Enjoying The Quiet Life: Corporate Decision- Making By Entrenced Managers Tokyo I nstitute of Technology with N. Ikeda and S. Watanabe School of Engineering Professor February 16, 2018 Japan Economic Seminar Kotaro Inoue Columbia Business School
Motivation: What is real costs of cross-shareholding? • Cross shareholding “Mochiai” – Interlocking ownership among business counterparties (keiretsu), lender banks, and member firms of corporate group (zaibatsu) • Stable shareholding “Antei-Kabunushi” – Long-term and stable shareholding by business counterparties and others who have close relation with the firms • Both were historically introduced to protect management from hostile takeover attempts in Japan – Still works as protection against activist hedge funds and against pressure from proxy advisory firms – Managers of firms with high cross shareholding should feel safe compared to those without such shield 2
Potential outcome of cross-shareholding • Japan is suffering from low corporate profitability, low economic growth, and poor stock market performance for the latest two decades, in spite of unprecedented monetary easing policy • Avoidance of risky investments and restructurings of unprofitable businesses are often pointed out as a cause of the low profitability and growth of Japanese firms • Under shield of cross-shareholding, managers might not take optimal risk for the firm value and growth, but simply enjoy their quiet life 3
Risk taking and Tobin’s q Arikawa, Inoue, and Saito (2017DP) 4
A hypothesis of inactive management • Quiet life hypothesis – Hicks (1935) and Hart (1983) argue that the managers of the monopolistic enterprises which are insulated from competition of the product market may not make adequate efforts simply because the negligence increases their utility – Bertrand and Mullainathan (2003JPE) shows the supporting evidences of this hypothesis from the US data that managers lower their effort level when they are protected from disciplinary effects from stock market – It seems possible explanation for behavior of Japanese firms in last two decades 5
An evidences of managerial quiet life • Bertrand and Mullainathan (2003) – Analyzed effects of the State Takeover Laws on decision-making of US firms using plant-level data – Introduction of the law into state where the corporate headquarter was located, the company’s plant construction and closure decreased, wages of workers increased, and the corporate performance turned worse – Managers avoid difficult decisions when they are protected from disciplinary effects from stock market 6
Cross-shareholding • Development and recent trend of cross-shareholding – Developed from late 1960s to serve as a deterrent to foreign takeovers (Hoshi and Kashyap 2001, p126) – In particular, banks and corporate group member firms are the center of interlocking shareholding arrangements – Cross-shareholding decreased in the period between 1997 and 2004 mainly due to selling shares by banks under banking crisis (Miyajima and Nitta, 2011) – Japanese firms still intentionally maintain the interlocking relation in the subsequent period • Many firms sustain cross-shareholding and this works as the strong protection against shareholder power (Tanaka and Xu, 2005) • Japanese firms start to reduce cross-shareholding recently to respond to Japanese Corporate Governance Code introduced in 2015 7
Historical ownership structure of Japanese Firms 35% 30% 25% 20% 15% 10% 5% 0% 1987 1991 1996 2001 2006 2008 Cross Shareholding Stable Shareholding Institutional Investors Individual Investors • This figure is based on the figures provided in Table 1 of Miyajima and Nitta (2011) 8
Effects of cross- and stable- shareholding • Two distinctive views to the effects – Positive effects from long-term commitment • Main banks, Keiretsu, and business counterparties provide effective monitoring and provide capital in flexible manner – Hoshi, Kashyap, and Scharfstein (1990, 1991) • This view seems to be more relevant in 1970s and 80s – Negative effects from management entrenchment • Whether they have positive or negative effects in current Japanese corporations is an empirical question 9
This study • To test the quiet life hypothesis in Japan, this study analyzes effects of cross- and stable shareholding on “difficult” corporate decisions – Large capital investments, M&A, R&D, and restructurings – panel data of listed firms on TSE1 from 2004 to 2014 • We find cross-shareholding allows managers to avoid difficult decisions, and this seems to result in lower risk taking by the firms – Institutional Investors show opposite effects – The results are consistent with quiet life hypothesis 10
