Self-fulfilling Distortion and Ownership Structure
At the Dawn of the Japanese Capitalism*
ISS Discussion Paper Series
F–181
September 2016
This version: September 2017
Masaki Nakabayashi†
Institute of Social Science
The University of Tokyo

Abstract
Does the ownership structure affect performance? We first theoretically show that in
an inefficient market, investors motivate managers to pursue a higher return on equity,
the short-term performance indicator instead of a higher return on asset, the long-term
indicator and encourage managers to distort the financial leverage. This self-fulfilling
distortion implies that, in an inefficient market, a greater concentration of ownership improves long-term performance through containing the distortion. To test the prediction,
we build a new data set of Japanese firms from 1878 to 1910. Then, we show that theJapanese market then was inefficient, that the bond flotation was distorted among low andmediocre performing firms, and that a greater concentration of ownership at the president
improved the return on asset. These results are consistent with the tendency in contemporary non-Anglo-American advanced economies. A greater concentration of ownershipoffsets the adverse effects of a less efficient capital market.
Keywords: multitask moral hazard; ownership structure; financial leverage; self-fulfilling
distortion; skewness adjusted variation coefficient.
JEL: G32; O16; K22.
* The author is thankful to Mayo Morimoto for support to build the data set for this research and is gratefulto William Megginson and Kentaro Asai for their suggestions. He also appreciates the participants in the special
session on “Issues in Issues in Corporate Finance” of the International Finance and Banking Society 2017 Oxford
Conference and the Southwestern Finance Association Annual Conference 2017 for their helpful comments. This
research was funded by the JSPS Grant-In-Aid KAKENHI JP17K18558 and The Japan Securities ScholarshipFoundation.
†
Corresponding address: Institute of Social Science, The University of Tokyo, Hongo 7–3–1, Tokyo 103–
0033, Japan. E-mail: mn@iss.u-tokyo.ac.jp

1

Introduction

Does the ownership structure affect firms’ performance? If the ownership structure matters,
under what conditions does it? The residual rights of control and residual claims have been
defined as the rights of shareholders in the modern corporate law for a long time. The idea
behind this legal structure is that with the residual control right over the object attached to
the residual claimant, she/he would exert the residual control right to maximize the residual,
which would, in turn, contribute to the improvement of resource allocation (Grossman andHart (1986)).
As long as the shareholders, the residual claimants, directly perform the residual control
right, the prospect surely holds. However, once a firm is established as a joint stock company,
its shares are widely held, and its management is delegated to somebody else than dominant
shareholders, good management is not secured anymore. The portion owned by a specificindividual might be too small to monitor the management strictly, or diversified investment
might even reduce shareholders’ incentives of monitoring (Smith (1937[1776]), pp. 699–700).
Sharing the view with Smith (1937[1776]), Jensen and Meckling (1976) argued that adecrease in the stock holding ratio of the founding manager intrinsically increase the efficiency
loss due to the moral hazard.
A remedy to mitigate the possible moral hazard is an active secondary market for corporateshares (Holmstrom and Tirole (1993)). The threat of acquisition and replacement of managers
is expected to discipline the current managers, as argued since Jensen and Meckling (1976)
and Fama (1980).
A question regarding the view is capsulated as whether the ownership structure matter forthe corporate governance. The question has been a focal point of discussion on corporate governance and corporate finance. Demsetz and Lehn (1985) rejected a possibility of relations
between the ownership concentration and performance for the major US listed firms, whowere later supported by Himmelberg, Hubbard and Palia (1999) and Demsetz and Villalonga1

(2001). Regarding the founding manager’s ownership, Anderson and Reeb (2003) did not findany evidence for exploitation of minority shareholders by founding owner-managers, using
the US data. Morck, Shleifer and Vishny (1988) using the US data found weak evidence thatparticipation by founding family in the board might deteriorate performance. Davies, Hillier
and McClogan (2005) using the British data also found a nonlinear relationship between theownership structure and performance. However, such effects are, at greatest, co-deterministic
as argued by Davies et al. (2005), instead of the dominant impact of the ownership structure.
Helwege, Pirinsky and Stulz (2007) dynamically described the evolution of listed firms, using
1970–2001 initial public offering data in the US, finding that the better performers have become faster and more widely held after being listed and that agency costs do not significantly
affect the evolution of the ownership structure.
As Shleifer and Vishny (1986), Bolton and Scharfstein (1996), Mahrt-Smith (2005), Gorton and Kahl (2008), Aslan and Kumar (2012), Dhillon and Rossetto (2015), and many othertheoretical works argue, there do exist diversity of ownership structure among the US firms,
and there must be a rationale of the diversity. Empirical results for the irrelevance of ownership structure do not contradict with those theoretical predictions. A point is how efficientthe market is. If the market is sufficiently efficient, any distortion is quickly arbitraged bymarket participants either by selling or buying shares. Then, on the equilibrium paths, we see
multiple types of ownership structure but do not find any statistical difference in performance
among them. Indeed, using the US data, Gambola and Marciukaityte (2013) showed that theleverage is a choice under managerial discretion, and Ağca, Şenay and Mansi (2008) showedthat with vast holding ratio of outside shareholders, managerial ownership rather increases
financial leverage. Jiraporn and Gleason (2007) showed that leverage tends to be greater ifshareholder rights are more restricted, using the US data. Furthermore, estimates by Ang,
Cole and Lin (2000) showed that agency costs depend on ownership and management structure. Meanwhile, Francis, Hasan, Koetter and Wu (2012) showed that interest rates of bankloans price in the expected behavior of the board, using the US data.
2

Thus, in the US, there does exist strategic behavior by owner-managers, which could potentially distort the financial leverage. However, it appears that the US market is so sufficientthat any possible distortion has been arbitraged and priced in, or effectively reined in by thebanking sector’s quick financial arrangements, and hence has left no statistically significant
variance of performance. This inference isconsistent with the observed high performance of
the US managers (Maloney and Sarrias (2017)).
Meanwhile, using the European data, Laeven and Levine (2008) showed that multiple
block holders help prevent managers from exploiting small shareholders, which indicates thatthe ownership structure matters for performance. Ben-Nasr, Boubaker and Rouatbi (2015)
demonstrated, using the French data, that the ownership structure does affect the financial
leverage, that is, the greater divide between ownership and management is prone to a longer
maturity of debt, while the presence of multiple block holders curbs such distortion. Although
Julian and Mayer (2001) denies the effect of the ownership structure on performance using
the German data, it does not reject the hypothesis by Laeven and Levine (2008), provided thatblock holders often control major German firms and that the banking sector dominates theGerman corporate finance.
Meanwhile, Driffield, Mahambare and Pal (2007) found that in East Asia excluding China
and Japan, manager-owned firms better weathered the financial crisis in the late 1990s. Abdallah and Ismail (2017) showed that a smaller concentration of ownership should be accompanied by a better governance to beat the same performance, using the data from the Gulf
Cooperative Council region. Furthermore, Lin, Ma, Malatesta and Xuan (2013) built a data set
from 20 non-US advanced economies. Focusing on a gap between the control and cash-flow
rights of controlling managers (Edwards and Weichenrieder (2009)), they found a possibilityof the leverage distortion through over-reliance on the bond flotation, when a greater concentration of ownership implies a greater difference between the control and cash-flow rights ofcontrolling managers.
In short, weakly monitored managers are suspected to leverage greater than optimal in3

