Academic journal article Management International Review

Long-Term Orientation and Relationship Lending: A Cross-Cultural Study on the Effect of Time Preferences on the Choice of Corporate Debt

Academic journal article Management International Review

Long-Term Orientation and Relationship Lending: A Cross-Cultural Study on the Effect of Time Preferences on the Choice of Corporate Debt

Article excerpt

Abstract We examine how time preferences impact the financing decision of firms. We hypothesize that the degree of long-term orientation in a country is positively related to the use of bank relationship lending. Based on a thorough theoretical investigation and an extensive empirical analysis using a large, worldwide dataset, we find strong support for our hypothesis on the role of time preferences for financial intermediation. Our results are robust to controlling for other determinants of the choice of debt financing as well as to applying alternative variables and different estimation methods. Firms in long-term orientation countries appear to prefer relationship bank financing, since it is usually available for the long run and will not be withdrawn quickly in response to adverse developments. This allows managers to preserve a more strategic view and pursue longer planning horizons.

Keywords Agency theory * Bank loans * Financial intermediation * National culture * Relationship lending

1 Introduction

Why do some firms borrow from banks while others rely exclusively on direct borrowing through issuing bonds? Despite the topic's appeal and a large number of theoretical models that make predictions about firm's debt source preferences, the answer to this question is still not well understood. Throughout the following analysis we present novel evidence by proposing a time preference based explanation for the corporate choice between the different forms of debt financing. Based on a review of the existing literature, we argue that a country's degree of long-term orientation affects the structure of corporate debt. Our findings show that bank financing is particularly related to a longer planning horizon.

A borrowing firm with long-term orientation chooses bank financing because banks may efficiently renegotiate loan contracts. Longer planning horizons might bring about periods of financial distress where loan renegotiation is valuable. As banks are long-term players on capital markets, they are interested in building up reputational capital regarding their role as a reliable creditor. Therefore, it may pay for banks to produce private information about the true quality of projects to better distinguish between good and bad projects. As a consequence, bank finance may provide an insurance against inefficient liquidation which is particularly important for long-term oriented firms. This does not necessarily imply that the maturity of bank financing is legally long-term. In contrast, bank financing is generally formally short-term, but may be prolonged in the case of good signals about project outcome.

The contribution of our study is fourfold. First, our analysis acknowledges the positive aspects of relationship lending as an insurance against inefficient liquidation based on a bank's superior information about a firm's creditworthiness. This insurance effect emerges as more important than the negative aspects of banking like misusing informational advantages in order to hold-up borrowers.

Second, our analysis tackles the country puzzle of debt ownership structure. There are large differences in the relative shares of bank loans and corporate bonds across countries. In countries such as Germany and Japan, firms rely more on bank debt than bonds, whereas the reverse pattern is true for countries like the UK and the US (Modigliani and Perotti 2000). Bank debt is usually assumed to be more expensive than bond debt (Johnson 1997), so there must be something unique about bank loans that warrants a premium (Fama 1985). Reviewing theoretical models, we derive an explanation of the comparative advantages of banks as lenders in the context of a firm's planning horizon. We extend the literature on debt financing by proposing time preferences as an important determinant. Prior empirical work on the cross-sectional determinants of the mix of debt sources has been largely focused on the US market (e. …

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