Annual Report on

The Japanese Economy and Public Finance


- Japanese Economy Heading for New Growth Era

with Conditions for Growth Restored -

Cabinet Office

Government of Japan

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Section 2 Changing Characteristics of Japanese Companies

    As the surrounding environment has turned around, some changes have been seen in those characteristics that had been represented by the phrase, "Japanese-style management." In this section, we will analyze the characteristics of the financial, employment and other practices at Japanese firms by international comparison. We will also utilize our questionnaire survey to look into the usual characteristics of the "Japanese-style management" at present and how those characteristics are influencing performances of Japanese firms.

1. Japanese Industrial Performance Worldwide

    We would like to first review Japanese industrial performance regarding productivity, trade, and research and development and look at which areas Japanese industry has comparative advantages in and the factors behind such advantages.

(Japan enjoys strong productivity in high-technology manufacturing industries)
    OECD data indicate high total factor productivity (TFP) growth between 1990 and 2003 for major industrial countries specialized in information technology. For example, TFP growth came to 3-4% in Ireland and around 2% in Finland. In contrast, Japan's TFP growth slipped well below 1% in the 1990s and has been lower than in other Group of Seven countries like the United States (Figure 2-2-1). However Japanese labor productivity growth has been around 2%, similar to figures for other OECD countries, due to a fall in the working population and reduction of working hours.
Figure 2-2-1 Productivity Growth in OECD Countries
    Industry-by-industry labor productivity data show that Japan posted relatively higher productivity growth than most OECD countries between 1995 and 2003 for manufacturing industries and for average-level growth for non-manufacturing industries. More specifically, Japan posted relatively higher productivity growth than other OECD countries for relatively high-technology industries like electrical equipment, motor vehicle and general machinery, but relatively lower growth for food, textile and other low-technology industries.
    In this way, Japan has retained its comparative productivity advantage for high-technology manufacturing industries on a global basis.

(Japanese falling share of global market and growth of other Asian countries)
    Japanese share of the global market (total global imports) has continued a slow decline since the 1990s. Specifically, the Japanese share dropped from around 8% in 1990 to around 5% in 2005 (Figure 2-2-2 (1)). Other industrial countries have also posted declines in their respective shares of the global market. The share fell from around 11% to around 8% for the United States and from the upper half of the 11% range to around 9% for Germany. On the other hand, Asian countries' shares rose fast. For Asian countries other than Japan, the share expanded from around 13% in 1990 to 22% in 2005. Particularly, the share for China soared fast from around 4% to about 10%. Falls in shares for Japan and other industrial countries can be taken as reflecting expanded exports by Asian and other emerging economies. However, expanded exports from these emerging economies led to the expansion of the global import market through their economic growth. This was not necessarily an unfavorable development for industrial countries. As reviewed in Chapter 1, the Japanese export market, in terms of the total of imports by countries where Japan exports, grew faster than other industrial countries' export markets due to high growth in China and other Asian economies. This contributed to Japanese export recovery (Figure 2-2-2 (2)).
Figure 2-2-2 Japanese Global Market Share

(Progressing compartmentalization of production between Japan and China)
    In a bid to illustrate Japanese comparative advantages, we have calculated Japanese trade specialization coefficients against the rest of the world, the United States, and China for major goods (Figure 2-2-3). The coefficient is the ratio of net exports to a combination of exports and imports for goods. A coefficient closer to 1 indicates greater specialization in export. Japanese trade specialization coefficients against the rest of the world indicate that Japan is specialized in export of transport equipment, general machinery and electrical machinery. Time series data since 1990 show that Japanese export specialization coefficient against the rest of the world has remained around 0.8 for transport equipment while falling persistently and substantially for general machinery and electrical machinery. Against the United States, Japanese export specialization coefficient has remained stable at high levels for transport equipment, general machinery and electrical machinery since 1990. But Japanese export specialization coefficient against China has been falling for those three categories. This indicates that Japanese exports to China have been replaced with goods produced by Japanese firms in China and that Chinese electrical machinery and general machinery exports to Japan have been increasing. Japanese comparative advantages against China have thus changed for some products. Compartmentalization of production has been progressing between Japan and China.
Figure 2-2-3 Japanese Trade Specialization Coefficients

(Japan not inferior to other OECD countries in R&D capacity)
    According to OECD statistics, Japanese research and development investment as a percentage of GDP in 2003 was the third highest among the OECD countries (Figure 2-2-4). But Japanese R&D investment growth has been lower than in other OECD countries since investment was already at high levels. In terms of wider intellectual investment including software and higher education as well as R&D, Japanese investment is at an OECD average level. This is because Japanese investment in software and higher education is relatively smaller.
Table 2-2-4 National R&D Indicators
    Reflecting its robust R&D investment, Japan is ranked second after the United States and tops the European Union in the number of patent acquisitions. But time series data show Japan's gap with the United States has been expanding since the early 1990s.
    Japan also runs the fifth largest technology balance of payments surplus (net royalty receipts) among the OECD countries. We must take note of the fact that Japan's technology balance of payments has improved as Japanese companies' overseas expansion has led to an increase in overseas Japanese firms' patent royalty payments to Japan. The ratio of high-technology and medium-high-technology products to total exports stands at some 80% for Japan, far higher than an OECD average at slightly more than 60%.
    In human resources, however, Japan features fewer doctorate holders at universities and far less international movement in and out of Japanese employment of highly skilled researchers or engineers. In future, we must take note of the possibility that a falling birthrate could make it more difficult for Japan to secure an optimum number of researchers.

