Does equity holding by main banks affect the earnings quality of client firms? Empirical evidence from Japan

Abstract

This paper empirically investigates the role of the main banks in enhancing earnings quality of their client firms in Japan and unveils some intriguing results. First, equity holdings of the main banks improve earnings quality of their client firms. Second, such shareholdings help attenuate the adverse effect of foreign shareholdings on earnings quality, indicating that the main banks can substitute the monitoring role of foreign shareholders. Third, the effect of institutional, executive and dominant shareholdings on earnings quality disappears when the main banks inject equity, implying that the main banks can significantly reduce agency problem in financial intermediation even in Japan’s contemporary financial setup where the market-based monitoring system for firms has been encouraged. Furthermore, the role of the main banks remains significant when the cross-shareholding and stable shareholding are taken into account, suggesting that the equity ownership of the main banks help improve earnings quality through effective monitoring.