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 ow n bargaining position, for a portion of its own gain from trade then i ncludes a share interest in the partner's gain from trade, but precise ly for this reason the firm can at any time penalize the trading partn er by divesting its share interest. Cross-shareholding therefore stren gthens the penalties for opportunism and this may be its purpose. Oppo rtunism here means substituting products of quality lower than claimed or promising and then failing to make investments that would lower th e other party's costs. Econometric analysis of the pattern of cross-sh areholding within Japan's keiretsu groups in 1980 reveals evidence tha t is consistent with this argument. (C) 1996 Academic Press,Inc.