U.S.-Japanese Corporate Finance

Abstract

U.S.-Japanese Corporate Finance For at least two decades, Japanese corporate investment consistently has outpaced U.S. corporate investment. One of the leading explanations of this phenomenon--and a favorite among U.S. corporate managers--is that the cost of capital is lower in Japan than in the United States. The combination of lower real interest rates and higher stock prices makes it cheaper for Japanese firms to borrow money and issue equity, enabling them to invest more. But how do we square this explanation with the view held by many economists that capital is mobile across national borders? If capital is indeed cheaper in Japan than in the United States, why don't U.S. companies go bargain hunting for capital in Japan? The answer may lie in differences in the structure of corporate financial markets between the two countries. 1) In 1977, the average debt-equity ratio of Japanese companies was roughly four times that of U.S. companies; it is now about the same. 2) Until fairly recently, about 90 percent of all Japanese corporate debt took the form of short-term bank loans; during the same period, only about 30 percent of U.S. corporate debt was financed by banks. 3) In a sample of financially distressed U.S. public companies, roughly one-half filed for reorganization under Chapter 11 of the Bankruptcy Code; in a comparable sample of Japanese companies, none filed for bankruptcy protection. These stark differences in financing behavior suggest tha there is more to understanding the cost of capital differences than a simple comparison of interest rates and stock prices. I have conducted research with Takeo Hoshi, Anil K. Kashyap, and David N. Weil that may shed some light on how structural differences in the two financial markets--many of which are quickly disappearing--could explain in part why corporate investment in Japan has been higher than in the United States. Relationship Banking in Japan Historically, the linchpin of Japanese corporate finance has been the close relationship between a firm and its main bank. The main bank provides debt financing, owns some of the company's equity (by statute, no more than 5 percent), and may even place bank executives in top management positions. This system is similar in many respects to West Germany's, but it contrasts sharply with U.S. financing practices. Here, large companies generally have a more arm's-length relationship with the capital market; their debt and equity tend to be held diffusely. Japanese banking practices are driven more by relationships, while U.S. banking practices are driven more by price. For many Japanese companies, the main bank relationship is part of a larger industrial structure known as the keiretsu, a group of companies centered around affiliated banks and other financial institutions. These companies also have strong product--market ties to each other that are strengthened by cross-share ownership. Historically, the links have been strongest in the six largest keiretsu--Mitsubishi, Mitsui, sumitomo, Fuyo, Dai-ichi Kangyo, and Sanwa. This corporate financial structure can facilitate investment through at least two distinct channels. first, the main bank and keiretsu system can provide a ready source of funds to companies that otherwise would be unable to raise capital in a decentralized market. Thus, even though the system may not affect the cost of capital, it can affect the availability of capital. Second, the main bank and keiretsu system can lower the costs of financial distress. This facilitates investment in two ways: by ensuring that companies with valuable investment opportunities are able to exploit them; and by enabling companies to take on more debt, which generally is thought to be cheaper than equity. I consider each of these channels in turn. Liquidity Constraints and Investment In a frictionless capital market, companies with valuable investment projects should have to trouble raising the funds they need to finance these projects. …