Professor Anjan Thakor, Olin School of Business, Washington University in St Louis
The role that banks play in screening and monitoring their borrowers is well understood. However, these bank activities are costly and unobservable, thus difficult to contract upon. This introduces the possibility of shirking and leads to the question – who monitors the monitor?
Financial intermediation theories posit that bank capital structure plays such a role in incentivizing banks to monitor their borrowers. Both bank debt and bank equity have been proposed in various theories as providing the discipline to induce banks to monitor. However, empirical evidence on how bank capital structure influences borrower monitoring is scant. To circumvent identification concerns with regressing (unobservable) bank monitoring on (endogenous) bank capital structure, we use variation in country-level creditor rights to capture banks’ need to monitor their borrowers. We develop a theoretical model in which greater expost protection offered to lenders (i.e., banks) during borrower bankruptcy/renegotiation reduces the bank’s ex-ante incentives to monitor. This is because the greater salvage value of bank loans reduces the bank’s expected loss from not monitoring. Our model also examines how banks alter their capital structures in response to changes in their country’s creditor rights, and shows that the reduced demand for bank monitoring induced by stronger creditor rights induces the bank to shift its capital structure away from the source of financing that induces it to monitor. We find empirically that increases in creditor rights result in banks tilting their capital structures away from equity and towards deposits. We verify (theoretically and empirically) that these demand-based tilts in bank capital structure are not explained by supply-side effects (i.e., creditor rights make it cheaper to supply bank debt), and conclude that bank equity is a stronger source of discipline on banks than bank debt.
We verify (theoretically and empirically) that these demand-based tilts in bank capital structure are not explained by supply-side effects (i.e., creditor rights make it cheaper to supply bank debt), and conclude that bank equity is a stronger source of discipline on banks than bank debt.
Anjan Thakor holds the John E. Simon Professorship of Finance and is Director of the Olin Business School’s doctoral programme, and the Wells Fargo Associates Center for Finance and Accounting Research. He is also a research associate of the European Corporate Governance Institute. Until July 2003, he was the Edward J. Frey Professorship of Banking and Finance and Chairman of the Finance Group (2000-03) at the University of Michigan Business School. Prior to joining the University of Michigan, he served as the NBD Professor of Finance and Chairman of the Finance Department at the School of Business at Indiana University. Anjan has also served on the faculties of Northwestern University and UCLA as a visiting professor.
Anjan received his PhD in Finance from Northwestern University. His research, teaching and consulting are in the areas of asymmetric information, corporate finance, banking, and corporate strategy. He has published research articles in leading economics and finance journals such as The American Economic Review, The Review of Economic Studies, The RAND Journal of Economics, The Economic Journal, The Journal of Economic Theory, The Journal of Finance, The Journal of Financial Economics, The Journal of Financial Intermediation, and The Review of Financial Studies. He has also published eight books, including The Four Colors of Growth, which introduces a new framework for developing value-enhancing growth strategies.