non-US markets. The bond market is more likely to be distorted because the risk of moral
hazard is better priced in by the banking sector, as shown by Lin, Ma, Malatesta and Xuan
(2011a), or the banking sector actively forms arrangements to curb moral hazard, as shown by
Lin, Ma, Malatesta and Xuan (2012). San Martı́n and Saona (2017) reported a similar casein Chile where with pyramidical ownership structure the concentration of ownership tends
to raise the leverage. Thus, the ownership structure does affect performance, likely throughpossible distortions in the bond flotation in non-US economies. These recent works supported
prediction by Dyck and Zingales (2004), which argued that less developed judicial system andthe financial media allow a greater private interest of block holders. By the same token, theprivate benefit of block holders might be an unavoidable social cost to make up a less efficient
market.
These results contrasting between in the Anglo-American and non-Anglo-American cases
indicate that as Jensen and Meckling (1976) and Fama (1980) inferred, the well-functioning
stock market of the US level could offset possible negative effects of the diffusion and dilutionof ownership. Then, a ramifying question arises. What happens along with own development
paths in the other markets around the globe that are less efficient than their US counterpart, as
implicitly addressed by Lin et al. (2011a, 2012, 2013), Ben-Nasr et al. (2015), Abdallah andIsmail (2017) and other recent works.
Japanese experience particularly in the period when the “separation of ownership and management” regarding Berle and Means (1933) and Chandler (1977) went under way, would be a
promising case. It transformed itself from the samurai’s nation to a modern capitalist economy
without sharing most of the historical background with the West, as many emerging economies
neither. After toppling the Shogunate in 1868, the new imperial government of Japan began its
effort for modernization. In 1878, the Tokyo Stock Exchange and the Osaka Stock Exchange
were established. Furthermore, the Commercial Code of 1899 explicitly stipulated legal requirements for a joint stock company and standardized the form of financial statements, which
made more information publicly available and prompted a further expansion of the stock and4bond markets after that.
From the late nineteenth century, the Japanese corporate finance and governance experienced two distinctive phases. The first one was the entrepreneurial boom from the mid-1880s.
The cotton-spinning, railway, and other modern industries raised large initial costs by taking
the form of joint stock companies and issuing corporate shares while relying on the banking
sector for debts. The second phase was a reduction in the bank loan reliance and an increasein the bond flotation from the late 1890s (Hoshi and Kashyap (2001), pp. 15–50). From thesecond phase, senior employees began to climb to management positions and be promoted toa board member from the late 1890s. Functional diversification of the board toward professional management meant that possibility of moral hazard by the management then faced theJapanese corporate sector.
This development suggests an opportunity to understand the interactions between variationin the ownership and management structure, the financial leverage, and the performance as an
outcome. Therefore, we retrace the changes experienced by the Japanese corporate sector,
focusing on the ownership structure, the financial leverage, the performance, and the market
valuation on them. To do this, we construct an original panel data set of all firms listed on
the Tokyo Stock Exchange from 1878 to 1910, by hand-collecting information published infinancial statements. Japan in the late nineteenth century was one of the early cases of nonAnglo-American nations that succeeded in nurturing a well-functioning capital market.
Study on experiences of advanced nations in the nineteenth and early twentieth centuries
also provide us with contemporary policy implications. Most regulations on the financial markets, which had been interventionist particularly until the 1980s, were introduced as a responseto the collapse of the financial markets followed by the Great Depression in the 1930s. Amid
the Great Depression, the great failure of the market, advanced nations tightened regulations
on the corporate finance, reckoning serious distortion of the market due to asymmetric information. An example was what the US typically went through such as enactments of the
Securities Act of 1933 and Securities Exchange Act of 1934, which created the Securities
5and Exchange Commission, and the Generally Accepted Accounting Principles formed in the
1930s. Among advanced nations, regulations in Japan and Germany were particularly stringently tightened, and there the banking sector replaced the stock and bond markets as theprimary source of corporate finance.
A half century later, responding to the development of information and communication
technologies, advanced nations commenced structural reforms to revitalize the financial sector in the 1980s. In the reform efforts, a cornerstone has been deregulation of the stock market.
In advanced nations, not least Japan and Germany, deregulations of the stock market and enhancement of direct finance mean recovery of the pre-regulated stock market in the pre-Great
Depression time. Sharing the motivation, quantitative evaluations of that period have been presented by Borg, O. and Leeth (1989), Leeth and Borg (1994, 2000), and Banerjee and Eckard(2001) on the US, Franks, Mayer and Wagner (2006) and Kling (2006) on Germany, Hamano,
Hoshi and Okazaki (2009) on Japan. Also, international cross-section overviews have beensuggested as a reference for regulatory alternatives, such as La Porta, Lopez-de Silanes andShleifer (2008). However, one of the most basic questions is not addressed; whether the market discipline worked or the ownership structure complemented a potentially imperfect market
under lighter regulations.
Thus, most nations have implemented structural reforms to recover vibrant stock markets
without being conscious about how much own market worked under lighter regulations, towhat extent it was distorted due to asymmetric information, and to what extent the ownership
structure complemented the potentially imperfect market in the pre-Great Depression period.
It is almost a navigation to be back home without an own chart. Without the own chart, inpractice, many nations simply have followed the US precedents for deregulation. This researchattempts to place a building block for understanding the origin of the Japanese capital market
with preceding works on pre-regulated markets from a long-sighted perspective. Reflection ofJapan’s experiences of changes in the ownership structure more than one century ago would
still bring out meaningful lessons to Japan’s ongoing structural reforms and other economies
6also running reforms.
The rest of the paper is organized as follows. Section 2 presents a simple model to captureself-fulfilling distortion of the financial leverage to manipulate the return on equity under the“separation of ownership and management,” and deducts a few hypotheses to be empiricallytested. Then it introduces the data set we build. Section 3 examines whether the ownership
structure affected performance, and how the market predicted the performance of firms. We
also test whether enactment of the Commercial Code of 1899 affected the impact of the ownership structure on performance. Section 4 focuses on the financial leverage as a possible
channel of governance distortion. Section 5 wraps up the results and discusses them.

2

Model and data

2.1

Model of self-fulfilling leverage distortion

Our focus is partly in line with that of Lin et al. (2011a, 2012, 2013), paying attention topossible distortion of the financial leverage. However, in this period, a greater concentrationof ownership simply implied the lion’s share against the total share and hence it did not imply
a greater difference between the control rights and cash-flow rights of controlling managers(Edwards and Weichenrieder (2009)). Instead, suitable would be a more naive and classicalinference of Israel (1992) that “more efficient managers use less debt” and that “firms withsupermajority rules issue less debt.”
Motivated by such a view, we obtain a prediction applying the multitask principal agent
model by Holmstrom and Milgrom (1991) to the context of the self-fulfilling undesirable equilibrium in the imperfect market (Diamond and Dybvig (1983); Goldstein and Pauzner (2004);
and Kunieda and Shibata (2016)). Assume that there are two-dimensional tasks for a manager;
the first dimension, t1 is to increase the return on equity (ROE) and the second dimension, t2
is to increase the return on asset (ROA). We standardize human resource endowment of the7manager as 1 such that t1 + t2 = 1. Let C denote the personal cost to be incurred by the man2
> 0 where C11 ≡ ∂ 2 C/∂t21 ,ager. We assume that C is strictly convex such that C11 C22 − C12

C22 ≡ ∂ 2 C/∂t22 , and C12 ≡ ∂ 2 /∂t1 ∂t2 . Provided that the cost of efforts to increase the returnon equity and the return on asset should be equivalent, we also assume that C11 = C22 , underwhich strict convexity assumption implies C11 = C22 > C12 . Note that we do not exclude alikely possibility that both efforts are complements such that C12 < 0.
Let B1 and B2 denote the marginal contribution of effort in each dimension such that
B1 ≡ ∂ROE/∂t1 and B1 ≡ ∂ROA/∂t2 . For simplicity, we assume that marginal contributionof the first best efforts for both ROA and ROE are equivalent and are standardized such that
B1 = B2 = 1. The following theoretical predictions are held also when allowing B1 6= B2 .
Given the random shock in the market, we assume that ROE and ROA are realized as(1)

ROE = t1 + 1 ,

and

(2)

ROA = t2 + 2 ,where 1 ∼ N (0, σ12 ), 2 ∼ N (0, σ22 ), and 1 2 ≡ σ12 .
For simplicity, we assume a full “separation of ownership and management” where themanager does not own shares. Here we assume that the manager is risk-averse such that
her/his utility function is approximated as(3)

u (w − C) = − exp [−r (w − C)] ,8

where w is remuneration and r is the constant absolute risk-averse coefficient. Often managers are encouraged to be risk-tolerant in an armchair theory. However, as many empirical works have shown or criticized, managerial compensations in contemporary US firms
are largely designed to reduce the risk imposed on managers (Blanchard, Lopez-de Silanes
and Shleifer (1994); Murphy (1990); Kraft and Niederpr´’um (1999) and Bertrand and Mullainathan (2001)). The most persuasive explanation is that managers are risk-averse as humanbeings (Murphy (2002)).
For simplicity to analyze the model, we temporarily assume that E [ROE] = E [ROA].
Then, in a perfect market under symmetric information, any distortion of the financial leverage is impossible and hence σ12 = σ22 and σ12 = 1, because random shock arises only inthe current profit, the common numerator. However, in an imperfect market, managers canmechanically stabilize and/or increase the return on equity by manipulating leverage, withholding the information about the manipulation. If the return on equity is used as an indicator
to evaluate managers in this inefficient market, then risk-averse managers would distort the
distribution of the manipulable return on equity such that σ12 < σ22 and σ12 < 1. Anotherlikely distortion in this inefficient market is to skew to the right the distribution of indicatorby which the market evaluates them. Thus, suppose that the market evaluates managers by the
return on equity as well as the return on asset that is not manipulable by the financial leverageand that the market is inefficient. Then managers would distort the distribution of the return on
equity such that its variance should be smaller, its skewness should be greater, and its expectedvalue should be greater than those of the return on asset.
Note that for shares to be actively traded and for sufficient liquidity to be maintained, there
need to participate in the market the sufficient number of “uninformed” investors who know
only publicly available information (Kyle (1985); Admati and R. (1988); and Collin-Dufresne
and Fos (2016)). Otherwise, no trade would be an equilibrium (Milgrom and Stokey (1982)),
because “informed” investors who know the manipulation of the leverage can arbitrage only if“uninformed” investors actively trade. Then, if investment by the “informed”is not sufficiently
9competitive, a market with active trades is inevitably left distorted.
For this moment, for analytical simplicity, we proceed with holding the assumption that
E [ROE] = E [ROA], 1 ∼ N (0, σ12 ), and 2 ∼ N (0, σ22 ). Relying on the monitoring power ofthe liquid market (Holmstrom and Tirole (1993)), in order to motivate risk-averse managers,
their compensations are designed to reflect stock prices, either directly by stock options or
indirectly by bonuses. For simplicity, we standardize the compensation schedule as

w = α + STP = α + β1 ROE + β2 ROA = α + β1 (t1 + 1 ) + β2 (t2 + 2 ),(4)

where STP is the firm’s stock price, and α is the minimum transfer that satisfies the individual
rationality constraint.
Since
E [u (w − C)]
 

