Monitoring the Monitors: The Corporate Governance in Japanese Banks and Their Real Estate Lending in the 1980s*
The corporate governance role of banks in “bank‐centered” countries like Japan has been well studied. This article studies the corporate governance in Japanese banks. It shows that large shareholders restrained bank managers from real estate lending in the 1980s. However, this effect was absent for the shareholders who belonged to the same keiretsu (corporate grouping) as the bank. Relationship banking and cross shareholding prevented these shareholders from disciplining the bank managers. In financial systems where banks play a large role in corporate governance, the more effective the banks are in monitoring other companies, the more difficult it may become to monitor bank managers.
The modern financial intermediation theory emphasizes the monitoring role of banks over nonfinancial companies as part of their lending to and, wherever allowed, equity holding in, the latter companies.1 Yet what is much less understood is the impact of these activities on monitoring the banks, in particular, the bank managers themselves. Does monitoring the managers of nonfinancial companies make disciplining bank managers themselves more complicated? Does corporate governance of banks become more difficult if the bank also lends to its shareholders and/or holds shares in its own shareholders? Put another way, how different is the corporate governance in banks from that in nonfinancial companies due to the particular role played by banks in the economy? This article studies these questions in the context of Japan, where banks play a very large role in the economy and where these problems seem to be especially acute.
The role of Japanese banks in monitoring other companies through their lending and shareholding has been well demonstrated.2 These relationships are considered particularly, though not exclusively, pronounced in corporate groupings called (financial) keiretsu. Some of the largest Japanese banks are at the center of these keiretsu, and many of the largest shareholders of these banks are themselves members of banks’ keiretsu. Furthermore, Japanese banks increased their real estate lending substantially in the 1980s even though the Japanese bank managers knew about the higher risks involved with such lending, as documented in the next section. Real estate lending in this period, almost half of which was made by keiretsu banks, subsequently proved to be detrimental for the banks. Did the monitoring capabilities of some Japanese banks over their shareholders through loans and cross shareholdings prevent these shareholders from restraining bank managers from real estate lending? This article studies this question by focusing on the role of shareholders in the real estate lending of Japanese banks in the 1984–89 period, which includes the “Japanese bubble.”
This article shows that shareholders, on average, had a restraining effect on Japanese bank managers regarding real estate lending. Banks decreased their real estate as the shares held by their largest five shareholders increased. However, this effect was absent when the shareholders belonged to a keiretsu led by the bank itself. This result is robust to controlling for bank size, income, capital ratio, bank fixed effects, and time fixed effects, as well as to using different measures of real estate lending.
By the end of 1989, real estate loans as a proportion of total loans exceeded an average of 11.6% across the banks in the sample, with some banks lending to the real estate sector more than 25% of all their loans. Moreover, these numbers understate the banks’ exposure to real estate, for many of the loans to other sectors had land as collateral. When commercial land prices in major urban areas decreased by 58% from 1990 to 1995, banks found themselves in serious difficulties.
Keiretsu banks were responsible for 45% of real estate loans outstanding by all the banks in the sample at the end of fiscal 1989. Similarly, their total lending was more than 40% of all outstanding loans by the sample banks. Hence, the corporate governance problems in keiretsu banks are likely to have exacerbated the financial crisis in Japan through the very large role played by these banks in the Japanese economy.3
The closest work to this article is that of Gorton and Rosen (1995), who study the role of corporate governance in risk taking by U.S. banks in the 1980s. They first provide a theory to demonstrate that, when there is excess capacity in banking and some banks—and their managers—have to exit banking, bank managers have incentive to take more risks than optimal from outside shareholders’ perspective. They also provide empirical evidence that the entrenchment through managerial shareholding led to risk‐taking behavior in U.S. banks in the 1980s, a period of shrinking lending opportunities for these banks due to deregulation.4 The 1980s were also a time of deregulation in Japan, and, as the number of subsequent mergers and bank failures suggests, there was excess capacity in Japanese banking: 21 nationwide banks in 1989 coalesced into just seven financial holding companies or banks as of October 2005. However, managerial shareholding was negligible in Japanese banks. Instead, shareholdings in keiretsu banks by same‐keiretsu shareholders were very important: among the largest five shareholders of keiretsu banks, keiretsu members held, on average, more shares than non‐keiretsu shareholders did. This article focuses on the entrenchment effect created by the shareholders over which the banks had control through keiretsu ties.
Relative to the research on corporate governance in nonfinancial companies in Japan, there are few empirical studies that focus on disciplining bank managers. Horiuchi and Shimizu (2001) find that the banks that offered jobs to retired bank regulators enjoyed less strict monitoring by regulatory agents. Anderson and Campbell (2004) show that the top managers of poorly performing Japanese banks were more likely to be replaced in the 1990s. Hanazaki et al. (2004) study the role of financial companies that are shareholders of other financial companies. These articles do not consider the influence bank managers have on some of the bank shareholders through lending and cross‐shareholding ties.
The findings in this article also complement—and contrast with—the studies that demonstrate distortions in bank lending caused by the influence of controlling shareholders. La Porta, Lopez‐de‐Silanes, and Zamarripa (2003) study how the controlling shareholders of Mexican banks channel resources to themselves through “related lending” at the expense of minority shareholders and the government. Sapienza (2004), Dinç (2005), and Khwaja and Mian (2005) show how the politicians use government‐owned banks for their own political purposes. This article focuses instead on the inability of certain shareholders to discipline bank managers where their inability is caused by the bank’s own relationship banking activities.
