This paper investigates the effect of banks' lending capacity on firms' capital investment. To overcome the difficulties in identifying purely exogenous shocks to firms' bank financing, we utilize the natural experiment provided by the Great Hanshin-Awaji (Kobe) Earthquake in 1995. Using a unique firm-level dataset that allows us to identify firms and banks in the earthquake-affected area, together with information on bank-firm relationships, we find that the investment ratio of firms located outside of the earthquake-affected area but with their main banks inside the area was lower than that of firms that were both located and had their main banks outside of the area. This result implies that the weakened lending capacity of damaged banks exacerbated the borrowing constraints on the investment of their undamaged client firms. We also find that the negative impact is robust for two alternative measures of bank damage: that to the bank headquarters and that to the branch network. However, the impacts of the two are different in timing; while that of the former emerged immediately after the earthquake, the latter emerged with a one-year lag.

This paper investigates the causal relationship between firms' bank dependence and financial constraints by utilizing the 2008 financial crisis and its impact on the Japanese economy as a natural experiment. Since the Japanese banking sector remained healthy while the corporate bond markets were paralyzed, firms that had reduced bank dependence were hit heavily by the shock. I examined whether firms with large holdings of corporate bonds maturing in 2008 were financially constrained, by comparing the changes in their investment expenditures and borrowing conditions with those of bank-dependent firms. The main empirical results show that (1) firms with large holdings of corporate bonds maturing in 2008 did not cut investment expenditures; (2) instead, they observed higher increments in bank loans; and (3) firms that maintained relatively close bank-firm relationships had more access to bank loans with low borrowing costs, but significant differences in investment expenditures were not found. These findings imply that although there is a cost to reducing bank dependence, it is not very high for Japanese listed firms.

In this paper, we investigate whether a natural selection mechanism works for firm exit. By using data of firms after a devastating earthquake, the Great Tohoku Earthquake, we examine the impact of firm efficiency on firm exit both inside and outside the earthquake-affected areas. We find evidence suggesting that more efficeint firms are less likely to exit both inside and outside the affected areas, which supports the natural selection mechanism. However, we also find that the mechanism is weaker for those firms whose main banks were damaged by the earthquake, which suggests that damage to banks weakens the natural selection mechanism. We also apply the same methodology to the case of the Great Hanshin-Awaji Earthquake, and again find that the natural selection mechanism works both inside and outside the affected areas. However, no significant impact of bank damage is found on the exit probability of a firm.

A part of this paper is based on research we have conducted at the Research and Statistics Department of the Bank of Japan. We would like to thank members of the Department, especially Kazuo Monma, Munehisa Kasuya and Masahiro Higo for helpful comments and discussions on our research. We also thank Takatoshi Ito for insightful suggestions at an early stage of this research. We are grateful to participants of the 20th East Asian Economic Seminar (Hong Kong, June 26-27, 2009), especially the discussants Donghyun Park and Yuko Hashimoto, as well as the organizers (Andrew Rose and Takatoshi Ito) for many invaluable comments that have led to substantial improvement of the paper. We also would like to thank two anonymous referees for their insightful comments. Shioji thanks financial assistance from the "Understanding Inflation Dynamics of the Japanese Economy" project of Hitotsubashi University, and Uchino thanks the Global COE Grant "Research unit for statistical and empirical analysis in social sciences" of Hitotsubashi University. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.