DP2012-12Japanʼs Orientation towards F oreign
Investments: Inertia Effects and Driving
Force of Institutional Changes*
Nir KSHETRI
Ralf BEBENROTH

April 11, 2012

* The Discussion Papers are a series of research papers in their draft form, circulated to encourage
discussion and comment. Citation and use of such a paper should take account of its provisional character.
In some cases, a written consent of the author may be required.

RIEB Discussion paper

Japan’s Orientation towards Foreign Investments: Inertia
Effects and Driving Force of Institutional Changes
Nir Kshetri, The University of North Carolina at Greensboro, USA
Ralf Bebenroth, Kobe University, Japan

Japan’s Orientation towards Foreign Investments: Inertia
Effects and Driving Force of Institutional Changes
Abstract
We use an institutional perspective to develop a framework for understanding the contexts,
mechanisms and processes associated with institutions and institutional changes related toforeign investment in Japan. We examine power dynamics and relational boundaries between
diverse actors and analyze why and how some components of institutions have changed andothers have not. Also explored in this paper are the conflicting discourses that have been raisedin regards to the participation of foreign investors. We also examine purposive efforts of various
institutional entrepreneurs to change prevailing institutions in Japan. We assess structural factors
working as sources of inertia in Japan’s openness to FDI including the nature of capitalism,
power of bureaucracy and culture and analyze various internal and external sources associatedwith exogenous shocks and gradual changes in institutions.
Keywords: Institutions, institutional changes, foreign investors, Japan, global financial crisis,
institutional entrepreneurs, institutional field

1. Introduction
In recent years, Japan has made a considerable progress in attracting foreign investment. In thefiscal year (FY) 2004/05, foreign investment in the country exceeded its investment overseas forthe first time in about fifty years (BBC News, 2005). During 2001-2009, Japan’s stock of foreign1direct investment (FDI) as a proportion of GDP grew from less than 1% to over 3.5%. It is fairto say that the growth in FDI is associated with and facilitated by a wave of change that iscoming in foreign investments-related institutions in Japan.
Unlike in the 1960s, politicians and government officials are wholeheartedly promoting andencouraging FDI inflows in recent years. A Ministry of Foreign Affairs (2002) provided therationales: “Japan cannot secure the advantages of FTAs without enduring some pain arisingfrom the opening of its markets, but this should be regarded as a process that is necessary forraising the level of Japan's industrial structures”. In 2006, Japan announced a plan to accelerate
efforts to attract foreign investments so that the total FDI stock would be 5% of GDP by 2010.
Significant efforts have been made to encourage foreign firms to invest in Japan. The quasigovernmental organization JETRO has over 70 overseas offices in more than 50 countries to help
foreign companies (Jetro, 2011). Japan has also announced a plan to translate relevant laws into
English (europa.eu, 2008). Observers have noted that trade associations and industry bodies,
which acted as informal barriers to inward FDI in the past have weakened (The Economist
Intelligence Unit, 2008). Despite this progress, however, foreign businesses report that enormousand vexing troubles continue to frustrate their efforts to enter and operate in the Japanese market(Bebenroth, Kshetri & Huenerberg, 2012). Observers often note that the costs of doing businessin the country remain high (The Economist Intelligence Unit, 2008). It has long been recognizedin academic and policy debates that Japan poses unique challenges for foreign businesses. The
popular press has also published many articles in which foreign traders and investors facevarious barriers to operate in the Japanese market.
We argue that contexts, mechanisms and processes associated with foreign firms’ perceptionsof trade and investment barriers in Japan, while well documented, are only partially understood.

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While some researchers have recognized the importance of studying “deeper, underlying
problems” in the Japanese economy (Porter & Takeuchi, 1999), in little research have scholars
examined this problem from an institutional theory angle. On the contrary, there seems to be
declining interests about Japanese companies and business environment among academic andbusiness scholars. In this regard, Numagami et al. (2010) are surely correct to claim that
researchers can get novel and unique insights by exploring the underlying processes andmechanisms at play in Japanese firms that have been relatively under-performers lately.
Likewise, Porter & Takeuchi (1999) have emphasized the importance of understanding thesources of successes as well as failures in providing prescriptions for Japan.
In light of the above observations, we have two objectives in this paper. First, we wish toinvestigate various forces in Japan that have led to the rise in foreign investment to the country inrecent years. Second, we seek to better understand the various forces that may still tend to act asbarriers to changes in institutions related to foreign investment.
The paper is structured as follows. We proceed by first providing some anecdotes andobservations regarding barriers to trade and investment in Japan. Then we discuss our theoreticalframework. Next, we apply our theoretical framework to examine inertia effects and driving
force related to institutional changes in Japan. It is followed by a section on discussion andimplications. The final section provides concluding comments.

2. Barriers to Trade and Investment in Japan: Some Anecdotes andObservations
A number of indicators point to the fact that the inflows of trades and investment in Japan areproportionately less than the country’s share of the global GDP of about 8.7%. For example,
according to the CIA World Factbook, Japan’s consumption accounts for about 4% of theworld’s oil and 5% of base metals. Another suggested indicator is to look at the revenues of3

