International Business and Management
Master Thesis
By Marc Josephus Jitta S1322664
“Keiretsu, a Giant under Pressure”
Master Thesis IB&M Supervisor: drs. H.C. Stek Second Supervisor: A. Hunneman
Key words: Horizontal Keiretsu companies, political and economical change, independent companies, share price volatility.
ABSTRACT
This Master Thesis delves into the question whether the Japanese horizontal keiretsu still functions in its characterizing manner. Prior studies show how the characterizing ties of the keiretsu provided competitive advantage to the affiliated companies in the past. Since then there have been several critical changes to the political and economic environment in Japan. By determining whether one of the important securities, the share price volatility has increased this research looks to prove that the once signifying influence of the keiretsu is corroding.
TABLE OF CONTENTS
INTRODUCTION page 6
ASHORT HISTORY OF THE KEIRETSU page 10
LITERATURE REVIEW page 12
The Horizontal Keiretsu page 12
Bank Ties page 12
Equity Ties page 13
Competitive Advantages Keiretsu affiliation page 14 Competitive Disadvantages Keiretsu affiliation page 15 Political and Economical Factors affecting the Keiretsu page 16
Stagnant Japanese Economy page 17
Banking Crisis page 18
Changing Japanese Equity Markets page 19
Foreign Policy page 20
Implications for Keiretsu Ties page 22
Bank Ties page 22
Reciprocal Cross-Shareholding page 23
Stable Shareholders page 24
The Demise of the Keiretsu page 25
HYPOTHESES page 29
METHODOLOGY page 31
Data page 31
The Model page 35
RESULTS page 37
1985 to 1989 page 37
1990 to 1999 page 40
DISCUSSION AND CONCLUSION page 46
1985 to 1989 page 48
1990 to 1999 page 49
2000 to 2007 page 49
Conclusion page 50
LIMITATIONS AND DIRECTIONS FOR FUTURE RESEARCH page 51
LIST OF FIGURES
Figure 1. The Japanese Keiretsu page 27-28
Figure 2. Rate of return keiretsu and independent companies’
shares versus NIKKEI 225 1985-1989 page 37
Figure 3. Share price volatility keiretsu-affiliated companies
vs. NIKKEI 225 volatility 1985-1989 page 38 Figure 4. Share price volatility independent companies vs.
NIKKEI 225 volatility 1985-1989 page 38
Figure 5. Rate of return keiretsu and independent companies’
shares versus NIKKEI 225 1990-1999 page 39
Figure 6. Share price volatility keiretsu-affiliated companies
vs. NIKKEI 225 volatility 1990-1999 page 40 Figure 7. Share price volatility independent companies vs.
NIKKEI 225 volatility 1990-1999 page 40
Figure 8. Rate of return keiretsu and independent companies’
shares versus NIKKEI 225 2000-2007 page 41
Figure 9. Share price volatility keiretsu-affiliated companies
vs. NIKKEI 225 volatility 2000-2007 page 42 Figure 10. Share price volatility independent companies vs.
NIKKEI 225 volatility 2000-2007 page 42
Figure 11. Division of outstanding shares in Japan’s TSE page 46
LIST OF TABLES
Table 1. Keiretsu-affiliated companies versus independent
companies page 33
Table 2. Overview Beta coefficients and Pearson Correlation
Keiretsu and Independent Companies. page 43 Table 3. Standard Deviations Nikkei 225, Keiretsu
INTRODUCTION
“Individual commitment to a group effort – that is what makes a team work, a company work, a society work, a civilization work.”
- Vince Lombardi
Security and stability. After the Second World War that was what Japanese companies were looking for (Schaede, 2006). For decades Japanese companies benefited from these competitive advantages through closely knit networks known as keiretsu(Sheard, 1991; Williamson, 1991). A widely used definition of the horizontal keiretsu is the following: “The keiretsu concept refers to clusters of interlinked Japanese firms and the specific ties that bind them. Keiretsu relations among industrial firms, financial institutions, and the individual managers and officials who staff them are distinguished by their long-term, personal, and reciprocal character.” (Lincoln, Gerlach & Takahashi, 1992: 561). In this study the focus is merely on the horizontal keiretsu as I am mainly interested in the interrelations across different industries that characterize this business form. Zhang (2006) shows that the vertical keiretsu differs significantly from the horizontal variant as it acts more like a supply chain in one particular industry. Therefore from now on if I refer to keiretsu I mean the horizontal keiretsu.
keiretsu-affiliated firms earn significant lower profits in comparison to their “independent” competitors, a conclusion also drawn by Lichtenberg and Pushner (1992).
The 1990s, sometimes described as “Japan’s lost decade” (Schaede, 2006), are considered to be a turning point in Japanese business history. For years Japanese companies had profited from the relative safety of the domestic market through anticompetitive practices. Silk and Kono (1994) state that the Japanese economy was run by conservative politicians, senior bureaucrats, and big business leaders (the “Iron Triangle”), emphasizing on the protectionist nature of their policy. However during the 1990s pressure from within and outside of Japan led to fundamental changes to the Japanese keiretsu. Schaede (2006) looks at changes in the Japanese political economy affecting the keiretsu. In her study, Schaede shows how political interference resulted in a more dynamic economy in which companies could no longer focus on the long-term. A conclusion with which Lincoln and Gerlach (2004) concur as they demonstrate that the Japanese economy transforms from an inward oriented economy to a export-led economy. A political change that was necessary after the economic slowdown (Schaede, 2006; Lincoln & Gerlach, 2004). So first of all there are the changes in the political environment. Second, the economic environment further pressurized the viability of the keiretsu system both domestic and international. Domestically the keiretsu were affected by the stagnation of the economy (Lin, 2005) and the banking crisis (Hoshi, 2001), while international competition further strained the networks (Borodayevsky, 2002).
Furthermore he provides evidence that hedging against industry risks by these same cross-holdings works. Nevertheless the infallible image of the keiretsu is corroding. A first sign of their diminishing dominance was the surge of independent Japanese firms after the 1989 recession (Taft & Singh, 2003; Yafeh, 2000). This led to ample literature on the question whether the existing keiretsu networks would prove to be viable in the future (Ito, 1997; Dow & McGuire, 1999), however keiretsu had proved to be resilient before (Gedajlovic & Shapiro, 2002).
