1
CORPORATE GOVERNANCE IN THE JAPANESE KEIRETSU SYSTEM
A dynamic process
The Japanese form of corporate governance differs from the Anglo-US and the German models (Futatsugi, 1990; Gilson, Roe, 1993; Sheard, 1989; Charkham, 1995). Prowse (1992) suggests that two distinct corporate governance systems exist in Japan: independent firms and keiretsu. Independent firms have more arms-length relationships with their suppliers, customers and financiers and their management appears to be disciplined in part by large shareholders taking larger equity positions.
Keiretsu may involve formal and informal relationships with suppliers, which have developed over the years), or other inter-firm links (for example, among manufacturers and supporting financial institutions). Within keiretsu, management is disciplined through a complex interaction of monitoring and control conducted by suppliers, customers and financiers who have long-term relationships with the firm in addition to being major creditors and shareholders. The main banks play an important governance role. Since Japanese firms did not have easy access to financial markets for a long time, bank loans were the only source of capital for many of them. In the late 1990s, the Japanese economic system underwent some changes, such as the dissolution of cross-shareholdings and the decline of the main bank system (relationship-based financing) leading to changes in the corporate ownership and the governance system of Japanese companies.
The shareholdings of foreigners have increased and pressures by foreign investors on Japanese managers have become stronger. These are shareholders who are much more interested in short-term profits rather than long-term growth. Most Japanese companies have started to change their corporate governance system.
This chapter aims to situate the keiretsu within the existing strategic management and economics of institutions literature on company networks and governance. It addresses the changes of vertical manufacturing keiretsu and highlights structural changes affecting governance modes in Japanese keiretsu. Since the end of the 1990s, vertical keiretsu have undergone restructuring plans designed to better prepare them to face the competition (Value Creation 21 – Matsushita; S21 – Fuji Electric; Vision 2000 – Marubeni; Reform Package – Sumitomo and Nissan Revival Plan).
To have a better understanding of the keiretsu corporate structure, it is necessary to analyse its industrial organization evolution. We will first situate the Japanese organizational structure and then present a review of the main stages of the change that has affected vertical keiretsu, together with the factors that have contributed to this change. Finally, we analyse the evolution of corporate governance and ownership of keiretsu. We will illustrate the evolution of keiretsu through the Nissan case study.
The historical and economic development of the Japanese industry and its keiretsu
Whether called zaibatsu or more recently keiretsu, corporate groupings have been a distinctive part of Japan’s industry for decades. These networks, representative of long-lasting and stable relationships are undergoing drastic changes. Many authors insist on the significant changes observed within keiretsu since the end of the 1990s. The role of keiretsu, seen as networks structured around a financial institution or a manufacturer and its production chain, seems to be less important. As a result, the relationships between the partners are weakened and the corporate governance issues are quite different.
From zaibatsu to keiretsu: historical background
The keiretsu has its origins in the Meiji era. Zaibatsu and keiretsu are the result of the ancient relationship between feudal landlords, or daimyo, and their samurai. In these organizational structures the paternalism of feudal times has survived. In the past, during the feudal period Takagawa (1603–1868), Japan was divided into feudal fiefdoms called han “controlled” by the daimyo.
At the end of the nineteenth century, the Meiji government wanted to foster the industrialization of Japan by creating family-controlled large industrial and financial enterprises (banking, insurance, mining, shipbuilding, manufacturing of cement, paper) known as zaibatsu. These emerged in response to market failures: the inability of capital markets to allocate resources efficiently, to mobilize savings and to facilitate risk assessment for investment in new business ventures (Todeva, 2005).
Each zaibatsu was owned by a family whose interests became diversified such that they were almost self-sufficient (Cooke, Sawa, 1998). These giant conglomerates, controlled by ten families (or clans), became the drivers of the pre-Second World War Japanese industry and economy. These families developed very close links with politicians, government members and the military.
Zaibatsu did have central direction, often through a dominant family, exercised via a holding company that had a controlling interest in zaibatsu companies. In that respect, they were similar to the chaebol (Ostrom, 2000). They were very powerful groups (among them Mitsubishi, Mitsui, Sumitomo and Yasuda) recognized as large monopoly firms owning interests in several companies. These were involved in industries such as steel, shipbuilding, international trading and banking.
During the Second World War, zaibatsu produced a large part of the country’s weaponry. In addition, they were seen to be monopolies by the Americans after the war. Consequently, between 1946 and 1948, following the American occupation forces, the zaibatsu dissolution programme was imposed by different laws (the Antimonopoly Law of 1947, the Law January of 1948 banning all members of the ten zaibatsu families, imposing a 5 percent ceiling on bank holdings in the stock of any firm and prohibiting inter-firm shareholdings).
But in the end of the 1940s, the allied forces changed policy. This resulting change in occupation policy is often called the ‘reverse course’ focusing on the economic recovery and political rehabilitation of Japan. Japan became a strong ally of the US during the Korean War (1950–1953). Consequently, to prevent the weakening of its economy, the Japanese government, concerned with concentrating on scarce industries crucial to Japan’s long-term economic security, encouraged the re-formation of the old zaibatsu known as keiretsu. Several keiretsu emerged from the zaibatsu, whereas others were new groupings of companies. These enterprise groups interlocked ownerships, stock shares amongst industrial enterprises, banks and other financial establishments on the one hand and closed buyer-supplier relationships on the other hand.
