GCOE Discussion Paper Series
Global COE Program

Human Behavior and Socioeconomic Dynamics
Discussion Paper No.29

Managerial Entrenchment, Banker Distribution,
and Corporate Governance: Evidence from Japan

Takanori Tanaka

January 2009GCOE Secretariat
Graduate School of Economics

OSAKA UNIVERSITY

1-7 Machikaneyama, Toyonaka, Osaka, 560-0043, Japan

Managerial Entrenchment, Banker Distribution, and Corporate Governance:
Evidence from Japan ✳

Takanori Tanaka ✝

Abstract
This paper investigates whether managerial entrenchment of controlling shareholders affects the
distribution of bankers to the boards of Japanese manufacturing firms. Bankers are not likely to
be appointed to firms with large corporate shareholders as controlling shareholders because
large corporate shareholders have incentives to entrench managers. Moreover, in the aftermathof executive appointments of banks and large corporate shareholders, restructuring andimproved performances of the appointing firms are facilitated. The results suggest thatmanagerial entrenchment of large corporate shareholders generates the substitution of role ofcorporate governance between banks and large corporate shareholders.

JEL classification: D23; G21; G32
Keywords: Corporate governance; Managerial entrenchment; Controlling shareholders;Banks

An earlier version of this paper was presented at the 2008 spring meeting of the Japanese
Economic Association. I am very grateful to Hideaki Miyajima for valuable comments andsuggestions on an earlier version of this paper. I have benefited from useful comments andsuggestions from Yuichi Fukuta, Yuzo Honda, and Kazuo Ogawa. The usual disclaimer
applies.
✝
Institute of Social and Economic Research, Osaka University, 6-1 Mihogaoka, Ibaraki,
Osaka 567-0047, Japan. Tel.: +81-6-6879-8581; fax: +81-6-6878-2766. E-mail address:
t-tanaka@iser.osaka-u.ac.jp.
✳

1. Introduction
Substantial ownership provides shareholders with incentives to exert influence over firmmanagement such that management makes decisions that can increase shareholder values. Fullcoincidence of the objectives of ownership and management plays an important role inmitigating the agency problem, in which the interests of shareholders are not aligned with thoseof managers (see, e.g., Jensen and Meckling, 1976). As a consequence, substantial ownership byshareholders leads to higher firm value.
Although increases in equity ownership by shareholders help to align the interests ofmanagers and shareholders at low levels of equity ownership, beyond a certain level ofownership, shareholders have strong incentives to maximize the private benefits of control. Of
course, these benefits include those that are not detrimental to other investors, including
minority shareholders and creditors (Denis and McConnell, 2003). Controlling shareholders,
however, can pursue interests that do not coincide with the interests of other investors (Shleiferand Vishny, 1997). Controlling shareholders use their control to extract private benefits that are
not available to other investors. Extraction of such private benefits creates an agency problem ofdivergence of interest between controlling shareholders and other investors. 1 Furthermore, thisextraction often leads to reduction in firm value (Stulz, 1988; Morck et al., 1988; McConnell
and Servaes, 1990). Conflicts of interest between controlling shareholders and other investors
become serious when other investors are directly involved in the management of the firm.
Intervention in management by other investors leads to decrease in the private benefits ofcontrol. Thus, strong incentive for controlling shareholders to entrench managers does not allow
other investors to serve on firm boards.
In this paper, we investigate whether managerial entrenchment of controlling shareholders
affect the distribution of bankers to the boards of Japanese manufacturing firms from 1991 to
1995. Given the discussions above, controlling shareholders do not permit bankers to serve on
firm boards if the benefits of the arrival of bankers on firm boards are outweighed by the cost
factors associated with decrease in private benefits. In addition, even in an environment inwhich the strength of creditor rights supports appointments of bankers to firm boards, thepresence of controlling shareholders can provide disincentives for banks to send their executives
to firm boards.
There are two main reasons why Japanese manufacturing firms are suitable for testing our
In a pyramid control structure in which wealthy family members dominate, large
deviations between control rights and cash flow rights provide controlling shareholders withincentives to extract the private benefits, for example, by transferring assets and moneyfrom lower level firms to higher level firms. For a detailed discussion, see, e.g., Morck et al.
(2005).

