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X-Efficiency and Management Quality in Commercial Banks

by Robert DeYoung

OCC Working Paper 94-1, January 1994.

Abstract

This study uses a thick frontier cost methodology to estimate the difference in X-inefficiency between well-managed and poorly managed national banks in 1991. National banks are separated into these two groups according to the management quality (M) rating assigned to them by OCC bank examiners. After adjusting for exogenous factors assumed to be beyond the control of management, unit costs at poorly managed banks averaged about 12 percent higher than unit costs at well-managed banks.

This result is around two-thirds as large as estimates of overall X-inefficiency found both here and in other banking cost studies, suggesting that a large portion of the cost inefficiency in commercial banks is associated with the quality of the managers that run those banks. About 90 percent of the management-related X-inefficiency is attributed to differences in management quality associated with subpar financial performance (e.g., poor asset quality or low earnings) and the remaining 10 percent is attributed to differences in management quality not reflected by financial performance (e.g., poor internal controls that might foster principal-agent problems).

Disclaimer

As with all OCC Working Papers, the opinions expressed in this paper are those of the author alone, and do not necessarily reflect the views of the Office of the Comptroller of the Currency or the Department of the Treasury.

Any whole or partial reproduction of material in this paper should include the following citation: DeYoung, Robert, "X-Efficiency and Management Quality in Commercial Banks," Office of the Comptroller of the Currency, E&PA Working Paper 94-1, January 1994.

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