PDF Ebook Relationship Banking and Debt Choice: Evidence from the Liberalization in Japan
There are many researches about the determinants of debt choice between bonds and borrowing (e.g. Bolton and Freixas, 2000). One approach for explaining this choice is to stress the comparative advantage of a bank as a monitor. By emphasizing the ability of the banking sector to mitigate the costs of asymmetric information, Diamond (1991) shows that firms with less established reputations tend to borrow from banks, while more successful firms tend to issue bonds. Following this idea, Petersen and Rajan (1994) find that close relationship with banks have made it possible for small U.S. firms to borrow at lower costs.
Thakor and Wilson (1995) discuss another benefit of bank borrowing. Because of its concentrated ownership, the banking sector decides efficiently whether to liquidate or bail out a firm in financial distress by renegotiating the terms of the debt contract with borrowers. Since the ownership of public bonds is dispersed among bondholders, they cannot rescue financially distressed firms as banks do efficiently.
Furthermore, this advantage seems to be stronger in economies in which relationship banking dominates arm’s length bank-firm relationships. Relationship banking is often characterized as an arrangement by long-term mutual commitments between banks and client firms. Given this relationship, to bail out client firms with financial distress is much more frequent as compared to the arm’s length relationship, because, as Chemmanur and Fulgieri (1994) explain, banks are long-term players in debt markets and try to acquire a reputation for financial flexibility. Consequently, it is plausible that a manager may choose between bonds and bank borrowing taking into account the possibility of distress.
Bank borrowing associated with strict monitoring in relationship banking, which mitigates agency problems might reduce the manager’s own non-pecuniary benefit created by having discretion over management. Then, some managers have incentives to entrench themselves by limiting the amount of borrowing from the banks with close ties as possible as they can.
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PDF Ebook Relationship Banking and Debt Choice: Evidence from the Liberalization in Japan
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