(Relations between characteristics of Japanese industry and systems)
    As reviewed above, the Japanese industry has retained its comparative advantages in the high-technology area, supported by its companies' R&D capacity. The excellent technological capacity, though owing partly to the government's contribution to education and basic research, is attributable primarily to the interaction between the private sector's enterprising spirit as based on robust entrepreneurship, incentives for technological innovation under sound market competition, and great demand that allows new products to be easily accepted.
    In addition, some characteristics of Japanese business management have apparently contributed to Japanese companies' proactive technological innovation(17). Specifically, Japanese companies have based their R&D investment on long-term perspectives as their business strategies have tended to pursue long-term growth. Japanese company management carefully include internally promoted executives specialized in engineering who are positive about R&D operations. Research, production and sales workers also demonstrate close cooperation and excellent adaptability to new technologies. These characteristics of Japanese companies may further be closely linked to Japanese-style management that features long-term employment practices, including lifetime employment, stable shareholders and internally promoted managers granted wide amounts of discretionary authority.
    But Japanese-style management does not necessarily bring about technological advantages in all areas. For example, long-term business relations between companies and internally trained workers' close cooperation, as typically seen in the Japanese-style management, are advantageous for products such as automobiles. Close cooperation between parts makers and assemblers and between development and production workers is required for production of automobiles. But some people argue that production of personal computers and other module products consisting of multi-purpose parts cannot necessarily benefit from such close cooperation, peculiar to Japanese-style management(18).

Column 5

Relations between Employment Systems and R&D Operations

    Many earlier studies have maintained that job market conditions. such as job mobility and wage-setting systems, can exert great influences on companies' R&D operations and incentives for training. Given low job mobility, employment adjustment costs are generally expected to be higher if long-serving employees become surplus on a major technological innovation. This may negatively affect R&D incentives. If wage gaps between companies are narrow (under a cooperative wage-setting system) under a low job mobility, skillful workers trained in a company may not get much higher wages at another firm. Employees, hence, may have no incentives to change jobs and companies may have incentives for investment in in-house training. Overall, low job mobility may not necessarily negatively affect companies' R&D investment.
    If such relationship exists between an employment system and R&D incentives, then each employment system may depend on technological characteristics of each industry. In the information technology industry (where discontinuous technological innovations come frequently) a company may be required to recruit outside workers with necessary skills depending on market conditions, instead of training workers internally. This kind of industry may be suitable to high-job-mobility countries (such as the United States). In the automobile industry where technological innovations are usually based on traditional technologies, however, a company may be required to train engineers with skills peculiar to the firm. Such industry may thus be likewise suitable for countries that feature low job mobility and a cooperative wage-setting system (such as Japan).
    In fact, an OECD demonstration study stated that the estimation of correlations between employment systems and R&D investment' ratios to sales in different industries, demonstrated that technology-intensive industries tend to promote R&D operations not only in high-job-mobility countries such as the United States but also in low-job-mobility countries such as Japan with smaller wage gaps under a cooperative wage-setting system (Figure for Column 5).

Figure for Column 5 Effects of Production and Job Market Regulations on R&D Investment

2. Japanese Companies' Characteristics for International Comparison and Their Changes

(1) Japanese Companies' Characteristics as Indicated by Financial Data

(Japanese companies' profit ratios are relatively lower than the world average)
    The return on assets indicates how efficient a company's assets are in generating revenues. It measures a profit ratio at one point in time, but it cannot indicate a company's future profitability representing corporate value. But the ROA, which can be easily calculated from companies' financial data, is widely used as a representative profit ratio indicator(19).
    Let's review time-series ROA data on a macro basis (covering all industries) in Japan and the United States. In Japan, the ROA continued a downtrend from the early 1980s to the early 2000s. Specifically, it dropped from around 6% in the early 1980s to levels below 3% in the late 1990s (Figure 2-2-5 (1)). Since 2002, however, the ROA in Japan has recovered. In 2005, it rose to around 4.5%. In the United States, the ROA has been stable in a rough range of 7% to 9%, though falling fast temporarily in the early 1990s and the early 2000s. Given companies' operations to maximize profit, the macro ROA can be expected to fall on a rise in the capital equipment ratio (capital per employee) and to rise on an increase in the total factor productivity(20). The capital equipment ratio has continued an upward trend both in Japan and the United States. Therefore, the difference between Japanese and US ROA moves apparently reflects TFP changes (Figure 2-2-5 (2)). In fact, the ROA and TFP moves for Japan show that the ROA fell on a sharp decline in TFP growth in the 1990s.
Figure 2-2-5 Japanese and US ROA and TFP Trends
    In a bid to review specific trends of companies' profitability, we have utilized financial data of some 4,000 listed companies in Japan, the United States and Europe to indicate the recent region-by-region trends. Profitability indicators made similar moves in the three regions. Both the return on equity and the return on assets hit bottom levels in FY2001 and improved substantially from the year to FY2004 (Figures 2-2-6 (1) and (2)). In the United States and EU countries, the ROA was above 7% and the ROE above 22% in FY2004. These indicators in Japan were relatively lower. The ROA slipped below 6% and the ROE below 17%. The leverage (ratio of total assets to shareholder equity) was roughly stable at around 3 in the United States and the EU. In Japan, the leverage stood around 3.5 in FY2000 and followed a downward trend before reaching around 3 equal to the US and EU levels in FY2004 (Figure 2-2-6 (4)). Given the definition that the ROA (return divided by total assets) can be multiplied by the leverage (total assets divided by shareholder equity) to calculate the ROE (return divided by shareholder equity), the fact that leverage ratios are the same in Japan, the United States and Europe can be interpreted as indicating that an ROA gap between Japan, and the United States and Europe causes an ROE gap.
Figure 2-2-6 Profitability and Leverage of Japanese, US and Europnean Companies (in All Industries)
    Given that the ROE can be broken down into three components - the return on sales (return divided by sales), the total capital turnover (sales divided by total assets) and the leverage (total assets divided by shareholder equity), the lower profitability in Japan can be attributed to a lower ROS or a lower total capital turnover since the leverage ratios in the three regions are almost equal. In fact, Japanese companies' ROS in FY2004 stood at about 6%, lower than US and EU levels exceeding 9% (Figure 2-2-6 (3)). Considering that the total capital turnover in Japan is higher than in the United States or EU, we can suspect that the lower profitability of Japanese companies is represented by the lower ROS indicating their failure to take sufficient profit margins.