Horizontal versus vertical keiretsu
The term keiretsu is not approved unanimously (Gerlach, 1992; Fujiki, 2002) because is difficult to define it. Considered generally as an “enterprise group”, this concept indicates also that corporations engaged in commercial transactions are bound in a financial relationship. Consequently, other notions are used such as “inter-firm alliances”, “network of industrial organizations”, “clusters of firms”, relationship companies (kankei gaisha), related companies (kanren gaisha), “keiretsu of capital”, “group of affiliates” (Aoki, 1988) and “J-Firm Group” (Aoki, 1986).
Most large Japanese firms are connected to affiliated companies with which they form a system called keiretsu. There are mainly two types of keiretsu (Miyashita, Russel, 1994), which may be horizontal (conglomerate) or vertical (many suppliers – subcontractors under the “umbrella” of a large industrial firm):
• horizontal (financial) keiretsu include a large number of major companies belonging to a wide range of unrelated industries (which may encompass manufacturing, electronics, construction, cement) with common ties to a main and powerful bank (shuryoku ginkô). The main bank provides debt financing to member firms with favourable conditions (low interest rates, long-term loans) and owns large amounts of their common stock. The entire horizontal keiretsu structure includes the shuryoku ginkô (a “city bank” or a “long term credit bank”), a trading company (Sogo syosha) often supported by other financial institutions such as: a trust bank, a life insurance firm and/or a non-life insurance company and firms in non-competing lines of business (Nivoix, 2002). Most analysts focus on the so-called Big Six groups and their banks: Mitsui (with Sakura Bank), Mitsubishi, Sumitomo, Sanwa, Fuyo (Fuji Bank) and Dai-Ichi. They are the strongest and most representative of all the horizontal keiretsu. More recently, in 2002, the Mitsui and Sumitomo Banks merged to form the Mitsui Sumitomo Financial Group and in 2003 the Fuji Bank, DKB and the Industrial Bank of Japan merged to create the Mizuho Financial Group.
• vertical (“production” or non-financial) keiretsu are quite different. They represent a pyramidal structure of intercorporate equity holdings. Some of them are industrial zaibatsu that escaped dissolution (Morck, Nakamura, 2003). They are generally industry-based (mainly manufacturing such as automobile, steel and electronics industries but also trading activities and financial services) with a large manufacturing company having equity (controlling in some cases affiliated suppliers) and other links to firms up and down the “production chain” and along the value chain. As much of value creation occurs in the supply and distribution chains, vertical keiretsu managers have to understand the value network, the set of inter-organizational links and relationships that are necessary to create products and/or services (Johnson et al., 2008). A vertical keiretsu consists of tiers, with a company at the top, followed by a secondary tier of major suppliers, and then a tertiary tier of smaller manufacturers. Staff and loans can flow from the lead company to these suppliers. The second tier is allowed to use the parent company name and reputation to promote its own activities. The parent company is responsible for the coordination. This organization is perceived to be highly hierarchical, hence the name vertical keiretsu.
The difference between horizontal and vertical keiretsu “is the glue that holds the group together as well as the strength of that bond. Members of horizontal keiretsu are linked by the power and the obligations of the large bank at the center of the organization and, to a lesser extent, by the group’s trading companies; in some instances, they are tied together by a shared history. The position of the keiretsu bank is particularly strategic. It is the nucleus of a keiretsu financial institution, and, in terms of pooling resources, it maintains a control power based on the provision of funds and share ownership and provides guidance to corporate investment behavior and opportunities. The cohesiveness of vertical keiretsu, by contrast, depends on one or more large nonfinancial companies that hold substantial equity positions in affiliates and that serve as important customers and suppliers to the rest of the group” (Ostrom, 2000, introduction).
The impact of keiretsu on Japan’s economic performance
Japan’s spectacular growth originated partly in keiretsu. Keiretsu and more specifically “vertical keiretsu” have been widely recognized as an important source of strength in Japanese industries. They contributed largely to boost the Japanese post-Second World War growth. They were a key feature of Japan’s economy, affecting, directly or indirectly, economic transactions within and across industries. They also structured the Japanese industrial system. They can be analysed as both an organizational phenomenon and a means which has enabled Japanese firms to expand their production capacities, their competitiveness and their exports growth (Aoki, 1988) until the 1990s. The following characteristics of keiretsu can explain Japan economic success:
A “pyramidal” structure based on long-term agreements and a nexus of relationships
Vertical keiretsu represents a group of independent firms developing complementary resources (human, technological) and competencies, organized around a prime manufacturing company, the main company (motouke). The cohesion of the keiretsu is based on a long-term commitment between the main manufacturer and other firms and on regular (formal and informal) relationships (supply chain, production, financial, commercial) between members. The economic logic is based on mutual trust and self-enforcing commitments. The contracts are generally determined for several years and are adjusted every six months depending on the economic evolution and the respect of quality and costs conditions by subcontractors. They help to ensure consistent and reliable quality, dependable delivery etc. As keiretsu are based on stable and vertical relationships (long-term subcontracting relationships), this network induces transaction costs reduction.
Corporate governance and stable shareholding (kabushiki antei hoyuu)
As Okabe (2001, p. 7) explains: “cross-shareholding is a concept relating to the owner of the stocks, while stable shareholding relates to the motivation and duration of holding stocks. That is, stable holding means the kind of investment attitude in which an investor, once he acquired stocks, does not sell them in principle and holds them for a long time, regardless of the market...