In my Master Thesis I will be looking closer at what political and economical changes have weakened the specific ties, referred to by Gerlach et al. (1992) that ensured security and stability in the keiretsu. Since security and stability are no longer ensured I will look at whether the share price volatility of the keiretsu affiliate has increased. This leads to the following questions central in this Master Thesis:
“What political and economical changes enforced the Japanese keiretsu to abandon its characterizing ties that provided security and stability, and consequently did it lead to more volatile share prices of keiretsu companies
vis-à-vis independent companies?”
and their share prices are compiled: First, 75 keiretsu-affiliated companies, and second, a list of 40 independent companies. These companies are all companies of the Nikkei 225 that can be categorized as either keiretsu or independent for the duration of the entire time frame according to Brown & Co1, and they are listed since the start date of this research. So a company that does not meet the requirements: (1) Nikkei 225 listing since 01/01/1985, and (2) keiretsu/independent entire period, is not included. Throughout the period the volatility of the keiretsu-affiliated companies and independent companies are computed, which subsequently are compared to view whether keiretsu shares have become more volatile in comparison to independent company shares. By showing that the security and stability the keiretsu provided, in terms of share price volatility as established by Nakatani (1984), has diminished I will (partially) prove that the rules of the game for the Japanese company have structurally changed. That is they have not simply found a new way of hedging themselves against market risks.
This Master Thesis is structured in the following manner: First, a short overview of the history of the keiretsu, necessary to understand its decent of the characterizing ties, is given. Second, I will gave a review of the literature on the keiretsu providing insight in the fundamentals of the system. From this information I infer the (dis) advantages of the keiretsu and how these were influenced by important political and economic developments. What makes that the competitive advantages, stability and security, loose their edge? This information is summarized in a conceptual model and followed by the formulation of the hypotheses, which serve the purpose of answering the second part of the main research question. Third, the methodology how to measure volatility is presented. Subsequently I present the results with respect to the different hypotheses. Finally, the last section discusses the implications of these results, reviews the limitations of the research and proposes directions for future research.
A SHORT HISTORY OF THE KEIRETSU
“History tends to be nice to me for I intend to write it.” - Winston Churchill
Economies of scale and scope were the goals emulated by Japanese companies at the end of the nineteenth century (Lonien, 2007). As Japan was opening up its economy to international trade it copied the German business model konzern (corporate group), large and powerful conglomerates relying on multiple industries (Miyashita & Russell, 1994).
In the period prior the Second World War four large zaibatsu (Mitsui, Mitsubishi, Sumitoma and Yasuda) dominated the Japanese economy (Yoshinari, 1992). Four holding companies in which the industrial and financial services were all aggregated (Lonien, 2007). The conglomerates used the years during the war to expand their business and further strenghten their dominance over the Japanese economy. By the end of the Second World War these four family-run conglomerates accounted for 24.5% of the joint stock capital in Japan (Yoshinari, 1992).
After Japan’s defeat the Americans aimed at dissolving the zaibatsu conglomerates: First, because of their active role during the war zaibatsu. Second, as they were seen as illegal cartels (Lonien, 2003). To make their change lasting the Americans replaced the management, of the most influential companies in Japan, by young and talented managers (Yoshinari, 1992). Despite their interference the Americans could not prevent the former zaibatsu from retaining their power as soon as the occupation ended, restoring their dominance by the second half of the 1950s (Yoshinari, 1992). Growing even more influential than before as they accounted for fifty percent of Japanese capital during the 1980s (Paddington, 1990). There was one important difference though, as from now on the industrial groupings would be known as keiretsu.
peak the keiretsu companies, affiliated to one of the “Big Six”2, accounted for fifty percent of all business in Japan (Edgington, 1990). For a long time the keiretsu were praised for their role in navigating Japan smoothly through economic shocks. That makes it even more striking that the same networks are now to blame for Japan’s regressive competitiveness (Lincoln & Gerlach, 2004).
2 The “big-six” horizontal groups include the reincarnation of the prewar zaibatsu (family-centered holding
LITERATURE REVIEW
“Keiretsu networks, the webs of relations that envelop many Japanese companies, continue to fascinate, mystify, and frustrate both the managers and policymakers who contend with them in trade and diplomatic dealings and the academics who study them.”
– Lincoln, Gerlach and Ahmadjian (1996: 67)
Before moving forward it is imperative that the concepts I will be looking at are completely clear. As the above quote exemplifies the keiretsu is a concept that is difficult to capture, making it all the more important to clarify. This section of my dissertation illuminates the structure of the Japanese horizontal keiretsu, its (dis) advantages and how specific developments in the political and economical environment have influenced its strength and viability. It is of great importance to understand how the inner workings of the keiretsu function, before looking at how and what made these ties diminish.
THE HORIZONTAL KEIRETSU
The horizontal keiretsu is characterized by its wide array of inter-industry grouping of companies (Zhang, 2006). Besides the horizontal links between different industries the keiretsu are characterized by two unique ties; (1) the bank, and (2) equity ties. McGuire and Dow (2003) show how these ties make the keiretsu fundamentally different from US based companies.
How do these ties operate exactly and what are its implications?
observation though is that the bank charges its lenders above market interest rates (Caves & Uekusa, 1976). There are two main reasons why the main bank charges its lenders a higher rate: (1) the bank actively monitors the companies’ performance (Flath, 1993), and (2) the “insurance fee” mentioned earlier (Gedajlovic & Shapiro, 2002). These funds would be employed when a keiretsu affiliate finds itself in financial distress. So it could count on the main bank to coordinate its bailout and assume disproportionate responsibility for bad debts (Morck & Nakamura, 1999). Obviously this was especially lucrative for the weaker companies within the keiretsu, while stronger companies paid for their survival.
o market risks through presence in multiple industries (Zhang, 2006);
o liquidity problems through a direct links with banks and other affiliates (Weinstein & Yafeh, 1998; Wang, Huang & Bansal, 2005; Lincoln, Gerlach & Ahmadjian, 1996);
o share price volatility through reciprocal cross-holdings of shares (McGuire & Dow, 2003; Gibson, 1998; Nakatani, 1984).
