This paper investigates the consequences of the collapse of internal capital market on firms’ financial decision making. We use a data set from Japan, where the existence of the traditional bank-oriented “keiretsu” system has been weakening in recent decades. In addition to the findings that firms in internal capital markets have higher financial leverage and a slower speed of adjustment, we find that as a banks’ influence weakens, member firms’ financial leverage decreases and their speed of adjustment increases. Several robustness checks ensure consistent results in the basic analyses such as: excluding firms with extreme financial leverage, controlling for firms’ financial distress, using multiple cut-off points representing different banks’ ownership levels, and whether there has been a shift from using bank loans to public bonds due to the decline of bank’s influence on other member firms.

JEL Classification : G21, G30

Keywords : Business groups; internal capital market; financial leverage; speed of adjustment