Section I presents the theoretical, empirical, and institutional background. The next section discusses the main hypotheses, while Section III introduces the data. Section IV presents the methodology and provides the regression analysis. Section V contains the robustness checks. The conclusion follows.
I. Background
Despite the worldwide importance of banking crises, bank risk taking seems to be best studied in the U.S. context. As the main insights are valid for other countries as well, this section first reviews the theoretical background and related empirical evidence in the U.S. context before discussing the institutional background in Japan.
A. Theoretical Background and Empirical Evidence from the United States
The moral hazard created by fixed‐cost deposit insurance and low capital values can be an important source of risk‐taking behavior in banking, as discussed by Merton (1977) and Keeley (1990), among others. When banks have low capital values, they have incentives to take advantage of fixed‐cost deposit insurance by increasing the risk they undertake. Since they have only low capital and the deposit insurance does not depend on their activities, they have little to lose if the risk they undertake does not pay off; however, they stand to gain substantially, if it does.
While the logic of this moral hazard argument is relatively straightforward, it assumes that the shareholders make the lending decisions in banks. However, if the bank managers make the loan decisions and disciplining the managers is costly, the agency problems between shareholders and managers must also be considered. In terms of risk taking, this agency problem may manifest itself in two ways. The firm‐specific investment made by managers may make them more risk averse than is optimal from the shareholder perspective because managers would lose their jobs and associated control benefits in bankruptcy. On the other hand, as Gorton and Rosen (1995) argue, conservative behavior may not be sufficient for the managers to maintain their jobs when their investment opportunities have deteriorated and an “excess capacity” exists in banking even if bank assets are still healthy. In that case, some banks have to exit the industry; hence, some managers lose their jobs even if they behave conservatively. Consequently, managers take more risk than is optimal from the shareholder perspective. Intuitively speaking, if the risk pays off, they keep their jobs; if not, they were going to lose their jobs anyway. Hence, in an environment characterized by excess capacity in banking, the risks taken by the managers increase as the cost of disciplining them increases.
Saunders et al. (1990) provide empirical evidence that the risks taken by U.S. banks in the period 1979–82 increased in the shares held by the managers, especially in times of deregulation. Gorton and Rosen (1995) show that, as their theory predicts, managerial entrenchment through insider ownership played a more important role in the risk taking by American commercial banks in the 1980s than the moral hazard problem created by the deposit insurance did. Similarly, Knopf and Teall (1996) demonstrate that the risks taken by U.S. thrifts before 1989 increased in the shares held by the managers but decreased in the shares held by institutions. Demsetz et al. (1997) show that insider shareholding increased the risks taken in U.S. banks with low charter value during the relatively stable banking environment of the 1990s but not in the banks with high charter value. Similarly, Anderson and Fraser (2000) find that managerial shareholding in the United States is positively related to risk taking in the 1980s but negatively related in the 1990s.
Hence, both theoretical arguments and empirical evidence suggest that the shareholding structure affects the risks taken by a bank. In particular, the risks taken by managers increase with the managerial entrenchment if the lending opportunities deteriorate after deregulation.
B. Japan
This article focuses on the lending behavior of Japanese banks from 1984 to 1989.5 In this period, the Japanese banking industry was healthy, unlike the U.S. thrifts in the late 1970s.6 However, it was also clear by 1984 that the lending opportunities of Japanese banks had deteriorated due to the low demand for bank funds because the traditional bank borrowers had become able to generate large funds internally to finance their investment needs, which were already decreased with the overall slowdown in growth. Furthermore, capital market deregulation allowed corporate borrowers to use bond markets, which caused an additional decrease in the lending opportunities of banks.7 Regulators, however, limited banks from entering new businesses, in particular, from securities underwriting.8 Hence, the conditions Gorton and Rosen (1995) analyze, as discussed above, existed for the Japanese banks during this period. In fact, there was a large subsequent decrease in the number of banks in Japan after 1989 through mergers, acquisitions, and failures. Twenty‐one nationwide banks in the sample analyzed in this article had decreased to seven banks and bank holding companies as of October 2005.
The 1984–89 period also contains the so‐called “Japanese bubble” years during which stock and real estate prices increased substantially. Japanese banks also increased their real estate lending significantly during this period. Stock prices started their slide in 1990, followed by real estate prices. From 1990 onward, a large number of Japanese banks could no longer be considered financially healthy, and the first use of funds from the Deposit Insurance Corporation took place in 1991.9
This study focuses on the real estate lending of banks. It is clear ex post that Japanese real estate was very risky. However, Japanese bankers seem to have been well aware of the high risks involved in the real estate loans relative to their other loans before the market crash even if they were unlikely to have foreseen the magnitude of the eventual crash. For example, in 1987, more than three years before the real estate prices started their eventual decline, Kenichi Komiya, then the president of Mitsui Bank as well as the president of the Federation of Bankers Associations of Japan, publicly stated that “the [Federation of Bankers] association recognized the importance of limiting the amount of money lent to finance land purchases. The association recommended its members [to] tighten up their lending procedures and … carefully investigate the uses to which the land in question is to be put.”10 Furthermore, Milhaupt and Miller (1997) describes how the Japanese banks used mortgage‐lending companies called jusen in channeling commercial real estate loans they deemed too risky. Naturally, this does not imply that the economic agents had foreseen the timing and magnitude of the eventual market crash. However, this study only requires the managers and shareholders to be aware of higher risks involved in real estate lending relative to the traditional loans of these banks.
