How Banks Affect Borrowers’ Corporate Governance and Incentive Structures

It is well known that banks play an important role in monitoring borrowing firms (e.g., Diamond, 1984). Yet, how banks choose among alternative mechanisms that reduce agency costs with borrowers is not completely understood. In our paper, “Bank Relations and Borrower Corporate Governance and Incentive Structures,” we document that, as banks and borrowers develop closer relationships, borrowing firms adopt corporate governance and incentive structures that help to reduce the banks’ risk of expropriation by the managers and shareholders.

While some bank monitoring can constrain managerial opportunism and thereby benefit debtholders and shareholders, banks also protect themselves against actions that benefit … Read more