Policy Research Institute

Table of Contents

Vol. 121 : Corporate Governance


Summary of Articles

Ownership Structure and Corporate Governance
― Has an Increase in Institutional Investors’ Ownership Improved Business Performance?―

By Hideaki Miyajima(Professor, Graduate School of Commerce, Waseda University)
By Takaaki Hoda(Associate Professor, Faculty of Global Business, Showa Women’s University)

(Abstract)

A dramatic increase in shareholder ownership by domestic and foreign institutional investors, along with the decline of the main bank system, is one of the greatest changes in the governance structure of Japanese companies in recent years. This paper aims to identify the effects of the rapid change in the shareholder ownership structure on corporate governance in Japan. Based on a comprehensive database concerning major shareholders in fiscal 1990-2008 that specifies the attributes of shareholders to a maximum possible extent, this paper indicated the following points. First, when selecting stocks, both domestic and foreign institutional investors not only make the selection based on companies’ size and stock liquidity but also prefer high-quality stocks in terms of profitability, stability and financial soundness. In contrast, banks and insurance companies continue to invest in low-quality companies. Furthermore, compared with domestic institutional investors, foreign ones have a strong tendency to attach importance to formal governance features (size of the board of directors and presence or absence of outside directors). Foreign institutional investors also consistently have a strong home bias. Second, an increase in share ownership by domestic and foreign institutional investors produces a substantial amount of positive effects on stock price performance. That is largely because of a demand shock, namely a rise in the stock price caused by their own investments in the case of both domestic and foreign institutional investors. However, in the case of foreign institutional investors, it is also because of the monitoring effect. Lastly, whereas shareholder ownership by banks and insurance companies has negative effects on enterprise value and corporate earnings, share ownership by domestic and foreign institutional investors has positive effects. This finding indicates that even if a rise in domestic and foreign institutional investors’ ownership ratio is based on an institutional investor bias or a home bias or if the impact on the stock price is due to a demand shock, an increase in share ownership by domestic and foreign institutional investors will enable them to virtually exercise the monitoring effect through actions such as indicating the possibility of an exit (possibility of selling off their holdings of shares) and voice.

Keywords: Ownership structure, investment criteria, corporate governance, corporate performance, institutional investors

JEL Classification: G11, G32, G34

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Determinants of Composition of Boards of Directors and Auditors

By Takuji Saito(Associate Professor, Graduate School of Business Administration, Keio University)

(Abstract)

This paper analyze the determinants of the composition of the boards of directors and auditors at Japanese companies. Although the importance of boards of auditors has long been pointed out, it has never been studied so far. Regarding the composition of the board of directors, this research expands on previous studies in two aspects. The first is how the board of auditors affects the composition of the board of directors. The second is what factors influence who are selected as outside directors. For this purpose, we empirically analyze the determinants of the boards using a sample of companies listed on the Tokyo Stock Exchange’s first section from 2005 to 2010. We find that the cost of acquiring information, which have substantial effects on the proportion of outside officers in previous studies, has significant effects on the composition of the board of directors but not on the composition of the board of auditors. Regarding the relationship between the boards of directors and auditors, the current numbers of outside auditors do not affects the number of outside directors. However, the number of outside auditors in 2001 affects the current number of outside directors. This finding contravenes a reason often cited for not introducing outside directors: that outside auditors play an important role. In addition, we find that outside directors were generally selected on advising needs, as exemplified by a case in which a company with a high overseas sales ratio selects a former government official.

Keywords: corporate governance, board of directors, board of auditors

JEL Classification: G34, G38, K22

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Estimating Private Benefits of Control from Stock Price Changes Around the Announcement of Tender Offer Bid (TOB)

By Kazunori Suzuki(Professor, Graduate School of Finance, Accounting and Law, Waseda University)

(Abstract)

This research analyzes 262 cases of tender offer bid (TOB) in which the acquired companies were expected to remain listed after the deals, from among TOB deals conducted between 1990 and 2011, and estimates the value of private benefits of control in Japan based on the premiums paid relative to the post-deal stock prices.