(Low capital cost behind low profitability of Japanese companies)
    Earlier studies have pointed to various reasons for the low profitability of Japanese companies. For example, an analysis on an international comparison of ROA figures based on companies' financial data indicates that ROA gaps between companies in Japan are narrower than in other countries and that ROA fluctuations at Japanese companies have been smaller(21). In this respect, Japanese companies' low profitability is attributed to their tendency to refrain from taking bold risk-taking actions or from taking new paths different from others. A reason cited for such tendency is that shareholders' governance may fail to permit risk taking. Other studies have also pointed to such oversight problems. According to one analysis of companies' ROA figures and their responses in questionnaire surveys, companies that tend to consider such qualitative factors as the balance between in-house divisions and other companies' moves in making investment decisions may have lower ROA figures than those that take businesslike investment actions emphasizing quantitative evaluation of profitability. This analysis also indicates that the great influence of main banks and stable shareholders is behind such investment behaviors(22).
Many studies have attributed the low profitability of Japanese companies to the suspected failure of shareholders' governance to exert effective control. Regarding investors' limited pressures on companies, there is a view that low capital costs have eventually led to the low profitability(23). As noted in the analysis on capital productivity in Section 1, capital costs are a weighted average of debt and equity capital costs and can be interpreted as a required rate of return that a company must provide when raising debt and equity capital from the capital market. On the other hand, a company is expected to make an investment that would provide investors with a return exceeding their capital cost over a long term(24). If an investor-required rate of return is low, therefore, a company may invest even in a less profitable project. This may result in a lower profitability for the company. The degree of shareholders' communication of their requirements for the management team may vary depending on their exercise of voting rights and buyout threats. In Japan, general shareholders' influences on management teams have been weak as companies have maintained strategic cross shareholdings and received capital funds primarily from their main banks. These practices are believed to have curbed capital costs generally in Japan.

(Capital costs for US firms have been higher than for Japanese companies)
    Using financial data of Japanese and US companies between 1999 and 2004, we have estimated capital costs and relevant economic value added for international comparison, based on a calculation method that is slightly simpler than proposed by Stern Stewart & Co. As in the earlier estimation, the financial data are from 800 listed Japanese companies other than financial and insurance firms, and more than 1,300 US companies (Figure 2-2-7).
Figure 2-2-7 Comparison of Japanese and US Capital Cost Levels
    According to the findings through the estimation, capital costs for US companies remained higher than for Japanese firms between 1999 and 2004. Specifically, capital costs ranged from 6% to 8% for US companies, against 3% to 4% for Japanese firms. Debt costs, or interest rates, in the United States remained higher than in Japan. Equity capital costs in the United States were also far higher than in Japan. The economic value added, calculated by subtracting capital costs from post-tax operating profit, has turned up since 2002 in Japan, as reviewed earlier. In the United States, the EVA declined on cyclical economic changes before turning up in 2003. At present, both Japanese and US firms have apparently achieved profitability meeting their respective capital costs.
    Since the capital cost estimation is affected by differences between national tax and accounting systems, the estimates should be viewed flexibly. But our findings seem to be consistent with earlier trends, since earlier studies(25) indicated that capital costs in Japan had been lower than in the United States in the 1980s or the first half of the 1990s. Given our findings and earlier studies, we can suspect that a higher rate of return required by US investors, as indicated by higher capital costs, has exerted some pressure on US companies to become more profitable. Recently, however, shareholders have increased their influences over companies in Japan. Rising shareholder-related pressures are expected to increase companies' capital efficiency in Japan.

(2) Japanese Companies' Characteristics Regarding Investment: Dividend Payment and Fund-raising Practices
    Do Japanese companies have any differences with other firms in basic business practices concerning investment, dividend payments and fund-raising? Basically, companies seem to have no differences in these practices irrespective of nationality in so far as they all take reasonable actions to maximize profit. What would be behind some other differences? We would like to analyze such differences by using Japanese, US and European corporate data.

