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USJI Voice Vol.4

Corporate Governance in Japanese Companies

January 09,2015
Waseda University

Traditionally there has been the belief that the actions of Japanese corporations differ from those of American corporations. One typical example is a corporation’s relationships with its shareholders and employees. There is the notion that American corporations are expected to take actions to maximize shareholder profits. Conversely, in Japan there is the strong belief that corporate management should be more for the benefit of employees and other such stakeholders. This belief has been indicated by questionnaire surveys and other sources.

Japanese corporations are frequently criticized for this approach. One major reason for such criticism is that the profitability of Japanese corporations is often lower compared to that for companies in other countries. Plenty of research comparing the profitability of companies in various countries has indicated that the profitability of Japanese companies is comparatively low. Such research has indicated that not only is profitability comparatively low at Japanese corporations, but their profitability dispersion levels are also low. Corporate Japan’s low profitability dispersion suggests that there is only a small number of companies with really good earnings and a small number with really poor earnings. On the other hand, countries with high levels of profitability dispersions, such as America, have many companies with very good earnings and many with very poor earnings.

The low profitability and profitability dispersion for Japanese corporations is seen as significant. A high profitability dispersion level probably means there are large investments in high-risk projects or, in other words, projects that entail high returns if successful, but have a high probability of failure. In short, while projects with high risk entail the potential for high returns, those projects with little investment risk tend to provide lower returns. This means that the low profitability and low profitability dispersion of Japanese corporations is consistent with the notion that Japanese corporations, compared to their international counterparts, are less likely to invest in high-risk projects. Securities markets, through the limited liability system, encourage the execution of high-risk projects.

This tendency of large Japanese companies to avoid risk is probably due to management stances that place more importance on employees than shareholders. This is because, for employees, it is more desirable for their companies to avoid large failures than take on risks to achieve high growth. For example, sticking with a business, even though its profitability is low, helps to create jobs.

While criticism of Japanese corporations has increased, there have been various changes to the systems surrounding these companies. For example, Antimonopoly Act revisions have allowed for the establishment of pure holding companies. As a result, it has become easier for corporations to reorganize through mergers, acquisitions, business sell-offs, and the spinning off of businesses into separate subsidiaries. Enforcement of the Financial Instruments and Exchange Act and Companies Act also tends to encourage mergers and acquisitions on the capital markets.

Such system changes were apparently introduced in order to enhance capital market functions. Promoting corporate mergers and acquisitions probably works to enhance the power of shareholders. Here, let’s use actual data to verify the manner in which this changes corporate governance. As corporate governance exists on various fronts, here we will focus on the two fronts of (1) board of directors, specifically outside directors, and (2) monetary incentives for executives.

The shareholders entrust the running of a company to executives, but executives do not run a company exclusively for the benefit of shareholders. This problem can likely be eased somewhat by either enhancing the monitoring of executives by shareholders or by providing executives with incentives to maximize shareholder value.

Here, let’s first examine the status of outside directors as a monitoring mechanism. Table 1 shows the numbers of outside directors at Japanese corporations between 2005 and 2013. This table covers all listed corporations using data obtained from the Nikkei Corporate Governance Evaluation System (NEEDS-CGES). According to this table, the number of corporations without a single outside director declined from 2,577 in 2005 to 1,623 in 2013. We can assume that this indicates environments where the interests of shareholders can to some degree be more easily reflected in corporate management. That said, even in 2013 there was a large number of corporations with no outside directors, while for many companies the presence of outside directors was very small at only one or two. This suggests that there are still limits to the degree to which monitoring can be conducted by external directors. Indeed, as of 2013 the percentage of outside directors on the boards at Japanese corporations was extremely low compared to that for corporations overseas.

Next, let’s consider monetary incentives for executives. Enhancing the relationship between executive remuneration and shareholder profits provides incentives for executives to manage their companies in a manner that maximizes shareholder profits. Therefore, an analysis of executive remuneration and shareholder profits can shed some light on these incentives for executives.

Here I would like to introduce some of my past research on this matter. My research made an empirical analysis of the relationship between executive remuneration and shareholder value for the Nikkei 225 constituents. A comparison of corporations with 1.9% and 20.8% total shareholder returns (TSR) showed that the difference in salaries between the presidents of such firms in Japan is typically around 20 million yen. On the other hand, research in America shows that the difference in salary between presidents of companies with the same difference in TSR was approximately 400 million yen. In other words, an equivalent improvement in TSR would result in an approximate 400 million yen salary improvement for an American CEO, but only a 20 million yen improvement for a Japanese CEO. This suggests that the monetary incentive to maximize shareholder value is much smaller for Japanese executives as compared to their American counterparts.

In summarizing these two points, while some changes have emerged regarding outside directors, their numbers in Japan are still extremely small compared to other countries, and monetary incentives for executives to maximize shareholder value is also still small. These results are consistent with the notion that the behaviors of Japanese corporations have not really changed that much in recent years.

Table 1: Number of Outside Directors

0 1 2 3 4 5 6 7 8 9 10 13
2005 2,577 626 320 136 45 25 18 9 3 1 0 1
2013 1,623 1,051 503 202 83 42 14 3 5 0 1 0

Source: Nikkei Corporate Governance Evaluation System

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