th
Julian Franks
London Business School, CEPR and ECGI
Colin Mayer
Saïd Business School, Oxford University, CEPR and ECGI
Hideaki Miyajima
Waseda University and RIETI

• Law & finance view that stock markets thrive with a strong system of Anglo Saxon legal protection.
• But pre-WW2, low levels of investor protection in UK & yet a thriving stock market. Franks, Mayer & Rossi (2009) attribute it to trust generating mechanisms such as local stock markets & local investors.
• For example, pre-1948 an equal price rule in mergers prevailed, despite no takeover rules.
• Japan provides a very different ownership setting normally characterized as an insider system with large holdings by banks and corporate cross holdings.
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• For half of the 20th century Japan was an outsider system
• That half coincided with weak investor protection.
• In the middle, there was a structural change (early postwar reforms) which destroyed institutions and introduced strong investor protection.
• Newly designed outsider system was short-lived, replaced by insider system.
• Japan is unusual in that it switched from one ownership system to another.
• A remarkable laboratory for examining the evolution of the ownership of corporations.
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• Long run evolution of ownership in 20th century in Japan
• Collects individual company ownership data
• Examines the dispersion of ownership, composition of shareholders, equity financing
• Influence of law & institutions
• Contrast first & second half of century
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• Investor protection cannot explain results
• Japan had dispersed ownership throughout the 20th century but insider ownership dominated the second half of the century
• Pre war, trust mechanisms that encouraged outsider ownership.
1) Business coordinators in the 1900s
2) Zaibatsu HC (family business groups) in the 1930s
• Post war: the dissolution of family groups & the lack of institutional support to sustain outside ownership.
• The failure to establish institutions with reputational capital
• Institutional trust explains the evolution to insider ownership
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Pre-WW2: 2 samples
1900-1937 based on largest 100 Cos in 1918 (N=50) & 1930 (N=29), alive in 1940.
1918 sample had to be incorporated pre-1907 (mainly textiles, food, light engineering)
1930 sample incorporated pre 1921 (more heavy engineering, shipbuilding, chemicals)
No Zaibatsu in 1907, 21 out of 29 zaibatsu affiliated in 1930 sample
Post WW2 sample: Largest 100 firms by assets in 1937 or 1955 (total
126).
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A comparison of C3 & C5 in UK and Japan
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• 1907 Sample: outsider ownership is dominant in the 1900-1937. Insiders are less than 30% and no. of shareholders increased. Business coordinators had significant stake. Major shareholders were individual.
• 1921 Sample: Insider ownership high, small decline during the 1930s, replaced by individuals and insurance firms
1900 1907 1914 1921 1928 1933 1937
1907 Sample
% held by top 10 stakes 48.9% 46.5% 44.7% 43.9% 39.5% 40.3% 39.1%
26.9% 27.9% 23.5% 30.3% 28.1% 27.3% 27.6% insider ownership
No. of shareholders
1921 sample
% held by top 10 stakes
Insider ownership
Founders/board members
Holding Company
Ave. no of shareholders -
-
-
-
302
-
-
-
-
675 1,060 3,893 5,769 5,932 6,682
-
-
-
-
65.8% 63.3% 63.6% 59.9%
58.8% 56.4% 54.5% 52.5%
21.7% 16.7% 15.2% 10.7%
22.4% 22.9% 26.6% 18.8%
2,399 2,735 3,973 4,881
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• Outsider: sole interests are in the financial returns eg. mutual funds, individuals, business coordinators.
• Insider: derive private benefits eg. managerial ownership, HC, corporations, bank.
• Prewar: outsider dominated
(insider ownership less than 30%)
• Postwar reform: completely outsider dominated.
• Transformed from outsider to insider in the 1950-60s
• After banking crisis: outsider dominated again
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• Pre-WW2 Sample: high levels of external finance with new equity providing between one third and one half of total.
