The Effect of Bank Relations on Investment Decisions:
An Investigation of Japanese Takeover Bids
Jun-Koo Kang, Anil Shivdasani, Takeshi Yamada*
June 17, 1999
We study 154 domestic mergers in Japan during 1977 to 1993. In contrast to U.S. evidence, mergers are
viewed favorably by investors of acquiring firms. We document a two-day acquirer abnormal return of
1.2 percent and of 5.4 percent for the duration of the takeover. Announcement returns display a strong
positive association with the strength of acquirer’s relationships with banks. The benefits of bank
relations appear to be greater for firms with poor investment opportunities and when the banking sector is
healthy. We conclude that close ties with informed creditors, such as banks, facilitate investment policies
that enhance shareholder wealth.
In perfect capital markets, investment choices are independent of financing choices. In the
presence of capital market imperfections, however, financing alternatives can have an important influence
on firms’ investment policies. A vast literature in this area emphasizes the importance of informational
asymmetries and the costs of financial distress and agency conflicts. In the presence of such market
imperfections, leverage can create incentives to deviate from the optimal investment policy. The asset-
substitution problem (Jensen and Meckling (1976)), the underinvestment problem (Myers (1977)), and the
overinvestment problem (Stulz (1990)) are well-known examples of such distortions of investment policy.
A possible mechanism to overcome these costs of debt financing is to have creditors who are
well-informed about firms’ prospects and investment opportunities. In this paper, we investigate how the
distribution of debt claims between informed and arms-length creditors influences firms’ investment
choices. We focus on the role of banks as informed intermediaries between firms and external capital
markets and examine whether firms with close ties to banks are able to overcome some of the distortions
to optimal investment choices induced by capital market imperfections.
We use the takeover market in Japan as the setting for our investigation. Japanese firms have
historically maintained close ties with a single commercial bank, known as the main bank, that serves as a
primary source of debt financing. The main bank also serves as the primary commercial bank for routine
financing transactions and is considered well informed about the firm’s prospects. Collection and
evaluation of information by the bank is facilitated by the frequent presence of bank executives on the
boards of client firms. Sometimes, the main bank and borrowing firm belong to a common industrial
group known as a keiretsu. These groups are characterized by extensive information sharing through
regular meetings of executives to discuss overall corporate objectives and formulate corporate strategy.
Thus, a Japanese main bank represents a close approximation to the concept of informed creditor
assumed in models of corporate financing choice.
We study the role of Japanese banks on investment choices by examining a comprehensive
sample of Japanese domestic mergers from 1977 to 1993. Unlike routine investment decisions, takeover
bids provide a natural experiment because they typically represent large and discrete investment choices
where detailed public information is reported in a timely manner. This allows us to examine the market’s
ex-ante valuation of these investment decisions. Further, acquisition decisions represent a setting where
managerial and shareholder interests frequently diverge. Acquisition announcements in the U.S. are often
greeted negatively by investors, and managers sometimes pursue private objectives during acquisitions at
the expense of shareholder wealth.1 Thus, acquisitions represent an instance where informed creditors can
have an important impact on managerial decisions.
Our research design complements other studies that evaluate the role of Japanese banks in
overcoming capital market imperfections. Hoshi, Kashyap, and Scharfstein (1991) examine the sensitivity
of firms’ investment expenditures to liquidity and find that this sensitivity is lower for firms in bank-
centered groups. Hoshi et al (1991) argue that firms with close bank ties are able to overcome
informational frictions in financing choices and are able to make better investment decisions. Kaplan and
Zingales (1997), however, point out that financing constraints may not be monotonically related to the
sensitivity of investment to cash flow and question the interpretation of investment-cash flow sensitivity
coefficients. Studying investors’ valuations of investment decisions thus provides complementary
evidence on the role of banks in influencing firms’ investment choices.
Our evidence also sheds light on the debate regarding the role of Japanese banks in corporate
governance. Diamond (1984) and Fama (1985) view banks as financial intermediaries specializing in the
collection and evaluation of client firm information. As argued by Diamond (1991) this informational
advantage permits banks to perform a valuable monitoring function. Kaplan (1994), Kaplan and Minton
(1994), and Kang and Shivdasani (1995, 1997) find that Japanese firms with close bank ties experience
high levels of director appointments, CEO turnover, and asset restructuring during poor performance and
conclude that banks perform a valuable monitoring role.
This informational advantage however, can also endow banks with substantial power that can be
used ex-post to appropriate surplus from client firms (Rajan (1992)). Weinstein and Yafeh (1998) find
that firms closely affiliated with main banks tend to pay above market rates of interest on their bank debt.
Morck and Nakamura (1999) argue that bank director appointments are precipitated largely by liquidity
crises, and conclude that banks act primarily in the interests of short-term creditors without regard to
shareholder wealth. According to this bank power hypothesis, significant bank control has the potential to
facilitate acquisitions that serve creditor interests, possibly at the expense of shareholder wealth.