V [w]
= − exp −r E [w] − C − r2 β T ΣβT= − exp −r β t − C(t) − r
,
2
where





 t1 
t=
,
t2





 β1 
β=
,
β2



Σ=


σ12
σ12

σ12 
,
σ22

the manager chooses t, given the remuneration schedule β, such that(5)t = arg max β T t − C(t) − rt10

β T Σβ,2whose first order condition is

βT =

(6)

∂C(t)
.
∂t

Then, shareholder j of n total shareholders maximizes the total surplus multiplied by own
share with subject to equation (6), the incentive compatibility constraint such that,
max sj(7)
β T ΣβB(t) − C(t) − r,2

where sj denotes sock holding ratio of shareholder j, and

Pj=n

j=1 sj = 1.

The first order condition of (7) gives the optimal vector of incentive weights,

β∗ =

(8)

∂B
[I + rΣ∇C(t)]−1 ,∂twhere I is unit matrix and ∇C(t) is Hessian matrix of C(t). Therefore, under the assumptions
B1 = B2 = 1 and C11 = C22 , we have optimal incentive vector β ∗ as follows.
1 + r (σ22 − σ12 ) (C11 − C12 ),2
2
2
1 + r [(σ12 + σ22 ) C11 + 2σ12 C12 ] + r2 (σ12 σ22 − σ12) (C11− C12)
1 + r (σ12 − σ12 ) (C11 − C12 )
∗
β2 =
.
2
2
2
1 + r [(σ12 + σ22 ) C11 + 2σ12 C12 ] + r2 (σ12 σ22 − σ12) (C11
− C12
)

β1∗ =
(9)

We immediately have the following lemma.
Lemma 1. Self-fulfilling distortion:(i) In an efficient market, the incentive is not distorted.
(ii) In an inefficient market, the incentive is distorted toward an overemphasis on the returnon equity.
(iii) Distortion is increasing in the degree of inefficiency of the market.
11

Proof.

(i) In an efficient market, σ12 = σ22 . This implies β1 = β2 that is the first best,

provided that B1 = B2 .
(ii) In an inefficient market, σ12 < σ22 due to the manipulated financial leverage. This implies
β1∗ > β2∗ , which deviates from the first best incentive under B1 = B2 .
(iii) The more inefficient is the market, the smaller is σ12 . Furthermore,
r2 (σ22 − σ12 ) (C11 − C12 )2∂ (β1 /β2 )=2 > 0,∂σ12[(rσ12 − rσ12 ) (C11 − C12 ) + 1]
in an inefficient market where σ12 < σ22 .

Specifically, if the managers’ distortion successfully reduces the risk of the return on equity
with which they are burdened and skews the distribution of the return on equity to the right in
an inefficient market, then σ1 /E [ROE] < σ2 /E [ROA] and γ1 > γ2 , where σ1 and σ2 are stan
dard deviation and γ1 ≡ E (ROE − E [ROE])3 /σ13 and γ2 ≡ E (ROA − E [ROA])3 /σ23
are skewness of ROE and ROA respectively. Then our statement is described by variances
standardized by the mean and the third-order central moment, or equivalently, by the skewness
adjusted variation coefficients, instead of raw variances; if the market is perfectly efficient,
then
σ12
σ12
=
× 
E [ROE] E (ROE − E [ROE])3(10)

σ1 /E [ROE]σ2 /E [ROA]
=
γ1
γ2
2
σ2
σ22
;
× 
=
E [ROA] E (ROA − E [ROA])3

moreover, if the market is inefficient, then(11)

σ1 /E [ROE]σ2 /E [ROA]
<
.
γ1
γ2
12

Investors can be aware that the variance of the return on equity is smaller than that of
the return on asset by a cross-sectional comparison and hence can infer that some managers
might have distorted the financial leverage to mechanically smooth and/or increase the returnon equity. However, given own small share, individual investors do not have incentives toinvestigate what a specific firm is doing, and because of it, they rely on the market price toknow firms’ performance and to monitor firms. Evoked is a free-riding problem of investors inmonitoring firms, as predicted by Smith (1937[1776]). The resulting distorted financial leverage implies that the variance of the return on asset is greater than that of the return on equity.
Provided that, to save risk premium to be paid to risk-averse managers, investors increase theweight on the return on equity, which indeed induces overemphasis on the return on equity
by managers, and distortion of the financial leverage mechanically attains an increase in the
return on equity. The risk-averseness of managers in an inefficient market where managers canwithhold information about their manipulation of the financial leverage implies that a distortion by the financial leverage is rather encouraged by the investors and arises in a self-fulfillingway. Although each investor reckons that emphasis on the short-term return on equity would
distort the leverage and reduce the value of the firm in the long term, everybody is free riding
on one another and does not cease myopic emphasis on the return on equity.
A way to almost remove the distortion is to have a dominant shareholder who holds own
share in the long term. The negative effects on longer-term profitability of a distorted leverage intended to mechanically smooth and/or increase the return on equity become discernible
only a few terms later when facing repayment of more than optimal debt. If an uninformed
shareholder pursues short-term transactions, she/he would believe that she/he can successfully
sell at a profit to another uninformed investor before the distortion is finally revealed, rather
than make costly efforts to curb the distortion. Short-sighted investment by an uninformed
investor pursuing a higher return on equity is an individually optimal response to one another,and hence a stable equilibrium strategy. Only if a dominant shareholder holds shares to explicitly seek long-term growth of the share price rather than a short-term uptick by the current
13return on equity, she/he will help improve efficiency. However, the return on a commitment
to long-term hold can be strictly greater only if she/he recognizes the short-term divergence
between the share price and the fundamentals unknown to other market participants, which
by definition means that she/he is an informed investor. The best position to be informed is
to be on the board. If she/he manages the firm, she/he would better know the fundamentals
of own business than outsiders. Then the agency problem would be reduced by the degree ofthe concentration of ownership at the manager because both of having a greater claim and ofbeing better informed.
In the case of real firms, since expected leverages are positive, we standardize varianceby variation coefficients with adjustment of skewness as in equations (10) and (11). Then,
paraphrasing Lemma 1 and its implications discussed above, our hypotheses to be empiricallytested are as follows.
H1 In an inefficient market where the skewness adjusted variation coefficient of the returnon equity is smaller than that of the return on asset, the stock prices are more responsive
to and better predict the return on equity than the return on asset.
H2 In an inefficient market, a greater concentration of ownership at the president implies asmaller distortion of the financial leverage.
H3 In an inefficient market, a greater concentration of ownership at the president implies abetter performance measured by the return on asset.

2.2

Structure of ownership

As Berle and Means (1933) and Chandler (1977) observed in US cases and Foreman-Peck and
Hannah (2013) in the British cases, also in Japan, case studies such as Yui (1979, 1989, 1992),
Miyamoto and Abe (1999), and Nakamura (2007) described prevailed promotion of senior
employees and hiring of independent business men as “professional managers” among leading
14

companies from the 1890s to the 1900s. Furthermore, Miwa and Ramseyer (2002) showed thatthe “prominent” managers’ participation in the board positively contributed to the performanceof the firm in the early twentieth century. These studies, however, did not deal with possible
implications of the changes in the structure of ownership within the board. To discriminate
the ownership structure, we introduce two simple measures. The first is the stock holding ratioof the president, and the second is the product of the stock holding ratio of the president, andthat of the board member whose stock holding ratio is the smallest within the board. The firstmeasure is expected to capture the effect of moral hazard that a decrease in stock holding ratioof the founding manager would compound. In other words, the performance of a case firmis expected to increase in this measure (H2 and H3). The second measure is to examine how
the degree of consolidation of ownership within management affects performance. When the
structure of the board is closer to the representatives of shareholders as originally presumed,
the value of the second measure is greater. Meanwhile, if an employee is promoted to a board
member, the value of the second measure is expected to become smaller. The measure is toevaluate how the deviation from the original form of the board and the promotion of employees
to board member could affect performance (H2 and H3).
In the entire Tokyo market, while shares were widely owned by small shareholders, ownership concentration was considerable in particular for institutions like banks. In total, the top
1 percent strong largest shareholders owned 53 percent of shares of listed firms as of 1897
(Table 1)

INSERT Table 1 HERE
Source Teranishi and Yuki (2017), p.142.

