Moral Hazard, Bank Monitoring, and Bond Spreads

Abstract

We test whether bank loans change public bond yields. A 10% increase in bank debt raises bond yields by 15bps, reflecting a trade-off between the benefits of bank cross-monitoring and higher bond risk. This effect is smaller for firms with no CDS and junk debt, where bank monitoring is most valuable. It is unlikely that firms with bank debt are riskier because they are less likely to be downgraded and have lower loan spreads. We find similar results using a natural experiment around the 2014 oil shock. Our results highlight how bond yields depend on incentive conflicts among creditors.