Asia-Pacific Financial Markets 5: 1–28, 1998.

1
© 1998 Kluwer Academic Publishers. Printed in the Netherlands.

The Structure of the Japanese Stock Market

YASUHIRO YONEZAWA1 ? and KAZUHIRO MIYAKE2

1 Yokohama National University; 2 Nikko Research Center;
E-mail: miyake@ird.nrc.nikko.co.jp

Abstract. The Japanese stock market is characterized by two prominent features. First, stock prices
have been extremely volatile over the past ten years. Second, the market is dominated by cross-
shareholdings and stagnant individual stock ownership. So, there are two purposes on this paper. The
first is to assess the effects of stock cross-holdings on the stock market. The second is to look at
recent stock price fluctuations, in the bubble period before 1990 and during the subsequent collapse.
It will be recognized that these two features are interrelated.

Key words: bubble, corporate governance, Japanese stock market, stock cross-shareholdings.

1. Introduction
The Japanese stock market is characterized by two prominent features. First, stock
prices have been extremely volatile over the past ten years. Second, the market is
dominated by cross-shareholdings and stagnant individual stock ownership. The
former trait is an issue pertaining to stock prices. The latter is a separate matter in
and of itself brought about by problems in market structure. Cross-shareholdings
are now under critical observation; however, amid recent stock price slumps and
the recessionary environment. The Japanese stock market structure is deeply influ-
enced by share price weakness, so these two dominant traits are interrelated. Here
we aim to introduce and analyze in theory and practice the special characteristics
of the Japanese stock market, especially pertaining to the two leading features just
mentioned.
With the first major feature of the domestic stock market, wide stock price fluc-
tuations were evident in the sharp stock price rises until 1989 and the subsequent
market plunge in the 1990s. Naturally, trends in investor levels figures prominently
in the market swings. For example, banks, insurance companies and other financial
institutions were large net buyers of stocks when share prices rose. Afterwards, they
became net sellers, if only temporarily. Regional and private companies carried
out large-scale equity financing activities in Japan and abroad when stock rallied,
but have largely refrained from such actions in the 1990s. Securities companies
also used their unprecedented profits for active capital investment before 1990, but
? Address for correspondence: Prof. Y. Yonezawa, Faculty of Business Administration, Yokohama
National University, 79-4 Tokiwadai Hodogaya-ku, Yokohama 240, Japan
2 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

recently all except a few major firms are posting losses. Such activities have been
the primary causes of the current weakness in the Japanese economy.1
Japanese-style management and its emphasis on cross-shareholdings – the sec-
ond major feature of the domestic stock market – are facing widespread reeval-
uation in the current weak economic environment. The seniority wage-order sys-
tem, for example, is being wholly reassessed. Japanese management practices that
largely ignore shareholder needs are facing criticism under the leadership of for-
eign investors amid increases in pension fund money. Cross-shareholdings were
originally maintained to support Japanese-style management, with its lack of em-
phasis on shareholder value. But the Japanese system is undergoing major changes
because of both difficulties in Japanese-style management and the unwinding of
cross-shareholdings.
The domestic stock market is currently experiencing a large-scale transforma-
tion. The previously mentioned stock price weaknesses and recession are impe-
tus for structural change. The Japanese financial Big Bang reform is a second
stimulus for reform. No one has an overall conception as to what the Japanese
stock market will look like as a result of these changes. But their effect on cross-
shareholdings will be of vital importance. We see a connection between changes
in cross-shareholdings and the transformation of the Japanese economy itself. The
objective of our analysis is to provide some limited answers as to what this outlook
will be.
Here we will closely examine these dominant characteristics and changes in the
market. Our principal aim is to clarify some of the realities and misconceptions
about the Japanese stock market through accurate information supply. In the next
section, we will show the characteristics of the Japanese stock market. In the third
section, we will focus our assessment on stock cross-shareholdings and their effects
on the Japanese stock market. In concrete terms, we will analyze their effect on
stock prices and corporate governance and afterwards examine the position they
will assume in the future. In Section 4, we look at recent stock price fluctuations,
in the bubble period before 1990 and during the subsequent collapse, including a
closer analysis of whether the bubble really existed. Finally, we will present a short
conclusion.

2. The Structure of the Japanese Stock Market

2.1. CHARACTERISTICS OF THE JAPANESE STOCK MARKET

(a) Declining individual shareholding rates and the withdrawal of individual

investors from the market
The proportion of shares held by individual shareholders is on a downward slide
in the Japanese market. This trend is not peculiar to Japan. We see a similar move-
ment in the United States, the United Kingdom and other developed countries.
THE STRUCTURE OF THE JAPANESE STOCK MARKET 3
Table I. Financial assets of personal sector in Japan
and U.S. (1996) (%)

Japan U.S.

Currency and deposits 55.0 14.5

Securities 12.5 38.6
Insurance 25.8 2.6
Trust 6.6 –
Pension fund reserves – 26.4
Bank personal trusts – 3.6
Equity in non-corporate business – 12.3

The breakdown varies widely between Japan and the United States, however (see
Table I).
First, in the United States, the individual investors’ shareholding rate is falling
but still remains at about 50%. In Japan, individual shareholders own only about
20% of stocks.
Second, in the United States, the portion of shares sold by individual investors
is being bought mainly by institutional investors who manage corporate and public
pension funds, investment trusts, and other institutional investors. Of course, the
principal beneficiaries of institutional investment are in fact company employees
and other individual investors. The assets utilized by institutional investors at the
very least are systematically and practically put to use to generate earnings for
individual investors to a much larger extent than in Japan. In other words, indi-
viduals are transferring their shares from direct ownership to indirect sources that
provide effective fund dispersion. But in the end the individual investor’s rights
are carefully protected in the fund. From a macroeconomic standpoint, individual
investors remain committed to the stock market and maintain an important position
in it.
In Japan, on the other hand, the portion of shareholdings sold by individual in-
vestors so far has been transferred to banks and private companies who have closer
ties with the issuer. Such investment fund sources reach individual investors and
employees if one looks to the final source. But instead of the straight connection
between institutional and individual investors as in the United States, the situation
is ambiguous. In fact, in many cases, bank and private company shareholdings are
not net investments for the primary purpose of generating profits. Instead, they are
mutual cross-shareholdings and means for providing stable stock ownership. If, for
example, the operating conditions for a company listing shares are sound, the banks
and private firms holding the shares will not exercise ownership rights and retain a
say in the company’s management.
4 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

In Japan, therefore, the portion of shareholdings transferred from individuals to

banks and private companies does not simply move from direct to indirect individ-
ual ownership, as in the United States. To put it bluntly, shareholdings changing
hands signify the partial exit of individual investors from the stock market.
Moreover, trust banks, insurance companies, investment trusts, and other insti-
tutional investors have picked up the slack from individuals selling stocks in Japan
as in the United States. However, even if institutional investors maintain close
relationships with beneficiaries (employees = individual investors), the trustees
responsible haven’t worked effectively to generate profits for beneficiaries (= in-
dividual investors) in Japan at the same rate as with companies. Profits for prin-
cipal beneficiaries were apt to be neglected. The portion of shares taken up by
institutional investors as the individual shareholding rate drops is not retained by
individuals through transfer from direct to indirect ownership as in the United
States. Rather, a considerable drop in individual substantial share ownership has
occurred.
Individual share ownership rates are on a long-term downward trend in both
Japan and the United States. But whereas individuals are actually withdrawing
from the market as the trend implies in Japan, they are merely switching from direct
to indirect ownership and staying in the market in the United States. In the U.S.,
individual investors are still committed to the market and maintain an important
position there in comparison with Japan.

