Corporate governance plays an important part in corporates, as the relationship between these companies and their shareholders are very important. Companies benefit more when a stable long term relationship has been formed with the shareholders, thus maximizing the benefits for both parties. The importance of corporate governance was further realised particularly after the Enron scandal that happened during the year 2001. As corporate governance is still fairly new and is still being developed and improved, there are still different countries using a different corporate governance system when compared to the widely used U.S and U.K system.
In this study, I investigate the form and effects of the Japanese corporate governance in Japan, by studying the unique types of ownerships that do not exist in the U.K system, for example the relationship between the Japanese companies and their stakeholders, the view on social responsibility from the Japanese perspective and how will it affect the performance of the Japanese companies.
The method of research that was used in this study is quantum analysis. The source of data used are from academic journals, newspaper cuttings, Japanese companies' financial statements, and so on. The companies chosen for the purpose of research will be based on the size of the firm, and the international aspect of the firm, and will be based on the manufacturing group. Further data from these companies were obtained from the Tokyo Stock Exchange (TSE). The companies' way of management, shares, corporate social responsibility and financial data were examined to determine the effects of Japanese corporate governance.
Chapter 1: Introduction
History
Corporate governance in Japan has come a long way, where a pause on it during the mid-twentieth century which significantly changed the way corporate governance worked in the country, due to the imperialism, war, defeat , and also occupation (Herrigel, 2006). [1] During the 1930's, Japan underwent the militarisation process, where a special form of corporate governance was developed. This involved the emergence of broadly-held joint-stock companies, the forming of securities markets that are highly liquid and the companies working towards the benefits of the shareholders (Hoshi & Kashyap, 2001). [2] Not long after, two different types of corporate governance in Japan were developed, where the first one involved the state ownership of enterprise where managers worked together for the benefits of the public economic goals of Japan (Samuels, 1994). The next form would be the zaibatsu of Japan, where it rose to prominence during the Meiji Era just before World War 2. Zaibatsu placed importance on family controlled businesses, where it controlled the majority of the Japanese economy during that period. The financing on these family controlled businesses were mostly internal, and by the early 1930's some of these zaibatsu business groups that did not fail became a major source of the economy of Japan. The zaibatsu method was then successful, in both the performance of companies and also in taking over companies that were not doing well (Okazaki, 2007). [3]
During the mid-twentieth century, the system underwent major changes once more. The economy was then taken over by the military government, as a result of war and the need for economy recovery. The securities markets from the prewar were destroyed by the military government, private stockholdings were taxed and banks were used by the government for direct investing. This bank centrality was reproduced in the postwar economy, though the state's role in directing bank lending and corporate investment became more indirect (Hoshi & Kashyap 2001,Vitols 2001, Morck & Nakamura 2003). [4]
The Keiretsu System In Japanese Firms
Over the years, business ethnics, management strategies, and the way trading is done has undergone a significant amount of changes. This applies to most countries around the world. The scandal which involved Enron sparked the need of better corporate governance in the system, which has since influenced most companies that are based in the U.K. and the U.S. Compared to Japan, the evolution of corporate governance in Japan has been interesting, and most particularly post-war and during the 1990's. The 1900's period has often been labeled as the "lost decade" (Schaede, 2012) by most but there are arguments that this in fact, is not a "lost-decade" for Japan, but a reform of the management and trading system of Japan that will allow modern Japanese companies to improve and enhance firm performance by implementing or using the guidance of the U.S. and U.K.'s corporate governance models.
After World War 2, the new Japanese government made new laws which disbanded the zaibatsu system, emphasized on the protection of minority shareholders, and also encouraged on transparency and auditing (Hoshi and Kashyap 2001, Morck and Nakamura 2003). At the same time, inflation hit Japan which affected the stock prices, and making companies to work together by purchasing shares within the circle of companies, working towards the benefits of the group. This would be known as the keiretsu system, where the majority stakes in a group will be owned by friendly companies, making it hard for foreign investors to be involved the Japanese companies (Okazaki, 2007).
