## _wp14140

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### Introduction: corporate cash holdings in Japan
- Japan’s corporate sector holds unusually high cash balances relative to other advanced countries.
- Positive roles of high cash holdings: provide insurance against shocks.
- Macroeconomic costs: may prevent efficient resource use, contributing to:
  - a negative contribution of private investment to growth in recent years;
  - falling real wages despite positive labor productivity growth for most of the last two decades.
- Conclusion: Japan’s high cash holdings are likely holding back both potential and short-term growth.

### Rationale for policy focus
- Large cash holdings can be individually rational if firms expect others to hoard cash, creating a suboptimal equilibrium.
- Policy can potentially break this equilibrium and encourage more corporate risk taking.
- Paper focuses on causes and economic consequences of current corporate behavior and suggests reform options.

### Japan-specific determinants of high cash holdings
- Japan-specific factors that may encourage excessive cash holdings:
  - entrenched deflation expectations;
  - aversion to bankruptcies and lack of pre-packaged bankruptcy procedures;
  - takeover regulations and ownership structure;
  - role of banks in financing firms;
  - weak corporate governance.
- Cross-country corporate governance comparison: Japan scores lower than other G-7 countries on firm-level governance attributes covering board composition, audit quality, shareholder rights, ownership structure, and compensation.

### Stylized facts and magnitude
- Average ratio of cash and cash equivalent holdings to market capitalization of Japanese listed companies during 2004–12: above 40 percent.
- Comparative G-7 range over the same period: 15–27 percent.
- Most sectors in Japan had cash balances (as percentage of market capitalization) higher than the G-7 (excluding Japan and Italy) average of 24 percent in 2012 and 19 percent between 2000 and 2012.
- SMEs: over 15 percent of total assets as cash and deposits for most years since 1960; more recently increasing to around 20 percent.
- Post-2008: larger companies also restarted accumulating cash.
- Policy concern: excessive corporate savings may prevent increases in wages and investment and hold back aggregate demand and potential growth.

### Determinants: theory and Japan-specific channels
- Theoretical frameworks highlighted:
  - Trade-off theory: firms hold more cash when smaller, with more volatile cash flows, and with higher investment opportunities.
  - Financing hierarchy theory: cash balances reflect profitability and financing needs; firms that invest more will have less cash.
- Cross-country evidence cited:
  - Dittmar et al. (2003): countries with weak shareholder rights have corporate cash holdings twice those in countries with good shareholder protection.
- Japan-specific drivers reiterated:
  - Deflationary expectations lower the opportunity cost of holding cash.
  - Low use of reorganization procedures (as little as 420 reorganization applications in 2012) may induce precautionary hoarding.
  - Takeover regulations and cross-shareholding reduce takeover pressure on managers.
  - Japan’s debt-to-equity ratio remains higher than in most G-7 countries; stronger bank influence can encourage hoarding.
  - Weak monitoring and governance increase managers’ leeway to pursue private benefits.

### Corporate governance: international comparison
- Corporate Governance Quality (CGQ) index (De Nicolò, Laven and Ueda 2006):
  - Japan’s CGQ improved since the early 1990s but remains the second lowest in the G-7 after Italy.
  - Japan is above the OECD average on the “accounting standards” sub-index and on “stock price synchronicity,” but below the OECD average on the “earnings smoothing” sub-index.
- Firm Level Governance (FLG) index (Aggarwal et al. 2010):
  - Japan scored consistently lower than any other G-7 country on the FLG index summarizing 41 firm-level governance attributes.
- Conclusion: scope exists to improve Japan’s corporate governance to match other advanced countries.

