RIETI Report October 2004

Emerging Pattern of Corporate Governance in Japan
<RIETI Featured Fellow> Gregory JACKSON

Greetings from RIETI

The year 2004 has turned out to be a bumper year for typhoons. So far, a total of 23 tropical depressions have developed into typhoons as of October 13, and Typhoon No. 22 was the record ninth to hit Japan this year. A typhoon brings high winds and torrential rainfall, causing devastating damage to crops and people's lives. At the same time, however, the rains they bring are also an important source of water, indispensable to agriculture and industry.

Typhoons have even played a central role in Japanese history. The most famous of these were probably the kamikaze (divine winds) of the 13th century. In 1274 and again in 1281, just as Japan was being attacked by the Mongols, the kamikaze swept in and beat back the otherwise formidable Mongolian sea warriors. In 1543, the Portuguese introduced the gun and Christianity to Japan and it was typhoon winds - now popularly called "teppokaze" (gun winds) - that brought the Portuguese to the southern island of Tanegashima.

While both kamikaze and teppokaze refer to typhoons or their winds in general, these days each typhoon is given its own nickname. For instance, Typhoon No. 22, which was the most powerful to hit eastern Japan in a decade, is called "Ma-on," a Cantonese word meaning a horse saddle. Now that Ma-on, the runaway horse, has run its course, Japan is finally entering into a period of autumnal calm. RIETI's autumn, however, is a time of harvest, with a series of symposiums and other events slated for October and November. Ahead of the upcoming symposium "Emerging Patterns of Corporate Governance among Japanese Firms - Converging to Any Specific Model?" to be held on October 20, RIETI Report interviewed RIETI Visiting Fellow Gregory Jackson. A corporate governance specialist, he will present some of his latest research at the symposium.

RIETI FELLOWS NOW

Dr. Jackson received a B.A. in sociology from the University of Wisconsin in 1992, and an M.A. and Ph.D. from Columbia University in 1996 and 2002, respectively. He has held numerous academic posts, including research scientist at the Max-Planck-Institute for the Study of Societies in Cologne, Germany, and at the London School of Economics Centre for Economic Performance. Dr. Jackson is currently senior lecturer in strategy and comparative management at King's College, London, and a visiting fellow at RIETI. His major works include Organizing the Firm: Corporate Governance in Germany and Japan, 1870-2000 (under review by Cornell University Press), and "The Cross-National Diversity of Corporate Governance: Dimensions and Determinants," published in Academy of Management Review, (with Ruth Aguilera).

Interview

RIETI Report: What fundamental challenges and changes do Japanese firms now face with respect to their postwar institutions of corporate governance?

Jackson: Japan's postwar model of corporate governance had numerous competitive strengths. Today, the challenges to that model are diverse, and fall under at least four sets of issues. First, internationalization has exposed Japanese firms to new types of social norms and values. Cross-border mergers, FDI and exposure to foreign and international regulatory standards are all things that call for a greater focus on capital markets and different management cultures. The most direct pressures come from the growing numbers of foreign institutional investors, which exert a tremendous influence on the Japanese market. These investors have championed corporate governance reform in the name of shareholder value in the U.S. and present a major clash of culture with traditional Japanese management. Of course, not all firms in Japan are strongly exposed to such international pressures, and so we have to look beyond that for the full story.

Second, the deregulation of Japan's capital markets has had a huge impact. The bright side has been the greater access of large firms to bond markets, but the dark side has been the banking crisis. The "main bank" system, which was a central feature in the postwar business structure, has lost much of its capacity to be an effective corporate monitor. This again underlines the need for urgent policy measures to break the downward spiral of "evergreen" loans to bad borrowers while elsewhere, worthy firms cannot get credit. Smaller firms will continue to need banks, and restoring the monitoring capacity of banks is therefore key.

Third, corporate governance is increasingly challenged by what can be called the lifecycle of companies - their transitions through birth, growth, maturity and death or transformation. Different phases place different demands on governance. Japan is currently dealing with a large number of mature sectors in need of restructuring, but at the same time new enterprises need to be supported in emerging sectors. The knowledge, resources and capacities needed for, say, corporate restructuring and venture capital are quite different.

