Relationships among earnings quality, bank monitoring, and cost of bank loans: evidence from Japan

Abstract

Earnings quality is frequently used as a proxy for information risk in accounting contexts. Following previous literature, I analyse the relationship between earnings quality and the cost of bank loans in Japan. I hypothesise and test how bank monitoring affects the relationship between earnings quality and the cost of loans. I find that total earnings quality, innate earnings quality generated from economic fundamentals, and discretionary earnings quality driven by managerial discretion over accounting affect the cost of bank loans. Additionally, I find that bank monitoring mitigates the effect of discretionary earnings quality on loan pricing. Empirical results support my predictions grounded in information risk and previous banking literature. Introducing bank monitoring to my research confirms and extends the previous literature.