Governance Challenge for Japanese Companies: A re-evaluation of equity block ownership by corporations

MIYAJIMA Hideaki
Faculty Fellow, RIETI

It is well known that the direction and extent of corporate governance reforms in any country are determined by the structure of ownership and control.

The management of Japanese companies has long been characterized by corporate control based on cross-shareholding between corporations (Note 1). However, over the past twenty years, their ownership structure has dramatically changed due to the dissolving of cross-shareholdings between companies and banks, and the rapid increase of domestic and foreign institutional investors. What is the current status? Is the ownership structure in Japan converging with the U.S. model, under which institutional investors play the central role?

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According to recent empirical studies, ownership and corporate control models around the world can be broadly classified into two types.

The first is the external market for corporate control, closely associated with the dispersed, outsider-dominated ownership systems of the United States and the United Kingdom. In this type, the agency problem of managers associated with dispersed ownership is mainly resolved by the external market for corporate control and the block shareholders (e.g., activist funds). If a company faces a management problem, takeover bidders, such as activist funds, appeal directly to shareholders of a target by bypassing its manager, and control right is transferred to the party that has offered the highest price through the takeover bid (TOB) process.

However, the time horizons of bidders are sometimes myopic and the market valuation of firms is not always accurate. Therefore, there is a significant risk that long-term management initiatives such as investing in research and development (R&D) and human capital and responding to environmental problems will be sacrificed in favor of short-term shareholder profit. In the United States and the United Kingdom, the focus of corporate governance is on resolving the problem of such short-termism.

The second model of ownership and corporate control is typically observed in continental Europe and Asian countries and is characterized by concentrated ownership and control by founding families. In fact, the ownership of listed companies around the world is significantly concentrated to a very high degree. According to the most recent analysis by Gur Aminadav et al., which covers around 26,000 companies in 85 countries, the average degree of ownership concentration is 56%, and in 51 of those countries, the degree of concentration is higher than 50% (Note 2).

Regarding this model, the block holding of founding families supports their strong leadership and long-term management, while a new agency problem has arisen in the form of exploitation by founding families (the controlling shareholders) of the minority shareholders’ rights. Developing protection for minority shareholders is therefore a corporate management challenge in this model.

The ownership structure in Japanese companies differs from both of these models. In Japan, it is characterized by dispersed ownership and the dominance of corporate insiders such as banks and corporations, while professional managers promoted within firms have strong control over the corporate decisions. In general, when share ownership is dispersed, the risk of management moral hazard grows. Until the early 1980s, main banks, which owned around 5% of client companies, resolved this problem. However, as companies have reduced their debts and the main bank system has collapsed, there has been a lack of external monitoring of management.

What emerged in the early 2000s might be the worst governance situation. In fact, there is a strong argument to be made that this situation is a significant factor behind the conservative management that has brought about the stagnation of Japanese companies in recent years.

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The figure shows the long-term trend of the ownership structure of listed companies in Japan. From the second half of the 1990s to the first half of the 2000s, the proportion of shares owned by banks and insurance companies dramatically declined, while the proportion of shares owned by domestic and foreign institutional shareholders instead rose rapidly. It is also noteworthy that during the same period, the proportion of shares owned by industrial corporations remained stable, at slightly higher than 20%. This fact seems to be inconsistent to the current common understanding, given that sales of cross-held shares have attracted strong attention since the introduction in 2015 of the Corporate Governance Code, which requires the disclosure of reasons for maintaining cross-shareholding. How should we interpret this fact?

Long-term trend of ownership structure among listed companies in Japan
Long-term trend of ownership structure among  listed companies in Japan
Note: The figures for domestic and foreign institutional investors denote the total of the percentages for foreign residents and trust banks. The figures for banks and insurance companies indicate the total of percentages for city and regional banks, and life and non-life insurance companies.
Source: “Share Ownership Survey” reported by the Tokyo Stock Exchange.

According to an empirical study with Keio University Professor Takuji Saito and myself, after the introduction of the Corporate Governance Code, sales of the relationship-based shareholdings (Saisaku hoyu-kabu) increased sharply. The number of securities that a listed firm held on average declined from 53.0 in 2010 to 34.7 in 2019. Moreover, the increasing sales was more remarkable in the case of cross-shareholding, which had previously been held so firmly that it had long been known as the corporate “bedrock.”

In addition, the probability of selling a stock is positively correlated to the number of outside directors, suggesting that outside directors could have played a significant role in dissolving cross-shareholding. In this respect, it is safe to say that the Abe government’s corporate governance reform steadily promoted the dissolving of the web of cross-shareholdings.