In addition to the ties in terms of the close relationship with a bank and the reciprocal cross-share holdings there is one more important feature. Especially the smaller affiliated companies benefit strongly from the internal market created by the larger and/or stronger companies (Cowling & Tomlinson, 2000). The bigger companies rely mainly on the intermediary products and services of their affiliated companies. So summarizing the horizontal keiretsu provides security and stability through the equity and bank ties. Furthermore it offers an isolated market on which smaller affiliates can fall back.
What are the (dis) advantages of keiretsu affiliation?
Competitive disadvantages Keiretsu affiliation. In an article for the Washington Post Sandra Yugaware (1998) wrote the following:
“The Keiretsu ties that bind can also strangle: The culture of mutual protection makes it hard for strong companies to break free and grow, and forces weak companies to bail out even weaker ones”
This shows that while keiretsu affiliates enjoy stability through their wide variety of interrelations in different industries, this is their largest threat as well (Weinstein & Yafeh, 1998). Gulati and Singh (1998) stress the point that these highly diversified conglomerates require extensive coordination. Due to the amount of relationships within the keiretsu the monitoring of managerial performance increases (Kang & Shivadasani, 1995), which makes decision-making lines longer. The fact that companies are active in several unrelated businesses makes the governance even more difficult. As a result transaction costs among affiliates increase and consequently put pressure on profitability. Another problem, after the “one-setism” rule3 was loosened, that has been growing in importance is the competition of companies within the keiretsu (Schaede, 2006). Furthermore it is argued that the confinement of intra-keiretsu transactions limits the affiliates in their search for the most appropriate supplier. By excluding external partners possibilities for more profitable deals including complementary products are foregone (Isobe, Makino & Goerzen, 2006). Kim, Hoskisson and Wan (2004) determine that keiretsu affiliates are three times more likely to deal with an intra-keiretsu firm than an external party. Isobe, Makino and Goerzen (2006) further note how the focus on the long-term competitiveness of the keiretsu hampers affiliates to take advantage of profitable short-term, risky investments. They explain how the main bank discourages this sort of behavior.
3One group would not include more than one competitor in each industry, to prevent intra-group
Also the strong social ties that lead to the competitive advantages mentioned earlier have their downside. The internationalization of business necessitates Japanese firms to strengthen their foreign presence; in this process the familiar social ties cause inertia (Isobe, Makino & Goerzen, 2006). It is very difficult if not impossible for keiretsu companies to replicate the keiretsu model in another country (Chang, 2002).
Now that we are familiar with the distinguishing ties that characterize the Japanese keiretsu, its implications and (dis) advantages it is time to turn to what changed in the circumstances.
What developments in the political and economical environment made that the disadvantages of the keiretsu got the upper hand and/or diluted the advantages?
POLITICAL AND ECONOMICAL FACTORS AFFECTING THE KEIRETSU
This part of my thesis emphasizes the changing political and economical factors that forced the keiretsu to abandon the security and stability of their characterizing ties. Silk and Kono (1993-94) point out that Japan regarded their foreign and economic policies to be timeless. The following quote shows not everybody shares that opinion:
“Although the Japanese corporate governance system played a key role in Japan’s outstanding economic performance of the 1960s and 1970s, times have changed and the Japanese corporate governance system has not.”
changes that had a significant impact on the keiretsu system in Japan: (1) the evolution of the Japanese equity markets, and (2) the changing banking relationships. Schaede (2006) adheres to the latter of these, proclaiming that the banking crisis of 1998 plays a key role in the transformation process. Furthermore she refers to several financial and legal revisions, which significantly influenced the Japanese economic environment. Besides these aspects Ahmadjian (2001) concludes that the stagnant Japanese economy during the 1990s made affiliation to the keiretsu more costly. Furthermore Borodayevsky (2002) places the changing Japanese corporate governance in an international perspective by looking at cross-border mergers and acquisitions as a result of governmental adjustments to the Commercial Code. In his research he finds that Japanese companies traditionally lagged behind in the international arena. Moreover McGuire and Dow (2003) bring to attention the influence of intensifying international competition due to the same political change of course. Recapitulating there are three major developments that deserve closer scrutiny: (1) Japan’s stagnant economy, (2) banking crisis, and (3) regulatory reforms. In this order I will go through them and look at their implications for the bank and equity ties.
refers to Toyota that advises its smaller keiretsu affiliates to look around for other contractors. While Wako and Ohta (2005) determine that the formerly closed distribution channel had become inferior to an (half) open system.
Bremner and Thornton (1999) state that during the decades the Japanese economy flourished the horizontal keiretsu overstretched their operations, chasing profits in all possible industries. After the economy slowed down Japan was left with huge overcapacity as it had 17 major banks, 10 semiconductor companies, 11 vehicle manufactures, and 5 integrated steel producers. Consequently the system in which predominantly profitable companies kept its weaker affiliates alive turned into a system in which even the strongest companies struggled to earn profits.
provide the necessary funds. Weinstein and Yafeh (1998) show how the changes on the equity markets provided companies with alternatives to get the funds. So the direct link of keiretsu affiliates became less important as there were alternatives, which also meant that the competitive advantage over independent firms was fading.
In addition to these economic factors influencing the viability of the keiretsu the regulatory adjustments by the Japanese government cannot be underestimated. Earlier I referred to Silk and Kono (1993-94) who stated that the Japanese government left their formerly conservative domestic centered politics. Moreover for the first time Japan admitted that their economy was in fact closed and riddled with anticompetitive policies. The following section from their work describes the Japanese economy at the end of the 1980s:
“ (…) a governmentally fortified economy, a very high national savings rate, strong pressures to hold down labour costs, a narrow-minded economic nationalism, inaccessible markets, a convoluted distribution system, an entrenched bureaucracy, a long-undervalued yen, a mass of regulations that inhibit imports and foreign investment, and corrupt money politics.” - (Silk & Kono, 1993-94: 116)
It would be an understatement to say that the Japanese (keiretsu) companies benefited from the economic environment provided by the government. More interesting is looking at what new directions were set out by the government and how new regulations affected the keiretsu.