major multinationals in Japan and compare them with corresponding global revenues. In thisregard, revenues of MNCs such as AstraZeneca, GlaxoSmithKline, Citigroup, British American
Tobacco and Diageo in Japan as proportions of their global revenues are less than Japan’s shareof global GDP (Ashby, 2011). Japan also consumes fewer commodities than its share of global
GDP.
Table 1 around here
According to the CIA World Factbook, Japan’s FDI stock by the end of 2010 was $199.4
billion1 or 3.7% of its GDP of $5.4 trillion. Japan thus failed to achieve its FDI goal for 2010.
Although Japan’s economy in size is comparable to China’s, the latter has been more successful
in attracting FDI. As of March 2010, China's inward FDI stock exceeded $1 trillion (Global
Times, 2011).
Prior research indicates that Japan’s restriction to FDI can be traced back to as early as
the Meiji period in the late 19th century (Chang, 2004). Excluding the socialist bloc, Japan’s
dependence on FDI was the lowest until the 1960s. Japan started opening its economy by the endof 1960s and continued the process until the mid-1970s (Suginohara, 2008). The increasing
openness of the Japanese economy during that time, however, was the result of externalpressures and obligations associated with entering international organizations, rather than fromlong- term dynamics within the country. Japan’s position vis-à-vis other industrial countries,
however, did not change much during the 1980s and 1990s. During 1981–95, FDI in Japanaccounted for 0.1% of total fixed capital formation compared to the developed country averageof 3.5 % (Chang, 2004). Japan’s FDI stock of 3.7% of GDP is much smaller than about 20% of
GDP in most European countries (europa.eu, 2008). The 2008 Economic Survey of the4Organization for Economic Co-operation and Development (OECD) indicated that Japan was theleast open OECD state.
Observers have noted various restrictive practices related to foreign investment in Japan.
Starting the mid-1960s, the level of intra-keiretsu shareholdings increased, which discouraged
foreign acquisitions by reducing the number of stocks publicly traded (Suginohara, 2008). For
instance, cross-shareholdings between companies, business partners and clients make it difficult
for foreign investment firms to buy sufficient stock to ensure a voice in management (Nannichi& Kakuta, 2010).
The low levels of trade and investments can be attributed to a host of barriers facing
foreign businesses. Foreign companies and policy makers have expressed their feeling that they
face a hostile environment in Japan. The EU has shown concerns about nontariff barriers inJapan. In a speech given to a business and government audience in Tokyo in 2008, EU Trade
Commissioner Peter Mandelson described Japan as “ a globalisation paradox” and noted thatwhile Japan benefitted from an open global investment climate, “at home it remains the mostclosed investment market in the developed world” (europa.eu, 2008, p. 1).
As a final observation, we should make it clear that the various agencies and programs
that are created to help foreign firms to invest in Japan lack the financial tools that have helped
other industrial economies to attract investment (Political Risk Yearbook: Japan Country Report,
2011). For instance, some of the lead agencies created for this purpose include The Ministry of
Economy Trade and Industry (METI) and Japan External Trade Organization (JETRO) (Jetro,2011). Moreover, several prefectural and city governments have programs to attract foreign
investors. It has been observed that these agencies’ effectiveness has not been proven.
2.1 Perceptions and experiences of foreign businesses operating in Japan5

Japanese and foreign businesses have expressed differing and competing views and beliefs about
Japan’s openness. Foreign businesses often are skeptical about Japan’s FDI friendliness (Table
2). As Table 2 makes it clear, Japan’s relative openness vis-à-vis its major trading partners,
stated and perceived motivations of foreign investors, potential social and economic
consequences of foreign trade and investment, intended and expected changes in orientation,
foreigners’ involvement in and partnership with Japanese companies, and victim vs. victimizer
roles. Foreign firms’ experiences, actions, activities, and behaviors describe the complexity of
the Japanese market. They have observed that government policies have superimposed onto
unique interactions with various elements of Japan’s economic system such as lifetime
employment, cross-shareholding, keiretsu and the banking system to amplify the entry barriers to
the Japanese market (OECD Economic Surveys: Japan, 2006).
Table 2 around here
Foreign firms’ complaints about specific aspects of the operations in Japan continue. One
compelling example concerns the requirement of local studies for pharmaceutical products. One
complaint is that while human genome research has demonstrated the similarity of human race ingenetic composition, Japan forces foreign drug companies to conduct bridging studies with thelocal population in addition to global trials. As one might expect, this requirement delays theintroduction of well-established drugs (Ashby, 2011).
To move to a different point, the reactions of many Japanese companies to the prospect ofmergers have been to create poison pill schemes, which allow the existing shareholders to buy
stocks at lower prices (BBC News, 2005; europa.eu, 2008). Hamao, Kutsuna & Matos (2010)
observed that shareholders widely adopted "poison pills" after 2006, especially those targeted by
activists, which led to a subsequent drop in investor activism. From the standpoint of the6participation of foreign firms, the 2007 revision of Japan’s mergers laws to allow triangularmergers of foreign companies with Japanese companies is an important milestone (Table 1).
Until 2009, however, there was only one instance of triangular merger in which a foreigncompany (Citibank) acquired a Japanese company (Nikko).

3. Theoretical Framework
3.1 Institutions and institutional fields
Nobel Laureate Douglas North defines institutions as “macro-level rules of the game” (1990, p.
27) which consist of ‘formal constraints (rules, laws, constitutions), informal constraints (normsof behavior, conventions, and self-imposed codes of conduct), and their enforcement
characteristics’ (North, 1996: 344). Institutions can be considered as a conceptual subset of thesocial ecosystem. An economic system, on the other hand, is a “coordinated set of formal andinformal institutions” (Dallago, 2002) influencing economic agents’ behavior (Matutinoviæ,2005). Put differently, all economic phenomena have institutional components and implications(Parto, 2005).
One way to view the Japanese FDI landscape would be to consider it as “arenas of power
relations” (Brint & Karabel, 1991, p. 355) in which various domestic and foreign players withcompeting interests and disparate purposes negotiate over issue interpretation (Hoffman, 1999;
White, 1992). These activities fit squarely into the framework of institutional field. An
institutional field is “formed around the issues that become important to the interests andobjectives of specific collectives of organizations” (Hoffman, 1999, p. 352). A field is a
dynamic system characterized by the entry and exit of various constituencies with competinginterests and disparate purposes and a change in interaction patterns among them (Brint &Karabel, 1991). That is, fields are “evolving” rather than being “static” (Hoffman, 1999).