(Recent Japanese, US and European investment, dividend and fund-raising trends)
    Key points of the recent investment, dividend and fund-raising trends in Japan, the United States and Europe are as follows:
    The ratio of investment cash flow to total operating cash flow for Japanese companies had been lower than for US firms. In FY2004, however, Japanese and US investment ratios were almost the same due to a recent fast fall in the US ratio (Figure 2-2-8 (1)). As for EU companies, investment might have deviated from normal levels due to costs for third-generation mobile phones. We must acknowledge that strict comparison of EU firms with Japanese companies is difficult.
Figure 2-2-8 International Comparison Regarding Investment and Dividend Payout
    The dividend payout ratio (ratio of dividends to net profit) stands at about 20% for profitable Japanese companies, lower than levels above 30% for US firms and 40% for EU companies (Figure 2-2-8 (2)). But the portion for dividend-paying companies in Japan is far higher than in the United States or EU, as far as sample companies for the current estimation are concerned. One reason non-dividend-paying companies are more abundant in the United States or EU may be that US or European companies include many young firms that have gone public over the recent years and cannot afford to pay dividends.
    As for fund-raising practices, the leverage ratio (total assets divided by shareholder equity), as reviewed earlier, remained roughly stable around 3. The ratio in Japan continued a downtrend before reaching the same level as in the United States and EU in FY2004 (Figure 2-2-6 (4) as earlier presented).

(Factors behind investment, dividend payment and fund-raising practices)
    The data supra indicate Japanese companies' differences with US and EU firms. Focusing on investment, dividend payout ratios and the capital mix (debt ratio), we have used panel data of Japanese, US and EU companies between FY2000 and 2004 to make relevant estimates and analyze how Japanese companies are different from US or EU firms. The estimates indicate the following regional characteristics:
    First, both Japanese and US companies tend to curb business investment when their interest-bearing debt ratios are high (Table 2-2-9 (1)). This apparently indicates that US firms as well as Japanese companies check balance sheets when making business investment decisions. One reason the business sector has become a net saver in the recent years both in Japan and the United States may be that Japanese and US companies have grown cautious of expanding business investment.
Table 2-2-9 Comparing Japanese, US and EU Indicators of Business investment, Debt Ratios and Dividends
    Second, the variation coefficient of operating profit has had no significant impact on dividend payout in Japan, while larger variation coefficients have worked to curb dividend payout in the United States and EU (Table 2-2-9 (2)). The variation coefficient is usually expected to indicate a bankruptcy probability. Theoretically, a larger variation coefficient indicates a higher bankruptcy probability and works to reduce dividend payout. The significant impact of the variation coefficient on dividend payout in the United States and EU meets the theory. One reason the variation coefficient of operating profit has had no significant impact on dividend payout in Japan may be that Japanese companies tend to stabilize dividend levels irrespective of profit fluctuations. Theoretically, a company with a higher debt ratio may tend to reduce dividend payments and expand internal reserves. But debt ratios have had a significant impact on dividend payout only in Japan. At US and EU companies, debt ratios have had little impact on dividend payout. One apparent reason for this may be that American and EU samples include many young companies that pay no dividend while limiting debt ratios by focusing on raising funds primarily through equity issues.
    Third, coefficient signs for two of the four variables regarding debt ratios are the same for the three regions, meaning that a debt ratio is lower for a higher ROA and a larger corporate size. Theoretically, the debt ratio rises along with the fixed asset ratio, an indicator of collateral capacity, as seen in the United States. But the relation between the two ratios is reversed in Japan and the United States. But overall estimates indicate that there are no major differences between Japanese, US and EU companies in respect to the corporate capital mix or relevant factors.

(3) International Comparison of Companies' Employment Adjustment Speeds

(US macro employment adjustment speed is remarkably fast)
    Japanese companies are frequently described as slower than foreign firms in adjusting employment in response to economic shocks. There are some theoretical reasons for such tendency. One is that as Japanese companies make human business investment through in-house training and as costs for such training become unrecoverable, they tend to adjust wages in response to macroeconomic shocks without dismissing employees easily(26). Some theories emphasize complimentary relations between the employment system and the financial system including main banks. According to these theories, banks as main creditors of companies may generally relax surveillances on these firms so long as the borrowers' business performances are robust. As their business performances deteriorate, however, banks may take relief measures to avoid these borrowers' dissolution or liquidation. This may allow borrowers to make human employment business investment decisions from a long-term perspective(27).
    According to analyses using macro data for international comparison of employment adjustment speeds, the rate in Japan has become faster than in 1960s or 1970s but has remained far slower than in the United States(28). But the employment adjustment speed in Japan is almost the same as in European countries such as Britain, France and Germany. Internationally, the US employment adjustment speed has been remarkably fast.

(Corporate-level improvements seen in Japan's employment adjustment speed)
    We have used corporate-level data to estimate Japanese and US companies' employment adjustment speeds. Adopted for this estimation is a partial adjustment model that has been utilized for many earlier studies(29). The model presumes employment adjustment costs to increase in line with an adjustment scale. This means that even if employment exceeds a desirable level, any company is expected to gradually adjust employment while avoiding large-scale or rapid adjustments.
    According to our estimates based on data in and after 2000, the employment adjustment speed at Japanese companies has been slower than at US firms in manufacturing industries. In non-manufacturing industries, however, no major difference has been seen (Figure 2-2-10). Based on data from 1990, our estimates have found that manufacturing industries' employment adjustment rate in Japan in the second half of the 1990s and the 2000-2004 period was faster than in the first half of the 1990s. In non-manufacturing industries, however, the speed changed little. In a bid to look into factors behind the rising employment adjustment speed in Japan's manufacturing industries, we have added debt ratio data to our estimates. We have found that companies with higher debt ratios have faster employment adjustment speeds (Appended Table 2-3). This indicates that over-indebted companies have promptly adjusted employment since the second half of the 1990s.
Table 2-2-10 Comparison of Japanese and US Employment Adjustment Speeds

3. Changes in Japanese-style Management and Corporate Performances

    The Japanese-style management was given high ratings at home and abroad in line with Japan's high economic growth in the 1980s. In the 1990s, after the collapse of the bubble economy, however, the Japanese-style management was next generally described as somewhat inefficient. While the environment surrounding Japanese companies have changed due to the growing globalization of business operations and relevant legal and accounting system reforms, the economic slowdown in the 1990s has forced these firms to restructure themselves, slightly revising their lifetime employment system, seniority-based wages and promotions. In this sense, the Japanese-style management has reportedly changed dramatically. Next, we will analyze how the Japanese-style management has changed and how such changes have influenced corporate performances.