funds, increased openness to foreign investment, and the easing of entry of foreign institutional investors into the Japanese market”; paving the way for the revisions McGuire and Dow (2003) refer to. Some examples of amendments include the following: (1) shareholder access to accounting records (1993), (2) removal of ban on corporate stock buy-back (1994), and (3) enhanced disclosure procedures (1999). Overall the regulatory adjustments’ main goal was to open the Japanese equity market to international competition. The inflow of more international investors placed more pressure on the Japanese companies to adhere short-term profitability standards (Useem, 1998). As established earlier the keiretsu were not fit to respond to short-term changes, but rather concentrated on long-term competitiveness (Dow & McGuire, 1999). Weinstein and Yafeh (1998) provide evidence the revisions work when referring to the increased international investments because of the liberalizing of equity regulations. At this point one of the most important features of the keiretsu, namely its insurance for affiliates against short-term market fluctuations came under pressure. For years uncompetitive keiretsu-affiliated companies had survived, depending on the support on competitive fellow affiliates. McGuire and Dow (2003) indicate that in an increasingly competitive market the burden of supporting those uncompetitive companies becomes unbearable, consecutively resulting in the repulsion of uncompetitive affiliates (Schaede, 2006).
the changes in the equity market discussed earlier increased the inflow of foreign investment forcing Japanese companies to shift their focus. Tiberghien (2004) formulates it as follows: “Once equity inflows reach a level high enough to have a significant impact on the stock market level, they become the vector of transmission for global corporate norms and a global power structure” (p. 35). Hence they started to converge towards a more Anglo-Saxon business model (Jacoby, Nason & Saguchi, 2005). The protective environment facilitated by the Japanese government, dubbed “Japan, Inc.” by Silk and Kono (1993-94: 123) was no longer viable. Awareness was growing that the globalization of business would instigate fundamental changes to the keiretsu system, as becomes clear from the following quote:
“The globalization of the marketplace has ushered in an era in which the quality of corporate governance has become a crucial component of corporate survival. The compatibility of corporate governance practices in an international context has also become an important element of corporate success. The practice of good corporate governance has been a necessary prerequisite for any corporation to manage effectively in the globalized market.” (Corporate Governance Forum of Japan, 1998: 36)
Having established what economical and political factors pressurized the distinguishing ties within the keiretsu companies it is time to determine what their implications were.
What were the implications of the changing factors in the economic and politic environment for the ties within the keiretsu?
IMPLICATIONS FOR KEIRETSU TIES
This section is divided into two parts. First, I look at how the above-described factors affected the bank ties and second the equity ties. The latter is once more split up into two different parts as we learned earlier that the equity ties are signified by the reciprocity of these ties and the stability. In this way it will be clear what the implications were for the respective ties and what made the keiretsu members abandon them.
Reciprocal cross-shareholdings. The reciprocal cross-shareholdings are commonly seen as one of the stabilizing factors in the keiretsu system (McGuire & Dow, 2003; Gibson, 1998; Nakatani, 1984). Besides stabilizing the cross-holdings were seen as an effective manner to safeguard keiretsu affiliates against hostile takeovers (Miyajima & Kuroki, 2006). There are some downsides to the crossholdings though. In their study Schleifer and Vishny (1997) demonstrate how the interests of large shareholders often do not match with those of other investors, and the companies’ managers and employees. This conflict of interest is proved in earlier work (Morck, Schleifer & Vishny, 1988) that finds an inverse U-shaped relationship between large shareholdings and company performance. Claessens et al. (2002) in this respect refer to the threat of entrenchment where corporate managers pursue private goals at the expensive of those of other investors. This conclusion links their study to that of Weinstein and Yafeh (1998), in which they find that “main” banks push their affiliated companies to “produce at levels beyond those warranted by pure profit maximization” (p. 359). Furthermore they find that the horizontal keiretsu compete more competitive in the markets in which they are active in comparison with their independent competitors. This fierce competition is imposed by the “main” bank and results in higher output, but lower prices. The questionable role of the bank finds approval of Morck, Nakamura and Shivsdasani (2000), who find that there is a negative relationship between the equity owned by the bank and the firm value. Now that the Japanese company in general was loosing its former protected home market such downsides became more pronounced as they prohibited companies from operating as profitable as possible.
in the short run incur certain real costs. Among the costs the shareholders are those of (1) foregoing the use of information to trade, (2) buying shares despite the expectancy of declining share prices, and (3) subscribing for new shares when the company is in an unfavorable position. Miyajima and Kuroki (2006) emphasize the point that the stable shareholders enable top management to pursue growth opportunities that are not share-price maximizing. Furthermore they combine several arguments, mentioned earlier, which according to them led to the unwinding of cross-holdings including:
o prolonged period of stagnation put pressure on long-term relationships within keiretsu (Lin, 2005);
o negative influence bank ownership (Weinstein & Yafeh, 1998);
o conflict of interest between small and large shareholders (Schleifer & Vishny, 1997)
Schaede (2006) shows the effects the stagnation of the Japanese economy in combination with the other costs of cross-shareholding had on the stable shareholdings4. Except for the individual shareholdings (-6.7%) all of the groups witnessed big changes between 1987 and 2006. Shares held by (1) foreigners +391%, (2) corporations -30%, (3) Insurance/investment banks -57%, (4) trust banks +137%, and (5) large banks -68%. These numbers clearly show that the once distinguishing strength of the keiretsu, the stable shareholder base, has diminished (Schaede, 2006; Miyajima & Kuroki, 2006).
Now is a good time to look at whether all of this information has brought us the answers we are looking for. Let me recapitulate. Once more the main research questions of my dissertation are the following:
“What political and economical changes enforced the Japanese keiretsu to abandon its characterizing ties that provided security and stability, and consequently did it
lead to more volatile share prices of keiretsu companies vis-à-vis independent companies?”
With the information gathered so far the first part of my main research question is answered. The next section in which I summarize the information and construct a conceptual model shows how.
THE DEMISE OF THE KEIRETSU
All of the preceding clearly explicates the rise, raison d’être and demise of the Japanese keiretsu. This section serves the purpose of recapitulating all of the above and put it in a framework depicted in figure 2.
