Corporate Restructuring in Japan: Who Monitors the Monitor?

Abstract

This is the first comprehensive study to empirically analyze the economics of private (out-of-court) debt restructurings of financially distressed Japanese companies spanning the period from the burst of the bubble economy of Japan in 1990 to the time when the excessive bad debt problems of major firms were recognized as resolved in March 2005 on the basis of the stock prices of more than 200 restructurings. In Japan the mechanism of corporate monitoring is not market based (shareholder and public bondholder based) but large-investor based (large stakeholder based)typically, banks and affiliated companies. These stakeholders are expected to efficiently resolve potential bankruptcy or collapse with better information resulting from their long-term relationship with the distressed firms. In contrast, however, this study finds that out-of-court restructurings led by banks or affiliated companies failed to gain the trust of the market because of their procrastinations in implementing fundamental solutions; and therefore, there is a need for third-party monitoring. Compared to the analysis of out-of-court settlements in the United States by Gilson et al. (1990), this study finds that agreements on out-of-court restructuring in Japan are attained more easily than in the United States. However, without third-party mediation, no fundamental changes can be expected from the restructurings. This forbearance by banks and affiliated companies in addressing the needs of distressed firms indicates the weakness of banks and affiliated companies in instituting discipline among themselves, thereby showing the importance of instituting a system to monitor the monitor.