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Financial profile of merging rural electric cooperatives in the year prior to consolidation: a study of coop merger activity over the time period 1948-1988.


There is an increasing amount of discussion and activity in the electric cooperative, rural public power and public utility industry regarding mergers and consolidations. These systems are pursuing merger and consolidation efforts as a means of improving competitive position through increased efficiency and cost savings. It is for these reasons that many industry officials from NRECA, CFC and state associations have also strongly supported mergers and consolidations.

The goal of improving competitive position through merger or consolidation may be accomplished through several motives, including:

1. To reduce debt.

2. To increase liquidity.

3. To increase asset utilization.

4. To increase profitability.

5. To increase managerial efficiency.

6. To engage economies of scale.

The purpose of this study is to seek to discriminate merged cooperatives from non-merged cooperatives through an analysis of financial and operational profiles of statistically similar systems in the year prior to merger or consolidation. If it can be shown that financial and operational performance improved from before to after the merger, then strong support exists for increased cooperative mergers and consolidation is suggested.

If mergers are motivated by the desire to improve efficiency and financial performance, then it follows that the performance of the non-merged cooperatives will be better than the merged cooperatives in the year prior to the merger. If the comparison shows the emerging cooperatives to be financially weaker than the matched sample of non-merged cooperatives, then it is reasonable to conclude that the underlying reason for the merger is to improve financial and operational performance.

The composition of the merged group of cooperatives consists of the 50 cooperatives which entered into a merger between 1948 and 1988. A like number of non-merged cooperatives were selected. To reduce bias, the merged and non-merged systems were matched on the basis of location, size, consumer density, revenue composition and the chronological time period. Therefore, the cooperatives were almost identical in every respect, except that one entered into a merger and the other did not.

The financial and operational performance was measured by several industry accepted rations which fell into one of five categories:

1. Profitability ratios

2. Efficiency or expense ratios

3. Debt usage ratios

4. Liquidity ratios

5. Activity ratios

In general, the results of the study indicate that the merging cooperatives exhibited weaker profitability, efficiency, assets utilization and liquidity, along with increased debt usage compared to the non-merged cooperatives in the year prior to merger or consolidation. These results offer strong support for promoting merger or consolidation as a means of generating economies of scale and increased efficiencies and savings for cooperative members. Continued research needs to be performed to conclude whether increased efficiencies and financial performances are achieved as a result of the merger.

Please read the following article by Dr. Bacon and Dr. Shin to gain a better understanding of the methodology and results, and of the direction of future research.


Recently, the concept of merger has captured much attention at the local, statewide, and national rural electric cooperative levels. Many industry officials (from NRECA, CFC, and statewide organizations) strongly support mergers as a means of increasing efficiency in the industry. While the expectation of savings resulting from mergers appears likely, little "hard" evidence exists to support the claim. With few exceptions (Claggett, 1987; Bacon and Shin, 1988; and Macke and Hahn, 1989) most explanations of merger effects have been primarily descriptive and normative (opinions, prescriptions, or unsupported statements about the should-be advantages of a co-op merger). The empirical works cited attempt to explain the effects of the observed rural electric cooperative (REC) merger activity in an unbiased manner.

In an article (Fall, 1990), we examined these studies, evaluated their findings, identified possible REC merger motives, outlined an acceptable model of REC merger research, and proposed a more appropriate study within the design of our model to further explain the effects of REC merger activity on the industry. In this article, we briefly explain how we conducted the REC merger study and provide a summary of the results. Specifically, the purpose of this work is to provide a financial and operating profile of merging RECs in the year prior to consolidation.


The merger issue advances several meaningful, common-sense questions. Why should co-ops merge? Are there financial, operating, or other economic benefits associated with an REC merger? If so, what are the sources of the gains? Also, what is the rationale for expecting such gains from REC mergers? It is reasonable to expect that REC mergers are motivated by attempts to maximize the benefits for the owner/consumers. Possible REC merger motives are presented in Table 1.

The reasons for co-op mergers appear to focus primarily on efforts to increase efficiency and/or engage economies of scale. In an effort to identify possible merger effects we examined the REC mergers that have taken place in the industry.


Specifically, this research seeks to discriminate merged from non-merged RECs on the basis of certain financial and operating characteristics and performance (possible motives for REC mergers) before the merger. The statistically significant discriminators are then labeled as possible reasons of co-op mergers. For example, if it can be shown that the merger phenomenon improves performance from before to after the merger, then strong support for increased REC mergers is suggested.

