Financial fragility and corporate debt: An empirical investigation of Canada, United States and Japan.

Abstract

The paper will assess the relevance of a rising debt to equity ratio for the fragility of the Canadian, U.S., and Japanese economies. In addition, it will also attempt to ascertain the significance of the nonfinancial corporations' liquidity and profits, as well as, the effects of moral hazard, adverse selection, and investor's confidence to the fragility problem. A series of Granger causality tests are performed in addition to the general statistical analysis of each country. The basic finding is that, despite a somewhat different banking structure, a rising debt to equity seems to be an important factor for the long-run stability of both the Canadian and U.S. economies. Whereas, in Japan, this seems to be less of a factor due to the relatively close ties between the banking and nonfinancial corporate sectors. Moreover, the lack of the moral hazard and adverse selection problems, coupled with the relatively smaller use of the securities market, the higher liquidity ratio, and the cooperative attitude of the Japanese workers and consumers, constitutes additional reasons as to why rising debt to equity has played less of a significant role in Japan.