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Firms Selling Off Cross-Held Shares

January 11, 2001
Japanese companies are today steadily selling off shares they hold in other firms. So-called intercompany shareholding, a practice carried out to prevent takeovers and promote stable business among groups of affiliates, looks like it is coming to an end. Increased competition and the reorganization of affiliated groups of companies are factors behind this development, which is expected to accelerate. In the short term, this trend could drive share prices down, but in the long term tougher checks on management, more transparent access to information for investors, and higher priority on the interests of shareholders are expected to bring new vitality to the stock market.

Keiretsu System Less Attractive
Japanese companies started cross-holding shares in the 1950s. After World War II, when Japan's zaibatsu (financial and industrial combines) were dissolved and holding companies were prohibited, the shares of former zaibatsu-affiliated companies flooded onto the market. This resulted in a flood of corporate takeovers. To defend themselves against this, former zaibatsu companies started buying up each other's shares and holding them as part of lasting relationships, the beginning of the intercompany shareholding seen today.

In the 1970s, banks and industrial firms got into the game, cross-holding shares to promote a stable business environment. The practice also took hold among members of keiretsu--groups of companies working exclusively under the umbrella of one major manufacturer--as they looked to guarantee long-term stability. With their stock locked up in secure relationships, companies were freed from some market pressure, and were able as a result to focus more on expanding their sales base and developing new technology rather than pursuing profits. In the bubble period of the late 1980s, booming stock prices caused the practice to spread, and companies began to purchase shares even in firms to which they were only distantly related.

It was in 1996 that these companies began reversing this trend and selling off their cross-held stock. At first, the motive was to make up some of the losses they had incurred when the stock market plunged from its bubble-era level. From 1997, however, banks also began to sell large amounts of the stock they held in order to increase their capital-assets ratios and to gain liquidity to cover their losses on bad loans. And with stock prices unlikely to rise, companies began scrambling to unload shares in companies with less promising business prospects. These moves have continued to this day.

In recent years structural changes making cross-holding less attractive have become more pronounced. Competition between corporations has intensified on a global scale, and it has become necessary for firms to choose business partners that offer better chances for profits, regardless of keiretsu ties. In today's business environment, deciding which companies to deal with solely on the basis of intercompany shareholding results in a loss of competitiveness.

According to a private-sector research institute, as of the end of March 2000 intercompany shareholding accounted for 10.53% of all shares in the 2,472 companies listed on the Tokyo Stock Exchange, a record 2.69-point drop from the same time the previous year. This was the lowest level of intercompany shareholding since the survey began in 1987 and is proof that companies are rapidly abandoning intercompany shareholding.

Bringing Long-Term Vigor to the Stock Market
The selling off of cross-held shares is expected to accelerate further. One of the causes of this is the reorganization of the financial sector. Japanese law now prohibits a bank from holding more than 5% of the shares in a company. As banks merge, cases will appear where the new banks hold more than the legal limit, and will have to sell off the excess shares. Correspondingly, businesses will likely sell off shares in banks.

Meanwhile, new accounting standards will also pressure companies to part with the shares they hold. Until now firms have been able to value the stock they hold at its purchase price, rather than the current market price, which is often much lower. But as new standards bring the value of their holdings in line with current prices, companies will be unable to manipulate their accounts, using inflated asset values to cover up bad results in their main operations. As companies' share prices come to depend on rises and falls in their profits and capital, the risks of cross-holding will become more apparent, and the pressure to sell off intercompany holdings will mount.

In the short term, the huge volume of shares released onto the market through this process could push stock prices down. However, as individual investors replace less scrupulous corporate stockholders, it is expected that checks on corporate management will become tougher. When this happens, companies will likely be forced to place greater priority on the interests of shareholders, raising the quality of their management and divulging more thorough information on the state of their business to general investors. As the volume of shares being traded on the market increases, it will broaden the choices available to individual and foreign stock purchasers. All this will make the stock market a more attractive place, both for investors and for companies hoping to list. In the long term, the end of intercompany shareholding does seem to have considerable merits.

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Trends in JapanCopyright (c) 2001 Japan Information Network. Edited by Japan Echo Inc. based on domestic Japanese news sources. Articles presented here are offered for reference purposes and do not necessarily represent the policy or views of the Japanese Government.