An analysis of inefficiencies in banking: A stochastic cost frontier approach

The properties of X-inefficiency and the relations of X-inefficiency with risk-taking and stock return for US banking firms is examined. After controlling for scale differences, the average small size banking firm is found to be relatively less efficient than the average large firm. Smaller firms also exhibit higher variations in X-inefficiencies than their larger counterparts. While the average X-inefficiency appears to be declining over time, the rank orderings of X-inefficiency are found to be quite persistent. Furthermore, less efficient banking firms are found to be associated with higher risk-taking, and firm-specific X-inefficiencies are significantly correlated with individual stock returns for smaller banking firms.