Starting from the period just after the Second World War in which Japanese companies were looking for security and stability (Schaede, 2006), shown as the starting point of the model. The keiretsu, characterized by the close ties with a “main bank”, reciprocal cross-holdings of shares and stable sharecross-holdings among companies in different industries (Zhang, 2006; Flath, 1993; Nakatani, 1984), provided this sought after features. During the years in which the Japanese economy flourished the keiretsu was widely praised and served as an example for international companies. However at the end of 1989 the banking crisis hit Japan, followed by a long period of economic stagnation forcing the national government to take action (Schaede, 2006; Miyajima & Kuroki, 2006). The banking crisis and economic stagnation combined with the adjustments to the Commercial Code, that facilitated international competition and changed the equity market, severely pressurized the once characterizing keiretsu. According to Schaede (2006) supported by Miyajima and Kuroki (2006) the unwinding of the keiretsu became inevitable. So there were three general changes in the political and economical environment that led to the demise of the keiretsu:
1) Banking crisis 2) Economic stagnation
SECURITY & STABILITY KEIRETSU MAIN BANK RECIPROCAL /STABLE CROSS -SHAREHOLDINGS Advantages:
o Ready access to funds o No necessity to hold
reserves
Advantages:
o Insurance against market
fluctuations, share price volatility and M&A
o Focus on long-term competitivity Disadvantages: o Limited distribution channel o Extensive coordination o Difficult to copy abroad
Disadvantages:
o Pressure to focus on
market share instead of profitability
BANKING CRISIS
BANKING CRISIS ECONOMIC STAGNATION REGULATORY ADJUSTMENTS o Banks could no longer serve keiretsu affiliates o Disposal of uncompetitive o Pressure on costly distribution channels o Overcapacity o Pressure on keiretsu pillars o Pressure on keiretsu network UNWINDING OF THE KEIRETSU
SHORT TERM ORIENTATION
PROFITABILITY
MERGERS &ACQUISITIONS
SHARE PRICE VOLATILITY
THE CHANGING SHARE PRICE VOLATILITY OF THE KEIRETSU
“When we are no longer able to change a situation, we are challenged to change ourselves.” - Victor Frankl
Now that the political and economical changes affecting the keiretsu have been determined we move on to the second part my dissertation. Based on an analysis embracing three different time periods I am going to find out whether the share price volatility of the keiretsu-affiliated companies increased vis-à-vis that of the independent companies.
According to the literature the keiretsu, as we knew it, has dismantled a considerable share of its characterizing ties. The security and stability Japanese companies were looking for in the post-World War II period could no longer offset the forces of the (inter) national market. A combination of voluntary and unavoidable actions led to the unwinding of the characterizing ties of the keiretsu. Consequently in line with the literature the volatility of the (former) keiretsu shares, considering the stabilizing influence of the stable shareholders and reciprocal cross-holdings has attenuated, should have increased. Nakatani (1984) clearly showed the positive effect of keiretsu membership on the volatility of the share price. Consequently this would mean that the share price volatility of (former) keiretsu affiliates has become closer to or comparable to independent firm share price volatility.
Hypothesis 1: During period 1 share price volatility of keiretsu - affiliated companies is significantly lower than share price volatility of independent companies.
Hypothesis 2: During period 2 share price volatility of keiretsu - affiliated companies is significantly closer to share price volatility of independent companies in comparison with period 1.
METHODOLOGY
“Reality is merely an illusion, albeit a very persistent one” - Albert Einstein
Earlier I have introduced the research by Nakatani (1984) who concluded that the share price volatility of the keiretsu is significantly lower than that of the volatility of the independent companies. In correspondence to Nakatani’s research I use the independent company share price volatility as a control group, ensuring that the changes in volatility are not just the result of changing market conditions. In the remainder of my dissertation the objective is to determine whether the causal relationship between keiretsu affiliation and share price volatility exist as found in the literature. In the literature section of my Master Thesis I have carefully constructed a theoretical base from which I have derived my hypotheses. These hypotheses form the starting-point of the final section of this Master Thesis. According to Saunders, Lewis and Thornhill (2007) these characteristics makes it an explanatory study with a deductive approach.
Data. Following from the literature review and the hypotheses the basis of the analysis is formed by share prices of keiretsu-affiliated and independent companies. Logically that brings us to the Tokyo Stock Exchange (=TSE), the second largest stock exchange5 in terms of market value (Yahoo Finance). Currently the TSE lists 2,271 domestic companies and 31 foreign companies. There are several indices following the performance of the shares listed in the TSE. Of these indices the NIKKEI 225 is most commonly tracked to determine how the Japanese stock market is doing. As follows from the name 225 companies are listed in the NIKKEI 225 selected by Nihon Keizai Shimbun, Japan’s largest business newspaper. Their goal is to give a representative picture of the Japanese industrial structure with the listed shares. Therefore this index is the most appropriate to withdraw the sample of companies from for my analysis.
Subsequently two lists of share prices need to be compiled, subtracted from the NIKKEI 225: (1) keiretsu-affiliated company shares, and (2) independent company shares. The NIKKEI 225 is a collection of three types of companies. First the horizontal keiretsu-affiliated
companies, second the vertical keiretsu-affiliated companies and third the independent companies. For the horizontal keiretsu companies there is another subdivision, namely those companies affiliated to one of the “Big Six” or to some other horizontal keiretsu. For the “Big Six” affiliated companies the characterizing ties are the most pronounced, which makes it easier to determine whether significant changes occurred. Therefore I only use those companies affiliated to one of the “Big Six”. Consequently the results of my dissertation will only be applicable for these members and cannot be generalized for all keiretsu-affiliated companies listed in the NIKKEI 225. Furthermore the vertical keiretsu affiliates are excluded as I am only focused in the horizontal keiretsu members in my research. Subsequently there are four different types of companies in the NIKKEI 225:
1. “Big Six” keiretsu-affiliated companies; 2. Non-“Big Six” keiretsu-affiliated companies; 3. Vertical keiretsu-affiliated companies; 4. Independent companies;
Besides the types of companies there is the time aspect of my research, which spans from the 1st of January 1985 to the 31st of December 2007. To be included in the sample a company must have been listed during the entire period. In case of any doubt concerning what group a company should be assigned to means that it is excluded from the analysis, for example when a company is both member of a horizontal as well as vertical keiretsu. Keiretsu affiliation to one of the “Big Six” or another is determined using the publication by Brown & Co. “Groupings of Japanese Industrial Firms”. This leaves us with 72 keiretsu-affiliated companies and 48 independent companies from which the day-to-day share prices are collected using DATASTREAM. Afterwards the data is divided into three different time periods.