11

hypotheses. First, La Porta et al. (1999) show that outside the United States and the United
Kingdom, countries have many firms with controlling shareholders. This view is in accordancewith the ownership structure of Japanese firms. 2 Managers in Japan have less equity than in the
United States (Prowse, 1992; Kaplan, 1994), but firms with larger firms as controllingshareholders are prevalent in the manufacturing firms. The controlling shareholders are often
described as parent firms or affiliated firms, and they have close relationships with the owned
firms through business in product and input markets. Second, it is commonly known that Japanis characterized as a bank-centered economy. In recent years, the importance of banks in Japandiminishes. Contributing factors include ongoing financial deregulation in capital markets, andthe 1987 antitrust law limiting ownership shares of Japanese banks to less than 5 ％. However,many firms have strong relationships with banks. Moreover, the strong creditor rights ofJapanese banks support appointments of bankers to firm boards, unlike the United States, inwhich banks are prohibited from taking a large role in governing United States firms (Krosznerand Strahan, 2001a). Given the prevalence of controlling shareholders, and active involvementof bankers in the management of firms, using a sample of Japanese manufacturing firms is well
suited to examining our hypotheses.
We find that bankers are likely to be appointed to larger firms with higher ratios of bankloans to total assets, and higher equity ownership by banks. More importantly, bankers are not
likely to be appointed to firms in which large corporate shareholders dominate. The higher
equity ownership by large corporate shareholders, the lower the likelihood of bankers being
appointed to firm boards. This suggests that large corporate shareholders have strong incentives
to entrench managers, and are then reluctant to accept bankers on their boards. However, we do
not find such a relation between appointments of bankers to firm boards and equity ownershipby inside owners as another type of controlling shareholders. Next, to concentrate on thestrength of creditor rights in Japan, we identify banker appointments with disciplinary roles, andthen examine the determinants of the appointment type. Results for large corporate shareholders
continue to hold in our regressions. Moreover, bankers with disciplinary roles are not likely to
be appointed to firms with inside owners. The higher the equity ownership by inside owners, thelower the probability of bankers with disciplinary roles being appointed to firm boards. Thissuggests that inside owners have incentives to protect the management against bankers withdisciplinary roles.
We are concerned about whether executive appointments of large corporate shareholders
have an impact on those of banks. We use information on executive appointments of large
corporate shareholders to check the robustness of our findings. The results do not change
2 For ownership structure of Western European corporations, see Faccio and Lang (2002).
For ownership structure of East Asian corporations, see Claessens et al. (2000).

2

irrespective of appointment type, and lead us to conclude that our results are robust. Moreover,
we find that executive appointments of large corporate shareholders include those that are
sensitive to poor stock performance, suggesting that such executives play a key role in corporate
governance. Finally, we examine the post-appointment performances of firms that accept
executives of banks and large corporate shareholders on their boards. After bankers withdisciplinary roles are appointed to firm boards, the appointing firms implement asset disposal,
and reduce employment. Similarly, after large corporate shareholders place executives as
disciplinary devices on firm boards, the asset growth rate and employment growth of theappointing firms reduce significantly. The results suggest that the appointed executives play animportant role in restructuring activities. Furthermore, unlike banks, sales and stock return
performances improve in the aftermath of executive appointments of large corporateshareholders. As a consequence, the results show that banks and large corporate shareholders
play a disciplinary role in corporate governance of the appointing firms. Taken together, weconclude that managerial entrenchment of large corporate shareholders generates thesubstitution of role of corporate governance between banks and large corporate shareholders. 3
This paper is associated with previous studies on corporate governance in Japan.

Aoki etal. (1994) provide anecdotal evidence that shows interactive role in exercising corporate
governance between banks and large corporate shareholders. They argue that corporate
governance by main bank depends on the ownership structure of the firm. If the firm has close
relationship with the parent firm as large corporate shareholder, main bank is likely to lendindirect support for large corporate shareholder that facilitates the restructuring of a troubled
firm, unless the shareholder is under financial distress. Sheard (1994b, 1997) presents direct
evidence that bankers are not likely to be on the boards of firms with dominant shareholders.
Unlike previous papers, this paper aims to examine empirically the interactive relation of
corporate governance between banks and large corporate shareholders.
The rest of the paper is organized as follows. Section 2 provides background. Section 3
describes data sources, variables, and descriptive statistics. Section 4 reports the results for thedeterminants of banker appointments. Section 5 reports additional results by focusing on
appointments of bankers with disciplinary roles. Section 6 checks the robustness of our results.
Section 7 investigates changes in corporate performances after executives as disciplinary
devices are appointed to firm boards. Section 8 concludes the paper.

