The Corporate Governance, Cash Holdings, and Economic Performance of Japanese Companies

The following post comes to us from Meng Li and Douglas Skinner, both of the Booth School of Business at the University of Chicago, and Kazuo Kato of the Osaka University of Economics.

In our paper, Is Japan Really a “Buy”? The Corporate Governance, Cash Holdings, and Economic Performance of Japanese Companies, which was recently made publicly available on SSRN, we investigate whether the governance practices of Japanese companies, as manifested in their holdings of cash, have improved over the past two decades, and whether any such improvements translate into improved economic performance. We find that, in general, some of the differences between Japanese and U.S. companies that were evident during the 1990s have become less pronounced over the past 10 years but that important differences remain. While overall levels of cash holdings are now roughly the same for U.S. and Japanese companies, when we condition on firm characteristics we find that Japanese firms still hold substantially more cash than U.S. firms. We do find, however, that regressions of the determinants of firms’ cash holdings developed using U.S. data (e.g., Opler et al., 1999; Bates et al., 2009) fit Japanese firms better in the 2000s than in the 1990s, suggesting that Japanese managers now pay more attention to the economic determinants of their firms’ cash holdings, consistent with improved governance.

Although the large majority of Japanese companies continue to pay dividends, and the size of those dividends has increased for some Japanese firms, dividends paid by the median Japanese dividend-payer are still about half as large as those of the median U.S. dividend payer. Further, while the performance (profitability) of Japanese firms has improved since the 1990s, it is still 200 to 300 bps below that of U.S. firms. And while P/E ratios of Japanese firms have steadily declined over time and are now roughly comparable to those of U.S. firms, market-to-book ratios of Japanese firms are still much lower than those of U.S. firms, with medians of around 1 during the 2000s (compared to at least 2 for U.S. firms in these years).

We find mixed evidence on whether the cash management practices of Japanese firms have improved over time, perhaps because governance has improved for some firms but not others. Consistent with this, we find that levels of excess cash display greater persistence for Japanese firms than U.S. firms, and that this tendency is stronger for high levels of excess cash, which we associate with poor governance. Further, and consistent with the idea that improvements in governance manifest themselves in lower holdings of cash, we find an inverse relation between changes in the (excess) cash holdings of Japanese firms and changes in their performance. This result does not hold for U.S. firms, which we argue are generally better governed. Further, we find that the valuations of cash holdings for Japanese firms were systematically lower than those of U.S. firms in the 1990s, consistent with the idea that these firms were, on average, poorly governed during this period. The valuation of cash holdings of Japanese firms increases from the 1990s to the 2000s, to levels comparable to those of U.S. firms, consistent with an improvement in governance.

Overall, our findings support two conclusions. First, there is mixed evidence about whether governance practices in the average Japanese firm improve over the last 10 years, at least as manifested in their management of cash holdings. Second, those Japanese firms that are able to improve their management of cash enjoy both an improvement in performance and improved valuation of cash holdings. This evidence generally then supports the ideas that there has been some improvement in the governance practices of Japanese companies and that this translates into improved performance. This evidence offers hope that further improvements in the governance of Japanese companies will improve corporate performance and perhaps stimulate overall economic performance in Japan.

The full paper is available for download here.

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