FS IV 93 - 3
The Institutional Framework of the Stockmarket in Japan
Stefan O. Georg
January 1993
ISSN Nr. 0722 - 6748
Forschungsschwerpunkt Marktprozeß und Unter
nehmensentwicklung (IIMV) Research Unit
Market Processes and
Corporate Development (IIM)
Georg, Stefan O., The Institutional Framework of the Stockmarket in Japan, Discussion Paper FS IV 93 - 3, Wissenschaftszentrum Berlin, 1993.
Wissenschaftszentrum Berlin für Sozialforschung gGmbH, Reichpietschufer 50, W-1000 Berlin 30, Tel. (030) 2 54 91 - 0
The Institutional Framework of the Stockmarket in Japan
A
This paper shows to what extent the institutional framework of the Japanese stockmarket differs from that of other stockmarkets. An evaluation with a typical 'western' set of instruments would be distorted, because of numerous Japanese peculiarities. Therefore, movements in stock prices must be examined against the specific Japanese institutional background. Elements of this institutional framework, which are assumed to have important influence on the evolution of stock prices, will be described and analysed. The organizational structure of stock exchange, the dominance of the Big Four securities houses, the influence of the Ministry of Finance and of mutal stockholding are shown to have significant influence on market behavior.
ZUSAMMENFASSUNG
Der institutionelle Rahmen des Aktienmarktes in Japan
In diesem Beitrag wird gezeigt, wie weitgehend sich der japanische Aktienmarkt in seinem institutioneilen Rahmen von anderen Aktienmärkten unterscheidet. Eine Bewertung mit dem üblichen "westlichen" Instrumentarium wird durch die Vielzahl von Eigentümlichkeiten verzerrt. Demzufolge muß die Aktienkursentwicklung in Japan im wesentlichen vor dem Hintergrund des - für Japan spezifischen - institutioneilen Rahmens verstanden werden, da die Kursentwicklung von den institutioneilen Faktoren beeinflußt wird. Es werden die Elemente des institutioneilen Rahmens aufgezeigt und analysiert, von denen angenommen werden kann, daß sie Einfluß auf die Aktienkursentwicklung haben. Von besonderer Bedeutung erscheint dabei die Struktur der Börsenorganisation, die durch Preisgrenzen und "Wellenbrecher" sowie durch weitere regulatorische Elemente Kursstürzen entgegen wirkt. Weiterhin wirkt sich die oligopolistische Marktstruktur mit der Dominanz von vier großen Wertpapierhäusem erheblich auf das Marktverhalten aus. Von großer Bedeutung ist ebenfalls der Einfluß des Finanzministeriums, das nicht nur die Kursentwicklung auf vielfältige Weise beeinflußt, sondern auch die Struktur des Aktienmarktes entscheidend geprägt hat. Des weiteren wirken die wechselseitigen Unternehmensbeteiligungen wesentlich auf die Kursentwicklung ein. Es wird gezeigt, daß ein zutreffendes Verständnis der japanischen Aktienkursentwicklung ohne eine explizite Berücksichtigung des institutionellen Rahmens nahezu unmöglich erscheint.
I wish to thank Nathan Musick for his linguistic assistance.
I. Aim of the Study page 1
II. The Market's Development 3
1. The Division of the Market 2. Historical Price Performance 3. Analysis of Price Movements 4. Analysis of the Price Level 5. Appraisal of Price Trends III. Formal Institutional Factors
1. The Structure of the Exchange
a. The Exchange's Organizational Structure b. The Course of Transactions
c. Monitoring of Stock Trading
d. Appraisal of the Exchange's Organisation 2. Regulations Concerning Insider Trading
3. Relevant Elements of the Tax System
4. Separation of Banking and Securities Activity 5. Restriction on Ownership
6. Firms Business' Reports a. Consolidation b. Reserves c. Write-offs
d. Disclosure Requirements IV. Informal Institutional Factors
3 5 7 12 11 14 14 14 15 17 17 18 18 20 20 21 21 21 21 22 22
1. Elements of the Market's Structure 22
a. The Dominance of the Big Four 22
b. The Role of the Finance Ministry 23
c. Savings Behavior of the Individual Investor 25
b. The Financial Behavior of Firms 28
c. Firms' Dividend Policies 30
d.
Zaiteku30
3. Marktet Irregularities 32
a. Insider Trading 32
b. The Significance of Speculators 33
c. The Underworld's Influence 33
V. Summary 34
VI. Reference 36
Appendix: The Market Participants
1. Securities Houses I
2. Individual Investors I
3. Financial Institutions I
a. The Banks I
b. The Insurance Companies II
c. Investment Trusts III
d. The Securities - Financing Companies III
4. Business Corporations IV
5. The Government IV
6. Foreigners IV
7. The Pension Funds V
I. Aim of the Study
The Japanese stock market has been the object o f increased interest over the past few years. The steep and continued rise in stock values in Japan has outpaced by far the performance o f other exchanges.
Indeed, in the wake o f the stock market crash o f October 19, 1987 the Tokyo exchange recovered faster than any other financial market in the world.
The TOPIX1 rose in the four decades since the April 1, 1949 re-opening o f the Tokyo Shdken Torihikijö (Tokyo Stock Exchange, abbreviated TSE) approximately 240-fold. In contrast, Standard and Poor's Index o f the New York Stock Exchange increased over the same time period only 20-fold.2
From a capitalization o f 0.122 trillion Yen in 1949 the TSE's market value rose to 611 trillion Yen in 19893, thereby overtaking for the first time the NYSE and becoming the largest financial exchange in the world. The TSE's capitalization represented 45% o f the world's equity capitalization. In comparison, the market value o f the NYSE in 1989 was valued at approximately 415 trillion Yen, and that o f the Frankfurt exchange at merely 47 trillion.4
A broad-based and yet for all appearances unpromising discussion took place to identify the causes behind this development.
Zielinski and Holloway assert that "despite its prominence in the -world o f finance, the Tokyo Stock Exchange remains an enigma to many investors, both at home a n d abroad. "5
During this discussion a great variety o f claims and conjectures to explain the Japanese stock market were advanced. One example is the conspiracy theory o f van Wolferen.6 Frequently found then - and even today - was a shoulder-shrugging mention o f the irrationality o f the Japanese stock market.
The TOPIX (Tokyo Stock Price Index) is, next to the Nikkei index, the second official share index and includes all those stocks listed in the first section of the TSE.
Author's own calculations.
Tokyo Shoken Torihikijo Chosabu 1991a, Volume 1, p. 10, 362.
Author's own calculations.
Zielinski/Holloway 1991, p. 5.
Van Wolferen's explanation is "...that the administrators in the banks, the ministries and the corporations have discovered a way o f making money with money by agreeing not to spoil the party fo r each other ” (Van Wolferen 1989, p. 401)
Following Matsumoto, who asserts that "there is nothing unique about share-price behavior in Japan,"1 this study will among other things show that the Japanese stock market works
fundamentally like any other stock market.
