5. Conclusion and Policy Remarks
This study empirically examined the influence of the main banks’ shareholdings on the earnings quality of their borrowing firms in the contemporary institutional and financial set up in Japan that seemingly encouraged Western-style governance system to replace the traditional bank–centered monitoring system for corporations. We find that equity holdings of the main bank significantly enhance earnings quality of its client firms through efficient monitoring of managerial discretionary behavior, suggesting that the effectiveness of the main bank monitoring not wither away in Japan. Moreover, the influence of the main bank continues to prevail even when different classes of shareholders such as domestic institutional, foreign, executives, small, dominant, cross and stable shareholders are included separately in the regression model with the main bank's shareholdings. We also find that the role of foreign investors in undertaking monitoring activities of firms, which was encouraged in the big bang reform, tend to work in the opposite direction, implying that they erode the earnings quality of firms instead of improving it. Besides, the adverse impact of foreign shareholding on earnings quality diminishes when the equity holdings of the main bank are considered. This implies that the main bank can counteract the undesirable effect of foreign shareholding by increasing equity holdings in firms. Most importantly, the influence of institutional and executive shareholders on earnings quality disappears when the main bank extends equity. However, cross-shareholding and stable shareholding are found to be associated with higher earnings quality in the presence of the main bank shareholding. These findings are consistent with monitoring rationale that postulates that the stringent monitoring of the main bank is effective in mitigating agency conflicts and information asymmetry, the existence of which provides the managers good opportunity to use their discretion over accounting choices opportunistically. Additionally, we found that shareholding by the main bank tends to reduce idiosyncratic return volatility meaning that it leads to a reduction in mispricing in securities or noise trading by irrational investors.