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In an institutional war, dominant field members exert control and influence in thedevelopment of structures and practices and shape the field’s evolution (Phillips et al., 2000).
Prior research indicates that powerful and dominant field members tend to be those with “greater
formal authority, resources and discursive legitimacy” (Phillips et al., 2000 p.33). Formal
authority is related to an actor’s “legitimately recognized right to make decisions” (Phillips et al.,2000, p.33). In most cases, such power lies with the government (Hardy & Phillips, 1998).
Actors with discursive legitimacy, who have less obvious self-interest are likely to be
more influential than resource-rich actors or formal decision makers (Hardy & Phillips, 1998). In
this regard, in some cases, foreign investors engaged in activism were perceived as looking for
short-term advantages.
3.2. Institutional changes and associated processes and mechanisms
Notwithstanding their connotation of inertia, resistance to change (Hoffman, 1999), persistence(Parto, 2005), durability (Hodgson, 2003) and stability (Scott, 1995, 2001), institutions are
subject to change. Institutions arguably have a higher propensity to change when they arecharacterized by contradictions that “create conflicting and irreconcilable incentives andmotivations” (Campbell, 2004; p. 186). These conditions are prevalent in the current Japanese
economy.
A simple approach to understand institutional changes would be to look at the various
contradictions that institutional embedding the Western traders and investors produce with theinstitutions in Japan. Institutional changes can be seen as an outcome of the dynamic interactionsof contradictions and “praxis” (Seo & Creed, 2002). Seo & Creed (2002) have proposed four
sources of contradiction: “(1) legitimacy that undermines functional inefficiency, (2) adaptationthat undermines adaptability, (3) intra-institutional conformity that creates inter-institutional8

incompatibilities, and (4) isomorphism that conflicts with divergent interests.” These arearguably accumulated results of organizations’ continuous isomorphic adaptations (Burns &Nielsen, 2006). First, conformance to the existing institutions may be at the expense of technicaland functional efficiency. Second, continuous isomorphic adaptations may lead to psychologicaland economic "lock-in" and “competency traps,” which may undermine further adaptability. Put
differently, “adaptive moves make adopters less able to adapt over the long run” (Seo & Creed,2002). Third, the legitimacy seeking process may require appeasing multiple institutions that are
conflicting and inconsistent. Finally, misalignment between institutions and the divergent
interests of actors embedded in the institutions may lead to contradictions.
In prior theoretical and empirical research, scholars have identified three mechanisms
related to changes in institutional fields (for a review, see Sauder, 2008). They are: “jolts” orexogenous shocks (Meyer, 1982; Meyer et al., 1990; Haveman et al., 2001), changes inorganizational logics (Friedland & Alford, 1991; Leblebici et al., 1991; Haveman & Rao, 1997;
Thornton & Ocasio, 1999) and gradual changes in inherent structure of the field (Clemens &Cook, 1999; Fligstein, 2001; Schneiberg, 2005; Scott et al., 2000).
Exogenous shocks“Jolts” and other exogenous shocks can disrupt a field (Sauder, 2008). Exogenous shocks cancreate opportunities for new norms in the field and may change existing boundaries and lead tothe emergence of new hierarchies (Meyer, 1982; Meyer et al., 1990). Examples of exogenous
shocks include the introduction of discontinuous technological innovation, social unrest, politicalchanges, new government regulations, and economic/financial crashes (Haveman et al., 2001).
Changes in organizational logics

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In prior theoretical and empirical research, scholars have emphasized the coevolving nature of
institutions and the organizational forms that embody them and found that changes inorganizational logics lead to a change in a field’s practices and conventions (Friedland & Alford,
1991; Leblebici et al., 1991; Thornton & Ocasio, 1999).
Gradual change in field structure
Institutional fields also change gradually (Scott et al., 2000). Related to this approach are studies
of how fields may be influenced by general institutional changes (Clemens & Cook, 1999;
Schneiberg, 2005). Some important mechanisms in this category include modifications inregulative and normative institutions, institutional logics, and the composition of actors
constituting the field (Scott, 1995, 2001, 2005).
3.3. Institutional change agents and institutional entrepreneurs
It may be helpful to consider the roles of institutional change agents. A central concept here is
institutional entrepreneurship. New institutions arise when institutional entrepreneurs “see inthem an opportunity to realize interests that they value highly” (DiMaggio, 1988, p. 14). A
growing number of studies have suggested that institutional entrepreneurs challenge or disrupt
particular models of social or economic orders and construct new organizational fields (Bartley,2007; Daokui Li et al., 2006; DiMaggio & Powell, 1991). They “lead efforts to identify political
opportunities, frame issues and problems, and mobilize constituencies" and "spearhead collective
attempts to infuse new beliefs, norms, and values into social structures" (Rao et al., 2000, p. 240).
They also engage in activities related to deinstitutionalization or dissolution of existing logic orgovernance structure as well as institution formation, which entails the birth of a new logic orgovernance structure (Scott, 2001).

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Institutional entrepreneurs’ "subject positions" need to be dominant that can allow themto gain wide legitimacy, bridge diverse stakeholders and compel other actors to change theirpractices (Hoffman, 1999; Maguire et al., 2004). It is important for them to mobilize external andinternal constituents, have financial resources (DiMaggio, 1989; DiMaggio & Powell, 1991;
Holm, 1995) and be able to communicate with other institutional actors in the system so that
their initiatives are perceived favorably (Groenewegen & van der Steen, 2007).
Theorization or "the development and specification of abstract categories and theelaboration of chains of cause and effect” is an important process through which institutional
entrepreneurs facilitate the diffusion of new ideas (Greenwood et al., 2002:60). Theorization
provides rationales for the practices to be adopted and thus increases the likelihood of acceptanceof the practice (Strang & Meyer, 1993). Two key elements of theorization concern framing andjustifying. Framing focuses on the need for change and justification is value of the proposedchanges for concerned actors (Greenwood et al., 2002; Maguire et al., 2004).
Discursive legitimacy concerns speaking legitimately about particular issues and affectedorganizations (Phillips & Brown, 1993). For example, Greenpeace derives discursive legitimacy
because it speaks on behalf of the environment (Hardy & Phillips, 1998). The research literatureprovides abundant evidence that acquiring discursive legitimacy is important for new field
members without formal authority or resources to secure a right to voice (Phillips & Hardy,1997).

