Role of Holding Companies in Prewar Japanese Economic Development: Rethinking Zaibatsu in Perspectives of Corporate Governance

This paper examines the function of corporate governance of the zaibatsu holding companies. Since 19th century, or in some cases since 17th century, zaibatsu accumulated assets and diversified them into various businesses. Expansion and diversification of the businesses caused problems which resulted from asymmetric information, namely adverse selection and moral hazard of the agents who executed the businesses. In order to resolve these problems, zaibatsu introduced organizational innovation. By early 1920's, each zaibatsu established the holding company, while it separated the businesses into joint-stock companies. The holding company of zaibatsu had the organizations and full-time stuffs to monitor the affiliated companies. In many cases, the concerning sections of the holding company, such as the section of audit, inspection etc., checked the budget and financial data of the affiliated companies, while the matters of the board of directors were approved by the holding company ex ante and ex post. There existed systematic rules on the allocation of powers between the holding company and the affiliated companies. Also, the holding company frequently dispatched directors to the affiliated companies. The efficacy of these devices of governance was tested quantitatively. We compared ROE between zaibatsu affiliated firms and non-zaibatsu firms, using panel data of 135 firms from 1922 to 1936. By controlling the effects of company scale, industry-specific shocks, and macro-shocks, we obtained the result that zaibatsu-affiliated firms clearly outperformed the other companies. This result supports the hypothesis that the zaibatsu holding company played the role of monitoring the affiliated companies. Besides this governance function concerning the affiliated companies, zaibatsu also disciplined the non-affiliated companies in the capital market. The holding companies and the core affiliated companies frequently executed take over, which contributed to restructure the targeted companies, thorough replacement of the directors, assistance of management.