There are two types of keiretsu's, the modern horizontal keiretsu and the modern vertical keiretsu. One good example of the modern horizontal keiretsu would be the Mitsubishi group. In the Mitsubishi group, the Bank of Tokyo-Mitsubishi acts as the main bank of the keiretsu group. The rest of the group consist of Mitsubishi Motors, Mitsubishi Trust and Banking, Meiji Mutual Life Insurance Company, and also Mitsubishi Shoji. These members all have different functions in the keiretsu group, and all of them work together for benefits as a whole (Twomey, 2009). [5]
The modern vertical keiretsu consist of a group of companies within a horizontal keiretsu group. One example would be Toyota. To have a successful business, Toyota needs to rely on manufacturers and suppliers for car parts. Manpower is needed to assembly the parts together, as well as electronic parts to be implanted in their cars. These supplies are provided by large companies from a horizontal keiretsu group. These companies cater to Toyota's needs, so if there is no Toyota, these companies will have no purpose in the group.
In a keiretsu group, there exist the central banks that provide for the purpose of financing. Compared to the members of a keiretsu group that usually own a portion of shares within the group, these banks usually own a small percentage of shares and stocks. The relationship between the group and the bank is crucial as the members of the keiretsu group will need to make borrowings at times from the horizontal bank. By having such a relationship with the bank, the keiretsu group will benefit from the bank monitoring its borrowings, and the group's customers. In the event where there will be issues and problems with suppliers, the group can also rely on the bank to help with maintaining or solving the relationship between the keiretsu group and its suppliers. This connection will ensure that the workforce and board of directors will be part of the keiretsu group (Twomey, 2009). The main banks have the ability to coordinate and strengthen the development of the group members. The central position of a main bank within a keiretsu group will also allow it to monitor the keiretsu members and will be responsible in any event crisis by restructuring the efforts of the keiretsu group members (Herrigel, 2006).
The modern Japanese corporate governance has evolved in another way since the last change, where the employees in the company are now recognized as the stakeholders within the firm. EPA (1998) did a research and showed the constituents of corporate governance where it was found out that shareholders are interested in maximizing their profits and asset protection, investors are particularly concerned with the efficiency of investments, creditors need corporate governance for the protection of receivables, main banks within a keiretsu group are concerned with corporate growth, employees of the firm want promotion, pay raise, and also a secure employment relationship, the suppliers have interests on business stability and the ability to expand business, and lastly the consumers would want high quality goods and services (Sakai & Asaoka, 2003). [6] Modern Japanese firms focus on the maximization of stakeholder's wealth, rather than just the shareholder's benefits as compared to the U.S and U.K's corporate governance code (Kester, 1991). [7] Stakeholders of a firm has a higher position and considered more important when compared to outside shareholders.
Differences between Corporate Governance in Japan and the U.S and U.K
In the U.S and U.K, corporate governance is mainly focused on maximization of the wealth of shareholders. Compared to the Japanese corporate governance, the stakeholders are given more priority than to the shareholders. Morck and Nakamura (1999) argue that the Japanese keiretsu and main bank system are largely in the hands of the creditors rather than the shareholders as compared to the U.S and U.K. The Japanese corporate governance implement the internalization of the outside stakeholders such as the creditors and shareholders. By doing so, the unique transaction relationship will then be created. Japanese firms can utilize this to save on agency costs that will arise from the separation of ownership and control. As a result, a stable financing scheme will be produced and benefits the firms. Firms that are based in the U.S and U.K usually focus on the short term profit of the firm, as compared to the Japanese corporate governance, Japanese firms focus more on the long term performance of the firm, hence having a more stable management and workforce. Japanese firms also tend to have instituitional complementaries such as a lifelong employment system and the seniority employment system (Sakai & Asaoka, 2003). However, the main bank system that exists in the modern Japanese corporate governance code has a few flaws when compared to the corporate governance code in the U.S and the U.K. One of the more obvious downside to it is the management transparency of Japanese firms. In the U.S and U.K, as shareholders benefits are being put in the first place, the firms are encouraged to disclose more information to the public and users, especially after the Enron scandal. Hence there is more transparency. Japanese firms and keiretsu groups mostly use closed-information sharing between firms, so there are limited information that are being disclosed to the public and users. Other than that, the profits of small shareholders and customers in Japanese firms are not on the priority list.
Dissertation Literature Review
This is a literature review of the studies and researches that were used in the study of my topic on "how does corporate governance in Japan affect the Japanese companies?". The list of academic journals used and read in this study will be listed in this section, which includes the evidence and findings of researchers to strengthen the statements and results for this research topic. These journals and materials will come to a conclusion that corporate governance in Japan does positively affect firm performance of the Japanese companies. However, there are still limitations surrounding this issue and these factors that will hinder the study will be listed later in this literature review.
