ORGANIZATION STRUCTURE AND CORPORATE DEMAND FOR REINSURANCE: THE CASE OF THE JAPANESE KEIRETSU

• Date: 01 June 2017
• DOI: http://doi.org/10.1111/jori.12092
• Author: Noriyoshi Yanase,Piman Limpaphayom
• Published date: 01 June 2017

ORGANIZATION STRUCTURE AND CORPORATE DEMAND

FOR REINSURANCE:THE CASE OF THE JAPANESE KEIRETSU

Noriyoshi Yanase

Piman Limpaphayom

ABSTRACT

This study investigates the impact of organization structure on corporate

demand for reinsurance. Previous research has shown that the unique

corporate groupings in Japan known as the “keiretsu” have relatively low

bankruptcy costs, low agency conflicts, low information asymmetry, and low

effective taxes. These conditions should mitigate the benefits of reinsurance

purchase. This conjecture is tested by examining demand for reinsurance of

Japanese non-life insurance companies during 1974–2010. Consistent with

the prediction, keiretsu non-life insurers have lower reinsurance purchase

than independent non-life insurance companies. The effects of the keiretsu

structure also receded when keiretsu groupings’ power was weakened after

the asset bubble burst and the breakdown of the convoy system in mid 1990s.

Consistent with previous studies, Japanese mutual insurers also purchase

more reinsurance than stock insurers.

INTRODUCTION

Although they are perhaps the most widely used contracts among corporations,

insurance contracts receive little attention in the finance literature (Mayers and Smith,

1982). In fact, the theory underlying corporate financing decision is very similar to

that of insurance decision. In their seminal article, Modigliani and Miller (1958)

contend that under a unique condition known as the perfect capital market, corporate

financing policy is not relevant. Similarly, in a world with no contract cost of

bankruptcy, no information asymmetry, and no agency conflicts (Coase, 1960;

Fama and Miller, 1972), insurance purchase by a business corporation is not a

Noriyoshi Yanase is at the Tokyo Keizai University. Piman Limpaphayom is at Portland State

University and Sasin GIBA of Chulalongkorn University. Piman Limpaphayom can be

contacted via e-mail: piman@pdx.edu. The authors are indebted to Kenneth Kim, Gene Lai,

Soichiro Moridaira, Gregory Niehaus, Hisashi Nakamura, Toshio Serita, Yukihiro Yasuda,

Thomas Berry-Stoelzle, S. Hun Seog, Takau Yoneyama, and seminar participants at the Japan

Finance Association Meeting, the World Finance Conference, the Western Risk and Insurance

Association Meeting, the Asia-Pacific Risk and Insurance Association Meeting, the World Risk

and Insurance Economics Congress (WRIEC), and Hitotsubashi University for comments on

earlier drafts of this article. This research is partially funded by the Postal Life Insurance

Foundation of Japan (Kampo Zaidan). All remaining errors are our own.

© 2015 The Journal of Risk and Insurance. Vol. 84, No. 2, 599–629 (2017).

DOI: 10.1111/jori.12092

599

value-maximization strategy (e.g., Mayers and Smith, 1982, 1990). Main (1983) also

argues that individual stockholders can diversify firm-specific insurable risk to such

an extent that costly insurance does not enhance firm value. Subsequently, over the

past decades, a considerable number of studies have provided explanations for the

reasons corporations purchase insurance. Overall, the literature on insurance

purchase provides sensible results that are generally consistent with relaxing

theoretical assumptions.

1

For instance, Mayers and Smith (1982) posit that the

transaction cost of bankruptcy and monitoring cost are major incentives that lead to a

purchase of insurance. Previous studies also show that violations of theoretical

assumptions, such as expected bankruptcy costs, agency conflicts, information

asymmetry, and the existence of taxes have all been cited to explain why a

corporations purchase insurance.

In the same vein, reinsurance plays an important role in risk management strategy for

primary insurance companies. Insurance companies frequently purchase costly

reinsurance. In fact, reinsurance purchasing has been one of the most popular risk

management activities for individual insurance companies (Mayers and Smith, 1990).

Intuitively, it is likely that an insurance company can minimize the cost of risk and

maximize the value of the firm by employing appropriate risk management activities,

such as risk identification, risk analysis and evaluation, or risk reduction. However,

Mayers and Smith (1982) suggest that because of risk diversification, risk reduction

alone cannot explain the need for insurance. MacMinn (1987) provides theoretical

proof and demonstrates that insurance decisions by corporations can be reversed by

an individual’s actions. Both Mayers and Smith (1982) and MacMinn (1987) conclude

that the expected cost of bankruptcy, agency conflicts, and information asymmetry

are major reasons for insurance purchase. Finally, Mayers and Smith (1982) posit that

insurance companies provide concrete benefits in terms of real service efficiency. It is

apparent that reinsurance purchase is one of the most critical financial decisions for

insurance companies.

Recently, the unique corporate grouping known as the “keiretsu” has received

considerable attention from finance researchers. The keiretsu groupings play

prominent roles in the Japanese economy.

2

Uniquely, financial keiretsu or horizontal

1

There is rich theoretical and empirical evidence on factors influencing insurance purchases

(e.g., Mayers and Smith, 1982, 1987; Main, 1983; McMinn, 1987; Han, 1996; Core, 1997; Yamori,

1999; Hoyt and Khang, 2000; Zou, Adams, and Buckle, 2003; Han and MacMinn, 2006; Regan

and Hur, 2007; Aunon-Nerin and Ehling, 2008; Michel-Kerjan, Raschky, and Kunreuther,

2011). Additionally, several studies have focused on why an insurance company purchases

reinsurance (e.g., Mayers and Smith, 1990; Hoerger, Sloan, and Hassan, 1990; Garven and

Lamm-Tennant, 2003; Shortridge and Avila, 2004; Cole and McCullough, 2006).

2

There are two types of keiretsu grouping in Japan. The main focus of this study is the

horizontal financial keiretsu or business group (Kigo-Shudan in Japanese). The other type of

keiretsu grouping is the vertical manufacturing keiretsu, with a manufacturer and its affiliated

suppliers (Torihiki-keiretsu in Japanese). The vertical keiretsu is characterized as manufactur-

ing or supply chain groups with suppliers, subcontractors, and distributors organized in the

vertical division of labor around a large industrial firm such as Matsushita (Panasonic),

Nippon Steel, or Toyota (Lincoln and Shimotani, 2009).

600 THE JOURNAL OF RISK AND INSURANCE