Corporate monitoring and the Japanese main bank system

Date

1995

Authors

Gower, Luke George

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Abstract

This dissertation asks whether Japanese main bank monitoring relationships were disturbed by the deregulation of the corporate finance market that took place in Japan during the 1980s. It is motivated by the observation that successful bank monitoring of the corporate sector depends, in part, upon the returns to banking. In Japan, these returns declined substantially during the 1980s, and so it becomes appropriate to ask whether bank based systems of corporate monitoring have become less effective. The study confirms that this conjecture is justified. A fonnal debt pricing theory is developed to show that, when the conte stability of the lending market intensifies, the potential for main bank monitoring failure increases, owing to the potency of moral hazard problems. A subsequent empirical study provides some formal evidence for this proposition, by showing that finns with stable main bank connections performed less efficiently, after financial deregulation. The argument is organised into six chapters. Chapter 1 motivates the study by contrasting perceptions that main banks are effective corporate monitors, with the reality that those same banks incurred substantial bad debts, as a result of their having misjudged the creditworthiness of their clients in the early post-deregulation era. The second chapter enlarges upon this material by explaining how reform of the financial markets in Japan contributed to a narrowing of bank margins and a decline in bank profitability after financial deregulation. I link these developments to perceptions, both official and public, that Japanese banks were much less effective in providing corporate monitoring than they had previously been. Chapter 3 explores the theoretical dimensions of monitoring failure from the perspective of main bank relationships. It first sets out the features of the main bank system, before showing that existing theory does not deal adequately with the effects of competitive capital markets on the pricing of main bank [mance, and on the closely related incentives of the main bank to monitor corporate borrowers. In the fourth chapter, I develop a theory of main bank debt pricing to explain how main bank debt is priced and how that pricing can lead to the failure of main bank monitoring mechanisms. The theory shows that when the main bank lending market is contestable by non-main bank sources of finance, the potential for main bank monitoring failure intensifies. The model put forward in Chapter 4 does not lend itself to direct testing. Nevertheless, it is possible to test the implication of the argument indirectly by testing for the effects of main banks on corporate performance. Such tests are carried out in Chapter 5. Econometric techniques that have not previously been applied in the literature on main banks are used to demonstrate that main bank monitoring has become less conducive to technically efficient corporate performance. A sixth chapter concludes the study. The main findings of previous chapters are summarised, and matters that bear further investigation are highlighted in order to identify a possible future research agenda.

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Thesis (PhD)

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