15

2.3

Data

Our sample covers all 95 firms (i) that were listed on the Tokyo Stock Exchange from the firsthalf of 1878 to the second half of 1910 (t). The financial statements of the firms are available in the Business Archives of the Japan Digital Archives Center delivered by MaruzenYushodo.1 Note that firms predominantly owned by conglomerates such as Mitsubishi and
Mitsui were not listed. Possible distortion due to the heavy protection of the conglomerates
by the government is irrelevant to our data set. We hand-collected information of financial
statements and the stock holding to build a panel data set of the 95 firms. Financial statevariables we use are sales (SALi,t ), total assets (TASi,t ), paid-in stock (STKi,t ),2 borrowing (BORi,t ), outstanding bond (BNDi,t ), profit in the current term (PRFi,t ), total dividend(DVDi,t )3 , and balance brought forward (BBFi,t ) for firm i in term t. Discrepancies of thetotal observation numbers come from not yet standardized financial statements, particularly
before the enactment of the Commercial Code of 1899. As measures of the ownership structure, we calculate the stock holding ratio of the president (SCEOi,t ), the stock holding ratio of
the board member whose ratio is the smallest among the board members (SMINi,t ), and theirproduct (CNSLi,t ≡ SCEOi,t × SMINi,t ) for firm i in term t. Regarding the share prices, weuse average prices STPi,t for firm i in term t published in Tokyo Stock Exchange (1928).4 The
number of observations is fewer than that of financial states because over-the-counter trades
off the exchange were active. To control for the financial market conditions when estimating
determinants of borrowing and bond flotation, we use average bank interest rates in the prefecture of Tokyo surveyed by the Bank of Japan.5 The series of interest rates is available only1

https://j-dac.jp/top/eng/index.html Last accessed: September 12, 2016.
The Japanese Commercial Code then, as its counterparts in the West, required a joint stock company tospecify the face value of its share and permitted partial payment at subscription and hence there existed two
kinds of “capital” as legal terms; the capital stock registered, which was the total sum of face value of issued
shares, and the paid-in capital, which was the amount really invested. Thus, the paid-in stock is the capital in an
ordinary sense.
3
The sum of ordinary dividend and special dividend in the term.
4
Tokyo Stock Exchange (1928), ”Sho tokei (Statistics),” pp. 125–261.
5
Historical Statistics: Institute for Monetary and Economic Studies, Bank of Japan (http://www.imes.
boj.or.jp/hstat/: Last accessed on September 18, 2016).
2

16

from the second half of 1886. Descriptive statistics are shown in Table 2.
INSERT Table 2 HERE
Source See the text.
Notes: All values are nominal terms.

As estimation method, we use cross-section fixed effects model to control for variables
that were invariant during the sample period, such as the long-established routines, historical legacy, corporate culture, corporate philosophy, and other constant factors. Then we canidentify the effect of changes in the ownership structure on financial leverage and the performance. When using cross-section fixed effects model, we need to control for exogenous,
and often cyclical, shocks. As such control variable, we use the growth in real gross national
product (∆GNPt ≡ GNPt − GNPt−1 ).6

3Structure of ownership and efficiency of market

3.1

Responsiveness and prediction power of the market

We first evaluate whether the Japanese market from 1878 to 1910 was distorted due to themarket inefficiency by our standard. The skewness adjusted variation coefficient of the returnon equity (ROEi,t ≡ PRFi,t / (STKi,t + BBFi,t )), which is standard deviation divided by themean and the skewness, is calculated as 0.8355 and that of the return on asset (ROAi,t ≡PRFi,t /TASI,t ) is as 1.2643 from Table 1. The measure of the return on equity (ROEi,t )becomes smaller as managers mechanically smooth or raise the return on equity or make itriskier by distorting the leverage. The measure of the return on equity is substantially smaller
6
The GNP series from 1877 to 1884 is from Teranishi (1983), p. 181 and those from 1885 to 1910 are from
Ohkawa, Takamatsu and Yamamoto (1974), p. 225. The GNP series in those sources are the annual basis, andhence we produced bi-annual series by linear supplements.

17

than that of the return on asset. The greater measure of the return on equity means that theTokyo market then was substantially inefficient to prompt managers to distort the leverage, inthe sense of our hypothesis H1 on the difference in the skewness adjusted variation coefficients(Equation (11)) and the market inefficiency. This result is consistent with that of Hamano etal. (2009) who pointed out the low market liquidity from 1878 to 1910.
Then to test hypothesis H1 on the market responsiveness to the return on equity and thereturn on asset, we first simply regress the growth in the stock price (∆ log (STPi,t )) on thegrowth in the return on equity (∆ROAi,t ) and the growth in the return on asset (∆ROAi,t ) inline with (4), with the growth in real gross national product (∆GNPt ) to control for cyclicalshocks common to all cross sections as follows.

(12)∆ log (STPi,t ) = β0 + β1 ∆ROEi,t + β2 ∆ROAi,t + β3 ∆GNPt + µi + i,t ,where µi is dummy variable for firm i and i,t is error term.
Specification 2–1 in Table 2 shows that investors rewarded only the growth in the returnon equity (∆ROEi,t ). The return on equity (ROEi,t ) and the return on asset (ROAi,t ) share thecommon numerator, profit in the current term (PRFi,t ). Thus, the result of equation (12) might
be unstable unless the market was perfectly inefficient in our framework such that σ12 = 0.
Therefore, we next regress separately the growth in stock prices (∆ log (STPi,t )) on the growthin the return on equity (∆ROEi,t ), growth in the return on asset (∆ROAi,t ), and growth in the
return on sales (∆ROSi,t ≡ ∆ (PRFi,t /SALi,t )). Here we also control for the growth in the
total dividend over the total asset (∆ [TODi,t /TASi,t ]). If the market is sufficiently efficientthat payout did not reveal additional information that has been privately withheld by the firm,
this term is expected to have a significantly negative coefficient to keep the shareholders’ value
at constant as predicted by Miller and Modigliani (1961). If the growth in dividend reveals
additional information to predict an increase in future cash flow, the term is expected to have18

a significantly positive coefficient, as predicted by Sasson and Huffman (1986). Our estimate
specifications thus are

(13)

(14)




TODi,t+ β3 ∆GNPt + µi + i,t ,TASi,tTODi,t+ β3 ∆GNPt + µi + i,t ,TASi,tTODi,t+ β3 ∆GNPt + µi + i,t .
TASi,t∆ log (STPi,t ) = β0 + β1 ∆ROEi,t + β2

∆ log (STPi,t ) = β0 + β1 ∆ROAi,t + β2

and

(15)

∆ log (STPi,t ) = β0 + β1 ∆ROAi,t + β2

Despite the limitation of sample numbers due to a smaller number of formal transactions
within the exchange and a greater number of off-exchange trades then, we again find that thestock prices responded only to the return on equity, to neither the return on asset nor the returnon sales. The market was not sufficiently efficient to respond to the return on asset, the longhaul predictor of the asset usage efficiency and profitability, or the return sales, a measure of
the operational efficiency. Significantly positive coefficients of the dividend payout ratio in
all specifications 3–2, 3–3, and 3–4 indicate that payouts provided investors with additional
information to predict an increase in future cash flow, which is consistent with our overall
evaluation of the market inefficiency. Our hypothesis H1 on the short-sighted emphasis by an
inefficient market on the return on equity is supported.

INSERT Table 3 HERE

19

Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.

To check the other side of the same coin, we estimate how the market predicted future
profitability, by regressing the return on equity (ROEi,t ) and that on asset (ROAi,t ) on thechanges in the past stock prices (∆ log (STPi,t−k ) , k = 1, 2, 3),

ROEi,t = β0 +β1 ∆ log (STPi,t−1 ) + β2 ∆ log (STPi,t−2 ) + β3 ∆ log (STPi,t−3 )+β4 ∆GNPt + µi + i,t ,(16)
ROAi,t = β0 +β1 ∆ log (STPi,t−1 ) + β2 ∆ log (STPi,t−2 ) + β3 ∆ log (STPi,t−3 )+β4 ∆GNPt + µi + i,t .
The results in Table 4 again provide a clear finding that the stock prices predicted only the
return on equity half or one year later and never predicted the return on asset.

INSERT Table 4 HERE
Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.

The market failed to predict the return on asset and priced in and predicted only the returnon equity. Again, our hypothesis H1 on the short-sighted emphasis by an inefficient market
on the return on equity is supported.

