the data
DRS in marketability, while some of them exhibited for prior years are incomplete. However, in future
IRS in profitability. This suggests that bank size may studies, we do expect to examine performance over
have a negative effect on marketability. Having exam- time with window analysis and the Malmquist pro-
ined performance at both the institutional level and ductivity change index techniques. Such an approach
would allow a dynamic view of the banks’ profitabil- oriented DEA method, then DMU o exhibits DRS under output-
ity and marketability over time. 11 oriented DEA method.
Theorem 1. (Relationship between the output-oriented and input- under an output-oriented DEA method.
oriented RTS classifications.) Suppose DMU o exhibits IRS under an Furthermore, we have
output-oriented DEA method. Then DMU o exhibits IRS under an
冘
n
input-oriented DEA method.
*j x ij ⭐ x io i ⫽ 1, 2, . . . , m;
Proof. Since DMU o exhibits IRS under an output-oriented DEA j⫽1
*j y rj ⭓ * y ro r ⫽ 1, 2, . . . , s;
max j⫽1
冘 冘
n
n
s.t. jx j ⭐ x o *j ⭓ 1,
j⫽1
j⫽1
.
冘
n where * is the optimal value of ot in (B.1) when evaluating DMU o
j ⭓ 0. (B.1)
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Accepted by Stavros A. Zenios; received April 1997. This paper has been with the authors for 2 revisions.