Internal and External Lending by Nonfinancial Businesses

We investigated how the large and growing volumes of lending by listed, Japanese, parent companies to their subsidiaries responded to parents’ and to subsidiaries’ sources and uses of funds during 1984-2014. We found that parents lent more to their subsidiaries when (1) parents’ profitability rose relative to that of their subsidiaries and (2) parents’ capital expenditures fell relative to those of their subsidiaries. We also found that the extent of ownership matters. Parents lent more internally when their existing equity investments in their subsidiaries was (1) larger relative to the parents’ total equity and when it was (2) larger relative to the subsidiaries’ total equity. Our results also pointed to important connections of internal capital markets to external lenders, particularly banks. We found that internal lending rose during economic and financial crises in Japan—unless its commercial banks were at the center of the crisis. Internal lending from parents softened the shocks to business groups’ subsidiaries more when Japanese banks were quite strong, such as during the 2008 global financial crisis. In contrast, parents provided much less credit through internal capital markets during the banks were quite strong, but not during the Japanese banking crisis around 2000.