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8/7/2019 Corp Gov jp

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Corporate Governance

Handout 4


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The structure of Corporate Ownership inJapan

One of the fundamental issues concerning corporategovernance is that each owner typically owns a smallfraction of the corporation.

Fragmented ownership makes it difficult for the owners(shareholders) to exercise effective control over themanagement.

Th

us, th

e problem of th

e separati

on of ownershi

p andmanagement is more severe when ownership isfragmented.


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Therefore, understanding the corporate

ownership structure is an important topic in thestudy of corporate governance. For example,

large shareholders may be effectively voice their

opi

ni

ons, th

us allevi

ati

ng th

e problem of th

eseparation of ownership and management.

We will discuss the structure of corporateownership in this handout. We will focus on the

issues in Japan, with some attention given to thecomparison between the situation in the US and

Japan.


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Our goal todayis to understand

1. Whyis the corporate ownership in Japan structured thewayit is (was).

2. Has th

ere been any ch

angei

n th

e structure of corporateownership in Japan overtime? If so, what are the factorsthat caused such changes?

3. What does the recent increase in foreign ownership

mean to Japanese firms?

Todays discussion will be based on Prowse (1992),and Miyajima and Kuroki (2008) for more recentresults.


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First, we investigate the determinants of the

structure of corporate ownership. By doing so,

we can understand wh

y corporate ownershi

pi

sstructured the wayit is (was)

We will take a look at the results in 1980s first.

Then, we will look at the change in corporate

ownership overtime.


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The structure of corporate ownership in theUS and Japan (1984)


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There are major differences between the

structure of corporate ownershi

p between th

eUS 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 inJapan 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 to10% of non bank equity (this will be reduced to 5% later). Onthe other hand in the US, banks were allowed to hold only up to

5%.


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The concentration of ownership in Japan and theUS.

The previous table shows that significant shares

are owned by corporation in Japan.

However, th

e previous tables does not revealanything about the concentration of ownership.

The table in the next slide shows the percentage

of equityheld by the top five shareholders in theUS and Japan.


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The concentration of ownership in Japanand the US.

Japanese data the top five shareholders of 734 largest

Japanese firms.

Ownership is moreconcentrated in Japanthan in the US in 1984.

33.1% of equityis heldby top five shareholders

in Japan, while 25.4% ofequityis held by top five

shareholders in the US.


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The concentration of ownership in Japan:A frequency table


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Who are the largest shareholders in Japan?

Top fiveshareholders

Financial

institution thatrank among

top fivesshareholders

Non financial

institution thatrank among

top fiveshareholders

Individual

shareholders thatrank among top

five shareholders

Financial institution dominates the importance as largeshareholders


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Determinants of ownership structure inJapan

From here, we will investigates the determinants

of ownership structure in Japan.

We pay a particular attent

ion to Japan spec

ific

issues such as the existence of corporate groupsor keiretsu in Japanese.

Let us first think what would determine the

concentration of corporate ownershipwhysome firms would have large concentration ofownership structure while others have very

fragmented ownership structure?/


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Two hypothesis1. Th

e larger th

e siz

e of th

e fi

rmi

s, less concentrated th

estructure of corporate ownership is.

The corporate form of business initially developed

since value maximizing size of firms exceeded thesize that can be financed only by a fewindividuals.Needless to say, the advantage of the corporate formof business is the ability to gather capital from many

individuals/institutions. Thus, we expect that theownership structure would be less concentrated in alarge firm.


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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?


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To think of an answer to the question in what firmsthe control potential is large, first consider a firm that

operatesi

n a very stable busi

ness envi

ronment (i

.e.,stable price, stable market share, stable technology, etc).In such a firm, managerial decisions would be lesscrucial in affecting firm performance.

On the other hand, if a firm operates in a less certainenvironment (unstable market share, changingtechnology etc), managerial behavior would be morecrucial in affecting firm performance. Therefore, in

such a firm, the profit potential from exercising moreeffective monitoring of managerial performance wouldbe greater.

Therefore, the control potential is likely to be large in a

firm operatingin a less certain environment.


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A Japan specific factor: Keiretsu

Japanese firms often form corporate groups calledKeiretsu. Keiretsu is a group of firms with strong long-term trading ties (such as supplyingintermediate goodsetc). Such relationship is enforced by cross-shareholding among them.

Among keiretsu firms, there are exchanges of managerswhich serves as alternative monitoring system.

