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Adoption and policy implications of Japan’s new corporate governance practices after the reform

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Abstract

In this paper we explain the process and policy implications of Japanese firms’ adoption of recently reformed corporate governance practices. We use a selective adaptation framework in doing so. We present some qualitative predictions about the possible outcome of their adoption process. One advantage of our approach is that we can describe various aspects of the evolutionary process of Japan’s corporate governance reform as a system in a consistent manner, rather than as independent pieces. Our predictions provide policy implications and are empirically testable. Japan’s post-bubble corporate governance reform has been extensive and involves the enactment and revisions of many relevant laws and affected institutions. Japan’s aim has been to install US-like practices (the de facto global standard), with these practices replacing the now tarnished bank-centered practices, and to facilitate Japanese industry in regaining global competitiveness. However, we show that Japanese businesses’ adoption of US practices has been selective and efficiency and other policy implications of such behavior are potentially dysfunctional.

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Notes

  1. We consider the US corporate governance system, or more broadly, the Anglo-American system as the de facto global standard corporate governance system (e.g., Nakamura, 2006).

  2. Stiles (2006) discusses the dissemination of liberal norms.

  3. For example, econometric specifications in most studies of Japanese corporate governance include keiretsu dummies as explanatory variables. But the origin of such dummies is unknown, still capturing large amounts of statistically significant unobservable effects.

  4. Highly developed economies, compared to developing economies, tend to have high levels of achievements in these state variables (e.g., La Porta, Lopez-de-Silanes, & Shleifer, 1999; Shleifer & Vishny, 1997).

  5. Morck and Nakamura (1999).

  6. Examples of these norms include: group behavior, consensus, long-term relationships, vertical keiretsu relationships among corporations, importance of group-oriented values, trust and networks, and male-female behavior (e.g., Nakamura, 2009; Reischauer, 1988; Tiessen, 1997). These societal norms and business norms are often intermingled and are not generally separable. See also Fang (2010).

  7. For example, Hadley (1970: 291) and Miwa and Ramseyer (2001). However, Nakatani (1984) and others also show the risk sharing function conducted by the horizontal keiretsu groups. In economics risk sharing is often thought to be efficiency increasing.

  8. Despite our focus on keiretsu-affiliated firms here, there are many non-keiretsu-affiliated firms in Japan. For example, Japanese METI (1999) reports that less than 10% of all Japanese firms have subsidiaries, which are essential components of vertical keiretsu groups. We develop our predictions to be discussed below taking into account the presence of such non-keiretsu firms. We are indebted to one of the referees for pointing this out.

  9. For some court cases, out-of-court settlements may mimic the court decisions as they are likely predictable. But it is unclear that the same can be said of out-of-court settlements for corporate governance litigations, which often allow the parties involved to withhold information which may be important for general shareholders to know.

  10. The Japanese economy’s prolonged post-bubble under-performance suggests significant efficiency loss under the bank-based corporate governance system.

  11. It is possible that our business norms, (N1–N3), do not adequately characterize some Japanese business practices. One such example might be the Japanese preference for long-term employment and other business relationships.

  12. Potter (2003, 2004) proposed using perception, legitimacy, and complementarity for explaining how selective adaptation proceeds in a foreign culture.

  13. We do not focus on this point in this paper but it is likely that the same can be said of Japan’s adaptation to the corporate governance reform currently being undertaken. We are indebted to one of the referees for pointing out the relationship of this paper to the Japanese studies literature cited above.

  14. In 2008, 54.8% of Japanese listed firms’ outstanding shares was owned by financial institutions and business firms (Table 2). Our conclusion is consistent with Roe (2001) who suggests that shareholder value maximization is, empirically, less likely to be accepted in countries where product market competition is weak (e.g., Europe, Japan) than in countries where product market competition is strong (e.g., the US).

  15. Firms adopting this system have some flexibility in designing how these three committees (appointment, compensation, and auditing) relate to the board of directors. For example, Sony adopted the US style system but Canon and Panasonic did not.

  16. We sometimes use this nomenclature for convenience but it does not imply that all keiretsu firms are non-progressive.

  17. For example, recent scandals in illegal accounting (e.g., creating of non-existing sale between related firms) by Fujitsu’s and NEC’s related firms (Nikkei, 2007: July 3).

  18. If one or both of these limitations were severe, no practically meaningful propositions could be obtained.

  19. To save space, we do not repeat the selective adaptation implications Propositions 1–5 in their entirety in this section.

  20. The shares of the outstanding shares owned by Japanese banks clearly decreased over the 1990s. Other types of corporate shareholding also declined somewhat, but the majority of vertical keiretsu-related shareholding remained.

