Relating Cost Efficiency and Profitability of Merged Firms in the Kenyan Financial Services Industry

Theory holds that firms merge to benefit from economies of scale, diversification and synergy, which are realized through cost efficiency. Empirical studies on the other hand report mixed findings with regard to the theoretical underpinnings given the changing financial and technological environment. This paper sought to determine the cost efficiency ratios of merged firms in the Kenyan financial services industry and establish the effect that those ratios have on profitability (inferred using the rates of return on assets and equity). Using a mixed research design, pre and post-merger secondary data was collected from 41 firms in the Kenyan financial services industry that had concluded their merger processes by 31 December 2013. Primary data was used to explain the results of the secondary data. Panel data analysis was used to determine the change in the study variables and trends over between 2009 and 2013, event window (pre-merger and post-merger) analysis was used to test the difference in cost efficiency means before and after the merger while regression analysis was used to determine the relationship between cost efficiency and profitability. Results indicate that cost efficiency improved after merger and resulted to the growth in the rate of return on assets and equity, which was attributed to the efficiency in the use of labour, financial resources and managerial effort.