the same firm. The legal doctrine of equitable subordination discourages all creditors in the U.S. from taking an equity position in the borrower, since the creditors are potentially liable to subordination should they be perceived to exert control over the firm.

Table 3

**Composition of companies' credit market debt, 1985** In percentages

||.. ---..<br>Unit<br>tites<br>n......|..|
|---|---|---|
|Intermediated debt .................|45<br>91|94|
|of which,<br>from banks .....................|36<br>n.a.|88|
|Securities .....................|55<br>9|**6**|

Note: Credit market debt excludes trade debt. Intermediated debt refers **to** loans from financial intermediaries. Securities includes commercial paper and other short-term bills and long-term bonds. Sources: Borio (1990) and national data.

Differences in the strength of bank-firm relationships are consequently significant. Bankenterprise relations in Japan have traditionally been very strong. Not only have banks typically held equity in firms, they have also been an extremely important source of financing. From 1970 to 1985, for example, Japanese firms relied on loans from financial institutions for more than 40% of their total financing needs (table 4). This may have given the main bank of a Japanese firm effective control over the firm's access to working capital and thus a much enhanced power to influence the firm's activities. In Germany, the story is somewhat different. German firms have never relied heavily on banks to finance their investment needs, because they have obtained most of their finance from internal funds.<sup>6</sup> From 1970 to 1985, for example, German firms raised only about 20% of total funds from financial institutions (primarily banks). What governance power the banks have does not appear to stem from any control over the firm's access to funds.<sup>7</sup> In the U.S., banks don't own equity nor are they an important source of funds to the typical large firm. Bank-firm relationships in the U.S. are typically arms length.

The strength of bank-firm ties in Japan is reflected in the frequency with which creditors are simultaneously equity holders of firms. For example, Prowse (1990) reports that in over 40% of a sample of large Japanese manufacturing firms the largest debtholder was also the largest shareholder; 6 This is partly a function of the differing institutional arrangements for pension provision in Germany. About two-thirds of the funds earmarked for the payment of private pensions is retained by the company as an unfunded liability. Only the remainder is invested outside the company via private pension funds. The funds retained by the company are used for general corporate purposes. The result is that there is less capital available for the capital market and less demand for outside financing than in Anglo-Saxon countries where the bulk of private pensions are channelled through private pension funds (see Edwards and Fisher (1994)). The Japanese private pension system is relatively small compared to the public pension system and is funnelled largely through the banking system via trust banks.

7 It is true that as universal banks, German banks typically underwrite equity and bond offerings by the firm, giving them more influence in this sense than Japanese banks, which are precluded from acting as investment banks. However, the low demand by German firms for external finance means that this power may not amount to much.

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