This does not mean, however, that all stock markets are identical and evolve in the same way.
Also, this study does not purport to be another theoretical investigation o f the perfect-market hypothesis. Rather, this analysis will focus on the role o f market institutions.
The institutional framework addressed by this study is understood to be the structure and interaction o f individual institutions of the stock exchange.
Especially in the case o f Japan, cultural factors are often emphasized. However, such an approach carries with it the risk o f remaining too vague. While the influence o f indigenous cultural traits should not be disregarded, one can proceed nonetheless with the assumption that they are reflected in institutional factors.
The above considerations lead to the heart of the study, which is based on the following thesis:
Developments in the stock market in Japan must fundamentally be understood against the backdrop o f this market's institutional framework. Institutional factors in Japan influence the stock markets' price performance.
Later in the paper it will be seen that, because o f the numerous peculiarities o f the Japanese stock exchange, an evaluation o f this market with the customary, "western-oriented" analytical tools produces error. In spite of the numerous existing (and unsatisfying) analyses o f the Japanese stock exchange, there has been no investigation o f this market's institutional framework. There is a paucity o f such studies even on the part of Japanese researchers.8
The institutional context is made more accessible by a division into formal and informal factors.
It will be shown that the latter are especially important.
Finally, it should be noted that this study will deal exclusively with the stock market, and will not consider other aspects of the securities market.
7 8
Matsumoto 1989, p. 8.
Information from Professor Mori Akio, Kobe University, interview of July 29,1991.
II. The Market's Development
1) The Divison o f the Market
After the Second World War the large Japanese conglomerates (zaibatsu) were broken up.9 Before their dissolution the four largest zaibatsu held approximately 25% o f the outstanding share capital in Japan.
The break-up o f the zaibatsu was effected by the formal dismemberment o f corporate groups and the sale o f stock ownership to the public.10 Through this act o f the American occupying power the individual investor became as a group the most important owner of shares (with 69.1% o f the total).
Figure 1: Share Ownership o f Corporations and Individuals
Year
Source: Tökyö Shöken Torihikijo Chösabu (1991 b), p. 94
As can be seen in Figure 1, over the course o f the post-war period private share ownership has steadily declined, while the percentage of shares held by firms has continously risen.11
This step seemed necessary because the zaibatsu had controlled the Japanese economy both before and during the war. By zaibatsu are meant large, family-owned corporate groups that are organized around a bank or a general trading company.
The individual market participants are presented in the Appendix.
In this figure the shareholding ratios are calculated as the proportionate number, and not value, of stocks held. The trend that emerges above becomes even stronger when the market value of shares is used as a
In contrast to the immediate post-war environment, present circumstances show a completely different picture. The share o f individual stock owners in 1990 was 22.6%, while the corresponding corporation share12 amounted to 72.8%.
In this regard Zielinski and Holloway remark that "it is ironic that the six big keiretsu today own a quarter o f shares outstanding - the same proportion held by the zaibatsu when they were dissolved in 1945. "13
Figure 2: Share Ownership by Type o f Investor, 1990
Source: Tökyö Shöken Torihikijo Chösabu (1991 b), p. 94
While Figure 1 relied on aggregate data, Figure 2 offers a comprehensive distribution o f the types o f investors in 1990.
basis for this calculation (such figures are not however available for 1949). In this latter case the share of individuals' holdings amounts to only 20.5%, and that of corporations reaches 75,0%.
Tökyö Shöken Torihikijo Chösabu 1991b, p. 60.
Under corporations here are subsumed financial institutions, business corporations, and securities companies.
Zielinski/Holloway 1991, p.21. By keiretsu are meant corporate groups of the post-war era which stand out by the degree of cross-share holdings they exhibit. Additionally, these interlocking claims are not brought together under the ownership of a holding company. Of the Top Six keiretsu, four are direct descendents of zaibatsu, and even more remarkably, three of them have kept the name of the original zaibatsu groups (Mitsubishi, Mitsui, Sumitomo).
2) Historical Price Performance
After closing upon orders o f the American Occupying Power at the end o f the Second World War, exchange trading of shares was only begun again in April 194914. With the outbreak o f the Korean War, the admission of Investment Trusts, and the introduction of Transactions on Margin (1951), the Japanese stock market at the beginning o f the 1950's experienced its first postwar- boom. This upswing ended in 1953; during this time however it had supplied the foundations for the market's further expansion.15 In the period from 1955 - 61 the volume o f trading on the TSE increased 13-fold, and the Nikkei-share index quadrupled. In the first half of the 1960's the TSE - as did the rest o f the Japanese economy - suffered a sharp setback from which, by 1965, it had only haltingly begun to recover.
Thereafter, Japanese share prices sharply rose until 1973. Suspension o f the Bretton Woods agreement as well as inflationary pressures (the latter exacerbated by the oil shock o f the early 1970s) put a decisive end to this phase o f rapid growth. Negative rates of growth in 1974 were translated into falling exchange levels. The second half o f the 1970's saw a modest growth in the TOPIX in spite o f the second oil shock in 1978/79. Since 1975 the Japanese government has abandonned its policy o f balanced budgets and has taken on an increasing amount o f government debt in order to stabilize economic activity. Driven by an expanding Japanese economy, growth in share prices continued into the 1980s. Accordingly, the Nikkei-Index level tripled between 1980 and 1986. A strong Yen in 1984 led to a temporary break in growth for the export-oriented Japanese industry and a setback for share prices. In the second half of the 1980s', however, share prices rose to levels previously unimaginable. As a consequence the TSE became the largest exchange in the world. Firms' abundant liquidity and the prevailing low interest rates spurred this growth. As well, after the world-wide stock market crash in 1987 the Japanese exchange was essentially the first to recover. In fact, the degree o f price decline in Tokyo (- 17.8%) was substantially less than that in New York (- 32.1%) or in London (- 36.1%).16 The Economic Planning Agency (EPA, Keizai Kikakuchö) advanced as cause o f the speedy recovery the fundamentally sound Japanese economy.17 Buoyed by continued low interest rates and plentiful liquidity, the increase in share prices had already resumed by beginning 1988.
14 The exchanges in Tokyo and Osaka were founded in 1878.
15 The Japan Securities Institute elaborates: "In the interim, the financial organization of this country was properly re-established ..."(Japan Securities Research Institute 1990, p. 16)
16 The lowest price index-value during the week of the Market Crash compared to the highest.
17 Ekonomisto of August 26,1991, p. 291(Publication of the most important results from the Economic White Book 1991).
Source: Tökyö Shöken Torihikijo Chösabu (1991 b) Vol. I, p. 34
After share prices on the Japanese exchange had, at the end o f 1989, reached their highest level in absolute terms - the Nikkei was then at 38915 Yen - they were to suffer a sharp fall in 1990. From January to September, 1990, the Nikkei-Index lost almost 50% o f its value; at 291 trillion Yen (or about 2,000 billion US $!) this represented the largest capital loss in world history.
