Bank risk – Return Efficiency and Bond Spread: Is There Evidence of Market Discipline in Europe

Abstract

We empirically investigate whether bank bondholders value bank managerial ability, measured as risk-return efficiency, when pricing bond spreads. We find, based on a sample of 1,924 bonds issued by 67 European listed banks, for the period 2002-2011, evidence that bank managerial ability affects bond spreads, banks with more capable managers obtain a lower cost of debt. In particular our results show that bank bondholders are always sensitive to bank managerial ability when pricing bonds, both in time of distress and sound periods, while the default proxy is only significant during the time of distress.