The Japanese Model, or Keiretsu Approach

ln pursuit of economic growth, the Japanese model attempts to provide a high degree of leverage to industrial firms. The approach builds on a strong, centralized banking and credit system in which firms are encouraged to rely on relationships with banks, suppliers, agents, and customers to maximize their borrowing (e.g., for government-authorized projects). Banks own shares in businesses, which also own shares in the banks. Although cross-holdings tend to be nominal, the practical effect links dissimilar companies together for mutual support and protection. These groups, called keiretsu, provide a unique approach to corporate control based on continuous surveillance and monitoring by the managers of affiliated firms and banks.

The keiretsu approach resulted in a single-minded pursuit of industrial objectives based on a management-bank-government consensus. Although effective early in providing for reconstruction following World War II.the Japanese system has demonstrated at least three weaknesses in the 1980s and 1990s:

• Near-total bureaucratization of the system, which has dampened initiative and innovation and made subsequent changes difficult

• Loss of control of the price-setting mechanism to powerful nonmarket forces with effects on efficiency and equity

• Deterioration of banking standards and quality-and-safety controls resulting from inefficiencies and corrupt practices

Smith and Walter [1993] conclude that the more powerful and successful a banking system is in fostering industrial development, the more difficult it is to alter or control later.

The German Model, or Universal-Bank Approach

The German model is a broad-based one built on four interrelated elements that link universal banks and industrial companies:

• The Hausbankapproach to providing financial services (i.e., reliance on only one principal bank)

• Bank ownership of equity shares

• Bank voting rights over fiduciary (trust) shareholdings

• Bank participation on supervisory boards

The Hausbank relationship results in companies accessing both capital-market services (new issues of stocks and bonds, mergers and acquisitions, etc.) and bankcredit facilities through their "universal bank.'" Hausbank credit facilities to client firms are "insured,'" for which the borrower pays a fee. ln addition, Hausbank loans are viewed as quasi-equity for the bank, because if financial difficulties arise, the Hausbank may convert the debt to equity and take control. In general the Hausbank is deeply involved in its corporate clients' business affairs, with the relationship considered a two-way street based on loyalty. By providing all of the financing needed to start a business (e.g., seed capital, initial public offerings of stock, bond under writings, and working capital), German banks gain Hausbank standing.

Although German universal banks' ownership of equity in all companies is not large (less than 1% in 1989), concentration is much greater in some larger companies, which comprise a major portion of the holdings of large banks. An unusual feature of the German system is that the voting rights of the shares held in custody by universal banks are typically exercised through proxy voting. Thus, banks have a degree of control over industrial enterprises that usually is larger than their own proportionate share ownership.

The previous three elements of the Hausbank relationship are cemented by bank representation on supervisory boards. Under German law, board members must act in the interest of the firm and its shareholders. In addition, bank board members provide advice on questions of financial management and capital markets. Supervisory board members are concentrated among the largest German firms. On balance, in the German model, bank-industry linkages involve strong surveillance and monitoring by banks of industrial firms and the potential for a high degree of control in maximizing shareholder value, because banks have an equity stake and fiduciary obligations with respect to shares held in custody.