• Post WW2 Sample: high levels of external finance but equity providing between one tenth and one third. By 1964 debt supplies virtually all external finance
No. of observations
No. of firms
1915-19 1920-29 1930-37 1938-42 1951-55 1956-64 1974-80
205
45
573
68
527
68
292
66
596
126
1067
119
895
112
% from e ach source :
Retained earnings
Total e xte rnal finance :
New issued equuity
43.2
56.8
21.9
34.9
New debt
New equity capital to total/ 38.6
New equity and debt (%)
5.4
94.6
48.9
45.7
51.7
26.9
73.1
40.8
32.3
55.8
16.5
83.5
26.2
57.3
31.4
27.1
72.9
24.9
48
34.1
9.5
90.5
28.5
62
31.5
14.8
85.2
7.7
77.5
9.1
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Complete reversal
• Investor protection was weak in the first half of the 20 th century and was
‘formally’ transformed by the US occupation into a strong regime in the second half of the century.
• Post WW2: one share one vote, pre-emption rights, high disclosure
(0.9) & Glass Steagall.
• How could an insider system emerge in such an investor protection environment?
Anti-director rights
Liabilities standard
Disclosure
Public enforcement
LLSV Score in Japan
Creditor rights
Japan
1900 1990
Year law/rules changed
1900 1990 1900 1990
1 4 1950,1974 1
0 0.667
1948
0 0.917
1948
0 0.658
1948
3 1 1952
UK
5
0 0.833
0 0.417
0 0.750 <0.25
0.25
4
Germany
1
0 0.667
0
NA NA
1
0
3
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• In Japan, ‘business co-ordinators’ (equivalent venture capitalists) played a critical role in IPOs: board membership and held significant share stakes. (Miwa and Ramseyer 2000)
• They were individuals with high reputations who sat on large number of boards & frequently took stakes in companies
• Function:
1) monitoring newly established firms in the face of a large number of cases of fraud
2) providing general business advice and promoting business relations with other firms
• Estimation results: Lower concentration and high no. of shareholders with business coordinator
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2/3 of firms had (at least) 1 business coordinator
Test Sample = 121 firms, 21 firms 1900, 50 firms in 1907 and 1914
C5 & no. of shareholders = F (Cordummy, size, year incorporated, industry, yeardummy)
Cordummy is 1, if coordinator took a seat on board of directors, or/and was one of largest ten shareholders.
Result = significantly negative at 5% level. Lower concentration and high no. of shareholder with business coordinator
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1930s is a bull market for equities & IPOs
• IPOs & carve outs of subsidiaries of zaibatsu firms,
• Given low minority shareholder protection, and ‘tunnelling’ of
Business Group (Morck and Namaura 2005) , how is this possible ?
Zaibatsu played the same certification role as business coordinators:
• Monitoring by holding company
• Risk sharing among groups
• Reputational capital
Estimation results: negative relation between zaibatsu and Δownership concentration and positive relation with new equity issues in our panel of firms 15

• Two cross sectional regressions (N= 69)
• C5 (1933-37)= F(Size, D/A, zaibatsu dummy)
Zaibatsu dummy (one = Mitsui, Mitsubishi, Sumitomo, Furukawa,
Nissan) is significantly negative. Larger negative changes in concentration of ownership with zaibatsu (13-15% lower than other firms.
• New equity/total assets 1933-37 =F(Size, D/A, invest, ROE,
Zaibatsu).
Zaibatsu dummy is significantly positive.
