Mainbanks, corporate governance and investment efficiency in financial distress

This dissertation explores the effects of different governance structures and mainbanks on investment efficiency in financial distress. These two issues are examined theoretically and empirically.; The Japanese corporate governance structure is different from the governance structure in the US. In the US corporate governance model, the board of directors is charged with monitoring management (Light, 1990) and the marketplace is relied upon as the ultimate monitor of a firm. The Japanese system utilizes a different corporate governance structure that is relationship based. As the board of directors is composed of corporate insiders and the ownership structure precludes an active market for corporate control, banks are the paramount monitor of the firm. The corporate governance structure in a relationship based system, as in Japan, is analyzed and it is posited that it promotes overinvestment. An analysis of 293 Japanese and US firms renders evidence consistent with the overinvestment premise.; Banking relationships also differ in Japan. Many firms in Japan, while borrowing from multiple banks, have a bank regarded as their "mainbank". A mainbank leads in lending funds to a firm and owns a significant portion of the firm's equity. A model that emplicitly captures the effect of a mainbank on the investment decision of a firm in financial distress is developed. This model suggests that an effect of a mainbank on a firm in financial distress is to induce overinvestment. The empirical analysis also renders evidence consistent with the mainbank premise.; Hoshi, Kashyap, and Scharfstein (1990) posit that firms with close financial relationships with banks and their trading partners reduce the costs of financial distress by reducing underinvestment. It is noted in this dissertation that firms with such close relationships may not face the disciplinary force of financial distress and therefore may overinvest in financial distress. Overinvestment is defined as investing when marginal q is less than unity. It is observed that conditions conducive to reducing underinvestment may also be conducive to inducing overinvestment. Thus, it is posited that the presence of a relationship based governance system and/or mainbank for firms in financial distress may induce a firm to invest and expand even when capacity reduction is warranted. The analysis section of this dissertation provides evidence consistent with these ideas.