The keiretsu puzzle

Why do large firms in Japan hold small percentages of stock in trading partners? A firm that holds stock in a trading partner weakens its own bargaining position, for a portion of its own gain from trade then includes a share interest in the partner's gain from trade, but precisely for this reason the firm can at any time penalize the trading partner by divesting its share interest. Cross-shareholding therefore strengthens the penalties for opportunism and this may be its purpose. Opportunism here means substituting products of quality lower than claimed or promising and then failing to make investments that would lower the other party's costs. Econometric analysis of the pattern of cross-shareholding within Japan's keiretsu groups in 1980 reveals evidence that is consistent with this argument. (C) 1996 Academic Press,Inc.