Productivity of banks and its impact on the capital investments of client firms

This paper proposes one measure for the productivity of banks and studies how it affects the sensitivity of a client firm's capital investment with respect to investment opportunity. As a direct measure for the productivity of banks, we employ the risk-adjusted profit of an individual bank, which is considered as output in a modified version of the FISIM (Financial Intermediation Services Indirectly Measured) concept, per its operating cost. We combine such productivity panel-data with bank and firm characteristics as well as the loan relationship data between Japanese listed companies and banks over the past three decades. The panel estimations for an extended investment equation based on Q-theory show, in a statistically and economically significant manner, that firms under cash flow constraintsas compared to those notare more sensitive to capital investment opportunities, provided that these firms hold close relationships with a high performance bank. These results imply that it is necessary to relate firm performances not only to the discrete characteristics of banks, e.g., relations with the main bank, as in the extant literature, but to the continuously measured characteristics of the banks having relationships with the firms.