Is managerial ability a moderator? The effect of credit risk and liquidity risk on the likelihood of bank default

This study investigates the effect of credit and liquidity risks as well as the moderating role of managerial ability on the likelihood of European commercial bank default during the period 2006 to 2017. We employ data envelopment analysis and a tobit model to measure banks' efficiency, the z-score to measure the likelihood of their default, and perform endogeneity and model specification robustness tests. Our results reveal that both risks significantly affect the likelihood of bank default and that the high skill of managers does not attenuate this effect. Rather, in the case of credit risk, managerial ability extenuates this effect. Managerial overconfidence and narcissism may explain the latter result. Another plausible explanation is that highly skilled managers who are likely to be rewarded with performance-based compensation schemes may be incentivized to hide bad news for an extended period of time. Such a scenario would increase the likelihood of bank default.