The index of agency cost and the financial accelerator: the case of Japan

An index of the agency costs is constructed using the Kalman Filter, and an example of this index, pertaining to small Japanese manufacturing firms is estimated for the period 1976-1998. The results indicate the index reflects macroeconomic fluctuations and it is appropriate for use as a proxy for agency costs instead of the cash flow proxy that most empirical studies have adopted to date. Employing this index, the author demonstrates via a Markov-switching model that a steep rise in agency costs occurred immediately before the depression of the 1990s. These results provide support for the financial accelerator theory.