4. Sources of Institutional Inertia
Organizational inertia can be defined as formal organizations’ tendency to resist internal changes
in response to external changes (Larsen & Lomi, 2002). Such a tendency may constraint anorganization's ability to exploit emerging opportunities (Dean & Mayer, 1996). In this paper’s
context, an inertia effect (resistance to change) is likely to lead to an underestimation of benefits
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associated with openness to foreign investment. Some of the important sources of inertia
associated Japan’s approach to foreign investment are discussed below.
4.1. The historical and societal circumstances behind Japan’s approach toforeign investment
In most cases, compared to formal institutions, de-institutionalization and reinstitutionalizationof social practices, cultural values and beliefs occur very slowly (Clark & Soulsby, 1999;
Ibrahim & Galt, 2002, North, 1990, Zweynert & Goldschmidt, 2006). North (1990, p. 6) notedthat “although formal rules may change overnight as the result of political and judicial decisions,informal constraints embodied in customs, traditions, and codes of conduct are much moreimpervious to deliberate policies”. In this regard, especially relevant to this article's context
concerns an observation made by Junichi Arai, head of M&A at Morgan Stanley Japan: “Thenotion that commercial code changes will lead to a wave of international firms snapping up
Japanese companies is over-simplistic” (Ibison, 2005). The findings of prior studies suggest that
informal institutions act as barriers for foreign firms’ operations in Japan (Bebenroth, Kshetri &Huenerberg, 2012).
In a New York Times Op-Ed, Yukio Hatoyama, who headed the Democratic Party ofJapan and was prime minister from September 2009 to June 2010, noted: “The economic order inany country is built up over long years and reflects the influence of traditions, habits and national
lifestyles. But globalism has progressed without any regard for non-economic values, or forenvironmental issues or problems of resource restriction” (Hatoyama, 2009).
To understand the problem of institutional changes in Japan, it may be helpful to consider
Japan’s history and culture. Historically Japan is characterized by high levels of cultural andtrade barriers. The country’s self-imposed isolation ended in the mid-1850s. While Japan12

gradually started opening its markets to international companies, analysts say that it is moreclosed than most industrialized economy (Ashby, 2011).
A related point is that Japan’s tight, insular and consensual culture is associated with ahigher incentive to cooperate than in other relatively loose countries such as the U.S. In a studyof 33 countries, Gelfand et al. (2011) found that Japan is among the 10 'tightest' countries. An
upshot of this orientation has been an emphasis on personal relationships. Japanese businesses
are reluctant to break or modify existing business relationships and prefer to do businesses withfamiliar corporate partners. A corollary is that Japanese companies tend to resist hostile mergers
and acquisitions (M&A) but that they are active in overtaking foreign firms (Yeh, 2011).
Understandably foreign investors trying to enter the Japanese market tend to label suchpreferences and practices non-tariff barriers (Political Risk Yearbook: Japan Country Report,
2011).
A consideration of traditional Japanese corporate governance would offer further insights
and understanding of the historical and societal circumstances. In the traditional Japanesepractice, a firm is not viewed as “a mere property of shareholders (Sako, 1997). Indeed,
employees are considered to be “the most important stakeholders” (Araki, 2005). Until the 1980s,
Japanese companies’ common stockholders were treated like preferred shareholders of westerncompanies, who lacked a say in corporate affairs (Abbeglan & Stalk, 1985). The top
management team consisted of internally promoted managers rather than appointed agents to act
on behalf of shareholders. Managers obviously identified more with other employees than withshareholders (Sako, 1997). Overall Japan’s insider-dominated corporate board differs
significantly in the structure of corporate boards of Western countries (Charkham, 1994; Shleifer

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& Vishny, 1997). That said it is also the case that Japanese institutional investors increasingly
monitor and control their targets (Yoshinori, 2011).
4.2. Japan’s big firm capitalism and cartel like arrangement
While the Western and Japanese economies are based on free-market ideologies and models,
they have exhibited different types of capitalism. In Japan’s big firm capitalism the government
has a tendency to collaborate with large firms to drive economic growth and entrepreneurial
activities (Schramm, 2004). Consequently, some industries are characterized by formal andinformal cartels (Political Risk Yearbook: Japan Country Report, 2011; Kimino et al., 2007).
Some considered the collaboration between the former Ministry of Trade and Industry and thelarge conglomerates equivalent to a cartel (baltimoresun.com, 1991).
To understand the cartel like arrangement, it might be helpful to consider Japan's securities
market and tobashi, the practice of reconciling favored clients’ accounts to compensate for stock
losses. Estimates suggested that between the 1989 Tokyo market crash and the mid-1991, Japan's"Big Four" securities firms had reimbursed about $1 billion to over 225 favored clients(fundinguniverse.com, 2011). In 1991, the presidents of two of the top 3 Japanese securities
firms, Nomura and Nikko quit after law enforcement investigations found that they had links
with underworld figures and they had compensated selected clients for stock-trading losses(baltimoresun.com, 1991). Furthermore, analysts argue that these practices were too common in
Japan.
Japan’s big firm capitalism is associated and facilitated by close ties between government
and industry. For instance, professional and trade associations act as quasi- regulatory bodies andare allowed to devise their own rules to regulate their business sectors (Japan Country Review,2011). We can illustrate this point with an example of legal profession. Foreign lawyers face14

