Large shareholder monitoring and regulation: The Japanese banking experience

During a period where Japanese banks operated under a less restrictive regulatory environment, 1986–1988, we find positive relations between bank risks and ownership concentration. This empirical evidence suggests that shareholder monitoring is present when the potential return to monitoring is high (the “shareholder monitoring hypothesis”). During the periods before and after this particular period, we do not observe evidence of shareholder oversight. These results are consistent with the argument that regulation (an external governance mechanism) and shareholder monitoring (an internal governance mechanism) are substitutes for one another (the “substitution hypothesis”) because the pre- and post-periods are characterized by stricter regulatory environments. Finally, tests on bank performance lend supporting evidence to both hypotheses.