Keiretsu Keiretsu Keiretsu Independent Independent
Ebara Fuji Electric Fujitsu Ajinomoto Aeon
Furukawa Isuzu Motors Itochu Astellas Pharma All Nippon
Kawasaki Heavy Ind. Kawasaki Kisen Kirin Brewery Chugai Pharma Casio
Kyowa Hakko Kogyo Nippon Light Metal Shiseido Clarion Citizen
Showa Shell Sekiyu Furukawa Electric Kobe Steel CSK Comsys
Canon Inc. Kubota Marubeni Daiwa House Dai Nippon
Nichirei Nippon Oil Nissan Motors Denki Kagaku Kogyokk Daiwa Securities
Nisshinbo Industries Oki Electric Showa Denko Eisai Dowa
Yokogawa Electric Yamaha Sapporo Breweries Fujikura Fanuc
Asahi Glass Kirin Holding Mitsubishi Heiwa Real Estate GS Yuasa
Mitsubishi Electric Mitsubishi Estate Mitsubishi Heavy Ind. Japan Air JTEKT
Mitsubishi Logistics Mitsubishi Materials Mitsubishi Paper Mills Kojima Kao
Mitsubishi Rayon Nikon Nippon Yusen Keio Kumagai
Toyobo NGK Insulators Mitsui Marui Minebea
Kikkoman Japan Steel Works Mitsui Fudosan Mitsumi Nisshin Seifun
Mitsui Chemicals Mitsui Engr. & Shpbld. Mitsui Sumitomo Nitto Boseki Nomura
Mitsui Mining Mitsui OSK Lines Toshiba Olympus Hokuetsu Paper Mills
Mitsukoshi Toray industries Kyocera Pioneer Osaka Gas
Toyota Motors Alps Electric Sharp Sanyo Electric Resona
NTN Sekisui House Unitaka Shin Etsu Chemical Secom
Teijin Ube Industries Sumitomo Taiyo Yuden Takeda
NEC Nippon Sheet Glass Sumitomo Metal Ind. Terumo Takara
Sumitomo Electric Sumitomo Heavy Ind. Bridgestone Tosoh Toppan Printing
Sumitomo Osaka Cement Sumitomo Real. & Dev. Chiyoda Ricoh Hitachi
The model. To calculate the volatility of the respective shares I use a portion of the well-known CAPM (=Capital Asset Pricing Model). The CAPM is used to value an individual asset or a portfolio of shares. According to CAPM an investor expects a return that consists of a risk-free part and a risk premium. As a formula CAPM looks as follows:
E (Ri) = Rf + im (E (Rm) – Rf)
Where:
E (Ri) = the expected return on the capital asset Rf = the risk free rate of interest
im = the sensitivity of the capital asset returns to market returns E (Rm) = the expected return of the market
E (Rm) – Rf = the market premium
For my analysis I am particularly interested in the sensitivity of the capital asset ( im), or the Beta coefficient. This shows the volatility of an individual capital asset or a portfolio in relation to the financial market it is part of. Next there are three possibilities: beta is (1) positive, (2) negative, (3) zero. In case beta is negative the capital asset moves inversely to the market. For example a beta of –1 would mean that when the market increases 3% the asset would decrease 3%. The same holds for a positive beta, when beta is 1 the capital asset follows the market. Should the beta be 0 there is no correlation between the movement of the asset and the market. So the more the beta coefficient deviates from 1 the more volatile the asset is. The formula for the beta coefficient of an individual capital asset is depicted below:
a = Cov (ra, rm) / Var (rm)
Where:
a = the volatility of the individual asset
ra = the rate of return on the asset
rm = the rate of return of the market
Cov (ra, rm) = the covariance between the rates of return
Out of this formula ra and rm need some more attention. For every share the day-to-day rate of return is calculated using the following formula:
RoR = ( St – St-1) / St-1
Where:
RoR = Rate of Return
St = Today’s Share Price
St-1 = Yesterday’s Share Price
Using these results the beta coefficient per share can be computed. From the collection of individual share price volatilities the average volatility of the portfolios of keiretsu and independent companies per period can be computed. The value of this figure is the one I am interested in.
RESULTS
“Informed decision-making comes from a long tradition of guessing and then blaming others for inadequate results.”
- Scott Adams
Following the three different time frames under scrutiny the results from the tests are presented in this section. So the first part deals with the period between 1985 and 1989, part two presents the outcomes for the period between 1990 and 1999, and part three treats those of the period 2000-2007. To make the information more comprehensible each part starts with a graphic display of the rate of return of the keiretsu-affiliated shares and the independent shares versus rate of return of the NIKKEI 225-index respectively. Afterwards I treat the changes in volatility of the shares across the three different time periods. For these graphs the following applies: LEGEND: = NIKKEI 225 = Keiretsu-affiliated companies = Independent companies X – axis = Date
Y – axis6 = Rate of return
1985-1989. To start with let me describe the situation the Japanese stock market NIKKEI 225 finds itself in during the period 1985-1989. Starting off from 11543 on the first of January 1985 the NIKKEI 225 closes at 38916 at the end of 1989. This means an increase of 237% in five years, as depicted in figure 2. Obviously we are dealing with the built up of the bubble referred to in the literature. From figure 2 we can derive that the keiretsu-affiliated companies perform better during the strong increase of the NIKKEI showing higher rates of return. However for this study the attention is on the volatility of these two lines, which are depicted in figure 3 and 4. To make the results easier to read the black line representing the volatility of the NIKKEI index is replaced by a dotted line.
6 Please pay attention to the values of the Y-axes as those of figure 3 and 4 differ from those of figure 6, 7, 9 and
At first sight, looking at figure 3 and 4, both types of shares seem to behave pretty much in line with the market and based on these visual aids it is not possible to draw any conclusions. Therefore we need the corresponding beta coefficients. The beta coefficient for the keiretsu-affiliated companies is 1.006 and that of the independent companies is 0.907. This means that the keiretsu-affiliated companies shares behaved in close correspondence to the overall market, but were more a slightly more volatile. At the same time the independent company shares followed the market as well, but not as strongly as the average keiretsu-affiliated company did. Their corresponding Pearson correlation between the keiretsu and independent companies is 0.888, which is significant at a 99% confidence interval. Which indicates that the overall behaviour shows strong resemblance. So during the period 1985-1989 the keiretsu-affiliated companies have been more volatile than the shares of the independent companies.
