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Are Japans keiretsu withering away?

This essay will outline and describe the Keiretsu with particular reference to their eco-
political backdrop in Japan during the lost decade that has led to the suggestion that
they are withering away. This essay will dissect the factors that seem to be
contributing to the apparent downfall of the Keiretsu. Each will be discussed and
illustrated with reference to industry examples. The empirical evidence for the
suggested demise of Keiretsu will then be assessed and a conclusion reached.

A keiretsu organisation is a network of companies with direct and indirect ties that
enables loose but broad coordination among a set of independently managed firms.
These modern Japanese business groups evolved in the post World War II period
from family dominated groups known as zaibatsu. The modern big six horizontal
keiretsu came into being when the former zaibatsu, Mitsubishi, Mitsui and Sumitomo,
were joined in the 1960s and early 1970s by the looser-knit bank-centred groups
formed around Fuji, Sanwa and Dai-Ichi Kangyo banks (Lincoln and Shimotani

At the core of the horizontal keiretsu is the main bank, which finances member firms
through debt and equity. This internal capital market insulates member firms from
market pressures. Complementing these horizontal keiretsu are vertical keiretsu
organized around a major industrial firm such as Matsushita, Nippon Steel or Toyota,
who display a vertical division of labour with its suppliers, subcontractors and
distributors. While still reliant on other members for finance these vertical keiretsu
are more concerned with the benefits of the customer and supplier relationship. The
web of shareholding between member firms within each keiretsu made foreign
takeover almost impossible, and was eyed suspiciously by the West as a structural
impediment to trade and investment in Japan (Imai, 1990). It leveled stock market
fluctuations, which helped reduce the pressure on management to achieve short-term
goals at the expense of long-term growth.

The benefits of keiretsu membership are well documented for affiliate firms. In
relation to the horizontal keiretsu, there is significant quantitative evidence
demonstrating main bank intervention not only preventing bankruptcy of troubled
affiliate firms but also restoring them to growth and profitability. For example, the
Sumitomo keiretsu rescue of the struggling Mazda Motors in the late 1970s, where
the group cautioned other group members not to sell their Mazda shares and even
encouraged Sumitomo executives to buy Mazda cars, as well as providing loans and
negotiating lower input prices.

While the keiretsu had clear advantages both for the member firms and the economy
as a whole throughout the 1960s and 1970s, as the Japanese economy faltered during
the the lost decade of the 1990s; government regulators, investors, and even the
popular press began taking aim at the keiretsu. Horizontal keiretsu intervention was
strongly criticized as weakening the economy as a whole and deepening the recession
by prolonging the life of inefficient and unproductive firms while preventing fit firms
and banks from recovering (Katz and Sugawara 1998). While the Japanese economy
postponed many of the worst consequences of recession through prosperous keiretsu
members supporting weaker ones, over time these weaker firms became an increasing
drag on the economy. In fact, it has been shown that big six membership benefits the
poor performing firms at the expense of the more successful firms (Ahmadjian and
Lincoln 2008).

There was fraying of specific intercorporate ties throughout 1980s and by the
late 1990s there was serious evidence of general keiretsu dissolution, owing to several
contributory factors. The business mindset in Japan was changing in order to bring
Japanese business practices in line with international standards. The Japanese
government, once loyal supporters of keiretsu networks, demonstrated this change in
attitude in 2002 when the Nagoya Regional Tax Bureau presented Toyota Motor with
a tax bill for undeclared income. The bureau ruled that the extraordinarily high prices
Toyota had paid a struggling supplier were transparent subsidies, not operating
expenses. In an earlier era, government agencies, whether local or national, would
have tolerated, if not tacitly supported, keiretsu risk-sharing interventions of this sort.

Banking Consolidation

The law that lead to the break up of the zaibatsu prohibited the use finance holding
companies and general holding companies. However, this was revised in 1981 to
allow for more banking integration.

Amidst economic downturn, threatened by constantly eroding capital bases due to
vast non-performing loans and declining stock prices, the main keiretsu banks were
forced to sell shares in their most profitable firms. In 1990, financial institutions held
43% of the market value of publicly traded shares yet by 2000 this had declined to
30.1%. This left the keiretsu weakened with a membership of relatively poorly
performing firms. This sell-off of cross-shareholdings by major banks, leaders of the
horizontal keiretsu, and their replacement with foreign institutional shareholders did
significant violence to the cohesion of the groups (Ahmadjian and Robinson 2001).
This was particularly noticeable for Mitsubishi post 2000 (Lincoln and Shimotani,

This reduction in profitability also led to a number of mergers for example: between
Sumitomo and Sakura Banks and the formation of Mizuho Bank in 1999. This
process reduced the number of major keiretsu banks from six to four. This reduced
the willingness of banks to lend resulting in increased use of commercial paper
(Ahmadjian (2008) shows that reliance on bank debt decreased since the 1980s) and
therefore independence of firms debt obligations.

