Growth Strategies and Information Technology Investment ofJapanese Securities Firms:
Econometric Analysis Using Financial Reports, 2000-2008

1. Introduction
Information technology has turned out to be a driving force of economic growth inmany industrialized countries. A burgeoning number of empirical economic studies
demonstrate that a substantial part of economic growth in developed countries can be
attributed to the rapid spread of information technology (IT). For instance, Oliner andSichel (2000) showed that use and production of computers account for 62% of theannual productivity growth through 1996-1999 in the US. The IT industry has had
positive impacts on the overall economic growth in Japan as well, accounting for 26%
to 41% of the nation’s real GDP growth through fiscal 2003-2006 (Ministry of Internal
Affairs and Communications, 2008). Thus, IT investment has become crucial forvarious industries in the modern economy.
The Japanese economy’s annual investment in network devices, computer hardware,and software totaled 19.1 trillion yen or 22.2% of the total annual private capital
investment in 2006 (MIC, 2008). One of the Japanese industries that have been engaged
in intensive IT investment is the financial industry 1 . Although the financial industry

1

Some point out this aspect of the financial industry. For example, Prof. Kazuto Ikeo says “The

produced only 5.2% of Japan’s GDP in fiscal 2005 (National Statistics Center, 2008),
the industry accounted for 19.0% of computer software investment by all Japaneseindustries in the same year (the ninth row and the fifth column in Table 1). Of all
sub-industries in the financial sector, the most actively compiling software asset is the
securities industry. Software investment by the securities industry as percentages of allindustries and of the financial industry grew from 1.9% to 4.2% and from 11.8% to17.2% over the fiscal years 2002-2007.

Table 1

Computer Software Investment of Japanese Financial Industries,
Fiscal Years 2002-2008 (100 million yen)

All industries including financial industries
Financial industry
Banks
Insurance companies
Securities companies
Non-deposit money corporations
Shinkin banks & other financial institutions
Shares of financial industries in all industries (%)
Shares of securities companies in all industries (%)
Shares of securities companies in financial industries (%)

FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008*
37755
37412
37367
40351
41808
44400
46747
6087
6047
6845
7667
7899
9177
9745
3313
3414
3767
4475
4204
4550
4675
1342
1173
1172
1002
1196
1543
2121
718
831
1173
1267
1276
1875
1675
478
421
614
589
741
815
810
237
209
118
334
482
393
464
16.1
16.2
18.3
19.0
18.9
20.7
20.8
1.9
2.2
3.1
3.1
3.1
4.2
3.6
11.8
13.7
17.1
16.5
16.2
20.4
17.2

Note: *Based on respondents’ projections in the September 2008 survey.
Source: The Bank of Japan (2008), “TANKAN: Short-term Economic Survey ofEnterprises in Japan (Financial Institutions)”

Nowadays IT system is an indispensable platform for operation of securities firms.
The basic service of the securities industry is to mediate purchasing and selling ofcompetitiveness of the financial industry largely depends on the performance of information system,
so it [the financial industry] can be called an ‘information system industry’.” (The Nikkei, 21
December 2005, p.7)
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securities (e.g. stocks and bonds) 2 (Figure 1). The business of securities firms has
basically relied on percentage-based commissions charged on transactions. Securities
firms have to process and analyze a tremendous amount of information concerning
orders, customers, risks, and market situations on a daily basis. The fast-changing natureof the financial markets necessitates high speed data processing. The accuracy of data is
crucial in order to avoid losses and to manage risk, as securities brokerage businessdeals with thousands of millions of yen at a time. From a managerial point of view, theminimum human resources should be allocated to such routine office work since it does
not directly contribute to raising revenues. These needs have led many securities firms
to make heavy investment in computer systems. Typical information systems of abrokerage firm are shown in Figure 2. The systems are interconnected to the securities
markets, institutional/individual investors, information vendors, and settlement/custody
institutions. The front system receives, processes, and executes orders on behalf ofinvestors and also sometimes trades on its own account. Information on transactions thatfinished confirmation and notification to investors is passed to the back office system,
where databases are updated, various documents are prepared, and checks and risk
management are conducted. Since the majority of individual investors join in trading via
online trading system, many securities firms provide advanced trading tools online.
There is also a growing need for sales assistance systems such as advisory software.
2

Securities firms are sometimes called by different names: stock brokerage firms, security brokers,
brokerage houses, and investment banks. This article uses the term “securities firms”.
-3-Figure 1

Position of Securities firms in the Securities Industry

Demand Side
Institutional
Investors(banks, insurancecompanies, retirement
funds, hedge funds,
and mutual funds)

Supply Side
Invest in securities

Securities
Markets

Brokerage
Firms(stockexchanges,
over-thecounter trading,bond markets)

Purchase securities

Raise finance

Brokerage
Firms

Corporations
Central/Local
Government

Issue securities

Individual Investors

Figure 2

Information Systems of Securities firms

Sources: Based on Financial Information System Center (2007), Financial Information
System White Paper, 20th fiscal year of Heisei, Zaikei Shoho Sha.

