Moral Hazard, Bank Monitoring, and Bond Spreads

Abstract

We test the hypothesis that bank monitoring causes lower yields on public bonds. We find that firms with a banking relationship have 15 basis points lower yield spreads on their public debt, similar in magnitude to a two-notch rating upgrade, or a standard deviation increase in profitability. The effect of a banking relationship is larger for firms with a dispersed bond ownership, junk debt, and no credit default swaps. Our results are robust to IV estimation and a quasi-natural experiment. In the market for information production, it appears that bank monitoring cross-subsidizes credit risk, directly benefiting bondholders.

Keywords: Bank Monitoring, Security Prices, Corporate Debt, Bond Yields, CDS Spreads, Cross-Monitoring, eMAXX, Trace

JEL Classification: G21, G23, G34