Reforming the Reforms: Analyzing how Managerial Entrenchment Impacted Performance During the Implementation of Japanese Corporate Governance Reforms

Abstract

Following its meteoric economic rise after World War II, Japan was reaching the global economic prowess of the U.S. and Europe. But, over-optimistic speculation instigated an economic crash, plunging Japan into the “Lost Decade”. However, the ensuing economic stagnation persisted well into the 2020s. To combat the persistent economic issues, Shinzo Abe introduced the “Three Arrows” to revitalize the Japanese markets. The third "arrow" hoped to address the structural issues - cross-holdings, zombie firms, and short-termism - facing Japan via corporate governance reforms. The three key reforms promising to address these issues and facilitate long-term growth were the 2014 Stewardship Code (‘SWC’), the 2015 Corporate Governance Code (‘CGC’), and the 2019 Fair M&A Guidelines (‘FMG’). Previous literature has commented on how cross-holding entrenchment protects managers from external investors, hindering firm performance and critical value-creating decisions. Using the degree of cross-holding as the method of understanding how firms of varying entrenchment levels reacted to the reforms, I implemented a firm-level panel data event study to analyze the subsequent results of each policy on Cash-to-Assets, Debt-to-Assets, Return on Assets, and Gross Margin. My study finds that the Stewardship Code prompted a de-leveraging campaign and temporary cash utilization within low cross-holding firms, resulting in an improvement in Return on Assets. The Corporate Governance Code supported the trends prompted by the SWC and marginal improvement in Gross Margins. Finally, the Fair M&A Guidelines yielded insignificant results for the outcome variables. Based on these results, I suggest that Japanese policymakers should imitate the SWC for future revisions and reforms. The three suggestions are 1) incorporate some level of pressure or punitive measure 2) reduce cross-holding entrenchment, and 3) bolster shareholder participation. With these three recommendations, Japan may re-emerge in the global markets