Grading bank managers: governance and performance implications of managerial ratings

Abstract

Banks face corporate and regulatory governance pressures. A critical tool of regulatory governance is direct monitoring by bank supervisors. Supervisors assess banks using a multi-dimensional rating scheme, including a rating of top management teams (M-rating). We examine implications of M-ratings from the distinct, but complementary perspectives of managerial capital and managerial discipline. We document that better M-ratings are associated with fewer future non-performing loans and lower likelihood of bank failure. Consistent with managerial capital commanding a higher performance premium during challenging economic times, we find that higher macro-economic uncertainty magnifies the performance premium associated with M-ratings. Relatedly, the value of managerial capital is conditional on bank fundamentals, where M-ratings positively influence future performance when they exceed the composite supervisory rating but have a negative effect when lower than the composite rating. Consistent with M-ratings serving an implicit incentive role through managers’ career concerns, we document that for poorly performing banks, higher M-ratings decrease the probability of CEO turnover. Overall, our study provides the first large-sample evidence of how bank regulators assess banks’ managerial capital and how M-ratings affect bank corporate governance.

Keywords: Subjective Performance Evaluation, Bank Supervision, Banking, Financial Institutions, Bank Regulation