In recent decades, the number of shares owned by institutional shareholders has grown rapidly due to financial globalization [1
]. This trend is not only being investigated in countries with shareholder- or market-oriented systems, such as in the United States, but also in countries that have stakeholder-oriented systems, such as Japan. The important monitoring role of institutional shareholders is expected in countries with a dispersed ownership structure, as is the case in the United States [2
]. Institutional shareholders are defined as block shareholders who are able to supervise and monitor the firms in which they have ownership. Their monitoring activities can be efficiently performed because they have financial incentives due to their stakes in these companies [3
]. In addition, institutional shareholders may have more industry-specific knowledge than smaller shareholders, and this information advantage results in low-cost, effective monitoring [4
]. Several studies analyze empirical questions about the monitoring role of institutional ownership (IO) on corporate performance [5
The presence of institutional shareholders increased under stakeholder-oriented corporate governance in Germany and Japan as part of the process of converging to the Anglo-American corporate governance system in the 1990s [6
]. In Japan, institutional investors have begun to take a more active stance only since the early 2000s [7
]. First, foreign institutional investors tend to behave as activists through annual general shareholder meetings, and their attitude and presence are enhanced [7
]. Second, domestic institutional shareholders, mainly comprising trust banks, pension funds, and non-life insurance companies, tend to have a more performance-oriented scope and seek higher profits than other domestic shareholders [9
]. In this sense, foreign and domestic institutional investors are characterized differently from other shareholders in Japanese corporations.
There remain important issues for both academics and practitioners to consider in clarifying the effectiveness of institutional shareholders under a stakeholder-oriented system [10
]. From the viewpoint of agency theory, larger institutional shareholdings are expected to improve firm value or performance for two reasons. First, institutional investors effectively take on monitoring roles to mitigate agency and asymmetric information problems [11
]. In fact, they can encourage managers to avoid under-investment, which can lead to poorer future performance. The second reason is that institutional shareholders actively respond to remove managerial entrenchment devices, such as poison pills [13
] Previous studies on institutional investors show other channels through which they improve corporate performance. For example, institutional ownership helps mitigate problems of managerial myopia, where firms tend to avoid investing in longer-term positive net present value projects [14
However, during the 1990s, institutional shareholders were not necessarily expected to be effective for firms under stakeholder-oriented systems. In the early 1990s, foreign ownership in Japan averaged less than 5% [17
]. Japanese corporations tend to be controlled by interlocking ownership structures, known as Keiretsu, and the main banking systems [18
]. Under the stakeholder-oriented system, the main banks’ monitoring mechanisms were considered standard practice prior to the late 1990s [19
]. Following the rescue of the Japanese financial system through government bailouts, the shares of the main banks and their cross-shareholdings were also reduced by the merger and acquisition activity in the 2000s [20
]. Monitoring by main banks has weakened following the financial deregulation era [21
The different perspectives of institutional and domestic shareholders could decrease the effectiveness of monitoring in Japanese firms controlled by stable domestic shareholders. The ratio of foreign ownership in Japanese companies has dramatically increased since the 1990s, and the increased influence of foreign institutional shareholders is expected to improve firm value [22
]. Foreign investors tend not to favor traditional Japanese management practices [24
]. In fact, foreign investors tend to have a negative view of the managerial incentives of diversified Japanese firms, unlike the perspective of domestic shareholders [25
This study focused on Japanese corporations to examine how institutional shareholders affect corporate performance. While several studies have analyzed the impact of foreign ownership on firm performance [26
], the effect of institutional investors on firm performance has not been fully explored by previous studies. However, they have highlighted two areas in which the new roles of institutional shareholders are complementary and are replacing the weakened monitoring mechanisms of the main banking institutions. First, foreign shareholdings contribute to reducing information asymmetry among investors [29
]. Therefore, institutional shareholders are expected to mitigate agency issues. Second, the rise in shareholder activism in recent decades has been effective in strategically applying pressure to managers in Japanese corporations [30
]. These points imply that institutional shareholders have begun to play a role in the Japanese stakeholder-oriented system.
The findings of this study shed light on the Japanese experience of an increase in institutional investors in a stakeholder-oriented system. Specifically, the empirical evidence reveals that institutional investors enhance firm value. Moreover, foreign investors play monitoring roles in firms with higher growth opportunities. In other words, institutional investors are expected to function effectively as monitors in the Japanese stakeholder-oriented system. This suggests that institutional shareholders contribute to generating sustainable returns and promoting economic and corporate governance performance in a stakeholder-oriented system.
The rest of the paper is organized as follows. The next section presents the theoretical framework and research context of the study, and we further develop the hypotheses and present the data and methodology in the third section. The fourth section presents the empirical findings. Next, we discuss our findings in the fifth section. The sixth section offers concluding remarks.