strict eligibility restrictions for legal practices in Japan. Foreign lawyers that are licensed inJapan under the 1986 Foreign Lawyers Law are not allowed to advise foreign investors on
various aspects. Moreover, these restrictions are strictly enforced by the Federation of Japanese
Bar Associations (Nichibenren). Consequently, there are only a small number of Japaneselawyers that can handle international business transactions, which means that foreign investors
lack adequate access to legal services related to doing business in Japan (Japan Country Review,2011). Using the approach of Phillips et al. (2000), we can say that the Federation of Japanese
Bar Associations is a powerful and dominant field member with significant formal authority andresources
4.3. Bureaucratic system
Foreign companies doing businesses in Japan have expressed their frustrations with the Japanesebureaucracy. For instance, an EU official recently put the issue this way: "You export a car to
Japan and later you discover that the authority in charge of road security blocks its sale because
it does not respect complex safety standards, like the shape of a side-window" (euractiv.com,
2011). Japanese bureaucrats’ power today is to a large part due to their past success in guiding,planning and implementing Japan’s developmental state model which led to the economic
miracle. Politicians’ excessive reliance on bureaucrats has acted as a barrier to institutionalchange.
One of the most important features of Japanese institutions concerns its bureaucratic
tradition, which has received a considerable amount of attention. Japanese bureaucrats haveplayed an unusually important and interesting role in the policy-making arena (Haggard, 2004).
About 75% of bills presented to the Diet come through Japan's bureaucracy. Scalise & Stewart(2009) comment: “In Japan, laws are usually vetted by ministerial advisory councils, drafted by15

the bureaucracy, reviewed by the relevant minister, reviewed again by the relevant Diet
committee, and finally rubber-stamped in a plenary Diet session. This is not because thebureaucracy has a chokehold on the legislative process, but because politicians lack the time,energy, staff, and expertise necessary to write bills”.
In this regard, one view is that there is a tacit division of labor between bureaucrats andpoliticians. In this division of labor, bureaucrats were the de facto rulers in the country’s
economic and social affairs, who pursued their own developmental objectives irrespective ofwhat the politicians wanted to accomplish (Johnson, 1982). The opposite argument is thatpoliticians dictated the country’s policy and the bureaucrats acted as politicians’ agents (Noble,
1998; Ramseyer & Rosenbluth, 1993).
Irrespective of which view prevails, most experts agree that bureaucrats in Japan possess
more power over policy than their Western counterparts. Analysts point out that historically“bureaucrats have always been held in high esteem and politicians played second fiddle” (Jain,
2009). For instance, following World War II, while Japan transformed most of the pre-war
institutions, the bureaucracy remained virtually untouched and unchanged. They became rolemodels for many other Asian nations. The Democratic Party of Japan has maintained that
institutional reforms are arguably hampered by “decades of policy collusion between bureaucrats
and ruling party lawmakers” (Nishikawa & Sieg, 2009). After the 1994 failed talks on economic
reforms with the U.S., Motohisa Furukawa, a DPJ representative in the House of Representatives,
was quoted as hearing a Japanese official say: “In our country, even if the prime minister says
'yes', nothing will change unless we agree" (Sieg, 2009).

5. Driving Force of Institutional Changes in Japan
Internal and external sources of institutional changes in Japan are presented in Table 3. Table 4
illustrates how institutional changes may affect the four key institutional actors in Japan: the16

government, bureaucrats, big businesses and the consumer (public). Some of the forces such as
the Tohoku earthquake, tsunami and nuclear meltdown can be considered as jolts, which takeplace in a discontinuous fashion. Others such as Japan’s integration into the global economy
constitute gradual changes.
Tables 3 and 4 around here
5.1. Domestic sources of institutional changes
Poor economic performance and existing institutions’ association with functional
inefficiency
Adverse economic indicators such as the government indebtedness at 200% of GDP, low returns
on capital in the domestic corporate sector state have forced state, non-state and private actors torethink the Japanese model and realize the drawbacks of prevailing institutions. Politicians inJapan know full well that opening their domestic markets for greater levels of investment would
be a compelling strategic choice. Financial and economic crises served as an important trigger
for the Japanese government to open its market for FDI.
Due to failures and losses, Western profitability and efficiency measures such as ROA
and return on sales are increasingly diffusing in the Japanese corporate culture. To take one
example, in the late 1990s, Sony reduced its board from 38 to 10, which included 3 outside
directors (Porter & Takeuchi , 1999).The Chief Japan Strategist for Goldman Sachs Japan wasquoted as saying: “Japanese did not know what ROE was in 1995” (Robinson & Shimizu, 2006).
ROE has been an explicit goal for a large number of companies in Japan in recent years.
Political changes: DPJ’s victory
The DPJ, which won a landmark victory in August 2009 over the long-governing Liberal
Democratic Party, created an impression among foreign investors that Japan would be more open
to foreign investment, especially from emerging Asian economies (Kodaira, 2009). Then Prime
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Minister Yukio Hatoyama promised a “grand cleanup of postwar governance” (Fackler, 2009).
Observers also noted that the DPJ's victory opened the door for the Japanese to ask themselves afundamental question related to orientation towards foreign investments (Scalise & Stewart,2009).
Triple Disaster: Earthquake, tsunami and nuclear meltdown
Natural catastrophes such as the earthquake, the tsunami and nuclear meltdown have also been
the sources of jolts. The disaster led to a significant decline in output in the first quarter of 2011
(OECD Economic Outlook, 2011). At the same time, there will be significant reconstruction
spending in areas affected by the earthquake and tsunami. Japan's huge public debt has forced thegovernment to find alternative sources to finance reconstruction spending. Following the tsunami
and nuclear meltdown in March 2011, Japan pressed the EU for a formal summit to launch free
trade negotiations (channelnewsasia.com, 2011).
Unethical and corrupt practices of local firms driving changed in the perceptions of foreignfirms
A December 2004 survey conducted among Japanese by Nomura Research Institute, for instance,
indicated that foreign companies’ image in Japan was improving. Over 30% of respondents
participating in the survey said that foreign companies’ image had improved compared to a
decade before then whereas less than 9% thought that it had worsened. This change is at least
partly due to unethical acts of fraud and corrupt practices of local firms. Suginohara (2008)
notes: “.. complaints that foreign companies are disruptive, ignorant of local customs, anddestructive of the Japanese economic system hold less water after the scandals surrounding
Japanese entrepreneurs such as Murakami Yoshiaki and Horie Takafumi, who jolted theJapanese economy in 2004 and 2005 by behaving contrary to the traditional Japanese way”.