Can the merged RECs be distinguished from a matched sample of non-merging RECs on the basis of certain operating and financial characteristics? If so, then the merged RECs can be presumed to possess commonalities (unique financial and operating characteristics) which can discriminate them from their non-merged counterparts. If mergers are motivated by the desire to increase efficiency, then it follows that in the year prior to consolidation, merging RECs should exhibit significantly measurable differences from the matched sample of non-merged firms on the basis of efficiency. Thus, it is reasonable to expect the merging RECs to exhibit significantly lower efficiency measures when compared to the non-merging RECs just prior to the merger. This is plausible because the merging firms may be suffering from inefficiency (excessive costs per consumer) partly due to suboptimal size. Therefore, as a rational solution, the smaller, weaker RECs could merge into larger more cost efficient organizations.

Motive Rationale

To reduce debt Because certain smaller RECS may face
 excessive debt and interest charges,
 it follows that a merger creating a
 larger firm might be more efficient
 and lower the firm's debt burden.

To increase liquidity Mergers of smaller RECs into larger
 organizations may improve cash
 availability and liquidity management.

To increase activity Low activity may reflect poor
(asset utilization) management use of assets;
 thus mergers may be a way of
 improving asset utilization.

To increase profitability Because of higher distribution costs,
 acquired RECs may be less profitable
 than their larger merger partners.
 Thus, mergers may increase efficiency,
 reduce unit costs, and elevate co-op

To increase managerial Firms with weaker managerial
efficiency can be acquired by firms with stronger
 managerial talent resulting in
 increased REC efficiency.

To engage economies of Mergers may produce economies of scale
scale - involve "indivisibilities," such as
 people, equipment, and overhead,
 which provide increasing returns if
 spread over a large number of units
 of output.

Specifically, the study statistically compares the financial data of a matched sample (by size, consumer density, time, revenue composition, and location) of nonmerging RECs to that of merging RECs in the year prior to the merger. Our interest is to identify any major financial and operating differences in the two groups that might link to possible motives for merger. For example, if the comparison shows the merging RECs to be financially weaker than the matched sample of nonmerging RECS, then it is reasonable to conclude that an underlying reason for the merger could be to financially strengthen the merging RECs.

This study utilized the data for 42 REC mergers reported by Gibson (1987) and other industry officials for the period 1948-1988. The RECs of interest in this study are of the distribution type only. Annual balance sheets, income statements, and other operating information for approximately 1000 RECs for the period 1942-1988 have been acquired from the Rural Utilities Service (RUS), an agency of the United States Department of Agriculture headquartered in Washington D.C. These data are presented in REA's annual publication of Bulletin Number 1-1, Statistical Report of Rural Electric Borrowers.

The merged group of RECs consists of the 50 co-ops which entered into a merger over the time period 1948-1988. For comparison, a group of 50 nonmerged RECs was selected. To minimize the bias associated with systematic differences between groups, merged firms were paired with nonmerged firms on the basis of location, size, consumer density, revenue composition, and the chronological time period. By matching these samples, we eliminate the effects of these obvious differences and are able to focus directly on the effects of the merger event. In essence, the 50 pairs of merged and nonmerged finns (total of 100 firms) are almost identical in every way except one entered into a merger and the [TABULAR DATA FOR TABLE 2 OMITTED! other did not. This technique strengthens the reliability of our findings. Since members of the two groups now have similar characteristics (due to matching), it is hoped that observed differences between groups can be attributed to the effect of the merger event with reasonable confidence.

If mergers are motivated by the desire to increase efficiency, then it is logical to expect significant group differences in financial and operating ratios to surface in the year prior to merger. Table 2 provides definitions of the financial and operating ratio variables and expected outcomes. If mergers are inspired by a desire to increase efficiency, then it is logical to expect the merging firms to be financially and operationally weaker than the matched sample of non-merged co-ops in the year prior to merger.

Using this rationale, the merger takes place because the parties involved apparently expect the combination (of smaller firms into one larger firm) to generate financial and operating gains in the future. Therefore, as shown in Table 2, it is reasonable to expect the merging group to exhibit lower profitability, lower efficiency (higher expense ratios), higher debt usage, lower liquidity, and lower activity (asset turnover) than the matched sample of non-merging RECs. Appropriate statistical tests are used to test for significant differences in the group measurements.


Table 3 presents means and the net group differences (merged variable means less nonmerged means) one year before merger. For example, the net difference in variable X4 (net income as a percent of operating revenue) between groups was -0.08315 as predicted. For example, the net difference in X10 (long-term debt as a percent of total assets for the merged group minus that for the nonmerged group) is positive as expected. Compared to the size, time, density, revenue composition, and location matched nonmerged group, the merged RECs exhibited heavier debt usage in its capital structure.

