Diffusion as a source of variety: Corporate governance reforms in the Japanese electronics industry

Christina AhmadjianHitotsubashi University

Shusai NagaiRitsumeikan University

An empirical puzzle

In the 1990’s, a set of board of director reforms, based on US practices, diffused among Japan firms

These practices spread at different rates: Firms selected some practices, rejected others

Firms reinterpreted and reshaped the practices in different ways Transplanted in Japan, board reforms took on very different

significance and function Furthermore, the resulting Japanese corporate governance

landscape was marked by increased diversity rather than isomorphism

What explains this partial diffusion and reinterpretation of the practices?

Is corporate governance converging to Anglo-American practice? Heated debate as to whether Anglo-American

corporate governance practices are spreading across the globe

Increasing consensus that the outcome has been neither convergence or continued divergence, but rather, hybrid forms combining Anglo-American and local practices

However, there is little research or theory about how that hybridization is occurring

This paper explores mechanisms for hybridization, by examining how external pressures for change interact with internal, firm-specific factors

Neo-institutional theory provides only a partial explanation of diffusion Research on diffusion of new practices dominated

by neo-institutional theory Neo-institutional theory posits that value of practices

is socially constructed Notions of legitimacy, taken-for-grantedness, institutional

logics Organizations adopt new practices to confirm to

external pressures Coercive, normative, mimetic

Diffusion processes lead to isomorphism within institutional fields

But, what happens within the firm? In neo-institutional accounts of diffusion, the

organization is a black box The adoption decision is binary The organization is a passive and unitary

actor These assumptions give us only a partial

picture of diffusion processes and outcomes

Black box/passive adopter image of the firm in neo-institutional theory has long been criticized But, large scale, quantitative studies of adoptions of new practices remain the rule

Some attention to firm and manager characteristics Little research looks at the adoption decision on the

level of the organization Very little theoretical development on how internal

firm dynamics might interact with these external pressures

Older streams of theory provide guidance on internal organizational processes in adoption of new practices Behavioral theory of the firm (Cyert and March)

Problem-solving within firms Internal actors define problems Search for solutions within cognitive limitations Role of internal politics in defining problems and their solutions

March and Simon Cognitive limits to search Attention

Selznick’s “old” institutional theory Competing notions of legitimacy within the organization Transformation of organizational goals and values based on

internal dynamics and interactions with the outside world

Internal factors determining adoption process include Reasons for adoption: process of search

Political dynamics Cognitive limits Competing notions of legitimacy

Interpretation: transformation of problem and solution Political dynamics Cognitive frameworks

Research objectives

Contribute to development of neo-institutional theory by examining interaction between external pressures and internal dynamics of the firm

Provide a richer accounting for dynamics of diffusion Answer a specific question: has the diffusion of

Anglo-American board practices led to convergence in Japan to US-style practices?

Setting: Board reforms in Japan In 1990’s, “corporate governance” became a

major debate in Japan Triggered by increase in foreign institutional

investors, poor performance of Japanese economy, increased interest in corporate governance in US and around the world

Japanese boards of directors (pre-reform)

Large (30-50 directors in large firms) Independent directors rare to non-existent, outside

directors from related companies, retired bureaucrats, bankers

Directors tended to have operational responsibilities (head of business units or functions)

Boards tended to be rubber stamps, decision-making based on consensus

Board of statutory auditors (kansayaku), in theory, monitored the board of directors

Board reforms of the 1990’s and 2000’s Corporate executive officer (shikko yakuin) system

Separate monitoring from execution Remove directors with executive responsibilities from the board Widely adopted (over 50% of TSE-listed firms)

Independent directors Appoint directors without other ties to the firm At most, one or two per firm

Board with committees system Permitted by Commercial Code revision of 2003 3 committees, nominating, compensation, audit, with majority of

independent directors, statutory auditors not necessary Firms allowed to choose between this and existing Japanese

system Very low rate of adoption—5% of TSE-listed firms

Research questions

How did firms decide to adopt these practices?

Were these practices adopted intact, consistent with Anglo-American practices, or reshaped to fit local context?

Case-based methodology Case selection

10 largest Japanese electronics firms (by sales) Why electronics?