(1) Japanese-style Management

(What is Japanese-style management?)
    Lifetime employment and other features of Japanese companies represent the "Japanese-style management." What is called Japanese-style management, however, is not necessarily given any unambiguous definition. Here, nevertheless, are the general models, systems or practices cited and conceived in current literature as components of Japanese-style management.
    Such frequently cited factors of the Japanese-style management model are grouped into three major components - (1) a company organization represented by lifetime employment and seniority-based wages, (2) a unique corporate governance system led by internally promoted managers and banks (for surveillance and discipline to secure efficient business management), and (3) long-term inter-company business relations represented by business groups and keiretsu affiliation(30).
    The lifetime employment and seniority-based wage systems are part of the company organizational guarantee for long-term employment and restricted mid-career recruitment of outside people. Promotions are based on seniority, the number of years of services and performances, providing employees with incentives to accumulate know-how and technologies and enhance cooperation within each section(31). Such organization allows its divisions and layers to share information, ensuring horizontal coordination for decision making without depending on a hierarchy. This leads to a bottom-up decision-making process that is frequently cited as a key feature of Japanese companies. Given greater decision-making authority, employees are expected to respond flexibly to situational changes(32).
    Regarding the unique corporate governance as the second component, much is written stating that employees of a company are viewed as the key stakeholder of the company in Japan(33). This leads internally promoted executives to dominate the board of directors with outside directors having limited impact at a Japanese company. In Japan, banks and their borrowing corporate customers have maintained cross shareholdings. Corporate banks for Japanese companies have acted as these firms' shareholders as well as their creditors, maintaining surveillance on corporate customers(34). An insider-dominated board and a resultant integration of management execution and monitoring may lead a company to choose an investment project that would benefit its employees while bringing about no benefit to its shareholders. But the pressure of debt or the presence of a main bank might act to curb such moral hazards.
    As for long-term inter-company business relations, as the third component, some studies say that large companies have played a great role in control of their subsidiaries and affiliates and that cooperative relations between finished goods and parts producers have supported Japan's industrial competitiveness(35). On the other hand, other studies doubt the effective presence of bank-led keiretsu affiliations originating from zaibatsu conglomerates(36).

(History of Japanese-style management)
    There are various studies about how these components of the Japanese-style management have been developed(37). One says that lifetime employment and seniority-based wage systems were adopted by textile and other companies to secure employees' settlement when they were plagued with labor shortages and high costs to solve such shortages in the course of Japan's industrial development in the late 19th and early 20th centuries. Another study says a factor behind the settlement of lifetime employment and seniority-based wage systems was that as Japan then lagged behind Western countries on technological level, companies had to internally train skilled workers on their own to quickly catch up with new technologies. Some theories view lifetime employment, seniority-based wage and company-by-company labor union systems of Japanese companies as having originated from various systems of the controlled economy during World War II, including labor-management cooperation to curb labor disputes amid effective wage drops under inflation(38).
    The Japanese corporate control led by internally promoted managers and banks is attributed to the elimination of excessive concentration of economic power after World War II, according to one study. Company managers were then expelled and equity shares were confiscated from holding companies in zaibatsu conglomerates. Primarily, employees were given opportunities to purchase these equity shares, working to boost individuals' share ownership(39). Although the management and ownership of zaibatsu-affiliated companies had been integrated, this process separated company management from company ownership. A rising number of internally promoted executives became company managers then. The study says that in the face of a free fall of stock prices that made it difficult for companies to raise funds from the capital market, companies increased borrowings from banks, asking banks to become stable shareholders for prevention of takeovers. Another study says cross shareholdings between banks and their corporate customers increased in the late 1960s as companies grew more sensitive to prevention of takeovers upon deregulation of international capital transactions(40). As for the keiretsu affiliation, some studies say banks emerging from zaibatsu conglomerates promoted integration of capital with big industrial companies primarily thorough lending and developed business groups based on enhanced cross shareholdings. But some other studies doubt such development as noted above.