### Empirical evidence from a panel of Japanese firms
- Data and sample:
  - Panel of 3,412 nonfinancial firms for up to 14 years between 2000 and 2013.
  - Dependent variable: stock of cash and cash equivalents in percentage of market capitalization (Bloomberg).
  - Governance proxy: Proprietary Bloomberg Score ranging from 0.1 to 100; industry-tailored; board data weighted more heavily.
  - Controls: log number of employees, log common stock, log capital expenditure, cash conversion cycle, debt-to-equity ratio, free cash flow per share, lagged dependent variables.
- Main regression coefficient estimates for Governance Index across estimation methods (Table 2 highlights):
  - Governance Index coefficients: -0.089; -0.089; -0.380; -0.327 (significance varies by estimator).
    - Fixed Effects: -0.089 (significant at 10% with default SE; 15% with robust SE).
    - Random Effects: -0.380 (significant at 1%).
    - Arellano-Bond (2 lags): -0.327 (significant at 1%).
- Selected control variable coefficients (reported across methods):
  - Log of Number of Employees: 8.179; 8.179; 2.002; 10.367 (positive and highly significant).
  - Log of Common Stock: -0.380; -0.380; 0.280; 0.232 (mixed signs, generally not significant).
  - Cash Conversion Cycle: -0.009; -0.009; -0.003; -0.014 (not significant).
  - Log of Capital Expenditure: -1.838; -1.838; -2.187; -0.790 (negative and mostly significant).
  - Debt-to-Equity Ratio: 0.010; 0.010; 0.005; 0.011 (positive and mostly significant).
  - Free Cash Flow per Share: 0.007; 0.007; 0.002; 0.014 (positive; significance varies).
  - Lagged Dependent: 0.095; 0.095; 0.786; 0.129 (persistence/habit formation; significance varies).
  - Additional lagged dependent coefficient in one specification: -0.158.
  - R-squared (overall) reported as 0.060; 0.060; 0.647...
- Interpretation:
  - Better corporate governance (higher Bloomberg score) is associated with lower corporate cash holdings.
  - Several controls (number of employees, debt-to-equity, free cash flow per share, capital expenditures) significantly affect cash holdings.
  - Caveats: Bloomberg governance score measures disclosure; disclosure does not guarantee governance practice improvements; regressions capture primarily first-round effects.

### Quantified potential impact of governance improvements
- Representative benchmark governance score used: panel average of 38.9 (alternative baseline 41.5 used in Table 3).
- Estimated reduction in cash-to-market capitalization (percentage points) when governance improves:
  - Average to Maximum in Panel (index from 41.5 to 62.5):
    - Fixed Effects: 1.9
    - Random Effects: 8.0
    - Arellano-Bond: 6.9
    - Average of Estimation Methods: 5.6
  - Average to Theoretical Maximum (index from 41.5 to 100):
    - Fixed Effects: 5.2
    - Random Effects: 22.2
    - Arellano-Bond: 19.1
    - Average of Estimation Methods: 15.5
- Overall range of estimated reductions in the cash-to-market capitalization ratio: about 1 to about 23 percentage points depending on estimator and assumed governance improvement.

### Policy progress and recommendations
- Recent measures and initiatives:
  - Government plans to strengthen audit and monitoring functions.
  - Encourage nomination of independent outside directors on a “comply-or-explain” basis.
  - Council of Experts at the FSA introduced a Stewardship Code in February 2014 to increase fiduciary responsibilities of institutional investors.
  - Launch of JPX-Nikkei Index 400 to include only profitable companies with good corporate governance; central selection criteria include a three-year ROE record and qualitative governance measures.
- Early uptake indicators:
  - Government Pension Investment Fund (GPIF), nearly 130-trillion yen ($1.3 trillion), accepted the Stewardship Code.
  - As of end-May 2014, 127 institutional investors, including most of the largest Japanese asset managers, had subscribed to the Stewardship Code.
  - JPX-Nikkei Index 400: number of funds linked to the index reached 22 with a total of 101 billion yen of assets under management as of end May 2014.
- Recommended policy actions:
  - Continue and deepen corporate governance and legal framework reforms beyond current plans to reduce excessive corporate cash holdings.
  - Complement the Stewardship Code with a corporate governance code for firms and expand the use of independent outside directors beyond current plans.
  - Strengthen enforcement and mechanisms that translate improved disclosure into effective governance practice.
  - Leverage institutional investor engagement (via the Stewardship Code) and market-based incentives (JPX-Nikkei Index 400) to pressure firms to allocate cash to investment and wages, supporting demand and exit from deflation.
  - Consider tax and regulatory reforms to reduce incentives for shareholders to pursue non-monetary benefits and measures to end excessive cross-shareholdings.
  - Consider reforms to bankruptcy/reorganization procedures (e.g., pre-packaged reorganization plans) and takeover regulations to reduce precautionary hoarding incentives.

