The Japanese Corporate Governance System and Firm Performance: Toward Sustainable Growth

Transcription

1 The Japanese Corporate Governance System and Firm Performance: Toward Sustainable Growth Hirotsugu Sakai Hoshi Asaoka Research Center for Policy and Economy Msubishi Research Instute, Inc. February 2004 Abstract Sakai and Asaoka (2003) suggest that the solution to problems of governance and firm performance is not que as simple as only shifting the system of governance from the Japanese type of corporate governance to Anglo-American. In addion, the Anglo-American type of corporate governance system has recently been heavily cricized. Considering the above, this study tries to find ways to explo the strengths of Japanese-type governance, especially by focusing on firm employment. Using panel data for Fiscal Years , this paper examines whether the utilization of temporary/part-time workers has improved firm performance in subsequent years. Although many studies have been made on the effect of firm performance on employment adjustment behavior, not much seems to be known about the oppose channel, that is, the effect of employment adjustment on firm performance. Section gives the introduction. Section 2 reviews previous research on corporate governance, principally concerning R&D and human capal. In Section 3, the datasets are explained while the models are presented in Section 4. The empirical results are discussed in Section 5. Concluding remarks are made in Section 7.

2 I. Introduction. Summary of the 2003 preliminary study on Japanese corporate governance and firm performance It has been argued that the lack of product market competion and poor corporate governance are two of the main reasons for the recent slow productivy growth in Japan. Morck and Nakamura (999) argue that Japanese corporate governance practices may have played a crical role, both in pushing Japan s economy into s current muddle and in keeping there. It is often pointed out that the Japanese corporate governance system has to change from an insider type of governance, or the so-called Japanese-type governance, to an open-type governance, or the Anglo-American-type governance, in order to achieve the sustainable growth of firms and the Japanese economy. In a preliminary study conducted last year, Sakai and Asaoka (2003) used panel data consisting of more than 400 Japanese firms for Fiscal Years , and examined how corporate governance and market competion affect firm performance. For their measure of firm performance, they utilized total factor productivy growth derived from the estimation of a production function. In contrast, most preceding lerature that investigated the relationship between Japanese firm performance and corporate governance used Tobin s q as their measure. Sakai and Asaoka (2003) found that market competion improved firm performance in Japan, which was consistent wh the results by Nickell (996). The result, however, contradicted the estimation results of Hoshi, McMillan and Schaede (997) that used a sample consisting of pooled data of major Japanese firms. They also found that higher debt-asset ratio likewise improved firm performance, suggesting that debt-based discipline is effective. It is inferred that the so-called Japanese-type corporate governance has been effective for the decades. Their results showed that not only market-based discipline, which is the feature of Anglo-American-type governance, but also debt-based discipline, which is one of the main characteristics of Japanese-type governance, still improves firm performance. They included an interaction term for market share and debt-asset ratio. They found the coefficient to be negative, implying that debt-based discipline is a complement for the market discipline. The coefficient, however, was statistically insignificant. This result was que interesting because contradicted the result by Hoshi, McMillan and Schaede (997), which found that debt-based discipline is a substute for the market discipline. The findings of Sakai and Asaoka (2003)

3 suggested that the solution to problems of corporate governance is not que as simple as changing the governance system from the Japanese type of corporate governance to Anglo-American. A far more elaborate study on corporate governance and firm performance is necessary to achieve the sustainable growth of Japanese firms and the Japanese economy. 2. The aim of the study Holmstrom and Kaplan (2003) point out that the Anglo-American-type corporate governance system has recently been heavily cricized, largely as a result of failures of Enron, WorldCom, Tyco and other prominent companies. Tradional corporate governance studies aimed mainly at major firms that have enormous physical capal. But the new economy is moving forward wh the role of human capal becoming increasingly important, and, in order to explo the potential efficiencies inherent in the new economic suations, new business models and organizational structures are likely to be desirable and valuable. Technological progress and skilled labor strongly correlate wh each other. Demsetz (996) finds that there is an economy-wide trend of increasing employment shares of highly skilled workers that result from the increase in skill-biased technological change. A study by Machin and Van Reenen (998) 2 find that the relative demand for skilled workers has increased in all seven OECD countries, and this is partly because technology has changed to one that requires more skilled labor. According to Nickell and Van Reenen (200), there remains a significant gap in market sector productivy between UK and Uned States. One of the reasons for this is the problem of skills. Also, is due to a weakness in technological innovation, which includes comparatively low and falling levels of R&D. From these perspectives, is imperative to focus on R&D and human capal in considering corporate governance matters. In this study, the main focus is on skilled labor. Due to the long recession, there is a trend in Japanese firms to change from full-time employees to part-time. This paper tries to assess the effect of this change on the productivy growth by industries, and makes clear the appropriate corporate governance system. It should be noted that firms vary, and the appropriate corporate governance system will change according to the characteristics of firms and the business condions that surround these firms. Using the panel data mainly consisting of the long existing manufacturing firms, this study finds that full-time employment is key to firm performance in the subsequent years. It is also finds that even in the supermarket industry, As Becker and Huselid (998) point out, the current state of the art practices, such as intellectual capal, knowledge work and workers, and high-performance work systems, all reflect new interest in people as a source of competive advantage, rather than as costs to be minimized. 2 It likewise finds that the changes in industrial organization and organizational structure also have had no small effect. 2

