Economic & Social Affairs ST/ESA/1999/DP.15 DESA Discussion Paper No. 15 Bank-firm Cross-shareholding in Japan:What is it, why does it matter, is it winding down? Mark Scher February 2001 United Nations DESA Discussion Paper Series DESA Discussion Papers are preliminary documents circulated in a limited number of copies and posted on the DESA web site http://www.un.org/esa/papers.htm to stimulate discussion and critical comment. This paper has not been formally edited and the designations and terminology used do not imply the expression of any opinion whatsoever on the part of the United Nations Secretariat. Citations should refer to a “Discussion Paper of the United Nations Department of Economic and Social Affairs.” Mark Scher Mark Scher is an Economic Affairs Officer at the Department of Economic and Social Affairs. Some of the work for this paper was undertaken while the author was Visiting Associate Professor of Management and International Business, Stern School of Business, New York University. Earlier versions of the paper were presented at seminars at DESA/DPAD, UNDP/HDR Office and the Japan Economic Seminar. The views and interpretations in this paper do not necessarily represent the views of the United Nations. The author would like to thank Hugh Patrick, Tom Pugel and the NLI Research Institute of Tokyo for their comments and assistance. Comments should be addressed to the author at the Development Policy Analysis Division, Rm. DC2-2114, United Nations, New York, N.Y. 10017, or by e-mail [email protected]. Additional copies of the paper are available from the same address. Authorized for distribution byIan Kinniburgh, Director, Development Policy Analysis Division United Nations Development Policy Analysis Division Abstract An institutional structure of corporate groups evolved over the post-war years in Japan, wherein members of a group were linked together through mutual shareholding, often with commercial banks at the centre of the network. This paper examines the functioning of cross-shareholding, as it involved Japan’s commercial banks in the 1990s. It finds that the banks have not been especially successful “monitors” of members of the corporate groups and that corporate management had relatively negative appraisals of the banks. Japan has been passing through a major financial crisis, which has shaken up the role of banks within its main bank system. It has also reduced the extent of cross-shareholding of banks. However, cross-shareholding continues to provide implicit relational contracts that play a role in Japanese business society. This study highlights the importance of paying adequate attention to historical and institutional factors in analyses of development. Key words: Banking, Japan, corporate governance, cross-shareholding JEL classification code: G32; L2. Introduction the governance of modern Japanese firms and questions of “industrial organization” [Scher, 1997, 1998; Ito, 1993; It has been a common practice in Japan for pairs of firms Nomura Sogo Kenkyujo, 1992; and Okumura, 1990]. to exchange equity shares in each other, a practice called Some economists suggest that the groups helped to “cross-shareholding.” Sometimes the firms have been in manage risk in the Japanese economy [Nakatani, 1984; the same industrial group, sometimes they are suppliers Aoki, 1984]. A number of Japanese studies have asked if and customers, and sometimes creditors and borrowers. there was a positive effect of cross-shareholding upon This paper focuses on the problems relating to bank-firm stock prices [Ikeo, 1993; Kanesaki, 1986; Kawakita, cross-held shares. 1992, 1993; Kobayashi, 1991, 1992; Kumagai, 1994; The shares cross-held by banks and firms Kurasawa, 1984; Ogishima, 1993; Wakasugi, 1982]. became a matter of grave concern in the 1990s in part Other analysts, including this author, have been critical of because most Japanese banks depended on the market bank-firm cross-shareholding. Two studies by Japanese value of stocks held in their portfolios to help satisfy research teams have analyzed corporate attitudes towards capital adequacy standards. With the huge decline in the cross-shareholding in the 1990s, based on surveys of Tokyo stock market during the 1990s, at times falling to management, focusing in particular on the firms’ less than one-third of its 1989 high level, banks had great relationship with their main bank [Omura, 1993; and Fuji difficulty in maintaining the level of capital required to Sogo Kenkyujo, 1993]. They found corporate meet the Basel Committee standards to operate management to be generally critical of bank-firm internationally, let alone to cover the burgeoning cross-shareholding relationships. amounts of bad debt. Moreover, the greatest part of This study draws upon these