Moreover, such cross-shareholdingis very stable.

Keiretsu firms seldom expresses their dissatisfaction tomanagement by selling out the (cross-held) shares.

Therefore, ownership concentration is not a goodproxy for the control of shareholders in Keiretsu firms.

It would be a good proxy only for independent firms.


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In sum, we have the followinghypotheses.

1. Ownership would be less concentrated in a largefirms

2. Ownership would be more concentrated in a

firm which operates in a less certain businessenvironment.

3. The above two hypotheses will be true only fori

ndependent fi

rms.Th

eseh

ypoth

eses may notapply for keiretsu firms, since theyhave

alternative corporate governance system.


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Variables

Variable Definition

MVE Market value of common equityin 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 dev iation of monthly stock market rates of return. This

is the second variable to measure the uncertainty of the business

environmentSTDA Standard dev iation of ROE. This is the third variable to measure

the uncertainty of the business environment


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The model

Prowse (1992) estimated the following OLS

regression.

(Top five ownership)

= 0+1(MVE)+2(Uncertainty variable)

[Prowse used log transformation of top five ownership: log(ownership/100-ownership) as the left hand side variable]


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The results 1 First, take a look at thecoefficients for the MVE

(the firm size variable).

For keiretsu firm, the

coefficients are notstatistically significant for

all the models. Also

when compared to theresults for independentfirms, the coefficients are

small in magnitude.

This shows that, among

keiretsu firms, the sizedoes not constrain theownership concentration.


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The results 2 On the other hand, thecoefficients for MVE are

negative and statisticallysignificant for

independent firms for all

the models.

This indicates that larger

firm has lessconcentrated ownershipstructure as predicted by

the hypothesis 1.


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The results 3 Now we take a look atthe coefficients for theuncertainty variables (SE,

STDS, STDA).

For the keiretsu firms, allthe coefficients are not

statistically significant. Inaddition, the coefficients

are much

smaller wh

encompared to

independent firms.

Therefore, uncertaintyinbusiness environment

h

as no effect onownership concentration

for keiretsu firms.


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The results 4 For independent firms, allthe coefficients for the

uncertainty variables arestatistically significant.

This indicate that firmsoperatingin less certain

business environment has

greater ownershipconcentration.

This result is consistentwith the second

hypothesis: A firm with

greater control potentialwill have a greater

ownership concentration.


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Thus, shareholders ofindependent and keiretsufirms behave differently.

For independent firms, the ownership is less

concentrated in larger firms. Also, firmsoperatingin less certain business environment

tend to have greater ownership concentration.These results are consistent with our twohypotheses regarding the determinants of the

structure of ownership.

However, for keiretsu firms, the above twohypotheses do not apply.


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More recent trend in the structure ofcorporate 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).


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The ownership structure of Japanese firms used

to be (1980s) characterised by substantial blockshareholding by corporations and financial

institutions.

In particular, substantial stable cross-

shareholding between financial firms andcorporation and among corporationsdistinguished the ownership structure in Japan

from th

atin ot

her countr

ies.

However, there has been a new trend. The stable

shareholdinghas been declining, and foreignownership has been increasing.


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The trend in the ownership of the stableshareholders

0

5

10

15

20

25

30

35

40

45

50

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

The % of equity owned by stable shareholders

The % of equity owned by stableshareholders

The percentage of equity (in value) held by stableshareholders has been declining overtime.Therefore, there has been a trend to unwind

cross-shareholdingin the past two decades.


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Ownership by type of shareholders

There is an increasing trend in foreign ownership.


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Long term trend in ownership structure

This shows the ownership structure overtime. You can notice an increase in foreignownership and a decline in financial institution.


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After the World War II, large family owned

corporate groups (Zaubatsu) were dissolved.This increased the potential threat of takeover.

Firms, and especiallyEx-zaibatsu firms, sought

friendly shareholders, and cross-held eachothers shares in order to reduce the possibilityof being taken over. Historically, cross-

sh

areh

oldi

ng became prevalent thi

s way.You can notice a clear upward trend in foreign

ownership.


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These trends raise several questions.

1. Why did cross-shareholding, whichhad beenfairly constant for more than thirty years, begin

to dissolve in the mid-1990s?

2. If cross-sh

areh

olding was a response to t

he

increasinghostile takeover threat, then why didit 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.


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In order to answer these questions, Miyajima

and Kuroki

(2008)i

nvesti

gates th

e followi

ng.