4 although wh lesser effects in comparison wh the manufacturing industry, full-time employment seems to be a key to productivy. Myopic changes in employment strategy to boost short-run profs are harmful for future productivy. Section 2 reviews previous research on corporate governance, principally concerning R&D and human capal. In Section 3, the datasets are explained while the models are presented in Section 4. The empirical results are discussed in Section 5. Concluding remarks are made in Section 7. 3

5 II. Corporate Governance and Productivy: Two Contributing Factors for Raising Productivy, R&D and Human Capal In this section, attention is focused on R&D and human capal as two contributing factors for raising productivy.. R&D (Research and Development) () R&D and Productivy Growth R&D is a que important factor for raising the productivy. Various studies show that R&D has a posive impact on the productivy growth. For example, the tradional study by Grilliches (986) examines data on all the major firms performing R&D in the Uned States. It presents evidence supporting the proposion that R&D significantly contributes to productivy growth. At the same time, the former seems to have earned a relatively high rate of return. The study also finds that basic research appears to be more important as a productivy determinant than other types of R&D. Hulten (992) reviss the hypothesis that technical change embodied in capal is a source of economic growth. He finds that approximately 20 percent of the residual growth of qualy-adjusted output could be attributed to embodied technical change. Jaffe (986) shows the strong impact of R&D on economic growth by giving attention to spillover effects. He quantifies the effects of firms R&D, and finds that firms whose research is in areas where there is much research done by other firms have higher returns to R&D, in terms of accounting profs or market value, through spillovers of R&D 3. (2) R&D and Corporate Governance R&D is a typical activy that needs corporate governance. A firm s corporate R&D strategy is subject to acute manager-stockholder conflicts of interest. Large investment in R&D is generally a high risk-high return strategy that is attractive to stockholders because they anticipate a posive effect on performance and they can reduce the inherent risk by keeping diversified investment portfolios. In contrast, executives will be reluctant to invest in long-term R&D projects because innovative projects have high failure rates and do not yield short-term returns. Alchian and Demsetz (972) point out that risky R&D projects imply an immediate employment risk that cannot be diversified away. Previous studies have some viewpoints and these are shown below. 3 At the same time, the study points out those firms wh very low own R&D suffer lower profs and market value if their neighbors are R&D intensive. 4

6 (i) Ownership Structure and R&D The effect of ownership concentration on R&D is mixed. Hill and Snell (988) report a significant and posive relationship between the level of corporate R&D spending and the concentration of equy ownership among individual stockholders, suggesting that large stockholders can encourage corporate investment in R&D. According to Baysinger, Kosnik and Turk (99), ownership concentration posively affects corporate R&D spending per employee when is measured as the cumulative equy owned by major shareholders. In contrast, wh the Herfindahl measure, no significant relationship wh R&D spending emerges. Also, while the concentration of stock among instutional stockholders posively affects R&D spending, the ownership concentration among individual shareholders does not. The study by Bond, Harhoff, and Van Reenen (2003) is que interesting in that compares the R&D strategy in firms in the UK, which have low R&D ratios, and German firms, which have high R&D ratios. The combination of comparatively low R&D expendures in the UK and comparatively high required rates of return support the argument that demand-side issues are at work. Brish firms require a higher rate of return from R&D investments and relatively ltle R&D is undertaken. The observed differences may be driven by larger shareholder concentration, the impact of equy holdings by banks and the lack of a market for corporate control in Germany, or by other instutional features of the financial system. The result is suggestive because bank-based systems of internal control, ownership concentration, and cross shareholdings are similar in Japan and Germany. (ii) Myopic Manager and R&D Aspects of the effect of inappropriate corporate governance on the level of R&D do not go together. It is believed that the stock market-oriented US financial system forces corporate managers to behave myopically relative to their Japanese counterparts, who operate in a bank-based system 4. Close relationships between banks and firms reduce asymmetric information problems and, therefore, may enable firms to behave less myopically. Since expendures on R&D are unlikely to generate revenues until such knowledge is incorporated in the production process, is likely that cuts in R&D are not going to affect sales in the current period. This would make R&D an attractive em to cut for a shortsighted manager faced wh a cash flow problem. Hall and Weinstein (996) hypothesize that if US firms are more myopic 4 From a survey of about 500 major US and Japanese companies, Abegglen and Stalk (985) discuss that Japanese managers ranked increasing market share as the most important objective and increasing stock price as the least important, while US managers ranked stock price second, and interpret these survey results as evidence that US managers are more short-sighted. Shleifer and Vishny (995), however, conclude that the theories and arguments in favor of the view that US companies are relatively shortsighted are remarkably short of any empirical support. 5