### Box 1 — Japan’s Stewardship Code (summary)
- Introduction date: February 26, 2014.
- Purpose: help institutional investors fulfill stewardship responsibilities to enhance medium- to long-term returns through constructive engagement and dialogue with investee companies.
- Development: prepared by a Council of Experts established by the FSA; drafts published in Japanese and English; Council recommended periodic updates about once every three years.
- Legal status: not a law; voluntary under “comply-or-explain”.
- Adoption as of end-May: 127 institutional investors, including GPIF, had accepted the Code.
- Core principles include public disclosure of stewardship policies; conflict of interest management; monitoring investee companies; constructive engagement; clear voting policies and reporting; in-depth knowledge and resources to engage effectively.
- Implementation approach: principle-based and flexible; “comply-or-explain” permits non-compliance with explanation.
- The paper views the Stewardship Code as positive but recommends more ambitious reforms to unlock large governance gains.

### Box 2 — Independent Directors (summary)
- TSE initiatives and timeline:
  - Since 2010 TSE required listed companies to appoint at least one or more independent officers.
  - August 2012: TSE recommended all TSE-listed companies secure at least one independent director.
  - February 2014: rules strengthened to require companies with shares listed on TSE to make best efforts to appoint one or more independent officers.
- Outcomes and statistics:
  - Share of companies with at least one independent director among all companies listed in the 1st Section of TSE: 32 percent in 2010 to 47 percent in 2013.
  - Only 1.2 percent of companies secure more than half of board membership as independent directors.
  - Proportion of independent directors out of all directors in 1,752 companies listed on the 1st Section of TSE: about 9 percent in 2013.
  - All 67 cases of Japanese nonfinancial listed companies with greater than 100 percent cash-to-market capitalization ratio in 2013 occurred in companies whose share of independent directors in total board membership is less than 30 percent.
- Comparative proportions cited:
  - United States: about 70 percent independent outside directors.
  - United Kingdom: 50 percent or higher.
  - South Korea: greater than 30 percent (Miyajima 2012).
- Interpretation:
  - Multiple independent directors are an important component of corporate governance reform; empirical association shows very high cash holdings tend to be associated with relatively low shares of independent directors.

### Empirical analysis and measurement notes
- Sample and methods:
  - Panel of about 3,400 Japanese firms; Appendix reports econometric model for 3,412 nonfinancial firms for 2000–2013 (or less if unavailable).
  - Estimation methods: fixed effects, random effects, Arellano-Bond with two lags.
- Variable definitions and sources (Bloomberg unless otherwise noted):
  - Dependent variable: Cash and cash equivalent in percent of market capitalization.
  - Corporate governance proxy: “Proprietary Bloomberg Score” ranging from 0.1 to 100; board data weighted more heavily; industry-tailored.
  - Common stock (log): company-reported value.
  - Number of employees (log).
  - Cash conversion cycle: Inventory Turnover Days + Account Receivable Turnover Days - Accounts Payable Turnover Days.
  - Capital expenditure (log).
  - Debt-to-equity ratio: (short term + long term borrowings) / total shareholder's equity × 100.
  - Free cash flow per share: (cash from operations - capital expenditures) / average basic number of shares.
- Empirical conclusion restated:
  - Panel regressions suggest improving corporate governance in Japan—proxied by an index summarizing company disclosure of governance data—could significantly reduce corporate cash holdings and should be a key component of Japan’s growth strategy.

*Source: IMF Working Paper (excerpt from _wp14140).*

### 1. Number of Bankruptcy Procedures in Selected Countries (2003–12) ...................................7

### 1. Number of Bankruptcy Procedures in Selected Countries (2003–12) ...................................7

### Introduction: corporate cash holdings in Japan
- Japan’s corporate sector stands out in terms of its high cash holdings compared to other advanced countries.
- High firms’ cash holdings play some positive roles, such as providing insurance against shocks, but also imply high macroeconomic costs if they prevent resources from being used more efficiently.
- In Japan, high cash holdings coexist with:
  - a negative contribution of private investment to growth in the last few years;
  - falling real wages in the face of positive labor productivity growth for most of the last two decades.
- Conclusion drawn: Japan’s high cash holdings are likely to be holding back both potential and short term growth.

### Rationale for policy focus
- Holding large amounts of cash may be rational for individual firms if they expect other firms to do the same, suggesting a suboptimal equilibrium.
- There is space for policies to break this equilibrium and encourage more risk taking in the corporate sector.
- The paper focuses on causes and economic consequences of current corporate behavior and suggests options for reform.