1. The determinants of unwinding of cross-

sh

areh

oldi

ng wi

th

banks by non-fi

nanci

alcorporation.

2. The determinants of unwinding of cross-shareholding with non-financial corporation by

banks.

3. Whether an increase in foreign ownership wouldincrease firm performance.


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The determinants of unwinding of cross-shareholdingwith 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.


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The need to sell shares

liquidity constraint (thus need for cash by selling shares)

Financial health of the bankIf the financial health of the bankis 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 (sayBBB), then the firm mayhave incentive to sell thebanks share in order to signal the investors that the

companyis making a rational managerial decision.Threat of take over

If there is a threat of takeover, the company may bereluctant to sell stable shares.


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Data and estimation modelD

ata:Th

e survey of cross-sh

areh

oldi

ngpublished by Nihon Life Insurance ResearchInstitute.

Each cross-share-holding bank-company pair is

treated as a distinct observation.

The following model is estimatedYi=0 +1(D_ICR)+2 (Dept/Equity)

+3(D_BK_RATE)+4(M_NOST)+(other variables)Where Yi=1 if the company sells the banks (cross-held) shares.

Yi=0 otherwise.

[Model is estimated using logit model]


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Result 1First of all, the results show that a

corporations had sold bank sharesbecause theyhad the need to sellshares.

The coefficient for the dummy forlowinterest coverage ratio is positive

and significant. This shows that acompany that has difficulty meeting

interest payment is more likely to sellbank shares.

A company withhighDept/Equity

ratio tends to sell off bank shares.This also shows that a company with

liquidity constraint (thus in need forcash) tend to sell of bank shares.

These results show that the trend in

the unwinding of cross-shareholdingoccurs partly because they simply

needed to do so to obtain cash.


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Result 2Second, when the banks financial

healthis low, the companyis morelikely to sell off the banks shares.

The coefficient for the dummy

variable for the bank with ratingbelowDhas positive coefficient.

This mean that when the bank rating

is D or below, the companyis likelyto sell off the banks shares.

This means that the trend in the

unwinding of cross-shareholdinghadbeen partly due to financial crisis in

Japan.


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Result 3Third, when the company faces

greater threat of takeover, thecompanyis reluctant to sell the(cross-held) bank shares whichisstable.

The coefficient for the percentageshare of non-stable shareholders is

negative, indicating that a companywith greater non-stable shareholders

is less likely to sell off the bankshares.

Thus, cross-shareholding still is a

device to reduce the threat oftakeover.


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In sum, the unwinding of cross-shareholding

occurred because1. Company needed to obtain cash

2. The financial health of the banks deteriorated

3. There was an incentive for company to sellbank shares in order to show the investors that

they are making rational managerial decisions.

4. However, companies were still reluctant tounwind cross shareholding when there is greaterthreat of takeover.


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What would the increase in foreign shareholders do toJapanese firms

There are many ways to answer to this question.

Today, let us discuss the following question.

Would th

ei

ncreasei

n forei

gn ownershi

pimprove the performance of Japanese firms?.

First, why would/would not an increase in

foreign ownership improve the performance ofJapanese firms?


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The model and variable

(Performance)it=0+1(Foreign ownership)

+ (other variables)

We use two performance variables: ROA andthe Tobins q. Tobins qis 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]


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The results The coefficient forforeign ownership ispositive and

statisticallysignificant for bothmodels.

Thus, foreignownership does have

a positive effect onthe performance of

Japanese firms


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SummaryStartingin mid 1990s, Japanese companies began to

unwind cross-shareholding.

The unwinding of cross-shareholdings was due to thefact that (1) some firms needed to sell share to obtain

cash

, (2) th

e fi

nanci

alh

ealth

of banks deteri

orated, (3)corporations needed to sell bank shares in order tosignal the investors that they are making a goodmanagerial judgment. However, firms facing greater

th

reat of take over were sti

ll reluctant to sell (cross-held) shares.

There has been an increase in foreign ownership. Thishas had a positive effect on the performance of

Japanese firms.


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Prowse S (1992) The structure of corporate

ownership in Japan Journal of Finance, 471121-1140

Miyajima and Kuroki (2007) The unwinding of

cross-shareholdingin Japan: Cause, Effects and

Implications In Corporate Governance in Japaned by Aoki G, Jackson and Miyajima, OxfordUniversity press

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