Keiretsu Membership, Firm Size, and Corporate Returns on Value and Cost

We test how keiretsu membership affects the Fama and French (1999) required IRR on value (or cost of capital) and the IRR on cost (or return on investment), 1974-95, of all listed non-financials in Japan. Rather than computing point estimates from aggregate data, we employ non-linear cross-sectional regression analysis of individual-firm data and we control for industry and size factors in returns. We find that firms have added value--and significantly so--regardless of industry, size, and governance system. In terms of cost of capital, we find no evidence of a keiretsu advantage. In fact, within the segment of medium- and small-sized firms the keiretsu ones often have the higher expected return on value. In terms of return on investment, mid- and low-cap firms show no clear difference but top-league keiretsu firms notched up definitely lower numbers than did comparable non-keiretsu ones. Our interpretation is that keiretsu groups have cross-subsidized their larger member firms, a strategy that led the latter to over-invest.