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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