20

3.2

Ownership structure and performance

We second analyze possible relations between the ownership structure and performance. We
regress the return on equity (ROEi,t ), the return on asset (ROAi,t ), which captures efficiency
in using firm’s total asset, and the return on sales (ROSi,t ), which measures how large themargin is and/or how operational costs are saved, on two measures of the ownership structure:1) the stock holding ratio of the president, SCEOi,t , and 2) the measure of the ownershipconsolidation within the board characterized as CNSLi,t = SCEOi,t ×SMINi,t , where SMINi,tdenotes the stock holding ratio of the board member whose stock holding ratio is the smallest
among the board members. The first measure directly captures how much controllable thefirm is by the president, often the founding owner-manager in the period. The second measurecaptures whether the board functions as the consolidated representative of shareholders. If theownership structure was diffused or employees were promoted as board members, then themeasure is expected to decrease. A decrease in CNSLi,t implies that the board becomes lessrepresentative of shareholders and hence that the board might more likely deviate from the
maximization of the shareholders’ value. We also insert the sales (SALi,t ) as a regressor tocontrol for cyclical but heterogeneous changes in business volumes.
Thus, for the return on equity (ROEi,t ), we run
ROEi,t = β0 + β1 SCEOi,t + β2 SALi,t + β3 ∆GNPt + µi + i,t ,(17)
ROEi,t = β0 + β1 CNSLi, t + β2 SALi,t + β3 ∆GNPt + µi + i,t ,for the return on asset (ROAi,t ),ROAi,t = β0 + β1 SCEOi,t + β2 SALi,t + β3 ∆GNPt + µi + i,t ,(18)
ROAi,t = β0 + β1 CNSLi,t + β2 SALi,t + β3 ∆GNPt + µi + i,t ,21and for the return on sales (ROSi,t ), dropping the sales from regressors,
ROSi,t = β0 + β1 SCEOi,t + β2 ∆GNPt + µi + i,t ,(19)
ROSi,t = β0 + β1 CNSLi,t + β2 ∆GNPt + µi + i,t .
The results are in Table 5. We find that the ownership concentration at the president(SCEOi,t ) did not significantly improve the return on equity (ROEi,t , specification 5–1), but
strongly improved the return on asset (ROAi,t , specification 5–3) and the return on sales(ROSi,t , specification 5–5). Furthermore, a greater consolidation of ownership within theboard (CNSLi,t ) improved all of the returns on equity, asset, and sales (specifications 5–2,
5–4, and 5–6).

INSERT Table 5 HERE
Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.

Thus, we can conclude that the greater concentration of ownership at the president and/or
greater consolidation of ownership within the board contributed to the long-term growth andprofitability by raising efficiency in asset usage and operations. Our hypothesis H3 on the positive impact of the ownership concentration at the president on the return on asset is supported.

3.3

Impact of enactment of the Commercial Code of 1899

In 1899, the long-awaited Commercial Code came into force and obliged joint stock companies to disclose its financial status in detail by the standardized form. It made more information about financial status of firms publicly available and might have reduced distortion due toasymmetric information. To examine a possible effect, we insert the interaction term between
22

the dummy variable of enactment (d1899), which takes value 1 if the year is 1899 or laterand 0 otherwise, and the ownership structure variables, and the dummy variable itself into
specifications (17), (18), and (19).
The results are in Table 6. Specification 6–1 shows that the enactment of the Commercial
Code did not affect the return on equity (ROEi,t ). Specifications 6–3 and 6–4 show that the enactment of the Commercial Code did not affect the return on asset (ROAi,t ). Specification 6–5
indicates that the ownership concentration and the enactment of the Commercial Code might
have a complementary positive effect on the operating efficiency captured by the return onsales (ROSi,t ). In sum, the enactment of the Commercial Code did not affect the performanceof the firms whose ownership was concentrated and which thus had been well disciplined by
the ownership. However, it helped the firms whose ownership structure was not necessarily
concentrated but consolidated improve the performance.

INSERT Table 6 HERE
Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.

Given the results in Table 5 and Table 6, we conclude that the ownership structure wasrelevant, differently from modern US firms. The results indicate that the Japanese market thenwas not sufficiently efficient and left the room of self-fulfilling distortion predicted by Lemma
1. A greater concentration of ownership helped offset the adverse effect, and our hypothesis
H3 on the relevance of the concentrated ownership to a greater return on asset is supported.

23

4

Distorted financial leverage

4.1

Financial leverage and performance

Our results so far indicate that, in the case where the concentration of ownership at the president was not sufficient, due to a weak discipline from the inefficient market, distortion somehow arose. Our prediction and the results of Lin et al. (2013) suggest that such distortion is
likely to emerge in the financial leverage. We first regress the return on equity (ROEi,t ) on
the financial leverages, the borrowing (BORi,t ) and the outstanding bond (BNDi,t ) over the
paid-in capital (STKi,t ) and balance brought forward (BBFi,t ),ROEi,t = β0 +β1(20)

BORi,tBNDi,t+ β2STKi,t + BBFi,t
STKi,t + BBFi,t+β3 SALi,t + β4 ∆GNPt + µi + i,t .
The results are shown in Table 7. Specification 7–1, including the entire sample, does notshow a significant tendency. The result hints that the effects were diverse depending on the
profitability of firms. Thus, specifications 7–2, 7–3, 7–4, 7–5, and 7–6 separate the sample
into the return on equity ranges less than 0 percent, 0 percent to 10 percent, 10 percent to20 percent, 20 percent to 30 percent, and greater than 30 percent, respectively. Then, for the
subsample where the return on equity is less than 0 and less than 10 percent (specifications
7–2 and 7–3), we see that the leverage by the outstanding bond strongly contributed to thereturn on equity. For subsample between 20 percent and 30 percent of the return on equity,
the outstanding bond weakly contributed to the return on equity (specification 7–5).

INSERT Table 7 HERE
Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.
24

To further inquire effects of the leverage, we next regress the return on asset (ROAi,t ) on
the financial leverages,

ROAi,t = β0 +β1(21)BORi,tBNDi,t+ β2STKi,t + BBFi,t
STKi,t + BBFi,t+β3 SALi,t + β4 ∆GNPt + µi + i,t .
The results are in Table 8, which show that only for the range of the return on equity greaterthan 30 percent (specification 8–6), the outstanding bond positively contributed to the returnon asset. Thus, except for the most profitable firms, financial leverages did not improve efficiency in using assets.

INSERT Table 8 HERE
Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.

Next, we regress the return on sales (ROSi,t ) on the leverages,(22)

ROSi,t = β0 + β1

BNDi,t
BORi,t+ β2+ β3 ∆GNPt + µi + i,t ,STKi,t + BBFi,t
STKi,t + BBFi,twhere we drop SALi,t from the regressors to avoid a mechanical correlation. The results are
in Table 9. We see that in the ranges of the return on equity between 0 and 10 percent and between 10 percent and 20 percent (specifications 9–3 and 9–4), the outstanding bond adversely
affected. Meanwhile, the results for the borrowing are mixed on depending on the ranges,
showing a negative impact in the range between 10 percent and 20 percent (specification 9–4)
25

and a positive one between 0 percent and 10 percent (specification 9–3).

INSERT Table 9 HERE
Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.

Therefore, the leverage by the bond positively contributed to efficiency in using asset only
for the cases of the most profitable firms whose return on equity was greater than 30 percent(specification 7–6 in Table 7). By contrast, the leverage by the bond is suspected to be distorted
in the range of the return on equity less than 20 percent. The leverage by the outstanding bondnegatively affected the return on sales in the ranges of the return on equity between 0 and 20
percent (specifications 9–3 and 9–4 in Table 9).
However, the impact of the outstanding bond was positive to the return on equity in theranges of the return on equity less than 10 percent (specifications 7–2 and 7–3 in Table 7). The
results indicate possible distortions of the leverage to mechanically increase and/or smooththe return on equity among low and mediocre performing firms. Regarding the impact ofborrowing, no significant effect on the returns on equity, asset, and sales in the ranges of the
return on equity greater than 20 percent, and the results are mixed for the ranges of the returnon equity less than 20 percent.

4.2

Ownership structure and financial leverage

From Lemma 1, we predict that in an inefficient market a smaller concentration of ownership
implies a greater distortion of the financial leverage to mechanically increase the return on equity at the expense of optimal capital structure. To specify a possible distortion, we first regress
the changes in the financial leverage by the bond flotation (∆ [BNDi,t /(STKi,t + BBFi,t )]) on
the changes in the ownership structure, considering a possible association between the changes
26

in the ownership structure and those in the return on asset (∆ROAi,t ), with controlling forchanges in business volume by the growth in sales (∆SALi,t ), changes in the market interest
rate in Tokyo (∆TKRt ), as follows.