### Japan-specific determinants of high cash holdings
- In addition to determinants highlighted in previous literature, several Japan-specific factors might encourage excessive cash holdings:
  - entrenched deflation expectations;
  - aversion to bankruptcies and lack of pre-packaged bankruptcy procedures;
  - takeover regulations and ownership structure;
  - role of banks in financing firms;
  - weak corporate governance.
- A cross-country comparison of corporate governance indexes shows that Japan scores lower than other G-7 countries regarding firm-level governance attributes covering:
  - board composition;
  - audit quality;
  - shareholder rights;
  - ownership structure and compensation.

### Empirical evidence from a panel of Japanese firms
- The hypothesis that improved corporate governance is associated with reduced cash holdings is confirmed by empirical analysis.
- Data: panel of about 3,400 Japanese firms.
- Regression approach: corporate governance proxied by an index summarizing company disclosure of governance data.
- Result: improving corporate governance in Japan—proxied in the regression by an index summarizing company disclosure of governance data—could significantly reduce corporate cash holdings.

### Second-round effects and macroeconomic feedbacks
- Expected second-round effects of corporate governance reform include:
  - encouraging higher investment and nominal wages;
  - helping Japan exit from deflation;
  - making holding cash on firms’ balance sheets more costly, thus encouraging further corporate spending in a self-reinforcing virtuous circle.

### Policy implications and recent developments
- Policy implication: comprehensive corporate governance reform should be an important component of the government’s growth strategy.
- Recent steps taken by the authorities are described as going in the right direction.

*Source: IMF Working Paper (excerpt).*

### introduction of the Stewardship Code for institutional investors and plans to encourage the

### _wp14140 - introduction of the Stewardship Code for institutional investors and plans to encourage the

### Paper structure and purpose
- Presents stylized facts on Japan’s high corporate cash holdings (Section II).
- Discusses determinants of cash holdings with Japan-specific factors emphasized (Section III).
- Compares Japan’s corporate governance indicators internationally (Section IV).
- Provides empirical evidence from a panel of Japanese firms linking governance to cash holdings (Section V).
- Reviews progress in corporate governance reform in Japan and offers policy recommendations (Section VI).
- Concludes (Section VII).

### Key findings on corporate cash holdings
- Average ratio of cash and cash equivalent holdings to market capitalization of Japanese listed companies during 2004–12 was above 40 percent.
- Comparative G-7 values were in the 15–27 percent range over the same period.
- Most sectors in Japan had cash balances (as percentage of market capitalization) higher than the G-7 (excluding Japan and Italy) average of 24 percent in 2012 and of 19 percent between 2000 and 2012.
- SMEs have held over 15 percent of total assets as cash and deposits for most years since 1960, and more recently the share has been increasing to around 20 percent.
- SMEs’ high cash holdings coincided with high debt; post-2008 larger companies have also restarted accumulating cash.
- Excessive corporate savings in Japan may be detrimental to the economy by preventing increases in wages and investment and holding back aggregate demand and potential growth.

### Determinants of cash holdings (literature and Japan-specific channels)
- Theories:
  - Trade-off theory: firms hold more cash when smaller, with more volatile cash flows, and with higher investment opportunities.
  - Financing hierarchy theory: cash balances reflect profitability and financing needs; firms that invest more will have less cash.
- Empirical and cross-country evidence:
  - Dittmar et al. (2003): countries with weak shareholder rights have corporate cash holdings twice those in countries with good shareholder protection.
- Japan-specific drivers:
  - Entrenched deflationary expectations lower opportunity cost of holding cash.
  - Bankruptcy procedures: low use of reorganization procedures in Japan (as little as 420 reorganization applications in 2012) may induce precautionary hoarding.
  - Takeover regulations and share ownership structure reduce takeover pressure on managers.
  - Cross-shareholding remains widespread and above the European average, potentially weakening shareholder pressure on managers.
  - Role of banks: Japan’s debt-to-equity ratio is still higher than in most G-7 countries; higher bank power can encourage firms to hoard cash.
  - Weaker corporate governance and monitoring mechanisms increase managers’ leeway to pursue individual benefits, contributing to higher cash holdings.

### Corporate governance: international comparison
- Corporate Governance Quality (CGQ) index (De Nicolò, Laven and Ueda 2006):
  - Japan’s CGQ improved since the early 1990s but remains the second lowest in the G-7 after Italy.
  - Japan is above the OECD average on the “accounting standards” sub-index and on “stock price synchronicity,” but below the OECD average on the “earnings smoothing” sub-index.
- Firm Level Governance (FLG) index (Aggarwal et al. 2010):
  - Japan scored consistently lower than any other G-7 country over the years on the FLG index summarizing 41 firm-level governance attributes.
- Conclusion: scope exists to improve Japan’s corporate governance to match other advanced countries.

