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Dynamic Capital Structure of Japanese Firms: How Far Has the Reduction of Excess Leverage Progressed in Japan?

November 2004
Shinichi Nishioka*1
Naohiko Baba*2

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  • *1 Financial Markets Department (currently, Personnel and Corporate Affairs Department), Bank of Japan.
  • *2 Financial Markets Department, Bank of Japan. E-mail: naohiko.baba@boj.or.jp

We benefited from discussions with staff members of the Bank of Japan. Any Remaining errors are solely our responsibility. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of Japan.

Abstract

This paper investigates the dynamics of capital structure of Japanese firms since the early 1990s to shed light on how far the reduction of excess leverage has progressed so far in Japan. Our main findings are as follows. First, the trade-off theory provides an appropriate framework to assess this issue after controlling for various variables as proxies for other hypotheses including governance structure, the pecking order theory, and market timing hypothesis. Among such variables, profitability as a proxy for the pecking order theory has significant explanatory power. Second, governance structure significantly influences the speed at which firms adjust their leverage ratios toward optimal ones. In particular, the higher the shareholding ratio of overseas investors, the more quickly market-value leverage ratios adjust. Third, implied excess leverage ratios show a marked contrast between the firms in good credit standing and others. Reduction of excess leverage by highly-rated firms has substantially progressed so far, while others still have a long way to go.

Keywords:
Capital Structure, Leverage, Trade-off Theory, Pecking Order, Corporate Governance, Market Timing, Panel Data, Dynamic GMM

JEL classification:
C23, G32