Abstract
The paper attempts to analyze whether shareholders value as intangible assets the management decisions of bank production plan, in terms of cost efficiency, and risk associated to bank portfolio composition, in terms of probability of default (PoD). To test the market response to both management decisions, we employ a regression equation for bank valuation, using the panel regression model estimation procedure with country and year fixed effects, for the listed banks of 15 European countries, during the period 1997–2016. The results show that shareholders value both the efficiency of the production plan and the default risk. In particular, shareholders positively value banks’ cost efficiency and negatively value those banks with high PoD. These findings have important policy implications and show that the market value performance allows for the provision of more insights than book value into potential drivers of banks’ system stability and potential mechanisms for regulators and supervisors to maintain and control bank stability.
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Notes
- 1.
The agency cost appears in banking when the goal of the manager is not aligned with one of the shareholders, since, while the goal of shareholders is to maximize the firm’s market value, the managers pursue maximizing their own utility. This nonaligned goal leads to outcome inefficiency in the production process.
- 2.
- 3.
The pioneer work on this area is the Demsetz et al. (1996) study. The authors relate the franchise value of the banks not with probability of default but with other bank risks as the solvency risk and the portfolio risk.
- 4.
In the banking literature, there are three alternative approaches to measuring bank outputs and inputs based on the classical microeconomic theory (production, intermediation, and user-cost approaches). Based on the intermediate role that banks play in the economy, we use the intermediation approach—approach widely used in the banking empirical analysis.
- 5.
During the sampling period, the average market capitalization increased until 2007, followed by a significant decline in 2008 and thereafter. A similar pattern is found in the median value, although, from 2013, the median market capitalization slowly rebounded.
- 6.
We consider as large banks those banks with total assets larger than $20 bn.
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Acknowledgment
The authors are very grateful to the participants of the Second Santander Chair International Workshop of Efficiency and Productivity 2018, the 8th International Conference of The Financial Engineering and Banking Society, and the X North American Productivity Workshop for the comments received. We also thank an anonymous reviewer for their valuable and insightful suggestions. Claudia Curi acknowledges the financial support from the Free University of Bozen-Bolzano. The authors acknowledge the financial support from the Spanish research national program (grant reference RTI2018-097620-B-I00).
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Curi, C., Lozano-Vivas, A. (2020). Probability of Default and Banking Efficiency: How Does the Market Respond?. In: Aparicio, J., Lovell, C., Pastor, J., Zhu, J. (eds) Advances in Efficiency and Productivity II. International Series in Operations Research & Management Science, vol 287. Springer, Cham. https://doi.org/10.1007/978-3-030-41618-8_13
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