We find that on average, shareholders of acquiring firms in Japan realize a significantly positive
two-day cumulative mean abnormal return of 1.2 percent surrounding the initial announcement date. Over
the entire takeover window, starting from a day prior to the initial announcement and ending a day after
the effective date, the mean cumulative abnormal return is 5.4 percent. The positive and statistically
significant announcement return for Japanese acquirers contrasts sharply with much of the evidence on
acquiring firms from the U.S., which documents either a statistically insignificant or a small negative
average stock market reaction for acquisition announcements.
We investigate several explanations for the overall positive market response to acquisitions in
Japan, including differences in the method of payment, the high frequency of privately held takeover
targets in the sample, possible revelation of bidder specific information, and the practice of some
Japanese bidders making acquisitions to rescue financially distressed targets. These explanations do not
appear to explain why Japanese bidders fare better than U.S. acquirers.
The bidders’ financial structure prior to the acquisition is important in understanding the cross-
sectional variation in bidder returns. We document that the abnormal returns are positively and
significantly related to the bidder’s preacquisition leverage. Separating total leverage into borrowing from
banks and non-bank debt, we find that the extent of borrowings from banks is positively and significantly
associated with bidder returns, but that non-bank debt has little statistically discernible effect on bidder
returns. Among all banks, firms’ borrowings from their main bank appear to be particularly important.
We find that the fraction of assets financed by debt from main banks prior to the acquisition is positively
and significantly related to bidder returns. These results support the hypothesis that the superior
information of informed creditors such as main banks helps lower the costs of market imperfections and
facilitates shareholder value-enhancing investment policies. Our evidence, however, questions the
interpretation that Japanese banks act primarily in the interests of creditors without regard to shareholder
We find that the relation between acquirer returns and main bank linkages is stronger for low Q
acquirers, indicating that the monitoring role of banks is more prominent for firms with relatively poor
investment opportunities. We also find that the positive relation between bank financing and acquisition
returns are driven primarily by the earlier years in our sample, when bank ties were generally stronger due
to stringent bond market regulation. This finding casts doubt on the view that strong bank control is likely
to result in investment choices that are detrimental to shareholders. Since banks were in weaker financial
health during the latter part of our sample, the results are supportive of the argument advanced by Kang
and Stulz (1999) that bank health is an important determinant of the effect of bank relations on client firm
Our paper is related to work by Pettway and Yamada (1986), who examine bidder returns in
Japanese mergers during 1977 to 1984 and find positive returns around the board meeting date, which is
usually the resolution date of the merger. Since the first public announcement typically precedes the board
meeting date, sometimes by as much as three years in our sample, board meeting dates are unlikely to be
informative. Therefore, we use the initial announcement date to infer the market’s ex-ante valuation of the
merger. In related work, Kang (1993) examines Japanese acquisitions of U.S. firms but does not explore
the valuation effect of domestic Japanese mergers.
The paper proceeds as follows. We describe the sample in Section I. Section II presents the
evidence on announcement returns and the cross-sectional analysis. Section III concludes.
Our sample consists of non-financial Japanese acquiring firms that are listed on either the First
Section or the Second Section of the Tokyo Stock Exchange (TSE). We identify an initial sample of
acquiring firms from the Shohou (Gazette) published by the TSE, for which the effective date of the
merger is between March 31, 1977 and December 31, 1993. We eliminate cases where the acquirer
owned all of the outstanding shares of the target prior to the merger because these cases typically
represent instances of internal reorganizations. We identify the initial public announcement date of the
merger from four daily newspapers published by Nihon Keizai Shimbun-sha: Nihon Keizai Shimbun
(Nikkei Economic Journal), similar to the Wall Street Journal in the U.S., Nikkei Sangyo Shimbun
(Industrial Journal), Nikkei Ryutuu Shimbun (Distribution Journal), and Nikkei Kinyuu Shimbun (Finance
Journal). The date that a merger announcement first appears in any one of these four publications is used
as the announcement date. We require acquiring firms to have available stock-price data in the Pacific-
Basin Capital Markets (PACAP) Research Center database. We obtain a final sample of 154
A concern arises as to whether the sampling procedure introduces selection bias. The PACAP
database does not contain information on firms that were acquired, went bankrupt, or were delisted. To
investigate whether this creates a survivorship bias in the sample, we identify firms that were delisted
from the TSE from 1977 to 1993. Over this period, six acquiring firms were delisted. Of these, two firms
were merged, one went bankrupt, and three were delisted because of a failure to meet the TSE’s minimum
capital requirements. Although the lack of complete financial and stock return data preclude us from
including these firms in the subsequent analysis, we manually collect stock-price data for these firms from
Nihon Keizai Shimbun and calculate market-adjusted returns for two and three-day windows surrounding
the acquisition announcement. We find that the results on announcement period returns are qualitatively
unchanged when these observations are included.
