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3 empirical methods in order to examine whether

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Unformatted text preview: s or 68.89 percent of the sample have at least one incidence of board connection with those of banks (Table 3). We investigate further to see the close relationships with bank formalized through board representation at different management levels. Our focus is on two management levels, namely executives and non executives. An executive is defined as someone who holds one of the following positions: chairman, honorary chairman, vice-chairman, president, vice-president, CEO or managing director, vice-CEO and vice managing director. Non-executives are other directors of the board. 12 Our results reveal that in 13 firms which accounts for 4.81 percent of our sample, the firm’s board is connected with those of banks at the executives level. In about 36.30 percent of the firms, the board connections are via the non executive level. Finally, in about 28.15 percent of the firms, the board connections are via both the executive and non executive levels. We expect that top managers who are at the same time serving at the boards of banks are likely to make it easier for their companies to get long term loans. [Insert Table 3 Here] 3.3 Empirical methods In order to examine whether strong connections with banks and finance companies provide firms preferential access to long term loans, we use the standard model of the determinants of debt maturity decision following Barclay and Smith (1995), Stohs and Mauer (1996) Demirg¨¸uc Kunt and Maksimovic (1999). Specifically, we estimate a measure of long term loans as a function of measures of crony relationship and control variables. As a proxy for long term loans, we use the ratio of long term borrowings from banks and finance companies to total debt. Total debt includes short term and long term debt borrowings from banks and other financial intermediaries, long term debt that is due in the current period, and debentures. Previous studies suggest since it is difficult to monitor firms due to a high degree of information asymmetry between insiders and outsiders, investors are likely to depend more on short term loans (Barclay and Smith (1995), Houston and James (1996), and Stohs and Mauer (1996)). Diamond (1991a) argues that low quality firms that have insufficient cash flows have no choice but to resort to short term debt. These firms are discouraged from using long term debt because they have low credit rating, and hence bear higher interest costs. As low rated firms are not able to participate in the directly placed long-term debt market, they end up borrowing short term from intermediaries such as banks and finance companies. ¿From the creditor side, short-term financing facilitates monitoring by creditors. With a short-term loan contract, banks can review the firm’s decisions more frequently and, if necessary, vary the terms of financing or liquidate the project before sufficient losses have accumulated to make default by the borrower optimal (Diamond (1991b) and Rajan (1992)). With a short-term loan contract, banks gain a degree of control an...
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