Corporate Governance

Handout 4
The structure of Corporate Ownership in
Japan
One of the fundamental issues concerning corporate
governance is that each owner typically owns a small
fraction of the corporation.
Fragmented ownership makes it difficult for the
owners (shareholders) to exercise effective control
over the management.
Thus, the problem of the separation of ownership and
management is more severe when ownership is
fragmented.
Therefore, understanding the corporate
ownership structure is an important topic in the
study of corporate governance. For example,
large shareholders may be effectively voice their
opinions, thus alleviating the problem of the
separation of ownership and management.
We will discuss the structure of corporate
ownership in this handout. We will focus on the
issues in Japan, with some attention given to the
comparison between the situation in the US and
Japan.
 Our goal today is to understand

1. Why is the corporate ownership in Japan structured the

way it is (was).
2. Has there been any change in the structure of corporate
ownership in Japan overtime? If so, what are the factors
that caused such changes?
3. What does the recent increase in foreign ownership mean
to Japanese firms?

Today’s discussion will be based on Prowse (1992), and

Miyajima and Kuroki (2008) for more recent results.
First, we investigate the determinants of the
structure of corporate ownership. By doing so,
we can understand why corporate ownership is
structured the way it is (was)
We will take a look at the results in 1980s
first. Then, we will look at the change in
corporate ownership overtime.
The structure of corporate ownership in the
US and Japan (1984)
 There are major differences between the
structure of corporate ownership between the
US and Japan.

1. The percentage of equity owned by corporation is much larger

in Japan than in the US.
2. The percentage held by financial institution is much larger in
Japan than in the US.
This could be due to different regulations between the US and
Japan. At that time in Japan, Banks were allowed to hold up to
10% of non bank equity (this will be reduced to 5% later). On
the other hand in the US, banks were allowed to hold only up to
5%.
The concentration of ownership in Japan and the
US.
The previous table shows that significant
shares are owned by corporation in Japan.
However, the previous tables does not reveal
anything about the concentration of
ownership.
The table in the next slide shows the
percentage of equity held by the top five
shareholders in the US and Japan.
 The concentration of ownership in Japan
and the US.
Ownership is more
concentrated in Japan
than in the US in 1984.

33.1% of equity is held

by top five shareholders
in Japan, while 25.4%
of equity is held by top
five shareholders in the
US.

Japanese data the top five shareholders of 734

largest Japanese firms.
The concentration of ownership in Japan:
A frequency table
Who are the largest shareholders in Japan?
Financial Non financial Individual
Top five institution that institution shareholders that
shareholders rank among that rank rank among top
top fives among top five shareholders
shareholders five
shareholders

Financial institution dominates the importance as large

shareholders
 Determinants of ownership structure in
Japan
From here, we will investigates the determinants of
ownership structure in Japan.
We pay a particular attention to Japan specific issues
such as the existence of corporate groups or ‘keiretsu’
in Japanese.
Let us first think what would determine the
concentration of corporate ownership ： why some
firms would have large concentration of ownership
structure while others have very fragmented ownership
structure?/
 Two hypothesis
1. The larger the size of the firm is, less concentrated
the structure of corporate ownership is.

The corporate form of business initially developed

since ‘value maximizing’ size of firms exceeded the
size that can be financed only by a few individuals.
Needless to say, the advantage of the corporate form
of business is the ability to gather capital from many
individuals/institutions. Thus, we expect that the
ownership structure would be less concentrated in a
large firm.
2. Control potential

Control potential refers to the profit potential

from exercising more effective monitoring of
managerial performance by the firm owners.

The question is ‘in what firms is the control

potential large?’
To think of an answer to the question ‘in what firms the control
potential is large’, first consider a firm that operates in a very
stable business environment (i.e., stable price, stable market
share, stable technology, etc). In such a firm, managerial
decisions would be less crucial in affecting firm performance.
On the other hand, if a firm operates in a less certain
environment (unstable market share, changing technology etc),
managerial behavior would be more crucial in affecting firm
performance. Therefore, in such a firm, the profit potential
from exercising more effective monitoring of managerial
performance would be greater.
Therefore, the control potential is likely to be large in a firm
operating in a less certain environment.
 A Japan specific factor: Keiretsu
Japanese firms often form corporate groups called Keiretsu.
Keiretsu is a group of firms with strong long-term trading
ties (such as supplying intermediate goods etc). Such
relationship is enforced by cross-shareholding among them.
Among keiretsu firms, there are exchanges of managers
which serves as ‘alternative monitoring system’.
Moreover, such cross-shareholding is very stable. Keiretsu
firms seldom expresses their dissatisfaction to management
by selling out the (cross-held) shares.
Therefore, ownership concentration is not a good proxy for
the control of shareholders in Keiretsu firms. It would be a
good proxy only for independent firms.
 In sum, we have the following hypotheses.
1. Ownership would be less concentrated in a
large firms
2. Ownership would be more concentrated in a
firm which operates in a less certain business
environment.
3. The above two hypotheses will be true only for
independent firms. These hypotheses may not
apply for keiretsu firms, since they have
alternative ‘corporate governance system’.
 Variables
Variable Definition

