Cross-Shareholdings and Japanese Benchmark Stock Indexes

1. Cross-shareholdings—or those shares that are cross-owned for strategic purposes by non-financial companies and their main banks, or among companies in the same keiretsu corporate groupings—account for a large proportion of the shares in Japan’s stock market as well as those shares that are not held for investment purposes. These shares that are not owned for the purpose of generating income or capital gains also include shares of a publicly traded subsidiary owned by the parent company (for example, NTT’s large stake in NTT DoCoMo), shares owned by the government, and shares owned by company founders and top executives. As passive fund management becomes increasingly efficient through lower tracking error and costs, an increasing proportion of assets—starting with those from large pension funds and postal savings, postal life insurance and other public sources—is likely to be passively managed. 2. The most widely used domestic benchmark index for Japanese investors is the TOPIX index, which by definition automatically includes all stocks that trade on the first section of the Tokyo Stock Exchange. 3. One market topic of much debate in Japan since 2000 is whether cross-shareholdings and other types of shares held for non-investment purposes have led to distortions in Japan’s market. One argument that has been made, for instance, is that the many stable shareholdings have led to a shortage in the supply of shares relative to demand from active fund managers, and thus distortions in share prices, since the stocks in the TOPIX index are included at proportions higher than their actual free floats. 4. This paper presents a quantitative model that shows a significant difference between the investable shares in the market and the shares that are included in the TOPIX benchmark index. The impact of this divergence can be expected to increase as the proportion of passively managed assets increases, assuming that proportions of stable shareholdings stay at roughly current levels. At the individual stock level, the 1 The author, currently the head of the Derivatives Research Group of the Nomura Financial Research Center’s Quantitative Research Department, joined Nomura Research Institute’s System Science Department in April 1991, immediately after receiving his master’s degree (with a specialty in mathematical engineering) from the University of Tokyo. After a stint in the San Francisco office of Nomura Rosenberg Investment Technology Institute in 1993-95, he returned to NRI’s System Science Department. He then transferred to the FRC’s Quantitative Research Department in 1997 and became a regular employee of the department in 1998. Major publications include “Oyako jojo to Nihon kabu benchimaku no kangaekata” (“Publicly Listed Parent/Subsidiary Pairs and Japanese Benchmark Stock Indexes”), Shoken Anarisuto Janaru (Security Analysts Journal), November 2000 (and winner of the Security Analysts Journal Prize for 2000); “Nenkin un’yo ni okeru passhibu un’yo no riron to saiteki passhibu hiritsu” (“The Theory Behind the Passive Investing Approach to Pension Fund Management and the Optimal Proportion of Passively Managed Assets”), Shoken Anarisuto Janaru, August 1999; and (with J. Shizuka) “Nenkin un’yo ni okeru un’yo kikan hyoka: Hyoka riron to hyoka no jissai” (“Evaluation of Pension Fund Management Firms: Theory and Practice”), Nenkin Un’yo Kenkyu, August 1999. ©2003, The Security Analysts Association of Japan® 2 distortions in supply and demand are significant in many cases, leading to greater demand than supply for some stocks and greater supply than demand for others. Over the past 20 years, the impact of these distortions has increased. For instance, stocks with high proportions of stable shareholdings have been affected by a decline in trading volume and an increase in volatility. 5. The divergence between the investable shares in the market and the shares that are included in the TOPIX index not only distorts the supply and demand for stocks but also significantly affects the evaluation of fund managers’ performance. The differences in the free floats of stocks are not likely to narrow significantly in the next few years given the likelihood of an increasing number of listed stocks of parent/subsidiary pairs and companies heavily owned by insiders, even as banks, nonfinancial companies, and keiretsu group members increasingly unwind their crossshareholdings. Meanwhile, managers of large public funds in Japan are increasingly opting for a passive investment approach, a development which makes it more and more critical to have a benchmark index that takes into account stable shareholdings. ©2003, The Security Analysts Association of Japan® 3 A comparison of the stock markets in Japan and the United States The foundation of Japan’s economy today was established during the high-growth period from the early 1950s (after the postwar reconstruction years) to the early 1970’s, when GDP growth consistently ranged between 10 and 20 percent. Then starting in the mid1970s, Japan’s economy downshifted to a lower rate of growth. It was during this period of slower economic growth that Japan’s stock market took off and became a major international financial market. At the end of 1975, the total market value of stocks listed on the Tokyo Stock Exchange (TSE)—still the most wellknown exchange in Japan and also the largest in terms of trading volume—amounted to $136 billion, not even 20 percent of the $685.1 billion market value of stocks listed on the New York Stock Exchange (NYSE) at the time. Over the following dozen or so years, Japan’s stock market and other capital markets quickly developed and grew in size. By April 1987—at the height of Japan’s economic bubble years—the value of stocks on the TSE had roughly matched the value of stocks on the NYSE. The asset bubble in Japan soon popped, and the stock market hardly grew at all in the 1990s, while the U.S. stock market took off. By January 2000, the total value of stocks on the TSE had dropped to just over $4 trillion, or about 36 percent of the value of stocks on the NYSE. Figure 1. Comparison of the total value of stocks on the TSE and NYSE, 1970-2000 1 10 10