A British pension fund manager, responsible for investing billions in Japan, once compared the country’s opaque and cumbersome business practices to politics in Zimbabwe. Several years on, many foreign observers remain critical of Japanese corporate governance and alleged failings to secure “shareholder value”.
Recent scandals, such as the one at camera manufacturer Olympus, seem to prove their point. Since the 1990s, Olympus had systematically covered up losses amounting to well over a billion dollars. This scandal was exposed only after a new British CEO, Michael Woodford, took the helm in September 2011.
Unquestionably, there remain numerous problems with Japanese corporate governance, but there are also some valuable lessons to be learned. The UK government has made a lot of noise about reviving the country’s ailing manufacturing industries – it might like to take a closer look eastwards.
From an Anglo-Saxon perspective, the essence of corporate governance boils down to: how do you make sure that self-interested managers pursue company policies that are in the best interest of their shareholders?
Following Adam Smith’s classical argument of the invisible hand, the allocation of economic resources will be efficient if firms maximise the wealth of their shareholders and individuals pursue their own interests. “Shareholder value” should thus be the ultimate rationale of corporate governance.
Comparative research confirms that managers in the United States and the United Kingdom have long subscribed to this “shareholder value” view of the firm. However, Japanese and, for that matter, German managers tend to have a broader view. They believe that firms exist for the interest of all stakeholders, including shareholders, employees, other firms, and customers, and that job security is at times more important than dividends.
The way a country sets up and runs its firms is a key part of its business system, reflecting economic as well as social structures and norms. So, if the Japanese model of corporate governance is so radically different, what lessons can be learned?
British firms are not the only ones to feel the shareholders’ squeeze. Ever since the burst of the so-called bubble economy in the early 1990s, Japanese firms have faced intense international competition and demands for short-term profits. Foreign investors, who now own 28% of all stocks traded on the Tokyo Stock Exchange, have made the loudest noise and demanded shareholder orientation and corporate governance reform.
Despite considerable changes in the 2000s, for most Japanese managers “shareholder value” remains only one corporate objective among others, much to the dismay of many foreign observers.
Deviant or different?
Is Japanese corporate governance thus deviant or is it just different? For example, even though cross-shareholdings with supplier companies or major customers have declined substantially since the burst of the bubble economy, why are many Japanese managers still holding onto such practices?
The cynical, and in some cases justified view might be that they want to simply shield themselves from potential hostile takeover bids. However, such cross-shareholdings are also a measure to reinforce mutual business ties and allow firms to engage in long-term strategic investments, without worrying too much about what shareholders demand in the short-term.
Note, for example, that Japanese spending on research and development is at 3.5% of GDP - substantially higher than in liberal market economies such as the UK (1.8%) or the US (2.8%). Only Scandinavian countries can match Japan’s level of investment.
This same strategic view applies in the job market too; long-term employment continues to be an important feature of the Japanese business world. The internal training and job-rotation of these workers supports crucial features of the Japanese production system such as just-in-time and total quality control. With a greater emphasis placed on the long-term value of staff, the automatic response to an economic crisis isn’t to simply to lay people off, as most Western firms would do.
These connections between corporate governance, relations with other key companies, and strategic investment in research and training are particularly important in manufacturing.
The manufacturing share of GDP in Japan remains at 21.9% substantially higher than in the UK (10%) and the US (13.5%). If we are prepared to recognise Japan’s strong competitive advantages in many manufacturing industries, especially in advanced materials, its corporate governance practices might be seen in a more favourable light: Japanese style corporate governance facilitates long-term strategic investments in manufacturing industries. It supports long-term employment practices, enhances skills development and it allows long-term R&D strategies to maintain competitiveness.
In light of the UK government’s aim to bolster manufacturing, we should develop a nuanced understanding of the setup that has delivered such results for Japan. A careful analysis of the merits of conducting business in the interests of numerous stakeholders rather than just shareholders could see the development of more meaningful policies to revive British manufacturing.
It could, however, also lead to the conclusion that the existing liberal market institutions of the British form of capitalism are not, or no longer, compatible with a revival of these industries.