Main bank relationships and the choice of private vs. public debt by Japanese firms.

Abstract

A notable feature of the Japanese corporate finance environment is the existence of close financial ties between some firms and the large Japanese banks that serve as their primary source of external financing. Prior research has generated substantial evidence that these "main bank" relationships mitigate information problems and relax liquidity constraints, thereby providing these firms with an important competitive advantage. Despite these alleged advantages, many Japanese firms that once relied on bank debt as their primary source of financing responded to the financial market deregulation of the 1980s by relaxing their banking ties and increasing their reliance on public debt. This trend suggests that there are costs associated with bank financing that offset the above benefits. This thesis integrates recent theoretical developments in bank relationships and public debt financing to present a theory of the choice between bank debt and public debt. The model distinguishes between firms that should maintain main bank relationships and firms that should gravitate toward public debt. Specifically, informationally constrained firms or firms affiliated with a financial keiretsu are less subject to interbank price competition and should switch to cheaper public debt. Firms with high ex ante bankruptcy or financial distress costs will benefit from the monitoring and assistance offered by a main bank relationship. I empirically investigate the debt financing response of Tokyo Stock Exchange industrial firms to public debt market deregulation. The results show that financially healthy but informationally constrained firms have increased their reliance on public debt. Firms with high ex ante bankruptcy or financial distress costs maintain or strengthen banking ties. Debt financing choices by member firms of Japan's financial keiretsu are more responsive than those of independent firms to changes in financial condition. I infer from this that healthy member firms pay more and financially weak member firms receive more from a banking relationship than do equivalent non-member firms. The evidence supports the contention that financial keiretsu engage in risk-sharing, implemented by the core financial firms. The results imply that risk-sharing and traditional levels of main bank assistance for distressed firms are incompatible with deregulated financial markets.