Even in the most advanced industrial economies there is intense debate about how good or bad the established arrangements for corporate governance are (Schleifer and Vishny, 1997). Some see wider emulation of the Anglo-American system of corporate governance as desirable. Others argue that a system patterned more on those in Japan or Germany would be better (Roe, 1993: Clarkham, 1994).
The Japanese model of corporate organisation and corporate governance has long been a subject of intense interest in the study of comparative economic behaviour and performance ( Abegglen, 1958; Dore, 2000) . In the past, Japanese corporate
organisational structures were lauded as an effective means for the promotion of high growth in industrialising economies – as a model to be emulated in East Asia by countries committed to industrial modernisation (Aoki and Patrick, 1994). They were seen as a primary agent of high economic growth in Japan until recent times. In the 1980s, the idea that keiretsu corporate structures in Japan were associated with
‘closed’ Japanese markets had wide currency in American policy and business circles (Drysdale,1995). The economic malaise in Japan over the last decade produced a sharp turnaround in perceptions of the efficacy of Japanese corporate organisation and of the effectiveness of Japanese corporate governance. Now Japanese corporate structures are commonly seen to be at the core of the weaknesses and vulnerability of the Japanese economy, its low growth and poor productivity performance over the last ten years (Horiuchi, 2001).
The object of this paper is simply to ask why there has been this re-assessment of Japanese corporate governance systems. If corporate organisation and corporate governance structures are at the heart of Japan’s economic problems, what are the issues of most concern and importance? What is the response in Japanese business and policy circles to the problems in Japanese corporate governance, real or
imagined? What changes are taking place in Japanese corporate organisation and how are they likely to affect Japanese economic performance? Are Japanese corporate governance structures going to become more like those in America?
* I am extremely grateful to Simon Smiles for his assistance in gathering together the materials on which this paper was based and for clarifying my thinking in its preparation. I am also grateful to Roger Farrell, Shiro Armstrong, Bill Bannear and Karina Sutherland for other research assistance.
The paper is structured around trying to answer these five questions in an attempt to identify some of the important issues in Japanese corporate governance today.
The prolonged and painful aftermath of the bubble economy in Japan has raised questions about Japan’s systems of corporate checks and balances. The crisis in the banking system – the linchpin of Japanese corporate organisational structures – is one aspect. The string of scandals related to the banking, securities and corporate sectors (including the role of stockholder meeting ‘fixers’, sokaiya, in insulating management from shareholder criticism) is another. And the fall in the fortunes of the Japanese economy and major Japanese corporations, such as Nissan, Mitsubishi Motors, Daiei, and Sogo, is yet another, perhaps over-riding, aspect. All three elements have shaken confidence in the integrity of the controls and discipline on top management and the efficiency of capital market structures in Japan (Sheard, 1998).
These problems have arisen in the context of an historic structural transformation facing the Japanese economy and its postwar economic institutions. Issues of corporate governance are at the centre of the policy debate about the structural, as distinct from the macroeconomic, solutions to Japan’s contemporary economic problems.
Nature of Corporate Governance
Corporate governance is the process and the set of arrangements whereby the capital market monitors the actions of corporate management and holds management accountable for its corporate decision-making. The health of any market economy requires that corporations be properly managed. Households entrust their assets and savings via the financial market for investment by corporations, and provide their labour services to corporations via the labour market. There are powerful incentives in market economies to deliver sound corporate governance, since the stakes in terms of economic welfare are high. Weak corporate governance produces mismanagement and misallocation of resources and potentially poor economic performance. Corporate scandals that result from executive greed or accounting improprieties, such as those
surrounding the American energy giant Enron, thrust corporate governance practice into the spotlight, underlining the key role it plays in the economy. Open and competitive market economies perforce have low tolerance for systemic corporate malfunction (Sheard, 1998).
Yet systems of corporate governance are very diverse across different market economies, even within the most successful industrial economies. The imperative to deliver sound corporate governance may be universal across such economies. The legal, regulatory, institutional and private arrangements that exist to promote it vary significantly from country to country (Guillen, 2000; Claessens, et al, 2002). Whether there is convergence towards a common model of corporate governance across
countries is another question (Guillen, 2000).
