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

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

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

17 Scopus citations

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.

Original languageEnglish
Pages (from-to)187-201
Number of pages15
JournalJournal of Banking and Finance
Volume87
DOIs
StatePublished - 1 Feb 2018

Keywords

  • Agency and information risk
  • Corporate governance
  • Managerial ability
  • Stakeholder relationship
  • The cost of debt

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