MVE Market value of common equity in millions of dollars (using

exchange rate 225 yen=$1)

SE Standard error of the estimated abnormal return. This is the

first variable to measure the uncertainty of the business
environment
STDS Standard deviation of monthly stock market rates of return.
This is the second variable to measure the uncertainty of the
business environment
STDA Standard deviation of ROE. This is the third variable to
measure the uncertainty of the business environment
 The model
Prowse (1992) estimated the following OLS
regression.

(Top five ownership)

= β0+β1(MVE)+β2(Uncertainty variable)

[Prowse used log transformation of top five ownership: log(ownership/100-

ownership) as the left hand side variable]
The results 1 First, take a look at the
coefficients for the
MVE (the firm size
variable).

For keiretsu firm, the

coefficients are not
statistically significant
for all the models. Also
when compared to the
results for independent
firms, the coefficients
are small in magnitude.

This shows that, among

keiretsu firms, the size
does not constrain the
ownership
concentration.
The results 2 On the other hand, the
coefficients for MVE
are negative and
statistically significant
for independent firms
for all the models.

This indicates that

larger firm has less
concentrated ownership
structure as predicted by
the hypothesis 1.
The results 3 Now we take a look at
the coefficients for the
uncertainty variables
(SE, STDS, STDA).

For the keiretsu firms,

all the coefficients are
not statistically
significant. In addition,
the coefficients are
much smaller when
compared to
independent firms.

Therefore, uncertainty
in business environment
has no effect on
ownership
concentration for
keiretsu firms.
The results 4 For independent firms, all
the coefficients for the
uncertainty variables are
statistically significant.

This indicate that firms

operating in less certain
business environment has
greater ownership
concentration.

This result is consistent

with the second
hypothesis: A firm with
greater control potential
will have a greater
ownership concentration.
Thus, shareholders of independent and
keiretsu firms behave differently.
For independent firms, the ownership is less
concentrated in larger firms. Also, firms
operating in less certain business environment
tend to have greater ownership concentration.
These results are consistent with our two
hypotheses regarding the determinants of the
structure of ownership.
However, for keiretsu firms, the above two
hypotheses do not apply.
 In sum, we can make the following conclusions
regarding the ownership structure of Japan before
1984.
1. Ownership concentration in Japanese firms are higher
than in the U.S. firms.
2. Firms with high control potential has greater
ownership concentration. However, this result only
apply to independent firms. This result do not apply
to Keiretsu firms.
3. Different behavior of shareholders in Keiretsu firm
indicate that keiretsu firms may have ‘alternative
corporate governance’ system.
 More recent trend in the structure of
corporate ownership in Japan
Now, we will discuss a recent trend in the
structure of corporate ownership in Japan.
Discussion will be based on Miyajima and
Kuroki (2008).
The ownership structure of Japanese firms used to
be (1980’s) characterised by substantial block
shareholding by corporations and financial
institutions.
In particular, substantial stable cross-shareholding
between financial firms and corporation and
among corporations distinguished the ownership
structure in Japan from that in other countries.
However, there has been a new trend. The stable
shareholding has been declining, and foreign
ownership has been increasing.
The trend in the ownership of the stable
shareholders

The percentage of equity (in value) held by

stable shareholders has been declining
overtime. Therefore, there has been a trend to
unwind cross-shareholding in the past two
Ownership by type of shareholders

There is an increasing trend in foreign ownership.

 Long term trend in ownership structure

This shows the ownership structure overtime. You can notice an increase in
foreign ownership and a decline in financial institution.
After the World War II, large family owned
corporate groups (Zaubatsu) were dissolved.
This increased the potential threat of takeover.
Firms, and especially Ex-zaibatsu firms,
sought ‘friendly’ shareholders, and cross-held
each others shares in order to reduce the
possibility of being taken over. Historically,
cross-shareholding became prevalent this way.
You can notice a clear upward trend in foreign
ownership.
 These trends raise several questions.
1. Why did cross-shareholding, which had been
fairly constant for more than thirty years,
begin to dissolve in the mid-1990s?
2. If cross-shareholding was a response to the
increasing hostile takeover threat, then why
did it begin to decline just as the takeover
threat grew much more serious than before.
3. What does the increase in foreign shareholding
do to Japanese firms.
 In order to answer these questions, Miyajima and
Kuroki (2008) investigates the following.

