Bank ties and bond market access: evidence on investment-cash flow sensitivity in Japan

The banking literature has established that banks can alleviate information asymmetries between lenders and borrowers, while the Q literature has used cash flow sensitivity analysis to test whether financing constraints hinder investment. This paper investigates whether bank ties in Japan were costly for mature and healthy firms in the 1980’s and 1990’s, and whether banks continued to facilitate investment once non-bank financing options became available. Using the explicit bond issuing criteria to solve the endogenous firm-sorting problem, I measure the investment-cash flow sensitivity of Japanese firms, and find it lowest for those firms known to have faced bond market constraints. I then find that the spread in sensitivity was much larger for main bank client firms, once bond market access is controlled for. This result, coupled with results on the relative profitability and bond activity of bank-affiliated firms, is consistent with banks capturing the net benefits of relationship lending during the period of bond market deregulation. ∗[email protected] I would like to thank Gary Saxonhouse, Matthew Shapiro, Susanto Basu, and I. Serdar Dinc, all from the University of Michigan. In addition, I received many helpful comments from Anil Kashyap and the participants in the NBER/CEPR/Tokyo University CIRJE/EIJS Japan Project Meeting in Tokyo, Japan (Sept 13-14, 2002). I would also like to thank Fumio Hayashi from Tokyo University, for help with data preparation, and the Ministry of Economy, Trade, and Industry in Japan and the Economics Department of Tokyo University for use of their raw data. Any errors are my own.