The Keiretsu system is a traditional system that exists in most large Japanese firms, where it means a grouping of companies that share common denominators with each other. In the Keiretsu system, there will be a major commercial bank which will function as the "main bank". This major bank will then serve as a central organization in the group and played a leading role of financial activities within the group. [8] It was also found that firms that used the Keiretsu system had better business ties and with other firms in the group, and would often work together for benefits as a whole. In another study (Nguyen, 2011), the total risks taken by companies were studied by measuring the standard deviation of the firms' monthly stock returns for a period of 60 months. The firms were divided into two categories, which are firms that are under bank control and the latter under family control. It was found that family oriented ownerships tend to take more risks as compared to the firms that are under bank control. The total risk taken per month is about 11.9%, where the idiosyncratic risk is larger than the systematic risk. This study can be linked to the researched done by the team of researchers Kato and Rockel in year 1992. A research was done to examine the relationship between the amount of top executive compensation and corporate governance, and also the relationship between corporate governance, keiretsu influences and firm performance in Japan. Kato and Rockel obtained date of outside directors of the chosen firms from Yakuin Shikiho. Next, the data on the percentage of shares in firms that are owned by the foreign shareholders were obtained from the source Kaisha Shikiho. To examine if the keiretsu concept did indeed strengthen the corporate governance aspect of the firms, further data on the keiretsu affiliation of the firms were obtained from the table Industrial Groupings in Japan during the year 1990. Firms were categorized into keiretsu or non-keiretsu firms. The data from these keiretsu groups were further obtained from the 1990 edition of Industrial Groupings in Japan that was published by Dodwell Marketing Consultants. The researchers found out that the firms that implement the keiretsu system has top executives with lower pays when compared to firms that not use the keiretsu system. Kato and Rockel (1992) argued that keiretsu groups are more efficient when it comes to monitoring the overall management of the group. In another study by Hoshi (1990), it was revealed that keiretsu groups have a higher ratio of loans that are mainly loaned from the main banks. However this is usually after an aftermath of an investment crisis. Hoshi (1990) argued that the keiretsu system that utilizes the main bank system has the positive side of helping to lower the financial distresses that arise in the firms. This can be seen with the Tobin's q equation that was used to measure the performance and internal financing of the keiretsu and non-keiretsu firms. The Q ratio, which was devised by James Tobin of Yale University, states that the combined value of all companies on a stock market should be about equal to their replacement costs [9] . From the results, it was showed that non-keiretsu firms had more internal financing constraints, and compared to the keiretsu firms where as shown from Hoshi's study that the main bank plays a role when it comes to financing stability, by letting the bank being a main core of financial elements to the keiretsu firms. The Tobin's q equation was used in another study by Mizuno and Tabner (2009), to study the return of equity of the firms to be used as a guideline to measure firm performance. In another research by Mitsuru (2010) on the effects of internal controls and the Japanese corporate governance, a list of companies on the Tokyo Stock Exchange (TSE) were chosen to be studied. The financial reports of these companies were obtained. Mitsuru's survey items are based mainly on the disclosure comapanies' executives' remunerations. The number of directors are also implemented in the study, where it was argued that it is related to firm performance in Japan. It was argued that good internal controls in a firm would result in a lower pay of the executives, as stated the same by Hoshi (1990). In another study did by the group of researchers Bauer, Frijins, Otten, and Tourani-Rad (2008), it was also suggested that directors' remuneration in a firm did affect the stock prices and firm performance of Japanese firms.
The stock price performance of a firm is also affected by corporate governance. In a study did by Bauer, Frijins, Otten, and Tourani-Rad (2008), they examined the effects of the quality of governance provisions and the effects of it on the Japanese firms. The effects of the Japanese corporate governance and firm performance were also studied. Data on the subjects were obtained from GMI by the writers. GMI stands for Governance Metric International, where firms from countries around the world have their governance ratings listed. These firms are mainly North American, European, and Asia-pacific companies. The list of companies were narrowed down by sorting the equally weighted portfolios in a group. After that, a point giving system was implemted to rate the firms' portfolios, from a scale of 1 to 10, where companies with the best performance will be given 10 points, and companies with the worst performance will be given 1 point. The firm performance of the subjects were measured by creating company portfolios that contained the subjects' stock price performance. This procedure was also weighted based on the point giving system ratings that were awarded. It was found out from the data that the stock performance of a company is affected by corporate governance provisions that deal with internal control, financial disclosure, director's remuneration and shareholders rights. Well governed firms with a higher score (10 etc,) were also found to outperform poorly governed firms (1 etc) significantly.