The shareholding structure of Japanese banks is particularly important for this study. The owner‐manager model does not represent the Japanese banking sector. In fact, managerial shareholding in the Japanese banks examined in this study is virtually nonexistent. No manager is among the top five shareholders, and the fifth largest shareholder usually has less than 3% of the shares outstanding.11 Hence, corporate governance problems and the effects of shareholders must be taken into account.
The role of shareholding, however, is more complicated in Japan than in the United States because shareholding is often part of a wider business relationship between banks and their shareholders. The bank often acts as the main bank of its shareholders, so there is a lending relationship between them. There is also cross shareholding; the bank itself is often a major shareholder of its own shareholders. Furthermore, the source of power a bank may have over its shareholders is not limited to lending and cross shareholding. For example, even though most of the life insurance companies that are among the large shareholders of banks are organized as mutual companies rather than as joint‐stock, a large bank often has leverage over a shareholding life insurance company through the life insurance coverage it purchases for its own employees.12 Finally, these ties are especially strong in a financial group called a (financial) keiretsu.13
It is clear that these ties have the potential to create managerial entrenchment as the bank managers may be able to influence their shareholders through them. As this managerial entrenchment is different from the one typically studied in the U.S. context, the hypotheses tested must be modified for the Japanese context. This issue is discussed in more detail in the next section.
II. Hypotheses
The main question studied in this article is “Did large shareholders of Japanese banks restrain bank managers from real estate lending in the 1980s?” As the previous discussion suggests, not all shareholders were likely to be as effective. In particular, a shareholder that borrows from the bank and/or has the bank among its own shareholders may be prevented from exerting any discipline on bank managers. The analysis below uses keiretsu ties to identify such shareholders. Hence, the second question of this analysis is “Were keiretsu shareholders as effective in disciplining bank managers as other shareholders?”
There are several advantages for using keiretsu ties to identify shareholders that have relationship banking ties with the banks of which they are a shareholder. First, the keiretsu are often led by the banks themselves and are characterized by financial ties among their members and the keiretsu banks. Second, keiretsu membership makes it possible to capture the leverage the keiretsu banks have over the keiretsu life insurance companies. These insurance companies are typically among the largest shareholders of banks but are organized as mutual companies so no cross shareholding is applicable. Finally, keiretsu membership is relatively easily identifiable.
Unfortunately, the keiretsu membership is not a perfect proxy for two reasons. First, cross shareholdings and relationship bank lending also occur outside keiretsu membership so the bank may have some power over non‐keiretsu shareholders as well. This may be especially important for the nationwide banks that do not lead a keiretsu but still have lending, cross shareholding, and other ties with their shareholders. Second, the strength of these ties is considered to have been weakened during the sample period, which decreased the influence bank managers may have over their keiretsu shareholders. However, the imperfect nature of the criteria used biases the analysis against finding any differences between keiretsu shareholders and other shareholders. The methodology used in testing these hypotheses is discussed after the data are presented.
III. Data
A. Overview
The sample covers fiscal years (April to March for all the banks) 1984 through 1989. It includes all of the 84 banks that were listed continuously in the first section of the Tokyo Stock Exchange and that did not take part in an acquisition or merger during this period.14 As no bank failed in that time period, the sample is free from survivorship bias. The data include both nationwide (city, long‐term credit, and trust) and regional (both tier one and two) banks. All the balance sheet data are obtained from the Nikkei Electronic Economic Data System (NEEDS) and include the trust operations of the trust banks. As in previous studies of Japanese companies, the balance sheet data are unconsolidated.
The 12 city banks in the sample are large commercial banks with a nationwide branch network that is especially extensive in large cities. They primarily lend to large companies and, through their large shareholdings, play an important role in the corporate governance of large companies in Japan. Nationwide banks in the sample also include three long‐term credit banks and six trust banks. Out of the 21 nationwide banks in the sample, five city banks and five trust banks belong to one of the six large financial keiretsu, as determined in Industrial Groupings in Japan by Dodwell Marketing Consultants (1986).15 There are 63 regional banks in the sample; each of these banks operates in one or a few neighboring prefectures and focuses on lending to small‐ and medium‐size companies. None of them belongs to a keiretsu.16
B. Balance Sheet Variables
Table 1 presents sample statistics on the main variables used in this study. The average size of banks based on the book value of their assets during the sample period is 8.3 trillion yen, which is about $69 billion at $1 = ¥120. However, the standard deviation is very large, which reflects the large size difference between the nationwide banks and the regional banks. Indeed, the average size for nationwide banks is 26.6 trillion yen. The nationwide banks that belong to a keiretsu are even larger; their average size is 35.5 trillion yen.
The biggest asset for banks is their outstanding loans, and this study focuses on the loans to the real estate sector. The loan data are unconsolidated and do not include the loans made by overseas branches. Of all bank loans, 9.9%, or 5.1% of all assets, are to the real estate sector. At 12.3%, nationwide banks have a larger share of loans to the real estate sector. However, due to these banks' large financial assets, including their shareholdings in other companies, the real estate loans constitute a lower proportion of their assets, at 4.3%. At 12.5%, the share of real estate loans in total loans is even higher for keiretsu banks, yet its share in total assets is lower, at 3.7%.
Table 1 also presents sample statistics for the capital ratio of banks, calculated as the book value of equity plus special reserves (excluding loan loss reserves) and divided by the book value of assets. A striking feature is that Japanese banks had a very low capital ratio in this period. The average capital ratio of all the banks during the sample period is 2.8%. The average capital ratio of nationwide banks is lower, at 1.8%. The keiretsu banks have even lower capital ratio, at only 1.6%. Japanese banks did not have a high market‐to‐book ratio in this period. The average was only 1.06 with nationwide banks and 1.09 with keiretsu banks.
