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Can lenders discern managerial ability from luck? Evidence from bank loan contracts

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  • Bui, Dien Giau
  • Chen, Yan-Shing
  • Hasan, Iftekhar
  • Lin, Chih-Yung

Abstract

We investigate the effect of managerial ability versus luck on bank loan contracting. Borrowers showing a persistently superior managerial ability over previous years (more likely due to ability) enjoy a lower loan spread, while borrowers showing a temporary superior managerial ability (more likely due to luck) do not enjoy any spread reduction. This finding suggests that banks can discern ability from luck when pricing a loan. Firms with high-ability managers are more likely to continue their prior lower loan spread. The spread-reduction effect of managerial ability is stronger for firms with weak governance structures or poor stakeholder relationships, corroborating the notion that better managerial ability alleviates borrowers’ agency and information risks. We also find that well governed banks are better able to price governance into their borrowers’ loans, which helps explain why good governance enhances bank value.

Suggested Citation

  • Bui, Dien Giau & Chen, Yan-Shing & Hasan, Iftekhar & Lin, Chih-Yung, 2018. "Can lenders discern managerial ability from luck? Evidence from bank loan contracts," Journal of Banking & Finance, Elsevier, vol. 87(C), pages 187-201.
    • Handle: RePEc:eee:jbfina:v:87:y:2018:i:c:p:187-201
    DOI: 10.1016/j.jbankfin.2017.09.023
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    More about this item

    Keywords

    Managerial ability; The cost of debt; Agency and information risk; Corporate governance; Stakeholder relationship;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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