### Empirical analysis: corporate governance and cash holdings in Japan
- Data and model:
  - Panel of 3,412 nonfinancial firms for up to 14 years between 2000 and 2013.
  - Dependent variable: stock of cash and cash equivalents in percentage of market capitalization.
  - Firm-level governance proxy: Proprietary Bloomberg Score ranging from 0.1 to 100; industry-tailored; board data weighted more heavily.
  - Controls: log number of employees, log common stock, log capital expenditure, cash conversion cycle, debt-to-equity ratio, free cash flow per share, lagged dependent variables.
- Main regression results (Table 2 highlights):
  - Governance Index coefficients across estimation methods: -0.089; -0.089; -0.380; -0.327 (significance varies by estimator).
    - Fixed Effects: -0.089 (t-statistics indicate significance at 10% with default SE; 15% with robust SE).
    - Random Effects: -0.380 (significant at 1%).
    - Arellano-Bond (2 lags): -0.327 (significant at 1%).
  - Log of Number of Employees: 8.179; 8.179; 2.002; 10.367 (positive and highly significant).
  - Log of Common Stock: -0.380; -0.380; 0.280; 0.232 (mixed signs, generally not significant).
  - Cash Conversion Cycle: -0.009; -0.009; -0.003; -0.014 (not significant).
  - Log of Capital Expenditure: -1.838; -1.838; -2.187; -0.790 (negative and mostly significant).
  - Debt-to-Equity Ratio: 0.010; 0.010; 0.005; 0.011 (positive and mostly significant).
  - Free Cash Flow per Share: 0.007; 0.007; 0.002; 0.014 (positive; significance varies).
  - Lagged Dependent: 0.095; 0.095; 0.786; 0.129 (persistence/habit formation; significance varies).
  - Additional lagged dependent coefficient in one specification: -0.158.
  - R-squared (overall) reported as 0.060; 0.060; 0.647...
- Interpretation:
  - Better corporate governance (higher Bloomberg score) is associated with lower corporate cash holdings.
  - Several control variables (number of employees, debt-to-equity, free cash flow per share, capital expenditures) also significantly affect cash holdings in expected or context-specific ways.
  - Caveats: governance proxy measures disclosure; disclosure does not guarantee improved governance practices; results capture first-round effects.

### Quantified potential impact of governance improvements (Table 3)
- Representative benchmark: Japanese firms’ panel average governance score of 38.9 (regression calculations use index values; alternative baseline 41.5 used in Table 3).
- Estimates of reduction in cash-to-market capitalization (percentage points) when governance improves:
  - Average to Maximum in Panel (index from 41.5 to 62.5):
    - Fixed Effects: 1.9
    - Random Effects: 8.0
    - Arellano-Bond: 6.9
    - Average of Estimation Methods: 5.6
  - Average to Theoretical Maximum (index from 41.5 to 100):
    - Fixed Effects: 5.2
    - Random Effects: 22.2
    - Arellano-Bond: 19.1
    - Average of Estimation Methods: 15.5
- Overall range of estimated reductions in the cash-to-market capitalization ratio: about 1 to about 23 percentage points (depending on estimator and assumed governance improvement).

### Policy progress and recommendations
- Recent policy measures and initiatives:
  - Government plans to strengthen audit and monitoring functions.
  - Encouraging nomination of independent outside directors on a “comply-or-explain” basis.
  - Council of Experts at the FSA introduced a Stewardship Code in February 2014 to increase fiduciary responsibilities of institutional investors.
  - Launch of JPX-Nikkei Index 400 to include only profitable companies with good corporate governance; central to selection is a three-year ROE record and qualitative governance measures.
- Early signs of uptake:
  - Japan’s public pension fund (GPIF), nearly 130-trillion yen ($1.3 trillion), accepted the Stewardship Code.
  - As of end-May 2014, 127 institutional investors, including most of the largest Japanese asset managers, had subscribed to the Stewardship Code.
  - JPX-Nikkei Index 400: number of funds linked to the index reached 22 with a total of 101 billion yen of assets under management as of end May 2014.
- Policy recommendations implied by the analysis:
  - Continue and deepen corporate governance and legal framework reforms beyond current plans to reduce excessive corporate cash holdings.
  - Complement the Stewardship Code with a corporate governance code and expand the use of independent outside directors beyond current plans.
  - Strengthen enforcement and mechanisms that translate improved disclosure into effective governance practice.
  - Leverage institutional investor engagement (via the Stewardship Code) and market-based incentives (such as JPX-Nikkei Index 400) to exert pressure on firms to allocate cash to investment and wages, supporting demand and exit from deflation.

