Essays on the economic implications of corporate governance reforms

Abstract

This thesis consists of three empirical studies on the economic implications of new regulations relating to corporate governance introduced in Japan in the 2000s. After decades of sluggish economic growth since the late 1990s, Japan introduced reforms that drastically changed its corporate governance mechanisms from the traditional system centred around close firm-bank relationships to the shareholder-oriented Anglo-Saxon approach; many of the reforms being aimed at reviving the economy. This consequently had implications on corporate behaviours and performances. The thesis specifically examines the impact on cash-management policies, innovative outputs and capital-market reactions at firms which deviated from a set of corporate governance practices recommended by the financial regulator. The first study examines the implications of opening up all-insider boards on firm value and cash management policies. As a result of the introduction of Japan’s first corporate governance code in 2015, over 800 public companies reformed their all-insider boards - boards whose directors are all inside managers - to adhere to the code’s recommendation of having at least two independent directors. The uniqueness of this study is to look at all-insider boards, whilst existing studies look only at firms that already have some independent directors and document implications of changes in the number of independent directors before and after a shock affecting the composition of a corporate board. By using an instrumental variable approach the study provides evidence showing that opening-up all-insider boards leads to a lower level of cash reserves on a firm’s balance sheet. Cash is an asset that that can be easily accessed by managers and turned to their private benefits and accounts for a significant portion of corporate wealth. The second study looks into the interplay between banks’ equity ownership in companies and corporate innovation. Using a regulation introduced in Japan in 2001 as a shock that triggered significant declines in bank ownership at numerous public companies, I find evidence supporting the view that bank ownership hinders innovation. Based on a difference-in-differences approach, I further find that the positive effect on corporate innovation from a decline in bank ownership is stronger at opaque companies. This is consistent with the literature documenting hold-up problems in lending relationships: Lenders use their informational advantage to hold-up borrowers, an influence associated with the opacity of the borrower. The third study examines reactions to the first comply-or-explain reports disclosed by Japanese firms after the introduction of the corporate governance code. Using hand-collected data on each firm’s compliance and deviation status for each of the 73 recommendations of the code, this study finds capital market pressure urging firms to adhere to the code’s recommendations related to protecting the rights of minority shareholders, value-added disclosure of non-financial information, an effective use of independent directors, and promoting communication with shareholders. This study also finds a significant positive, though small, market reaction to a series of news and announcement events leading up to the introduction of the code. The three empirical studies of this thesis enhance our understanding of the economic implications of corporate governance reforms resulting in transformations of companies’ board and ownership structures, and of the introduction of the corporate governance code promoting Anglo-American governance practices. Overall, I show that the three components of corporate governance mechanisms discussed in my thesis have a positive influence for shareholder value, through higher firm valuation, enhanced innovative outputs, or inducing positive equity market reactions. The findings presented in this study are related to the academic literature on corporate governance, corporate cash holdings, corporate innovative activities, the costs of bank financing and the convergence of corporate governance practices.