A fourth related issue is what can be called organizational architecture, or the characteristics of information-sharing and knowledge needed for coordination or innovation in different types of economic activity. IT and modular production are changing how knowledge is distributed, and this also affects governance by changing the boundaries of organizations.

RIETI Report: What are the impacts on Japan's corporate governance of recent legal reforms and public policy measures?

Jackson: The extent of legal reform in Japan has not been well appreciated by most foreign observers. Policy has been incremental, but it has opened many new options. Most measures have been enabling legislation, namely removing constraints on behavior and thus allowing management more flexibility, particularly in how corporate equity is used - such as stock options, share swaps, buybacks and so on. While these freedoms may support corporate restructuring, they also carry dangers. For one, more power goes into management's hands. Another issue is related to the international market for corporate control. If Japan allows foreign firms to buy Japanese firms through stock swaps, the threat of hostile takeovers in Japan may become real very quickly. As we see in Europe, U.S. or British firms tend to be valued highly by the stock market given their existing equity culture and the sheer size of pension funds that invest in blue chip firms. Greater valuations could also help U.S. firms leverage takeovers of their competitors in Japan too. While takeovers are often promoted as an effective governance mechanism, many target firms will not be the poor performers, but successful firms that are quite viable on their own.

On the issue of board reform, legal measures have also aimed to increase the role of outsiders, in particular outside directors. This issue remains controversial, and has been resisted strongly in Japan. But international experience suggests that we should not expect too much from outside directors - good or bad. In most cases, I doubt if outside board members are tough monitors of the CEO. If board members do not represent some stakeholder interest such as banks, employees or other investors, those outsiders are usually chosen by the CEO. A trade-off thus seems to exist between to two different meanings of independence - independence from so-called special interests of stakeholders, or independence from existing management. Japan's approach has been gentle - to enable but not mandate outsiders. So existing outsiders such as those dispatched from banks may continue playing a role, but newly appointed outsiders will probably be more important for advice and consultation than as true watchdogs. That role may nonetheless be valuable at many firms. A final word should also be said about statutory auditors (kansayaku). Little social science research has been done on their role, and whether recent moves to strengthen their independence from the firm have made it easier for them to play their legally prescribed role in corporate monitoring.

RIETI Report: Do you think Japan's corporate governance is now converging on the U.S. model, or has Japan made progress in developing a new approach to corporate governance?

Jackson: Corporate governance in Japan is becoming much more diverse, but it is not converging on the U.S. model. A most obvious example is that the commitment of Japanese managers to providing long-term employment has remained quite strong. So I think the emerging new Japanese model, if you like, is one that tries to blend a stakeholder orientation with greater transparency to the outside and greater "tension" within. Many latent issues will have to be discussed more openly, but few businesspeople in Japan seem to believe that the corporation should solely serve the interests of its shareholders, and that markets will take care of the rest. In this sense, I think Japan continues to have much in common with countries like Germany, where they are also trying to find a new balance within the stakeholder model. Meanwhile, the U.S. model has gone into a deep crisis since the Enron scandal. Many core features of the U.S. model have proved highly problematic. The Sarbanes-Oxley law may improve things at the margins, but it does not address many of the deeper underlying issues. Meanwhile, it makes more red tape.

In our academic recent studies, we use survey evidence to identify the major patterns of corporate governance among Japanese firms. Three main ones emerge. First, the traditional Japanese model continues to account for nearly 70% of firms. Within this large group, different segments of firms exist, and some are doing very badly in the context of the banking crisis. Others who are in stable, domestically-oriented businesses or part of successful, internationally-oriented business groups remain successful. Second, about 17% of Japanese firms are rather independent from old-style Japanese corporate governance. This group includes both some younger venture firms that are quite oriented to capital markets, but also firms with strong family legacies. Legacies of family control remain a neglected topic in Japan.