The research finds that the estimated value of private benefits gained through TOB deals in Japan has been positive (the average value was 12.7% and the median value was 7.7%, and both figures were statistically significant at a 1% level) since the prohibition of a partial tender offer beyond 66.7% of outstanding shares was introduced in December 2006, although the average private benefits during the whole of the 1990-2011 period was not statistically significant.

Regarding factors that affect the estimated value of private benefits gained through TOB deals, the research finds the following:
 (1) The acquiring company’s high shareownership ratio before the TOB deal has positive effects.
 (2) A high share ownership ratio resulting from the TOB deal has negative effects.
 (3) The presence of a block holder has negative effects.
 (4) When the acquired company is reporting financial losses, it has negative effects.
 (5) There is a negative correlation between the cash flow improvement effect achieved under the management of the acquiring company (new management team) and the estimated value of private benefits.

It was also confirmed (6) that when the stock price immediately before the announcement of the TOB deal was lower than the peak price during the one-year period prior to the announcement, the estimated value of private benefits tended to be high and (7) that the value of private benefits has been relatively high since the prohibition of a partial tender offer beyond 66.7% in December 2006.

Keywords: tender offer bid (TOB), control premium, private benefits

JEL Classification: G34, G38

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Diversification Discount and Corporate Governance

By Tatsuo Ushijima(Professor, Graduate School of International Management, Aoyama University)

(Abstract)

Many studies concerning U.S. firms reported on the presence of a diversification discount (which refers to the tendency of firms which have diversified into multiple industries to be valued lower by the market than firms focused on a single industry). This research examines whether there is a diversification discount among Japanese firms as well and the relationship between their diversification and governance based on consolidated business segment data in 2004 to 2012. As a result of the analysis, it was found that diversified firms were valued 6% to 7% lower by the market than focused firms, meaning that there was a diversification discount among Japanese firms. The research also showed that the quality of governance is an important determinant of the enterprise value, that diversification weakens the value-enhancing effect of governance and that the effects of governance on corporate behavior materialize strongly when diversification is terminated (when a diversified firm becomes a focused firm). These findings indicate that Japanese firms’ diversification involves an agency problem, which tends to take the form of continuation of inefficient business operations.

Keywords: diversification, enterprise value, agency problem, corporate governance

JEL Classification: G32, G34

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General Shareholders’ Meetings and Corporate Governance
-Focusing on Electronic Provision of Reference Materials for General Shareholders’ Meetings-

By Wataru Tanaka(Associate Professor, Institute of Social Science, University of Tokyo)

(Abstract)

This paper examines the possibility of revising institutional systems concerning electronic provision of reference materials for general shareholders’ meetings to shareholders as part of a legal system reform intended to promote dialogue between companies and investors (shareholders). Electronic provision of reference materials for general shareholders’ meetings to shareholders not only helps to reduce paper consumption and lower companies’ expenses but it could also improve the quality of shareholders’ decision-making and promote dialogue between companies and shareholders through the enhancement and speeding-up of the provision of information before general shareholders’ meetings. Under a system based on the current Companies Act, companies may electronically send a notice of the convening of general shareholders’ meetings and electronically provide all reference materials for general shareholders’ meetings after obtaining consent from investors individually. However, this system is rarely used, and it has been pointed out that there are limits to a system that requires that consent be obtained from shareholders individually. This paper analyzes the U.S. legal system under which companies publish reference materials for general shareholders’ meetings via their website and send shareholders written notices providing a minimum set of information, including the date and venue of the meeting and the method of accessing their website, and, based on the analysis, it considers the possibility of Japan adopting a similar system and challenges that must be overcome to that end.

Keywords: corporate governance, use of electronic provision of information to facilitate general shareholders’ meetings, promotion of dialogue between companies and investors

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Trends in European Corporate Group Law System and the Future of the Japan’s Corprate Law System

By Koji Funatsu(Associate Professor, Faculty of Law, Doshisha University)

(Abstract)

Balancing the interests of the parent company (the corporate group as a whole) and those of its subsidiaries when managing a corporate group is a challenge in corporate law. To address this challenge, legislative proposals based on the understanding that protecting the interests of subsidiaries should be the top priority have been repeatedly presented in Japan and Europe. However, in Europe, rules that appear to place priority on the activities of parent companies and corporate groups as a whole have recently been presented due to the practice of conducting corporate activities on a group basis and the effects of globalization.

