The Declining Power of Business Groups and Firms’ Financial Decision-Making

This paper investigates the consequences of the declining power of business groups on firms’ financial decision-making. We use a dataset from Japan, where the power of the traditional keiretsu system and banks has been weakening in recent decades. In addition to the findings that firms in business groups have higher financial leverage and slower speed of adjustment, we find that as the banks’ power weakens, firms’ financial leverage decreases and their speed of adjustment increases. This is consistent with our prediction that as the power of the business group weakens, internal capital markets disappear. Several robustness checks ensure consistent results in the basic analyses such as: excluding firms with extreme financial leverage; controlling for firms’ financial distress; using multiple cut-off points representing different banks’ ownership levels; and whether there has been a shift from using bank loans to public bonds due to the decline of banking power.