The cause was the persistent fall in the Yen, caused primarily by an economic policy of low interest rates. After three increases in the discount rate (from a historical low o f 2.5% to 5.25%) failed to stem inflationary pressures, prices collapsed. An intervention by the Ministry of Finance was successful in stabilizing the price level. On October 1, 1990 the Nikkei fell below the 20,000 - Mark. These declines were brought on by the crisis in Kuweit. Yet another intervention by the Finance Minister Hashimoto stabilized prices once again. The fiscal year 1991 has been marked by lingering financial- and stock-market scandals whose impact has been seen in price drops. The most noteworthy of these scandals was the so called "Reimbursement Scandal", where securities firms were accused and found guilty of compensating preferred clients. The total amount of compensation was about 150 billion Yen. An additional aspect concerned the large brokerage houses Nomura and Nikko which had in the past cultivated business relations with a large crime syndicate. Further through tacit agreements with the leader o f this syndicate stocks had been manipulated.
In 1992 the problems o f the Japanese Stockmarket became even more serious. The bad general condition of the world economy led to massive drops in profits and shortages in investment. The competitivness o f the Japanese economy is not in serious danger for the near future since the preceeding investment boom leaves the industry with modem equipment and plants. Until mid 1994 approx. 18 trillion Yen of warrant and convertible bonds will be mature and with a Nikkei
index under 18,000 almost all outstanding warrant and convertible bonds are "under water" - the exercise price will be above the current share price and the debt will have to be repaid.
But the Achilles heel o f the economy is the financial sector, the Nikkei fell to an all time low at 14,309 Yen in September 1992. After the surge in asset values that drove Tokyo land and share prices to unsustainable heights in the late 1980s', shares have been almost halved and property values have dropped by a third. Speculators are now paying the price with their banks. Japanese banks have bad (non-performing) loans worth perhaps 60 trillion Yen.
Just as important is the way the declining stockmarket affects the capital adequacy standards of the Bank o f International Settlements.18 With a Nikkei index below 17,000 many banks would not meet the new standard. Therefore banks are unable to provide enough capital that is needed to stabilize the situation.
Hence, it is understandable that neither continuous interest rate cuts nor the largest-ever financial rescue package, valued at almost 11 trillion Yen, was able to set the stock market back on an upward trend.
31 Analysis of Price Movements
It has been posited above that the Japanese share market functions basically like any other. An appraisal o f this statement requires o f course that one clearly identify those factors that are important for price performance. (It seems clear that the Tokyo stock market operates under laws o f supply and demand.) To this end one can use the approach o f "Fundamental Analysis,"
which rests on the distinction between the "inner value" o f a stock and its price on the exchange.
Deviations between the inner value and the exchange price lead to decisions to buy or sell. The speed with which information is disseminated determines how quickly the exchange price approaches this inner value. Under a profit-oriented appraisal o f a share's value the inner value reflects the cash value of future revenues. These revenues include future dividends (including a possible dividend from the liquidity o f the share) as well as returns to capital from increases in stock prices.
These standards require international banks to have capital equivalent to 8 per cent of assets. Half that capital must be "tier 1", shareholders' equity; the other half is "tier 2", such as subordinated debt.
18
The Keizai Kikakucho (Economic Planning Agency) carried out the following econometric analysis o f price movements from 1985 to 1988. The following variables were included as explanatory factors:
1) the Fundamentals, which were assumed to be sufficiently reflected in the profits and losses o f the firm ( "P + L" variable);
2) the interest rate, as the opportunity cost o f financial resources (chosen here was the rate on long term government bonds);
3) the level of the money supply, which represented changes in Marshall's "k";19
4) the expectations o f market participants regarding future returns to capital, which were assumed to be function o f past growth in share prices (more precisely, to be the arithemetic mean o f the rate of growth over the past two years).
The Economic Planning Agency specified the following equation:
ln (T O P IX )= -3.54 - 0.260 R + 0.767 ln P + 2.20 M + 0.014 K
(-1.31) (-17.23) (4.52) (2.18) (3.86)
R = Rate of Interest Factor P = P + L - Factor
M = Money Supply Factor K = M arket Expectations Factor
19 The Marshall's "k" is the level of money supply at year's end divided by the Gross National Product.
Figure 4: Factors Influencing Stock Prices:
Degree and Directions o f Impact Each Quarter
r I Rate o f Interest P & L - Factor H i Money Supply Fac. Market Expec. Fac.
Source: Keizai Kikakuchö (19989), p. 597
Explanatory Remarks: The graph shows in detail how well the factors in the preceeding equation explained observed changes in stock prices each quarter. The length o f each "Factor-box"
indicates the degree o f influence; factors found above and below the zero mark on the vertical axis had a positive and negative impact, respectively, on stock prices in that quarter.
One can clearly see the large influence the rate o f interest had on share price movements in 1985 and 1986. Needless to say, interest rate declines during this period contributed substantially to rising share prices. From the end o f 1986 another financial variable, the money supply, gained importance for price movements. At the same time, investors' expectations o f returns to capital before the market crash o f October, 1987 spurred price rises to such a degree that the phrase
"Bubble Economy" seems to be completely justifed.
Drawing on this study the Economic Planning Agency advanced the following explanation for the quick recovery o f the Japanese share market: the good "Fundamentals" o f the Japanese economy were the most important factor behind the rapid recovery. In fact, since the third quarter o f 1987 the "P + L" variable turns out empirically to be the factor exerting the greatest influence on price movements. Readily available money also contributed, via the money supply and the interest rate, to the market's recovery.20
20 Keizai Kikakuchö 1989, p.289.
An additional factor that seems o f substantial importance for share price performance, but which was left out o f the preceeding analysis, is the price o f land. Firstly, real estate prices play a role via their substitutability for other assets held by investors. If the marginal return from investments in property is significantly lower than that from investments in shares, one can expect portfolio shifts to occur such that share prices rise. Second, the capital value o f firms with property holding rises proportionately to increases in land prices. This will likely mean as well an increase in the prices o f stocks o f those firms listed on the exchange. An additional consequence of spiraling land prices was the so-called "Credit Pyramid," in which mortgage loans were granted for 150% o f the underlying property's current market value, based on the anticipation o f future increases in real estate prices.21 Such loans, taken out at interest rates o f about 5%, were then invested on the exchange where returns of up to 20% could be realized.
The Economic Planning Agency also applied a multi-variable, auto-regressive econometric model to explore the relationship between real estate prices, long-term interest rates, and the share-price level.
Figure 5: Long-term Relationship between the rate o f Interest and Prices o f Stocks and Land, 1970-1990
%
Explanatory 80
Variables 70
□
Rate of Interest 60 Price of Stocks 50 Price of Land 40 50 20 10 0
» 1 1
1 I
i 1
Price of Stocks Price of Land Rate of Interest
Variables to be Explained Source: Ekonomisto from August 26,1991
Explanatory Remarks:
Bonds = Return on long-term NTT-Bonds Prices o f Stocks = TOPIX
Prices of Land - Urban Land Prices
Interview with Professor Helmut Becker, Sophia University Tokyo, August 23,1991.