7 than Japanese firms, then episodes of financial distress should cause US firms to decrease their R&D spending, which is a proxy for long-term investment, more than Japanese firms. But they find no evidence that this is the case. The similar responses of US and Japanese firms to financial distress cast doubts on the view that US managers are more shortsighted than their Japanese counterparts. As Graves and Waddock (990) suggest, the observed posive effect of equy concentration among instutional investors on corporate R&D spending sharply contrasts wh the popular claim that their shortsightedness forces top executives to adopt a short-term focus when making investment decisions. It is inferred that instutional stockholders posively value capal investments in long-term R&D projects. Instutional investors, whose investment portfolios are typically diversified, may be able to spread R&D risk more effectively than individual investors wh undiversified or small investment portfolios. Jensen (986) argues that managerial myopia will only be a problem if managers do not care enough about stock prices. He also points out that managers have incentives to cause their firms to grow beyond the optimal size. Outside stakeholders find hard to evaluate the effectiveness and necessy of expendures on R&D, and this tends to increase as more resources are brought under the managers control. As a result, less profable R&D projects will be executed, and thus, bring about inefficiency. According to Stein (989), however, even a fully efficient market can lead managers who care about stock prices to behave myopically. R&D investments are relatively invisible in nature, and money spent on them cannot be accurately disentangled from increased operating cost. It is also noted that while takeovers may be an important disciplining mechanism in the US, has also been argued that they lead to managerial myopia. If managers choose actions that have long-term benefs, such as R&D, but temporarily lower earnings, the company s stock price will be undervalued, making an attractive takeover target for relatively informed raiders. This viewpoint suggests that insider-dominated boards and other corporate governance mechanisms that reduce the threat of hostile takeovers in Japan may release Japanese managers from being preoccupied wh short-time concerns that lead to myopic behavior, and thus, expand the R&D expendures to the appropriate level. (iii) Debt ratio and R&D High debt ratios have disciplinary effects by restraining the executive s incentive to seek private benef, and, thus, is supposed to restrain R&D expendures. Hall (992) finds strong evidence that changes in the financial structure of firms which tilted the balance sheet toward debt were followed immediately by substantial reduction in R&D in a large panel of US manufacturing firms during the 980s. The hypothesis that R&D investment is particularly 6

8 constrained by cash flow has been suggested, at a theoretical level, by Leland and Pyle (977). They argue that there is an inherent moral hazard problem in transferring information about a risky project from a firm to shareholders. It seems somewhat plausible that the extreme riskiness of R&D projects, and the difficulty and cost of revealing information about such projects might lead firms to prefer internal finance when they undertake them, to an extent which is not true for investments in physical capal. Prowse (990) examines the agency problem between shareholders and debt holders of Japanese and US firms, and finds that the agency problem is migated to a greater degree in Japan than in the US. He likewise finds that debt ratios of US firms are negatively related to the firm s potential to engage in risky, suboptimal investments such as R&D, whereas Japanese debt ratios show no such relation 5. (3) The Impact of R&D on TFP Growth: Japanese Case Does a firm s expendure on R&D have a posive impact on TFP growth? According to Tokui and Tomiyama (2003), the result changes depending on the period of estimation. It is insignificant until Fiscal Year 990, but is significant 6 after It is inferred that the Japanese firm s R&D strategy was in line wh s attude toward the maximization of firm s value. In the 980s, stable stockholders relaxed the executive s discipline, and thus, bringing about excess expendures on R&D. In 990s, however, mutual monoring among executives worked well during the recession. (4) R&D and Human Capal: Is R&D and Human Capal a complements? It seems that R&D intensy pushes up the demand for skills 8. Skilled workers are more highly paid and more educated than production workers. Its growth has been in the higher skill occupations such as professionals, including scientists, engineers, and computer programmers and managerial occupations, while the decline in production labor has been primarily in lower skill occupations such as operators and laborers. Mincer (99) shows that the observed steepening of experience profiles of wages is explained in part by the growing profabily of human capal which extends to that acquired on the job, and in part by relatively strong demand for R&D. Firms that put strong emphasis on R&D and new product 5 It is worth noting that Hirota (999) argue that if a firm has made a large investment in fixed assets, will have smaller costs of financial distress than a firm wh a large investment in R&D. The reason is that fixed assets have relatively high resale values whereas most of the value of R&D disappears in financial distress. Therefore, a firm wh large expendures on R&D prefers to have low leverage to reduce the probabily of default. 6 A firm s R&D expendure raises s TFP two years later. 7 Tokui and Tomiyama (2003) also find that the debt ratio has a negative impact on R&D after 99. It seems more plausible to explain the result by continued downward revision of prof prospects that restrain the posive investment such as R&D, than by effective debt-based discipline. 8 Other explanation for the changing relative demand for skilled workers is that the adoption of new sophisticated capal equipment and the introduction of flexible manufacturing methods have raised the demand for more skilled workers (Dunne, Haltiwanger, and Troske (997)). 7