On the other hand, in cases where companies that were linked through shareholding have a strong transactional relationship and where a company held a large stake of the issued shares of the other company in which it is invested (i.e., where a company own equity blocks), the relational shareholding arrangement is highly likely to have been maintained. In other words, sales of the relationship-based shareholdings have been mainly observed in small amounts of mutually held shares.

There have been prominent cases recently where an industrial corporation purchased an equity block in another corporation, an arrangement known as a partial acquisition. The purchase is conducted mainly through a private placement.

According to a study by Ryo Ogawa, a lecturer at Chiba University of Commerce and his co-authors, of all private placements (those involving shares accounting for 1% or more of the total value of shares issued) by companies on the former First Section of the Tokyo Stock Exchange between 2001 and 2018, those whose purchasers were industrial corporations accounted for 76% (258 cases). In 20% of those cases (51 cases), the motivation for the purchase was to supply liquidity to a company facing a financial crisis. While cases of bailouts by main banks decreased, industrial corporations continued to perform the similar bailout function. The market showed a positive response of the equity block transfer: the cumulative excess return during the three days from the date of announcement of an equity block purchase was higher than 3% on average.

Another prominent trend was the formation of strategic partnerships involving joint ventures and joint R&D investment. What is remarkable is that in many cases, treasury shares derived from sales of cross-shareholdings were used to form a partnership. Originally, the Abe administration’s policy initiative assumed that funds procured through sales of the relationship-based shareholdings would be used for capital investment, R&D, and mergers and acquisitions. However, in fact, such funds were mostly employed for share buybacks, and the repurchased stocks were utilized for the private placements after being held as treasury shares.

Examining both cases of the use of treasury shares and the issuance of authorized shares, the number of cases of private placements with the intention of strategic partnerships amounted to 85 cases between 2001 and 2018. This number is much higher than the cases of private placements to existing shareholders (61 cases) with the intention of renewing the cross-shareholding arrangement. The market’s reaction to those events, as measured in terms of the cumulative excess return, was almost zero for cases of private placements with the renewal the cross-shareholding arrangement, and was higher than 2% for cases of private placements with the intention to establish a strategic partnership.

The share ownership structure in Japan, which was quite unique for its dispersed ownership and the dominance of inside shareholders such as banks and corporations, underwent a dramatic change in the first decade of this century. This was followed by a moderate evolution from cross-shareholding between corporations to equity block ownership. The shift has been carried out through the processes of the sale of cross shareholdings, stock repurchases and the maintenance of treasury stocks, and the transfer of equity blocks between corporations via private placements. The Japanese system of transferring corporate control, under which it mainly occurs between corporations via private transactions, is very different from using the external market for corporate control in the United States and the United Kingdom, under which the transfer of control occurs in public markets via investment funds. We can refer to the Japanese system as an “internal market for corporate control.”

Moreover, it is notable that the pressure from the capital market has promoted the development of the internal market for corporate control in Japan. The companies that are now facing pressure from institutional investors and activists are likely to be active in selling their relationship-based shares and stock repurchases. The capital market only responds positively to private placements of industrial corporations if they contribute to supplying liquidity and strengthen strategic partnerships.

Block shareholders are ubiquitous around the world, as exemplified by institutional investors in the United States and the United Kingdom and founding families in continental Europe. What is unique in Japanese companies is that block shareholders mainly take the form of industrial corporations whose control is managed by professional managers and that in many cases, they contribute to the creation of corporate value. In that sense, it is not appropriate to exclusively regard the presence of relational shareholding as an entrenchment of management, or the presence of listed subsidiaries as a source of conflict with minority shareholders. In order to design a relevant ownership structure that supports effective corporate governance in Japan, it is desirable to hold careful discussions that take the economic rationality of equity block ownership by industrial corporations into account.

>> Original text in Japanese

* Translated by RIETI.

April 4, 2023 Nihon Keizai Shimbun

Footnote(s)
  1. ^ For a more detailed look at the argument by the authors, see Miyajima, H. (2023), “Corporate governance reform, and ownership, and control: perspective from Japan”, Asian Journal of Political Science, vol. 30 (3), pp. 260-272, Franks, J., Mayer, C., Miyajima, H., & Ogawa, R. (2022). Managing ownership by Management. RIETI Discussion Paper Series, 23-E-022, pp.1-56.
  2. ^ Aminadav, G., & Papaionnou, E. (2020). Corporate control around the world. The Journal of Finance, 75(3), 1191–1246.

May 16, 2023