1. The determinants of unwinding of cross-

shareholding with banks by non-financial
corporation.
2. The determinants of unwinding of cross-
shareholding with non-financial corporation by
banks.
3. Whether an increase in foreign ownership would
increase firm performance.
The determinants of unwinding of cross-shareholding
with banks by non-financial corporations

First, let us discuss what factors affect the

decision of non-financial corporation to sell-
off (cross-held) bank shares.
 The need to sell shares
liquidity constraint (thus need for cash by selling shares)
Financial health of the bank
If the financial health of the bank is low, it makes it risky to hold the shares
of the bank.
Credit rating of the company
If the company does not have a good credit rating (say BBB), then the firm
may have incentive to sell the banks share in order to signal the investors
that the company is making a rational managerial decision.
Threat of take over
If there is a threat of takeover, the company may be reluctant to sell stable
shares.
Variable Definition

Need to sell Dummy variable showing interest coverage ratio is

D_ICR less than 1.5. Interest coverage ratio (EBIT/interest
expense) shows how easily the company can pay
interest on debt

DERATIO Dept/Equity: A company with excess debt (greater

D/E) may need to sell shares to obtain cash.
Financial health of the bank
D_BK_RATE Dummy variable showing if Moody’s bank financial
rating is D or below
Threat of takeover
M_NOST The ratio of shareholding by non-stable shareholders
Data and estimation model
Data: The survey of cross-shareholding published
by Nihon Life Insurance Research Institute.
Each cross-share-holding bank-company pair is
treated as a distinct observation.
The following model is estimated
Yi=β0 +β1(D_ICR)+β2 (Dept/Equity)
+β3(D_BK_RATE)+β4(M_NOST)+β(other variables)
Where Yi=1 if the company sells the bank’s (cross-held) shares.
Yi=0 otherwise.
[Model is estimated using logit model]
Result 1 First of all, the results show that a
corporations had sold bank shares
because they had the need to sell
shares.

The coefficient for the dummy for

low interest coverage ratio is
positive and significant. This
shows that a company that has
difficulty meeting interest payment
is more likely to sell bank shares.

A company with high Dept/Equity

ratio tends to sell off bank shares.
This also shows that a company
with liquidity constraint (thus in
need for cash) tend to sell of bank
shares.

These results show that the trend in

the unwinding of cross-
shareholding occurs partly because
Result 2 Second, when the bank’s financial
health is low, the company is more
likely to sell off the bank’s shares.

The coefficient for the dummy

variable for the bank with rating
below D has positive coefficient.

This mean that when the bank’

rating is D or below, the company
is likely to sell off the bank’s
shares.

This means that the trend in the

unwinding of cross-shareholding
had been partly due to financial
crisis in Japan.
Result 3 Third, when the company faces
greater threat of takeover, the
company is reluctant to sell the
(cross-held) bank shares which is
stable.

The coefficient for the percentage

share of non-stable shareholders is
negative, indicating that a company
with greater non-stable
shareholders is less likely to sell off
the bank shares.

Thus, cross-shareholding still is a

device to reduce the threat of
takeover.
In sum, the unwinding of cross-shareholding
occurred because
1. Company needed to obtain cash
2. The financial health of the banks deteriorated
3. There was an incentive for company to sell
bank shares in order to show the investors that
they are making rational managerial decisions.
4. However, companies were still reluctant to
unwind cross shareholding when there is greater
threat of takeover.
What would the increase in foreign shareholders do to
Japanese firms

There are many ways to answer to this

question.
Today, let us discuss the following question.
‘Would the increase in foreign ownership
improve the performance of Japanese firms?’.
First, why would/would not an increase in
foreign ownership improve the performance of
Japanese firms?
The model and variable
(Performance)it=β0+β1(Foreign ownership)
+ β(other variables)

We use two performance variables: ROA and the

Tobin’s q. Tobin’s q is the market to book asset
ratio, and expected to capture the growth
opportunity of the firm.

[The model is estimated using the fixed effect model. Under a certain assumption, this model estimates the causal effect of
foreign ownership on performance]
The results The coefficient for
foreign ownership is
positive and
statistically
significant for both
models.

Thus, foreign
ownership does
have a positive
effect on the
performance of
Japanese firms
Summary
Starting in mid 1990s, Japanese companies began to
unwind cross-shareholding.
The unwinding of cross-shareholdings was due to the
fact that (1) some firms needed to sell share to obtain
cash, (2) the financial health of banks deteriorated, (3)
corporations needed to sell bank shares in order to signal
the investors that they are making a good managerial
judgment. However, firms facing greater threat of take
over were still reluctant to sell (cross-held) shares.
There has been an increase in foreign ownership. This
has had a positive effect on the performance of Japanese
firms.
Prowse S (1992) ‘The structure of corporate
ownership in Japan’ Journal of Finance, 47 1121-
1140

Miyajima and Kuroki (2007) ‘ The unwinding of

cross-shareholding in Japan: Cause, Effects and
Implications’ In Corporate Governance in Japan
ed by Aoki G, Jackson and Miyajima, Oxford
University press