BNDi,t∆= β0 +β1 ∆SCEOi,t
STKi,t + BBFi,t+β2 ∆SALi,t + β3 ∆TKRt + β4 ∆GNPt + µi + i,t ,
(23)


∆



BNDi,t= β0 +β1 SCEOi,t + β2 ∆SCEOi,t × ∆ROAi,t + β3 ∆ROAi,t
STKi,t + BBFi,t+β4 ∆SALi,t + β5 ∆TKRt + β6 ∆GNPt + µi + i,t ,and

BNDi,t∆STKi,t + BBFi,t

(24)



= β0 + β1 ∆CNSLi,t + β2 ∆SALi,t + β3 ∆TKRt + β4 ∆GNPt + µi + i,t ,
BNDi,t∆STKi,t + BBFi,t= β0 + β1 ∆CNSLi,t + β2 ∆CNSLi,t × ∆ROAi,t+ β3 ROAi,t + β4 ∆SALi,t + β5 ∆TKRt + β6 ∆GNPt + µi + i,t .

The results are in Table 10. We first find that the concentration of ownership to the president (SCEOi,t ) in general tended to lower the financial leverage by the bond flotation (specification 10–1). However, we second find that it raised the leverage by the bond flotation whenit could be accompanied by an increase in the return on asset (ROAi,t ) as shown by the significantly positive coefficient of the interaction term (∆SCEOi,t × ∆ROAi,t ) in specification
10–2. The ownership consolidation (CNSLi,t ) did not have a significant impact on an increasein the leverage by the bond flotation (specifications 10–3 and 10–4). The concentration ofownership at the president was likely to rein in the financial leverage, but exceptions were27

when it was associated with improvement in the efficiency of asset usage, which is consistent
with our hypothesis H2 on the reduction in the leverage distortion by the concentration ofownership.

INSERT Table 10 HERE
Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.

By running the same regressions for the changes in the leverage by an increase in borrowing, we find no significant impact of the ownership structure as shown in Table 11. A
distortion of the leverage due to a diffused ownership structure through borrowing was unlikely. The results are consistent with those for modern non-US advanced economies by Lin
et al. (2013).

INSERT Table 11 HERE
Notes ***, **, and * denote significance of 1 percent, 5 percent, and 10 percent levels respectively.

4.3

Bond flotation as the channel of distortion

Sharing the motivation with Lin et al. (2011a, 2012, 2013), our overall results are partly consistent with theirs but partly not. Using the data from modern non-US advanced economies
including Japan, they concluded that a greater concentration of ownership tends to lead towards a greater distortion through the bond flotation but that it is hard to deceive banks when28borrowing. In our case of Japan more than one century ago, the latter half is supported. The
ownership structure was irrelevant to the distortion of the financial leverage through borrowing. However, regarding the leverage through the bond flotation, a greater concentration ofownership in general reined in the bond flotation, and led to a greater leverage through thebond flotation if it was accompanied by an increase in the return on asset, the longer-term predictor of performance. Thus, our results indicate that dominant owners were circumspect inraising leverage but pulled a lever if it was associated with a greater expected return on asset.
A greater concentration of ownership at the president led to an increase in the return on
asset in general (Table 5). A greater concentration of ownership at the president, in general,lowered the financial leverage through the bond flotation but raised it if it was accompanied byan increase in the return on asset (Table 10). The concentration of ownership at the president
never affected the return on equity (Table 5). A greater leverage through the bond flotation
increased the return on asset only for the range of the return on equity greater than 30 percent(Table 8). Furthermore, a greater leverage through the bond flotation raised the return on
equity only in the ranges of the return on equity less than 10 percent (Table 7). Given the
results, we conclude that low or mediocre performing firms whose ownership structure wasmore diffused were more prone to the distortion of the financial leverage through over-relianceon the bond flotation. In summary, a possible channel is that low or mediocre performing firms
in the ranges of return on equity less than 10 percent deceived the market to raise the leverage
only to mechanically smooth and/or increase the short-term return on equity. The results andour inference are consistent with our hypotheses H2 on a reduction in the leverage distortion
by a greater concentration of ownership.
These different results between our results and those of Lin et al. (2011a, 2012, 2013)leave us with a possibility of nonlinear relations between the ownership structure and leverage distortion. The key variable that distorts the leverage in Lin et al. (2011a, 2012, 2013)is the gap between the control and cash-flow rights of controlling managers, which they call“control-ownership wedge.’ The measure is increasing in the difference between the stock29

holding ratio of the president and the total equity and hence is increasing in the concentrationof ownership among modern listed firms whose share are widely held. Meanwhile, the maximum stock holding ratio in our sample was 70 percent (Table 2), which formed a dominantmajority and hence a smaller gap between the control and cash-flow rights of the controlling
managers. In our sample of Japanese firms more than one century ago, a greater concentrationof ownership at the president appears to result in a smaller gap.
The inefficient Japanese market from 1878 to 1910 was prone to a self-fulfilling distortionof the financial leverage, particularly for poorly performing firms. A greater concentrationof ownership at the president reined in the bond flotation but raised the bond flotation in
the case where it contributed to an increase in the return on asset. Thus, in the inefficient
market, a greater concentration of ownership helped close to the optimal capital structure, aspredicted by our hypothesis H2 on the relevance of a greater concentration of ownership to aless distorted leverage.

5

Conclusion

Irrelevance of the ownership structure in modern US firms is explained by a possible disciplinefrom the market (Demsetz and Lehn (1985); Himmelberg et al. (1999) and Demsetz and Villalonga (2001)). Meanwhile, our finding shows that the stock prices in Tokyo market from 1878
to 1910 strongly responded to the return on equity in the current term, but never responded to
the return on asset (Tables 3). Furthermore, the skewness adjusted variation coefficient of the
return on equity was smaller than that of the return on asset by 34 percent. The result indicatesthat firms mechanically smoothed or raised the return on equity and or skewed it to the rightby the leverage distortion. The Japanese market in its early stage was inefficient in the senseof our hypothesis H1 on a self-fulfilling overemphasis on the return on equity to end up in
exacerbating the distortion.
The distortion was unambiguous among low and mediocre performing firms. The leverage30

by blond flotation contributed to the return on asset only in the case of excellent firms, but it
did not raise the return on asset of low and mediocre performing firms (Table 8) while itraised the return on equity of low and mediocre performing firms (Table 7). The distortion ofborrowing was apparently weak.
A remedy to complement the imperfect market was the concentrated and/or consolidated
ownership structure within the board. An increase in the concentration of ownership at thepresident in general reined in the bond flotation except for the case of being accompanied by
the growth in the return on asset (Table 10). Our hypothesis on a reduction in the leverage
distortion by a greater concentration of ownership is supported.
After all, the ownership concentration and/or consolidation within the board improved thereturn on asset and the return on sales (Table 5). Our hypothesis on the positive impact of
the ownership concentration on the return on asset is supported. Meanwhile, we are in thisstudy not explicitly focused on why the founder who pursued the return on asset instead of
the return on equity. A straightforward conjecture is that in a less developed market, private
benefit for the founder is greater (Dyck and Zingales (2004)) and hence the founder sought togreater control (Zingales (1995)). The individually optimal response might contribute to thelong-term growth of the firm, as founders sought the long-term growth in the private benefit
and hence emphasized the return on asset instead of the return on equity.
The concentration and consolidation of ownership curbed the leverage distortion, and theownership concentration, in particular, was the driver to pursue the long-term growth in theshareholders’ value. The discipline of the concentrated ownership needed to offset adverse
effects of an inefficient market.
We did not capitalize on any Japan-specific features to obtain the results. The significanceof discipline by ownership had better be considered when understanding no-US markets andplanning reforms of them in particular.

