Corporate Governance

1
Corporate Governance

• Handout 4

2
The structure of Corporate Ownership in Japan

• One of the fundamental issues concerning
  corporate governance is that each owner typically
  owns a small fraction of the corporation.
• Fragmented ownership makes it difficult for the
  owners (shareholders) to exercise effective
  control over the management.
• Thus, the problem of the separation of ownership
  and management is more severe when ownership is
  fragmented.

3

• Therefore, understanding the corporate ownership
  structure is an important topic in the study of
  corporate governance. For example, large
  shareholders may be effectively voice their
  opinions, thus alleviating the problem of the
  separation of ownership and management.
• We will discuss the structure of corporate
  ownership in this handout. We will focus on the
  issues in Japan, with some attention given to the
  comparison between the situation in the US and
  Japan.

4

• Our goal today is to understand
• Why is the corporate ownership in Japan
  structured the way it is (was).
• Has there been any change in the structure of
  corporate ownership in Japan overtime? If so,
  what are the factors that caused such changes?
• 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
  recent results.

5

• First, we investigate the determinants of the
  structure of corporate ownership. By doing so, we
  can understand why corporate ownership is
  structured the way it is (was)
• We will take a look at the results in 1980s
  first. Then, we will look at the change in
  corporate ownership overtime.

6
The structure of corporate ownership in the US
and Japan (1984)
7

• There are major differences between the structure
  of corporate ownership between the US and Japan.
• The percentage of equity owned by corporation is
  much larger in Japan than in the US.
• The percentage held by financial institution is
  much larger in Japan than in the US.
• This could be due to different regulations
  between the US and Japan. At that time in Japan,
  Banks were allowed to hold up to 10 of non bank
  equity (this will be reduced to 5 later). On the
  other hand in the US, banks were allowed to hold
  only up to 5.

8
The concentration of ownership in Japan and the
US.

• The previous table shows that significant shares
  are owned by corporation in Japan.
• However, the previous tables does not reveal
  anything about the concentration of ownership.
• The table in the next slide shows the percentage
  of equity held by the top five shareholders in
  the US and Japan.

9
The concentration of ownership in Japan and the
US.
Ownership is more concentrated in Japan than in
the US in 1984. 33.1 of equity is held by top
five shareholders in Japan, while 25.4 of equity
is held by top five shareholders in the US.
Japanese data the top five shareholders of 734
largest Japanese firms.
10
The concentration of ownership in Japan A
frequency table
11
Who are the largest shareholders in Japan?
Financial institution that rank among top fives
shareholders
Non financial institution that rank among top
five shareholders
Individual shareholders that rank among top five
shareholders
Top five shareholders
Financial institution dominates the importance as
large shareholders
12
Determinants of ownership structure in Japan

• From here, we will investigates the determinants
  of ownership structure in Japan.
• We pay a particular attention to Japan specific
  issues such as the existence of corporate groups
  or keiretsu in Japanese.
• Let us first think what would determine the
  concentration of corporate ownership why some
  firms would have large concentration of ownership
  structure while others have very fragmented
  ownership structure?/

13
Two hypothesis

• The larger the size of the firm is, less
  concentrated the structure of corporate ownership
  is.
• The corporate form of business initially
  developed since value maximizing size of firms
  exceeded the size that can be financed only by a
  few individuals. Needless to say, the advantage
  of the corporate form of business is the ability
  to gather capital from many individuals/institutio
  ns. Thus, we expect that the ownership structure
  would be less concentrated in a large firm.

14

• 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?

15

• To think of an answer to the question in what
  firms the control potential is large, first
  consider a firm that operates in a very stable
  business environment (i.e., stable price, stable
  market share, stable technology, etc). In such a
  firm, managerial decisions would be less crucial
  in affecting firm performance.
• On the other hand, if a firm operates in a less
  certain environment (unstable market share,
  changing technology etc), managerial behavior
  would be more crucial in affecting firm
  performance. Therefore, in such a firm, the
  profit potential from exercising more effective
  monitoring of managerial performance would be
  greater.
• Therefore, the control potential is likely to be
  large in a firm operating in a less certain
  environment.