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Behind the active investment by Japanese securities firms in IT systems is thegrowing need for the industry to manage households’ financial wealth in preparation for
their old ages. The accelerating aging of the Japanese society made the social security
system no longer completely reliable. As a complement to the insufficient public
support, the Japanese securities industry is expected to support living standards of theJapanese households in the future by offering wealth management services. In fact, as aresult of the gradual shift of household financial assets from savings to securities andthe parallel increase in the sales of investment trust, the portfolio investment income(returns to investment in foreign stocks and bonds) of Japan as percent of the nominal
GDP increased from 0.64% in 1994 to 2.3% in 2007 (Ministry of Finance, 2008).
However, difficulties arise when the securities industry seeks further expansion. For
instance, the growing number of sophisticated financial products will increase theburden of office work of financial institutions and make it more and more difficult forhouseholds with low financial literacy to make appropriate investment decisions.
Besides it is unrealistic that sales staffs of securities firms could consult with all richand non-rich households due to the cost and limited human resources. One of thesolutions to such problems is considered to be development of IT systems.
Nevertheless, the growing social needs for the securities industry do not justify
generous IT system investment. First, the unprecedentedly extensive world financial
crisis and the subsequent deepening recession of the Japanese economy will force-5-Japanese securities firms to slash IT expenses in the upcoming year, which is alreadysuggested in the last column of Table 1. With the high sensitivity of corporate profits to
ups and downs of economies, it is a disadvantage for securities firms to possess assets
as fixed ones rather than as fluid ones, because idle fixed assets tend to suppress
revenues in an adverse period; and one of the largest fixed assets of securities firms isthe very IT system 3 . Second, IT investment is not the objective itself but merely one ofthe possible means to improve quality and reduce cost of financial services. Third, it isthought that the competitiveness of securities firms rely much more on human resources(e.g., abilities of consultation and product development) than on computer systems.
Effective use of IT system requires both assessing the effectiveness of the past IT
investment and, more importantly, considering the relative importance of IT investmentcompared with other strategies from the view point of overall corporate and industry
growth strategies. How much contribution, if any, has IT made to the development ofJapanese securities companies until today? Should Japanese securities companies invest
more in IT system in order to achieve higher growth? Isn’t there any alternative, more
promising strategies other than simply focusing on IT usage?
While the economic impact of information system investment has been examined
for the macro-economy, industries, and individual companies in a number of studies,3

For example, software asset amounted 9.2%, 21.2%, and 35.9% of total fixed assets in fiscal 2007
for Nomura, Daiwa, and Nikko, the three major Japanese securities firms. These figures take into
account only software asset and do not include hardware fixed asset.
-6-there are only a few for the Japanese securities firms (see Section 2). Given that since
the late 1990s the Japanese financial system has experienced dramatic changes such as
financial liberalization, globalization, computer automation, and expansion of direct
finance, it is worth analyzing the impact of IT investment of Japanese securities firms
on their performances, taking into account alternative development strategies.
Therefore, this article aims to investigate the relationship between the performanceof Japanese securities firms and their growth strategies including information system
investment. The article estimates profit functions of Japanese securities firms. The
estimation utilizes the panel (consisted of multiple years and multiple firms) datacollected from annual financial reports of 64 Japanese securities firms over the fiscal
year 2000-2008. There were 317 securities companies operating in Japan as of 20
March 2008 (Japan Securities Dealers Association, 2008). However, financial reports offoreign-affiliated securities firms and the majority of small Japanese securities firms failto provide some past figures such as the number of employees and the amount ofsoftware assets, which are keys for econometric estimation. This forced the analysis tofocus on major Japanese securities firms.
The remainder of the article proceeds as follows. Section 2 briefly reviews related
studies and presents an overview of the recent trend of the Japanese securities industry.
Section 3 explains expected roles of IT in the future Japanese security industry. Section
4 describes the data and the econometric methodology employed. Section 5 presents and-7-

discusses the result of the estimation. Section 6 gives conclusions.