(b) The conservative stance of Japanese individual investors

The individual financial asset balance is continuously rising in Japan. The ratio
of individual financial assets to nominal GDP is steadily growing. As individual
financial assets have increased, observers have been stating for some time that indi-
viduals will change their asset selection from cash, savings and other low-risk and
low-return products to stocks, investment trusts, and other high-risk, high-return
offerings that fluctuate in tandem with markets as well as to trusts, insurance, and
pension-related financial products, like trusts and insurance, as they age.
But individuals have not altered their asset selection to the degree anticipated.
Specifically, the shift from cash and savings to market-volatile products has not
occurred. Instead, individuals appear to have returned to cash and savings in the
wake of the collapse of the bubble economy in the 1990s. They are maintaining
their usual conservative investment stance (see Table II).
From a mid-term perspective, however, individual financial asset utilization will
change and gradually approach the U.S. model. Weight in investment trusts and
other market-volatile offerings and pension-related products is on an upward trend.
Investment in pension funds, in particular, should increase steadily.
THE STRUCTURE OF THE JAPANESE STOCK MARKET 5
Table II. Shareholder of listed companies
in Japan and U.S. (1996) (%)

Japan U.S.

Individual 20.3 49.3

Investment trust 2.6 13.4
Insurance company 12.5 5.9
Financial institution 24.7 2.6
Domestic corp. 27.3 0
Pension fund – 22.4
Securities company 1.6 0.3
Foreigner 10.3 6.1
Govt. and public inst. 0.7 0

(c) Rising risk aversion among institutional investors

Risk aversion among life insurance companies, trust banks, and other institutional
investors has risen to an excessive degree. In the 1990s, they have favored domes-
tic bonds while reducing stock investment to maintain conspicuously conservative
investment stances.
Until now, Japanese institutional investors have maintained an active investment
stance as results improve. Conversely, they have rushed to avoid risk when perfor-
mance weakens or latent profits narrow and latent losses are incurred. For example,
in the second half of the 1980s, as life insurance companies enjoyed higher latent
profits on stocks, they stepped up investment in stocks, foreign bonds, and other
high-risk, high-return assets. In the 1990s, these same firms conspicuously reversed
course as hidden profits shrank to favor domestic bonds and other minimal-risk
investments.

(d) Leading role shift in the stock market

The 1990s have seen significant structural changes among institutional investors as
participants in the stock market. First, the leading role has shifted to pension funds
and public funds in the 1990s from ‘tokkin’ and ‘kingaishin’ funds and investment
trust in the second half of the 1980s. The second point, related to the first, is the
change in fund characteristics and investment style away from ‘tokkin’ investors
focused on short-term, capital gains to pension funds and other long-term, buy-and-
hold investors. Third, a cyclical and temporary trait in common as part of a general
change among the wide range of shareholders is that their investment activities are
becoming more cautious and risk-averse.
Of these three changes, the first two – the shift in the nucleus of investors and
the transformation in fund characteristics and investment style – are highly unlikely
6 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

to revert to the conditions seen in the second half of the 1980s. These are structural
changes that are probably irreversible. The shift toward caution may not be an
irreversible structural change. But some time will likely be required to return to a
more normal condition.

2.2. WHY DON ’ T INDIVIDUALS OWN STOCKS ?

We noted in the previous section that one structural characteristic about stock
ownership in Japan is that individuals and households own a low percentage of
stockholdings and investment trusts despite large asset holdings. The individual
investors’ shareholders rate is strikingly low compared with the United States and
on a lesser level even when matched against Germany. A deeper look reveals that
Japanese households keep much of their assets in bank savings accounts and life
insurance policies.
Consequently, the portion of shares held by individuals is low and declining
annually even when analyzing the breakdown of stock shareholders. No matter
how high the amount of household assets, this result is not at all unusual if the
proportion of investments in stocks is on a declining slope.
Why don’t Japanese households own stocks? The long-running debate on this
subject hasn’t provided any persuasive answers. Among the responses given are
(1) the lowest number of shares purchasable (1,000 shares at the issue price) is
too expensive, (2) stock prices are too high because of cross-shareholdings, and (3)
many households are burdened with housing loan liabilities and don’t want to incur
risk. If this first reason were accurate, however, households would actively invest
in investment trusts. If the second point were true, households would own stocks
with minimal cross-shareholding amounts, but they don’t seem to be making this
choice. Proving the third point would require confirmation that Japanese house-
holds are burdened with large debts compared with households in other nations.
But the differences with the United States, for example, are minimal, and this
third reason doesn’t seem particularly convinging.2 Concerning the second point,
however, the decline in household shareholdings should certainly be discussed in
the same context as the cross-shareholding phenomenon, but the issue is complex.
If the lack of share ownership by households is a phenomenon unique to Japan,
then the cause must also be something peculiar to this country. Let us examine this
problem in more detail.

(a) Japanese-style management and stock demand

The consumption capital asset pricing model (CCAPM) is an efficient tool for
determining current stock demand and subsequent stock prices. Below we use
the model to ascertain household stock ownership activities in Japan. Accord-
ing to CCAPM, asset demand can be most effectively determined from lifetime
consumption optimization.3 For example, stock ownership is less focused on risk
dispersion in cases of a strong correlation between future income and return on
THE STRUCTURE OF THE JAPANESE STOCK MARKET 7

stock investment. Households look favorably on riskless asset when making asset
selections, so in such cases expected return on assets on balance has to pay high
risk premiums.
In Japan, a standardized wage profile under the lifetime employment and senior-
ity wage-order systems shows depressed wages for younger workers and a salary
peak for employees in their fifties. This earnings picture differs sharply from other
countries where earnings picture are relatively stable. The wage formula is peculiar
to the Japanese-style management system. Although it is difficult to measure real
labor productivity, we imagine that it peaks at a younger age than when wages
reach their height.
The basis of this incompatibility is the fact that younger workers, who don’t re-
ceive wages commensurate to productivity, are forced into compulsory savings and
hidden investments. These savings make up other moneys and capital investment
funds. We think that the high wages in the second half of their working lives spring
in part from earnings on investments.
To put it simply, let us divide labor periods into first and second halves of the
working life span and consumption into first half (C1 ) and second half (C2 ) over
this same period. In the same way, labor productivity is separated into first-half
(W1 ) and second-half (W2 ) sections. Stock demand is S and riskless asset demand
is B. Household budget constraints are
C1 = W1 − Z − S − B , (1)