C. Shareholding
The data on the identity of and the shares held by each of the top five shareholders of each bank in the sample are obtained from the Japan Company Handbook by Toyo Keizai (various issues). The data are collected for each year in the sample period to construct a panel. Table 1 presents sample statistics on the total shares held by these shareholders. On average, the top five shareholders hold a combined 18.1%. This average is lower for nationwide banks and keiretsu banks, with 16.5% and 16.9%, respectively.
The sample statistics provided in table 1 demonstrate the importance of same‐keiretsu shareholders for keiretsu banks. On average, the same‐keiretsu shareholders that are among the top five shareholders hold a combined 10.2% of the keiretsu banks. This compares with the total average holding of 16.9% of the top five shareholders in these banks. In other words, if the managers of keiretsu banks can influence their same‐keiretsu shareholders, they can neutralize any monitoring discipline the other shareholders may provide.
IV. Regression Analysis
A. Methodology
The following analysis aims to uncover the effects of large shareholders on the real estate lending of Japanese banks. To isolate these effects from the other determinants of a bank loan portfolio, the analysis controls for bank characteristics such as size, bank capital ratio, cash flow, market‐to‐book ratio, and bank type. However, there are also several factors that are not so easy to observe but can affect a bank’s real estate lending. First, banks may differ in the credit‐screening ability of their loan officers. In fact, it may be optimal for a bank with highly able officers to focus on riskier sectors like real estate. Although this difference across banks is not likely to change over a short time period given the long‐term employment practices of Japanese banks, it may still be reflected in the overall riskiness of a bank’s loan portfolio.
Second, the level of shareholding of each shareholder is partially determined by historical reasons, especially for shareholdings that are part of wider business relationships as in a keiretsu. These shareholders adjust their portfolio only slowly, due to tax reasons, as they may face a large capital gains tax when they sell shares bought long ago at much lower prices.17 Third, and related to the second factor above, relationship bank lending practices are very important in Japan. Hence, the existing lending relationships at the beginning of the sample period will affect the bank lending during the years covered in the sample.
Although it is very difficult to control for these factors in a cross‐sectional analysis, they can be controlled for in a fixed‐effects analysis that the panel data allow. However, two issues complicate the panel analysis. First, banks often make loans with maturity longer than one year—the sampling frequency used in this analysis—so they may wait until the maturity of a loan to implement general policy changes on a specific loan. This suggests that, when the dependent variable is based on the loans extended by the bank, lagged dependent variables must be included as explanatory variables.18 Second, the explanatory variables are likely to be only predetermined with respect to the error term but not strictly exogenous. In particular, the shareholders may adjust their shareholding based on the bank’s past lending policies. As ordinary least squares would give inconsistent estimates with either of these problems, Arellano and Bond’s (1991) panel estimation approach, which is based on Generalized Method of Moments (GMM) and uses the past values of explanatory variables as instruments, is adopted in the analysis below (Wooldridge 2002).
B. Main Results
Table 2 presents the results of the regression analysis where the dependent variable is the total loans to the real estate sector normalized by the total assets (book) of the bank. All the explanatory variables are as of year 
and instrumented with their past values. The regressions also include lagged dependent variable, bank fixed effects, and year dummies.
All the regressions include as control variables log (assets), which is the logarithm of total (book) assets; capital ratio, which is the shareholder equity (plus special reserves) divided by total assets; income, which is cash flow divided by total assets; and market to book, the market‐to‐book ratio. The first regression does not include any shareholding variables and serves as a benchmark. Log (assets) has a positive coefficient while capital ratio, income, and market‐to‐book all have negative coefficients. However, with the exception of income in some later specifications, none of these coefficients is statistically significant.
The second regression includes “top 5,” the total shares held by the top five shareholders. The coefficient of this shareholding variable is negative and significant at the 10% level, which indicates that the large shareholders restrained bank managers from lending to the real estate sector on average. However, the effect of shareholders that were members of the bank’s keiretsu was very different, as shown in the next regression. Regression 3 includes both the top five and the same‐keiretsu shareholders, which is the total shares held by the shareholders that are among the top five shareholders and belong to the same keiretsu as the bank.19 The coefficient of same‐keiretsu shareholders is positive and statistically significant at the 5% level. The sum of the coefficients of the top five and the same‐keiretsu shareholders, measuring the total effect of keiretsu shareholders, is positive but statistically insignificant. This indicates that the shareholders that belonged to the bank’s keiretsu did not restrain bank managers from real estate lending.
The different role played by same‐keiretsu shareholders has to do with their keiretsu ties rather than with the type of bank in which they hold shares, as the next three regressions show. In regression 4, same‐keiretsu shareholders are replaced with nonaffiliated shareholders, which indicate the shares held in a keiretsu bank by the shareholders that are among the largest five shareholders but do not belong to the bank’s keiretsu. The coefficient of nonaffiliated shareholders is negative though not statistically different from zero.
The different roles played by the same‐keiretsu shareholders and the independent shareholders are also beyond the differences between the shareholders of nationwide banks and those of regional banks. Regressions 5 and 6 include the interaction term “top 5 × nationwide‐non‐keiretsu bank,” where “nationwide‐non‐keiretsu bank” is a dummy variable that takes the value of one for nationwide banks that are not part of the six main keiretsu. The coefficient of same‐keiretsu shareholders continues to be positive and significant at the 5% level while the coefficient of nonaffiliated shareholders remains negative and statistically insignificant.
