The impact of financial distress on external financing: A comparison of non-financial corporations in market- and bank- based financial systems

Christiane Freund

Student thesis: Master thesis


This paper addresses a so far unexplored area of the difference between market- and bank-based financial systems. It addresses how the ability of non-financial corporations to obtain finance under the recent financial crisis is expected to change and how it actually changed. Non-financial corporations are the main value drivers of any economy. Their ability to obtain external financing affects the profitability of their investments and thus the economy’s ability to cease the crisis. Large quantities of literature exist in the field of valuation of external finance, market- and bank-based financial systems and the fragility of financial systems towards financial distress. Very little literature exists in the cross-field of these three areas of external finance. The literature has so far left unexplored the subject of how developed financial markets, with different types of capital structure differ in their reaction to shocks. I use existing literature to formulate suggestions for the unexplored area. 7 hypotheses summarize the suggestions. The 7 hypothesis claim that credit tightening would force banks to sell securities and decrease their holding in bank loans. Depositors were expected to move their savings to investments in T-bills. Defaults in the Asset Backed Security market reduced the liquidity for banks with the consequence of banks selling assets and transforming the remaining assets to high risk liquid assets. All of these consequences were expected to be larger in market-based countries because systematic risk was expected to be higher. The increase in perceived risk both rationally and irrationally founded, were expected to be higher in market-based countries. Therefore value reductions in all types of external finance should be larger. Irrational behaviour should make lending and borrowing through bank loans more attractive. NFCs’ need for new finance should be reduced because prospects of future income decreased. Expansionary monetary policy should increase the value of especially bonds, but also bank-loans and equity. It is believed that changes in the value of already existing external financing affect the ability non-financial corporations to obtain new finance. Thus, I measure changes in the value of external finance and the mix of new finance. Regression analysis is used to measure both types of changes. The former showed highly significant results for bond, equity and bank loan financing. The latter showed insignificant results with respect to the mix of new financing. The empirical findings were as expected for bonds, equity and bank loans: The value of bonds never decreased, but it almost stagnated through 2008. Equity decreased the most through 2008 and rebounded in 2009. Bank loans already showed signs of a slowdown in 2006 and its value decreased in 2008 and 2009. The empirical findings were unexpected when comparing the change in external finance of bank- and market-based countries. Contrary to the hypotheses, bank-based countries were more volatile. They experienced a larger value reduction of securities in 2007-2008 and a larger increase in 2009.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2010
Number of pages203