C2 = W2 + (1 + rz )Z + (1 + rs )S + (1 + r)B . (2)

Here Z is compulsory savings, the earnings rate is rz , and the stock return is
rs . rz and rs are uncertain. r is the earnings return on riskless assets, which is
deterministic.
Essentially, Japanese actual wages are equivalent to W1 − Z in the first half and
W2 + (1 + rz )Z in the second half. In the event of a strong correlation between
rz and rs , Z and S become substitute assets. Z is low in the United States but
high in Japan. And we think that stock investment is declining because of similar
expectations for earnings on compulsory savings as on stock investments. To state
it another way, Japanese households are forced into large, high-risk savings in the
younger years. As a result, incentive to take on additional risk from savings is
lacking.
But why don’t we see large-scale stock demand from the workers in their fifties
receiving high earnings? If demand for stocks is high during this period, from a
macroeconomic perspective it shouldn’t necessarily follow that shareholdings are
low. However, savings during this period serve as an income source after retire-
ment. Their gestation period is not long, and such savings cannot be exposed to risk.
Thus, earnings during this period are not appropriate for stock market investment.
Other reasons for high savings in Japan are the large number of inheritances
received late in life and high wage payments for workers in their fifties, which
8 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

explain why Japanese often have savings in excess of their needs late in life. Thus,
the fact that Japanese households own few stock assets can be attributed in part to
Japanese-style management and institutionally complementary practices.

(b) Future trends

What about the future? Rising investment by Japanese pension funds, the larger
presence of foreign investors in the market, and lower corporate productivity sug-
gest scope for the development of management practices placing greater emphasis
on shareholder value. In short, Japanese-style business is going through a revision.
Many companies are scrapping the seniority wage-order system and introducing
incentive-based wages. If wages based on real capabilities narrow the gap Z, stock
demand could rise on higher income paid to younger workers. With the collapse of
institutionally complementary practices, an investment climate with asset choices
similar to those enjoyed by U.S. households could develop. In such a case, one
problem would be the cross-shareholdings that absorb stocks. Even as Japanese-
style management undergoes revision and the seniority wage-order system comes
under special consideration for change, how will cross-shareholdings be unwinded
to allow for U.S.-style asset selection?

3. The Influence of Cross-Shareholdings

Cross-shareholdings are a special feature of the Japanese stock market in which
companies and banks retain stocks in each others’ enterprises. Four company
groupings – Mitsui, Mitsubishi, Sumitomo and Fuyo – sprang from the pre-World
War II zaibatsu. These and Sanwa and Dai-Ichi form the six major cross-share-
holding groups (called keiretsu).
There has been little real analysis of the influence of these corporate groups on
the stock market, however. The scant research to date is limited mainly to analysis
of the financial particulars of group companies based on their accounting data. Here
we provide a corroborative analysis of cross-shareholdings from two perspectives.
First, we will examine their influence on stock prices and stock returns. Second,
we will look at their impact on corporate governance.

3.1. INFLUENCE ON STOCK PRICES AND STOCK RETURNS

Focusing on the six traditional corporate groups – Mitsui, Mitsubishi, Sumitomo,

Fuyo, Sanwa, and Dai-Ichi – we carried out an actual analysis of whether com-
pany stock returns differed between cross-shareholding grouped firms and other
companies in general.4
It has been generally stated that company cross-shareholdings boost stock prices
with other conditions being equal. However, from a macro standpoint, the ar-
gument concludes, cross-shareholdings have the same function as treasury stock
repurchases from households. Therefore, in theory, the impact on stock prices is
THE STRUCTURE OF THE JAPANESE STOCK MARKET 9

nonexistent. But in fact there is no clear evidence that this is true. If stock prices
were to rise, under the same risk factors the expected stock returns would have to
be lower.
Another argument is that the percentage of shares in circulation declines if
cross-shareholdings increase, causing higher risk from stock-price fluctuation.
There is a counter-argument, however, that such risk is actually lower. The six
major company groups have a stronger image for stability than for growth poten-
tial, and business risk is shared with cross-shareholders and main banks. Earnings
fluctuations are relatively low even for company groups. So one could argue that
risk is therefore lower.
To clear up these uncertainties, as a first step in the weighted analysis of the
six groupings it is necessary to surmise whether or not return on stocks and return
after risk adjustment is higher for the six major company groups than for the market
portfolio or market average. We will examine this issue using CAPM (Capital Asset
Pricing Models) to assess return, risk factors, and the distinctive features for the six
major company groupings.

(a) Measurement methodology

First, we compare the six company groupings with the market portfolio using the
Sharpe Measure, which, as the formula indicates, uses standard deviation to assess
excess return per each one unit of risk. (Sharpe Measure allows for risk measure-
ments of standard deviation on return. Later we use the Jensen Measure for risk
measurement for β.)
If provisionally the Sharpe Measure is higher for the six company groupings
than for the market portfolio, the six groups will show a relatively higher return
than the market portfolio under the same total risk (standard deviation on return).

Sharpe Measure = E(rp − rf )/σp . (3)

Here the numerator on the right side of the equation illustrates the average value
during the time period of excess return for targeted company group P . rp is return
over t months for group P , and rf uses the call rates for t months as a represen-
tation of risk-free interest rates. The denominator σp is standard deviation for the
relevant period of excess return.
Next, for efficient markets formulated under the capital asset pricing theory, as
is illustrated in Equation (4), E(rp ), or expected stock return for targeted group
(portfolio) P , is equal to the value (total on right side of equation) of rf , added to
risk premium βp [E(rm ) − rf ]. Further, E(rm ) is the expected return on the market
portfolio.

E(rp ) = rf + βp [E(rm ) − rf ]. (4)

The Jensen Measure evaluation based on CAPM (Jensen’s α) shows whether ex-
post-facto return on targeted group P reaches the levels of returns on the right
10 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

side of the equation in Equation (4) calculated with CAPM. When positive α
is included, the relevant portfolio achieves excess profit over estimated CAPM.
Return after risk adjustment outperforms the market.
The Jensen’s α can be estimated using the following time series regression
analysis, and extracts the estimated value of αp . The capital letter R is excess return
calculated by subtracting interest rates on risk-free assets rf from relevant portfolio
returns and market portfolio return, respectively.