These results indicate that large shareholders tried to restrain Japanese banks from lending to the real estate sector, on average. However, the keiretsu ties of big keiretsu banks provided protection to these banks as the same‐keiretsu shareholders did not discipline the banks of their keiretsu. The results confirm that the keiretsu banks have leverage over their keiretsu shareholders. Notice that the keiretsu shareholders are likely to be less tolerant to risks taken by their banks as these banks are their main bank. Any financial distress in their main bank can adversely affect their ability to raise funds for their needs, as was the case in the 1990s.20 Hence, these lending ties bias our analysis against obtaining the findings above. Finally, notice that the regressions have bank fixed effects and year dummies so they are unlikely to capture other effects specific to a given bank or to a given year. The next section provides further robustness checks.
V. Robustness
A. Real Estate Lending to Keiretsu Companies
One possible concern is whether the keiretsu effect reflects the loans of keiretsu banks to the real estate companies of their keiretsu. To explore this possibility, data on the amount borrowed by each listed keiretsu real estate company from each bank are obtained from NEEDS. Data show that the loans to the real estate companies that are members of the bank’s keiretsu are only a small fraction of the total real estate loans for these banks. Such loans are less than 7% of a bank’s total lending to the real estate sector in any given year in the sample period with an average across all the keiretsu banks of approximately 3% or less.21 In fact, only one keiretsu real estate company (Mitsui Fudosan) is ever among the top five shareholders of a keiretsu bank. When total loans made by keiretsu banks to the real estate companies are subtracted from their total real estate lending and the regressions in table 2 are repeated, the qualitative results remain unchanged, as reported in table 3.
B. Keiretsu Lending and Real Estate Loans
Hoshi (2001) finds that decreases in loans to keiretsu companies were associated with increases in real estate loans in the 1980s, which is consistent with the risk taking by banks that lost their traditional customers. One natural concern is then whether the effects due to the shareholding by keiretsu companies merely capture a similar loss of traditional borrowers rather than the effects related to corporate governance. To distinguish between the two effects, data on the borrowing of each listed keiretsu company from each bank are obtained from Nikkei NEEDS, and the total lending of each keiretsu bank to its own keiretsu companies is calculated.
Table 4 presents the regression analysis when “keiretsu loans,” the annual change in the fraction of keiretsu loans to the total loans, is included in the regressions. Keiretsu loans are negative but not statistically significant. The coefficient of same‐keiretsu shareholders, however, continues to be positive and significant. These results indicate that keiretsu shareholding is not merely a proxy for the lost lending opportunities of keiretsu banks to their traditional borrowers.22
C. Top 1 and Top 3 Shareholders
The main analysis is repeated by focusing only on the largest shareholder or the three largest shareholders instead of the largest five. The results are presented in table 5, panels A and B. The coefficient of same‐keiretsu shareholders remains positive and statistically significant. The magnitude of the coefficient is also similar to the magnitude when the analysis is focused on the largest five shareholders. This may be due to the fact that most of the same‐keiretsu shareholders are either the largest or second‐largest shareholders of their keiretsu bank, as the median rank of the same‐keiretsu shareholders among the largest five shareholders is two.
D. Nonlinear Effects of Shareholding
Gorton and Rosen (1995) find evidence of nonlinear effects in their study of bank shareholding and real estate lending. Main regressions are repeated by including the squared terms of “top 5,” the total shares held by the top five shareholders, and of same‐keiretsu shareholders, the total shares held by the shareholders that are among the top five shareholders and belong to the same keiretsu as the bank. The results are presented in table 6. No evidence of nonlinear effects is found. In particular, the coefficients of both the linear and squared terms of same‐keiretsu shareholders are positive, with the latter being statistically significant.
The lack of nonlinear effects comparable to those found in studies focusing on the United States may be due to the fact that the holdings by most of the shareholders of Japanese banks are much smaller than the levels at which nonlinear effects are detected for U.S. banks. With Japanese banks in this sample, 95% of each shareholding‐year is 6.1% or smaller. For same‐keiretsu shareholders, the largest shareholding in the sample is only 8.7%. Despite the lack of comparable nonlinear effects of shareholding, the effect of same‐keiretsu shareholding remains similar to earlier results and statistically significant.
E. Other Measures for Real Estate Lending
The analysis presented in the previous section is repeated with five different measures of real estate lending: (a) shares of real estate loans in total lending; (b) real estate loans normalized by the market value of the bank, which is defined as the sum of the market capitalization of the bank and the book value of bank liabilities; (c) real estate loans normalized by the book value of bank assets in 1982; (d) real estate loans normalized by the total loans in 1982; and (e) the real estate loans normalized by the market value of the bank in 1982. Normalization by the market value of the bank takes into account the increase in the market value of bank equity and the amount of funds the bank can raise by an equity issue. The use of 1982 values, on the other hand, corrects for any effect peculiar to the deregulation or large increases in the equity prices during the sample period. Table 7 presents the regressions with these alternative real estate lending measures. The effect of keiretsu shareholders relative to other shareholders remains positive and statistically significant.
VI. Conclusion
This article studies the effects of bank shareholding structure on the real estate lending of Japanese banks in the 1980s. It shows that large shareholders restrained the managers on average and that the real estate lending of banks decreased as the total shares held by the top five shareholders increased. However, this effect was absent when the shareholders belonged to a keiretsu led by the bank itself. The additional business ties between the banks and these shareholders, such as cross shareholding and bank borrowing, weakened the ability of the shareholders to discipline bank managers.
