Debtholder Monitoring and Earnings Opacity

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Klaus Schäck (University of Bristol)

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IWH conference room

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Klaus Schaeck is a Professor of Banking and Finance at the School of Economics, Finance and Management at the University of Bristol. His research interest focuses on the empirical modelling of bank behaviour. In particular, he primarily investigates the role of the government in banking systems in terms of regulation, supervision, and bank bailouts, and how such government interventions affect bank conduct.

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We show that debtholder monitoring reduces earnings opacity. Using a natural experiment in the U.S. banking industry that subordinates junior creditors’ claims, we find that exposing junior creditors to greater losses in bankruptcy significantly reduces earnings opacity. This effect is driven by limiting banks’ propensity to overstate earnings and is concentrated among banks that rely more on funding provided by junior creditors, consistent with market discipline. Our findings highlight the importance of junior creditors’ monitoring incentives in curbing earnings smoothing, reducing information asymmetries, and improving the quality of information that banks disclose to the public to limit bank opacity.