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5.2. Foreign sources of institutional changes
Perceived functional efficiency of foreign institutions and mimetic isomorphism
Institutional changes are more likely to take place when institutionalized values, norms andpractices conflict with functional efficiency and are incompatible with and fail to respond to achanging environment (Seo & Creed, 2002). In this regard, an increasing number of Japanesefirms are considering Western practices associated with a higher degree of functional efficiency
and are imitating such practices. This phenomenon is also referred as mimetic isomorphism(DiMaggio & Powell, 1983). Wilbur Ross, chairman of W. L. Ross & Company noted: ''Now
that Ghosn has become a cult figure in Japan, there's a growing awareness that some degree ofWestern notions might not be a bad thing. Restructuring is no longer the dirty word it used to be''(Belson, 2003).
Foreign investors and activists’ roles as institutional entrepreneurs
Foreign investors and activists are playing a key role in bringing changes in Japanese institutions.
Prior research indicates that institutional change measures are likely to be initiated by lesspowerful actors from the periphery of an inter-organizational field (Leblebici et al., 1991). For
such actors, the costs for changing the existing order are arguably lower and they are also lesslikely to be sanctioned by the central powerful players.
Due to its highly tight, insular and consensual business culture (Gelfand et al., 2011;
Political Risk Yearbook: Japan Country Report, 2011), institutional entrepreneurs to challenge
the existing order are less likely to come from inside the country. Unsurprisingly, foreign
institutional actors have initiated most of the visible activities to change the existing institutional
order.
A commonplace observation in recent years is that Japanese corporate governance has
been strengthened by foreign institutional investors (Mizuno, 2010). An institutional
19

entrepreneur that stands out as the most influential foreign actor is California Public Employees’
Retirement System (CalPERS). In addressing, Keidanren, the peak association for large Japanesecompanies, CalPERS board president William D. Crist reminded his audience that CalPERS
was an investor interested in long-term returns rather than speculation. He provided detailed
criticism of Japanese corporate governance based on the CalPERS programs in the U.S. (Jacoby,2007).
In the beginning, many Japanese companies viewed CalPERS as a foreign blackmailer(Learmount, 2002). CalPERS seemed to have an obvious self-interest and perceived as looking
for short-term advantages. As one can expect (e.g., Hardy & Phillips, 1998), the agency
struggled to achieve discursive legitimacy and receptivity in the country. The attitude, however,changed over time. Subsequently CalPERS’ actions generated intense interest among local
companies. Some Japanese companies sent delegations to the U.S. to meet with CalPERS
officials (Jacoby, 2007). To some extent, entrepreneurial activities of CalPERS and otheractivists have been successful to bring change in the existing institutional order.
Integration into the global economy
Japan’s integration into the global economy has also generated unprecedented pressure to open
for foreign businesses. In the 2008 World Economic Forum in Davos, Switzerland, the former
Japanese Prime Minister Fukuda Yasuo promised that his administration would intensify efforts
to attract foreign investors (Suginohara, 2008).
Regional rivalry
Some activities related to institutional change took place in the context of regional rivalry. For
instance, the EU-South Korea free trade agreement of December 2010 forced Japan to accelerate
FTA negotiations with the EU. South Korea's lead served as a jolt to Japanese policy makers andput pressures on them to close the gap with their challenging competitor (euractiv.com, 2011).
20

Global financial crisis (GFC)
Due to heavy dependence on exports, particularly to the U.S. market, Japan has been affected by
the GFC more than many other economies (Wall, 2010). Slowing export demand, especiallyfrom the U.S. remains a matter of concern for Japan. Japanese are thus forced to realize theimportance of increased domestic consumption. In this way, the GFC has acted as a jolt or an
exogenous shock, which has disrupted the field formed around foreign investment.

6. Discussion and Implications
In this paper, we provided insights into the forces of institutional changes as well as the sourcesof institutional inertia and the problems associated with overcoming them. While formal
institutions such as laws and regulations restrict foreign companies’ market access, informal
institutions are no less restrictive (Bebenroth, Kshetri & Hunerberg, 2012). Although foreign
actors such as CalPERS have had some success in changing Japanese corporate governance,
economic and political factors have limited its influence and permitted the persistence of Japan’s
distinctive governance system (Jacoby, 2007). A critical barrier to foreign firms’ effectiveness inbringing institutional changes is a lack of intangible resources.
Japan’s powerful bureaucracy, big firm capitalism and tight culture have superimposed
onto a unique interaction that has led to vague legal standards in some aspects notwithstanding
its strong rule-of-law tradition. To cite one compelling example, in the Nikko scandal mentioned
above, most of the charges against the company were dropped. It was found that the firm
technically had not broken Japan's securities laws, which were arguably vague(fundinguniverse.com, 2011).
As noted above, some of the Japanese politicians seem to be interested in increasing theircountry’s openness to FDI. One of their obvious goals is also vote maximization. Looking fromthis angle, the government can be viewed as a mediator for various institutional actors (Kshetri,
21