But among the largest and most important Japanese firms, corporate governance is moving increasingly to a hybrid model. What is a hybrid? Hybrids recombine distinct elements from different governance models, such as transparency and internal information sharing, or capital market orientation and commitment to stakeholders, or even lifetime employment with merit-based pay. These companies make up around 13% of those in Japan, but employ about half of the corporate workforce. Only a few of these firms have moved in a very strongly "Anglo-Saxon" direction, whereas about 80% of this group has been very selective in which new practices it adopts and how they are adapted to the existing company culture. So we may see stock options being picked up by many firms, but these are not the same stock options you find in the United States - luckily, I might add! The encouraging thing about these hybrid patterns is that many of the firms are performing very well, and seem very successful in slowly bringing their distinctive competitive strengths based on cooperative business relationships and strong corporate culture forward into a changed, more open, and internationalized world. But only time will tell if such experiments prove durable in the long term, or if investor pressures and generational change among top managers will erode these commitments to the stakeholder model. Much may depend on shareholders and employees learning to work together to increase the accountability of management.

RIETI Report: Would you explain briefly about the topics that will be dealt with at the upcoming RIETI Symposium "Emerging Patterns of Corporate Governance among Japanese Firms - Converging to Any Specific Model?"

Jackson: The symposium will present a selection of the topics covered in a forthcoming book, Corporate Governance in Japan: Organizational Diversity and Institutional Change, which I am editing for Oxford University Press, together with Masahiko Aoki of Stanford University and Hideaki Miyajima of Waseda University. The book emerged around our corporate governance study group at RIETI, but grew to include various other contributors. Since then, Professor Miyajima has been visiting at Harvard, and I have moved from Tokyo to London. But we have remained dedicated to presenting the state-of-the-art research on Japan to a broader international audience. Many international observers fail to understand just how much Japan is changing, and in what ways. So we hope this will help experts and practitioners toward a more informed and evidence-based view.

At the RIETI conference in Tokyo, we will deal specifically with four groups of topics: 1) changes in the main bank relationship and governance under conditions of financial distress such as bankruptcy; 2) changes in corporate ownership, such as the changes in cross-shareholding and the impact of increasing foreign ownership; 3) corporate law reform and board reform, especially the issue of outside directors; and 4) the impact of changes in finance and governance on Japanese employment institutions. In the last session, we hope to elaborate the picture above by presenting how changes in these areas interrelate and give rise to much more diverse patterns of corporate governance among Japanese companies than in the past. As a foreign observer of Japan, I especially look forward to the insight of leading Japanese experts in interpreting the results of our present study.

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For your reference,
Hot Issues "Corporate Governance"
http://www.rieti.go.jp/en/special/hot-issues/categories/corporate-governance.html

"Emerging Patterns of Corporate Governance among Japanese Firms - Converging to Any Specific Model?" October 20 (Wed.), 2004
For the program and to register your attendance, http://www.rieti.go.jp/en/events/04102001/info.html

EVENTS INFORMATION

Brown Bag Lunch Seminars

Coming Soon
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All BBLs run 12:15 - 13:45, unless otherwise stated.

10/21: Reinhard DRIFTE (Visiting Professor, Okuma School of Public Management, Waseda University)
"The Outlook for Japanese-Chinese Relations" (in Japanese)

10/26: HIROSE Ichiro (Senior Fellow, RIETI)
"Realignment of Professional Baseball Teams and Design of Institutional Arrangements" (in Japanese)

10/28: Peter COWHEY (Dean, Graduate School of International Relations and Pacific Studies, University of California, San Diego)
"The Impact of the US Presidential Election on United States Trade Policy"

For a complete list of past and upcoming BBL Seminars, see http://www.rieti.go.jp/en/events/bbl/index.html


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This month's featured article

Emerging Pattern of Corporate Governance in Japan
<RIETI Featured Fellow> Gregory JACKSON

Gregory JACKSONVisiting Fellow, RIETI

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Fellow titles and links in the text are as of the date of publication.

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RIETI Report is published monthly.