  21. These are highly potent poison pills, as was proved in the post-World War II period.

  22. Another interpretation of this might be that this process maximizes banks’ (creditors’) firm value.

  23. Our selective adaptation theory does not give explicit predictions regarding firms’ choice of using US style executive committee-based boards. We also note that “the role of committees generally and their relation to the overall board specifically are not fully understood” even for US boards (Adams, Hermalin, & Weisbach, 2010: 101).

  24. Most outside directors on Japanese company boards are not really independent directors. Many are sent in by their banks and affiliated companies (e.g., parent firm, subsidiary firm, keiretsu firm). Adams et al. (2010) also point out some ambiguity about the nature of outside directors on the boards of US firms.

  25. It is likely that there is more firm specificity in operations for vertical than horizontal keiretsu group firms, and hence our Proposition 2 may be more appropriate for arguments involving vertical keiretsu groups. We should also note that Proposition 2 does not explicitly discuss the conditions under which firms improve their performance by simply reducing their board size. This could occur, for example, if a firm, rejecting new board mechanisms, decides to improve their contribution to its stakeholders by reducing the number of their directors. We thank an anonymous referee for pointing out these issues to us.

  26. Such stable shareholding prevented hostile takeovers of listed firms in Japan since the early 1950s.

  27. See, for example, Bebchuk and Cohen (2005), Gompers, Ishii, and Metrick (2003), and Hermalin and Weisbach (2003). Arikawa and Mitsusada (2008) show that Japanese firms experience negative abnormal returns right after announcing introductions of new poison pills.

  28. Yomiuri Shinbun, 2007: May 17.

  29. These include Oji Paper’s attempt to absorb Hokuetsu Paper, Rakuten’s attempt to takeover Tokyo Broadcasting System, and Livedoor’s attempt to takeover Nippon Broadcasting System, as well as Steel Partners’ takeover attempts of some target firms.

  30. In this paper we do not discuss Japanese firms’ decisions on divestiture (i.e., which units to divest while which units to retain in their restructuring efforts to refocus). But we expect the Japanese market for corporate control to treat divested units in the manner described by Proposition 3. See also Choe and Roehl (2007) for a detailed analysis of this issue for South Korean chaebols. See also Chang (2003). We are indebted to one of the referees for pointing this out.

  31. See, for example, Kang, Shivdasani, and Yamada (2000), Komoto (2002), Lin, Michayluk, Oppenheimer, and Reid (2008), and Yeh and Hoshino (2002).

  32. For example, Arikawa and Miyajima (2007). However, the volume of M&As involving Japanese firms is still small by international comparison. The amounts (in billion dollars) of M&As reported for different countries for the first 6 months of 2007 are as follows: US (1,372.7); UK (632.3); Spain (217.6); Italy (208.5); Canada (185.4); France (159.9); Germany (155.1); Australia (110.4); and Japan (81.3).

  33. In 2005, there were 3,734 reported transactions of M&As in Japan. 2,725 (73%) of these were between group (affiliated) firms, while the remaining 1,009 (27%) involved non-group firms. Furthermore the fraction of in-group M&As has been increasing since the early 1990s (DBJ, 2007).

  34. Niimi (2007) also raises some concerns about this. We expect that the level of disclosure and transparency in Japan will continue to be less than that in the West for activities involving intra-keiretsu group transactions. One factor that contributes to transparency is the revision of Japan’s certified public accountants law, which has gone through a number of revisions since the 1990s. All revisions were intended to strengthen CPAs’ monitoring capacity and improve quality of accounting auditing of Japanese listed and unlisted corporations. A number of scandals triggered these revisions. The most recent revision of 2007 requires accountants to audit and report fraudulent book keeping by firms with more stringency. It will also be accompanied by strengthening of the penalty terms for accountants who violate the rules.

  35. For example, Morck and Nakamura (1999) and Morck, Nakamura, and Shivdasani (2000).

  36. On balance, our empirical evidence seems to suggest somewhat less optimistic prospects for the value of transparency Japanese firms place than our theory implies.

  37. A more recent example which resembles the Tokyo Steel case discussed here is Steel Partners’ gaining control of wigmaker Aderans. Steel Partners directly appealed to Aderans’ general shareholders about Aderans management’s failure to maximize share value (Hardin, 2009). See also Chen & Young (2010) for the infringements of minority shareholder rights in recent Chinese M&A.

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  1. Sauder School of Business, University of British Columbia, 2053 Main Mall, Vancouver, BC, Canada, V6T 1Z2

    Masao Nakamura

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Nakamura, M. Adoption and policy implications of Japan’s new corporate governance practices after the reform. Asia Pac J Manag 28, 187–213 (2011). https://doi.org/10.1007/s10490-010-9230-8

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