Christina Ahmadjian Hitotsubashi University Shusai Nagai Ritsumeikan University

1. Diffusion as a source of variety: Corporate governance reforms in the Japanese electronics industry Christina Ahmadjian Hitotsubashi University Shusai Nagai Ritsumeikan University

2. 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?

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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?

10. 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

11. 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

12. 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

13. 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?

14. 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

15. 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

16. Table 1: Board characteristics by firm

17. Table 2: Firm characteristics

18. 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

19. How do firms themselves justify adoptions of new practices? • Content analysis of interviews, securities filings • Identify themes • Themes mentioned by 3 or more firms

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

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

22. 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.”

23. 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.”

24. 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

25. Table 2 (repeat): Firm characteristics

26. 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.

27. 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.”

28. 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

29. 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

30. 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.”

31. 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

32. Table 4: Affiliations of outside directors (2006)

33. 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?”

34. “Independent” directors often from the same business group or even same company • Mitsubishi Electric: Directors from Mitsubishi Bank and Mitsubishi Corporation • Fujitsu: Fuji Electric

35. 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

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

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

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

39. 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

40. 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

41. Rather, we find… • Problem-based search • Local search for available solutions • Solution chosen and tailored in response to internal political dynamics

42. 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

43. 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

44. 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