(1st change in Japanese-style management: decline seen in dependence on main banks and cross shareholdings)(41)
    Debt and main banks' strong influences, which have been viewed as key factors of the Japanese-style management, have apparently undergone a dramatic change. Japanese companies' debt ratio has declined sharply since the second half of the 1990s and stands at a level as low as US and EU levels. Their shift away from banks is not necessary a recent phenomenon. A long-term trend indicates Japanese companies' debt ratio has been falling since a peak in the second half of the 1970s. Behind the trend has been deregulation of requirements for issuing bonds and capital transactions. An earlier study says gradual deregulation in the 1980s prompted highly profitable companies to increase their dependence on bond issues, while less profitable firms remained dependent on loans from banks. This was described as Japanese companies' bipolarization(42). In the 1990s, a full shift to a credit rating system and the 1996 comprehensive financial liberalization and deregulation prompted companies to accelerate their shift away from banks.
    While companies have generally shifted away from banks, some studies say, banks' monitoring of borrowers did not work as well as expected. This was indicated by the fact that bank loans extended in the bubble period became non-performing later. Anyway, main banks' corporate control seems to have dramatically declined at large companies.
    Cross shareholdings between industrial companies or between industrial firms and banks have been declining. Specifically, cross shareholdings' percentage of total outstanding shares dropped from nearly 20% in the early 1990s to 7.6% in 2003. Stable shareholdings (including bilateral cross shareholdings and stable shareholdings at financial and non-financial firms) saw their percentage falling from around 45% in the early 1990s to 24% in 2003 (Figure 2-2-11 (1)). As a result, shareholders have been diversified further. Foreign shareholders owned more than 20% of total Japanese outstanding shares in 2004, a sharp increase from some 5% in the early 1990s (Figure 2-2-11 (2)). Behind such structural changes in shareholdings since the 1990s, industrial companies that had no close relations with banks have reportedly promoted selling of fast-falling banking shares to emphasize their business efficiency under the pressure of the capital market including institutional investors(43). It has been reported that banks saw their business relations with industrial firms weakening and positively sold shares in these firms to raise funds for disposing non-performing loans. But all industrial companies have not necessarily unwound cross shareholdings. We must take note of the fact that industrial companies that heavily depend on banks and are less profitable have tended to maintain cross shareholdings with banks(44).
Figure 2-2-11 Changes in Percentage for Stable Shareholdings and Stock Ownership Structure

(2nd change in Japanese-style management: Seniority-based wages decrease with lifetime employment maintained)
    Japanese firms' unique employment system including lifetime employment and seniority-based wages has also changed dramatically. Seniority-based wages have been adopted as an incentive to maintain lifetime employment. Under the seniority-based system, wages for young people are usually set at lower levels than merited by their productivity and raised in accordance with seniority. Such seniority-based wages can be sustained only when companies continue high growth and increase employment of new graduates. Since the 1990s, an economic slowdown has forced companies to reduce their recruitment of new graduates, raising an average age of employees and increasing overall personnel costs. This has prompted companies to eliminate a seniority-based automatic wage hike and introduce performance-based wages, leading to changes in the employment system.
    Our FY2004 annual survey of corporate behaviors found that 83% of 1,000 companies sampled for the survey had then adopted performance-based wages, with 13% considering the adoption. We have conducted a probit model analysis to find what kind of companies adopts performance-based wages. The analysis indicates (1) that companies with more mid-career recruitment are better expected to adopt performance-based wages, (2) that companies that emphasize special skills rather than company-specific skills are better expected to adopt performance-based wages, and (3) that corporate earnings have no relations with performance-based wages (Figure 2-2-12). In this way, performance-based wages have been adopted primarily by companies that aggressively recruit outside people with special skills. Due to the adoption of performance-based wages, an age-wage curve has recently flattened (Appended Table 2-4).
Table 2-2-12 Characteristics of Companies Adopting Performance-Based Wages
    On the other hand, many Japanese companies have apparently maintained lifetime employment for regular employees. According to a basic survey on wage structure, an average employment tenure for regular employees other than part-time employees came to 12.0 years in 2005, compared with 10.9 years in 1990. Employment tenures totaled 10 or more years for about 47 percent of regular employees in 2004. According to an international comparison survey by the International Labor Organization, the average employment tenure in Japan was far longer than 6.6 years (in 1997) in the United States or 8 years (in 2002) in Britain. It was even longer than an average of 10.6 years (2002) for 14 EU countries where employment is relatively longer (Figure 2-2-13). The percentage of employees with employment tenures totaling 10 or more years in Japan was higher than 26.2% (in 2002) in the United States, 32.1% (in 2002) in Britain and 41.5% (in 2002) in the 14 EU countries. Although the average employment tenure might have shortened due to part-time workers' growing share of employees in Japan, the lifetime employment practice have continued more or less.
Figure 2-2-13 International Comparison of Average Employment Tenures

Column 6

Relationship between Employment Tenure and Productivity

    Employment tenure, or the amount of time that a worker has spent working for the same employer, sharply differs from one country to another. How does employment tenure affect productivity at national, industrial and corporate levels? Here is an ILO analysis on this point (Note 1).
    As noted above, the average employment tenure sharply differs from one country to another, ranging from 7 years for the United States to 11 years for Japan. There are four key points behind the wide employment tenure gaps: (1) the younger the population is in one country, the shorter the national average employment tenure is; (2)higher economic growth can produce more employment and job changes to shorten the average employment tenure; (3) If anti-dismissal and other employment protection regulations are tougher, the average employment tenure may be longer; and (4) the higher the unionization rate for workers is, the longer the average employment tenure is.
    Theoretically, there is no unambiguous view on the relationship between employment tenure and productivity. On a national basis, a country where jobs are highly mobile with the average employment tenure being shorter is expected to have greater productivity as workers move quickly from lower-productive sectors to higher-productive sectors. On a corporate level, a worker who remains employed at one company longer may absorb more skills peculiar to the company. If job changes are limited, companies may have incentives to expand training for their employees, resulting in higher corporate level productivity.
    An ILO analysis uses data for each industry in 13 European countries between 1992 and 2002 to estimate the correlation between the average employment tenure and productivity within each industry. The estimates indicate that a one-year extension of employment tenure can boost productivity 0.16%. But an analysis of workers broken down by employment tenure into cohorts showed the cohort for more than one to nine years in employment tenure may have higher productivity than other cohorts. If the cohort for one year or less doubles its percentage share of total workforce in each industry, overall productivity may decline 4.2%. If the cohort for 10 to 20 years doubles its share, overall productivity may fall 1.8%. If the cohort for 20 years or more doubles its share, overall productivity may decrease 9.2%. If the relationship between productivity and employment tenure is presumed to be indicated by a concave function, productivity may be found to peak when employment tenure is 13.6 years.
    The relationship (shown supra) between productivity and employment tenure is seen within each industry. When we look at a national economy as a whole, however, we have to take into account the effect of workers' moves between industries, as noted above. This is a key point we must remember. On a company level, however, Japanese firms' tendency to maintain the lifetime employment practice may be viewed as rather reasonable.