The role of corporate governance in different market economies may largely be the same. Management needs appropriate incentive to work hard, to be honest, and to make effective decisions about the use of the resources in its trust. The capital market needs to be able to monitor management and its corporate investment planning and effect redress when problems arise. A key function of corporate governance
arrangements is to align management incentives with social goals, sometimes narrowly defined as the interests of shareholders. Another is to allow the capital market to influence, and intervene in, corporate management to get rid of managers who are incompetent, intransigent or malfeasant and to restructure the assets of failing or failed companies. These monitoring and control functions are present in all
corporate governance systems. But their form varies vastly both within and across different economies (Sheard, 1998).
Features of Japanese Corporate Organisation
Jacoby (2001) cites a recent study that identifies six main features of Japanese corporate governance structures: stable cross-shareholdings; steady payment of dividends; heavy reliance of bank debt for financing; internal labour markets for managers; flexibility on pay cuts to protect employee jobs; a stakeholder ethos that includes employees. Currently, 82 per cent of listed Japanese firms have four or more
of these characteristics; only 5 per cent have less than three of them (Iganami et al, 2000).
These attributes of Japanese corporate organisation are deeply complementary. Two aspects of the first attribute stand out as integral to Japanese corporate governance structures.
The first is that both financial and non-financial Japanese corporations have a strong tendency to have their equity owned by other corporations with which they have relational business or financial dealings, and themselves to own the equity of related firms (Okabe, 2002). Data on cross-shareholdings among Japan's six main corporate groups are set out in Table 1.
More particularly, Japanese corporate organisation has been structured around a main-bank system with extensive mutual or cross-shareholding among the members of these main-bank groups or financial keiretsu. Still, at the end of March 2003, financial institutions held 39.4 per cent of the market value of all stocks issued and traded publicly and non-financial corporations held 21.8 per cent. Japanese
corporations themselves owned 61.2 per cent of all stock, slightly more than the 59.8 per cent they held at the end of March 2000 (TSE, Factbook, 2003). The main features of Japanese corporate governance are intimately related to corporate cross-shareholding and the main-bank system.
The second aspect is that corporate shareholdings are not positioned for short-term financial gain. They are strategically placed for the longer term to ensure stable shareholdings and ownership structures (antei kabunushi).
These features of Japanese corporate organisation are central to corporate governance as it has operated in Japan, in what may be characterised as an insider-oriented system. They distinguish it from the system that is common in the Anglo-American and Australasian economies and which may be characterised as an outsider-oriented system of corporate governance (Sheard, 1998).
Table 1 Cross shareholding ratios: comparison of member corporations and non-member corporations of six large corporate groups, 1987–2001
Cross [Cross Cross Intra-group
Cross shareholding shareholding shareholding shareholding shareholding ratio of member ratio among ratio of ratio for each ratio for corporations that member corpo- corporations that of the six the entire belong to the six rations within the do not belong to large
stock large corporate six large corpo- the six large corpo- corporate
market groups rate groups] rate groups groups
1987 18.3 28.0 12.1 12.5 22.7
1988 17.9 25.3 11.0 13.1 –
1989 16.9 25.1 10.9 12.6 21.6
1990 18.0 26.2 11.1 13.6 –
1991 17.8 26.1 11.2 13.4 –
1992 17.7 26.2 11.1 13.1 22.2
1993 17.5 26.3 11.1 12.7 –
1994 17.4 25.6 10.8 12.7 –
1995 16.9 24.6 10.5 12.5 –
1996 16.2 23.8 10.2 11.9 21.4
1997 15.0 23.4 10.1 10.7 –
1998 13.2 21.8 9.9 9.3 –
1999 10.5 20.3 9.4 6.8 –
2000 10.1 16.7 7.5 7.0 –
2001 8.9 14.1 6.6 6.8 –
Notes:
1 ‘Cross shareholding ratio of member corporations that belong to the six large corporate groups’
includes both the case where the counterparty of mutual shareholding is a member corporation of the group and the case where the counterparty is not a member corporation.
2 ‘Cross shareholding ration among member corporations within the six large corporate groups’ is the case where the counterparty of mutual shareholding is a member of the same corporate group.
3 ‘Intragroup shareholding ratio for each of the six large corporate groups (Fair Trade Commission)’
is calculated for each corporate group as the percentage of member corporation shares owned by member corporations of the same corporate group. The figure is the average of the six corporate group. Thus, this includes the case where shareholding is not reciprocal but both the issuer and the owner are simply member corporations, as well as the case of note 2 above (the case that includes only mutual shareholding of member corporations).
Source: First four columns are from NLI Research Institute research, fifth column is based on data table 13 of the Fair Trade Commission (1998).
