Criss-crossed capitalism

When Japanese shares plunged to a 26-year low on October 27th, it was not just investors who felt the pain. Billions of dollars of corporate assets were also wiped out because many Japanese companies own stakes in their peers. Cross-shareholdings (when two firms hold each other’s shares) and stable-shareholdings (friendly firms holding shares they almost never sell) are the blood-brotherhood of corporate Japan. 

Such holdings are regarded as a way to cement business relationships, rather than as investments.

After falling for a decade, the level of cross-shareholding has crept up since 2004 (see chart). Greater shareholder activism, mostly on the part of foreign investors, and fear of hostile takeovers prompted managers to adopt mutual shareholdings to insulate themselves from nettlesome outsiders. Over 20% of the shares on the Tokyo Stock Exchange are owned by Japanese companies and financial groups.

The practice is most common in traditional industries such as steel, paper and energy. But big global carmakers and electronics firms participate as well. Toyota, Honda and Nissan are all involved in webs of interlocking shareholdings with their business partners and suppliers. In 2007 Toshiba and Sharp bought stakes in each other, as did Sharp and Pioneer. Panasonic, which is considering taking a controlling stake in Sanyo, held shares in over 300 companies as of March 2008, valued at ¥446 billion (around $4 billion).

Cross-holdings cement alliances, but also make firms captive to their partners. They make it harder to work with firms outside the circle, reinforcing the inflexibility of Japan’s business environment. 

The most visible impact is in financial services. Banks need to recalculate the value of their assets daily, since the shareholdings are part of the core capital they lend against. When shares hit a trough last month, Japan’s three “megabanks” wrote down around $12 billion in paper losses from some $120 billion in shareholdings. Their capital ratios fell by half a percentage point, putting the banks in uncomfortable territory. The result was a scramble to recapitalise.

Japanese bosses say cross-holdings are an aspect of their business culture that will endure, however much foreigners object. . Because banning the practice is impossible, the head of JTP wants regulators to require that firms at least disclose their stakes, so that transparency can help investors press managers to use their company’s capital more wisely.