The effect of poor corporate governance in borrowing companies on financial crises has been shown (Johnson et al. 2000; Mitton 2002). The results in this article indicate that corporate governance problems in banks are also likely to have an important role in financial crises. With 45% of all real estate lending and more than 40% of total lending by the sample banks, the sheer size of keiretsu banks suggests that their corporate governance problems may have increased the magnitude of the financial crisis in Japan.
The results also suggest avenues for future research. This article only shows the link between corporate governance problems in banks and their real estate lending. While it is clear from bankers’ statements made in the 1980s that banks regarded these loans riskier than their average loans, it would still be helpful to extend the analysis using nonperforming loan measures. Unfortunately, data on nonperforming loans of Japanese banks are very unreliable due to perverse incentives of banks, among other reasons, as shown by Peek and Rosengren (2003). Hence, a more fruitful direction might be to extend the analysis to loan level by using the data from borrowing companies.
The findings in this study have further implications for countries where banks play a central role in the finance and governance of large companies. While these countries may be capturing the benefits of relationship banking, they may be particularly vulnerable to problems in the corporate governance of banks themselves, especially after deregulation and integration in the credit markets.23 Furthermore, the impact of these problems are also likely to be transmitted to other countries, as found by Peek and Rosengren (1997, 2000). To the extent that relationship banking prevents effective disciplining of bank managers, as this article demonstrates for Japan, financial systems with a large role of corporate governance for banks may have a built‐in fragility to deregulation, an issue little discussed in the literature.
The results presented in this article also highlight questions for future research about corporate governance in banks. One question is how the shareholders acted in the 1990s when the banks were no longer financially healthy. Did the shareholder pressure facilitate restructuring or further risk taking? Anderson and Campbell (2004) find that the top managers of poorly performing Japanese banks were more likely to be replaced in the 1990s. Another question is who will provide corporate governance in banks after the crisis. Some of these banks are very large but currently very few financial players in the Japanese economy are a source of discipline for the postcrisis banks.
The role of regulatory incentives and politics in dealing with failing banks has been well demonstrated (Kroszner and Strahan 1996; Brown and Dinç 2005). Another interesting question is whether cross shareholdings also led to regulatory forbearance because a bank failure can adversely affect the biggest nonfinancial companies through the loss of value of their cross‐shareholding investments. This may help explain why so few large banks were allowed to fail in Japan.
References
- Allen, Franklin, and Douglas Gale. 2000. Comparative financial systems: Competition versus insurance. Cambridge, MA: MIT Press.
- Anderson, Christopher W., and Terry L. Campbell II. 2004. The corporate governance of Japanese banks. Journal of Corporate Finance 10, no. 3:327–54.
- Anderson, Ronald C., and Donald R. Fraser. 2000. Corporate control, bank risk taking, and the health of the banking industry. Journal of Banking and Finance 24, no. 8:1383–98.
- Aoki, Masahiko. 2001. Toward comparative institutional analysis. Cambridge, MA: MIT Press.
- Aoki, Masahiko, and Hugh Patrick. 1994. Japanese main bank system. Oxford: Oxford University Press.
- Arellano, Manuel, and Stephen Bond. 1991. Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies 58:277–97.
- Barth, James R. 1991. The great savings and loan debacle. Washington, DC: AEI Press.
- Brown, Craig O., and I. Serdar Dinç. 2005. The politics of bank failures: Evidence from emerging markets. Quarterly Journal of Economics 120:1413–44.
- Demsetz, Rebecca S., Marc R. Saidenberg, and Philip E. Strahan. 1997. Agency problems and risk taking at banks. Research paper no. 9709, Federal Reserve Bank of New York.
- Dinç, I. Serdar. 2000. Bank reputation, bank commitment, and the effects of competition in the credit markets. Review of Financial Studies 13:781–812.
- ———. 2005. Politicians and banks: Political influences on government‐owned banks in emerging markets. Journal of Financial Economics 77:453–79.
- Dodwell Marketing Consultants. 1986. Industrial Groupings in Japan (1986–87). Tokyo: Dodwell.
- Gibson, Michael S. 1995. Can bank health affect investment? Evidence from Japan. Journal of Business 68:281–308.
- Gorton, Gary, and Richard Rosen. 1995. Corporate control, portfolio choice, and the decline in banking. Journal of Finance 50:1377–1420.
- Gorton, Gary, and Andrew Winton. 2003. Financial intermediation. In Handbook of the economics of finance, vol. 1A, Corporate finance, ed. George Constantinides, Milton Harris, and René Stulz. Boston: Elsevier Science.
- Hanazaki, Masaharu, Jung Wook Shim, Toshiyuki Souma, and Yupana Wiwattanakantang. 2004. Do large shareholders monitor or collude with banks in Japan. Working paper, Asian Development Bank Institute.
- Horiuchi, Akiyoshi. 1995. An evaluation of Japanese financial liberalization: A case study of corporate bond markets. In Financial deregulation and integration in East Asia, ed. Takatoshi Ito and Anne Krueger. Chicago: University of Chicago Press.
- Horiuchi, Akiyoshi, and Katsutoshi Shimizu. 2001. Did Amakudari undermine the effectiveness of regulatory monitoring in Japan? Journal of Banking and Finance 25, no. 3:573–96.
- Hoshi, Takeo. 2001. What happened to Japanese banks? Monetary and Economic Studies 19, no. 1:1–29.