This graph depicts the interplay of stock prices, interest rates and land prices. For example, the price o f land (viewed as a dependent variable on the horizontal axis) can be explained to 60.98 % by the interest rate and to 20.42 % by stock prices. The price o f land is thus substantially more dependent on fluctuations in interest rates than in stock prices. Because this model is restricted to the mutual influence o f only these three variables, the values of each set o f explanatory variables always add up to 100 %.
In this long-run study, which covered a period of 20 years, the level o f interest rates emerged as an important factor for share price performance in Japan. The interest rate variable explains 45.22% o f movements in share prices. The 0.3% explanatory power o f real estate prices shows them to be of exceptionally little influence. However, these results must be sharply modified when the time-period 1982 - 88 is singled out for analysis:
Price of Land
Figure 6: The medium-term relationship between the Rate o f Interest and the Prices o f Stocks and Land, 1982-1988
% Explanatory
Variables
□
Rate of Interest Price of Stocks
Rate of Interest Variables to be Explained
Source: Keizai Kikakucho (1989) p. 293
Explanatory Remarks:
Bonds = Return on long-term NTT-Bonds Prices o f Stocks = TOPIX
Prices o f Land = Urban Land Prices
Things are fundamentally different during this period o f the 1980s. Now property prices explain over 60% o f share price movements, supporting the earlier discussion of the importance o f real estate prices to the stock market.
4) Analysis o f the Price Level
The preceeding analysis o f movements in stock prices is still insufficient as an explanation for the overall price level. In past years the level o f stock prices has regularly been considered too high.
The Price - Earning Ratio (PER) is the standard measure for evaluating a stock's price.22 As can be seen in Figure 7, by 1980 the PER in Japan had already reached 20.4, more than twice its value in the United States (7.9). By 1988 it was 5 times as large.
Figure 7: An international Comparison o f Price/Earnings Ratios
- A — Japan “ USA x Germany Source: Keizai Kikakuchö 1989, p. 597, Japan Securities Research Institute 1990, p. 52
If a stock's price is considered to be the cash capital value of expected future returns, then the PER reflects the discount factor that the investor uses to calculate the present discounted value of future returns on investment. The lower is the discount factor, the higher is the PER. The relationship between the PER and the rate o f interest in this way becomes clear. The very low (by international standards) rates of interest in Japan contributed to a high Japanese PER. An additional factor which the Economic Planning Agency considers to be an influence on the PER
The Price-Earning - Ratio compares a stock's price with its earnings per share.
and stock prices is the phenomenon, widespread in Japan, of firms' reciprocal holding and trading of each others stocks (pyramiding). Such a connection can be made because such cross- shareholding increases the quantity o f shares outstanding in the economy,23 without changing the economic return to or number o f shares held by the average investor. A larger number o f shares corresponds, given a constant return, to a higher PER. The number of tradable shares is however reduced through this type of trading, which via decreased supply raises stock prices and the PER as well.24
Additional factors that ratchet the PER upwards can be found in the reporting of unconsolidated profits, in excessive reserves and in depreciation rules.25
51 Appraisal o f Price Trends
It should be clear from the above discussion that movements in stock prices in Japan - as also in other countries - can be explained by rational economic behavior. Returns from various types of investments, such as real estate or secure monetary investments, play an important role in stock price fluctuations; o f great importance also, however, are the expectations held by market participants, which are based both on current economic fundamentals and past developments. In this explanatory context structural factors specific to Japan hardly play a role. One may thus, for all practical purposes, consider the Japanese stock market to behave basically like any other.
In spite of all o f the above, however, the factors which explain the direction o f stock price movements do not seem to be sufficient also to explain both the extremely high price level of the 1980s, and the fall in prices since 1990. In order to interpret these developments one must look to the institutional framework of the Japanese stock market.
23 Keizai Kikakuchö 1989, p.289.
24 See Chapter IV.2.a.
25 See Chapter in.6.: Firms Business' Reports.
i n . Formal Institutional Factors
A complete presentation o f all the formal institutional factors, indeed merely all the legal requirements, that are relevant to the stock market would fill volumes and therefore cannot be attempted here. Rather, the following will sketch those elements o f the formal system which are
"peculiar" to Japanese markets and to which can be attributed, through their influence on the behavior o f market participants, an impact on the performance o f stock prices.26
11 The Structure o f the Exchange
a. The Exchange's Organizational Structure
The basis o f the organization o f the Japanese exchange is the Securities and Exchange Law (SEL) (shaken torihiki ho) o f 1948 (revised in 1981, 1985, and 1988).27 Japanese exchanges are independent collective-oriented associations of their members, and thus display a similarity in organization to German exchanges. This is in contrast to the NYSE or the LSE, which are organized more like firms. The official offices of the TSE can be divided into decision-making, executive, consultative and monitoring branches.28 The general meeting o f all members constitutes the highest decision-making body; every member has one vote independent o f his capital holdings. Until 1968 brokerage houses were only required to register with the Ministry of Finance. In 1968 a licensing system for securities firms was introduced, which fostered greater investor trust in the brokerage houses and thereby strengthened the stock market. This act thus served to reduce the exchange's reputation as a speculator's market.
Only securities firms can become members o f the exchange (SEL §90), and only members are allowed to take part in transactions (SEL §107). In contrast, in New York (and also in London since 1986) there is a system of individual membership where one finds a large percentage of private individuals among these exchanges' members. In contrast to the NYSE the TSE has much fewer members: the NYSE's 1366 regular members and 120 yearly members (of which 596 are firms) stand in contrast to the 144 regular members o f the TSE at the end o f 1987.29 Because of
For an extensive overview of regulations concerning the stock market see Japan Research Institute, 1990, p. 224.
The law is complemented by edicts (shorei) and decrees (tsütatsu) from the Ministry of Finance, as well as by the regulations of the Japanese Federation of Securities Dealers (Nihon Shokengyo Kydkai) and the Rules of the Stock Exchange.
For more extensive treatment of the formal structure of the TSE see: Japan Research Institute 1990, p. 114.
Okurashö Daijin Kanbö Chösa Kikakuka 1990, p. 98. Since then the number of members of the TSE has risen to 124.
the fact that relatively few members carry out the exchange's business, information tends to spread very quickly. On the other hand, tacit agreements are also more easily arranged.
In addition to the regular members, who buy and sell on their own or their clients' account, the TSE has four additonal saitori members.30 Saitori members function as price brokers: they cannot, however, carry out direct orders from non-members, or make trades for their own account. Members with the function o f market makers, such as one finds frequently on the NYSE or LSE, do not exist in Japan. For this reason the insufficient capitalization o f market makers, considered to be an important factor behind the NYSE market crash in 1987, cannot exert a negative influence on market events.
