Distracted Banks and Corporate Bond Pricing

Abstract

Bank attention plays an important role in the pricing of corporate debt. Prior studies show that bank loans serve as certification and monitoring mechanisms that signal firm quality to bond markets. To separate continuous monitoring effects from certification effects, we use a measure of bank distraction that results from exogenous shocks to unrelated parts of the bank loan portfolio. Firms with distracted bank lenders have higher credits spreads, especially when distraction is caused by negative attention-grabbing events. The effect is stronger in lower-rated bond issues and when default risk and information asymmetry are high. Bank distraction remains important even for bond issues with a high degree of covenant protections. Greater monitoring losses arise from the distraction of industry specialist banks. Overall, our findings suggest that a temporary decrease in bank monitoring due to unrelated attention-shifting shocks creates negative externalities in the public debt market.

Keywords: Agency Problems, Conflicts of Interest, Limited Attention, Bank Monitoring, Bond Yields

JEL Classification: G12, G21, G30