Another similar study was done by the team of researchers Aman and Nguyen (2008). The research was to find out the relationship between Japanese firms' stock prices with the quality of Japanese corporate governance that was used in the firms. This was to verify if poor corporate governance is actually related to poor stock prices, and the research would be useful as it can provide potential investors with adequate risk adjusted returns. It was revealed that when compared to the U.S corporate governance, the corporate board of the Japanese firms are often controlled by the insiders, there are also more interlocked shares when compared with U.S firms. A corporate governance index was also built for the purpose of this study. A list of 15 Japanese firms were selected from the Nikkei CGES. Agency conflicts were sought in these subjects as Aman and Nguyen believed that this factor plays an important role when it comes to determining good or bad corporate governance in a firm. However, the authors found out from the data that the rate of disclosure of these firms had a rather mixed effect when it comes to firm performance, meaning that it could not be determined if the rate disclosure has a constant effect on firm performance. Accounting transparency, on the other hand, had a positive influence. Firms that showed a good rate of transparency were also shown to have better firm performance when compared to the other firms that do not focus much on accounting transparency. Although the Japanese corporate governance does not put much importance on accounting transparency, there are more firms implementing accounting transparency into the firms' system. Aman and Nguyen also found out from the reports that investors often recognised firms that were governed well, as these firms have lower risk, allowing potential investors to invest in these firms with higher confidence. In return, these firms will benefit from having additional returns as compared to firms that have lower corporate governance (Aman & Nguyen, 2008). However, there is also evidence that by disclosing with slow price adjustments and announcement creations will allow investors to exploit the stock market. Aman and Nguyen argued that this could explain why there are exceptions where some firms with poor corporate governance have unusually high returns due to the higher exposure rate of a poor governed firm to the book-to-market risk factor.
Mizuno and Tabner (2009) did a research on the relationship between the institutional investors and corporate governance in Japan and the U.K. This research's purpose was to obtain more information on how is the relationship between the firms and their respective corporate governance system as there are differences between the Japanese corporate governance and the U.K corporate governance, as it is known that the Japanese corporate governance places importance on stakeholder capitalism while the U.K corporate governance places importance on shareholder capitalism. The subjects for the study were selected from the list of stock exchange listed firms in Japan. Other than that, the voting guidelines used by the PFA was also used as a reference for the research. A list of Japanese firms were selected from the years 2004 to 2007, where the company portfolios are retrieved and studied. From the company portfolios, a list of aspects are then studied and observed. First of all, a selected firm will be observed if it is adopting the three committee-based structure or corporate auditor structure; whether a system of non-statutory executive ofï¬cers is introduced or not in the case of a ï¬rm adopting corporate auditor structure; whether outside directors exist or not in the case of a ï¬rm adopting corporate auditor structure; the PFA states that at least one-third of directors should be outside directors; whether corporate auditors are of an independent stance with no material interests whatsoever in the company concerned or not; the number of directors in the firm; Whether a ï¬rm is introducing the stock option or not, Whether there is a disclosure of total executives' remuneration or not; whether there is a disclosure of each executive's remuneration or not; and also lastly whether defensive measures against corporate takeover have been introduced by judgment of the board of directors without obtaining an authorisation at a general shareholders meeting or not (Mizuno & Tabner, 2009). The Tobin's q equation was used to calculate the return of equity of the selected firms. The results are then used to measure the firm performance of the firms. It was noted that when the return of equity of a firm is high, it resulted in an overall better firm performance. However, Mizuno and Tabner argued that when it comes to the relationship between corporate governance and firm performance, there are not a lot of difference that will matter as to the model or type of corporate governance that is being implemented by a firm. It was suggested that Japanese firms made much effort when it comes to improving the corporate governance that will be implemented in the firm, disregarding whatever type of corporate governance that is chosen. Instead, it was argued that firm performance is affected more by mostly foreign investors and domestic institutional investors of the firms. There was an additional problem which the authors raised which is even though that the U.K corporate governance emphasizes on shareholder capitalism, but when compared to the Japanese, shareholders' rights were not being fully exercised in both countries.