This paper closely examines recent debates concerning this matter in Europe and identifies the factors that have brought changes in the basic thinking behind the debates. By doing so, the paper reviews existing views concerning corporate group law system in Japan (particularly in relation to the management of groups) and presents points of attention concerning how to proceed with future debates.

Keywords: corporate group law system, protection of minority shareholders of subsidiaries

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The Fiduciary Duties of Directors of the Target Companies Facing the Mergers and Acquisitions in Delaware and Japan

By Hidefusa Iida(Associate Professor, Graduate School of Law, Kobe University)

(Abstract)

This paper studies the relationship between the Revlon duties and the principle of maximizing shareholders’ interests, and its position under the systems of Corporate Law, and then identifies the characteristics of relevant laws in Japan and Delaware. When considering the duties of directors regarding the fairness of the acquisition price, the right approach is discussing how to deal with conflicts of interest and the final period problem as issues specific to the acquisition of companies, rather than considering the issue based on deduction from the principle of maximizing shareholders’ interests. There are two prominent features of relevant Japanese laws with respect to judicial examination of the duties of directors regarding the appropriateness of the acquisition price: (1) respect for shareholders’ intentions and (2) the approach of paying attention to the price itself, rather than the process of mergers and acquisitions. Among background factors for that is a consistency with related systems such as regulation on transactions involving conflicts of interest and regulation on issuance of new shares in Corporate Law. Therefore, in order to require revision of the duties of directors of target companies, it is necessary to present a package of reforms regarding relevant systems as a whole.

Keywords: corporate governance, acquisition of companies, duties of directors

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Estimate of Long-term Governmental Expenditures and Analysis of the Scale of Necessary Fiscal Consolidation of the Japanese Government in the 21st Century

By Nobutoshi Kitaura(senior research fellow, Institute for International Policy Studies, visiting researcher, Policy Research Institute, Ministry of Finance)

(Abstract)

I first looked at an overview of theories concerning fiscal consolidation and previous studies concerning governmental expenditures in Japan and then made a long-term estimate of government expenditures in the period through 2110 and the scale of necessary fiscal consolidation while taking into consideration problems in previous studies and pressures for increasing governmental expenditures associated with the aging of society. The outline of the results is as described below.

First, regarding previous studies concerning estimates of governmental expenditures in Japan, I pointed out that the previous studies failed to indicate to what level governmental expenditures will increase and by which time and on what scale Japan must carry out fiscal consolidation. The Japanese government’s estimation period is around only 15 years, although Japan’s population is expected to continue aging until the 2070s according to the median estimate of future population and pressures for increasing governmental expenditures are expected to continue growing. In addition, estimates of the Social Security Funds and those of the Central and Local Governments are being analyzed separately in the government’s analysis. Regarding the IMF’s analysis (2013), I pointed out that the analysis did not take into consideration pressures for increasing governmental expenditures associated with the aging of society, although the IMF estimate was done under a comprehensive framework and proposed specific fiscal consolidation measures.

Second, I confirmed that there is a strong correlation between the past population aging rate, share of population aged 65 and over, and the governmental expenditures as a proportion of nominal GDP (hereinafter referred to as the “governmental expenditure level”) through the demographic aging effect. A rise of 2 percentage points in the population aging rate increased the governmental expenditure level by 1.2 percentage points in Japan.