4. Estimated Results
4.1. Regression Results
This subsection investigates whether institutional shareholders function well as monitors in the Japanese stakeholder-oriented system. The variable definitions are summarized in Table A1
, and the sample descriptive statistics are summarized in Table 1
The results of estimating Tobin’s Q are shown in Table 2
, with standard errors clustered by firm and year. The coefficients of IO were significantly positive for Models (2) and (3), which supports Hypothesis 1A. Furthermore, FO showed significantly positive results for Models (4) and (5), which was consistent with Hypothesis 1B. This implied that institutional shareholders in Japan are expected to actively act as monitors post-2010. In other words, they might substitute for the monitoring role previously held by the main banks [20
]. We also investigated the impact of a one standard deviation increase in IO and FO. First, IO was associated with a 8.19% (= 14.03 × 0.58) increase in Tobin’s Q (column (2)) and was related to a 11.17% (= 14.03 × 0.80) increase in Tobin’s Q (Column (3)). Second, FO was associated with a 8.87% (= 12.54 × 0.81) increase in Tobin’s Q (column (4)) and is related to a 11.57% (= 12.54 × 0.92) increase in Tobin’s Q (Column (5)). As for the other control variables, high sales growth and free cash flow were significantly positive for all models. This means that firm value tends to be higher in firms with higher growth opportunities.
presents the relationship between institutional shareholders and firm performance, measured as ROA. The results of Models (2) and (3) provided significantly positive results for IO, consistent with Hypothesis 1A. Next, the coefficients of both FO and DIO were significantly positive in Models (4) and (5). These findings imply that institutional investors and foreign investors enhance firm value, which is consistent with their shareholder-oriented views.
The results of including the interaction terms of the ownership variables and the high sales growth dummy are presented in Table 4
. Using the results of the four models, both IO and FO show significantly positive results, consistent with Hypotheses 1A and 1B. As for the interaction terms of IO and the high growth rate of sales (High SG), the results were significantly positive for all models. The coefficients of the interaction terms of FO and High SG are also significantly positive. These results supported Hypotheses 2a and 2b and implied that institutional shareholders strengthen monitoring in firms with higher sales growth.
We examined the impact of a one standard deviation increase in IO and FO to consider economic significance. First, IO was associated with a 8.64% ( = 14.03 × 0.62) increase in Tobin’s Q (column (2)). In addition, IO was associated with a 1.66% (= 14.03 × 0.12) increase in ROA (column (5)) and is related to a 2.02% (= 14.03 × 0.14) increase in ROA (Column (5)). Second, FO was related to 9.14% (= 12.54 × 0.73) increase in Tobin’s Q (Column (4)). Furthermore, FO was associated with a 1.86% (= 12.54 × 0.15) increase in ROA (column (7)) and was related to a 2.17% (= 12.54 × 0.17) increase in ROA (Column (8)).
We further examined whether the other monitoring mechanisms such as audit quality could affect the moderating effects of institutional shareholders. Table 5
presents the results of including the interaction terms of the ownership variables and the dummy of Big N auditors. In Table 5
, we can find that both IO and FO are positive and significant results, consistent with Hypotheses 1A and 1B. As for the interaction terms of IO (or FO) and the dummy of Big N auditors, the results were not significant. This implies that the other external monitoring mechanisms such as higher audit quality do not give a role of moderating the role of institutional shareholders.
The results of this subsection are summarized as follows. First, the findings show that institutional shareholders and foreign investors are functioning effectively as monitors, consistent with Hypotheses 1A and 1B. This reflects the weakened role of the main Japanese banks and the possibility that institutional shareholders can serve as substitutes for the banks’ prior level of influence. Second, the results are consistent with Hypotheses 2A and 2B. This implies that institutional investors or foreign investors are also interested in investing in and monitoring firms with higher sales growth. These results are interpreted as showing that foreign investors effectively play a monitoring role in Japanese corporations.
We confirmed the robustness of our results using two additional analyses First, we adopted the stability of Tobin’s Q and ROA as the proxy of sustainable performance. In some cases, stakeholder-oriented corporate governance might sacrifice corporate performance, measured as ROA to keep a sustainable relationship with various connected stakeholders. In this case, the stability of corporate performance is an important goal for firms under stakeholder-oriented corporate governance.
shows the estimated results to adopt the stability of ROA. Using this table, we find that IO and FO were significant and negative to the stability of ROA. This implies that institutional and foreign shareholders are helpful to stabilize corporate performance. Thus, we interpret that both corporate performance and sustainable performance are enhanced by monitoring the roles of IO and FO.
Second, we focused on the effect of regulation such as the establishment of the Stewardship Code in Table 7
. To confirm whether this regulation affects the monitoring role of institutional shareholders, we used a post-period dummy which equals to 1 after the period of the accounting year 2014. We interacted post dummy with IO, FO, and DIO to confirm the effect of the Stewardship Code towards the monitoring roles of institutional shareholders. Using this table, we found that IO and FO were positively significant. In addition, we found that the monitoring effect of IO and FO has strengthened post the establishment of the Stewardship Code establishment.
