Does the Ownership Structure of Debt and Equity Affect the Agency Costs of Debt? Japanese Evidence

Abstract

This paper examines the effect of the ownership structure (of debt and equity) on the agency problems of debt. This issue is particularly relevant for Japanese keiretsu firms. Member firms in a keiretsu are linked through business ties and reciprocal shareholdings. A central figure of the keiretsu is the main bank that serves as a corporate monitor. We hypothesize that the main bank's monitoring intensity varies with the degree of its keiretsu member banks' financial interests in the member firms. We first find that the leverage of keiretsu firms in our sample is significantly negatively related to proxies for the source of potential agency conflicts (e.g., R&D expenditures and intangible assets), implying that Japanese keiretsu firms also suffer from agency problems of debt. This is contrary to the popularly held view that Japanese firms are free of agency problems of debt since banks are often both large creditors and shareholders. We then consider the ownership structures based on debt and equity holdings by member banks and member firms within the same keiretsu. Consistent with our hypothesis, our empirical results show that agency costs of debt are pronounced among firms in which the members have low-debt and low-equity holdings, but are mitigated substantially for other firms in which the members have significant holdings of debt and/or equity, in the order of low debt and high equity, high debt and low equity, high debt and high equity.