The Evolving Nature of Japanese Corporate Governance: Guaranteed Bonds vs. Rated Bonds

Abstract

We investigate a large set of yen-denominated Japanese corporate bonds composed of bank-guaranteed vs. unguaranteed bonds and find evidence of the demise of main bank relationships and transformation to market-based corporate governance since the 2008 financial crisis. We find that issuers with unrated and bank-guaranteed bonds have more information asymmetry and possess poorer firm quality. Japanese banks provide credit guarantees to the bonds issued by small or opaque firms with weaker financial profiles, thus reducing the risk of issuer default, as well as saving on bond rating fees and the costs of a public offering. The bank guarantee for private and unrated bonds serves as valuable (but costly) protection for investors who invest in these riskier issuers’ bonds. Most importantly, after the U.S. financial crisis, the impact of bank guarantees on yield spreads becomes much less significant as bond issuers have begun to rely more on credit ratings as a potentially cheaper and more effective monitoring/corporate governance mechanism.