previous works, as bank-held shares have been in each bank’s client firms well as on interviews undertaken by the author with the and thus the fortunes of banks and firms were lashed management of Japanese banks. It embodies an extension together, as Japan faced its most profound economic of the information collected in multiple in-depth crisis of the post-war era. interviews with seventy-seven Japanese bank By the middle 1990s, it appeared that the practitioners,1 so as to now cover the period from 1992 to prevalence of bank-firm cross-shareholding might be 1999, a very turbulent period for the Japanese financial winding down, although it was not yet clear in the data. sector. However, the major mergers and closure of large banks as the decade ended could signal the start of a new era. Whether or not winding down, it appears that bank-firm The development of cross-shareholding has been a factor in the protracted cross shareholding financial crisis of the second largest economy in the world. This in itself would warrant investigation of the Kabushiki mochiai (mutual aid shareholding) is the phenomenon; but such a study may be of interest as well Japanese term for what is customarily translated as for the light it sheds on relations that can develop “cross-shareholding”, that is, equity shares that two between banks and their client firms, albeit in a specific companies hold in one another. Cross-shareholding, in institutional context. turn, is a subset of what is known as antei kabunushi Much of bank-firm cross-shareholding in (quiescent stable shareholding), which may be held in Japan has taken place within groups of interrelated trilateral, multilateral, or otherwise stable arrangements firms, typically with a large bank at the centre, the “main among companies, usually based on group and/or bank”. The implications of cross-shareholding and transactional relationships. Together, the various forms of related issues in regard to the role of the main bank have stable shareholdings comprise some 65 per cent to 70 per been extensively studied and debated in the context of cent of all stock issued by publicly traded corporations in 1 For a detailed description of the interview methodology, see Scher 1997, 1998. 2 DESA Discussion Paper No. 15 Japan. The remaining shares are freely traded on the stock Pros and cons of cross-shareholding exchanges. Cross-shareholding in Japan, however, In 1992, Japan’s Economic Planning Agency (JEPA) represents much more than a single-dimension ownership responded to criticism raised by the Government of the relationship. It often also reflects other understood but United States in the Strategic Structural Initiative (SSI) unstated obligations. As will be noted, cross-shareholding trade negotiations that cross-shareholding promoted arrangements in the post-war era operated as tacit mutual unfair trading practices and that Japan’s pacts designed to insulate the management of both sides cross-shareholding and main bank system specifically from any market threat of hostile takeover. The purpose of locked out foreign-owned banks. In its reply, JEPA most cross-shareholding is to avoid rather than confer advanced three main economic justifications, among shareholder rights, so stable shareholding relationships others, for cross-shareholding, characterizing them as function as a strategy of corporate management to limit “merits.” shareholder governance of the firm. First, it argued that cross-shareholding Cross-shareholding may be divided into two provides a stable source of funding for businesses by categories: (1) cross-shareholding between members of a ensuring that there will be partners who will be stable horizontal corporate conglomerate group, or kigyo investors and who will buy new issues of stock shudan, the core of stable shareholding arrangements, and whenever needed. Second, according to JEPA, (2) cross-shareholding that reflects business relationships cross-shareholding strengthens the stability of corporate between suppliers and customers. In neither case is the management by acting as a bulwark against the threat of cross-shareholding relationship intended to confer the hostile takeover. Such arrangements relieve ownership rights inherent in the Anglo-American model management of the necessity of responding to excessive of corporate governance. Cross-shareholding pressures from the capital markets, permitting it to arrangements between suppliers and customers are develop operations according to a long-term primarily a franchise to do business, a method of perspective. Lastly, JEPA maintained, cross- cementing transactional relationships. It is within this shareholding stabilizes and strengthens business category of transactional relationships that one should transactions between