Governance expert and Oxford academic, Professor Colin Mayer says Japan’s experiences in the 20th century are a warning against importing institutional structures and regulations. As Japan tries once again to reform corporate ownership, and as China and other Asian nations start to establish the institutions that they will need for the promotion of their stock markets, Professor Colin Mayer, Saïd Business School, University of Oxford, has warned them against trying to impose UK- or US-style institutional structures or governance arrangements.
In a paper to be published by The Review of Financial Studies, The Ownership of Japanese Corporations in the 20th Century, Professor Mayer and his co-authors, Julian Franks, London Business School, and Hideaki Miyajima, Waseda University, argue that the collapse of the banking system and the “lost decade” in Japan at the end of the 20th century show that there are real risks in trying to import institutional structures from one country into another, particularly when their social contexts and financial and legal systems are very different.
“Our research into the striking history of the ownership of Japanese corporations, which features a structural break in the middle of the twentieth century, has yielded important lessons for governance reform in other Asian countries,” said Professor Mayer. “Governance reform in these countries should focus on strengthening the role of dominant owners in upholding trust in their societies rather than adopting policies and practices from western economies with completely different ownership, legal and financial systems.
The Japanese experience should be a reminder to us of how little we know about institutional and legal design and how cautious we should be in making policy recommendations about it.” In the most comprehensive description to date of Japanese corporate ownership pre-World War II, Mayer et al demonstrate that, in the first half of the 20th century, Japan’s flourishing equity markets were characterised by weak legal protection for shareholders, but strong institutional arrangements, particularly through the dominance of the zaibatsu, family-based financial and industrial conglomerates.
These “institutions of trust” allowed outside shareholders to have confidence that their interests would be upheld by those responsible for the management of the firms in which they were investing. When, after the war, the American occupation authorities introduced high formal levels of investor protection and instigated the breakup of the zaibatsu, it initially resulted in even higher levels of dispersion of equity ownership and in particular widespread ownership in the hands of individual investors.
But without institutions of trust to represent the interests of the shareholders, and with an increase in debt-for-equity and other similar bank practices, ownership by individuals was gradually replaced by cross-shareholding by banks and corporations. This model of “inside ownership” – ownership by shareholders with more than a purely financial interest in the firm — dominated post-war Japan, but began to fall apart in in the last quarter of the century, leading to a systemic banking failure and prolonged recession.
“The changes made in Japan in the middle of the century show how difficult it is to import structures from one country to another without a nuanced understanding of the differences between their social and legal contexts,” said Professor Mayer. “As countries in Asia are attempting to reform their corporate governance, it would be tempting but risky for them to draw on established models such as those in the UK and US.
The latter countries rely heavily on the existence of markets for corporate control and well-developed systems of corporate law and enforcement, which are embryonic at best in most emerging markets. The trust-based mechanism that prevailed in pre-WW2 Japan and is now beginning to re-emerge in 21st century Japan may be a more relevant model for many Asian countries.”
However, he pointed out that institutions of trust take time to establish and embed in local arrangements. They are highly country- and context-specific, and laws and rules that function in one country may be inadequate or inappropriate in another. The importance of families in some Asian countries, such as Korea, and the state in others, such as China, means that the sources of trust relationships in these countries are very different.