9 development want their employees to learn firm specific skills. This kind of skills is not acquired by self-study, but learned through job experiences and on-the-job training. Creating the mechanism of improving the stabily of work force is que necessary for them. According to Grossman and Helpman (99), human capal means a set of specialized skills that agents can acquire by devoting time to an activy called schooling. The more time that an individual spends in school, the greater is the human capal that the individual acquires. Since, in realy, unskilled and skilled labor generally perform very different tasks in both the industrial research laboratory and in the manufacturing enterprise, is plausible to treat these two types of labor as distinct and imperfectly substutable inputs. Specialized skills are deeply linked wh R&D, and has to be made endogenous together wh the rate of technological change 9. Dunne, Haltiwanger and Troske (997) shows that R&D and skill complementary contribute significantly to the average secular change in share of skilled labor. The aggregate change in the share of skilled labor reflects technical change inducing existing individual plants to reorganize and new more skill-intensive plants to displace existing less skill-intensive plants. Machin and Van Reenen (998) also show a significant association between skill upgrading and R&D intensy in all OECD countries. The result provides evidence that skill-biased technical change is an international phenomenon that has had a clear effect of increasing the relative demand for skilled workers. These analyses lead to the conclusion that there exists important skill-technology complementaries across all countries. It is likely that the move toward higher R&D intensies and increased computer usage are factors that have contributed to reduce the relative demand for unskilled workers. Growing importance of skilled labor is acknowledged in R&D intensive firms. A firm s organization will change accordingly. Wh skilled labor becoming increasingly important, fostering becomes a key task for firms 0. 9 Taking technical change to be exogenous, which is common wh most existing lerature, may be a problematic assumption. The technology-skills correlation would be due to endogenous technological advance. 0 As Ichniowski and Shaw (995) point out, is worth noting that in older lines, workers have made previous investments in relationship-specific skills that are valuable only under the existing set of work rules. When firms invest in the relationship-specific human capal of their workers, the firm is liming s future abily to make changes in workplace organization, because will diminish the strong birth effects. It is not desirable for firms to rely too much on skilled labor. 8

10 2. Human Capal Add Weight on Skilled Labor and Human Capal in Corporate Governance Matters The firm s human capal, as represented by s employees, has become much more important. As competion has increased, physical assets have become less unique and employees have many more outside options. In addion, according to the reforms in financial system, manufacturing technology and organization, demographic change, and intense global competion, firms have to change the type of corporate governance. A firm s employment system also has to respond to the change. The relative importance of human capal has increased tremendously. Rajan and Zingales (2000) insist that a firm has to be distinct in terms of s costs or qualy to make money in the competive market place. This has increased the importance of innovation, not only as represented by R&D but also as reflected in process innovation and qualy improvement. Innovation comes from human capal, not from inanimate assets. The growing prominence of corporations where physical assets are unimportant relative to human assets raises a number of new issues of governance. According to Hart (995), the owner of the asset has residual control rights over that asset by the property rights approach. It makes more sense to allocate the scarce ownership rights so as to motivate key employees, whose actions have a greater effect on company value or whose human capal is very important 2. Control over valuable human capal would seem to be a greater source of power than control over physical assets since almost all control rights over are residual. At the same time, while the control rights associated wh ownership may have diminished, the role of ownership in providing motivation may have increased. It is desirable to spend less time discussing how to strengthen the rights of dispersed owners, and more time on mechanisms to control and retain human capal. (2) How to Measure Human Capal and Skilled Labor? Tradional growth papers give an emphasis on human capal in the production function. Romer (990) uses the model that separates labor and human capal. Labor services are skills like eye-hand coordination that are available from a healthy physical body, and measured by counts of people. Human capal is a distinct measure of the cumulative effect of activies such as formal education and on-the-job training. The most interesting posive implication of the model is that an economy wh a larger total stock of human capal will According to Becker and Huselid (998), ignoring human resource is entirely appropriate in an economic environment wh limed demands for change, where products and services are not knowledge driven, and a firm s labor force is a factor of production, but rarely a source of competive advantage. 2 Hart (995) also suggests that in large companies, ownership and control rights are often in the hands of outside shareholders rather than key employees. 9