16
A Japan specific factor Keiretsu

• Japanese firms often form corporate groups called
  Keiretsu. Keiretsu is a group of firms with
  strong long-term trading ties (such as supplying
  intermediate goods etc). Such relationship is
  enforced by cross-shareholding among them.
• Among keiretsu firms, there are exchanges of
  managers which serves as alternative monitoring
  system.
• Moreover, such cross-shareholding is very stable.
  Keiretsu firms seldom expresses their
  dissatisfaction to management by selling out the
  (cross-held) shares.
• Therefore, ownership concentration is not a good
  proxy for the control of shareholders in Keiretsu
  firms. It would be a good proxy only for
  independent firms.

17

• In sum, we have the following hypotheses.
• Ownership would be less concentrated in a large
  firms
• Ownership would be more concentrated in a firm
  which operates in a less certain business
  environment.
• The above two hypotheses will be true only for
  independent firms. These hypotheses may not apply
  for keiretsu firms, since they have alternative
  corporate governance system.

18
Variables
19
The model

• Prowse (1992) estimated the following OLS
  regression.
• (Top five ownership)
• ß0ß1(MVE)ß2(Uncertainty variable)
• Prowse used log transformation of top five
  ownership log(ownership/100-ownership) as the
  left hand side variable

20
The results 1
First, take a look at the coefficients for the
MVE (the firm size variable). For keiretsu firm,
the coefficients are not statistically
significant for all the models. Also when
compared to the results for independent firms,
the coefficients are small in magnitude. This
shows that, among keiretsu firms, the size does
not constrain the ownership concentration.
21
The results 2
On the other hand, the coefficients for MVE are
negative and statistically significant for
independent firms for all the models. This
indicates that larger firm has less concentrated
ownership structure as predicted by the
hypothesis 1.
22
The results 3
Now we take a look at the coefficients for the
uncertainty variables (SE, STDS, STDA). For the
keiretsu firms, all the coefficients are not
statistically significant. In addition, the
coefficients are much smaller when compared to
independent firms. Therefore, uncertainty in
business environment has no effect on ownership
concentration for keiretsu firms.
23
The results 4
For independent firms, all the coefficients for
the uncertainty variables are statistically
significant. This indicate that firms operating
in less certain business environment has greater
ownership concentration. This result is
consistent with the second hypothesis A firm
with greater control potential will have a
greater ownership concentration.
24

• Thus, shareholders of independent and keiretsu
  firms behave differently.
• For independent firms, the ownership is less
  concentrated in larger firms. Also, firms
  operating in less certain business environment
  tend to have greater ownership concentration.
  These results are consistent with our two
  hypotheses regarding the determinants of the
  structure of ownership.
• However, for keiretsu firms, the above two
  hypotheses do not apply.

25

• In sum, we can make the following conclusions
  regarding the ownership structure of Japan before
  1984.
• Ownership concentration in Japanese firms are
  higher than in the U.S. firms.
• Firms with high control potential has greater
  ownership concentration. However, this result
  only apply to independent firms. This result do
  not apply to Keiretsu firms.
• Different behavior of shareholders in Keiretsu
  firm indicate that keiretsu firms may have
  alternative corporate governance system.

26
More recent trend in the structure of corporate
ownership in Japan

• Now, we will discuss a recent trend in the
  structure of corporate ownership in Japan.
  Discussion will be based on Miyajima and Kuroki
  (2008).

27

• The ownership structure of Japanese firms used to
  be (1980s) characterised by substantial block
  shareholding by corporations and financial
  institutions.
• In particular, substantial stable
  cross-shareholding between financial firms and
  corporation and among corporations distinguished
  the ownership structure in Japan from that in
  other countries.
• However, there has been a new trend. The stable
  shareholding has been declining, and foreign
  ownership has been increasing.

28
The trend in the ownership of the stable
shareholders
The percentage of equity (in value) held by
stable shareholders has been declining overtime.
Therefore, there has been a trend to unwind
cross-shareholding in the past two decades.
29
Ownership by type of shareholders
There is an increasing trend in foreign
ownership.
30
Long term trend in ownership structure
This shows the ownership structure overtime. You
can notice an increase in foreign ownership and a
decline in financial institution.
31

• After the World War II, large family owned
  corporate groups (Zaubatsu) were dissolved.
• This increased the potential threat of takeover.
• Firms, and especially Ex-zaibatsu firms, sought
  friendly shareholders, and cross-held each
  others shares in order to reduce the possibility
  of being taken over. Historically,
  cross-shareholding became prevalent this way.
• You can notice a clear upward trend in foreign
  ownership.