Rpt = αp + βp Rmt + pt . (5)

(b) Results of measurement

Table III illustrates the results of measurements for the six major company group-
ings, E(Rm ) average value for excess return on all issues on the three markets
(Tokyo, Osaka and Nagoya), standard deviation, σ , and Sharp Measure [E(R)/σ ]
for the period from April 1978 to August 1994.5 We see higher return and standard
deviation (high-risk, high-return) than the market average for both the six major
company groupings together and for individual groups. The Sumitomo group, in
particular, records monthly average excess return for the period of 0.807% and
standard deviation of 7.08% to greatly surpass the market averages of 0.461% and
5.26%, respectively. Furthermore, what is surprising is that the Sharpe Measure
of excess return per unit of risk shows all major company groups excluding the
Fuyo group as well as the other five groupings surpassing the market average (see
Table III).
Figure 1 indicates the estimates for α and β in Equation (5) for the six major
company groups together and for individual groupings. We see that β for both
the six major company groups as a whole and for individual groupings is higher
than one. And, with equilibrium (under CAPM formulation), α should equal 0, but
here (using t-value appraisal) the data are not particularly significant. However,
excluding the Fuyo group, α > 0 for both the six major company groups and for
the other five individual groupings. In other words, despite the lack of statistical
significance, the six leading company groups boast slightly better performance than
equilibrium, and probably realize better return commensurate to risk (see Figure 1).
We can draw several conclusions from these results. First, we see that stock
price fluctuation exceeds the market average both under standard deviation and
under β. In essence, this is because risk is high. Second, we can confirm that
return commensurate to risk is slightly better than the market equilibrium level.
Consequently, all things being equal, cross-shareholdings are a weakening factor
for share prices, in contrast with common opinion. However, the levels are not
particularly prominent. In fact, we would conclude that cross-shareholdings are
not that significant a factor in determining share price levels.
 THE STRUCTURE OF THE JAPANESE STOCK MARKET
Table III. Sharpe’s measure of six major Japanese company groups and three major markets (measuring period: from April 1978 to August
1994. Number of data: 197 data per month)

Grand total of Total of 6 Mitsui Mitsubishi Sumitomo Fuyo Sanwa Daiichi Kangyo
3 markets company groups group group group group group group

E(R), % 0.461 0.588 0.566 0.691 0.807 0.484 0.556 0.584

σ, % 5.260 6.028 6.142 6.792 7.080 5.981 5.768 5.927
E(R)/σ 0.088 0.098 0.092 0.102 0.114 0.081 0.096 0.099

Number of companies 2104 176 24 26 19 27 42 45

as of August 1994

Notes: E(R) is average of monthly excess return; σ is standard deviation of monthly excess return.

11
 12
YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE
Figure 1. Estimated α and β of major 6 company groups (measuring period: from April 1978 to August 1994).
THE STRUCTURE OF THE JAPANESE STOCK MARKET 13

3.2. INFLUENCE ON CORPORATE GOVERNANCE

We now understand that cross-shareholdings do not exert a significant influence

on stock prices. But this is not the only area in which they are significant. Let us
examine their impact on corporate governance.
The famous Caves-Uekasa and Nakatani (1984) studies showed that Japanese
group (keiretsu) companies have low-level, stable return on capital compared with
non-group companies. The real explanation for this phenomenon is that these com-
panies are akin to labor-managed firms that place priority on employee wage rates
rather than neoclassical economy-type companies that emphasize return on assets.
We say that these companies operate under Japanese-style management. Of course,
in stock markets, these Japanese-style managed firms must sooner or later face
takeover bids and similar market mechanisms and act like neoclassical economy-
type companies. But the total shares held by general investors is small, and takeover
bids and similar actions are difficult for firms with cross-shareholdings. Such possi-
bilities are minimal. In this way, cross-shareholdings are understood to be a feature
of Japanese-style management and institutionally complimentary.
But do Japanese cross-shareholdings really have this sort of influence? In short,
do they somehow cause company productivity to deteriorate, or do cross-share-
holdings exert influence on labor allotment without worsing productivity itself?
Here we will reexamine the function of cross-shareholdings through factual analy-
sis of these points.6
According to the standard neoclassical production functions, the indexes of
return on capital or labor productivity to assess company productivity are not nec-
essarily appropriate because they rely on capital–labor ratios. Below we overcome
this weakness through the use of a similar concept, total factor productivity (TFP),
which does not depend on such ratios.7

(a) Breakdown of company shareholders and productivity

Let us begin by showing a simple model for measuring company productivity.
The following assumption is for measuring the TFP of each company in industries
targeted for analysis whereby production functions (a and b) are the same for each
company i.

Yi = Ai Kia Lbi . (6)

Here K is capital stock, L is the number of employees, and A is the parameter

indicated for productivity. Because intermediate input goods is not taken into con-
sideration, Y does not represent output but is equivalent to value-added. a and b
are parameters indicated for the structure of production functions. For production
functions, a + b = 1 is not necessary because we are not assuming an homogenous
degree of one production function.
For the production function argument, each company’s A which is a function
of time, and is interpreted as the parameters indicated by Hicks neutral technical
14 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

progress. However, we will interpret it as ‘productivity (TFP) A’ with broader in-

terpretation encompassing the strengths and synergy of the company organization
itself, marketing expertise and technological skills. In general, for example, if a
company’s organizational structure is inappropriate or its marketing and techno-
logical skills are inferior, its value-added productivity will be no match for the
superior company even if the same capital stock and employee numbers are uti-
lized in production. We draw attention to these differences in productivity, and our
hypothesis reflect these variants for each company’s A.
Let us evaluate the results for A to determine the influence of company cross-
shareholdings on productivity.

(b) Measurement methodology for productivity

Our analysis focused on 227 companies in the machinery industry and 252 firms
in the electrical equipment sector on the TSE-1 and TSE-2. We used panel data
covering the period from 1984 to 1993 for our analysis. Actual calculations were
restricted to companies that closed their accounts in March, not negative gross
value-added, and maintained holding ratios. These data restrictions reduced the
number of companies tested.
‘Capital stock’ is total assets, ‘number of employees’ refers to the workforce
at the end of the fiscal period, and ‘value added’ is defined as labor costs + rental
fees + tax effects + royalty payment fees + depreciation amounts + operating
earnings.
Several variables were used to test stock cross-shareholdings. We calculated the
shareholding rates for government and public institutions, financial institutions,
securities companies, other domestic corporations, foreign companies, and indi-
viduals and others. At the same time, we looked at important variables; ratio of
shareholdings among company executives and ratio of the top-ten concentration of
shares. In addition, group dummy variables and main bank dummy variables were
considered.
Table IV illustrates the basic statistics from the sample.