1990-1999. At the end of 1989 the banking crisis would hit Japan and mean a strong decline of the NIKKEI 225. During the “lost decade” the NIKKEI 225 would loose more than 51%, dropping from 38916 to 18934. Figure 5 illustrates this strong decline and how the keiretsu and independent companies’ shares dealt with this downfall. Clearly the rates of return of the shares of the keiretsu companies show more similarity to that of the overall market, while the independent shares look to have been affected less.
Figure 5. Rate of return keiretsu and independent company shares versus NIKKEI 225 1990-1999
Figure 6 and 7 show the related volatilities of the keiretsu-affiliated and independent companies’ share prices. Both figures make clear that the volatility of the NIKKEI 225 between 1990 and 1999 was higher than that of the keiretsu and independent companies, which is enforced by the beta coefficients. The keiretsu-affiliated companies have a beta coefficient of .974 and the independent companies .870. So both types of companies are less volatile than the overall market in the second period. Moreover the Pearson correlation is .953, which is even stronger than during the first period.
2000-2007. During the last period the NIKKEI 225 would decrease another 19% from 18934 to 115307. At some point in this period we should be able to see the results of the interference by the Japanese government. What were the effects of the changes to the political and economical environment? Figure 8 once more shows the rate of return of the NIKKEI 225 the keiretsu-affiliated shares and the independent shares. However this picture is rather misleading as during the last period companies in both categories show very dissimilar rates of return. For example the share price value of Japan Steel Works increases by more than 1400%. So despite the fact that the volatilities seem to be very high they are in fact even lower than the earlier periods. Keiretsu shares have an average beta coefficient of .937 and independent shares of .880, which are depicted graphically in figure 9 and 10. Consequently the Pearson correlation is somewhat less than during the second period with .927, nevertheless still significant at a confidence level of 99%.
Evidently there have been major alterations in the market. Despite the fact that the overall market declined by 19% both the keiretsu and independent average share price increased in value. A possible explanation is the possibility for companies to buy back their shares meaning that there are fewer shares in the NIKKEI 225. However I will go more in-depth in the following discussion part of my dissertation.
Now what does this mean with respect to the hypotheses formulated earlier. Table 2 summarizes the results for the three different periods. Important to know is that the Pearson correlation is significant at a 99% confidence level for all three periods. This means that contrary to the conclusions of Nakatani (1984) the volatility of the keiretsu and independent companies’ shares do not significantly differ, which is in line with the conclusions of Beason (1998). Therefore we have to reject the first hypothesis stating that the volatility of the keiretsu-affiliated shares would be significantly lower than that of the independent companies. Moreover we need to reject the second and third hypothesis as well since there are no significant differences between the periods. Striking though is the fact that during the years the Japanese economy was in recession the correlation between keiretsu and independent companies increased to .953.
Table 2. Overview Beta coefficients and Pearson Correlation Keiretsu and Independent Companies.
So now we have established the volatility relative to the market lets look at how the volatility developed over time. In Table 3 I present the volatility of the NIKKEI 225, keiretsu-affiliated companies and the independent companies. Clearly the overall market was far more volatile during the recession in comparison to the period between 1985 and 1989. So the years during
which the Japanese economy was in recession the volatility of the market and with it the keiretsu and independent companies were much higher. After a number of changes in the political and economical environment the market is now settling down again, however overall the NIKKEI is still more volatile than before the recession hit Japan.
Table 3. Standard Deviations Nikkei 225, Keiretsu and Independent Companies.
1985-1989 1990-1999 2000-2007
NIKKEI 225 .0107 .0155 .0142
Keiretsu .0114 .0153 .0138
Independent .0104 .0139 .0128
However the most remarkable thing about these results is that both the keiretsu and the independent companies’ share price volatility is lower than that of the market. Earlier on page 32 I divided the NIKKEI 225 in four types of companies. From those I selected the companies affiliated to one of the “Big Six” and the independent companies. Following Nakatani’s research (1984) I expected to find the biggest differences in results, which would be representative for the entire market. Nevertheless from these results I have to conclude that the remaining one hundred and five companies in the NIKKEI 225 have to be more volatile than the market.
DISCUSSION AND CONCLUSION
“New opinions often appear first as jokes and fancies, then as blasphemies and treason, then as questions open to discussion, and finally as established truths.”
- George Bernard Shaw
The results showed some interesting outcomes as it first sight they deviate quite strongly from what Nakatani (1984) concluded. This section once more deals with the different time periods determined earlier. Before I turn to the discussion of the respective time periods though I want to take a moment to discuss the results in general and look for explanations in the literature for these surprising results. For example by taking a closer look at the papers that challenges the conclusions drawn by Nakatani.
volatility of a market. In fact they conclude that the behavior by foreign shareholders is alike that of the domestic shareholders. However there is one important difference between domestic and foreign investors according to Hiraki, Ito and Kuroki (2003), namely that the foreign investors have a preference for large companies.
Something else that becomes obvious from figure 11 is the sharp decline of the percentage shares held by the stable shareholders. While at the end of 1989 combined the stable shareholders held almost fifty percent of the outstanding shares of the “Big Six” this percentage dropped to just over twenty seven percent at the start of 2002 (Miyajima & Kuroki, 2006). Simultaneously the diversity and number of the shareholders grew. Amihud, Mendelson and Uno (1999) state in their research that as the number of shareholders in a company increases the share price increases. According to Yoshikawa and McGuire (2008) the reciprocal cross shareholdings decreased from eighteen percent to only seven percent between 1990 and 2003. So formerly reciprocal cross shareholdings and the stable shareholdings made way for more performance-oriented foreign investors and institutional investors (Yoshikawa & McGuire, 2008). In the end this would bring about the biggest changes to the keiretsu-affiliated companies. The new shareholders were actively involved
15,4 15,6 15,9 15,8 15,9 15,7 15,7 15,6 15,5 15,4 15,2 14,5 13,7 11,3 10,6 8,4 7,7 6,2 5,6 4,9 7,9 9,1 10,2 10,1 10,2 10,2 10,0 10,3 10,7 10,8 11,4 12,9 13,5 14,2 17,8 20,3 21,4 20,2 19,1 18,7 19,8 19,5 18,9 18,6 18,1 17,6 17,5 17,2 16,9 16,2 15,8 14,7 13,9 12,4 11,6 10,8 10,2 9,0 8,8 8,6 30,6 30,2 29,6 30,2 30,2 29,6 28,6 28,2 27,7 26,5 25,8 25,1 25,4 25,7 21,8 22,1 21,7 21,7 21,9 21,4 5,5 4,7 4,8 4,8 4,9 6,1 7,4 8,1 9,0 11,4 12,1 13,0 14,6 17,6 18,8 18,5 18,4 22,4 24,3 27,0 20,8 20,9 20,6 20,5 20,7 20,8 20,8 20,6 20,2 19,7 19,7 19,8 18,9 18,8 19,4 19,9 20,6 20,5 20,3 19,4 0% 20% 40% 60% 80% 100% 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Large Banks Trust Banks Insurance/Inv. Banks Corporations Foreigners Individuals
with the day-to-day business of the companies and for example pressurized companies to downsize in times of disappointing results (Yoshikawa & McGuire, 2008). Accordingly this is another argument in favor of the increased volatility of the keiretsu members as the once stabilizing ties were dissolving.