*Source: IMF staff calculations and analysis (from _wp14140).*

### Box 1. Japan’s Stewardship Code

### Box 1. Japan’s Stewardship Code

### Overview
- Japan’s Stewardship Code for institutional investors was introduced on February 26, 2014.
- Purpose: to help institutional investors fulfill their “stewardship responsibilities”, i.e. enhancing the medium- to long-term investment return for their clients and beneficiaries through constructive engagement and purposeful dialogue with investee companies.
- Objective: improve investee companies’ corporate value and sustainable growth based on in-depth knowledge of the companies and their business environment.
- Development: prepared by a Council of Experts established by the Financial Services Agency (FSA) at the request of the Prime Minister; the Council included academics, managers, and government representatives. Drafts were published in Japanese and English and comments solicited and incorporated. Council recommended periodic updates about once every three years.
- Legal status: the Code is not a law or legally binding regulation; adoption is voluntary under a “comply-or-explain” approach.
- Adoption as of end-May: 127 institutional investors, including the Government Pension Investment Fund (GPIF), had accepted the Code.

### Principles of the Code
- Institutional investors should have a clear policy on how they fulfill their stewardship responsibilities, and publicly disclose it.
- Institutional investors should have a clear policy on how they manage conflicts of interest in fulfilling their stewardship responsibilities, and publicly disclose it.
- Institutional investors should monitor investee companies so that that can appropriately fulfill their stewardship responsibilities with an orientation towards the sustainable growth of the companies.
- Institutional investors should seek to arrive at an understanding in common with investee companies and work to solve problems through constructive engagement with investee companies.
- Institutional investors should have a clear policy on voting and disclosure of voting activity. The policy on voting should not be comprised only of a mechanical checklist; it should be designed to contribute to the sustainable growth of investee companies.
- Institutional investors in principle should report periodically on how they fulfill their stewardship responsibilities, including their voting responsibilities, to their clients and beneficiaries.
- To contribute positively to the sustainable growth of investee companies, institutional investors should have in-depth knowledge of the investee companies and their business environment and skills and resources needed to appropriately engage with the companies and make proper judgment in fulfilling their stewardship activities.

### Implementation and flexibility
- The Code adopts a “principle-based” approach focused on substance rather than a “rule-based” checklist.
- The Code explicitly states that principles should be applied depending on specific conditions and situations (e.g., investor size and investment policies such as long term versus short term; active versus passive strategies).
- Comply-or-explain: institutional investors may decide not to comply with some principles provided they explain their reasons.

### Relationship to corporate governance reforms and recommended measures
- The paper views the Stewardship Code as a positive step but suggests reforms could be more ambitious to unlock large gains from improving corporate governance.
- Recommended additional measures:
  - Expanding the use of outside directors beyond current plans and reinforcing their independence.
    - Proportion of independent outside directors out of all directors in 1,752 companies listed on the first section of the Tokyo Stock Exchange is about 9 percent in 2013.
    - Comparative proportions: about 70 percent in the United States; 50 percent or higher in the United Kingdom; greater than 30 percent in South Korea (Miyajima 2012).
    - Many advanced countries require substantial numbers of outside directors either mandatorily (more than half of the board in the US; more than one quarter of the board in Korea) or under “comply or explain” (more than half of the board in the UK; an “appropriate number” in Germany; half of the board in France).
    - Current plan in Japan is to introduce a requirement under “comply or explain” for only one outside director; scope exists to adopt stronger mandates or increase the number required under “comply or explain”.
  - Measures to enhance board diversity.
    - Female board representation: 20.7% in the U.K; 16.9% in the U.S.; 1.1% in Japan.
    - Argument: more women on boards associated with better financial measures (Return on Equity, Return on Sales, Return on Invested Capital) per Catalyst (2007); also creates role models and synergies with policies to increase female labor participation (see Steinberg and Nakane 2012).
    - Increasing foreigners on boards could aid corporate expansion abroad and counteract demographic decline.
  - Adoption of a corporate governance code for firms to complement the Stewardship Code for institutional investors (the Cabinet approved such a corporate governance code for firms as part of its growth strategy on June 24).
  - Implementation of tax and regulatory reforms to reduce incentives for shareholders to pursue “individual” rather than monetary benefits; measures to end excessive cross-shareholdings could be considered (Germany’s successful tax reforms in the early 2000s are cited; cross-shareholdings in OECD countries are frequently limited by law per OECD 2007).
  - Measures to reduce the threat to firm managers from filing for bankruptcy (e.g., pre-packaged reorganization plans like US Chapter 11; limit business owners’ individual liability in bankruptcy; encourage creditor-led debt workout) to lower firms’ incentives to hold cash as insurance.
  - Removing takeover bottlenecks (e.g., reduce asymmetry between bidder and target duties in takeover regulations; introduce more favorable tax treatment for owners of stocks of acquired companies) to encourage takeovers and pressure managers to prioritize profitability over cash holdings.

