Understanding the Japanese keiretsu: overlaps between corporate governance and industrial organization.

• Author: Gilson, Ronald J.

CONTESTS

1. The Berle-Means Model of American Corporate Governance 876 II. The Japanese Main Bank as the Missing Monitor 879 III. The Japanese System as Global Contractual Governance of Which

   Specific Corporate Governance is a Subset 882 A. A Stylized Model of the Japanese System 884 1. The Continuum: Contract Versus Organization 884 2. Japan: A Hybrid Between Contract and Organization 885 3. Illustration: General Motors and Fisher Body 889 B. But What About Monitoring? Product Market Competition as the

   Catalyst that Makes the Hybrid Work 891 1. Competition as Catalyst 891 2. Vertical and Horizontal Keiretsu: Helping to Explain Some Performance Differences 894 3. Is Competition Enough? 895 IV. IMPLICATIONS FOR COMPARATIVE CORPORATE GOVERNANCE ANALYSIS 895 A. Implications for Understanding the Japanese Corporate

   Governance System 896 1. Understanding the Role of the Main Bank 896 2. Understanding the Significance of Cross-Holdings' Antitakeover Role 897 3. Understanding Japanese Contract 899 4. Understanding the Role of Public Shareholders in Japan 900 5. Understanding the Stability of the Contractual Governance Model 901 B. Evaluating Reform Proposals for the U.S. Corporate

   Governance System 901 1. The Keiretsu and the LBO Association 902 2. Where Might the Japanese Model Provide Guidance? 904 V. CONCLUSION 905 We aim here for a better understanding of the Japanese keiretsu. Our essential claim is that to understand the Japanese system--banks with extensive investment in industry and industry with extensive cross-ownership--we must understand the problems of industrial organization, not just the problems of corporate governance. The Japanese system, we assert, functions not only to harmonize the relationships among the corporation, its shareholders, and its senior managers, but also to facilitate productive efficiency.

   Comparative corporate governance, once an academic backwater, now enjoys important government and scholarly attention. U.S. government reports attribute Japan's competitive success in part to features of the Japanese system.(1) Harvard Business School's major, multi-disciplinary study of American management's time horizons recommends, as a way to combat "short-termism" among U.S. managers, restructuring American corporate governance so that it resembles Japan's more closely.(2)

   This newfound interest derives from two changes, one domestic and one international. The domestic change is evident in scholars' new understanding of America's corporate governance system; during a short period of time, the basic paradigm has shifted. The "traditional" model of American corporate governance presented the Berle-Means corporation--characterized by a separation of ownership and management resulting from the need of growing enterprises for capital and the specialization of management--as the pinnacle in the evolution of organizational forms. Given this model's dominance, the study of comparative corporate governance was peripheral; governance systems differing from the American paradigm were dismissed as mere intermediate steps on the path to perfection, or as evolutionary dead-ends, the neanderthals of corporate governance. Neither laggards nor dead-ends made compelling objects of study.

   More recent scholarship challenges the "traditional" view, arguing that the separation of ownership and management--and the absence of substantial shareholders or lenders to monitor professional management--is historically and politically contingent. In particular, in the United States, populism, federalism, and interest group conflicts combined to restrict the growth of large financial intermediaries, especially banks, and constrained other efforts to oversee management, through a regulatory web of banking, insurance, tax, and securities laws.(3) The American system may be the product of an evolutionary process, but its development has been affected by features of our politics, some of which are fundamental to democracy, some peculiar to American democracy. Nothing in that process assures the American system's productive superiority to systems that evolved under different conditions.