Finally, we checked the causal relationship between institutional shareholders and performance using two-stage least square models (2SLS) estimation models. We show the results of the first stage in Table 8
. We adopt ADR (American Depository Receipts) dummy as an instrument of IO and FO. As foreign shareholders can decrease the cost of holding and trading ADR listed stocks, they favor them. In addition, ADR is an important determinant of institutional shareholders [81
]. ADRs are associated with higher foreign ownership in Japan [82
]. In addition, corporate performance would not be affected by the selection of ADRs. Thus, we select ADR as an instrument variable of IO and FO. The results of the 2SLS are reported in Table 9
. Table 9
shows that IO and FO were significant and positive to both of Tobin’s Q and ROA. Therefore, we confirmed the causal effects of performance and institutional or foreign shareholders.
We additionally discuss the robustness of our results in accordance with anonymous referees’ comments. First, we also performed an analysis of listed firms on the 1st Section of TSE in the additional un-tabled results. Second, we additionally confirm the robustness of the results from 2007 to 2016. Third, we drop the observations which indicate upper and lower 1% of Tobin’s Q and ROA in our samples. Using these un-tabulated results, we also confirm similar results.
This study analyzed the effect of institutional shareholders on firm performance. Institutional shareholders were divided into foreign and domestic institutional shareholders and the results suggest that these effectively function as monitors in stakeholder-oriented systems. In addition, institutional shareholders, including foreign shareholders, are more effective in monitoring firms with higher growth opportunities. Thus, institutional shareholders contribute to improving firm performance, especially for firms with higher growth opportunities.
This study makes several theoretical contributions. First, it investigates whether institutional shareholders with shareholder-oriented scope effectively perform a monitoring role in stakeholder-oriented corporate governance countries such as Japan. The results imply that institutional shareholders are capable of taking on a role that is complementary to bank monitoring in stakeholder-oriented corporate governance environments. Second, this study also reveals that institutional shareholders play a stronger monitoring role in firms with higher growth opportunities. This implies that institutional shareholders or foreign shareholders more effectively monitor firms with higher growth projects, which leads to higher future profitability. These findings suggest that foreign shareholders function effectively as monitors in this transitional era, marking the introduction of a shareholder-oriented system.
There are several limitations found in this study. First, subsequent corporate governance reforms like Japan’s Stewardship Code and Japan’s Corporate Governance Code have been implemented since 2015. While the dialogue among shareholders based on these two codes is only in its early stages, the effects of the two codes are expected to change the attitudes of institutional shareholders in Japan. Second, the Corporate Governance Code recommends appointing at least two independent directors from 2016 onwards. These subsequent changes for Japanese corporations might function as a mechanism for convergence into the Anglo-American corporate governance system. From the substitute theory perspective [83
], board monitoring would matter as a substitute for bank monitoring. Thus, an increase in independent directors might also serve as a substitute for traditional main bank monitoring in Japan. These recent changes should be treated as part of the changing institutional context of stakeholder-oriented corporate governance, and thus provide potential avenues for future research.
This study investigated the role of institutional investors in Japan following the financial restructuring, which affected the country’s main banks. Under a stakeholder-oriented system, previous studies indicated that stable shareholders such as banks, Keiretsu
groups, and parent-subsidiary relationships have functioned as effective monitors in Japan. On the other hand, several studies investigated the relationship between foreign ownership and firm performance [26
]. However, these studies did not focus on either the role of institutional shareholders or the difference between foreign and domestic institutional shareholders. This study focused on the effect of the monitoring role of institutional investors. Thus, the analyses sought to reveal certain aspects of the role of institutional investors, including the difference between foreign and domestic institutional shareholders in stakeholder-oriented corporate governance environments such as Japan.
The results of this study are summarized in the following three points. First, the results show that institutional and foreign shareholders are as effective as monitors in Japanese corporations. In addition, domestic shareholders, including stable shareholders, are also expected to have a monitoring role. This implies that the increased influence of institutional investors functions as a monitoring mechanism that is complementary to that of domestic and stable shareholders. Second, monitoring by institutional and foreign shareholders is expected to strengthen firms with higher growth opportunities.
Our study explored the sustainability of economic growth based on constructive dialogue between a corporation and its institutional investors. Under FSA guidelines, institutional shareholders are expected to engage in proactive dialogue. Therefore, they are able to play an effective and complementary monitoring role in stakeholder-oriented economies, such as Japan. In this sense, the study contributes to the understanding of the roles of institutional investors under non-Anglo-American economies, which differ from shareholder-oriented economies. There might be an empirical question as to whether institutional shareholders effectively function in emerging economies, which do not completely follow a pure market discipline. These might be valuable areas for future research.