(c) Measuring the effects on productivity

Table V shows the results for the machinery and electrica equipment industries. 8 a
and b results vary for the respective industries. For machinery, a is 0.77 and b is
0.14. for electrical equipment, a is slightly lower, at 0.72, and b amounts to 0.18.
Looking at the effect of the composition of stock ownership on the productiv-
ity of the two industries, we find that for both industries a proportional increase
in stock ownership by securities companies shows a statistically significant de-
terioration of productivity while a proportional increase in stock ownership by
foreign corporations shows a statistically significant improvement in productivity. 9
We find also that the results for the government and public institutions, financial
institutions, and other corporations categories are neither conclusively positive nor
THE STRUCTURE OF THE JAPANESE STOCK MARKET 15
Table IV. Fundamental statistics for sample: 1984–1993 (ma-
chinery and electric appliances)

Shareholders by type Average holding ratio (%)

Govt. and public institutions 0.02

Financial institution 27.15
Securities company 1.96
Other domestic corp. 29.52
Foreigner 4.55
Individual, other 35.37
Executive 8.79
Top 10 concentration 52.82
WL/Y 61.00

Table V. Panel estimation results on TFP: 1984–1993

Machinery Electric appliances

t-value t-value

Govt. and public institutions –0.057 –1.30 0.114 1.04

Financial institution 0.001 0.47 0.007 3.55
Securities company –0.025 –4.59 –0.023 –4.78
Other domestic corp. –0.003 –1.54 0.003 1.56
Foreigner 0.011 3.24 0.009 4.47
Top 10 concentration 0.005 2.82 0.005 3.18
Executive 0.008 3.62 0.008 3.91
ln (K/L) 0.770 16.43 0.718 19.58
ln L –0.087 –2.54 –0.101 –3.80
Group dummy –0.119 –0.70 0.139 1.03
Main bank dummy 0.058 0.94 0.074 1.27
Constant –1.418 –4.83 –1.358 –5.23

Note: The estimated time dummy coefficients are omitted from this table.

conclusively negative. Individual investors are not included in the explanatory vari-
able, so we may interpret as follows: when share ownership shifts from individual
investors to, for example, foreign corporations, productivity improves.
Next, we find that productivity improves significantly when the top ten con-
centration and executive categories represent a high portion of stock ownership,
with an especially big positive impact in the case of high executive ownership.
This indicates that when shares are concentrated in the hands of a relatively small
number of shareholders, management tends to be highly committed to the share-
16 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

holder, and shareholders’ interests and corporate governance tend to be in sync.

Further, companies featuring relatively high executive ownership are in many cases
so-called owner-operated companies. For these companies there is no conflict of
interest between management and the shareholder, and incentives for striving to
improve productivity increase.
The dummy variable representing the six corporate groupings was conclusive
for neither industry, a finding which is of considerable interest in connection with
the point we made at the outset of this section. Earlier in this report we mentioned
the Caves–Uekusa study, which contains the finding that return on capital is con-
sistently low for companies belonging to keiretsu groups. 10 But I submit that it
does not follow from this that the productivity of keiretsu member companies
is necessarily lower than that of non-keiretsu companies. For instance, it is not
difficult to imaging that a keiretsu member company’s value added might not be
low simply because the wage rate it pays its employees is high. And our analysis
may show that this is in fact possible. This will be our next point of inquiry.
Returning to Table V, we see that while main banks show positive values, these
are not statistically significant. As we are at the same time employing an ex-
planatory variable for financial institutions generally, we can see that the financial
institution result and the main bank result do not differ perceptibly.

(d) Cross-shareholding and distribution of surplus

We have demonstrated that cross-shareholdings, especially keiretsu dummy, have
no discernible effect on productivity. But they may yet exert some influence on
distribution of value added. We shall now attempt to ascertain whether this is the
case.
Where the process of distributing added value to employees and shareholders
is concerned, we may infer that other factors being equal, shareholders stand in
an advantageous position relative to employees inasmuch as they hold sway over
management.
To give mathematical expression to this concept, we formulate distribution of
value added with production function Y = AK a Lb . If for the purpose of simplifi-
cation we set the price of value-added at 1, we may define surplus (expressed here
as π ) as follows
π = Y − wL − rK , (7)
where w = average market wage rate, and r = shareholders0 expected return on
equity. For either type of company, optimal values of L and K are determined by
maximizing π under given w and r. When the production function is the Cobb
Douglas function, the result can be easily verified via π/Y = 1 − a − b = 0, where
labor distribution rate wL/Y = b and capital distribution rate rK/Y = a.
Now, if the production function is an homogenous of degree one (a + b = 1),
surplus are null and if it is a diminishing return equation (a+b < 1) surplus accrue.
Whether this surplus flows predominantly to the worker or to the stockholder will
THE STRUCTURE OF THE JAPANESE STOCK MARKET 17
Table VI. Panel estimation results on wL/Y : 1984–1993

Machinery Electric appliances

t-value t-value

Govt. and public institutions –0.008 –0.05 –0.133 –0.67

Financial institution –0.008 –1.72 –0.005 –2.59
Securities company 0.067 3.69 0.022 2.94
Other domestic corp. 0.001 0.22 –0.002 –0.99
Foreigner –0.006 –0.65 –0.007 –2.67
Top 10 concentration 0.001 0.11 –0.001 –0.42
Executive –0.010 –1.37 –0.006 –2.26
Group dummy 0.539 1.89 –0.005 –0.05
Main bank dummy –0.109 –1.01 0.043 0.96
Constant 0.983 2.75 1.114 7.90

The estimated time dummy coefficients are omitted from this table.

be determined by the negotiating clout of the respective parties. Specifically, in

the case of the pure neo-classical company, the surplus will be added to profit as
in rK + π , the formula representing maximized profit. Conversely, in the case
of the pure labor-managed company, surplus will be added to wages as in wL +
π , the formula representing maximized wages. Next, premising the diminishing
return-type production function, we will define the neo-classical company and the
labor-managed company and then attempt to elucidate the mechanism by which
surplus are distributed in Japanese company.

(e) The labor distribution rate

The surplus assets that accrue when the production function is of the diminishing
return type will be distributed differently depending on whether the shareholder
or labor holds sway over management, and the labor distribution rate will differ
accordingly. As we have seen, the neoclassical company’s labor distribution rate is
calculated via wL/Y = b, while the labor-managed company’s labor distribution
rate is calculated via (wL + π )/Y = 1 − a. When b < 1 − a, surplus flow
disproportionately to labor.
Next, we will express labor distribution rate as an explained variable and regress
this variable to determine which share holder groups aim at which type of company,
and whether membership in a keiretsu group effectively increases labor distribution
rate. Finally, we will consider the results thus obtained in relation to the results from
our other exercises, and in this manner gain insight into the nature of corporate
governance. Estimated results are summarized at Table VI.
The results for the machinery industry differ somewhat from those of the elec-
trical equipment industry. But we do find that for financial institutions, the for-
18 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

eign corporation and executive categories’ share ownership correlates with a rela-
tively low labor distribution rate, while ownership by securities companies corre-
lates with a relative high labor distribution rate. However, given securities com-
panies’ propensity for owning companies that feature extremely poor earnings
performance (for the reasons given in note 8), we exclude the securities company
from our analysis. We can understand that, as the portion of overall stock ownership
represented by financial institutions, foreigner and top 10 concentration increase,
corporate manager will tend to flow to neo-classical type companies which boast
relatively high profit distribution rates.
Moving along, we find that in the case of the machinery industry, the dummy
variable for the keiretsu category is a positive coefficient. From this we conclude
that these companies tend to hold labor-managed companies and that these labor-
managed companies feature relatively low rates of return on capital. In contrast, in
the case of the electric equipment industry, the keiretsu group dummy variable was
not statistically significant and did not yield a conclusive result.
Finally, while many financial institutions – particularly main bank system –
have doubtless positioned themselves as protectors of the labor-managed corpora-
tion, or what is otherwise known as institutionally complementary to the Japanese
management system, the results of our inquiry show that, contrary to standard hy-
pothesis, financial institutions’ share-holding behavior is putting downward pres-
sure on labor distribution rates and showing a preference for neo-classical-type
corporations.

