Investigating Abe’s Third Arrow: The Effect of Japanese Corporate Governance on Firm-Level TFP and Company Performance

Abstract

In response to a two-decade period of deflationary pressures and economic stagnation, Japanese Prime Minister Shinzo Abe has pushed for significant economic changes. Among his three arrows of fiscal stimulus, expansionary monetary policy, and structural reform, the third arrow of structural reform, which focuses on corporate governance, appears to be the most compelling. Japan has a long history of cross-shareholdings in which conglomerate networks of companies hinder the efficient allocation of resources. Additionally, compared to all other G7 countries, Japanese companies hoard cash and cash equivalents at the highest rate. With this in mind, the main purpose of this paper is to quantify the relationship between corporate governance (specifically cash-hoarding) and firm-level TFP. As a supplementary topic, this paper explores if corporate governance has an impact on company performance. To accomplish this task, this paper first constructs firm-level TFP presuming a Cobb-Douglas production function with time and firm-fixed effects. Then, this paper employs a series of panel regressions, using data between 1987 and 2016, in which the manufacturing and non-manufacturing sectors are analyzed separately. Results indicate that cash-hoarding, measured by cash to interest expense and cash to asset ratios, had a negative impact on TFP in both manufacturing and non-manufacturing firms. Additionally, relationships with main banks had a negative relationship, though small in magnitude, with TFP in both sectors. This is the first paper to conclude that indicators of corporate governance influence firm-level productivity in Japan. Supplementary results suggest that cash-hoarding had a positive relationship with ROA in manufacturing firms but a negative relationship with gross margin in non-manufacturing firms.