The frequency of acquirers is relatively low during the beginning of the sample, with 27 of the
154 transactions (17.5 percent of the sample) occurring during the 1976 to 1981 period. The period
between 1988 and 1992 represents the most active years of Japanese merger activity with 69 transactions
(45 percent of the sample) occurring during this interval. A breakdown of mergers by industry shows that
most of the acquiring firms are classified as manufacturing (108 cases), followed by wholesale and retail
(25 cases), construction (nine cases), transportation, communications and utilities (six cases), real estate
(four cases), and agriculture, mining, and fisheries (two cases).
Table I shows summary statistics for the sample of acquiring firms. These data are obtained
from the PACAP database, the Nikkei database, the Analyst's Guide by Daiwa Institutes of Research
Ltd., Shohou by the TSE, the Annual Securities Statistics by the TSE, Kigyo Keiretsu Soran, and
acquiring firms' annual and semi-annual reports. Panel A reports merger-specific characteristics and the
past stock return performance of sample firms.
A noteworthy feature of the sample is that a majority of mergers involve targets that are privately
held firms. Of the 154 targets, 108 (70 percent of the sample) are unlisted firms. Thus, for a majority of
targets, publicly available financial data is unavailable and we are restricted to the financial data reported
in newspaper articles describing the acquisitions.
The mean ratio of book value of target equity to bidder equity is 17 percent and the mean ratio of
transaction value2 to the market value of the bidder’s equity is 16 percent. However, medians for both of
these variables are considerably lower, at 3.6 percent and six percent, respectively. Thus, the sample
consists largely of targets that are much smaller than the acquirers, but does include a few relatively large
transactions. This pattern is consistent with the observation by Kester (1991) that most Japanese merger
and acquisition activity is concentrated among small and unlisted target firms.
Using the three-digit SIC codes provided by the PACAP, and assigning SIC classifications for
targets from the newspaper descriptions when needed, we find that 70 percent of our sample firms acquire
target firms operating in the same industry.3 Ninety seven firms finance the entire transaction through an
exchange of common stock, and 57 firms use a combination of common stock and cash as the form of
payment when they acquire targets. For these 57 firms, the ratio of cash paid to total transaction value
averages 2.5 percent, indicating that even when cash is used, it represents only a small fraction of the
In 15 cases, representing 10 percent of the sample, the newspaper story notes that the bidder is
acquiring the target for rescue purposes. In two of these cases, rescuing the target is mentioned as the
explicit reason for the merger. In the other 13 cases, the article refers to the poor performance or
financially distressed status of the target. Of these 15 rescue mergers, the bidder is affiliated with a
financial group in seven cases.
Panel A also shows that Japanese acquiring firms hold a relatively large fraction of target shares
before the merger announcement, with a mean of 24 percent. We measure the past performance of
acquirers using cumulative excess stock returns relative to industry. We compute the industry-adjusted
cumulative excess stock return from 220 days to 20 days before the merger announcement using the
value-weighted Tokyo Stock Price Index (TOPIX) for each industry. The mean and median prior
industry-adjusted returns are 3.9 percent and 2.5 percent, respectively, and are statistically significant at
the 0.05 level.4 Thus, the bidders in the sample are generally well performing firms, similar to the pattern
documented by Harford (1998) for U.S. bidders.
Panel B of Table I shows summary statistics for firm-specific and governance characteristics for
the sample firms for the fiscal year prior to the acquisition announcement. The market value of bidder
equity averages ¥204 billion, and the mean book value of assets is ¥288 billion. Leverage, measured as
the book value of total debt divided by the sum of book value of debt and the market value of equity,
averages 52 percent. We define the bank loan ratio as the ratio of a firm’s total borrowings from financial
institutions as a fraction of the sum of the book value of debt and the market value of equity, and find that
it averages 21 percent. Accounts payables, notes payables, deferred taxes, straight bonds, and convertible
bonds account for the difference between total debt and bank borrowings. Hereafter, we refer to this
difference as other debt.
Because the literature emphasizes the special role of main banks in Japan, we compute the main
bank loan ratio as the fraction of a firm’s total borrowings from its main bank to the sum of book value of
debt and the market value of equity. Following Hoshi, Kashyap, and Scharfstein (1990) and Aoki,
Patrick, and Sheard (1994), we define the main bank as the firm’s largest lender, and collect this data
from issues of Kigyo Keiretsu Soran. Because this data is generally unavailable to us prior to 1980, our
tests employing this variable are conducted over a slightly smaller sample, though our results are similar
if we use the bank loan ratio and the entire sample period instead. For the sample firms, main bank
borrowing averages 3.6% percent of the sum of book value of debt and equity, and ranges from 0 to 14.6
We collect data on the equity ownership by managers, shown to be an important determinant of
bidder returns in the U.S. (Lewellen, Loderer, and Rosenfeld (1985)). On average, equity ownership by
the board of directors is 3.3 percent of the firm’s outstanding shares. Following Nakatani (1984), we
identify each firm’s affiliation to a bank-centered keiretsu using various issues of Keiretsu No Kenkyu.
Our procedure follows Nakatani (1984) in classifying firms to be part of a group if they are identified as