(f) Summing up
Taken together, the results of the analysis undertaken so far lead us to the following
conclusions. Cross-shareholdings do exert something of an influence on corporate
governance, productivity, and the labor distribution rate. But when we narrow the
focus of our analysis to the six major keiretsu groups, we can only conclude that
this influence is not highly significant. There are no theoretical grounds for assert-
ing that the consistently low rates of return on capital of the companies belonging
to the six big groups translate directly into low corporate productivity, as has been
argued heretofore. In fact, we have demonstrated that in the case of TFP no such
connection exists. A low rate of profit on capital may be indicative of nothing
more than a high labor distribution rate, and the cross-shareholding structure of
a company may be understood to be the product of a labor-managed company’s
efforts to defend against takeover plays from outside shareholders. However, even
this factor is also relatively minor. In short, where the six major keiretsu groups
are concerned, productivity is not substantially different from that of non-keiretsu
companies. Still, because the structure of share ownership does influence corporate
behavior, it should not be ignored.
THE STRUCTURE OF THE JAPANESE STOCK MARKET 19

3.3. THE BIG BANG

Corporations have been loosening keiretsu ties and liquidating stable shareholdings
since the beginning of this decade and the structure of Japanese stock ownership
has begun to undergo a dramatic shift as a result. The portion of equity owned
by financial institutions and other corporations rose steadily in the post-war years
amid widespread strategic investment aimed at securing relationships through mu-
tual shareholding. But this so-called corporatization of stock ownership is showing
signs of coming unraveled in this decade. And corporations have begun to look
critically at Japanese-style corporate governance (i.e., corporate capitalism and
management capitalism which is unresponsive to the average shareholder) as well
as at the structure of Japanese stock ownership. As a result, large scale liquidation
of cross-held share positions is getting underway.

(a) Formation period of cross-shareholdings

Looking back over the fifty years since the end of WWII, we find that the most
dramatic turning points for the stock market have come during (1) the first oil shock
(around 1975), when Japan’s economy and financial structure underwent dramatic
transformations, and (2) the present decade. Strategic investment in keiretsu busi-
ness relationships occurred throughout the long stretch of high-speed economic
growth that preceded the first oil crisis. But two periods saw especially heavy
keiretsu-type investment, with the first of these booms occurring in the 1950s and
the second beginning in the late 1960s and running through the early 1970s.
Today’s corporate groupings first took shape during the first wave of activity in
the 1950s. At the time, the directors of the pre-war Zaibatsu groups faced two big
problems. First: the break-up of the Zaibatsus and sale of the stock to the public
meant they were in danger of losing their companies to outsiders. At the same time,
they faced a financial crisis, the worst part of which was an extreme shortage of
funding. To guard against takeovers and cope with the shortage of capital, the new
managers of these companies actively sought to put stock in the hands of trusted
shareholders and build interlocking relationships with friendly companies, and it
was through this process that corporate groupings took shape.
In the boom that ran from the late 1960s through the 1970s, keiretsu relation-
ships evolved further and corporate groupings assumed their present-day forms.
During this period the economy was growing at around 10% per year, and Japanese
companies were enjoying a business environment unrivaled in the nation’s history.
Amid booming demand for durable goods, it is scarcely an exaggeration to say
that it was an era when companies could invest in capital equipment and sell as
much as they could produce. And yet, in contrast with the abundant investment
capital available to companies today, companies then faced a severe shortage of
funds. And for companies that were unable to secure a sufficient and stable flow
of funds either from domestic or foreign capital markets, a long-term relationships
with a closely-linked bank was viewed as a means of overcoming this financial
20 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

bottleneck. The relationship was also advantageous to the bank in that it provided
a means of expanding business through bringing growing companies under its
umbrella. Naturally, had Japan’s financial markets been sufficiently developed,
Japanese companies might have met their financing needs via the capital markets.
However, with an eye to catching up with the U.S. and Europe as quickly as pos-
sible, the government of the time was pursuing a growth strategy which focused
on funneling available funds to strategic industries through banklending. And with
the capital markets still too underdeveloped to meet their needs, companies came
to place a great deal of importance on the relationships with their main bank. These
linkages were secured with cross-held shares, and relationships between companies
and banks that are the principal providers of their financing comprises the main
bank system.
Companies likewise needed partners to take care of their trading requirements
and to facilitate upstream and downstream distribution, and the practice of cement-
ing ties with trading and distribution allies through interlocking further advanced
the practice of cross-shareholding. Cross-shareholding expanded still further when
a stock market slump around 1965 prompted companies to employ the practice
to guard against takeovers by foreign firms. Along with Japan’s growing strength
and OECD membership in 1964 came international responsibilities, and Japan was
compelled to gradually open its market to trade and to liberalize capital flows. And
worries that this liberalization would invite a massive inflow of foreign capital gave
further impetus to efforts to secure stable shareholders.
The biggest change since the first oil crisis came during the bubble period.
From around 1975, cross-shareholdings began to look less important from the
perspective of fundamentals than they had before. However, the percentage of
stable shareholdings actually increased in the late 1980s thanks to the increase in
superficial cross-shareholdings stemming from the excessive zai-tech activity and
equity finance during the period.

(b) Japanese stock ownership patterns shift dramatically

As the plunge in share prices at the beginning of this decade compelled com-
panies to liquidate positions built up during the bubble period and adjust cross-
shareholding positions that had taken shape since the war (particularly prior to the
first oil shock), companies began to take a hard look at their keiretsu relationships.
After the first oil crisis, the three factors that had supported the build-up of cross-
shareholding activity since the war began to recede. First, after 1975, annual rates
of economic growth fell sharply, and companies that had long pursued a strat-
egy of expanding operations reversed course and strove to slim down operations.
The resulting reduction of assets and debt served to alleviate Japanese company’s
shortage of capital, while at the same time the public sector was suddenly facing
its worst fund shortage ever because of diminished revenue and the expansion of
stimulative public works spending. The government funded this spending through
large scale bond issuance. And the subsequent development of the bond market,
THE STRUCTURE OF THE JAPANESE STOCK MARKET 21

financial deregulation and other aspects of Japan’s financial revolution served to