Corporate social responsibility (CSR) has a strong footing in the Japanese corporate governance as the top performers in the Tokyo Stock Exchange have a strong belief in it. Wokutch and Shepard (1999) [10] did a research on the Japanese's belief in CSR where Japanese firms' business activity has been known to be linked with the society's moral values. It was suggested that a simple way to understanding the CSR is through the stakeholder management model (Freeman, 1984). [11] From this model, managers will manage for the common benefits and balance of the various stakeholders within the corporation. Wokutch and Sheppard (1999) argued that the stakeholders, which include the customers, stockholders, employees, suppliers, the local community and even interest groups can have a strong influence on a corporation's performance, hence Japanese firms emphasize on this section, as if the firms attempt to benefit these stakeholders, although it is expensive in the short run, but in the long run there will be visible benefits especially in terms of finance. In the study did by Wokutch and Shepard, the Japanese has unique management techniques based on their view of CSR. This includes having a lifetime employment system (shogai koyo), exclusive benefits for the employees, workplace safety, and also the health benefits of the employees. These practices has been shown to promote in an increase of employee morale and productivity, thus increasing the quality of products and services produced (Ouchi, 1981). [12] In another study by Mueller, Karsten, Hattrup, Kate, Spiess, Sven-Oliver, Lin-Hi, Nick (2012) [13] , it was also shown that by using a short eight item general CSR measurement, which included good convergent validity when combined with another measurement of CSR and discriminant validity such as such as perceived organizational support, justice perceptions, job satisfaction, and high performance work climate. The employees of these companies studied showed positive job satisfaction, this showed a positive relationship between the employees and employers. The authors concluded that CSR is an important factor to a company's wellbeing as it will have positive effects on the production and management, also customers and the public will have a better image of the company. Worker illness and injuries have been shown to be at a lower rate too. However, there are also a few negative factors to the Japanese CSR. Even if the Japanese takes priority in the workers' safety and wellbeing, there are still gaps to it. Working conditions for seasoned workers seem to be more favourable when compared to the part time or temporary workers. One of the examples is that when it comes to the lifetime employment system, it might have a different perspective when it comes to even the most privileged worker of the firm, as most workers usually face mandatory retirement when they hit the mid 50 years old age barrier.
Another study by Fukukawa and Moon (2004) on the top 50 Japanese companies on the attitudes towards CSR. The authors suggested a number of drivers that drive Japanese companies in undertaking CSR, where there are the imperatives in the Japanese society, leadership in the business aspect, and globalisation. Japanese firms have become more involved in globalisation, as we can see there are more Japanese products appearing outside of Japan. These Japanese businesses not only sell their products overseas, but also have been starting to find manufacturers that are located outside of Japan, which include countries that associate with CSR such as the U.S, U.K, and Australia. This not only allows these Japanese corporations to learn and improve their CSR guidelines, it will also improve the business relationships with these countries (Fukukawa & Moon, 2004). Out of the 50 companies that were studied, only 3 (6%) company websites were exclusively in the Japanese language. Of the remainder, 35 (70%) have domestic sites in both Japanese and English (the contents being almost the same or equivalent) while 11 (22%) have domestic sites in Japanese and 'global' sites in English (with the contents bearing some differences) (Fukukawa & Moon, 2004). 96% of the companies claimed to have sectors that are dedicated to CSR management, together with 90% of the companies claiming to produce CSR reports on a regular basis (Fukukawa & Moon, 2004). It was found that most of the companies have a policy statement on CSR which includes dedicated organisational units, policy guidelines, environmental reports (recycling, waste management, and natural resources management). The involvement of Japanese firms in CSR can be further confirmed by looking at the Asahi Foundation Survey that was carried out during 2001. 21 companies took part in the survey and the results were: 19 (90%) were given a grade A, 2 (10%) were given a grade B. Fukukawa and Moon also argued that Japanese companies place importance in CSR when it comes to corporate governance is due to the fact that any issues relating to public health and environmental can have a negative impact on Japanese firms as they rely much on public opinion (Wokutch, 1991). [14] The customers of these selected firms were also provided with information regarding the products' after purchase services and the customers' safety. 34% of these companies provided information for customer care and service while the 56% provided much more detailed contact points such as telephone numbers, email addresses, and also online forms. When it comes to customers' privacy, 14 (66%) out of the 21 companies were given an A grade. 95% of the companies are found to make good attempt to letting customers know about their rights.
