Unnatural Selection of Outside Directors: Consequences of Japanese Corporate Governance Reforms

Abstract

We examine whether firm compliance with the corporate governance reforms is associated with enhanced effectiveness of corporate governance in practice. Past literature has cast doubts on the efficacy of the "one-size-fits-all" approach and pointed out the possibility of inform compliance, decoupling substance from appearance. Regarding this issue, we focus on the rapid increase in the number of outside directors in Japanese markets driven by the new corporate governance code and amended Companies Act. We find that, after implementation of the governance reforms, there is an increase in cases in which a company's former auditors become new outside directors for the same company. We also report that firms that had no outside directors prior to the reforms are more likely to engage in decoupling owing to their innate unwillingness to change and redeploy former company auditors as new outside directors. Moreover, we find no evidence that increases in the number of outside directors are related to a firm's future performance. We provide consistent but new evidence on the prediction of institutional theory and it suggests that firms tend to decouple their appearance of compliance from their practices when they have lower incentives to change.

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“…In the wake of Prime Minister Shinzo Abe's economic reforms (Abenomics), the Japanese government published the 'Japan Revitalization Strategy' in June 2013 and advocated enhancing corporate governance to improve investor confidence and facilitate a more aggressive business management, as well as increase the earnings capacity of firms. This strategy was followed by rapid and significant responses from financial regulators (Yanagi 2018;Kochiyama and Ishida 2020). These include the Stewardship Code of June 2014 (Financial Service Agency), the Ito Review of August 2014 (Ministry of Economy, Trade and Industry), and Japan's Corporate Governance Code of February 2015 (Tokyo Stock Exchange).…”