Until recently the number of business days on the TSE was substantially higher than those of its Western counterparts. Prior to February 1, 1988 trading took place every second Saturday in the month. One remarkable feature o f the period for daily business on the TSE is the noon break, which exists on no other major exchange. This two hour pause is considered to function as a circuit breaker, which in crises like the crash of October, 1987, limits panic on the floor o f the exchange.31
b. The Course o f Transactions
Trading in stocks takes place in two sections, complemented by the Over the Counter Market.32 The trading o f 150 especially active stocks takes place on the exchange floor; transactions in other stocks o f the first section, as well as issues of the second section, are processed by computer.33
In Japanese exchanges there are two different systems for establishing the stock prices that lead to trades. A t the beginning of the daily session and usually after interruptions o f activity, existing orders are processed in an auction (itayose) independently o f the time elapsed since they were
3U Japanese exchanges further recognize special types of affilitation. For instance, there are members of the exchange who are responsible for transacting in Tokyo or Osaka orders that cannot be carried out on regional exchanges. Additionally, on both the TSE and the OSE there is one member (Tokyo Rego Securities and Nanaiwa Securities, respectively) which only handles orders from non-member securities houses.
3^ Schaede 1990, p. 247.
32 Listed on the TSE in 1990 were 1191 firms in the first section and 436 corportions in the second.
33 On March 18,1991 a computer system was introduced to support floor trading (FORES = Floor Order Routing and Electronic System), which replaced the manually-kept order books of the saitori and in particular made more efficient transactions in smaller orders of up to 3000 shares (Floor Runners did not have to be called on). The computer system for trades in inactive stocks (CORES = Computer-assisted Order Routing and Execution System) was implemented in 1982.
placed.34 This establishes an opening rate for the exchange. This system effects the opening of the exchange with stock prices that incorporate the most recent information available to market participants. Subsequent orders are processed on the basis o f the so-called zarafea-Method, which rests on the principle of the price-, time-, and volume-ranking o f trading orders.35
In the event o f a disequilibrium between buy and sell orders trading stops. The exchange officials then set a "tendency price" (kehai nedari) which should facilitate reaching an equilibrium price.
This procedure is in contrast to that carried out by market-makers on the exchanges o f New York (called "specialists") and London, who announce prices for stocks they are responsible for, and accept orders at these prices. The system in Japan places limits on securities firms o f the number o f trades they can make for their own account (a maximum o f 20% o f capital).36
An important particuliarity o f Japanese exchanges is the existence o f price limits for all stocks.
These are set based on the final price o f the preceeding trading day; orders which allow prices outside o f these limits are not accepted.37
All o f these features can be considered parts o f a system intended to stabilize price fluctuations and similarly to stop price-falls in panic situations on the exchange. It is o f note here that a number o f the proposals made in conclusion to the Brady Commissions' investigation o f the 1987 stock market crash had already been implemented in Japan.
The units o f trade on the exchange are an additional point to consider. The smallest negotiable bundle must have a nominal value o f 50,000 Yen.38 This regulation has led to small investors being excluded from the market and to an increase in the share o f stock trading by institutional investors.
Commissions which clients pay to brokers for carrying out transactions orders are set in Japan by the exchange's Brokerage Agreement Standards (based on §131 SEL). Changes to this are made by the Ministry o f Finance. Because these fixed commissions preclude competition, brokers are in a position to make large profits. However, one point that must not be overlooked is that these fixed commissions also protect small brokerage houses from being forced out o f the market.
Individual investors benefit as well from these regulations, because otherwise they would have to
For more Details see Schaede 1990: p.78.
Price-ranking means priority is given to the order with the highest purchase price and the lowest selling price; time-ranking means that the earliest-tendered order gets priority; volume-ranking favors "market"
orders over limited orders. The books of the saitori are always open to inspection, so there is no uncertainty surrounding received orders.
Schaede 1990, p.253. In laws governing German exchanges there are as well limits on the activities-for- own-account of price brokers.
In this case trading in the concerned share is not suspended; trades continue following the ranking of orders within the allowed price interval.
There are exceptions for trading in especially high-priced shares.
pay higher commissions than large investors. An additional important peculiarity o f the Japanese exchange is the ban on short sales (SEL §133). This prevents market participants from taking advantage o f a downturn, so that the market lacks the technical impetus for a price fall.39
c. Monitoring o f Stock Trading
An independent organization which monitors business on the exchange (such as the Securities and Exchange Commission (SEC) in the United States) does not yet exist in Japan. Supervision of activity on the exchange is in the hands o f the Ministry of Finance (ökurasho). Although the American Occupying Power set up an SEC similar to the one in the United States, this was dissolved immediately after the Americans left in 1952 and its responsibilities transferred to the Ministry o f Finance. The Securities Bureau (shöken kyoku), an autonomous division of the Ministry o f Finance which is exclusively responsible for administering the stock exchange, was founded in 1964. Complementing this division is the Securities and Exchange Council (founded in 1952), which serves as an advisory body to the Ministry o f Finance. The Japanese Securities Dealers Association (JSDA), founded in 1973, is an official organization o f securities dealers which is registered with the Ministry o f Finance, and which works with it to regulate and monitor the Japanese securities markets.40 The Japanese monitoring system is very similar to the one in England, in that each one relies on members' self-regulation. However, on closer comparison there are many differences between the two systems. For example, in Japan the influence of the Ministry of Finance is very strong despite the JSDA's existence.41
The strong emphasis which is placed on self-regulation o f market members is evidenced by the miniscule number o f government officials responsible for monitoring the exchange. Between the Ministry o f Finance, the TSE and the JSDA there are a total o f about 180 people responsible for regulation, in constrast to the 2000 employees o f the Securities and Exchange Commission (SEC) in the United States 42 On the infrequent occasions that they occur, investigations o f illegalities in Japan claim a commensurately larger amount o f time.
d. Appraisal o f the Exchange's Organization
The Stock M arket Crash o f October, 1987, brought home in the most impressive way the amount of influence an exchange's institutional framework can exert on price movements.
The existence o f price controls and circuit breakers, the ban on short sales, and the central monitoring and coordination o f transactions by the Ministry of Finance, prevented prices in Tokyo
39 Schaede 1990, p.117. However, a few exceptions from these regulations still exist.
40 For extensive treatment see Ogawa 1988, p.65 and Horiguchi 1983, p.99. It is also noteworthy that the JSDA was founded upon the suggestion of the Finance Ministry following cases of price manipulation in 1971 /1972. Tabuchi 1988, p. 150.
41 Ogawa 1988, p. 67.
4^ Zielinski/Holloway 1991, p.113 and Oda 1988, p. 93.
from falling as much as they did on the NYSE.43 Beyond these factors, the margin requirements on trades are significantly higher in Japan; the computer system on the TSE is as well far more capable than the one on the NYSE. On the NYSE the system o f market makers and their limited capital holdings reinforced the price crash.
2. Regulations Concerning Insider Trading
For many years in Japan there were no explicit rules about Insider Trading. N ot until the Toheto- Affair44 in September, 1987, was the pressing need for action made undeniably clear and the impetus for reforms given. The corresponding laws finally came into force in April, 1989.