- Hoshi, Takeo, and Anil Kashyap. 1999. The Japanese banking crisis: Where did it come from and how will it end? In NBER macroeconomics annual 1999. Cambridge, MA: National Bureau of Economic Research.
- ———. 2001. Corporate financing and governance in Japan: The road to the future. Cambridge, MA: MIT Press.
- Hoshi, Takeo, Anil Kashyap, and David Scharfstein. 1993. The choice between public and private debt, an analysis of post‐deregulation corporate financing in Japan. Working Paper no. 4421, National Bureau of Economic Research, Cambridge, MA.
- Johnson, Simon, Peter D. Boone, Alasdair Breach, and Eric Friedman. 2000. Corporate governance in the Asian financial crisis, 1997–1998. Journal of Financial Economics 58:141–86.
- Kane, Edward J. 1989. The S&L insurance mess: How did it happen? Washington, DC: Urban Institute.
- Kang, Jun‐Koo, and Anil Shivdasani. 1995. Firm performance, corporate governance, and top executive turnover in Japan. Journal of Financial Economics 38:29–58.
- ———. 1997. Corporate restructuring during performance declines in Japan. Journal of Financial Economics 46:29–65.
- Kang, Jun‐Koo, and Rene M. Stulz. 2000. Do banking shocks affect borrowing firm performance? An analysis of the Japanese experience. Journal of Business 73:1–23.
- Kaplan, Steven. 1994. Top executive rewards and firm performance: A comparison of Japan and the United States. Journal of Political Economy 102:510–46.
- Kaplan, Steven, and Bernadette Minton. 1994. Appointments of outsiders to Japanese boards: Determinants and implications for managers. Journal of Financial Economics 36:225–58.
- Keeley, Michael C. 1990. Deposit insurance, risk, and market power in banking. American Economic Review 80:1183–1200.
- Khwaja, Asim Ijaz, and Atif Mian. 2005. Do lenders favor politically connected firms? Rent provision in an emerging financial market. Quarterly Journal of Economics 120:1371–1411.
- Knopf, John D., and John L. Teall. 1996. Risk‐taking behavior in the U.S. thrift industry: Ownership structure and regulatory changes. Journal of Banking and Finance 20:1329–50.
- Komiya, Ryutaro. 1994. The life insurance company as a business enterprise. In Business enterprise in Japan: Views of leading Japanese economists, ed. Kenichi Imai and Ryutaro Komiya. Cambridge, MA: MIT Press.
- Kroszner, Randall S., and Philip E. Strahan. 1996. Regulatory incentives and the thrift crisis: Dividends, mutual‐to‐stock conversions, and financial distress. Journal of Finance 51:1285–1319.
- Kyodo News International. 1987. Global stock plunge a natural correction, banker association head declares. Kyodo News International–Japan News Wire, October 27.
- La Porta, Rafael, Florencio Lopez‐de‐Silanes, and Guillermo Zamarripa. 2003. Related lending. Quarterly Journal of Economics 118, no. 1:231–36.
- McGuire, Patrick M. 2002. The changing nature of Japanese firm bank relationships. Ph.D. diss., University of Michigan.
- Merton, Robert C. 1977. Analytic derivation of the cost of deposit insurance and loan guarantees: An application of modern option pricing theory. Journal of Banking and Finance 1:3–11.
- Milhaupt, Curtis J., and Geoffrey P. Miller. 1997. Cooperation, conflict, and convergence in Japanese finance: Evidence from the “Jusen” problem. Law and Policy in International Business 29, no. 1:1–78.
- Mitton, Todd. 2002. A cross‐firm analysis of the impact of corporate governance on the East Asian financial crisis. Journal of Financial Economics 64:215–41.
- Morck, Randall, and Masao Nakamura. 1999. Banks and corporate control in Japan. Journal of Finance 54, no. 1:319–39.
- Morck, Randall, Masao Nakamura, and Anil Shivdasani. 2000. Banks, ownership structure, and firm value in Japan. Journal of Business 73, no. 4:539–67.
- Peek, Joe, and Eric S. Rosengren. 1997. The international transmission of financial shocks: The case of Japan. American Economic Review 87:495–505.
- ———. 2000. Collateral damage: Effects of the Japanese bank crisis on real activity in the United States. American Economic Review 90:30–45.
- ———. 2003. Unnatural selection: Perverse incentives and the misallocation of credit in Japan. Working Paper no. 9643, National Bureau of Economic Research, Cambridge, MA.
- Sapienza, Paola. 2004. What do state‐owned firms maximize? Evidence from the Italian banks. Journal of Financial Economics 72:357–84.
- Saunders, Anthony, Elizabeth Strock, and Nickolaos G. Travlos. 1990. Ownership structure, deregulation, and bank risk taking. Journal of Finance 45:643–54.
- Suzuki, Yoshio, ed. 1987. The Japanese financial system. Oxford: Clarendon.
- Toyo Keizai. Various issues. Japan company handbook. Tokyo: Toyo Keizai.
- Weinstein, David E., and Yishay Yafeh. 1998. On the costs of a bank‐centered financial system: Evidence from the changing main bank relations in Japan. Journal of Finance 53:635–72.
- White, Lawrence J. 1991. The S&L debacle: Public policy lessons for bank and thrift regulations. Oxford: Oxford University Press.
- Wooldridge, Jeffrey M. 2002. Econometric analysis of cross section and panel data. Cambridge, MA: MIT Press.