Figure for Column 6 Relationship between Employment Tenure and Productivity

(2) Analysis Based on Questionnaire Survey on Corporate Management

(Questionnaire survey on corporate governance, finance and employment)
    Macroeconomic statistics as cited above reflect changes in Japanese firms' unique practices representing the so-called Japanese-style management. This apparently indicates that Japanese companies have been reviewing and reforming employment and financial practices as the environment surrounding Japanese companies have turned around on globalization of business activities, the falling birthrate and aging population and legal revisions. The Cabinet Office has conducted a questionnaire survey to analyze the present Japanese-style management and how Japanese-style management factors are affecting companies' performances(45).
    We sent questionnaires to 3,791 listed companies and received responses from 669 (17.6%) of them. Of the responding companies, some 50% were listed on the first section of stock exchanges, about 20% on the second section and about 30% on emerging company exchanges. Manufacturers accounted for about 40% of the responding companies and non-manufacturers (including construction firms) for some 60%. Details of the questionnaire survey and their analysis follow:

i) Survey agenda
    The questionnaire asked companies to make a five-grade evaluation about how important each item is in respect to such areas as corporate financial and business strategies and employment. More specifically, the questionnaire covered important stakeholders, financial indicators and fund-raising means, as well as policies on employment matters (including regular employment, mid-career recruitment, non-regular employment and wages), business relations with other firms, business strategies and reorganization.

ii) Extraction of average Japanese-style management factors through principal component analysis
    We used a standard deviation to canonicalize the five-grade evaluation results in the survey responses into scores, which were combined with corporate governance variables cited from an outside database(46) to develop a database. We then conducted a principal component analysis using these variables to extract synthetic benchmarks summarizing common characteristics of Japanese companies and identify average characteristics of Japanese-style management at present.

(iii) Each principal component and corporate performances
    For each principal component gained through the principal component analysis, we calculated scores at each company and analyzed correlations between these scores and corporate earnings.

(Major survey findings)
    Questionnaire survey findings are summarized below (Figure 2-2-14).
Figure 2-2-14 Findings of Corporate Questionnaire Survey
    First, many companies emphasize lifetime employment and employee-oriented corporate governance among key components of Japanese-style management, while a more-than-expected number of firms give priority to shareholders. Specifically, nearly 70% of responding companies view employees as their "extremely or fairly important" stakeholders. On employment of regular employees, 90% plan to maintain long-term stable employment. On the other hand, 80% view shareholders as "extremely or fairly important" stakeholders, indicating that most of Japanese companies are very conscious of shareholders' presence.
    Among other key components of Japanese-style management, not so many companies view relations with main banks and long-term inter-company business relations as extremely or fairly important. Specifically, some 40% view main banks as extremely or fairly important stakeholders. Main banks are thus less important than other stakeholders(47). Some 50% intend to maintain long-term business relations with other companies or explore new business partners while refraining from affecting relations with existing long-tem partners. But nearly 30% have no long-term business relations with others. On the other hand, more than 10% plan to expand cross shareholdings and nearly 60% intend to maintain present cross shareholdings. A fairly large percentage of companies thus give priority to cross shareholdings. This may be because Japanese companies have grown more cautious in the face of growing corporate buyouts.
    Third, companies still has a strong tendency to give priority to greater sales or size under their financial strategies. To some extent, however, they emphasize efficiency. Specifically, 80% to 90% view sales and profit as extremely or fairly important. More than 50% give priority to such capital efficiency indicators as the ROA and ROE. Nearly 70% emphasize cash flow.

(Deep-rooted Japanese-style management practices)
    We use the principal component analysis to reorganize questionnaire data on financial, management and employment axes into new comprehensive axes and grasp relations between variables and their characteristics.
    We canonicalized questionnaire response data regarding finance, management and employment into scores, which were then subjected to the principal component analysis to integrate 35 variables into a smaller number of principal components. The seven most explanatory principal components among them are mostly seen as linked to Japanese-style management (Figure 2-2-15). Particularly, the first principal component features main banks as key stakeholders, greater dependence on loans for raising funds, stable dividend payout (given as a percentage of par value), regular employees' greater share of workforce, seniority-based wages, limited mid-career recruitment and emphasized cross shareholdings, covering most of Japanese-style management elements. The second and third principal components indicate Japanese companies give strategic priority to sales rather than capital efficiency indicators like the ROA. The sixth principal component shows Japanese firms emphasize employees as key stakeholders. On the other hand, the fifth principal component depicts companies as positive about equity issues for raising funds, while the seventh principal component shows companies emphasizing the improvement of corporate value. These characteristics are somewhat different from those of Japanese-style management.
Figure 2-2-15 Breakdown of Highest-ranked Principal Components
    The above principal component analysis indicates that Japanese-style management elements are still deep-rooted at Japanese companies. However, the four highest-ranked principal components can explain only a quarter of the whole variance. This means that while some Japanese-style management elements are still left deep-rooted, Japanese companies now have diverse practices including those deviating from the scope of Japanese-style management.
    We have also conducted a principal component analysis for corporate governance, financial strategies and employment in a bid to look into what Japanese-style management elements are still shared by Japanese firms or how Japanese companies have diversified their practices. The analysis indicates that while some of Japanese-style management elements are left deep-rooted, Japanese firms now have practices running counter to Japanese-style management elements. According to the analysis for each area, the most explanatory or first principal component for each area indicates Japanese-style management elements such as the emphasis put on employees, the priority given to expansion of size like sales, and regular employees' high portion of workforce. But the first principal component can explain some 10% to about 20% of the whole variance. On the other hand, the second principal component indicates the emphasis put on shareholders, the priority given to equity issues for raising funds, and regular employees' low portion of workforce. These elements run counter to those indicated by the first principal component. This means that corporate practices have now been diversified.