2. Related Studies and Recent Trend of the Japanese Securities Industry
Motivated by the increasing importance of the financial industry, a large number ofstudies have examined various factors influencing the productivity of the financial
industry. Though financial industry can be roughly classified into banking, securities,
insurance, and lease, the majority of the past research have focused on the banking
industry 4 .
For example, productivity development of US banks was studied to gauge theeffects of deregulation (Humphrey and Pulley, 1997), mergers and acquisitions(Akhavein et al, 1997) and the degree of competition (Berger and Mester, 2001). Amongothers, Parsons et al. (1993) estimated cost functions of a large Canadian bank andfound a slightly positive correlation between productivity growth and adoption ofcomputers. Auror et al. (2000) argued that their empirical study on the 20 largest US
banks suggested the complementary relationship between the adoption of automatic
image processing of checks and computer-skilled labor. Using panel data of over 600
Italian banks over the period 1989-2000, Casolaro and Gobbi (2005) found that IT
capital accumulation significantly contributed to both cost cuts and profit increase for

4This is partly due to limited data availability. In Japan many companies started to mention
computer software asset only after 1998 March, when the accounting standards as to computer
software was established (see Takemura, Ukai, and Nagaoka (2008) for detail).
-8-the Italian banking industry. Ukai and Takemura (2008), based on their originalquestionnaire surveys, showed that an increase of ¥1 had led to about a ¥14 increase in
the market value (stock price) for 27 Japanese banks through 1993-1999. They also
found no positive effects of computer equipment or computer software assets to themarket value of nationwide banks, although the market values of regional banks wereraised by computer software assets.
The source of competitiveness of securities firms has been examined by several
economic studies. Shudo (1987) and Murayama and Watanabe (1989) showed that there
were

economies-of-scale effects among the major Japanese securities firms during

the period 1972-1977 and 1985-1987. Matsuura (1998) estimated stochastic frontierfunctions for 25 Japanese securities companies over the periods 1986-88 and 1991-96.
The results showed a widening efficiency gap between major competitive brokers andthe others in the post-bubble economy period. Using a similar estimation method,
Zhang and Luo (2006) investigated the technological progress, efficiency, andproductivity of the US securities firms between 1980 and 2000. They revealed that only
a few large investment banks achieved technological innovation, while most firms,
especially smaller regional firms, lagged far behind both in efficiency and productivity.
Tsutsui and Kamesaka (2005) examined the degree of monopoly of the Japanese
securities industry over the periods 1983-1988, 1991-1996, and 1997-2002. They foundthat the industry had not been perfectly competitive throughout the three periods and-9-that in the second period the degree of competition actually decreased despite financial
reforms.
The above four studies on the securities industry revealed the existence of firm-level
and industry-level inefficiencies. However, the drastic changes in the Japanese securities
industry’ business environment in the subsequent years took place after these studies.
Various liberalization reforms carried out in the Japanese financial industry since 1996
have had huge impacts on the management of securities firms (Securities Management
Study Group, 2008). First, securities firms’ traditional main source of revenues,
commission fees for undertaking trade, has been threatened by the rise of online
discount brokerage firms.

As a result of the liberalization of entry to securities

industry (December 1998) and the liberalization of securities firms’ commission fees
(October 1999), the revenues of securities firms that depended on commissions
deteriorated. Today almost 90% of orders by individual investors come through online
trading. In addition, more and more bank-owned security subsidiaries joined theunderwriting market of corporate bonds, which further fueled competition (Takaoka and
McKenzie, 2005). Second, the expanding selection and sales route of financial products
has led to the separation of selling and production of financial products, both of which
had been the business of securities firms. The sales of mutual funds, which had been
exclusively allowed for securities firms, began at banks in 1998. New financial products
such as Exchange-Traded Fund (ETF), Money Management Fund (MMF), and Mutual- 10 -

Reserve Fund (MRF) started to offer individual investors a simple, low-cost means todiversify investment portfolio. Such expanding sales routes and selection of financial
products resulted in the rise of investment advisory firms and investment management
firms that are independent of securities firms.
In response to these drastic changes of the financial industry, different securities
firms selected different development strategies. The three major securities firms aregradually shifting their central business from this “traditional” commission businesstoward “untraditional” businesses, such as asset securitization, mergers and acquisitions
advisory services, wealth management specialized for affluent clients, and merchantbanking investment for their own accounts. The leading online securities brokers havemade intensive investment in their Internet-based trading systems to offer a variety ofadvanced trading tools for individual traders. Among middle to small securities firms,
some select mergers, some find a niche market such as foreign exchange trading, someenter a partnership with nationwide banks, and others are forced out of securities
business.