The difference between the two systems relates crucially to who undertakes corporate monitoring and what are the rules and conventions that determine who takes part in the process (Brecht, 2003). In the Japanese insider-based system, the role of corporate governance has been directly the responsibility of a small number of principal
economic agents, namely the main banks or large parent firms, and corporate governance is primarily a matter of internal regulation by them. In outsider-oriented systems such as that in the United States or in Australia, each of which have their own
particular institutional features, the arrangements for monitoring and control of corporations are effected more directly through the stock market and the presence of an active and hostile takeover market. These open market-oriented systems also have a more diverse set of monitoring and control mechanisms and which mechanism is more important will depend on the circumstances in response to competitive market pressures.
Often the distinction between these two systems of corporate organisation is described in terms of whether stock markets or banks play the dominant role in corporate
governance or in the monitoring and control of large corporations. This in turn hinges on whether there is an active takeover market in which the right to control listed corporations can be achieved by acquiring a large enough ownership stake.
Sometimes the former system is called the 'shareholder' system, the latter the
'stakeholder' (or 'blockholder') system. In the former, which can be thought of as an exit model, shareholders sell shares to discipline bad management; the latter is a 'voice' model where shareholders and other stakeholders are locked in and their discipline on bad management has to be through direct intervention. After successful takeover in the shareholder system like that in the US or Australia, those in charge of managing and directing a corporation may bear no relationship to those who were in charge before. In a bank-based stakeholder system like that in Japan this happens to large corporations extremely rarely. When things go wrong, it has commonly been the banks that intervene to sort them out. This process does not rely on an external
takeover market to deliver corporate change and restructuring. Insiders do the job and insiders are frequently left in the driver's seat after the job is done. Takeovers are traditionally insider takeovers.
There is, of course, controversy about this characterisation of the distinctiveness of the Japanese system and whether indeed it is entirely an insider-oriented system. It clearly is not entirely insider-oriented, because of the way in which some large independent firms, and to some degree all firms, relate to the equity market in Japan and globally. Miwa and Ramseyer (2001) have argued forcefully that the Japanese main-bank system is a myth, the intellectual construct of Marxist analysts and incompletely informed commentators. Milhaupt (2002) provides a robust and reasonable rebuttal of that view. The institutions of Japanese corporate governance
that almost everyone took for granted do exist. They may never have measured up to the stereotype but they are distinctive in sufficient degree to have significance for understanding the operation and performance of the Japanese economy.
The differences between these two systems, and their strong points and weak points, are critical to understanding the challenges now facing corporate organisational structures in Japan. It is not that one system is always and necessarily superior to another (Brecht, 2003; Jacoby, 2001). Nor are they impervious to change or purposeful reform. All systems have their distinctive origins and, as circumstances and market imperatives demand, they are forced to change and adapt.
The main banks play a major role in Japanese corporate organisation and the Japanese system of corporate governance, there is a the high degree of
cross-shareholding among main bank related corporate groups, or financial keiretsu. Cross-shareholding among major firms and banks in Japan has long been a central feature of Japanese industrial organisation (Gibson and Roe, 1993; Aoki and Patrick, 1994;
Sheard, 2000; Okabe, 2001). It is not an isolated element in the way in which the Japanese economic system works. It has been at the core of the whole system: the way in which the capital market worked to protect Japanese management against external competition; the structure of the labour market; and the system of industrial
innovation.
Here the main interest is on the way in which the system affects the operation of the capital market. Where stable shareholdings are a large proportion of firm shares, and the top shareholders are key creditors and business partners, they constitute a
powerful coalition in maintaining corporate control against takeover by domestic or foreign firms. This does not mean that firms are free from market disciplines. But when they get into trouble, it is the main banks or large parent firms who undertake the job of sorting problems out. There is an extensive literature on the way Japanese main banks have intervened to perform rescue operations on ailing firms, serving the function of the takeover market in other systems (Sheard, book 2001).
The Strengths of Japanese Corporate Governance
The set of complementary institutions that constitute the foundations of Japan's system of corporate governance has evolved in response to the circumstances and needs of an economy that achieved rapid and successful industrial development, notably in the latter part of the twentieth century. It would be difficult to argue that these institutions were a handicap to Japan's industrial transformation at least up until the last decade or so. Indeed, it could be argued that the Japanese system of corporate governance was well suited to the task of industrial catch-up if not an important factor in Japan's early industrial success. There is a wide variety of systems that have served the same purpose effectively (Claessens et al, 2002), so it is not clear that the
Japanese system, as many once claimed (Milhaupt, 2001) was the only or best model, but it certainly had its strengths.