undermine the importance of the keiretsu relationship.
Prior to the first oil shock, the government channeled funds to key industries and
held down capital costs by keeping interest rates artificially low and kept strict reg-
ulatory framework on the money market. However, the need to issue government
bonds on a larger scale necessitated the reinforcement of a secondary bond market.
And on this secondary market interest rates after the reinforcement are determined
by market forces. To optimize utilization of the bond market, securities compa-
nies and banks were allowed to phase in floating-rate financial instruments. And
as the liberalization of interest rates progressed, the market function of Japanese
securities came into its own.
Amid liberalization of domestic and offshore capital flows, companies now had
access to offshore and domestic capital markets replete with funds, as well as
to floating-rate financing from banks. This meant that the long-term stable rela-
tionships with banks that companies had traditionally relied on to secure a stable
flow of funds for investment were no longer necessary. Thus the importance of the
mutually held shares that cemented these types of relationships naturally declined
as well.
At the same time the stronger management capability of Japanese companies
that has accompanied their growth and their increasing ability to operate inde-
pendently in global field means the dependence on the trading aspect of keiretsu
relationships has also diminished. This, coupled with complaints from the U.S. and
other countries that keiretsu type operations represent non-tariff barriers, means
that companies that view their operations from a global perspective are also being
forced to rethink their keiretsu structures.
Moreover, while management continues to view the keiretsu as an effective
means of defending against hostile takeover, Japan alone continues to protect itself
from takeovers financed by foreign capital, and for this reason Japanese companies
are often criticized by other nations when they buy out foreign firms. In fact, by
discouraging M&As, utilising the high ratio of stable shareholdings undermine
the real economy by obstructing the efficient distribution of capital through the
economy. There is also concern that the global competitiveness of Japanese firms
will decline relative to that of U.S. and European companies that are boosting their
competitiveness through M&As – this is an especially big concern where domestic-
demand related firms are concerned. For these reasons, Japan’s high ratio of stable
shareholdings is becoming a liability.
Given these problems, there is a good chance that keiretsu relationships will
be dismantled and stable shareholding positions unwound at a rapid rate going
forward. At this point, the positions built up during the bubble years have already
been unwound and now companies are in the process of taking a critical look at the
holdings built up during the second keiretsu investment boom of the late 1960s and
early 1970s.
22 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

A look at the combined stable shareholdings of non-financial corporations and

financial corporations (excluding pension funds, public funds, tokkin funds, invest-
ment trusts and securities company holdings) reveals that cross-held shares stood
at 53% of overall outstanding shares as of March 1997.

4. Stock Price Trends of Recent Years and the Factors Behind Them
4.1. THE LATE 1980 S SHARE PRICE RUN - UP

(a) Falling interest rate and increasing return on stocks

When discussing Japanese stock price trends, we must at some point examine the
dramatic share price appreciation that occurred during the late 1980s. This share-
price run-up is generally judged to have been a speculative bubble. But there is no
quantitative evidence that it actually was. In this report we will make no attempt
to verify the existence of a bubble directly, but will instead analyze the events
that occurred during that bull market as well as the investor behavior and corporate
funding behavior that characterized the period so that we might hazard an informed
guess about whether a bubble did exist.
During that period, share prices were rising with the help of falling interest rates,
and corporations were responding by actively executing capital increases. This is
rational financial behavior: when the cost of capital decreases, companies wishing
to boost spending on capital equipment will naturally boost their funding activity.
However, this phenomena features three problems. First: when rates fall and
companies wish to increase capital, is there a rational entity through which the
capital increase can be effected? If the stock market cannot absorb newly issued
stock, a company cannot realize a capital increase regardless of its desire to do so.
In this connection, it should be pointed out that when interest rates fall, and this
drop is unexpected, the rate drop is followed by the emergence of a high return on
stock investment. This is because the decline in rates that defies rational expecta-
tions is by definition as ‘unexpected dip’, and share prices rise whenever there is
an unexpected drop in interest rates, a relationship that holds for the duration of the
interest rate downtrend.11
An increase in return on stocks also accrues to the shareholder following a
drop in interest rates. And the possibility of a capital gain occurs even for the
shareholder who has accurately appraised the company’s earnings prospects. As
these conditions continue, participation that does not have sufficient information
about fundamentals often increases among investors. These investors are referred
to as noise traders. And the participation of these noise investors make it easier for
the market to digest newly issued stock.

(b) The corporate earnings slump and financial liberalization

The second problem is to determine which investor group represented played the
role of the noise trader, facilitating capital increases during the period. From the
THE STRUCTURE OF THE JAPANESE STOCK MARKET 23

investor group buying trends depicted in Figure 2 we can surmise that banks and
insurance companies played this role. In the case of the banking sector, banks’
trust account divisions grew rapidly because banks introduced new tax-preferred
investment vehicles like tokkin funds and kingaishin funds.
Financial system liberalization enabled the marketing of tokkin and kingaishin
funds, but corporations became the most aggressive buyers of these instruments.
At the same time, the earnings growth of the Japanese manufacturing sector was
slumping, so instead of using the proceeds of capital increases to invest in capital
equipment, companies put the money in large lot deposits and into these new fi-
nancial instruments. Was this rational financial behavior? This question will be our
next point of inquiry.

(c) Was there a bubble?

Share prices rose through the mechanism described above. But whether a specu-
lative bubble was actually formed during this process is the third problem. When
share price rises above the level justified by market fundamentals, the difference
between the actual share price level and the market fundamentals level is referred
to as a bubble. For example, if a stock should be at U 500 according to its market
fundamentals but is instead at U 700, there is said to be a U 200 bubble. As is well
known, there are rational as well as irrational bubbles. But for our purposes here
we won’t distinguish between the two but will instead refer to any share price that
is higher than is justified by market fundamentals as a bubble.
In determining the existence of a bubble, it was originally the common practice
to judge whether or not a bubble existed by appraising share price level or the time
series characteristics of return on stocks. However, the problem with this approach
is that it is not easy to infer the intrinsic value from market fundamentals, and
when basing analysis on stock returns it is necessary to take some assumptions on
bubbles (e.g., a rational bubble). For this reason I will approach the problem from
a different perspective.
If a bubble forms and the management at least is aware that a bubble has formed,
what behavior is likely to ensue? Probably the manager will issue overvalued stock
and use the proceeds to purchase relatively cheap assets. This is to say, that the
company will invest funds acquired via a capital increase to invest in relatively
safe assets, and distribute the proceeds from this fund operation to shareholders.
Through this financial strategy, the excess U 200 yen per share described in the
example above would duly accrue to existing shareholders. This is nothing less
than a sort of dynamic arbitrage.
In fact, a look at corporate financial strategies of the late 1980s reveals numer-
ous examples of companies pursuing strategies of shifting the proceeds of capital
increases into large-lot deposits, or other financial instruments. Domestic issuance
of stock and convertible bonds and offshore issuance of warrant bonds by Japanese
companies peaked in FY 89, when issuance was double the amount of only two
years earlier. Issuing activity fell off sharply thereafter, and in FY 90 was less than
24 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