Up to that time the SEL contained only general rules to prohibit illegal behavior in connection with securities transactions (§§ 50,58 SEL).45 46 Oda comments that "These provisions were fa r from being an effective device fo r controlling Insider Trading."^
The lack o f a clear definition o f Insider Trading was one obstacle to sanctions levied against this abuse.
The revised regulations follow closely those in effect in the United States. They clearly identify who is considered an "Insider," and define exactly just what constitutes Insider information.47
3. Relevant Elements of the Tax System
Tax regulations are expected to have a profound influence on investor behavior via their impact on net-returns from different types of investment, and consequently their power when changed to spur substitution effects.
43 The good overall economic climate in Japan was naturally also of decisive importance for the milder price fall.
44 See Chapter IV.3.a.
4-> More details in Tatsuta 1983, p.191.
46 Oda 1988, p. 89.
47 Nishikata names as three pillars of the regulations (Nishika 1991, p. 82.):
(1) internal-control mechanisms of securities houses, banks, etc., to prevent Insider Trading (so- called "Chinese Walls," in securities houses, that separate emissions- and brokerage-divisions);
(2) a surveillance system for short-term trades made by Directors and major share-holders in their own stocks;
(3) Penalties (offences can bring incarceration and financial penaltiesof up to 500,000 Yen).
In 1988 a tax reform was introduced targeting corporate income as well as interest dividends.
Similarly to German practice, up to 1988 retained profits fell under a higher corporate tax (42%) than distributed profits (32%).48 Since 1990 these rates are a uniform 37.5%, so that an incentive no longer exists for firms to distribute rather than retain profits. Even until that time distributing dividends was not really an attractive option, because dividends were also heavily taxed upon receipt - in contrast to returns on capital. The system of dividend taxation in Japan contains a variety o f rates and possibilities under which returns can be off set against other forms o f taxation, all according to the status of the recipient and the amount of the return. Individuals pay as a rule 20% with-holding tax on dividend payments; depending on the level of taxable income an additional 5 to 10% is added to the tax rate finally paid. For corporations 80% o f received dividends are not taxed.49
Before the 1988 tax reform, returns on capital were only lightly taxed. Individual investors paid no income tax on capital gains.50 This is not the case today. Individual investors have a choice between a 1% with-holding tax on the sale value or a 20% tax on returns to capital. Firms must as before pay taxes on the full amount o f capital gains.
Taxation o f interest dividends was, on the other hand, revised such that today a 20% with-holding tax is levied. Until April, 1988 the so-called maruyu-systcm was in effect, under which investors were practically freed from taxes on interest dividends.51 After this was replaced by tax exemptions only for savers over 65 years o f age, many private individuals lost the incentive to place money in investments with a fixed interest rate. As a consequence a large volume o f money was made available for stock market investments.52
Other tax rates apply to small and middle-sized corporations as well to cooperatives. Nishikata 1991, p. 290.
This rule is generally applied in cases where the corporation receiving dividends holds more than 25% of the stock of the corporation paying the dividends.
Exceptions from this regulation were returns to capital, that were realized through (1) continuous stock purchases and sales;
(2) sales of more than 200,000 shares of a single firm;
(3) transactions comparable to business committments. (Nishikata 1991, p.294.)
Under this system up to 3 billion Yen of investment was exempt from taxation. Investors with large savings accounts could also profit from it by opening several accounts and distributing their funds - still not in excess of 3 billion Yen - over them, thus avoiding taxation. The Ministry of Finance first intervened in the 1980s, although by 1979 the number of accounts (out of a population of 120 million) had reached 236 million. (Rosenbluth 1989, p. 180.)
Matsumoto estimates that through the dissolution of the maruyu-system over 220 billion Yen of investment capital became available for use in the stock market. (Matsumoto 1989, p. 21.)
O f direct importance for the stock market is the tax on exchange trades (Securities Transfer Tax), which is payable by the seller and which in the case o f stocks is set at 0.12% for brokerage houses and 0.3% otherwise.53
An additional feature o f the Japanese tax system which should be kept in mind is real estate taxation. Land-holdings are taxed at extremely low rates; on the other hand, the sale o f land is taxed very heavily. The "artificial land shortage" this creates results in high real estate prices which, via substitution effects, also raise the price o f stocks.
4. Separation o f Banking and Securities Activity
In Japan there is a strict division between securities trading and banking services. The basis for this is found in §65 SEL. This paragraph was written in 1948 closely following the Glass-Steagall (1933) and the Securities and Exchange Acts in the United States. It prohibits bank equity participation in securities firms and by extension the offering and/or trading o f stocks.54
Only after this clear division o f the financial market had been made were the (up to that time) small securities firms able to expand to become large concerns. Other financial organizations also profited from this artificial market segmentation, because remaining firms in certain areas were guaranteed expansion without serious competition. Through this regulation the Ministry of Finance secured for itself ties to a few competent market members, thereby retaining numerous ways o f influencing the markets.
5. Restriction on Ownership
The basic rules governing ownership can be found in the Anti-Monopoly Law of 1949. This law was intended to prevent misuse o f market power by a few firms. This aim is in particular achieved by a prohibition of Holding Companies. Additionally, banks can only hold a maximum o f 5% o f the shares o f any one firm (§ l l ) . 55 Since 1977 large firms are allowed to hold shares in other firms equal to their own share capital or net assets, whichever is higher.56 In § 15 can be found further sharp restrictions on mergers. To this should be added the fact that the Commercial Code does not allow a firm to buy back its own shares.
53 Tokyo Shoken Torihikijo Chösabu (1991b), p. 76.
54 Conversely, securities houses cannot engage in banking activities. See for the division of the banking system Yazawa 1983, p. 29, Schaede 1990, p. 73., Viner 1989, p. 46, Suzuki 1987, p. 35, Karihara 1988, p. 80.
55 in 1951 the Finance Ministry had raised this limit to 10%; it was brought back down to 5% in 1987.
56 Qda 1988, p. 116.
These regulations have significantly contributed to the Japanese phenomenon of firm cross
shareholding, which is extensively discussed in Chapter IV, Section 2.a.
6. Firms Business' Reports
a. Consolidation
For many years in Japan no consolidated financial statement was required o f firms listed on the exchange. Since 1984 these are obligatory only in those instances when affiliated companies constitute more than 10% o f assets, sales and profits. In calculating taxes only unconsolidated profits are today exempted. These tend to be smaller than consolidated profits.57
Based on this difference Japanese firms' Price - Earning Ratios (PERs) - which as a rule are calculated from unconsolidated results - tend to be overstated. This fact should be kept in mind during analysis.58
b. Reserves
Japanese firms tend to maintain large reserves. For example, the disaster reserves o f Tokyo Marine and Fire in fiscal year 1988 were 279 billion Yen, while the firm's taxable income was reported at 152 billion Yen. In addition, the hidden reserves o f Japanese firms are estimated to be very high because o f the under-valuation of property- and securities-holdings.59 Excessive reserves push down a firm's profits, and thereby must also be regarded as a factor behind the artificially high Price -Earning Ratios.
c. Write-offs
An additional factor which distorts the profits o f Japanese firms (and thus drives up the PER) is found in write-off practices.
