Microfoundations for Performance, Competition and Econometric Implications

We consider two agency-theory-based structural models and a reduced form model of bank inefficiency. The two structural models assume that the inefficiencies and quantities are sequentially and simultaneously determined, respectfully. The reduced form model assumes that inefficiency of a bank depends on other banks' inefficiencies. We argue that conventional stochastic frontier models would give inconsistent parameter estimates as they ignore systematic nature of managerial decision making process. We estimate the inefficiencies of Eurozone banks using our novel structural and reduced form approaches that calls for certain MCMC techniques. Bayes factor favors the sequential model where the efficiency is determined first. In the empirical application for the Eurozone, we find a pick in structural and non-structural inefficiency after the financial crisis and considerable variability across Member States. A way of tackling such banking imbalances is to move towards a banking union