Figure 2.
THE STRUCTURE OF THE JAPANESE STOCK MARKET 25

half the amount of 1989. And while money placed in large lot deposits did not fall
as sharply as equity finance activity, it did rise sharply during the years of the late
1980s.
It was inferred that this dynamic arbitrage is evidence for bubbles. However,
there is one point that must be considered in this connection. While corporations
were making direct purchases of each other’s stock only in small amounts dur-
ing the period, they were investing in stock indirectly through their investment
of surplus funds in tokkin and kingaishin funds. Using a portion of the stock
raised through a capital increase to buy stock is effectively the same as employing
that portion for a treasury stock repurchase, and this is completely different from
dynamic arbitrage.
However, these corporations were often guaranteed against losses on stock in-
vestment as was revealed when it came to light that securities companies were
compensating clients for losses. So, at least in a limited sense, companies were
acting rationally. And if companies had been engaging in dynamic arbitrage the
bubble might have collapsed and share prices fallen. But instead, investment in
tokkin and kingaishin funds made it possible for the bubble to inflate further.
While this process kept share prices moving higher, the process could only
be sustained if interest rates kept falling. Therefore the factors that sustained the
process were irrational interest rate expectations, the corporate earnings slump,
financial deregulation, and noise traders. Of course, from the macro side, smooth
growth of the money supply was also essential. However, during this period, indi-
vidual investors and foreign investors deserve special mention for having behaved
rationally.

4.2. THE SHARE PRICE TREND SINCE THE COLLAPSE OF THE BUBBLE

The nature of stock price formation changed in two fundamental ways follow-
ing the collapse of the bubble. First: During the bubble period Japanese stocks
were expensive compared to U.S. or European stocks as measured by PCFR and
other yardsticks of value. But Japanese stocks have since come down to the levels
prevailing in those two markets.
Second: In assigning value to stocks, emphasis is now being place on prof-
itability as measured by consolidated-based cash flow and consolidated ROE. In
addition, the low PBR effect and low priced stock effect that prevailed until the
1980s have vanished.
A two-tier trading trend has prevailed since the fall of 1996. This bipolarization
of weak and strong performing stocks has simultaneously taken shape between
different industries and between different companies operating within the same
industry. Specifically, led by international blue chips and companies that are mak-
ing progress in globalizing their operations, the manufacturing sector occupies the
upper tier and non-manufacturing industries dependent on domestic demand (i.e.,
finance and construction) occupy the lower tier.
26 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

Behind this two-tier trend is a clear disparity in earnings performance, and

the bipolarization reflecting differences in profitability and valuations is also pro-
gressing. Another factor contributing to bi-polarization is coming deregulation,
liberalization and other structural reform. In short, as deregulation and liberal-
ization progress, industries that have long been protected by Japan’s regulatory
framework (i.e. financials, transportation, electric power and gas, etc.) will gener-
ally see earnings deteriorate as deregulation cuts into their profitability, and this
means that these industries may see further reorganization and company failures.
Conversely, manufacturers such as processing industries whose companies have
made progress in globalizing operations will feel little negative impact from struc-
tural reform. This means structural reform will enhance the strengths of the strong
and heighten the weaknesses of the weak, and in this manner will effectively hasten
the division of the market into strong and weak groups.

5. Conclusion
Our analysis has lead to the following conclusions:

1. When discussing the history of the Japanese stock market, prominence should
be given to cross-shareholdings and the speculative bubble of the late 1980s.
2. Our analysis here shows that the effect of interlocking share holdings on share
prices is not particularly strong. In addition, while we have shown how the
practice of cross-shareholding supports Japanese style management and we
also ascertained that the companies of the six major keiretsu groups display
no marked propensity for employing Japanese-style management practices
than are other companies.
3. However, the relatively low productivity and efficiency of Japanese industry
means that an overhaul of the Japanese system of management is inevitable,
and through this process industry is taking a critical look at the practice of
cross-shareholding.
4. If cross-shareholdings positions are unwound, the stock will be purchased
by other investor groups. Likely candidates are pension funds, investment
trusts and foreigners. There is also a good chance that individual investors
will increase in number.
5. We ascertained that large-scale capital increases and the practice using the
proceeds from stock issues to invest in relatively non-bubble assets (i.e., the
practice) were a chief feature of Japanese finance in the late 1980s and we
may conclude from this dynamic arbitrage that the share price run up of those
years was in fact a speculative bubble. We may also conclude that the source
of this bubble was mistaken expectations on the direction of interest rates.
6. In the years since the collapse of the bubble, the various valuation measures
have come down to levels prevailing in other leading global markets, but that
at the same time a two-tier trading pattern has taken shape in the Japanese
THE STRUCTURE OF THE JAPANESE STOCK MARKET 27

market. And the emergence of this two tier trading trend is properly under-
stood as being a reflection of the dramatic structural transformation that the
Japanese market is undergoing.

Notes
1. Stock and other asset prices also surged in Northern Europe and other developed countries in
the second half of the 1980s, but not to the levels seen in Japan. The subsequent stock price
stagnation and accompanying recessions were deeper in Japan than in these nations.
2. For example, we can calculate the debt-disposable income ratio of households. The Japanese
ratio is 111.9% (1994), and the U.S. ratio is 97.7% (1995) respectively. The difference is not so
much. See Sato (1997).
3. With CCAPM, see Breeden (1979).
4. This analysis is based on Miyake (1994).
5. Strictly speaking, value weight on market portfolio must be adjusted by cross-share holdings.
We omit this adjustment. However, impact of this adjustment on return of market portfolio may
not be so significant.
6. This analysis is based on Yonezawa and Miyazaki (1996). Since re-estimation is tried in our new
paper, estimated results are different from Yonezawa and Miyazaki’s paper.
7. Lichenberg and Pushner (1994) also analyzed the same problems using the TFP. They esti-
mate the TFP as residuals of production function and then estimate the simple correlation
between TFP and each shareholder’s holding ratio. They report that financial institution, other
domestic corporation, individual, concentration and executive have positive correlation with TFP
respectively.
8. Estimation is run on the following panel regression with random effect method;

ln y = ln A + a ln k + c ln L = a0 + a1 X1 + a2 X2 + · · · + a ln k + c ln L

where y = Y/L, k = K/L, c = a + b − 1. Xj is holding share of stockholder j . Regression

error term is vit + ei where t is year and i is company.
9. With securities company as stockholders, it must be remarked. When the stockholder does not
transfer the title to the stocks, his stocks are treated as being held by the securities company. The
stockholder of speculative stock or stockholder who planned to take over on some corporation
does not generally transfer. Performance of these corporations are not so good on average.
10. With Caves–Uekusa proposition; see Nakatani (1984).
11. For simplicity, assuming the risk neutral investors. For constant dividend case, stock price P is
formed as

P = d/r

when the investor has static expectation on interest rate r. However, when the interest rate is
fallen to r ∗ in the next year, actual stock price of next year is

P ∗ = d/r ∗ .

Then one year realized rate of return on this stock rs can be calculated as

rs = (P ∗ − P + d)/P
= (r/r ∗ − 1) + r.

In case of r > r ∗ , it is verified that rs > r.

28 YASUHIRO YONEZAWA AND KAZUHIRO MIYAKE

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