It is common practice in Japan to perform degressive write-offs, which - in combination with large and growing net investment60 - results in firm profits that seem unsuitably small.
Zielinski/Holloway refer to the 592 corporations from the non-financial sector which published their consolidated results. Among these firms the average consolidated result was 24% higher than that of unconsolidated parent companies. (Zielinski/Holloway 1991, p. 136.)
For regulations regarding consolidation seeKozuma 1987, p.48; Yazawa 1983, p. 36.
Viner 1987, p. 141.
Net investment in maufacturing grew 22.2% in 1989. Nihon Ginkö Chösa Tökei Kyoku 1991, 58
59 60
d. Disclosure Requirements
As is the case in other countries, firms listed on the stock exchange in Japan must comply with special disclosure requirements on both a regular basis to shareholders as well as when they issue stocks. Until the reform o f the SEL in 1971 this disclosure system displayed a few loopholes.
Firms whose shares where traded solely on the OTC-Market were exempt from the disclosure requirements o f the SEL.
Dissatisfaction with the intricacies o f the disclosure process, as well as investors' need for detailed information, led to a further reform in 1988.
In spite o f all this, disclosure requirements in Japan seem rather lax, or as Zielinski/Holloway remark, "Disclosure requirements are negligible."61
IV, Informal Institutional Factors
1. Elements of the Market's Structure
a. The Dominance o f the Big Four
The four largest brokerage houses in the world are Japanese. Nomura, Daiwa, Nikko, and Yamaichi are labeled the "Big Four" (yondai shdkeri). Between them they carry out 40.1% o f all stock transactions on Japanese exchanges in 1991.62 For bond transactions the corresponding figure reached as high as 71.9%. Their actual influence is much greater, however, because they control many o f the small and medium-sized securities firms. For instance, through its affiliated companies Normura's own share in all stock transactions at the TSE was 20%.63
Through their market power these brokerage houses are able to influence prices. When stocks are issued the underwriters are chosen based on their ability to sway prices, which results in the Big Four issuing 80% o f all stocks. Such manipulation of stock prices is o f course illegal in Japan;
however, it is tolerated as long as it stays within certain bounds.64
Zielinski/Holloway 1991, p. 117. Nevertheless, a tendency towards making disclosure requirments more comprehensive persists. For instance, since April, 1990 corporations have for the first time ever been required to report unrealized capital losses from their securities holdings whenever the latter exceed 10% of the net wealth or make up 30% of profits. However, the real aim of this regulation was to restrict zaiteku.
(For discussion of the zaiteku see also Chapter IV.2.d.) 62 Tökyö Shöken Torihikijo Chösabu 1991a, p. 276 63 Alletzhauser 1990, p.144.
64 For instance, the Finance Ministry prohibits the emission of stocks when the price of shares in the corporation emitting them has unaccountably risen more than 30% within the preceeding six weeks.
The importance o f the Big Four is reinforced by their substantial influence on the media and thereby on investors. Accordingly, every day at 7:30 am, following the morning meeting o f its top directors, Nomoura informs the financial press of its investment strategy for that day. In addition, the Big Four are shareholders in the financial newspapers most relied on by investors.
Beyond this, they constitute these papers' most important advertising clients. Each of these factors contribute significantly to the influence that the Big Four have on other investors. In this regard Matsumoto comments that "in the p a s t as much as 90% o f Japanese institutions followed the advice o f securities firms, now about 60% continue to do so..."65
The government tolerates the exercise o f such market power by this oligopoly because it insures that the market will behave according to the wishes o f the Ministry o f Finance.66 As well, the Big Four carry out transactions on their own account to keep the market active - which, because of scarce liquidity resulting from firms' cross-shareholdings, it otherwise might not be.67 68
It seems also worthy o f note that Nomura seldom recommends that a stock be sold, because "To say 'Sell' is to blaspheme a company in the eyes o f the Japanese."69, This posture tends to work against sharp price drops.
b. The Role o f the Ministry o f Finance
The Ministry o f Finance is by far the most influential governmental agency in Japan.69 Because Japanese laws are usually written vaguely to insure that they are kept on the books for long periods, they are supplemented by decrees (tsütatsu) and edicts (shörei). Informal directives (gyosei shido, window guidance), for which Japan is known, constitute an important policy tool of the Ministry o f Finance.70 It is worth mentioning that the Ministry o f Finance often issues many of these gyosei shido only over the phone.
65 Matsumoto 1989, p.162.
66 Thus, Nomura is still today described as the "Finance Ministry's Nihonbashi Office" (Nomura's main administrative offices are located in the Nihonbashi section of town). Nikkei Weekly from July 13,1991, p. 15
67 This concern for keeping trading active is also motivated by self-interest since revenues from trading commissions are thereby increased.
68 Alletzhauser 1990, p.8.
69 An additional sign of the power of the Ministry of Finance is the seating order in Parlement: the Finance Minister sits alone next to the Prime Minister.
70 It is interesting to note that through the gyosei shido subsidies, at least as we know them in Europe and the United States, are made superfluous. If the government thinks that a reduction in capacity in particular branches is absolutely necessary, it has only to issue the appropriate instructions. The concerned industry branches will, based on the power of the administrative apparatus, behave according to the government's
This influence is used to shape the stock market to accomodate the government's goals for economic growth. Accordingly, when the financial system was divided into banking and securities branches, care was taken to ensure that there were a few big firms with large market shares in each particular market, so that the Ministry o f Finance would have available a suitable contact.71 An additional element o f the government's growth orientation is the system o f fixed interest rates, which provides Japanese industrial firms with capital at modest cost. The Bank of Japan regulates, via the gydsei shidd, the volume of credit dispensed by commercial banks.
In order that enough funds can be made available for investment, individual savings were encouraged through tax-free accounts. Cases of apparent tax fraud which arose in connection with these accounts were for many years tolerated by the government.72 The overall structure of the market also corresponds to the government's priorities in that there is no large group of shareholders who can demand that the government's long-term growth targets be sacrificed to short-term profit considerations.
The power o f the Ministry o f Finance was forcefully demonstrated when, in the wake o f the M arket Crash of October, 1987, then-Minister Matsukata saw to it that a concerted action by the large brokerage houses slowed the price fall. The potential influence of the Ministry of Finance on stock prices is also clear from the fact that the largest price rise in the history of the TSE (9.4% on October 2, 1990) followed the Ministry o f Finance's announcement of measures in support of the market.73 This was done in a forceful television appearance by Finance Minister Hashimoto, in which he announced that insurance companies would be allowed to hold more shares in their portfolios and that the allowed amount of stock-purchase on collateral would be increased. He additionally left no doubt that he was prepared to take even stronger measures.
However, the Ministry o f Finance also has good reason to favor high stock prices. During the Crash of 1987 Finance Minister Matsukata had to bolster investor's confidence because a second large issuance of NTT-stocks was to be brought on the market in November.74 Because privatization in Japan is still ongoing, the Ministry of Finance remains desirous o f high stock prices. Indeed, the goverment is the largest issuer of bonds on the Japanese market.