3. Data
The econometric estimation employs an unbalanced panel data of 64 Japanese
securities firms over the fiscal years 1999-2007. We used two sources, Nikkei NEEDS®
and eol-ESPer®, which compile detailed data reported in annual financial reports of- 11 -

individual firms. Some of the unreported financial statistics such as the number of
online accounts come were supplemented by websites of individual securities firms andrelated associations. Foreign-affiliated securities firms operating in Japan were excluded
from the dataset, since they do not provide information on software assets (they use
different accounting standards from the Japanese ones) and their performances arestrongly influenced by the market condition of their host countries. The reason we do
not use data prior to fiscal 1999 is that with the change in the law, majority of theJapanese securities firms started to report the value of their software asset in 1999. In
order to precisely measure the impact of information technology on the outcomes of
securities firms, we had to restrict the samples.

4. Econometric Estimation
With the above firm-level dataset at hand, we measure the extent to which different
corporate strategies including information system investment contribute to the growth
performance of individual Japanese securities firms. We estimate the revenue functionsof individual securities firms. Potential factors explaining increases in the revenues can
be classified into (1) individual characteristics (the amount of asset, the composition ofsales, and investment in education and advertisement), (2) group-level characteristics(major securities firms, online-trading-specialized securities firms, and others), and (2)market factors (e.g. stock prices). In general notation, this regression can be expressed- 12 -

as:

Ri ,t = α i + βx i ,t + δy i + λz t + ε i ,t ,t = 1999,2000, L ,2007; i = 1, 2, L 64,(1)

where Ri,t is the revenue of a securities firm i in period t , x i,t is a vector ofindividual characteristics (e.g. the number of employees and the book value of software
asset), y i is a vector of characteristics specific to the groups to which a securities firms
i belongs,z t is a vector of various market factors that vary over time but take the samevalues for all firms in the same period, and ε i,t is an error term. The regression analysis
estimates the signs and sizes of coefficient vectors ( β , δ , and λ ), which reveal how
much each of the factors in x i,t , y i , and z t contributed to the revenues.

4. Estimation Results

The results of the econometrics analysis are presented in Table 2 and Table 3 5 . The
estimation employed the Ordinary Least Square (OLS) method and Fixed Effect (FE)method. Model (3) separately estimates the revenue regressions for major firms, online
brokers, and other securities firms. On the whole, all the coefficients for employees,
software asset, and the average TOPIX are positive and statistically significant. The
decomposition in Model (3) shows that the contribution of software asset is larger forlarge firms and online brokers than for other firms. The coefficients in the eight row in

5

While model (1)-(3) uses logarithms for revenues, employees, software, education andtraining ,and advertisement, model (4)-(6) uses normal values to keep the sufficient number ofobservations.
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- 14 -

- 15 -

Model (3) (0.315, 0.400, and 0.056) implies that a 1% increase in software assets leads
to 0.315%, 0.400%, and 0.056% increases in the total revenue for each group of
securities firms..
Table 3 looks into more detail the factors of growth. In Model (4) and Model (5) it isfound that education/training for employees and advertisement, in addition toemployees and software, have made positive impacts on the revenues. In Model (6) the
coefficients for the number of employees and education/training are highly significant
for large securities firms. On the other hand, for online brokers, software makes strongly
positive impacts on the revenues, while the number of employees is not much related tohigh revenues of online brokers. Another finding is that branches tend to raise revenuesof the securities industry except large securities firms. Besides, whereas software asset
is not much important for higher revenues of “other securities firms”, advertisement
turned out to be effective to raise revenues.

7. Conclusion

This article investigated how much different corporate strategies have contributed to
the growth performance of individual Japanese securities firms, with a special focus on
IT systems. It is confirmed that software assets have made positive impacts on therevenues of the whole securities industry, but the effect differs for the three groups of
securities firms: large securities firms, online brokers, and the others. The results imply- 16 -

that IT system is important especially for online brokers. The main sources of highrevenues of large securities firms seem to be both skilled employees who are given
much training and education and the intensive investment in IT system. The desirable
strategies for other securities firms may be either expanding branch networks orinvesting more in advertisement to improve their publicity, rather than extensive use of
IT system. In order to survive and keep developing in the changeable financial market,
the Japanese securities firms have to recognize their sources of competitiveness andconcentrate their limited resources into the most effective measures. IT system is by nomeans an exception.
(2994 words)- 17 -

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