11 experience faster growth. Mankiw, Romer and Weil (992) use as proxies for the rate of human capal accumulation measures that approximate the percentage of the working-age population that is in secondary school. As surveys by Card (999) show, the studies on the causal relationship between human capal and earnings almost always use educational attainment as the proxy for human capal. In this study, attention is given to skilled labor that might be acquired through on-the-job training. It is assumed that full-time employees can accumulate human capal through the on-the-job training, while part-time employees cannot. (3) Recent characteristics of Japanese employment system: Long-term employment practice and employment adjustment It is often said that employment stabily is one of the main characteristics of Japanese labor market. As Tomiyama (200) suggests, firms that invested and accumulated human capal will not make layoffs easily. In case those training expenses for employees become sunk cost for firms, is not desirable for firms to let them go. The paper finds the sluggish speed of employment adjustment especially for firms wh typical corporate governance that is under the main bank and financial keiretsu systems. On the other hand, some studies insist that Japanese firms are continually adjusting their employment. According to the estimates made by Komaki (998), employment adjustment tends to be executed after two consecutive years of operating defics. It might be explained from a corporate governance perspective. Credors, such as main banks, request restructuring to raise the possibily of debt collection when the firm is plagued by an operating defic. This firm is obliged to accept the request of restructuring and employment adjustment in order for to suffer contraction of commment lines and hikes in loan rates. Wh respect to the relationship between employees and employer, firms wh consecutive defics will go bankrupt, and all the employees will lose their jobs. This means that firm-specific skills, that cannot be transferred, will be completely impaired. To avoid this, employees tend to accept negotiations through labor unions, and substantive employment adjustment will be realized. Procedures of employment adjustment differ by industry and firm. Nakata and Takehiro (200) find that the coefficient of employment adjustment of the automobile industry is smaller than that of retail businesses. Automobile manufacturing firms restrain the frequency and size of employment adjustment among full-time employees using the flexible operation of overtime working hours. Supermarkets and department stores posively use part-time employees that could be substutes for full-time employees. It is worth noting that the employment adjustment differs according to the characteristics of industries and firms. 0

12 (4) Effective Utilization of Human Capal : Organizational Reform The focus of corporate governance shifts from alleviating agency problems between managers and shareholders to studying mechanisms that give the firm the power to provide incentives to human capal. It is becoming more important for corporate governance matters to clarify control mechanisms and effective use of human capal than to study the distribution of various rights to stakeholders. Then, what measures need to be effected in order for human capal to have a posive impact on productivy? Changes in the nature of organizations, the extent and requirements of markets, and the availabily of financing have made specialized human capal much more fundamental. As the importance of human capal grows, power has moved away from the top and is much more widely dispersed through the firm. Reforms in organization and enrichment of education, including work-related education and on-the-job training, are the solutions 3. The human resource management system can indeed be a strategic asset 4, capable of generating above-normal economic rents. Firms that rely on human capal as a source of competive advantage ultimately require the productive behavior necessary to implement their strategies. A fundamental source of this productive behavior, both in terms of the inial acquision and subsequent development and motivation, is the firm s human resource management system. Ichniowski, Shaw and Prennushi (997) find that groups or clusters of complementary human resource management practices, such as incentive pay, teams, flexible job assignments, training and the like, have large effects on productivy, while changes in individual work practices have ltle or no effect. Bauer (2003) uses a German employer-employee matched panel data, and examines the effects of High Performance Workplace Systems (HPWSs 5 ) on labor productivy and efficiency 6. He shows the estimated effects of HPWSs on labor productivy rise over time 7. The study by Caroli and Van Reenen (200) find that Brish and French establishments that introduced organizational changes were significantly more likely to 3 According to Dunne, Haltiwanger and Troske (997), long-run secular increases in the nonproduction labor share are concentrated in recessions. It is consistent wh models that predict that retooling and reorganization of the workforce will be concentrated in recessions, since the opportuny cost of the disruption from undertaking retooling/reorganization is low during these periods. Nickell, Nicolsas and Patterson (200) have undertaken an empirical analysis of the notion that firms introduce managerial innovations as a consequence of bad times, and conclude that a competive firm operating in a perfect capal market may well devote more of s employees time to reorganization and other productivy improving activies during recessions. 4 Strategic assets are the set of difficult to trade and imate, scarce, appropriable, and specialized resources and capabilies that bestow the firm s competive advantage. 5 Adopting HPWSs is significantly affected by negative external transory shocks, indicating that ignoring the potential endogeney of HPWS measures leads to downward biased estimates of these practices on establishment performance. 6 Labor productivy is defined as sales per worker, and labor efficiency is defined as the inverse of un labor costs. 7 It points out, however, that the corresponding posive effects of HPWSs on labor efficiency occur only in the long run.