Third, I made a long-term estimate of governmental expenditures in the period through 2110 while taking into consideration the past trend and the characteristics of various social insurance systems. As a result, it was found that in the case of a birthrate of 1.35 (the government’s median estimate of future population), the governmental expenditure level (38% as a proportion of nominal GDP in fiscal 2012) will continue to increase until around 2080 mainly because of the aging effect (3.6 percentage points higher in fiscal 2040, 6.2 percentage points higher in fiscal 2060 and 7.3 percentage points higher in fiscal 2110 compared with the level in fiscal 2012). On the other hand, in a birthrate recovery case, where the birth rate will recover to 2.07 by 2030, it was found that the governmental expenditure level will stay higher than the level in the case of a birthrate of 1.35 until the mid-2050s due to the reduction of the period of pension adjustments made in accordance with the macroeconomic condition and an increase in educational expenses and will subsequently decline due to a positive aging effect resulting from a decrease in the aging rate caused by an improvement in the birthrate (in the case of a birthrate of 2.07, the governmental expenditure level will be 5.2 percentage points higher in fiscal 2040, 5.8 percentage points higher in fiscal 2050 and 0.7 percentage points higher in fiscal 2110 compared with the level in fiscal 2012).

Fourth, I calculated the sustainability gap, or the margin of improvement in the fiscal balance that would be immediately necessary in order to reduce the level of outstanding public debts on a net basis (126% as a proportion of nominal GDP in fiscal 2012) to 126% or 60% (60% on a net basis is equivalent to 90% on a gross basis, a threshold level below which the probability of a fiscal crisis is deemed to decline). As a result, it was found, as in previous studies, that fiscal consolidation equivalent to 11 to 15 percentage points of nominal GDP would be immediately necessary.

Fifth, in order to consider a more realistic scale of fiscal consolidation and a path to achieving it, I calculated the scale of fiscal consolidation that would be necessary in the next 10 to 20 years in order to reduce the level of public debts on a net basis to 60% as a proportion of nominal GDP. As a result, it was found that fiscal consolidation equivalent to 15 to 19 percentage points of nominal GDP would be necessary. Given the large scale of fiscal consolidation required each year (1% to 1.5% as a proportion of nominal GDP) and the long period of consolidation (10 to 20 years), such a fiscal consolidation measure would be difficult to realize. It could cause a “fiscal consolidation fatigue.”

Sixth, I calculated the scale of additional fiscal consolidation that would be necessary in the 10-year period from fiscal 2030 in order to achieve the target level of public debts (60% as a proportion of nominal GDP on a net basis) 100 years later if after the implementation of the rigorous fiscal consolidation measures proposed by the IMF (2013) for the period through fiscal 2020, fiscal consolidation is suspended for 10 years as a measure based on a more realistic long-term fiscal plan. As a result, it was confirmed that additional fiscal consolidation equivalent to 2.1% (in the case of a birthrate of 2.07%) to 5.1% (in the case of a birthrate of 1.35%) of nominal GDP would be required.

Finally, I calculated the scale of fiscal consolidation that would be necessary in the 10-year period from fiscal 2030 in addition to the IMF-proposed fiscal consolidation measures if additional measures to improve the low birthrate that are comparable to those adopted by France and Sweden (2% as a proportion of nominal GDP) are adopted. As a result, it was confirmed that no additional increase in the scale of fiscal consolidation would be required (rather, the necessary scale would be smaller) if the starting age of pension benefits payment is raised from 65 to 70. Raising the starting age of pension payment has already been legislated in other advanced countries. In addition, as improving the low birthrate is expected to increase the economic growth rate substantially in the period leading to the 2040s, until when the aging of society will continue, it is presumably a desirable policy measure.

During the “lost two decades,” the Japanese economy failed to fully exercise its potential power as a result of such factors as the clean-up work after the collapse of economic bubbles, the occurrence of deflation and the materialization of structural problems. Japan already faces the severest fiscal condition among advanced countries, and the medium- to long-term potential growth rate is expected to decline due to further progress in the aging of society coupled with the low birthrate. In order to overcome such severe economic and social conditions, it is important to improve the birthrate and implement structural reforms under a clear long-term vision while securing public trust in fiscal management, as indicated by this paper. Japan is moving closer to a situation in which it will have to depend on foreign funds as a result of a decline in domestic savings due to the progress in the aging of society. It is desirable for debate to deepen widely among the Japanese people as soon as possible.

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Any article in the Review reflects the writer's own opinion, and has nothing to do with any statement issued by the Ministry of Finance or the Policy Research Institute.