Strong Managers, Weak Owners: The Political Roots of American Corporate Finance

By Mark J. Roe | Go to book overview

CHAPTER 19
Industrial Organization as the Problem?

LET US now shift from financiers, short-term thinking, and monitoring of managers to the organization of industrial production. A recurrent task in organizing industry is to coordinate long-term investments, especially simultaneous long-term investments by suppliers and customers. A supplier considers a massive investment in new machinery to make a good that only a specific customer can use. But what will stop the customer from reneging or extorting concessions from the supplier later on, after the supplier builds the specific machines? Although a detailed contract between the supplier and the specific customer may protect the supplier, many ways that the customer can exploit the supplier are unforeseeable. Vague promises from a customer to act in good faith are often not enough. Multiple cross-holdings of stock, however, may mitigate opportunism. If the customer tries to mulct the supplier after the supplier has committed itself, a coalition of stockholders could intervene to stop the opportunism. When a half-dozen suppliers and customers must simultaneously make such commitments, industrial coordination becomes important. Cross-ownership as coordination helps to explain keiretsu cross-ownership in Japan, where one-third of the stock is cross-owned, often between suppliers and their customers,1 as I have analyzed elsewhere with Ronald Gilson.2

To coordinate complex investments under potential opportunism, the parties have a continuum of choices between pure contract and pure organization. At the idealized contractual pole, one party becomes the organizer and writes highly specific contracts with the other suppliers and customers; these contracts specify the terms on which the organizer can buy goods and services from the others. Every future circumstance must be specified to prevent anyone from acting opportunistically. In this idealized contracting, the organizer anticipates every contingency, and courts will enforce these perfect contracts without friction. This kind of a contractual “firm” is a loose connection of suppliers and customers, linked through a nexus of arm's-length, highly specific contracts. At the idealized organiza-

____________________
1
Yusaku Futatsugi, What Share Cross-Holdings Mean for Corporate Management, Economic Eye, Spring 1990, at 17, 18. Industrial ownership of stock is also significant in Germany.
2
Ronald J. Gilson and Mark J. Roe, Understanding the Japanese Keiretsu: Overlaps Be-
tween Corporate Governance and Industrial Organization, 102 Yale Law Journal 871 (1993).

-248-

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