Column 5 - Corporate Governance or Corporate Culture?

Over the past 10 years, the issue of corporate governance has been one of the hottest topics in the Japanese media. It has been argued that Japan's corporate governance has not functioned properly and was one reason behind the slumping Japanese economy in the 1990s. There has also been active debate on the need to proactively develop a new system for shareholders to discipline corporate managers; U.S.-style corporate governance typified by boards composed mainly of outside directors, stock option plans, and hostile takeovers.

Yet it appears that U.S.-style governance has not been adopted as widely as was first expected. Only 2% of listed companies have shifted to a U.S.-style board of directors (company with committee) system, while the number of outside directors per Japanese company averages 0.8. There have also been moves to introduce and rebuild cross-shareholdings with friendly companies and introduce measures to counter the rising threat of hostile takeovers.

Media reports have often cast these moves in a negative light, as Japanese corporate managers' attempts to save their own necks. But I suspect there might be other rational reasons why so few Japanese companies have adopted U.S.-style corporate governance. Corporate culture might be playing an important role in Japanese companies' securing competitiveness, and not shifting to U.S.-style governance may have been to preserve this culture.

In U.S.-style governance, only two actors - shareholders and managers - are concerned with a company. The sole goal of the company is to maximize profit for its shareholders, a goal which hinges solely on the decision-making and conduct of the managers. Therefore, how shareholders discipline corporate managers, the only player in corporate management, is a pressing question.

I cannot support applying U.S.-style governance to Japanese companies due to the following two reasons. First, in the case of Japanese companies, it is considered practical to include employees, business partners, and associated banks - in addition to shareholders and managers - as parties concerned. Thus, the goal of a company cannot be as simple as maximizing profit for shareholders. Second, the employees of Japanese companies play a significant role in making decisions and taking action. A Nihon Keizai Shimbun survey (published March 24, 2004) of approximately 300 corporate managers in Japan, China, and South Korea, found that "skills and attributes of manager" is ranked first as an element required for corporate competitiveness both in China and South Korea, whereas "creativity for product and service development," "cost competitiveness," and "ability to develop products" top the list in Japan ("skills and attributes of manager" ranked sixth). This indicates that the ability of front-line employees, their ingenuity and high motivation for work, is a major source of Japanese companies' competitiveness.

That is, Japanese companies have two important characteristics: 1) presence of multiple stakeholders, and 2) involvement of not only managers but also employees as important players. Thus, vital issues in the management of a Japanese company are "what corporate goals should be set given the presence of multiple stakeholders" and "how to motivate the whole company; not only managers but also employees." These issues cannot be solved by U.S.-style governance.

I believe that corporate culture and its implantation in the company hold the key to solving these issues. Corporate culture refers to a set of values, beliefs, and behavioral norms shared by each individual within the company. Values and beliefs explicitly present the goals of the company to its members, while the behavioral norms provide them with specific guidance on how to conduct themselves. Furthermore, values boost the motivation of managers and employees who share them and the behavioral norms bring an element of self-discipline. In other words, in Japanese companies with characteristics 1) and 2) specified above, corporate culture is a prerequisite to effectively motivating corporate managers and employees to work toward achieving corporate goals. Superior corporate culture can be built and implanted in the company by presenting a corporate mission statement and educating each employee on these values, principles, and norms.

Thus, Japanese companies are more likely to improve performance by fostering a superior corporate culture and fostering its understanding in their employees, rather than by introducing U.S.-style corporate governance. And Japanese corporate managers might instinctively know this. In fact, issues related to corporate culture often arise when managers talk about corporate governance, saying things like, "good corporate culture is the key to the growth of the company," "corporate culture itself functions as corporate governance," and "implanting the values of a corporate mission statement within the employees is the best way to maximize the strength of a Japanese-style organization."

I teamed with Drs. Katsuyuki Kubo and Hideaki Miyajima, both of Waseda University, to conduct an empirical analysis on the importance of the corporate culture of Japanese firms. I would like to briefly discuss the findings and conclusion from this study that were summarized in "Does Corporate Culture Matter? An Empirical Study on Japanese Firms" (RIETI Discussion Paper Series 07-E-030, May 2007).

We classified sample companies listed on the first section of the Tokyo Stock Exchange into two groups; those with a mission statement and those without. We assumed that companies in the first group have strong corporate culture and those in the second weak corporate culture. Then we looked for any difference in business performance between these two groups (based on data for the 15-year period from 1986 to 2000). It was found that the return on assets (ROA) of companies with a mission statement is 0.42% higher than that of a company without, keeping other variables constant. Furthermore, companies with both a mission statement and a program to clarify it to employees show an ROA 0.84% higher than companies with no mission statement. This accounts for 26.6% of the average ROA for all sample companies (3.13%). And it indicates that the penetration of corporate culture within the organization works to raise corporate profitability by more than one quarter.

Companies with strong culture were also found as typically trying to reflect and capitalize on their corporate culture in employment policy, organizational structure, and financial policy. More specifically, companies with a mission statement, as compared to those without, exhibit some patterns:
1) Longer average length of service of the employees
2) Higher ratio of internally promoted directors
3) Lower leverage (debt-to-total assets ratio)
4) Higher cross-shareholding ratio
Of these, 1) is attributable to company policy that seeks to retain core employees familiarized with its corporate culture, and 2) to policy seeking to promote employees internally (promote those well-versed in the corporate culture) into management and/or board members. Numbers 3) and 4) seem to reflect companies' intentions to avoid default crises or hostile takeovers, which would undermine their corporate culture.

Interestingly, each of the above characteristics is considered undesirable from the viewpoint of U.S.-style governance. A board consisting mainly of internal directors, a low debt-to-total assets ratio, and a high cross-shareholding ratio are regarded as factors that weaken shareholder discipline of corporate managers. The practice of long-term employment, which often prevents well-timed restructuring in response to an economic downturn, is viewed as a factor that drags down profit. However, all these measures are considered reasonable for maintaining their corporate culture, which is a source of their competitive advantage.

So, which to choose, corporate governance or corporate culture? A U.S.-style governance system imposes greater discipline on corporate managers but it may undermine corporate culture, a driving force for Japanese companies. It appears that Japanese companies decided not to adopt U.S.-style governance as they believe corporate culture is more important than corporate governance.