Dick Beason

Keiretsu affiliation and share price volatility in Japan

It has been argued that keiretsu affiliation among Japanese firms gives rise to more stable management practices which result in more stable but lower average profits for member firms relative to independent firms. Using financial market performance data, such as the volatility of share prices, we find no evidence to support this hypothesis.

Cross-Shareholding, Returns and Entrenchment Behaviour Among Japanese Firms, 1990-2008

This paper is concerned with the nature of ownership, returns and corporate performance and investment behavior in the ‘post-bubble’ environment surrounding Japanese firms. Market participants have feared that ‘unwinding’ of cross-shareholding would have negative consequences for returns, on the assumption of a downward sloping demand curve for equities. We examine whether this is the case, but more importantly consider what consequences the changing nature of ownership might have for firm behavior. Interestingly, while overall unwinding of cross-holdings is indeed consistent with downward sloping demand curves for equities, controlling for endogeneity biases and focusing on holdings by financial institutions, we find the opposite result. We interpret this as evidence that at least one facet of the traditional ‘main-bank system’ of Japan is alive and well- namely that increased bank holdings can be viewed as intervention by banks in assistance of financially distressed firms. In terms of firm behavior, our results are consistent with the literature on entrenchment. That is, firms that are more closely cross-held by other firms (financial or non-financial) tend to invest more heavily in capital stock and research and development. This is consistent with the notion that firms that are less vulnerable to takeover tend to spend and invest more than their more takeover prone counterparts.

Separation risk and firm size-earnings relationships in Japan and the US

Separations among workers in large Japanese firms, while rare until recently are quite costly. Such workers must re-enter another firm at a relatively low level along the tenure-earnings profile, or move to a smaller firm where the tenure-earnings profile is much flatter. In either case, in relative terms, separations are very costly to workers in large firms, and such workers must be differentially compensated for the risk of separation. The results here show that compensation for such separation risk is an important factor in the firm size-earnings differential in Japan, but not in the US.

Japan’s Financial Crisis

Whether Japan’s bubble was a bubble in the sense that is was driven by pure speculation, or only in the sense that agents had unrealistic expectations about future growth prospects, the legacy of the bubble is the same. After asset prices began to tumble after 1989, the negative wealth effects of the crash had major economic consequences. Households as equity and landholders bore massive realized and unrealized capital losses. For those who bought land at the peak, average prices had fallen by 40 per cent on average between 1989 and 1993. Equity prices fell by half from the all-time high of nearly 40,000 in 1989 to just under 15,000 at one point in 1995. Indeed, these losses, realized or otherwise, caused households and businesses alike to retrench, sending the Japanese economy into its deepest and most prolonged slowdown. As this cyclical slowdown resulting from such wealth effects coincided with major structural changes inherent in an industrial economy at Japan’s stage of maturity, the adjustments have been particularly severe. The recession was not, as Chalmers Johnson (Atlantic Monthly, 1993) has suggested, the invention of Japanophiles seeking to give Japan breathing space in trade negotiations with the US, but a very serious period of adjustment.

Japanese Equity Market Valuation

Valuations in the Japanese equity market have been persistently puzzling to outsiders, and to many insiders too, over the last decade. The most common rule-of-thumb valuation measure used by investors around the world is the price:earnings ratio (PER). This simply divides the price of a stock by its earnings per share, indicating how many years of earnings it will take for a holder to earn back his original investment. In the case of a whole market rather than an individual stock, this calculation becomes the total market capitalization divided by the aggregate net profits of the market — in other words, the number of years it would take the total market to earn back the cost to an investor of buying the entire market. Japanese PERs were relatively high by international standards in the early 1980s, but foreign investors were generally comfortable that this could be explained by the higher growth rates of Japanese earnings. By the mid-1980s, however, the PERs were becoming so extremely high by comparison with other markets that this explanation was straining credibility. And PER levels have remained comparatively high in the early 1990s.

Institutions, Accounting Practices and Incentives in Japanese Equity and Other Financial Markets

There are several main types of institutional player in the Japanese financial markets. First, by virtue of their huge size, come the life insurance companies. Second only to these come the public funds, which are discussed in a separate chapter. Then come corporate pension funds, extremely underdeveloped by comparison with their counterparts in the West, but nevertheless players of growing importance in the markets. Next come securities investment trusts and the non-life insurance companies. Finally come banks, corporations and other entities investing on their own accounts, sometimes in the form of tokkin (‘special money trust’) funds, and sometimes directly. We shall review each of these categories of investor in turn, not only looking at their historical development, but also making some guesses as to what the future holds. We start by briefly discussing the different types of fund management company, and then look at the characteristics of the different pools of institutional money, to show what kind of assets they invest in and how they are developing.

The Cost of Capital in Japan and Semantics of the Bubble

One issue which has arisen from time to time in this study is that of the relative cost of capital in Japan. A very lengthy debate exists as to whether the cost of capital in Japan is or has been lower than in other countries. The traditional Japanologists have simply taken it for granted that government policy was aimed at achieving low interest rates and cheap cost of capital during the high growth period. More important than this, the typical Japanologist view is that such policies were successful in attaining their goals. Somewhat interestingly, however, is the fact that most of these Japanologists argue that the cost of capital was low in Japan during the high growth period, but then assign the role of capital a subordinate role in their explanations for rapid growth (Johnson, 1982). Typically, some vaguely defined industrial policy and exotic blend of cultural factors are argued to have been of central importance by such ‘scholars’.

Towards a More Liberal Structure

Initially, financial market liberalization has taken the form of facilitating or recognizing new markets and instruments. In turn, most of these instruments or markets emerged in order to facilitate transactions or financing means not available under the highly intermediated structure, or to facilitate the international flow of capital. Not surprisingly, as more ‘free’ or unregulated markets and instruments emerged, the efficacy of regulation waned. Specifically, we have argued earlier that the highly intermediated structure of the high growth period was subject to successful regulation. As all institutions in the framework had highly specialized and well-defined functions, and the flow of funds from original wealth holders to end-users was clearly defined and specialized, regulation at each stage in the flow of funds was possible. This allowed regulators to separate or segment certain financial markets from one another. As a result, for example, it might be possible for monetary authorities to exert greater control over the shape and nature of the yield curve than might be the case in unregulated markets. Thus, if regulators felt that very low long-term interest rates were desirable, this segmentation of financial markets might facilitate successful regulation of long-term rates.

End of the Party (but not the end of the world)

In Part I, we traced the development of the modern Japanese financial system from its highly functional origins during the Second World War and immediate postwar period and through the high growth episode. We have a picture of a structure that was highly inter-mediated, with each step in the intermediary process performing a highly specialized function. The entire process was closely supervised and as each step or transaction was regulated, and alternative markets prohibited, regulation of the interest rate structure from depositor to ultimate corporate borrower was highly effective. Competition for scarce funds which might otherwise create arbitrage opportunities and black markets was limited by regulation, and consumers did not directly vie with corporations for scarce capital.

Public Funds, ‘Price-Keeping Operations’, Deregulation and ‘Big Bang’

In Japan, prices in financial markets have not normally been directly targeted by government policy, but there have been some exceptions to this general rule. The authorities in principle object to excessive volatility in financial markets. Excessive volatility is seen as likely to reduce the attractions of financial assets to investors, and thus raise the cost of capital over the longer term. Given its role in setting various interest rates, unjustified moves in the bond market in particular are capable of leading to inappropriate interest rates in the real economy, and therefore the authorities try at the very least to let the markets know when they believe that price moves are unjustified by fundamental factors.