   The second change--heightened international competition--has made it important to understand the contingency of American corporate governance. The globalization of commerce and the postwar reemergence of the Japanese and European economies has required American corporations to compete with organizations having dramatically different governance systems. In this new environment, competition exists not only among products, but also among governance systems, and American firms are not always winning. Thus, real world competition has obliged business scholarship to focus on comparative corporate governance. Because the American system is now seen as contingent, and other systems seemed in the 1980's to be doing better, understanding the differences has become urgent.(4)

   Yet, we shall argue here, our system's characteristics color the lens through which the first comparative studies viewed the rest of the world. Analysis of American corporate governance has always sought to solve the problem of separation of ownership and control: who will monitor management in light of dispersed shareholdings. Favored candidates for this monitoring role have shifted from outside directors(5) to the market for corporate control, and, most recently, to institutional investors. As a result, the primary focus in comparative studies of Japanese corporate governance has been the role of the main bank. Conventional wisdom among American scholars has been that the Japanese system solves the corporate governance problem--who monitors management--through continuous monitoring by a financial intermediary, rather than through intermittent and often disruptive monitoring by capital markets.(6) Relying on this analysis, reform proposals have identified institutional investors as having the potential to provide Japanese-style monitoring in the American system.(7)

   To date, comparative analyses of the Japanese corporate governance system have assumed that the central purpose of the Japanese system, like that of the American system, is solving the Berle-Means monitoring problem. We argue that the Japanese system serves a function in addition to the monitoring of management. Our Japanese model reflects not only the need for corporate governance, the traditional factor American scholars have identified as shaping corporate structures, but also the need to support production and exchange--what we will call contractual governance.(8) To be sure, complex multi-level monitoring is part of the production process, but this monitoring is motivated not just by financial institutions seeking a return on capital, but also by product market competition. Bank monitoring thus should not be seen in isolation, but as one specific (although important) kind of a wide range of contractual monitoring types in Japan. An empirical observation informs this perspective: although financial institutions hold one-half of Japanese public firm stock, often in highly-concentrated blocks, another quarter of Japanese stock is held by other corporations, often suppliers or customers.(9)

   Our claims are modest. We do not contend that our model fully describes the Japanese system; we do not seek to displace the main-bank-as-monitor paradigm. Indeed, we doubt that any single model fully captures the system's complexity. Rather, we mean to show only that (1) our model captures an important element missed thus far, and that (2) intermediary monitoring is only one part of a larger Japanese system of contractual governance. We also do not seek to discredit proposals that would reform American corporate governance by enabling intermediaries to monitor management more effectively. The path-dependent development of the American Berle-Means corporation might well indicate that intermediary monitoring is now the best solution for the American corporation's deeper governance problems. But the broader contractual governance structure characteristic of large Japanese firms, having taken another evolutionary path, cannot be duplicated exactly in the United States by changing only the role of financial intermediaries.(10)

   Apart from the corporate governance debate, international trade issues surround the keiretsu. Some Americans see keiretsu cross-ownership as an anticompetitive, exclusionary structure, sufficient to make it a subject of bilateral trade talks.(11) Specifically, the U.S. Structural Impediments Initiative (SII) views cross-ownership as a productive, yet exclusionary, device.

   These two functions of cross-ownership--monitoring and producing--are left unconnected in the literature. While we offer no comment on the specific elements of the SII (in fact, the keiretsu structure's efficiency may be a source of the exclusionary effects), academic theory would profit by seeing, as SII does, keiretsu cross-ownership not only as a managerial monitoring mechanism but as a productive structure as well. The bank-as-monitor theorists need to account for cross-ownership among nonfinancial producers. The impediments theorists must consider the potential organizational advantages arising from partial cross-ownership among factors of production.(12)

   In Part I, we sketch the development of the traditional Berle-Means conception of American corporate governance and the succession of potential monitors that have led to a comparative focus on Japan. In Part 11, we briefly summarize the dominant theme of current comparative analysis of Japanese corporate governance: the monitoring role of the main bank. In Part 111, we set out our contractual governance model of the Japanese corporate system, and, in Part IV, we explore the model's implications both for comparative corporate governance analysis of the Japanese system and for reforming America's corporate governance system.

1. THE BERLE-MEANS MODEL OF AMERICAN CORPORATE...