The Value of Prominent Directors: Lessons in Corporate Governance from Transitional Japan

Observers of modern transitional economies urge firms there to ignore stock markets. Stock markets simply will not work in such environments, they explain. Firms should instead rely on debt finance, particularly bank debt. Only then will they be able to keep principal-agent (i.e., investor-manager) slack to manageable levels. Turn-of-the-century Japanese firms faced problems that closely mirrored those in modern eastern Europe. Yet in Japan, the successful large firms did not rely on debt. Instead, they raised their funds through the stock market, and took a variety of steps to mitigate the agency slack involved. As one of those steps, they recruited prominent investors to their boards. Using data on firms in the cotton-spinning industry (arguably the most important industrial sector in turnof-the-century Japan), we explore why the firms recruited prominent directors. First, we note that firms who hired such directors in one year had higher profits than others in succeeding years. Endogeneity is an obvious issue, and in part they probably had higher profits because those investors had an eye for firms that would likely succeed. Yet the most successful firms were not those who hired directors who were so prominent that they would not have had the time to monitor and intervene in the firm. Instead, they were prominent men who also had the resources (most critically, time) to monitor and intervene. In part, apparently, the firms with prominent directors had higher profits because those investors brought basic management skills. Second, prominence held constant, we find that firms did not have higher profits by having directors affiliated with a bank or with other spinning firms. One might have thought directors with access to a bank or spinning technology would raise profits at a firm. In fact, they did not, for banks did not have the funds to lend, and the technolgy was freely available. Last, we explore whether the directors certified firm quality on behalf of other investors. Although firms with prominent directors may have had an advantage in the capital market, we conclude that quality certification was at most a by-product (if even that) of the monitoring and intervention these directors