As predicted, all expense measures as a percent of operating revenue (X5, X6, X7), and X8 (total employees as a percent of total consumers) were higher for the merging group when compared to similar non-merging co-ops. This evidence points to merging firms' weaker ability to control costs. This result supports the claim that mergers may be motivated by the desire to increase efficiency. These differences advance the possibility of economies of scale in operations as a maximization of savings intention of merger. In the year before merger the nonmerged RECs significantly outperformed the merged sample on the basis of all the profitability measures. As predicted, all profitability ratios (X1, X2, X3, and X4) for the merged group were significantly lower than the matched control sample. The poor profitability performance strongly supports a possible rescue motive for merger.

As expected, results on debt usage (X9, X10, and X11) for the two groups indicate that the merged firms relied more on debt financing than the matched sample of nonmerged co-ops. The merged group's high debt and financing costs help explain the group's weak profitability. Also, the large debt could signal impending financial distress, a logical excuse for intra-industry rescue.

As predicted, the liquidity measures (X12 and X13) showed the merged group's liquidity position to be significantly weaker than the nonmerged RECs. In agreement with earlier explanations, the poor liquidity position is yet another logical warning of forthcoming financial problems.

In general, the results indicate that the merging co-ops exhibit weaker profitability, efficiency, asset utilization (X14), and liquidity along with increased debt usage in the year before merger when compared to a time, size, density, revenue composition, and location matched sample of non-merging co-ops. Though not reported here, these findings were supported by other more sophisticated statistical tests conducted using the above data. This study offers strong support for promoting mergers as a [TABULAR DATA FOR TABLE 3 OMITTED! means generating economies of scale and increasing savings for co-op members. To provide stronger evidence of the link between mergers and economies of scale (savings to members), further study is necessary.


Since the merging RECs appear to be significantly less efficient than the non-merging RECs just prior to merger, a logical research extension of the question of REC mergers and efficiency would be to see if efficiency increases from before to after the merger. Do the combined RECs exhibit significant efficiency performance gains from before to after the merger event? If mergers are motivated by desires to increase efficiency, then it follows that merged finns ought to show significant gains in efficiency variables from before to after the merger.

Bacon and Shin are currently conducting this study using the same 42 REC combinations over the period 1948-1988. The group of merged firms will be statistically compared to a matched sample (by size, consumer density, location, and chronological time period) of non-merged RECs. Observations up to five years before and five years after the merger will be statistically analyzed. If REC mergers are associated with increases in efficiency, then the merged RECs in this study ought to significantly outperform the matched sample on the basis of the efficiency variables.

This direct study of REC mergers should aid in clarifying the questions raised by the work reviewed herein. Also, this research should provide some "hard" evidence for the industry leaders (RUS, CFC, and NRECA) in directing the future growth of rural electrification through merger.


Bacon, Frank and Tai Shin, "A Study of Selected Rural Electric Cooperative Mergers During the Period 1962-1984." Management Quarterly, (Fall, 1988), pp. 13-25.

Claggett, E. Tylor, "Cooperative Distributors of Electrical Power: Operations and Scale Economies," Quarterly Journal of Economics and Business, (Summer, 1987), pp. 3-21.

Macke, Donald and Kandra Hahn, "A Deeper Look at Economies of Scale and the Question of Merger: A Study of Nebraska's Rural Electric Systems," Management Quarterly, (Winter, 1989-1990), pp. 25-38.

Frank W. Bacon, Ph.D., has served on the board of directors of Southside Electric Cooperative in Crewe, Virginia since 1984 and currently holds the office of treasurer. He also serves on the board of the Virginia-Maryland-Delaware Association of Electric Cooperatives. He is an associate professor of finance at the Longwood College School of Business and Economics in Farmville, Virginia. Dr. Bacon recently completed Ph.D in finance at Virginia Commonwealth University. He has published several articles in both academic and industry journals from his dissertation which focused on rural electric cooperative merger research. One of these articles was published in Financial Management (the Journal of the Financial Management Association) which is considered to be among the "top three" finance journals in the world.

He received his Bachelor of Science in business administration from the University of Richmond and a Master of Science in finance from Virginia Commonwealth University. Dr. Bacon resides in rural Southside Virginia where he farms part-time (tobacco, cattle, and small grain) and also serves on several regional and local boards including his local county board of supervisors. He has strong research interests in the Rural Electric Cooperative Organization's development and role in rural economic growth.

Tai S. Shin, Ph.D., is a professor of finance and the coordinator of the finance faculty in the School of Business at Virginia Commonwealth University. He received his B.A. from Oklahoma City University, his M.A. and Ph.D. from the University of Illinois at Champaign-Urbana. He teaches corporate finance, investments, and banking. He has published articles in academic and professional journals.
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Author:Bacon, Frank W.; Shin, Tai S.
Publication:Management Quarterly
Date:Mar 22, 1996
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