Business Unit Governance in Japan: Focusing on corporate boundaries and two-layer agency relationships

With the diversification and globalization of Japanese companies in recent years, their business portfolios have become more complex, and the grouping of companies has progressed via carve-outs and M&As. As a result, adequate control of business units by headquarters (business unit governance) has grown in importance. Meanwhile, as organizational structures have become more decentralized, companies have to face two-tier agency relationships in corporate governance—the traditional agency relationship between shareholders and managers and the increasing number of agency relationships between headquarters’ managers and divisional managers or between a parent company and its subsidiaries. In this paper, we analyze the current practice of business governance, from the viewpoints of authority delegation and monitoring of business units. We use a survey on corporate diversification and the governance conducted by RIETI in April 2007, targeting the firms listed on the First Section of the Tokyo Stock Exchange (excluding financial and insurance companies). Through our analysis, we found that more authority was delegated to the wholly owned subsidiaries than to the in-house business units. Furthermore, we show that there was significant complementarity between the delegation of authority and monitoring of in-house business units, while that between the delegation of authority and wholly owned subsidiaries was not found. With respect to two-tier agency relationships, we illustrate that companies under stronger pressure from the capital market or those more actively reforming their board of directors are likely to monitor their business units more strictly.