Column 7 - For Whose Benefit Are Japanese Companies Run?

KUBO Katsuyuki
Associate Professor, Graduate School of Commerce, Waseda University

What incentive do corporate mangers have?

"Who owns a company" has been a topic of increasing debate. However, much of this discussion centers on the normative issue of "who should own a company." In contrast, very few analyses have dealt with the empirical issue of, "for whose benefit Japanese companies have been run," in part because it is difficult to empirically analyze this question. However, the question of the incentive for managers managing their companies can be analyzed. For instance, where there is a strong linkage between executive compensation and a company's stock price, corporate managers work hard to maximize the stock price. By analyzing monetary incentive for corporate managers, it becomes possible to examine how the motives of Japanese companies differ from those of their counterparts, such as companies in the United States.

A number of studies, particularly in the U.S., have examined monetary incentive for corporate managers. In many of these studies, it is implicitly assumed that the objective of the listed firms is to maximize shareholder wealth and it is considered desirable for companies to in some way align the interests of managers with those of the shareholders. Based on this idea, corporate managers, as agents for the shareholders, are required to run the company so as to maximize shareholder wealth. However, a conflict of interests exists between the two. While shareholders want corporate managers to maximize returns to them, corporate managers have incentive to run the company so as to maximize their own utility.

Such conflict occurs, not surprisingly, because ownership and management are separate. A company president who owns a majority share of the company has a strong incentive to work hard to increase the stock price. However, where ownership and management are separate, the president will not necessarily run the company for the benefit of shareholders. For instance, as of March 31, 2005, Matsushita Electric Industrial Co., Ltd. had 275,413 shareholders and 2,453,053,497 shares outstanding, of which only 3,900 shares, or 0.00015%, were held by the president. In this situation, an increase in the market capitalization of the company would give very little boost to the personal wealth of the president. In a case like this where the president's ownership is extremely low, can the president be counted on to work to increase the company's stock price?

Shareholder-manager conflict resulting from separation of ownership and management

The separation of ownership and management is often seen as problematic in terms of incentive effects. In reality, however, it is nearly impossible for presidents of today's major companies to own the bulk of their company's stock. The market capitalization of Toyota Motor Corporation is now approximately ¥20 trillion. Very few professional managers would have sufficient personal wealth to become a major shareholder of such a vast company. Corporate managers are risk-averse by nature and there is a limit to what they can do with their personal wealth. Thus ownership and management are naturally separate.

Where ownership-management separation is more pronounced, problematic conflicts of interest emerge between shareholders and managers. Monetary incentives have been employed against this problem. Systems in which a manager's income increases together with a rising company stock price impel the manager to seek to increase the stock price. U.S. corporate managers are known to receive enormous compensation through stock options and other means. This compensation, though criticized even in the U.S., is not necessarily bad from the viewpoint of corporate governance. For a corporate manager with significant stock options, the company's stock price is extremely important as a management target. When the stock price goes up, the manager's personal wealth increases just as sharply. Conversely, when the stock price goes down, the manager's personal wealth falls. This prospect of personal wealth provides corporate managers with a strong incentive to work to increase the stock price. Indeed, studies in the U.S. have found that U.S. corporate managers receive huge compensation by increasing the stock return of the firm.

Findings show that top Japanese managers lack monetary incentive to maximize stock price

So then how do Japanese companies handle this issue? In a joint study with Takuji Saito, assistant professor of economics at Kyoto Sangyo University, we analyzed monetary incentive offered to presidents of Japanese companies on the Tokyo, Osaka, and Nagoya stock exchanges between 1990 and 2003. Specifically, we focused on the amount of top managers' incomes when the stock return increased by 1%. Japanese corporate managers, unlike their U.S. counterparts, were found to receive little boost in their personal wealth by delivering excellent business results; but conversely, they receive little punishment for extremely poor results. In other words, managers of top Japanese companies have little financial incentive to maximize shareholder wealth. In 1991, top managers typically receive ¥497,000 for a 1% rise in their company's stock return. The amount was as low as ¥129,000 in 2003.

We also found that a ¥1,000 increase in a top company's market capitalization equaled a ¥0.832 increase in top management compensation in 1991 but the amount was even smaller, at ¥0.723 in 2003. That is, Japanese top managers have been given little monetary incentive to maximize their companies' stock prices and such incentive declined between 1991 and 2003. These figures are considerably lower compared with those in the U.S.

Japanese corporate governance in manager incentives moving away from U.S. style

Corporate managers are able to exercise strong control over corporate management. Therefore, the possibility always exists for them to spend on projects that do not maximize shareholder interests. Corporate managers, whose personal income is linked weakly with shareholder value, have incentive, not for maximizing profit by minimizing expenses, but for maximizing their own utility by expanding the company's size. In the U.S. pressure has increased on providing stronger monetary incentive for corporate managers as a means to solve this problem. Indeed, the amount of income for U.S. corporate managers attributable to an increase in shareholder value has been increasing every year.

Our study found that Japanese corporate mangers have little incentive for increasing shareholder value. In fact, such financial incentive becomes weaker. Contrary to popular perception that Japanese corporate governance is converging toward the U.S. style, our findings show that Japanese companies are moving away from U.S. style in the area of monetary incentive for corporate managers. As noted, it is not easy to identify for whose benefit Japanese companies have been run. However, findings from our recent research support the traditional perception that Japanese companies have not necessarily been run for the benefit of shareholders.

March 19, 2008

March 19, 2008

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