The Governance Structure of the Japanese Financial Keiretsu

Abstract

In the Anglo-American capital market tradition, shareholders hold only equity and creditors only debt. Suppliers and corporate customers may extend credit to each other, but they typically do not have shareholding relationships. In particular, these relationships are rarely reciprocal. On the European continent, and in Asia, trading relationships are often cemented with financial ties. Enterprises are part of complex customer and supplier networkswhere financing patterns and trade are interlinked; financial institutions holds both corporate debt and equity. This article analyses one of the most conspicuous and well-known example of such networks: the Japanese financial keiretsu. We rationalize the crossholdings of debt and equity within the Japanese keiretsu as acontingent governance mechanism through which internal discipline is sustained over time. The reciprocal allocation of control rights supports cooperation and mutual monitoring among managers through a coalition-enforced threat of removal from control. This suggests that the main bank is not a dominant agent while firms are performing well. In financial distress the threat of control loss is less effective. While the coalition still relies on mutual monitoring by trade creditors, the governance mode shifts to hierarchical enforcement under the leadership of the main bank, which absorbs losses suffered from junior trade creditors within the coalition and broadens its residual control role. We can thus interpret the apparent consensual behavior by Japanese firms as cooperative behavior by self- interested parties supported by severe implicit threats, which in equilibrium need not be employed.

JEL Classification: G21, G3