The Ministry of Finance influences stock prices with the help o f the Big Four brokerage houses, to whom it also provides generous support. They are protected from competition by banks and foreign securities firms, and are allowed to profit from the system of fixed commissions. The
wishes. An example is provided by the shipyard industry, which reduced its capacity by 40% from 1976 to 1978. Abegglen/Stalk 1987, p.22.
The magnitude of the Ministry of Finance's success in this regard can be seen in the reduction in the number of brokers from 1127 to 272, between 1949 to 1990.
72 See Chapter IV.l.c.: Savings Behavior of the Individual Investor.
73 Tökyö Shöken Torihikijö Chösabu 1991b, p. 87.
74 The Japanese Government began privatizing shares in NTT in 1987.
Ministry o f Finance often ignores manipulation of the latter and keeps capital-gains taxes as low as possible. The Ministry o f Finance's support o f the securities firms became evident when, after the collapse o f Yamaichi in May, 1965, the Ministry of Finance secured over the Bank of Japan a loan o f 28 billion Yen to enable Yamaichi to avoid bankruptcy. It is easy to infer that such supportive measures left a strong impression on investors, who could thus be sure that the government would intervene to support the exchange in crisis situations.
c. Savings Behavior of the Individual Investor
The foundation o f Japanese financial power is the savings propensity o f the population. One could go further to claim that this savings propensity is a conscious objective o f the government.
The government exerted influence over savings behavior not only through setting interest rates and taxes, but also through control over alternative investments. There were no consumption- or mortgage-loans; as a rule the private investor could not buy bonds because they were traded in prohibitively large amounts.75
It is often maintained that, after securities markets became attractive for small investors upon the issuance of NTT-stocks in February, 1987, savings behavior in Japan has had a large influence on the stock market. The market's attraction would be further enhanced by extremely sharp-rising stock real estate prices.76 The dissolution o f the maruyu-accounts, which made available a large volume o f capital, is also attributed such a role (as described in Chapter III, Section 3). However, the influence o f the large number of savers on the stock market cannot be significant, because as was mentioned above stocks are only traded in big bundles (with a nominal value o f 50,000 Yen).
The average price o f a stock with a nominal value of 50 Yen was in 1990 1586.7 Yen.
Consequently, it is necessary to pay 1.6 million Yen for a tradable bundle o f stocks, which corresponds to 5 times the average Japanese monthly salary.77
Also for this reason the number o f individual investors holding shares (measured in number of shares) has not risen since 1987 as expected, but has fallen steadily from 25.2% in 1986 to 22.4%
in 1989.78
It should be noted that in the beginning there was no secondary market for bonds.
76 The price of real estate rose 2.5 times during the period of one year.
77 Sömuchö Tökeikyoku 1990, p. 92f.
78 Tökyö Shöken Torihikijo Chösabu 1991b, p. 94.
Figure 8: Breakdown of Individuals' Financial Assets, 1989
I n v e s tm e n t- T r u s ts ( 5 , 5 x 2 )—\ / - C u r r e n c y + D em an d D e p o sits ( 9 , 652)
Insurances (1 9 , 052)
S to c k s ( 1 3 , 8 % )
B o n d s ( 4 , 352)
Time + Saving Deposits (4 7 , 852)
Source: Tökyö Shöken Torihikijo Chösabu (1991 b), p. 82
Stocks make up only 13.8% of individual investors' portfolios (in comparison, this share in Germany and the United States is 2.8% and 22.5%, respectively), while savings constitute 47.8%.79
The high savings rate in Japan - in tandem with interest rates kept low by the government - has an indirect influence on stock prices in that the two factors must be considered important forces behind the economic expansion of Japanese industry.
2. Elements o f Enterprise Structure
a. Interlocking Firm Shareholdings
As was mentioned above, firms hold 72.8% o f all stocks. By far the largest part o f these are held for strategic reasons and not as portfolio investments. These holdings are often of a reciprocal nature, by which is meant that the parties holding each others' stocks also conduct business with each other. The pattern o f these shareholdings often reflects the actual flow of goods and services. These firms also consider returns from these investments, but in a longer-term and broader sense than for short-term portfolio profits.
Interlocking firm investments contribute, firstly, to mutual confidence among business partners and thus to good business relations. A second function of these shareholdings became apparent in the 1950s1, when Japanese firms used them to protect themselves against takeover attempts by
79 Tökyö Shöken Torihikijo Chösabu 1991b, p. 82.
foreign investors.80 When Japan's entry into the OECD in 1964 brought with it liberalization of capital flows which would in principle have allowed foreign takeovers, these reciprocal shareholdings were increased as a defensive measure. These shareholdings in any one firm are rarely greater than 5%, reflecting the advantages to a firm from knowing that many small-sized holdings are in friendly hands. In this way no one investor is able to exert decisive influence.
Management is thus able to secure its control over the firm: the voting rights o f these "quiet"
shareholders are exercised based on firm reciprocity, and thus always correspond to the interests of firm management.
To prevent growth in the influence o f outside investors when new stock is issued, allied firms usually buy all of the new capital to which they are entitled. Their willingness to do so stems from their knowledge that other firms will act likewise when they themselves raise new capital.
It should be kept in mind here that such mutual capital purchases result only in changes in balance sheet entries between allied firms. In the final analysis this increases firm-capital and share ownership, without costing firms anything. Futatsugi is critical of this process, because this form of increasing firm book-value does not, in extreme cases, provide any liquidity to firms.81
However, this objection does not appear valid. Rising share prices generate quiet reserves82 from which firms benefit both by their positive impact on firm value and by their availablity for sale in times o f crisis.83
The practice o f interlocking shareholdings also has a direct influence on the individual investor.
These are disadvataged to the extent that - in contrast to firms - they must pay for shareholders' rights.84
Futatsugi shows that the stock dividends that individuals receive are in fact reduced by these reciprocal shareholdings. For the same profit and pay-out rate the share o f individual investors' holdings o f stock - and thus o f dividend payments - is much smaller.85
Interlocking shareholdings have a direct influence on stock prices because they drastically reduce the amount o f tradable shares.86 This restriction o f supply means that stock prices may rise
80 The most spectacular case occured when Fujizuna Kunirö tried to gain control over Yowa Real Estate, a subsidiary of the Mitshubishi Group which owned all the real estate property of the Mitsubishi Group in Tokyo. Alletzhauser 1990, p. 121.)
Futatsugi 1986, p. 100.
82 Losses from price declines are extremely rare, as the largest part of of these holdings were acquired before 1970 at nominal value.
82 For example, firms compensated for losses that occured in the wake of the first oil crisis by selling bundles of these stocks. It is noteworthy here that these discarded shares were repurchased by firms once conditions improved.
84 Under share-holders' rights are understood the right to vote and the right to receive dividends.
85 Futatsugi 1986, p. 101.
