Problems of conflicting interests between management and firm stakeholders have been the focus of a large volume of literature since the 1930s. In particular, much attention has been devoted to the study of available mechanisms for the disciplining and monitoring of managers. In Discussion Paper No. 1178, Yishay Yafeh and Oved Yosha shed light on the actual nature of monitoring activity by large share- and debtholders. They present empirical evidence indicating that monitoring involves a significant reduction of activities with scope for managerial moral hazard. Their sample includes approximately 180 listed Japanese manufacturing firms in the chemical industry.

The authors construct five measures of managerial moral hazard: the ratio of cash and marketable securities to sales; R&D intensity; the ratio of R&D expenditures to sales; `entertainment expenses' divided by sales; and general sales and administrative expenses, deflated by sales. They also use the following measures of monitoring: cumulative percentage of all shares held by the ten largest shareholders; affiliation with a financial corporate group centred around one of the major (eight) banks; the ratio of borrowing from members of the firm's corporate group to total debt; and the percentage of shares held by group members. Their empirical results indicate that there is a strong and negative correlation between the above measures of monitoring and expenditures on activities which may involve private benefits to managers. They show that ownership concentration and stable shareholding within the financial corporate groups are particularly important in this respect. They also present some evidence on monitoring by debtholders within the bank-centred groups. The negative correlation between bank monitoring and expenditures on activities with scope for managerial moral hazard is less robust, however. This leads them to suspect that the driving force behind managerial monitoring in good times is equity stake, while banks may play an important role during financial distress, as shown in other studies.

Large Shareholders and Banks: Who Monitors and How?
Yishay Yafeh and Oved Yosha

Discussion Paper No. 1178, May 1995 (FE)