(Representative management practices as seen from attributes of companies)
    We combined the seven most explanatory principal components with industrial categories and other attributes of companies as well as other questionnaire responses to analyze types of companies that have representative management practices (Appended Table 2-5).
    First, we would like to look at relations between such practices and attributes like industrial categories and stock markets. In the first principal component where Japanese-style management elements are seen most clearly, scores are higher for companies listed on first sections of stock exchanges and for manufacturing, construction, and electric and gas utility industries. In the third principal component, scores are higher for first-sections companies. In the second and fourth principal components, however, scores are higher for companies listed emerging company exchanges. Japanese-style management elements are widely seen irrespective of stock market differences.
    Next, we would like to consider correlations between representative management practices and responses to other questions. Regarding reorganization, companies that have implemented personnel cost reduction, streamlining and other restructuring measures have high scores for the first principal component featuring the priority given to main banks and regular employees' high portion of workforce. On strengths of companies, firms citing excellent management capabilities as their strengths are fewer among companies with high scores for the first principal component featuring Japanese-style management practices. Among companies with high scores for the sixth principal component where employees are emphasized as key stakeholders, many cite superior sales and marketing capabilities in addition to excellent technological capabilities as their strengths.

(Influences on Earnings)
    We have used companies' principal component scores to analyze how their different corporate governance practices and business strategies are correlated with their profitability and stock prices. Specifically, the company size, the number of years since an initial public offering and financial performances as explaining variables were added to the ROA, Tobin's q, total assets growth and price-to-book value ratio (PBR) as explained variables for adjustment. Then, we looked at correlations between explained variables and scores for the seven highest-ranked principal components and area-by-area principal component scores (Table 2-2-16).
Table 2-2-16 Relationship between Japanese-style Management and Corporate Performances
    Findings are summarized below:
    First, the first principal component, which indicates the priority given to main banks and regular employees' high portion of workforce, has negative correlations with the ROA, Tobin's q, total assets growth rate and PBR. Therefore, companies featuring the priority given to main banks and regular employees' high portion of workforce may be mature firms with lower growth potentials, lower capital efficiency indicators and lower stock market ratings.
    Second, the principal components featuring the emphasis put on employees (the sixth principal component for all areas and the first principal component for the corporate governance area) have significantly positive correlations with the ROA. This indicates that capital efficiency is not necessarily lower for companies that feature the emphasis given to employees as a key element of Japanese-style management.
    Third, the principal component emphasizing shareholders (the second principal component in the corporate governance area) and such components giving priority to equity issues for raising funds (the fifth principal component for all areas and the second for the financial strategy area) have positive correlations with Tobin's q, total assets growth rate and the PBR. Therefore, companies that emphasize shareholders and equity issues for raising funds can be expected to have greater growth potentials and higher stock market ratings. In other words, companies with greater growth potentials and higher stock market ratings can be expected to give priority to shareholders and equity issues for raising funds.

(Companies emphasizing employees feature greater earnings)
    How can we interpret these findings in comparison with earlier studies and theories?
    First, we would like to consider the finding that the first principal component, which features the priority given to main banks and regular employees' high portion of workforce as key Japanese-style management elements, has negative correlations with Tobin's q, total assets growth rate and the PBR. As noted earlier, companies with high scores for the first principal component were forced to restructure themselves. These firms have had no choice but to take restructuring measures in the face of excess debt and employment and might have gained lower stock market ratings. An earlier study said companies that depended heavily on main banks tended to expand their sizes in the early 1990s. These companies might have reduced their sizes as banks have disposed non-performing loans. Therefore, we may have to take note of the fact that companies that emphasize main banks do not necessarily reduce their sizes.
    How should we interpret the finding that capital efficiency is higher for companies with high scores for the principal component featuring the emphasis given to employees. Companies with high scores for the sixth principal component featuring the emphasis given to employees tend to cite sales & marketing and technological capabilities as their strengths. They are among firms that have not taken personnel cost reduction and other restructuring measures. These points indicate that companies that emphasize employees are utilizing their marketing and technological advantages to enhance their profitability. An adverse cause-to-effect relationship is conceivable. This means that companies with excellent financial profiles can give priority to employees without having to consider requests from shareholders or main banks. But the ROA may fall for these firms if they become inefficient by ignoring shareholders or main banks. A more plausible conclusion may be that companies emphasizing employees have been successful in business management. Our survey came after Japan's economic recovery entered the fourth year. In this sense, an earnings recovery might have allowed a rising number of companies to restore confidence in Japanese-style management.
    Finally, the finding that the principal components featuring the emphasis put on shareholders and on equity issues for raising funds have positive correlations with Tobin's q, total assets growth rate and the PBR may indicate that companies with greater growth potentials tend to aggressively issue equity shares for raising funds and emphasize shareholders as key stakeholders.

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