32

• These trends raise several questions.
• Why did cross-shareholding, which had been fairly
  constant for more than thirty years, begin to
  dissolve in the mid-1990s?
• If cross-shareholding was a response to the
  increasing hostile takeover threat, then why did
  it begin to decline just as the takeover threat
  grew much more serious than before.
• What does the increase in foreign shareholding do
  to Japanese firms.

33

• In order to answer these questions, Miyajima and
  Kuroki (2008) investigates the following.
• The determinants of unwinding of
  cross-shareholding with banks by non-financial
  corporation.
• The determinants of unwinding of
  cross-shareholding with non-financial corporation
  by banks.
• Whether an increase in foreign ownership would
  increase firm performance.

34
The determinants of unwinding of
cross-shareholding with banks by non-financial
corporations

• First, let us discuss what factors affect the
  decision of non-financial corporation to sell-off
  (cross-held) bank shares.

35

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

36
(No Transcript)
37
Data and estimation model

• Data The survey of cross-shareholding published
  by Nihon Life Insurance Research Institute.
• Each cross-share-holding bank-company pair is
  treated as a distinct observation.
• The following model is estimated
• Yiß0 ß1(D_ICR)ß2 (Dept/Equity)
• ß3(D_BK_RATE)ß4(M_NOST)ß(other
  variables)
• Where Yi1 if the company sells the banks
  (cross-held) shares. Yi0 otherwise.
• Model is estimated using logit model

38
Result 1
First of all, the results show that a
corporations had sold bank shares because they
had the need to sell shares. The coefficient for
the dummy for low interest coverage ratio is
positive and significant. This shows that a
company that has difficulty meeting interest
payment is more likely to sell bank shares. A
company with high Dept/Equity ratio tends to sell
off bank shares. This also shows that a company
with liquidity constraint (thus in need for cash)
tend to sell of bank shares. These results show
that the trend in the unwinding of
cross-shareholding occurs partly because they
simply needed to do so to obtain cash.
39
Result 2
Second, when the banks financial health is low,
the company is more likely to sell off the banks
shares. The coefficient for the dummy variable
for the bank with rating below D has positive
coefficient. This mean that when the bank
rating is D or below, the company is likely to
sell off the banks shares. This means that the
trend in the unwinding of cross-shareholding had
been partly due to financial crisis in Japan.
40
Result 3
Third, when the company faces greater threat of
takeover, the company is reluctant to sell the
(cross-held) bank shares which is stable. The
coefficient for the percentage share of
non-stable shareholders is negative, indicating
that a company with greater non-stable
shareholders is less likely to sell off the bank
shares. Thus, cross-shareholding still is a
device to reduce the threat of takeover.
41

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

42
What would the increase in foreign shareholders
do to Japanese firms

• There are many ways to answer to this question.
• Today, let us discuss the following question.
  Would the increase in foreign ownership improve
  the performance of Japanese firms?.
• First, why would/would not an increase in foreign
  ownership improve the performance of Japanese
  firms?

43
The model and variable

• (Performance)itß0ß1(Foreign ownership)
• ß(other
  variables)
• We use two performance variables ROA and the
  Tobins q. Tobins q is the market to book asset
  ratio, and expected to capture the growth
  opportunity of the firm.
• The model is estimated using the fixed effect
  model. Under a certain assumption, this model
  estimates the causal effect of foreign ownership
  on performance

44
The results
The coefficient for foreign ownership is positive
and statistically significant for both
models. Thus, foreign ownership does have a
positive effect on the performance of Japanese
firms
45
Summary

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

46

• Prowse S (1992) The structure of corporate
  ownership in Japan Journal of Finance, 47
  1121-1140
• Miyajima and Kuroki (2007) The unwinding of
  cross-shareholding in Japan Cause, Effects and
  Implications In Corporate Governance in Japan ed
  by Aoki G, Jackson and Miyajima, Oxford
  University press