-
* An earlier version of this article was circulated with the title “The Shareholding Structure of Japanese Banks and Their Real Estate Lending in the 1980s.” I started this research when I was visiting the Faculty of Economics and the Center for International Research on the Japanese Economy at the University of Tokyo. I am grateful for the hospitality and financial support. I would also like to thank the referee, Masahiko Aoki, Akiyoshi Horiuchi, Harumi Ito, Takuma Nakatsuka, Tetsuji Okazaki, Masahiro Okuno‐Fujiwara, Katsutoshi Shimizu, and seminar participants at numerous institutions and Western Finance Association, for comments and discussions; several practitioners who prefer to remain anonymous, for insights; Julian Atanassov, Makoto Itani, Patrick McGuire, Kamran Parekh, Alexander Serebrinsky, Junko Takahara, Shinako Tsugawa, and the staff of the Economics Library at the University of Tokyo, for their help with data and Japanese. Contact the author at s‐dinc@kellogg.northwestern.edu.
-
1. For a recent survey, see Gorton and Winton (2003), who also argue that corporate governance in banks remains poorly understood.
-
2. See, e.g., Kaplan (1994), Kaplan and Minton (1994), Kang and Shivdasani (1995, 1997), Morck and Nakamura (1999), and Morck, Nakamura, and Shivdasani (2000) for empirical evidence. Aoki and Patrick (1994) and Hoshi and Kashyap (2001) provide detailed treatments of Japanese banking.
-
3. See Gibson (1995) and Kang and Stulz (2000) for the effects of bank health on their borrowers in Japan in the 1990s.
-
4. See also Saunders, Strock, and Travlos (1990), Knopf and Teall (1996), Demsetz, Saidenberg, and Strahan (1997), and Anderson and Fraser (2000), among others, about the effects of corporate governance on risk taking by banks in the United States. This literature is discussed in more detail in the next section.
-
5. For a more detailed discussion of the financial environment in Japan during the 1980s, see Hoshi and Kashyap (2001, esp. chaps. 7 and 8).
-
6. U.S. thrifts were hit by rising interest costs on their deposits in the late 1970s while their main assets, mortgage loans, carried a fixed rate, which led to a rapid deterioration of their balance sheet (see, e.g., Kane 1989; Barth 1991; and White 1991).
-
7. See, e.g., Hoshi, Kashyap, and Scharfstein 1993; Horiuchi 1995.
-
8. The slow and incoherent deregulation has often been seen as one of the main sources of banking problems in Japan. See esp. Hoshi and Kashyap 1999.
-
9. See Hoshi and Kashyap (2001, 272–73) for the rescue of Toho Sogo in 1991 and other early signs of banking troubles.
-
11. Low shareholding by the management is also typical for nonfinancial corporations in Japan (see Kaplan 1994).
-
12. Komiya (1994) describes how banks purchase life insurance policies for their employees from a shareholder life insurance company according to the magnitude of its shareholdings.
-
13. There are two types of industrial groups in Japan, and both are called keiretsu. Roughly, the financial keiretsu is a group of companies from diverse industries with a large nationwide bank among the nucleus companies (e.g., Mitsubishi, Mitsui, Sumitomo); the production keiretsu is a vertically integrated group of companies in one or few related industries (e.g., Toyoto, Nissan, Matsushita). Unless otherwise noted, all the references to keiretsu in this paper are to the financial keiretsu. While relationship lending and bank shareholding are not exclusive to companies within a financial keiretsu, the membership in a keiretsu is often a good proxy for the identity of a company’s main bank and the strength of its bank ties.
-
14. The latter requirement is not very stringent however. The only excluded bank is Sumitomo Bank, which acquired Heiwa Sogo Bank in 1986.
-
15. They are Mitsubishi Bank and Mitsubishi Trust (Mitsubishi group), Mitsui Bank and Mitsui Trust (Mitsui group), Sumitomo Trust (Sumitomo group), Fuji Bank and Yasuda Trust (Fuyo group), Dai‐ichi Kangyo Bank (Dai‐ichi Kangyo group), and Sanwa Bank and Toyo Trust (Sanwa group).
-
16. For more details about Japanese banks in the 1980s, see Suzuki (1987) and Hoshi and Kashyap (2001, chap.7 especially) .
-
17. The potential adverse price reaction that a large shareholder may cause when it liquidates its portfolio would also lead to a slow adjustment of shareholdings.
-
18. Indeed, the lagged dependent variable tends to be highly significant.
-
19. Same‐keiretsu shareholders and nonaffiliated shareholders are trivially set to zero for banks that do not belong to one of the six keiretsu.
-
21. It is interesting to note that keiretsu real estate companies had a larger share in keiretsu banks’ real estate lending in 1980–82, before the study sample period.
-
22. As an additional evidence that keiretsu shareholding is not just a proxy for the lost customers of keiretsu banks, notice that Hoshi (2001) also finds that the banks that had a higher decrease in the fraction of loans to the listed companies had a higher increase in the fraction of real estate loans. If keiretsu shareholding were a proxy for the lost customers of keiretsu banks, one would expect a similar effect from the nonaffiliated shareholders of keiretsu banks as well because most of those shareholders are also listed companies.
-
23. See Aoki and Patrick 1994; Allen and Gale 2000. Weinstein and Yafeh (1998) and McGuire (2002) argue that most of the benefits from relationship banking in Japan were disproportionately captured by the banks in the 1980s, while Dinç (2000) provides a theory of relationship banking and capital market competition where the division of benefits is a function of capital market competition. See Aoki (2001) for a theory of institutional change through increased integration and competition.