Board reforms originated with Sony Wide variation in reforms adopted Considerable variance in size, foreign ownership, diversification

Data Interviews with board members Analysis of annual reports, securities filings and newspaper articles Comparison of financial data

Approach Inductive Use elements of behavioral theory of the firm, “old” institutional theory, to

guide our analysis of case material Identify points of intersection between these external and internal

perspectives

Interviews

2-hour interview with one board member of each firm

In Japanese, hand-transcribed Arranged by co-author, a senior Japanese

bank executive and board member Triangulation through comparing with publicly

available documents: annual reports, securities filings

Firm

board with

commit-tees

year of intro-

duction

corp. exec.officer system

year of intro-

ductionnumber of directors

number of outside directors

(2007) (2007) (1995) (2007) (1995) (2007)

Hitachi ○ 2003 ○ 1999 33 12 0 3

Sony ○ 2003 ○ 1997 38 14 2 10

Toshiba ○ 2003 ○ 1998 32 14 2 4

Mitsu-bishi

○ 2003 ○ 2003 33 11 1 5

NEC × ○ 2000 39 15 5 3

Fujitsu × ○ 2002 32 10 2 2

Sanyo × ○ 1999 30 8 0 1

Matsu-shita

× × 32 17 2 2

Sharp × × 34 25 0 0

Canon × × 26 27 0 0

Table 1: Board characteristics by firm

firmboard with commit-

tees

corp. exec. officer system

% foreign owner-

shipUS listing

diversi-fication

number of segments

number of employ-

ees

perfor-mance versus

industry*

company system or equiva-

lent

(2007) (2007) (1999) (1999) (2000) (2000) (1999) (2007)

Hitachi ○ ○ 29 ○ 0.23 5 323,827 -8.9 ○

Sony ○ ○ 45 ○ 0.48 6 189,700 5.1 ×**

Toshiba ○ ○ 27 × 0.19 6 190,870 -1.6 ○

Mitsubishi ○ ○ 16 × 0.17 6 116,588 -1.6 ○

NEC × ○ 30 ○ 0.28 4 154,787 -1.6 ×***

Fujitsu × ○ 28 × 0.24 6 188,053 -23.2 ×

Sanyo × ○ 10 × 0.22 6 83,519 -1.5 ○

Mat-sushita

× × 23 ○ 0.34 3 290,448 ×

Sharp × × 18 × 0.6 3 81,009 ×

Canon × × 41 ○ 0.52 2 49,748 ×

Table 2: Firm characteristics

Predictions of neo-institutional theory have limited validity Coercive isomorphism?

Board reforms are not related to foreign ownership or listing

Normative isomorphism? Board reforms are not related to educational

experience or career background of CEO Mimetic isomorphism?

Yes, for corporate executive officer system No, for board with committees

How do firms themselves justify adoptions of new practices? Content analysis of interviews, securities

filings Identify themes Themes mentioned by 3 or more firms

THEMESNumber of companies mentioning

representative quote

Respond to shareholders 7"We have many foreign shareholders so we must have a governance structure that they can understand."

Improve monitoring of management

6

"To strengthen the management monitoring function of the board of directors and at the same time, give a wider scope of authority to executive officers to make decision-making more rapid."

Increase speed of decision-making

7"It is important in the electronics industry to have speedy decision making on the board, since the product life-cycle is so short."

Increase transparency of management

6

"When we first adopted the board with committees system, we were looking for greater transparency. With 30 or more board members in the past, it was hard to expect anything to get done in the board meeting—it was “like an elementary school class.” Things were determined beforehand, and the point was to make board meetings very simple, with very little documentation, so things would proceed smoothly. All the decisions were made in informal meetings before the board meeting so there was no documentation on how the decisions were actually made."

Table 3-1: Themes related to introduction of board with committees or corporate executive officer system

THEMESNumber of companies mentioning

representative quote

Facilitate group-wide management, support the "company system"

5"Our governance system evolved as the company system was evolving. So, our governance matches our management style."

Push authority downwards through giving more authority to executive officers

6

“Through the move to the committee system, we separate monitoring and execution, and the board of directors will take on the function of monitoring management and the corporate executive officers will take on the job of execution. Also, the authority to make decisions on many of the things that the board was required to decide on will be passed to the corporate executive officers.”

Respond to poor performance/facilitate restructuring

3"…performance was very bad. There was a feeling that management had to do something."

Respond to globalization 2"Electronics is a very competitive and global industry, and we are also listed in New York, We can’t just talk about Japan. "

Table 3-2: Themes related to introduction of board with committees or corporate executive officer system

Companies hesitant to emphasize “maximize shareholder value” “Shareholder value maximization is not the only

thing, and is not cultural-even good US companies balance all stakeholders.”

“The board represents shareholders, community, employees, customers. Probably, the shareholders come first in this list, but we have to consider all the stakeholders. We have to say that shareholders are most important.”

Every firm justifies reforms in terms of “separation of execution and monitoring” But, language concerning monitoring is weak and vague.

