Outside Directors (Auditors) Affiliated through Interlocking Shareholding and Firm Value

The Japanese Corporate Governance Code compiled by the FSA and TSE in 2015 requires listed companies to have at least two outside directors or to provide explanations for having fewer outside directors. Thereafter, the proportion of companies with at least two outside directors increased rapidly to almost 100% in 2018. As of September 2018, however, in 348 companies, or about 20% of companies listed in the first section of the Tokyo Stock Exchange, half or more of the outside directors (auditors) are affiliated through relational shareholdings. This paper explores the determinants of incidences of these outside directors (auditors). We show that low firm value, high relational ownership and weak pressure from foreign institutional investors are related to having half or more of the outside directors (auditors) affiliated through relational shareholding. Moreover, we find that having half or more of the affiliated outside directors (auditors) is associated with an economically significant reduction in firm value. Our findings call for a reconsideration of disclosure rules on relational shareholding; in particular we argue that outside directors (auditors) affiliation through relational shareholding should be disclosed.