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1 Acknowledgments. We would like to thank the University of Zagreb for fi nancial support granted to the research project "Impact of Enterprise Risk Management on the company's fi nancial performance in a period of the global fi nancial crisis". Thanks are extended to delegates of the 1 st International Conference in Financial Analysis for valuable suggestions how to improve our research. We appreciate all the help we received, but any remaining errors are our own responsibility. *

Abstract:The fact that cap-weighted indices provide an ineffi cient risk-return trade-off is well known today. Various research approaches evolved suggesting alternative to cap-weighting in an effort to come up with a more effi cient market index benchmark. In this paper we aim to use such an approach and focus on the Croatian capital market. We apply statistical shrinkage method suggested by Ledoit and Wolf (2004) to estimate the covariance matrix and follow the work of Amenc et al. (2011) to obtain estimates of expected returns that rely on risk-return trade-off. Empirical fi ndings for the proposed portfolio optimization include out-of-sample and robustness testing. This way we compare the performance of the capital-weighted benchmark to the alternative and ensure that consistency is achieved in different volatility environments. Research fi ndings do not seem to support relevant research results for the developed markets but rather complement earlier research (Zoričić et al., 2014).

According to the agency theory, debt brings discipline to management and therefore, one way of reducing agency costs is by increasing the level of indebtedness. Even though there are a number of specificities of banks as corporations, this agency theory postulate should still be valid. This research is motivated by the need to understand microeconomics of banking better, which could be especially rewarding in CEE countries where the issues of credit risk, bank capital and corporate governance are specific. Accordingly, by testing the disciplinary role of debt in Croatian banks, we contribute to the still scarce literature on bank governance in Croatia. We operationalise the research by first generating an efficiency measure, which we believe adequately represents management efforts and ability to maximize the value of owners’ investment. In the next step, we explore the relation between banks' efficiency and leverage. Our results do not indicate that debt generally creates a discipline mechanism for bank managers in Croatia.