In 1998 the Japan Association of Corporate Executives published its 13th Corporate White Paper. They used this publication as a way to express what changes were needed in the corporate governance. What follows is just a selection of points to improve: “(1) capital efficiency-oriented management by pursuing greater self-discipline, transparency and speedy decision-making, (2) more importance to company’s share price, (3) specialization in profitable operations and downsizing in loss-making operations, and (4) putting more emphasis on investor relations.” (Inagami, 2001: 229). Following these recommendations Inagami (2001) conducted hundreds of surveys among Japanese managers of the biggest companies. The results show that the Japanese corporate governance model is shifting towards the shareholder value model in which the shareholder is at the center of every decision. So emphasis is shifting from the long-term stable operations and market share growth to short-term profitability and return on investment rates, concepts central to the shareholder value model (Booth, 1998). Specialization in profitable operations and divesting the loss-making ones increases the value of a company, which in turn is reflected in higher share prices after 1998. This is in line with the increasing share prices of the keiretsu-affiliated company especially after 2000 where growth rates increased strongly. Moreover short-term orientation will also drive up the volatility as the circulation of shares increases.
Especially the high diversification added to this profitability, nevertheless it were these same diversifications that would prove to be unprofitable when the Japanese economy fell into a recession (Cowling & Tomlinson, 2000).
1990-1999. For the second period between 1990 and 1999 I was expecting that the volatility of the keiretsu affiliate would get closer to that of the independent companies. Despite the fact that the keiretsu share became less volatile relative to the market it did not get closer to the independent share as that became less volatile as well. Actually the difference in volatility grew a little. Overall the volatility increased meaning that the NIKKEI 225 became more volatile and despite the fact that the beta coefficients declined the standard deviations shows that both keiretsu and independent companies’ shares became more volatile. Lincoln, Gerlach and Ahmadjian (1996) provide an explanation by demonstrating that the once competitive advantage of mutually bearing risks turned on the business form. Because of the economic recession all affiliated companies found themselves in heavy weather. The strong companies could no longer nurture the weaker companies as they themselves were struggling. Dewenter (2003) finds evidence of weaker companies from within the keiretsu increase their reliance of group-provided debt and equity. From figure 11 we can clearly see that formerly large shareholders in terms of percentages started to sell off their shares. As a result the diversity and number of shareholders started to increase, which according to Dvorak (2001) increases volatility. At the same time independent companies were able to react faster and more decisive to the changed economic conditions enabling them to cope better.
Conclusion. The goal of the second part of my dissertation was to answer the question whether the volatility of keiretsu-affiliated companies had increased over the period 1985-2007. This question should be answered positively. Following the results in table 3 we can clearly see that the standard deviation of the keiretsu shares have increased. However relative to the NIKKEI 225 the keiretsu shares have become less volatile. In the 1980s the keiretsu-affiliated companies used the flourishing economy to increase their diversity by acquiring a wide variety of smaller companies in all different kinds of industries. At the time those companies were profitable and it was expected to stay that way as long as the economy kept on growing. Surprisingly enough the results show that their share price volatility was higher compared to that of the independent companies, nevertheless the results have showed that there were no significant differences in volatility. Yet when the main banks of the keiretsu system were hit by the banking crisis the whole situation became very instable, resulting in a strong increase in the overall volatility of the market. During these years keiretsu companies were hit harder by the economic recession than their independent counterparts. The investments of the eighties suppressed the results of the keiretsu. Carefully changes started to occur from which the keiretsu would benefit. Focus shifted from the long-term stable market growth strategy to short-term profitability meaning that unprofitable companies were divested. Slowly the once characterizing ties of the keiretsu were corroding. First the main bank tie dissolved at the end of the eighties. Second the cross-holdings and stable share holdings would break up. At the same time foreign investors were moving in as some of the formerly strongest companies of Japan had lost the most of their value. As a result the diversity and number of shareholders in the keiretsu increased and consecutively share price volatility increased.
LIMITATIONS AND DIRECTIONS FOR FUTURE RESEARCH
The complexity of the Japanese keiretsu is what makes it very interesting to review, however simultaneously it is what makes it so difficult. Alike all scholars that have done research in this field I have encountered the difficulty of determining whether companies are affiliated and if they are in what manner. As mentioned earlier the results from this research cannot readily be generalized to the entire keiretsu-affiliated population in the NIKKEI 225 as they hold only for those affiliated to one of the “Big Six”. Nevertheless I did prove that the volatility of these keiretsu-affiliated companies have become more alike the volatility of the independent companies. This conclusion contributes to the overall literature looking to prove that the influence of the keiretsu in the Japanese economic environment is decreasing. More specifically that Japanese companies are adhering to more Anglo-Saxon ways of conducting business. An important side note that has to be made is one, as I mentioned earlier, that the criteria I used in selecting the individual companies caused that I reviewed only the strongest individual companies in the NIKKEI 225.
Besides the decline in the visible ties, of which this research is another example, there are the invisible ties that are typical for the Japanese business environment. Japanese managers of cordial companies often met to discuss the directions for future business. Something that looks very similar to collusion. Did these types of meetings vanish as well or are Japanese companies still bundling their strengths against foreign competitors. Another interesting angle to review are the mergers and acquisitions. Following the dismantling of the long held reciprocal and stable share holdings the number of mergers and acquisitions should have increased very strongly.
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