Do Bond Issues Mitigate Hold-up Costs? Evidence from Japan's financial liberalization period

This study is an empirical attempt to investigate whether firms' bond issues mitigate rent extraction by their banks. To that end, I focus on the cash holdings of Japanese listed firms in the early 1980s, when Japanese banks used compensation balances as a device to extract rent from their client firms. Concretely, this study examines whether firms' bond issues lead to a decrease in their cash holdings. The unique feature of this study is its exploitation of the eligibility for bond issues—i.e., Bond Issue Criteria—that formerly existed in Japan to address a possible endogeneity problem. Estimation results from the two-step least squares (2SLS) model and an instrumental variable quantile regression model show that (1) a decline in cash holdings is accompanied by bond issues; and (2) the magnitude of decline becomes larger as the quantile of the conditional distribution of cash holding levels increases. These results imply that bond issues mitigate bank rent extraction, and that the effect is larger for firms facing severe bank power.