31

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Table 1 Distribution of ownership, 1897.
Individuals
Shares owned
share

Number ofsharesshare

467 24.4%
962 50.3%
207 10.8%
151
7.9%
50
2.6%
22
1.2%
9
0.5%
13
0.7%
4
0.2%
3
0.2%
2
0.1%
2
0.1%
20
1.0%
1,912 100.0%

22,043
209,432
140,402
201,586
120,260
73,14240,137
68,84425,31822,524
16,766
18,625
482,785
1,441,864

1.5%
14.5%
9.7%
14.0%
8.3%
5.1%
2.8%
4.8%
1.8%
1.6%
1.2%
1.3%
33.5%
100.0%

Number ofshareholders
1-99
100-499500-999
1,000-1,999
2,000-2,999
3,000-3,999
4,000-4,999
5,000-5,999
6,000-6,999
7,000-7,999
8,000-8,999
9,000-9,999
10,000Total

Institutions

Total

share

Number ofshares

share

2
4.5%
10 22.7%
7 15.9%6 13.6%
4
9.1%
2
4.5%
1
2.3%
1
2.3%
0
0.0%
2
4.5%
3
6.8%
1
2.3%
5 11.4%44 100.0%

189
2,571
3,917
9,808
8,182
7,286
4,000
5,250
0
14,221
25,694
9,575
691,558
782,251

0.0%
0.3%
0.5%
1.3%
1.0%
0.9%
0.5%
0.7%
0.0%
1.8%
3.3%
1.2%
88.4%
100.0%

Number ofshareholders

Number ofshareholders

share

Number ofsharesshare

469 24.0%
22,232
1.0%
972 49.7% 212,003
9.5%
214 10.9% 144,319
6.5%
157
8.0% 211,394
9.5%
54
2.8% 128,442
5.8%
24
1.2%
80,4283.6%
10
0.5%
44,1372.0%
140.7%
74,0943.3%
40.2%
25,3181.1%
50.3%
36,7451.7%
50.3%
42,4601.9%
3
0.2%
28,2001.3%
25
1.3% 1,174,343 52.8%
1,956 100.0% 2,224,115 100.0%

Table 2 Descriptive statistics of firms listed at the Tokyo Stock Exchange, from the first half of 1878 to the second half half of 1910.
Number of individual firms (crosssections)

95

variables

Number of
total
observations

Unit

Mean

MedianMaximum

MinimumStandard
deviation

Skewness

KurtosisAmount of sales in the current term

SAL

1,101

Yen

1,673,988

524,863

19,305,644

600

2,818,222.923

2.791

11.617

Total assets as of the current term

TAS

1,119

Yen

15,717,824

3,651,671

301,457,885

52,16835,907,995.178

5.014

31.721

Paid-in stock as of the current term

STK

1,077

Yen

6,111,014

1,600,000

102,000,000

25,00012,036,180.793

4.681

32.877

Borrowing as of the current term

BOR

1,119

Yen

375,992

0

13,146,042

0

1,083,525.975

4.911

36.511

Outstanding bond as of the current term BND

1,119

Yen

1,471,965

0

93,568,012

08,000,257.208

7.924

70.028

Profit in the current term

PRF

1,081

Yen

388,115

97,992

18,084,554-1,318,361

837,159.095

9.887

188.851

Total dividends in the current term

DVD

979

Yen

283,61575,0003,648,813

0480,640.730

2.721

12.120

Balance brought forward as of the end of
BBF
the current term

1,113

Yen

88,17010,1952,316,513-1,065,271

241,258.728

3.750

26.400

Average share price in the current term

STP

323

Yen

89.101568.3000

425.5000

6.240076.721

1.818

6.290

Return on equity: =PRF/(STP+BBF)

ROE

1,040

percent

8.1012%6.2254%104.6430%-104.7981%

0.108

1.598

33.371Return on asset: =PRF/TAS

ROA

1,080

percent

3.3989%2.9467%34.6725%-33.8713%

0.038

0.875

23.463

Stock holding ratio of the president as of
the current term: =[Shares owned by
SCEO
President]/[Total Share]

610

percent

5.1408%2.7633%70.0000%

0.0000%

0.071

4.248

30.622

Stock holding ratio of the director whose
stock holding ratio is the smallest in theboard as of the current term: [Share
SMIN
owned by the board member]/[Total
Share]

610

percent

1.1309%0.7000%10.0000%

0.0000%

0.015

3.360

17.700Measure of ownership consolidation in
the board: =SCEO×SMIN

610

per tenthousand

8.7819‱2.0000‱130.0000‱

0.0000‱

0.002

3.630

16.941CNSLTable 3 Determinants of the stock prices (STP), from the first half of 1879 to the second half of 1910.
Δlog(STPi , t )Δlog(STPi , t )Δlog(STPi , t )Δlog(STPi , t )Dependent variable
estimation method
Cross section fixed effect
Independent variables
Constant
ΔROEi , t
ΔROAi , t3 1
panel least squares
fixedt statistic-0.0042-0.20
2.2891

3.24 ***-2.4499

-1.31

3 2
panel least squares
fixedt statistic
0.00480.24
1.26693 3
panel least squares
fixedt statistic0.00180.09

3 4
panel least squares
fixedt statistic
0.00220.11

2.53 **-1.2504-0.62

8.85693.09

0.0000

0.31

ΔROSi , tΔ(TODi , t /TASi , t )ΔGNPt

0.00002

0.16

4.52662.21

0.0000

0.11

**

***

-0.0233-0.36

7.62654.36 ***

0.0000

0.31

0.04

0.11

0.08

0.08

-2.40
1.35

14.96
2.08 ***

12.17
1.70 **

12.34
1.74 **

Number of individual firms(cross sections)

24

21

22

22

Number of total
observations

217

201

202

201

adjusted R

Log likelihood
F statistic

Table 4 Stock prices' prediction power against profitability (ROE, ROA),
from the second half of 1882 to the second half of 1910.
Dependent variables
Estimation method
Cross section fixed effect
Independent variables
Constant
Δlog(TSPi , t  1)

ROEi , t

ROAi , t4 1
4 2
Panel least squares
Panel least squares
fixed
fixed
t statistict statistic
18.46 ***
0.078012.42 *** 0.0346
0.04392.21 **

0.00611.03

Δlog(TSPi , t  2)

0.0322

1.76 *

0.00410.75

Δlog(TSPi , t  3)
ΔGNPt

0.01620.86

0.00060.10-0.0001-1.21

0.0000-1.61

adjusted R2

0.38

0.33

log likelihood
F statistic

202.56
6.69 ***

358.615.60 ***

Number of individual firms(cross sections)1111

Number of total
observations

129

129

Table 5 The return on equity (ROE）, return on asset (ROA), and return on sales (ROS) and the stock ownership structure, from the second half of 1878 to the second halfof 1910.
Dependent variables

ROEi , t

ROEi , t

ROAi , t

ROAi , t

ROSi , t

ROSi , testimation method51Panel least squares

52
Panel least squares

53
Panel least squares

54
Panel least squares

55Panel least squares

56
Panel least squares

fixed

fixed

fixed

fixed

fixed

fixed

Cross section fixed
effectIndependent variables
Constant
SCEOi , t

0.06780.0945t statistic
8.37 ***
0.83

SALi , t

0.0000ΔGNPt-0.0001

CNSLi , t

20.0688t statistic
11.44 ***

7.05532.29 **

8.41***

0.0000

8.56

***

-3.52

***

-0.0001

-3.55

***

0.0292
0.0943t statistic
10.44 ***
2.45 **

0.00000.00000.0317t statistic
14.96 ***

2.86182.76 ***

6.77

***

0.0000

6.76

-2.97

***

0.0000-3.09 ***

-0.3955
11.9172t statistic-3.90 ***
7.90 ***

0.0351t statistic
0.47

223.2661

5.32 ***-0.0004

-0.96

***

-0.0003

-0.64

0.47

0.48

0.42

0.42

0.18

0.12

599.538.21 ***

591.108.36 ***

1,225.36
6.86 ***

1,226.28
6.90 ***-909.40
2.76 ***-927.25
2.17

Number of individual
firms (cross sections)

67

67

70

70

70

70

Number of total
observations

560

560

582

582

582

582

adjusted R

Log likelihood
F statistic

Table 6 Impacts of the Commercial Code on the asset and operation efficiency, from the second half of 1878 to the second half of 1910.
ROEi , t
ROEi , t
ROAi , t
ROAi , t
ROSi , t
Dependent variables
estimation method

61Panel least squares

Cross section fixed effect fixed
Independent variables
Constant
SCEOi , t

0.08290.0555t statistic
5.53 ***
0.24

d1899×SCEOi , t

0.0397

0.17

ROSi , t62
Panel least squares

63
Panel least squares

64
Panel least squares

65
Panel least squares

66
Panel least squares

fixed

fixed

fixed

fixed

fixed

0.0817t statistic
7.15 ***

0.03130.1086t statistic
6.23 ***
1.47-0.0186-0.25

0.0345t statistic
8.77 ***-0.11191.039513.0829t statistic
-0.59
0.37

-0.1238t statistic-0.78

4.59 ***CNSLi , t8.22571.39

3.18511.65 *

192.4261

2.48 **

d1899×CNSLi , t-1.2086-0.20-0.3774-0.19

37.1312

0.46

d1899
SALi , t
ΔGNPt-0.0220-1.31-0.0198-1.39-0.0034-0.58-0.0045-0.89

0.00008.57 ***

0.00008.74 ***

0.00006.83 ***

0.00006.85 ***-0.0001-3.51 ***

-0.0001-3.54 ***

0.0000-2.96 ***

0.0000-3.09 ***

-0.3508-1.58

0.23261.17-0.0003-0.62-0.0004

-0.98

2

0.47

0.48

0.42

0.42

0.21

0.13

Log likelihood
F statistic
Number of individual
firms (cross sections)

601.088.03 ***

592.838.19 ***

1,225.98
6.67 ***]