Three aspects of Japanese corporate governance constitute its important strengths.
First, corporate organisational structures in Japan provide a high degree of managerial stability and autonomy. This is a considerable advantage when corporate decision-making can be focused on clear long-term growth goals, as was the case in the first forty years or so after the Pacific War. This was an era in which the introduction of technologies from abroad and the incremental development of technologies in Japan laid the foundations of Japan's industrial strength. In a rapidly catching up and growing economy, the development and maintenance of valuable and stable relationships with employees, suppliers and customers were critical to success and international competitiveness. As Sheard (1998) observes, successful Japanese firms were able to build up dedicated, skilful workforces and incredibly sophisticated, efficient parts and components supply systems. At least in part this was possible because the corporate governance system gave the parties concerned confidence that they would be able to engage in transactions over a long time horizon. This protected them from unexpected withdrawal of access to long-term capital or a change in control rights through takeover.
Second, the Japanese system had the advantage, especially important in a newly evolving financial market, of economising monitoring and intervention costs. Major
shareholders, including the banks, enjoyed economies of scope through their access to information relevant to corporate monitoring in the course of doing business with relational corporate partners within keiretsu groups (Aoki, 1990; Sheard, 2000). The same coalition of business partners that had the capacity to block hostile takeovers also had the information to judge management, and the incentive and means to effect change as necessary. The delegation of the principal responsibility for this monitoring function to the main bank reduced duplication of the task. The impact of the banking crisis over the last ten years raises questions about how the role of the banks in this system will evolve in future.
Third, in the past the Japanese system allowed firms to internalise training and employment adjustment costs (Aoki, 1990). This may have led to the overall level of these costs being lowered and certainly there were lower levels of explicit
unemployment in cyclical downturns in Japan than was common in other industrial countries. This strength was associated with the period of high growth and strong catch-up. In present circumstances this employee protection system is a burden for firms and corporate groups that have to undertake radical restructuring of their operations and workforces.
The Weaknesses in Japanese Corporate Governance
For each of the strengths of the Japanese system of corporate governance, there is also a weakness.
First, the system lacked transparency. Lack of transparency and open accountability inherently discriminates against outsiders. When things went bad generally, as they did post-bubble, it was prone to system-wide failure. Most important of all, though the Japanese system had its own domestic and internal logic, an open, accountable
market-oriented system is an essential requirement in the growth of interaction with the international financial market that is a necessary condition for keeping up with the industrial leaders.
Second, in the high growth era, the technology gap made corporate planning for growth more straightforward, investment opportunities were abundant, and micro and
macro economic goals were closely aligned. In an investment environment that is less certain, the system undervalues entrepreneurial risk-taking and the rewards for it.
Third, the system is not geared to promote active corporate restructuring. There were no hostile takeovers, boards of directors were large and there were no outside
members. Managerial autonomy and the lack of an active and hostile takeover market lessens the incentive to undertake radical and timely corporate rationalisation (Brecht, 2003). In a period of high growth and easy productivity gain through technology upgrading, this weakness was not apparent. When the demands are to dismantle, rearrange and recombine productive assets rather than simply to grow them, the system performs less effectively.
These observations about the strengths and weaknesses of Japanese corporate governance need to be put in comparative perspective.
In the stakeholder model of corporate organisation, the stakeholders command most of the votes at shareholders meetings. They appoint and remove the board of directors and the president or CEO. In the shareholder model, individual shareholders
command a small number of votes and are commonly passive players in appointment of the board. The incumbent board nominates the new board, often in practice at the initiative of the CEO. There are costs and benefits associated with each model.
Widely held stock diversifies risk over a large investor base. It also generates deeper secondary market liquidity and, as a result, a lower cost of equity. Boards are made accountable through the threat of the external takeover market. In the stakeholder model, boards are captive to stakeholders who may pursue their own aims over those of shareholders, for example, trading with related firms at non-competitive prices. The OECD Principles of Corporate Governance (1999), for this reason, recommend the appointment of directors who are independent of stakeholders.
Obviously, a more strongly shareholder-based corporate governance system has advantages over Japan's stakeholder system in terms of the powerful incentives if provides to deliver shareholder value. Direct competition for corporate control via the equity market keeps managers active. The prospect of managerial failure is much