Relationship Banking and Firms’ Earnings Quality – Does it Matter Whether Banks are Creditors or Owners?

57 Pages Posted: 21 Jul 2023

See all articles by Jochen Bigus

Jochen Bigus

Free University Berlin, Department Accounting and Finance

Marina Weicker

Free University of Berlin (FUB)

Date Written: July 14, 2023

Abstract

There is mixed empirical evidence on whether close bank relationships are associated with lower or higher earnings quality of borrowing firms. This paper analyzes how this evidence can be explained by the role of the bank, whether the bank is a creditor or equity-holder of the firm. We use a sample of Japanese public firms. In Japan, (1) banks historically have both close financial and personal ties to borrowing firms, (2) banks are not only lenders, but are also permitted to have an equity stake in the firm, and (3) detailed data on bank relationship characteristics are publicly available.

One key result is that relationship banking is associated with lower earnings quality if the bank only provides debt. This effect is more pronounced in years of an economic upturn. The results are in line with the theoretical literature, which argues that borrowing firms that want to conceal good performance from competitors benefit from relationship banking because banks’ access to private information lowers the demand for high earnings quality. However, if banks have an equity stake, they are more concerned about complying with insider-trading rules and governing agency problems of equity by efficient executive compensation contracts. Consistently, the second main finding is that the firm’s earnings quality improves significantly with a bank’s equity stake, regardless of the state of the economy. These results are robust according to various specifications of relationship banking or earnings quality.

Keywords: relationship banking, earnings quality, bank’s equity holdings

JEL Classification: M41, G21

Suggested Citation

Bigus, Jochen and Weicker, Marina, Relationship Banking and Firms’ Earnings Quality – Does it Matter Whether Banks are Creditors or Owners? (July 14, 2023). Available at SSRN: https://ssrn.com/abstract=4509958 or http://dx.doi.org/10.2139/ssrn.4509958

Jochen Bigus (Contact Author)

Free University Berlin, Department Accounting and Finance ( email )

Van't-Hoff-Str. 8
Berlin, Berlin 14195
Germany
++49-30-83852509 (Phone)

Marina Weicker

Free University of Berlin (FUB) ( email )

Van't-Hoff-Str. 8
Berlin, Berlin 14195
Germany

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