Banks' Monitoring and Profitability of Borrowing Firms

We constructed measures representing the magnitude of Japanese banks' monitoring activities. The date were used to test two competing hypotheses about nature of banks' monitoring, (1) the monitoring improved profitability of borrowing firms and (2) it simply "screened" out unprofitable firms, by using the data of all Japanese corporations listed in the Tokyo Stock Exchange between 1986 and 1997. The result was inconsistent with the profitability-improving hypothesis of banks' active involvement in borrowing firms, and strongly suggested a passive role as a screening device for banks.