13 reduce their demand the most for unskilled workers than those that did not. Likewise, the introduction of organizational change in skill-intensive firms leads to significantly faster productivy growth than the introduction of organizational change in unskilled-intensive firms. Organizational change and human capal are thought to be complements. To be more precise, what kind of organizational reforms and their combinations are effective? Black and Lynch (200) examine the impact of workplace practices, information technology and human capal investments on productivy, and find that allowing greater employee voice in decision-making is what seems to matter most for productivy 8. Ichniowski and Shaw (995) insist that certain combinations of innovative work practices, combinations that emphasize high levels of employee participation in work teams, flexible job design, heavy reliance on incentive pay, and extensive training and communication, produce significant productivy advantages over other combinations of more tradional work practices. According to Becker and Huselid (998), flatter organizational structures wh decentralized decision rights are a reaction to product markets demands for more timely and consumer friendly responses. Firms understand that individual employees have valuable local specific knowledge, and indeed many now have no choice but to rely on employees to use that information to successfully implement the firm s strategy. Boning, Ichniowski and Shaw (200) find strong support for the proposion that problem-solving teams are important for increasing the effectiveness of group incentive pay plans in establishments wh complex production processes. Their results suggest that, as manufacturers invest more and more in new computer and information technologies, the use of new work practices like problem-solving teams will become increasingly common. Information technology puts information in the hands of production workers and innovative work practices give them the authory to use that information. It is also clear from the study of Bresnahan, Brynjolfsson and Ht (2002) that there is evidence for complementary in the use of information technology and a new workplace organization, which includes broader job responsibilies for line workers, more decentralized decision-making and more self-managing teams. In addion, they find that both IT and new organization complement worker skill. On the other hand, there is some doubt on the effect of organizational reform and restructuring. For example, Godard and Delany (2000) insist that the broader interest in human resource management practices and associated innovations forming the core focus of the new paradigm will prove to be short-lived. Cappelli and Neumark (200) conclude that work practices transferring power to employees, often described as high-performance practices, raise labor costs per employee, suggesting that they may raise employee compensation. It also means that higher compensation is a cost to employees, although some statistically weak 8 It is worth noting that re-engineering has a posive impact on the labor productivy, but measures such as prof sharing and stock options are insignificant factors for labor productivy (Black and Lynch (200)). 2

14 evidence suggesting that these practices raise productivy and that high-performance work practices have minimal effects on overall labor efficiency. Osterman (2000) shows that high performance work organizations practices continue to diffuse at a rapid rate, and finds that adoption of those practices is associated wh increased layoff rates in subsequent years and no compensation gains. As Nakata and Takehiro (200) point out, reforms in human resources will not be a right measure unless they will strengthen full-time employees morale, even if they help promote the certain degree of employment adjustment. It is que necessary for each firm to create sustainable incentives to work for s employee by taking into consideration the characteristics of the category of business belongs to and the firm self. From this viewpoint, reforms in organization and employment structures are thought to be effective. (5) Effective Utilization of Human Capal 2: Employment Strategy; full-time and part-time employees Recently, there is a trend toward the reduction in full-time employees and increase in part-time employees in Japanese firms. As Yashiro and Oishi (995) point out, is que natural for firms to replace full-time employees wh part-timers in cases when the firm s expected growth rate is declining because will both cut down the expected return from human capal and relatively increase the employment cost of full-time employees. In realy, there is a discrepancy in the share of part-time employees among firms. At present, business establishments wh high hiring rate and labor turnover rate are likely to hire part-time employees. They retain a stable number of employees through the flexible adjustment of part-timers. According to Ishihara (2003), full-time employees are substutable by part-timers in these business establishments because firm-specific skills 9 are not likely to be accumulated by full-time employees 20. Decreasing skilled labor force, however, does not have insignificant effect on productivy. Higuchi and Shinpo (2003) suggest that firms wh proactive R&D tend to stress the retention of employees so as to accumulate and efficiently improve the skills in the firm. High ratios of full-time employees, slow employment adjustment, and minimal fluctuations in 9 Firm-specific skills are acquired by specialization in the idiosyncratic needs of the firm, while technical skills are tied to the industry, but not to a firm specific. Then, why would employees choose to specialize on firm-specific skills when they know that this will make them dependent on the firm? One reason might be that their skills are not very valuable individually, but they have immense value collectively. 20 Ishihara (2003) also points out the possibily of complementary, not substutabily, between full-time and part-time employees in retail businesses and service industries that have a high part-timer ratio. Remarkable reduction in full-time employees occurs in those business establishments wh few part-time employees. At the same time, the share of part-time employees that pursue equivalent jobs wh full-time employees in some industries should be noted. In that case, establishing a fair evaluation system between full-time and part-time employees is necessary. It is also a required condion for work sharing to prevail. 3

