The Changing Role of Main Banks in Aiding Distressed Firms in Japan

Abstract

The objective of this study is to investigate the consequences of increased bank lending to distressed Japanese firms in order to determine the extent to which increased loans were associated with the improved performance of distressed firms. In particular, a key focus of the study is the extent to which such a relationship in the 1980s persisted into the 1990s after the bursting of the stock market and real estate bubbles when both firms and banks came under increasing stress. The evidence in this study suggests that increases in main bank loans are, in fact, associated with improved firm performance subsequent to entering distress during the 1980s. However, not only did that pattern disappear during the post-bubble period, but increased main bank loans were associated with a deterioration in operating income during the late 1990s and early 2000s. This is consistent with main banks evergreening loans to zombie firms rather than focusing their lending on supporting distressed, but viable, borrowers. The change in bank behavior was likely related to the perverse incentives banks faced as their own health deteriorated sharply. In contrast, no similar change in behavior is observed for secondary lenders to distressed firms, in part because of the weaker relationships and responsibilities of secondary banks compared with main banks. * I thank participants at the New York and San Francisco ESRI conferences for their insightful comments on earlier versions of this study, and Sunayan Acharya for valuable research assistance.