“Through the move to the committee system, we separate monitoring and execution. The board of directors will take on the function of monitoring management and the corporate executive officers will take on the job of execution.”

Firms justify adoption of board reforms in terms of internal factors All firms mention speed, 6 mention

transparency in decision-making Speed and transparency necessary because

of need for stronger “group management,” pushing authority downwards

firmboard with commit-

tees

corp. exec. officer system

% foreign owner-

shipUS listing

diversi-fication

number of segments

number of employ-

ees

perfor-mance versus

industry*

company system or equiva-

lent

(2007) (2007) (1999) (1999) (2000) (2000) (1999) (2007)

Hitachi ○ ○ 29 ○ 0.23 5 323,827 -8.9 ○

Sony ○ ○ 45 ○ 0.48 6 189,700 5.1 ×**

Toshiba ○ ○ 27 × 0.19 6 190,870 -1.6 ○

Mitsubishi ○ ○ 16 × 0.17 6 116,588 -1.6 ○

NEC × ○ 30 ○ 0.28 4 154,787 -1.6 ×***

Fujitsu × ○ 28 × 0.24 6 188,053 -23.2 ×

Sanyo × ○ 10 × 0.22 6 83,519 -1.5 ○

Matsushita

× × 23 ○ 0.34 3 290,448 ×

Sharp × × 18 × 0.6 3 81,009 ×

Canon × × 41 ○ 0.52 2 49,748 ×

Table 2 (repeat): Firm characteristics

Firm structure and strategy related to board reforms The more diversified a firm, the more likely to

adopt board with committees system. Intermediate levels of diversification are related to adoption of corporate executive officer system.

Firms that have adopted the “company system” are more likely to adopt the board with committees system.

Firms with poor performance are more likely to introduce board reforms.

Company system

An organizational structure in which business units are run as much independently as possible, with separate P&L’s, distinct HR and other systems (in theory, at least)

A half-way point towards the holding company system As one manager said, “It might be desirable for companies this

diversified to go to the holding company form, but, this would break up the company, and cut access to management and other resources. The committee system is a way to duplicate the function of a holding company system, but with the company as one. The “companies” can remain in the same company, but they can operate with different salary systems, performance targets, etc—this is a way to push authority downwards.”

The crisis of the 1990’s led (some) companies to rethink strategy and structure Increased restructuring through downsizing

and spinning off unrelated businesses Decentralization of management decisions to

business unit level Increased centralization of strategic decision-

making at corporate level

Board reforms driven by poor performance The firms that adopted no reforms (Sharp

and Canon) had strong performance during the entire period

Firms adopted board reforms when they were underperforming the industry

Non-adopters of reforms tend to emphasize internal communication Companies that haven’t adopted board reforms

justify the need to maintain existing board structure (large boards, dominated by executive officers) in terms of promoting communication and interaction between businesses.

For example, one firm says: “Other companies have gone to the corporate executive officer system to make decision-making more speedy—but this just increases the separation between businesses. Money-losing businesses can go off on their own and nothing is done about them.”

Firms interpret role of independent directors for their own needs Independent directors

Adopt board with committees system while keeping independent directors to minimum (Toshiba, Hitachi, Mitsubishi)

Maintain existing group relationships through independent directors (Mitsubishi, NEC)

Independent directors are seen as advisors rather than monitors

Hitachi

Japan Association for the Advancement of Working Women

Mitsubishi

Mitsubishi Corporation

Asahi Glass Lawyer

Nippon Steel Bank of Tokyo Mitsubishi-UFJ

Sony

Sumitomo Mitsui Financial Group Chuo University

JFE Steel Lawyer

Fuji Xerox

NEC

Sumitomo Mitsui Banking

Korn Ferry International Daiwa Research Institute

Orix Taisho Pharmaceutical

Sumitomo Mitsui Financial GroupFujitsu

Fuji Electric Holdings

Ericsson Hitotsubashi University

Sumida Accounting OfficeSanyo

Daiwa Securities SMBC

Toyota Goldman Sachs

Clayton Dubilier and RiceMatsushita

Nippon Life Insurance

Toshiba

Waseda University Japan Post

The Promotion and Mutual Aid Association for Private Schools in Japan

Sharp None

Sumitomo Mitsui Banking Canon None

Toin University of Yokohama, Lawyer

Table 4: Affiliations of outside directors (2006)

Independent directors function as advisors, not monitors “Our corporate culture is closed—people grow up drinking the

same water and eating rice from the same pot, It is necessary to be able to explain our decisions to outsiders, and not just nod and agree with each other. This is an important part of transparency. It is also important for outsiders to suggest all the choices—for example, one outside director who asked ‘What would happen if you don’t make this investment?’ Someone from the inside of the firm cannot say this.”