Hypothesis 1 • Under the quiet life hypothesis, managers tend to decrease investments even when they have positive net present value to avoid the managerial efforts associated with large investments • H1: When a company has high cross- and stable- shareholding ratio, the level of capital expenditure, M&A investments, and R&D expenses are low 11
Hypothesis 2 • Under the quiet life hypothesis, even if the company has an unprofitable business, the protected managers are likely to postpone the decision to restructure the unprofitable business since it requires a significant managerial efforts in Japan • H2: When a company has high cross- and stable shareholding ratio, the probability of executing restructuring is low 12
Alternative hypotheses relating to the effects of cross shareholding • Career concern hypothesis – Protected managers do not have to concern their own career and will increase risky investments such as R&D • Aghion, Van Reenen, and Zingales, 2013 – Predicts opposite effects on risky investments such as R&D from cross shareholding • Over investments by entrenched managers – Entrenchment can result in overinvestment which also provides private benefit to managers • Jensen (1986), Harford (1999) – Predicts opposite effects on investments from cross shareholding 13
Data and Sample • Data – Governance related data: Nikkei Needs Cges – Other financial data: Nikkei Needs Financial Quest – M&A related data: Recof M&A database • Sample – Listed firms on Tokyo Stock Exchange 1 st Section – Panel data from FY2004 to 2014 • 24,506 firm-year 14
Independent Variables of Interest • Cross shareholding – Nikkei data captures interlocking shareholding more than 1% of outstanding shares – It is reports that even when it includes less than 1% but within the largest 30 shareholders, the ratio increase by only 2% • Stable shareholding – Ratio of stable shareholders excluding cross-shareholding and director ownership – The relation between stable shareholders and the firms are less clear due to lack of interlocking ownership relation 15
Dependent Variables • Investment behaviors – CAPEX: Capital expenditure / Total Assets – M&A: Annual M&A investments / Total Assets – R&D: R&D expenses / Total Assets • Restructurings – Sub dummy: dummy variable which takes one when the firm sells its subsidiaries – Reducing Seg dummy: dummy variable which takes one when the firm reduce its number of business segment (test in multiple business segment subsample) 16
Descriptive Statistics N Mean S.D Min Median Max Ratio of Capital expenditure to total CAPEX[t] 22362 0.0418 0.0438 0.0000 0.0307 0.9429 assets M&A[t] Ratio of M&A value to total assets 19811 0.0068 0.0464 0.0000 0.0000 1.7675 R&D[t] Ratiof of R&D expenses to total assets 14801 0.0227 0.0381 0.0000 0.0127 2.2593 Sub dummy[t] Dummy variable of subsidiary divesture 22363 0.1110 0.3141 0.0000 0.0000 1.0000 Dummy variable of business segment Reducing Seg dummy[t] 13952 0.0673 0.2506 0.0000 0.0000 1.0000 reduction Industry and year adjusted standard Risk-taking[t] 18271 0.0274 0.0322 0.0015 0.0195 0.7211 deviation of ROA Cross[t-1] Ratio of cross shareholders 21689 0.0786 0.0858 0.0000 0.0537 0.5630 Ratio of stable shareholders excluding Stable.exc.Cross[t-1] 19593 0.2711 0.1866 0.0000 0.2267 0.9289 cross shareholders and directors Inst[t-1] Institutional investor ownership 21608 0.1806 0.1572 0.0000 0.1392 0.8560 Ind[t-1] Independent director ratio 21820 0.0615 0.1148 0.0000 0.0000 0.8889 Dir[t-1] Director ownership 21697 0.0644 0.1175 0.0000 0.0082 0.9970 Dummy variable of introduction of SO[t-1] 21718 0.3458 0.4756 0.0000 0.0000 1.0000 stock option Ratio of Market capitalization to net MtoB[t-1] 21910 1.5066 2.1474 0.0032 1.0033 47.9082 assets Ratio of Cash and short-term securities Cash[t-1] 21998 0.1706 0.1428 0.0002 0.1314 0.9816 to total assets Ratio of interest-bearing debt to total Lev[t-1] 21998 0.2026 0.1980 0.0000 0.1611 8.6923 assets Assets[t-1] Total Assets (million Yen) 22008 306,864 1,196,878 0 52,941 35,500,000 ROA[t-1] ROA 21984 0.0546 0.1322 -7.4231 0.0577 11.7428 17
Ownership structure in the period • We exclude FY2004 from analysis using stable shareholding due to change of definition of the stable shareholding in the database – It adds treasury shares and corporate block shareholding of more than 3% from FY2005 18
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