Palvia & Dai, 2011). From the government’s perspective, various institutional actors differ interms of power to affect an outcome. Prior researchers have provided valuable insights into
organizations engagement in decoupling. The exact nature of decoupling is a function of relative
powers of competing organizational interests (Westphal & Zajac, 2001). Clearly, substantial
responses cannot be made to appease actors that oppose diametrically. The substantive response
relates to the actor that is perceived to be more powerful and the symbolic response relates to theactor perceived to possess less power (George, Chattopadhyay, Sitkin, & Barden, 2006). In somecases, symbolic actions constitute measures that just satisfy the minimum expectation of the lesspowerful actor (Kshetri, Palvia & Dai, 2011). The various external and internal stimuli
discussed in Table 3 have led to an increased power of foreign businesses. As discussed above,
foreign businesses are resourceful and acquiring discursive, which is likely to lead to bigger rightto voice (Phillips & Hardy, 1997). Such changes are likely to force the Japanese government totake substantive actions to appease foreign investors.
Informal institutions both reflect as well as determine the nature of the formal institutions(Hayek, 1979). North (1994) observes that informal rules provide legitimacy to formal rules.
Likewise, Axelrod (1997) notes: “Social norms and laws are often mutually supporting. This istrue because social norms can become formalized into laws and because laws provide external
validation of norms” (p. 61). Even if Japanese politicians like to open their market for FDI,
informal institutions such as power and influence of bureaucrats and life time employment areless likely to provide validity to formal rules favoring FDI. Especially, Japanese bureaucracy, by
virtue of its association with past success, still possesses enormous power and influence. On thecontrary, changes in formal institutions related to FDI in Japan are likely to trigger changes in
informal institutions and vice versa.

22

Zucker (1988: 26) draws an analogy from physics to describe institutional changemechanisms. She argues that institutions continuously undergo change due to entropy, thetendency toward disorder or disorganization. An implication of the entropy-like characteristics isthat institutions can be modified and reproduced (Scott, 2001). Understanding the contexts
associated with the effectiveness of a strategy would help devise effective measures to bringprogressive institutional changes. For one thing, to function effectively in Japan, managers needto recognize the power dynamics that frames the relationships among various institutional actors
such as bureaucrats, politicians, big conglomerates, trade associations and foreign investors.
Moreover, various national as well as international social, political, demographic and economic
events and natural catastrophes may affect such dynamics.
In some cases, what some consider as a non-tariff barriers and discriminative practices
against foreign firms are actually equally enforced and applicable to domestic companies. Indeed,
researchers have reported that the “stringent government standards” in some industries havehelped stimulate innovations (Porter & Takeuchi, 1999; p. 70). Likewise, buyer-supplier
networks and alliances (or "keiretsu") also limit the entry of domestic newcomers (Japan Country
Review, 2011). Likewise, Ibison (2005) quotes Junichi Arai, head of M&A at Morgan Stanley,on the widely criticized poison pills: “While in some cases genuine concern about foreign hostilebids has led companies to put poison pills into place, in general they are being used to protect
Japanese companies from domestic acquirers, especially from non-traditional players”.
Just because a strategy is successful in one context does not mean that it would work in adifferent context. Prior research has indicated that successful organization may stick to outdated
strategies because past success has encouraged them to follow the strategies that worked well
(Audia & Locke, 2000). In this regard, experts agree that while Japan’s policy-making process

23dominated by bureaucrats worked well during a growth period, such approach is much lesseffective in the current contexts facing the country (Sieg, 2009). A similar point can be madeabout the consensual nature. Researchers argue that while internal consensus offered various
practical benefits and helped Japanese firms to respond quickly to various challenges during a
growth period, it may have potential negative impacts when they need to identify new directions
for continued growth (Makino & Roehl, 2010; Numagami et al., 2010).
Some sources of resistance to FDI are more economic rather than cultural. Prior research
indicates that if institutionalized norms and practices are serving the interests of certain actors,
they may resist any attempts to bring changes in such norms and practices (Seo & Creed, 2002).
Given the many examples of Japanese companies’ hostile takeover of U.S. firms, analysts argued
that hostile and unsolicited deals were culturally acceptable for Japanese companies (Ibison,2005). The problems started when Japanese companies themselves started becoming targets ofhostile deals, which obviously were against their interests and desires.
6.1. Future research
Clearly, there is much to be learned about the institutional changes undergoing the Japanese
economic system. The above analysis indicates that foreign actors such as CalPERS as well as
domestic actors such as the Democratic Party have taken various initiatives to change institutionsin Japan. In future conceptual and empirical work scholars need to compare and contrast thevarious institutional entrepreneurship related activities associated with domestic and foreign
actors. The domestic and foreign actors may differ in terms of opportunity they would like torealize, their framing of issues and problems, and economic and non-economic resources they
possess and mobilization of various constituencies.
Further inquiry is also needed to investigate the differences in the natures of practices thatJapanese companies imitate and mimic from domestic companies and foreign companies. For
24

instance, it is observed that foreign companies are bringing “cutting edge” corporate governancein Japan. At the same time, Japanese companies are the world leaders in some areas such as total
quality management. In this regard, research would benefit from a comparison of businesspractices that Japanese companies are perceived as world leaders compared to those that nonJapanese companies are perceived as on the cutting edge.
Future research based on the present framework can be extended to other economies in
Asia and elsewhere. For instance, other economies in Asia may differ in terms of powers andorientations of various institutional actors (e.g., the government, bureaucrats, businesses andconsumers) discussed in this paper. They are also likely to differ in the contexts, mechanisms
and processes associated with various forces discussed in this paper.

7. Concluding Comments
Our explanations shed some light into idiosyncratic and unusual features of the Japaneseinstitutions that have led to various real and perceived barriers to the inflows of foreign trade andinvestments. From the Western perspective, one important source of complexity has been theJapanese culture. Some practices that limit competition from foreign firms are acceptable andlegitimate according to the traditional norms.
This paper identified various sources of institutional changes. Important economic andpolitical changes have triggered new views, considerations and strategies with respect to foreign
investments. Various actors representing domestic and foreign firms’ interests are competing for
power and discursive legitimacy. Natural catastrophes and international political events have also
triggered big Jolts for Japanese politicians and forced to take actions to further open the Japanesemarket. In some cases, political changes have also been an important trigger for institutionalchanges. For instance, if nothing else, the DPJ victory prompted the Japanese to critically think25

about the economic models prevalent in the country. Overall, there are ample signs ofinstitutional changes that are likely to affect the Japanese FDI landscape.