15 the number of employees are the typical characteristics of these firms. Substuting part-time employees for full-time employees sometimes becomes an optimal choice in the short-run, but has some harmful effects. 2 It is often said that the firm restructuring is effective in the recovery of corporate profs, and, thus, making possible to offer more job opportunies afterwards. Higuchi and Shinpo (2003) express doubt on this assertion. Their estimate shows that restructuring is effective in increasing the value-added, especially in the firms that belong in the manufacturing sector, but does not have a posive effect on expanding future employment 22. In a workplace that needs skilled workers and non-managerial professionals, an increase in the ratio of part-time employees will make difficult for full-time employees to bring in new recrus and, they would rather concentrate on their primary occupations. Hence, lowering the proportion of part-time employees is necessary to solve the problem. It is also thought to be necessary to reduce the ratio of part-time employees in clerical jobs to prevent the leak of classified materials and weaken the shared awareness of the workplace (Kimura (200)). Currently, negative effects of the increased ratio of part-time employees are thought to primary result from the deterioration of the labor qualy, not from the quanty. But as the ratio goes up, not only will labor qualy but s quanty will have negative effects on the firm s performance over the medium and long terms. The significant increase in part-time employees in the firm will promote the substution of full-time employees wh part-time employees. This will cause full-time employees to concentrate on jobs that need advanced skills and expertise, and, thus, raise their labor productivy. However, becomes difficult for those firms to discharge full-time employees, and this will increase the firm s labor expenses 23. The strategy to raise the share of part-time employees has both posive and negative effect on the performance of firms. It is que important for them to balance s strengths and limations, and attain an optimal proportion of part time employees depending on the characteristics of the firm and the industry that belongs to. 2 Mainly seen are the microeconomic harmful effects on the following, but there are some macroeconomic harmful effects, such as rising unemployment rate. Nickell and Ours (999) point out the evidence that the equilibrium unemployment rate is higher than needed because of the shortage in the supply of skilled workers and excess low-skilled workers in the UK. 22 Higuchi and Shinpo (2003) use the panel data of METI s research conducted in 2000, and find that improvement in productivy by restructuring will be preserved only for a short period. In addion, is hard for firms that have once cut staffs to shift towards increasing the number of employees, and thus also making hard for them to improve their productivy in the long run. 23 According to Miyamoto and Nakata (2003), promoted employment adjustment in retail businesses in the latter half of 990s reflected the strong reduction of sales amount and the relative increase of labor cost of full-time employees. 4

16 (6) Effective Corporate Governance will Change by Firms and by Industries Osano (2002) classifies effective corporate governance into three types depending on the characteristics of firms and industries, and these are discussed below. Industries such as those engaged in computers, and processing and assembly of electric-appliances where information sharing among employees is unnecessary because of the developing modularization belong to the first category. Introducing a wage system that will fluctuate automatically wh firm performance or stock options will be effective incentives for firms that belong to this category. Anglo-American-type governance, also called open-type governance, may be effective for the firms of this category. Industries such as automobile, machine tool, and certain electronic components industries where information sharing and prior consultation among employees matter belong to the second category. It is necessary for these firms to retain their employees. Employees of these firms are hoped to acquire the firm-specific specialization. Autonomous governance 24, where employees implicly discipline employers, works effectively for the firms that belong to this category. It should also be noted that capable human resources are apt to be picked out by other industries. Matured and sunset industries belong to the third category. It is fundamental for them to reallocate their resources and capal according to the shareholder value, and to design the incentive mechanisms, such as introducing stock option and employee stock ownership program, that will not result in the discrepancy of interests between shareholders and employees 25. Optimal corporate governance will change according to the characteristics of firms and the industries that they belong to. This study especially focuses on the corporate governance from the viewpoint of employment strategy. It is becoming increasingly important to devise measures to add an incentive to employees, and thus, realize the improvement in productivy. 24 Lifetime employment system, illiquid labor market and employer-employee information sharing are the necessary condions for autonomous governance mechanism to work. However, Kawamura and Hirota (2002) argue that those firms that do not have the above characteristics are not expected to improve the performance by adopting an autonomous governance mechanism. In addion, such governance mechanism will prevent effective management if is applied to depressed industries that need restructuring. Those industries need outsiders governance such as that provided by shareholders. 25 Rajan and Wulf (2003) show that pay increases more sharply wh promotion, and long-term incentives, such as equy based compensation, help tie employees into the company, thus bringing management and shareholder interest into closer alignment. 5

17 III. Data The following empirical analysis of the effects of change in the structure of workers on firm performance is based on a firm-level dataset, ranging from FY979 to FY2002. More specifically, the paper uses the sample of Japanese private firms from "Kigyo Keiei no Bunseki (Analysis of Corporate Management)" compiled and published yearly by Msubishi Research Instute, Inc. This dataset contains data from balance sheets (B/S) and from prof and loss statements (P/L) of selected Japanese private firms. Most of the series originally come from firms official financial statements, but some, for example, value added and s components data, are obtained by directly sending questionnaires to firms. Balance sheet data appear in unconsolidated form. Included are firms that went bankrupt before FY2002 in order not to have a survival bias in the empirical analysis. Highly "public" firms, i.e., electric power and airline firms, are excluded. Also excluded are firms that cannot match wh external data needed for estimation, and those that changed their accounting periods after FY990. Eventually, the dataset used becomes an unbalanced panel wh 477 firms from FY979 to FY2002. The construction of the variables used in the panel data analysis is discussed below. Value added Value added, denoted by Y, is the sum of the following ems: (i) personnel cost (employees compensation, welfare expense and allowance for employee retirement benefs), (ii) rental cost, (iii) financial cost, tax and public charges (excluding the taxes enumerated in (iv)), (iv) corporate, residence and enterprise taxes, (v) current net prof, (vi) depreciation allowance. Thus, this em is in line wh the concept of value added in the System of National Accounts (SNA). Capal stock Capal stock, denoted by K, is measured using the tradional perpetual inventory method", which is the sum of past investments adjusted for depreciation. Specifically, the estimation of each firm s capal stock is done in the following manner. For each firm, the annual increments of tangible fixed asset are calculated, and defined as net fixed investments. Then, by adding depreciation allowances to net fixed investments, gross fixed investments are 6

