Relational Banking in Post Bubble Japan : Co-Existence of Soft and Hard-Budget Constraint

The purpose of this paper is to provide an overview of relationship banking in Japan, a country in which banks have assumed a more prominent role than that played by counterparts in other countries. First, we survey corporate finance trends for listed firms in the 1990s and present two puzzling facts: 1) an increase in dependence on bank borrowing in spite of deregulation of the bond market; and 2) a rise in main bank loans to firms highly dependent on bank borrowing, notwithstanding the increased risk posed by these borrowers. Next, applying the findings of Miyajima and Yishay (2004), we show that the banking crisis has not affected borrowers equally, and that the firms most affected by the crisis had the following characteristics: a high level of leveraging, a high degree of dependence on main banks, lower Ramp;D expenditures, lower profitability, and difficulty accessing the capital market. Then, we analyze the impact of the banking crisis on corporate behavior by estimating the standard investment function with cash flow constraints, focusing on firms with high growth opportunities. We find that there is scant evidence that listed firms encountered serious financial constraints, which suggests that most listed firms did not experience a systematic credit crunch. Lastly, we address the effect of the bank-firm relationship on corporate restructuring, focusing on firms whose earnings declined substantially in the early 1990s. By estimating the employment adjustment function, we show that leverage was inversely related to the change in employment. This is an indication that the level of leveraging played a disciplinary role in the 1990s. On the other hand, a high concentration of loans from main banks tended to delay corporate restructuring, indicating that close ties to main banks did not serve to discipline firms that needed to restructure. Or, to put it differently, our study supports the conclusion that the main bank system may have been an impediment to creative destruction during the period of the banking crisis