1,227.04
6.72 ***-895.133.16-925.62
2.15

67

66

70

70

70

70

560

552

582

582

582

582

adjusted R

Number of total
observations

Table 7 The return on equity (ROE) and the financial leverage, from the second half of 1878 to the second half of 1910.
ROEi , t
ROEi , t
ROEi , t
ROEi , t
Dependent variables
71
72
73
74
estimation method
Panel least squares
Panel least squares
Panel least squares
Panel least squares
Cross section fixed effect

fixed

fixed

fixed

fixed

ROEi , t

ROEi , t75Panel least squares

76
Panel least squares

fixed

fixed

Independent variables
Constant
BORi , t /(STKi , t +BBFi , t )t statistict statistic***
0.063914.69-0.1969-1.92
0.00971.24-0.0137-0.04

t statistict statistict statistic******
0.046939.50
0.144830.77
0.226618.02 **
0.00130.74-0.0106-0.49-0.0168-0.17

t statistic0.2806
2.69 **-0.0169-0.06

BNDi , t /(STKi , t +BBFi , t )0.00120.31

1.1332

SALi , t
ΔGNPt

2.72592.21 **

0.0041

4.10 *** -0.0023-0.69

0.00007.31***

0.0000-2.32**

0.00006.10

0.0000-2.83-0.0001-3.70 ***

0.00031.36 *

0.0000-1.75 *

0.00000.54***

0.0870***1.74 *

1.39

0.00000.55

0.00002.14

0.00001.24

0.00000.08 **

adjusted R2

0.63

0.54

0.49

0.22

0.24

0.33

Log likelihood
F statistic

1,184.50
10.18 ***

57.67
3.18 ***

1,991.91
9.59 ***

364.042.05 **

132.96
1.91 **

21.81
2.24 *

number of individual firms(cross sections)

89

24

82

37

15

9

Restriction of observation
by ROEno restriction

ROE≤0%

0%<ROE≤10%

10%<ROE≤20%

20%<ROE≤30%

30%<ROE

1,031

52

746

148

54

31

Number of total
observations

Table 8 The return on asset (ROA) and the financial leverage, from the second half of 1878 to the second half of 1910.
ROAi , t
ROAi , t
ROAi , t
ROAi , t
Dependent variables
81
82
83
84
estimation method
Panel least squares
Panel least squares
Panel least squares
Panel least squares

ROAi , t85Panel least squares

86
Panel least squares

fixed

fixed

Cross section fixed effect

fixed

fixed

fixed

Independent variables
Constant
BORi , t /(STKi , t +BBFi , t )t statistic
0.033419.94-0.0018-0.61

t statistic-0.0707-1.37-0.0279-0.16

t statistict statistict statistict statistic
***
***
***
0.024124.63
0.075428.94
0.114612.88
0.10134.22-0.20-0.0127-0.18-0.0022-1.48-0.0292-2.44 ** -0.0134

BNDi , t /(STKi , t +BBFi , t )-0.0007-0.45

1.00021.62-0.0006-0.72-0.0008-0.44-0.0413-1.17

0.50412.68 **

SALi , t

0.00001.79 *

0.0000-1.65

0.00002.61 ***

0.0000-8.35 ***

0.0000-3.11 ***

0.0000

-0.29

ΔGNPt

0.0000-2.61

0.00011.26

0.0000-0.69

0.0000-1.04

0.00001.29

0.0001

0.75

2

***

fixed

ROAi , t

0.32

-0.08

0.32

0.76

0.78

0.73

2,169.01
6.36 ***

93.48
0.86

2,135.60
5.15 ***

451.6112.77 ***

151.6311.70 ***

67.34
7.86 ***

number of individual firms(cross sections)

89

24

82

37

15

9

Restriction of observation
by ROEno restriction

ROE≤0%

0%<ROE≤10%

10%<ROE≤20%

20%<ROE≤30%

30%<ROE

1,031

52

746

148

54

31

adjusted R

Log liklehood
F statistic

Number of total
observations

Table 9 The return on sales (ROS) and the financial leverage, from the second half of 1878 to the second half of 1910.
ROSi , t
ROSi , t
ROSi , t
ROSi , t
Dependent variables
91
92
93
94
estimation method
Panel least squares
Panel least squares
Panel least squares
Panel least squares
Cross section fixed effect

fixed

fixed

fixed

fixed

ROSi , t

ROSi , t95Panel least squares

96
Panel least squares

fixed

fixed

Independent variables
Constant
BORi , t /(STKi , t +BBFi , t )t statistict statistic***
0.2522
6.21-1.2166-0.31
0.11231.16
0.87500.06

t statistict statistict statistic******
0.305035.39
0.352829.63
0.450915.35-4.43 *** -0.9404-2.16
0.06753.80 *** -0.3112

BNDi , t /(STKi , t +BBFi , t )-0.0164-0.34

0.66680.03-0.0177-1.83 *

-0.0289-2.69 *** -0.0347-0.15

2.2648

0.75

ΔGNPt

-0.0003-1.00-0.0041-0.43

0.0000-0.03-0.0001

-1.78

2.08

-0.0006-0.26

adjusted R

2

Log likelihood
F statistic*

0.0003t statistic
0.69972.82 **-0.2063
-0.13

0.10

-0.44

0.59

0.84

0.65

0.39

-1,401.04
2.28 ***-137.610.40

283.7113.76 ***

187.8820.35 ***

50.67
6.75 ***-33.892.78 **

number of individual firms(cross sections)

89

24

82

37

33

9

Restriction of observation
by ROEno restriction

ROE≤0%

0%<ROE≤10%

10%<ROE≤20%

20%<ROE≤30%

30%<ROE

1,031

52

746

148

54

31

Number of total
observations

Table 10 Determinants of the changes in outstanding bond (BND), from the first half of 1887 to the second half of 1910.
Δ[BNDi , t /(STKi , t +BBFi , t )] Δ[BNDi , t /(STKi , t +BBFi , t )] Δ[BNDi , t /(STKi , t +BBFi , t )]Dependent variables
estimation method
Cross section fixed effect
Independent variables
Constant
ΔSCEOi , t

101
Panel least squares
fixedt statistic0.00110.56-0.1238-1.88 *ΔSCEOi , t ×ΔROAi , t

102
Panel least squares
fixedt statistic0.00180.90-0.0475-0.63

14.2044

2.03 **ΔCNSLi , t

103
Panel least squares
fixedt statistic0.00130.63-0.0302-0.01

ΔCNSLi , t ×ΔROAi , t
ΔROAi , t-0.1619-2.59 **

Δ[BNDi , t /(STKi , t +BBFi , t )]104
Panel least squares
fixedt statistic0.0019-0.5787-0.22-45.9281-0.56-0.1795-2.78 ***ΔSALi , t

0.0000-0.01

0.00001.23

0.0000-0.06

0.0000

1.50

ΔTKRt

0.00070.34

0.00110.54

0.00020.08

0.00020.10

0.00000.97

0.00000.52

0.00000.95

0.0000

0.48

ΔGNPt
2

0.02

0.07

0.01

0.05

808.571.20

818.371.61

806.581.11

813.64
1.40

Number of individual firms(cross sections)

43

42

43

42

Number of total observations

397

390

397

390

adjusted R

Log likelihood
F statistic

Table 11 Determinants of the changes in borrowing (BOR), from the first half of 1887 to the second half of 1910.
Dependent variables
estimation method
Cross section fixed effect
Independent variables
Constant
ΔSCEOi , t

Δ[BORi , t /(STKi , t +BBFi , t )]Δ[BORi , t /(STKi , t +BBFi , t )]Δ[BORi , t /(STKi , t +BBFi , t )]Δ[BORi , t /(STKi , t +BBFi , t )]111
Panel least squares
fixedt statistic-0.0185-0.54

112
Panel least squares
fixedt statistic-0.0185-0.53

113
Panel least squares
fixedt statistic-0.0190-0.56

114Panel least squares
fixedt statistic-0.0190-0.55-0.2910-0.27

ΔSCEOi , t ×ΔROAi , t

0.03420.03

55.1128

0.44

ΔCNSLi , t-1.6403-0.32

ΔCNSLi , t ×ΔROAi , t
ΔROAi , t

-10.2520-0.22-2.57170.00-0.6215-0.56-0.6353-0.56

ΔSALi , t

0.0000-0.05

0.00000.22

0.0000-0.06

0.0000

0.26

ΔTKRt

0.1136

3.17 ***

0.1147

3.15 ***

0.11293.17 ***

0.11303.13 ***

0.00041.60

0.00041.52

0.00041.61

0.0004

1.51

ΔGNPt
2

-0.04

-0.05

-0.04

-0.05

-307.900.64-305.52
0.63-307.880.64-305.63
0.62

Number of individual firms (crosssections)

43

42

43

42

Number of total observations

397

390

397

390

adjusted R

Log likelihood
F statistic