“There is more of a sense that people from the outside are looking at us. In day to day management, management are more aware that outside eyes are upon them, and even the president will frequently ask me, What do the outside directors think of this?”

“Independent” directors often from the same business group or even same company Mitsubishi Electric: Directors from Mitsubishi

Bank and Mitsubishi Corporation Fujitsu: Fuji Electric

Firms reshape corporate executive officer system to fit own needs Continue to keep executive officers on

boards despite talk of separation of execution and monitoring

New system determines who are insiders and who are outsiders—reshapes political dynamics

Hitachi chairman of the board

Toshiba

chairman

chairman president

presidentVP and head of electronic devices group, division manager for innovation promotion

director

VP

Hitachi Chemical Co. VP and head of consumer electronics group, etc. Hitachi Software Engineering Co.

Hitachi High Technologies Co. VP

Hitachi Capital Co. VP and head of digital products group, etc

Hitachi Construction Machinery Co.

Sony chairman head of legal department

president head of security and finance department head of TV/Video group

director

　 director

Table 5-1: Affiliations of inside directors (companies with corporate executive officer system only)

Table 5-2: Affiliations of inside directors (companies with corporate executive officer system only)

Mitsubishi

chairman

NEC

chairman

president vice-chairman

VP and head of planning department president

VP and head of finance department VP

CFO director

head of personnel department director

director director

director director

director director of intellectual property departmentFujitsu chairman

president director

VP and CFO

Sanyo

chairman, chief of "brand"

VP and head of manufacturing and electronic devices

president

VP and head of international business 　 　

VP and head of domestic business 　 　

Vice Chairman 　 　

Nameboard with

committees

corporate executive

officer system

share buybacks% change

in dividends

stock options

mention of increase shareholder value?

(2007) (2007) (total from 2003-2006, yen) (2000-2006) (2006)(annual report,

2006)

Hitachi ○ ○ 40,749,282,000 -50 ○ ○

Sony ○ ○ 8,199,942,000 -75 ○ ×

Toshiba ○ ○ 0 267 × ○

Mitsubishi ○ ○ 4,740,142,000 100 ○ ×

NEC × ○ 0 -33 ○ ×

Fujitsu × ○ 0 -40 ○ ○

Sanyo × ○ 0 -100 ○ ×

Matsushita × × 400,688,742,000 140 ○ ○

Sharp × × 4,182,996,000 117 × ○

Canon × × 199,999,521,000 488 × ×

Table 6: Shareholder-oriented policies not associated with board reforms

Combining neo-institutional theory and internal dynamics Board reforms diffuse at the same time that (some)

firms face low performance, need for restructuring, changes in organizational structure and decision-making practices

Board reforms adopted as a solution for these internal problems

Legitimacy and prevalence of board reforms makes them easily accessible and easy to justify

Firms reshape reforms to fit their needs Adopt selectively Interpret “independent director” and “executive officer” to fit

their own situations

If we had only used a neo-institutional theory lens we might have… concluded that firms are “decoupling” or

managing symbolically, adopting board practices cynically

looked at adoptions as yes/no, not considering how they were interpreted and shaped to the situation

underestimated the degree to which the diffusion of board reforms was generating greater diversity

Rather, we find…

Problem-based search Local search for available solutions Solution chosen and tailored in response to

internal political dynamics

Implications for neo-institutional theory De-coupling over-emphasized? Importance of legitimacy, institutional logics as

internal justifications Degree to which organizations are able to

selectively adopt, customize, reshape practices requires greater consideration

Importance of more case-based research on diffusion and adoption

Puzzles, limitations, further research Does the diversification/board reform relationship

hold in other companies and industries? But, our main point still holds—the importance of

understanding internal organizational factors in studying diffusion of new practices

Why isn’t foreign ownership more correlated with these board reforms? Evidence of relationship between foreign ownership and

other practices related to corporate governance

Summary

Firms adopt board reforms to address internal problems To respond to new demands for decentralization of operating

decision-making and centralization of strategic decision-making in diversified firms

Legitimacy and prevalence of new board forms help internal actors justify new decision-making system: also, increase the familiarity of these forms

Firms shape board reforms to fit their own needs Choose practices selectively, to facilitate internal decision-

making without increased outside pressure Tailor practices in accordance with internal politics

Firm-specific factors interact with external pressures for board reform to promote increased diversity