18 obtained. Deflating gross fixed investments by private fixed investment deflator taken from the SNA 26 results in real gross fixed investments. In order to get the depreciation rate, depreciation allowances are divided by tangible fixed asset at the beginning of each fiscal year. Taking real tangible fixed assets at the inial year (for most firms, FY979) as an inial value of real capal stock, capal stock is computed using: K = I + ( δ ) K, where K denotes firm i s real capal stock at time t, δ denotes the depreciation rate. I denotes real gross fixed investment, and Labor input Each firm s labor input, denoted by L, is the product of the total number of full-time and temporary/part-time employees of the firm and hours worked by industry. "Full-time employees" refer to the sum of the number of full-time employees and that of board members. Temporary/part-time employees are what is termed as nonstandard workers; hence, they do not necessarily work part-time. "Hours worked by industry" is taken from the "Monthly Labour Survey" of the Ministry of Health, Labour and Welfare. Measure of change in the structure of workers One of our main concerns in this paper is whether temporary/part-time staffing actually improves firm performance or not. Utilization of temporary/part-time staffing and outsourcing part of businesses are considered to be financially effective measures for firms to make profs. It is true that, in the short run, the reduction in personnel costs surely improves prof, but the effect of temporary/part-time staffing on firm performance is empirically ambiguous in the long run, especially among Japanese firms, many of which have been applying the life-time employment system for years. Here the following dummy variables are included: CISW is a dummy variable equal to if FEMA > 0 and TEMA > 0 ; otherwise 0 (both full-time and temporary/part-time employees are strictly increasing); CISW 2 is a dummy variable equal to if FEMA > 0 and TEMA 0 ; otherwise 0 (only full-time employees are strictly increasing); CISW 3 is a dummy variable equal to if FEMA 0 and TEMA > 0 ; 26 That is, the deflator used here is the same across all firms. 7

19 otherwise 0 (part-time employees are strictly increasing, while full-time employees eher stay unchanged or decrease); where FEMA is a three-year moving average of the annual change in the number of full-time employees and TEMA is a three-year moving average of the annual change in the number of temporary/part-time employees 27. The purpose of taking moving averages of the change in the number of employees is to make discrete changes in the number of employees smooth 28. In the empirical analysis, lagged dummy variables, i.e., CISW, CISW 2, and CISW 3, are used as explanatory variables for firm s productivy growth. Measure of temporary/part-time employees utilization The above dummy variables are adopted to check the effect of marginal changes in the structure of employees on firm performance. Hence, a variable representing average changes in the structure of employees is obtained by defining the temporary/part-time employees ratio as TER TE /( FE + TE ), where FE is the number of full-time employees for firm i in year t and TE is the number of temporary/part-time employees for firm i in year t. Since this variable is almost certainly correlated wh the labor input L 29, in generalized method of moments (GMM) estimation, this variable is treated as an endogenous variable. Measures of corporate governance and market competion Following estimation results of the previous study by Sakai and Asaoka (2003) where the debt-asset ratio seems que robust, is included as an explanatory variable for TFP growth representing financial discipline 30. Similarly, the market share as a proxy of the degree of market competion is utilized. Market share is defined as the share of the firm s sales in total sales in the industry. Data on total 27 For example, if we denote the number of full-time employees for firm i in year t as FE, then the annual change in the number of full-time employees is defined as FE FE FE. Therefore, FEMA is ( 2 3 FE + FE + FE ) / 3 = ( FE FE ) / Many studies on Japanese firms suggest that employment adjustment in terms of the number of employees occurs discretely, especially when firm suffers from difficult financial status (for example, Komaki (998)). However, there is also some oppose views on this hypothesis. Nakata and Takehiro (200) suggest that employment adjustment in Japanese firms had been common, not discrete. This is an empirically unsettled and intriguing question, but whether employment adjustment decision is discrete or not in Japanese firms is not the main interest in this paper. 29 Since is implicly assumed in this paper that full-time employees and temporary/part-time employees are different labor inputs (wh different human capal accumulations), the temporary/part-time employees ratio represents production technology, similar to the capal-labor ratio, as Miyamoto and Nakata (2002) suggests. 30 Hoshi, McMillan and Schaede (997) suggest that a large amount of debt obligation reduces the amount of free cash flow that the manager can put to unprofable activies. 8