As a result banks also retreated from their role in bailing out firms, and were
rewarded for doing so, and not punished as in the past, by the stock market (Lincoln
and Gerlach 2004). Sumitomo Bank, well known for its rescue of Mazda in the early
1970s, refused to play the same role twice, allowing Ford to take a controlling stake in
the troubled automaker in 1996 (Hoshi and Kashyap 2001).

Accounting Rule Changes

Changes to accounting rules certainly helped to unravel the keiretsu. 1996 brought a
big bang in the financial reforms taken by the Japanese government. From 1999
public firms were required to produce consolidated accounts, thus preventing the
practice of tunnelling where firms could hide both assets and liabilities in partner
firms. Additionally in 2001, firms were forced to use mark to market accounting.
This is because firms were overpaying for acquisitions and then failing to adequately
depreciate them. To reduce exposure banks further reduced their cross holdings. I
believe these changes indicate recognition by the Japanese government that the
antiquated and inward Japanese business practices were detrimental to their
international competitiveness.

Foreign Ownership

The shift towards IFRS lead attracted foreign investors. From 1990 to 2002, foreign
investment in Japanese shares increased from less than 5% to about 18% (Dow and
McGuire, 2001). This change coincided with increased pressures towards Anglo-
American performance expectations as many foreign portfolio investors were from
the USA and UK.

This affected Horizontal and Vertical Keiretsu differently. Foreign ownership in
horizontal keiretsu firms led to weakened group affiliation but among vertically
affiliated firms foreign ownership actually reduced the likelihood of tie strength
dissipation (Dow and McGuire 2001). Empirical evidence actually shows vertical, but
not horizontal, keiretsu-based alliances formed for economies of scale and efficiency
actually accelerated in the late nineties (Lincoln and Shimotani 2008). This appears to
be motivated by a desire to prevent foreign takeover of strategically important
suppliers, with the liberalization of M&A rules and rise in foreign investment, as well
as seeking gains from closer ties in a fiercely competitive global market. Perhaps this
marks a revival of the vertical keiretsu whose claim to economic rationality was
always stronger than the horizontal groups and had yet dissolve to the same degree.
When the Brazilian CEO of Nissan, Carlos Ghosn, undertook to dismantle the Nissan
supply keiretsu he was heavily criticized but as his turnaround of Nissan succeeded
his methods were vindicated, public opinion shifted and the keiretsu-style supplier
relations became less sacred.

Corporate Governance Reform

Traditionally, large boards, whose interests came before those of the shareholders,
had played an integral role in the keiretsu system of executive exchanges and
interlocking directorates. Due to the cross-holdings within the keiretsu, shareholder
pressure has traditionally been minimal while there is also a systematic failure of
Japanese boards to question management. However, changes to corporate governance
codes of practice have encouraged firms to adopt the North American style with a
smaller board and an increased role of independent outside directors. For example,
in 1997 Sony reduced its board from thirty-eight to ten while increasing its outside
directors from three to five. In spite of this, the recent 2011 Olympus scandal
illustrates that while keiretsu ties may have loosened during the domestic recession
and despite the corporate governance reforms, the cronyism has remained. Japanese
business still displays the practices of old despite the general trend of reform.
According to a recent Financial Times article, the outcome of the Olympus scandal
will send a strong signal to the outside world about whether Japanese attitudes
towards corporate governance have really changed. (M Nakamoto 22/2/2012)


Despite the recent restoration of equity ties, without the other characteristics such as
preferential business and personnel transfer, such cross-shareholding cannot constitute
a revival of the keiretsu in the traditional network sense. While the Japanese
economy retains its distinctive features, the restructuring and management of its
business organizations it is now much closer to the Anglo-American West, as shown

While some core features of the post war keiretsu remain, the underlining business
mentality has been eroded away such that these traditional business groups no longer
represent a significant feature of the Japanese economic landscape. I suggest the
banking reform, with less cross-shareholding and fewer core banks, allied with the
new mindset of the government, recognising change was required to compete
globally, did the most destructive damage to the keiretsu. A spiral occurred with the
corporate governance reform and foreign ownership introducing greater transparency
into the business groups, which encouraged and allowed greater foreign ownership
and corporate governance. This promoted a more efficient and capitalist
environment, with a sink or swim mentality.

The disintegration of the keiretsu should be seen as a positive process for the Japanese
economy. The modern global economy is fiercely competitive and for Japan to attract
foreign investment, especially with a stagnating domestic economy, it is imperative
they have open and transparent corporate governance, a willingness to embrace free
market economics and efficient business practices. While the keiretsu certainly held
benefits in the past, the structure is unsuited to the interdependent and open modern
economy where national boundaries are less relevant.

Some groups will survive and others will not. This split is already apparent in the
contrast between Toyota and Nissan, which have now established two very different
models: one of existing Japanese-style group management and the other with a far
more arm's-length stance towards its suppliers. It is not clear which model will win.
Nissan has overcome a near-death experience, while Toyota has been achieving
record profits.