First draft, September 29th 2002 This draft, June 1st 2003 Preliminary: Comments welcome. The History of Corporate Ownership in Japan Randall Morcka and Masao Nakamurab a. Stephen A. Jarislowsky Distinguished Professor of Finance, School of Business, University of Alberta, Edmonton, Alberta, Canada, T6G 2R6. Tel: (780) 492-5683. Fax: (780) 492-3325. E-mail [email protected]; Research Associate, National Bureau of Economic Research, 1050 Massachusetts Avenue, Cambridge, MA 02138 USA. b. Konwakai Japan Research Chair and Professor, Sauder School of Business, The University of British Columbia, 2053 Main Mall, Vancouver, B.C., Canada V6T 1Z2, Tel: (604) 822-8434, Fax: (604) 822-8477, E-mail: [email protected] We are grateful for comments from participants in the NBER Pre -Conference on the "History of Corporate Ownership: The Rise and Fall of Great Business Families," October 5, 2002. Abstract Japan’s corporate sector began as zaibatsu family pyramids, was subjected to Soviet style central planning, was reorganized into widely held firms, and finally organized itself into keiretsu corporate groups. Both zaibatsu and keiretsu were probably rational responses to weak institutions, a talent shortage, abundant private benefits of control, and an environment where political rent seeking earns high returns. Other common justifications for corporate groups are at best of second order importance. These include economies of scope and scale and internal capital allocation. The latter provides short term benefits, but undermines the group in the longer term. Once dominant, such groups lobby for institutional reforms that further their dominance. Examples include the suppression of the bond market in postwar Japan, managerial entrenchment in keiretsu firms, and an increasing importance of rent seeking as a source of competitive advantage. This lobbying was almost surely not social welfare enhancing. 1. Introduction The history of Japanese corporate ownership is especially interesting because it has changed more radically and more often than in any other major industrial economy. These changes, and the successes and failures associated with them, cast light upon fundamental issues in corporate governance and the economics of institutions. Both historical and contemporary research into corporate ownership in Japan focus on intercorporate networks. In the last third of the twentieth century, the inter-firm networks of interest were horizontal and vertical keiretsu groups of corporations. Horizontal keiretsu are inter-industry networks of firms whose small individual equity stakes in each other collectively sum to control blocks. An example is the Mitsui group of companies. Vertical keiretsu are similar structures that encompass the suppliers and customers of a single large firm, such as Toyota Motors. In both variants, public shareholders only have access to minority interests, which renders the stock market essentially irrelevant to corporate governance role. Adjunct to the keiretsu networks, most Japanese firms have strong ties to their lead lenders, or main banks. However, keiretsu are a relatively recent development in Japanese economic history. During the feudal Takagawa period (1603 -1868), Japanese firms were owned entirely by families - or, perhaps more properly, by clans. The Mitsui and Sumitomo family businesses both emerged during this era. In both cases, extensive sets of family rules and traditions determined corporate governance issues. Following the Meiji Restoration of 1868, the new government promoted rapid industrialization. The Mitsuis, Sumitomos, and other new family businesses like Mitsubishi (run by the Iwasakis) needed capital vastly in excess of their own wealth, and turned to public equity markets. The families organized a new corporation to raise equity financing for each new 1 venture, and organized them into family controlled pyramidal groups. At the apex of each was a family partnership (later a family corporation), which also served as a holding company to control several public corporations. These, in turn, each controlled other public corporations, which in turn controlled yet other public companies. These inter-firm networks, called zaibatsu, were essentially identical to modern Korean chaebol and similar pyramidal business groups elsewhere.1 Despite much research, there seems to be little consensus in the literature regarding the contributions of zaibatsu to the rapid development of the prewar period. For example, the powerful zaibatsu families may have been more concerned about preserving their wealth and control, and may have been too conservative to undertake high-risk projects in new industries that might have accelerated Japan's modernization. Also, the ability of zaibatsu with different structures to survive the depressions of the 1920s and 1930s points to the importance of a bank with a widely diversified loan portfolio. During World War II, Japan de facto nationalized all its major corporations, subordinating them to central planners in a rigid system virtually identical to that prevailing in the Soviet Union. The Temporary Funds Adjustments Law of 1937 created the Kikakuin, or Planning Agency, to centralize economic planning and administration. This required boards to obtain government approval before most important corporate decisions, such as changing their articles of incorporation and issuing equity or debt. Further government decrees abolished boards’ rights to set dividends in 1939 and to appoint managers in 1943, reassigning these powers to Kikakuin. The Kikakuin consciously imitated many of the planning methods the 1 The Chinese characters for zaibatsu are pronounced chaebol in Korean. One distinction between pre-World War II Japanese zaibatsu and contemporary Korean chaebol is a stricter adherence to blood kinship in the governance of the latter. Authority based on blood kinship is an important element of Confucianism, which is influential in both Chinese and Korean culture. Japanese Buddhist beliefs allowed more leeway for inept blood kin to be sidelined. 2 Soviet Union used for its heavy industrialization in the 1930s.2 This was accomplished amid much condemnation of shareholders (meaning the zaibatsu families) for their self-interest, risk aversion, and unpatriotic concern with short term profit. This rhetoric would resurface later as a justification for depriving small shareholders, rather than controlling shareholders, of governance input. The great zaibatsu families, of course, protested these charges. Following the war, Japan was governed by the United States military from 1945 to 1952. The left-leaning General MacArthur, taking the wartime condemnations of the zaibatsu families at face value, confiscated their stock in their holding companies, unwound all the intercorporate stakes among zaibatsu firms, and sold these shares into the equity market. Consequently, Japan (briefly) was a widely held economy, similar to the United States and United Kingdom, in which most large public companies had no controlling shareholder. A market for corporate control quickly took off, as Japanese firms undertook hostile takeovers of each other, and raiders extracted greenmail from unwilling target firms. Japanese managers and bankers disliked the job insecurity of the Anglo-American system of corporate governance. Following the end of the US Occupation in 1952, Japanese firms began purchasing white squire positions in each other to head off raiders. The major banks were soon organizing intercorporate equity placements, and the current keiretsu system emerged during the 1950s and developed more fully in the 1960s. That system, which has characterized Japanese big business up to the present is now under increasing stress. At the beginning of the current century, Japan is once again bracing for major institutional changes. Throughout all of these changes, the principals of Japan’s great businesses actively pursued their own interests, mainly profit and control, with varying degrees of success. In general, they shaped organizational forms to accommodate these objectives, and reconfigured 2 See Okazaki (1994) for details. 3 their organizational forms as new legal and other constraints were imposed upon them. This paper examines the emergence and evolution of these different organizational structures as responses changing political and institutional circumstances. Of course, institutional changes sometimes also reflected the lobbying activity of big business. Consequently, we also discuss the extent to which institutional environments changed in response to business. However, critical points in Japan’s business history seem to involve clearly exogenous events that clearly required adaptation by the business sector. The abrupt opening of Japan to world trade and the decision of the Meiji government to embark on a crash program of modernization was one such occasion. The generally negative attitudes of both the Japanese military government and the Allied Occupation Force in the mid 20th century were two others. There are doubtless many reasons for the rise of the zaibatsu and the spontaneous organization of the keiretsu. Certainly, economies of scope and scale, reputation, circumventing flawed markets and institutions, and numerous other factors are in play. However, this paper argues that the primary purpose of both the zaibatsu and the keiretsu was to protect the control rights, first of the great zaibatsu families, and later of the professional managers running keiretsu firms. While