26

Table 1: Some milestones that have had an impact on institutions related to foreign
investment inflows in Japan
Time
1993
1994
2001
2003

FY 2004/05
June 2005

December2006
May 2007

Event
CBCC invited CalPERS board president William D.
Crist to visit Tokyo and address the Keidanren d.
The Japanese Commercial Code adopted rules
facilitating share buybacksf.
The Japanese Commercial Code adopted rules
regarding the issuance of stock options.
Japan adopted the “company with committees”
system.

Foreign investment exceeded the country's investment
overseas for the first time in 50 years.
The upper house of parliament backed a law
facilitating a merger with foreign firms, which was
already passed by the lower house a. The 2005
Companies Act expanded the types of possible
corporate structures and M&A transactions available
for corporate consolidation/restructuring.
The Diet approved legislation to relax restrictions onpolitical donations by foreign-owned companies g.
Financial Instruments and Exchange Law wasenacted.

December
2010
March 2011

Explanation
This was arguably a historic event, which
was widely covered by the Japanese media
The rules were further revised in 1997 and1998.
It gives companies the optionof not having statutory auditors if they
have a majority of outside directors on
board committees and if operational
responsibilities are with the board e.
The law allowed a foreign firm to use stock
as consideration in a cross-border M&A
transaction by means of a triangular mergerc.
The old Political Funds Control Law did
not allow companies with more than 50%
shares held by foreign investors to makepolitical contributions.
Restrictions in the use of shares as
payment in triangular merger deals werelifted for foreign firms b.
It was the EU’S first FTA in Asia

An EU-South Korea free trade agreement was
concluded
The Tohoku earthquake, tsunami and nuclear
meltdown.
a
BBC News. 2005; bWallace, 2007; cPolitical Risk Yearbook: Japan Country Report, 2011; dCBCC (1993);geHashimoto (2002); fJacoby (2007); Suginohara (2008)27

Table 2: Japanese and Western views on the status and contexts associated with theopenness of the Japanese
The degree of
openness

Japanese views/perceptions
Japan's foreign ministry spokesperson
Satoru Satoh: "The European market ismuch more protected than the Japanese".
aMotivation offoreigninvestors

Potential
consequences offoreigninvestment

Framing theneed for change(allowing more
FDI)

Referring to foreign funds’ orientation
towards short term-profits, an official of acompany listed in the First Section of theTokyo Stock Exchange whose largest
shareholder was once a foreign
investment fund, was quoted as saying:"Honestly, I don't understand what those
funds are really thinking about or what
they are after" c.
Ex-prime minister Yukio Hatoyama: “Itis no exaggeration to say that the global
economy has damaged traditional
economic activities and destroyed local
communities”.
“How can we put an end to unrestrained
market fundamentalism and financial
capitalism, that are void of morals ormoderation, in order to protect thefinances and livelihoods of our citizens?
That is the issue we are now facing” d.
Hatoyama: “…we must not forget ouridentity as a nation located in Asia. I
believe that the East Asian region, whichis showing increasing vitality, must berecognized as Japan’s basic sphere ofbeing. So we must continue to build
frameworks for stable economic
cooperation and security across theregion” d.
Some Japanese investors’ views: outside
funds tend to pursue short-term profits,
which tends to make collaboration withthem unattractivee.

Western views/perceptions/arguments
EU Trade Commissioner Peter Mandelson: "Asa foreigner looking at Japan from the outsidewhat I see is a globalisation paradox. For
decades Japan has taken advantage of an open
global investment climate. Both it and the hosteconomies have benefitted from that investment.
Yet at home it remains the most closed
investment market in the developed world....
Japan went global long ago, but at home it holds
back from becoming globalised"f.
In addressing, Keidanren, CalPERS board
president William D. Crist reminded his
audience that CalPERS was an investor
interested in long-term returns rather than
speculation b.

Crist stressed “we are not crusaders – we do notwant to make over countries’ corporate
structure” b.

EU Trade Commissioner Peter Mandelson:"Japanese companies have been manufacturingin Europe for decades. Yet until the reform of
the Large Retail Store Law .., a foreigner setting
up retail operations in the Japanese market was
extremely cumbersome”.

The degree of
Foreign investors’ view: foreign funds tend toforeigners’
be disregarded by Japanese management.
involvement
andparticipationaeuractiv.com (2011); bJacoby (2007); cNannichi and Kakuta (2010); dHatoyama (2009); eNannichi and Kakuta(2010); feuropa.eu (2008, p. 1)

28

Table 3: Internal and external sources of institutional changes in Japan

Exogenous shock/Jolts

Gradual changes

Domestic sources Triple Disaster:earthquake, tsunami andnuclear meltdown
 Political changes: DPJ’s
victory Poor economic
performance and existing
institutions’ association
with functional inefficiency
 Unethical and corrupt
practices of local firms
driving changed in theperceptions of foreignfirms

Foreign sources
 GFC
 Korea’s FTA agreement

 Perceived functional efficiency of
foreign institutions and mimetic
isomorphism (e.g., Foreigncompanies bring “cutting edge”
corporate governance)
 Foreign investors and activists’roles as institutional
entrepreneurs
 Japan’s integration with global
economies

Table 4: Benefits of the status quo and institutional changes: The prospective of key
institutional actors in JapanActor
The government

Benefits of the status quo
 Support from big businesses whichhave driven the Japanese economy.

Bureaucrats

 Enjoy power and privilege under thecurrent institutional arrangement.

Big businesses

 Privilege of a shield fromcompetition.

Consumers/public A sense of national
pride.

29

Benefits of institutional changes
 Gain in legitimacy frominternational institutions and foreigncountries.
 Increase in FDI.
 Can win the support and approvalof the government and the public ifthey make genuine efforts informulating policies to attract
foreign investments.
 Increased competition andopportunity to observe foreignbusiness practices would makethem more effective.
 More choices for consumption andemployment.

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Notes:
1

Other estimates put Japan's inward FDI stock by the end of 2009 at $221 billion (Global Times 2011).

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