Debtholder Monitoring Incentives and Bank Earnings Opacity

Abstract

We exploit exogenous legislative changes that alter the priority structure of different classes of debt to study how debtholder monitoring incentives affect bank earnings opacity. We present novel evidence that exposing nondepositors to greater losses in bankruptcy reduces bank earnings opacity, especially for banks with larger shares of nondeposit funding, listed banks, and independent banks. The reduction in earnings opacity is driven by a lower propensity to overstate earnings and becomes larger during crises, when the incentive to conceal capital shortfalls is stronger. Our findings highlight the importance of creditors’ monitoring incentives in improving the quality of information disclosure.

Keywords: debtholder monitoring incentives, bank earnings opacity, earnings management, debt structure

JEL Classification: G21; G28