### Box 2 — Independent Directors (summary)
- Tokyo Stock Exchange (TSE) initiatives:
  - Since 2010 TSE required listed companies to appoint at least one or more independent officers (outside director or outside statutory auditor not likely to have conflict of interest) for protection of general investors.
  - August 2012: TSE recommended all TSE-listed companies secure at least one independent director.
  - February 2014: rules strengthened to require any company with shares listed on TSE to make its best efforts to appoint one or more directors as independent officers.
- Outcomes:
  - Share of companies with at least one independent director among all companies listed in the 1st Section of TSE increased from 32 percent in 2010 to 47 percent in 2013.
  - Only 1.2 percent of companies secure more than half of board membership as independent directors.
  - Proportion of independent directors out of all directors in 1,752 companies listed on the 1st Section of TSE was only 9 percent in 2013.
  - All 67 cases of Japanese nonfinancial listed companies with greater than 100 percent cash-to-market capitalization ratio in 2013 occurred in companies whose share of independent directors in total board membership is less than 30 percent.
- Interpretation:
  - While multiple independent directors may not be sufficient alone to reduce cash holdings, they are an important determinant and should be a necessary component of corporate governance reform.
  - Empirical association shown: companies with high shares of independent directors rarely have extremely high cash holdings; very high cash holdings tend to be associated with relatively low shares of independent directors.

### Empirical analysis and measurement notes
- Panel regressions:
  - Panel of about 3,400 Japanese firms used in empirical analysis.
  - Appendix reports an econometric model estimated for a panel of 3,412 nonfinancial Japanese firms for the 14 years between 2000 and 2013 (or less, depending on availability).
  - Regression methods: fixed and random effects, and Arellano-Bond estimation with two lags.
- Dependent variable:
  - Cash and cash equivalent in percent of market capitalization (available from Bloomberg).
- Key explanatory variables and data sources:
  - Corporate governance proxy: “Proprietary Bloomberg Score”, an index which ranges from 0.1 for companies that disclose a minimum amount of governance data to 100 for those that disclose every data point collected by Bloomberg. Each data point is weighted; board of directors data carries greater weight; score tailored to industry sectors.
  - Common stock (logarithmic form): value of common stock as reported by the company, from Bloomberg.
  - Number of employees (logarithmic form), from Bloomberg.
  - Cash conversion cycle: Inventory Turnover Days + Account Receivable Turnover Days - Accounts Payable Turnover Days, from Bloomberg.
  - Capital expenditure (logarithmic form), from Bloomberg.
  - Debt-to-equity ratio: sum of short term and long term borrowings divided by total shareholder's equity, multiplied by 100, from Bloomberg.
  - Free cash flow per share: free cash flow (cash from operations - capital expenditures) divided by the average basic number of shares for the period, from Bloomberg.
- Empirical conclusion:
  - Panel regressions suggest that improving corporate governance in Japan—proxied by an index summarizing company disclosure of governance data—could significantly reduce corporate cash holdings.
  - The paper concludes comprehensive corporate governance reform should be a key component of Japan’s growth strategy; the Stewardship Code and plans to encourage outside directors are positive but could be more ambitious (e.g., complement with corporate governance code for firms and expand outside directors beyond current plans).

*Source: Box 1. Japan’s Stewardship Code, _wp14140 - Box 1. Japan’s Stewardship Code*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2014/_wp14140.pdf_