• Small investors regarded zaibatsu as providing a trust mechanism rather than a minority exploitation vehicle. Case study of
Mitsubishi
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• Outside ownership was not stable, and gradually replaced by inside ownership of banks and corporate cross-holdings
• Three mechanisms: deleveraging, breakdown of trust mechanisms and external financing requirements
First mechanism: Deleveraging
• High Leverage after financial reconstruction of postwar reforms
(Hoshi 1995), debt/asset over 60 %
• Creditor unfriendly regulation (Corporate reorganization law in
1953)
• Banks and other (creditor) firms of distressed [and bankrupt] companies exchanged their debt for equity i.e. through swaps
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INSIDE =F(SIZE, LA, Distress dummy)
Sample is 126 largest firms/ Period : 1950-1955 and 1962-1967
INSIDE= insider ownership which is % share held by managers, banks and other corporations
LA = leverage (borrowing/ asset t-1),
Distress dummy is one if firm had negative profits in estimation period.
LA is significantly positive in the 1950s.
Distress dummy is significantly positive in the 1960s.
Firms in poorer financial condition were more likely to have insider ownership. More leverage is associated with higher insider ownership.
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Evidence: Distressed companies reorganized through the Corporate
Reorganization code: 19 cases of 30 bankrupt firms engaged in debt for equity swap from 1953-1965 (equity swapped was 75% of postswap equity).
Case study 1: Workout. Oumi Silk had debt ratio of 71% in 1951. Faced financial distress after Korean War ended. Through debt for equity swap insider ownership rose from 28% in 1953 to 60% in 1955.
Case study 2: Bankruptcy. Sun Wave Corporation. 1964 plan of reorganization offered debt for equity swaps with 18 secured creditors of which 10 were banks. 9 refused and shares allocated to other 3 largest creditors including Iwai Industrial Co. Mitsui &
Nissan Steel.
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• Conventional understanding: takeover defence
• Equity boom in the late 1950s and early 1960s. (Toyota)
• A lot of market manipulation and fraud by securities firms in the
1960s. Investment trusts grew to 12% of market in 1960, collapsed by 1970:
• Stock price collapse in 1962
• 2 institutions set up to buy Japanese equities in 1964/65.
Purchased 5% of all equities.
• Purchased more of fast growing companies that made frequent equity issues. Eg. Toyota stake 9.4%.
• 1968: Sold stakes predominantly to insiders.
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• In early 1970s, move from rights issues to new seasoned equity offerings
• Securities houses refocused their business away from investment management to underwriting.
• In collaboration with firms allocated new equity to friendly third parties at a substantial discount.
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• PKO bought Japanese equities in 1964/65
• Collected data from annual accounts for our 126 firms for equity issuance
• Toyota made 10 equity issues 1961-1974 when insider ownership rose from about 35% to 80%
•
• Some of these issues made without pre-emption rights and at a discount (19.8% for Yokohama Rubber in 1973)
• Frequency of equity issuance related to growth of insider holdings
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Figure 4 Insider Shareholdings and Paid-in Capital:
Toyota Motor
Insider ownership 1200000 80%
70%
1000000
PKO 60%
800000
50%
600000
400000
200000
New equity
0
1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974
0%
# Issued Shares Insider1
40%
30%
20%
10%
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• Significant variables: no. of share issues (+), price support institutions (+), keiretsu membership (-), firm size (-)
• Sub period 1 1964-1969 (whole sample): individual ownership at the beginning (++), price support institutions (++) but not no. of share issues
• Sub period 2 1969-1974 (whole sample): individual ownership at the beginning (++), # of seasoned issues (++), no. of years of negative ROA
• Implication: Growth in insider holdings correlated with equity issuance and sales by price support institutions
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• High levels of dispersion throughout the 20 th century
• Absence of insider ownership in first half of century – where there were insiders they took the form of families
• Emergence of insider ownership in second half – took the form of banks and cross-shareholdings
• Switch was associated with strengthening of minority investor protection
• Business coordinators and zaibatsu supported share issuance and dispersion in the first half of the century
• Banks did not support share issuance in second half
• Banks accumulated holdings through debt for equity swaps in the
1950s, purchases from price support institutions in the 1960s and new equity issues in the 1970s
• Institutional trust explains the ownership evolution in the 20 th century Japan
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