Delegated Bank Monitoring by Bond Investors: Evidence from Japanese Main Banks

We investigate whether bank monitoring based on private information in private debt reduces the reliance on public earnings information in public debt. We focus on Japanese main banks, which have a high ability to access the private information of borrowing firms by exploiting their position as both large creditors and shareholders. Previous studies show that the Japanese main bank has a strong incentive to monitor borrowing firms when they are performing poorly, while it never intervenes in their management as long as their financial performance is stable. We find that under stable financial conditions in bond-issuing firms, accrual quality is negatively associated with bond yield spreads. In contrast, when bond-issuing firms with a main bank have a high default risk, there is no relationship between accruals quality and bond yield spread. The results suggest that when a main bank has a stronger incentive to monitor its borrowing firms, bondholders are more likely to delegate the screening role to the main bank with private information, leading to a reduction in the reliance on firms’ public earnings information in bond contracts.