Inter-Firm Relationships and Leverage Adjustment

This paper investigates the impact of inter-firm relationships on a firm’s incentive to adjust its capital structure. We predict that firms with tight business relationships with other firms have less incentive to adjust their capital structure because their information will be propagated through the inter-firm relationships and they will be able to seek assistance if they have problems with liquidity. Using a Japanese dataset and constructing three measures of inter-firm relationships, we find that the adjustment speed of firms with tight relationships is slower than that of those without such relationships. Lastly, we explore whether deregulation in the financial markets stimulates the adjustment speed and find that the speed increased after series of deregulations of the Japanese stock market. Overall, these results are consistent with our prediction that inter-firm relationships affect a firm’s incentive to adjust its capital structure.