2. BackgroundNickell et al. (1997) study the relation between factors that discipline managers. They findthat there are substituting roles among disciplinary factors: product market competition,
financial market pressure, and shareholder control.

3

3

2.1.

Legal protection and corporate governance in Japan

Corporate governance pays increased attention to the ways in which outside investors
protect themselves against insiders to maximize the returns on their investments. However, in anenvironment in which expropriation of minority shareholders and creditors by controllingshareholders is extensive, the returns will not materialize. In such environment, all outside
investors need to have their rights protected. Enforced rights require insiders to distribute theprofits to shareholders, and repay the creditors. The protection of outside investors through thelegal system is an important consideration for corporate governance.
Recent studies suggest that a complementary combination of legal protection of investors
and concentrated ownership have an influential impact on the effectiveness of corporate
governance. (Shleifer and Vishny, 1997; La Porta et al., 1998; La Porta et al., 1999). In
common-law countries with strong protection of investors, the legal system includes protectionsof minority shareholders. In contrast, French-civil-law countries have the weakest protection ofshareholders. In such legal systems, strong incentives for shareholders to own higher control
and cash flow rights to circumvent expropriation of profits by managers or low demand forequity by shareholders results in concentrated ownership. Concentrated ownership could be a
substitute for weak legal protection of investors (La Porta et al., 1998).
While the United States in common-law countries offer shareholders strong legal protection,
Japan is in the German-civil law countries in which the rights of shareholders are weaker than in
the United States (La Porta et al., 1998). 4 The relatively weak protections of shareholders can beassociated with the higher fraction of firms with large shareholders in Japan than in the UnitedStates. Indeed, in our sample of manufacturing firms listed on the stock exchange from 1991 to
1995, using a 10％ definition of control, we find that 46.3％ of our sample firms have
corporate shareholders as the top shareholder. Even using a 20％ definition of control, we findthat 33.4％ of our sample firms are ones in which corporate shareholders dominate. Most
controlling shareholders with more than 20％ shareholdings are nonfinancial firms listed on thestock exchange. Note that firms with financial institutions as large shareholders are very limited,
because the antitrust law in 1987 restricts the equity ownership offinancial institutions,5especially banks, to be no more than 5 ％. Consequently, our findings show that the ownership
structures of Japanese firms are relatively concentrated, and many Japanese firms haveAmong German-civil law countries, Japan has relatively good shareholder protection(Shleifer and Vishny, 1997; La Porta et al., 2000).
5 Using the five largest owners in Japanese firms listed on the Tokyo Stock Exchange,
Prowse (1992) shows that financial institutions dominate among the top five shareholders.
However, in 1984, the year in which he gathered information on the firms, Japanese banks
were permitted to have more than 5 ％ shareholdings.
44controlling corporate shareholders. 6
As mentioned above, controlling shareholders as insiders have strong incentives to pursue
their own interests, and these self-interest actions often leads to deterioration in firm value.
However, large corporate shareholders in Japan do not adversely affect firm value, corporate
performance, and stock returns (Kang and Shivdasani, 1996; Morck et al., 2000; Miyajima andKuroki, 2008). Large corporate shareholders effectively exert control over the management of
the owned firms, and even play an important role in lowering expenditure on activities withscope for managerial private benefits (Yafeh and Yosha, 2003). In particular, executive
appointments to the boards of poor performing firms are pronounced (Kaplan and Minton,
1994; Kang and Shivdasani, 1995). These appointments aim to intervene in management,
discipline the managers, and then replace incumbent managers with the newly appointed
executives. The appointments are indicators that large corporate shareholders exert control overmanagement to maximize their own interests through increased attention to the appointing
firms.
On the other hand, Japan, as a German-civil-law country, affords stronger legal protection tocreditors, in particular senior secured creditors, than common-law countries, including theUnited States. If client firms violate their financial obligations, then creditors can enforce theirrights effectively. Creditor rights include the right to possess collateral, the right to dismiss the
managers mandatorily

in reorganization, the right to liquidiate the firm, and so on (see, e.g.,

Shleifer and Vishny, 1997; La Porta et al., 1998). In addition, effectively enforced rights ofcreditors enable banks to send executives to the boards of poor performing firms. As Krosznerand Strahan (2001a) suggest, a higher fraction of firms with bankers on firm boards in Japan
than in the United States indicates that creditor rights in Japan are relatively strong.
Appointments of bankers play a crucial role in Japanese corporate governance. In particular,
the appointments to firm boards become important when client firms are under financial distress(Kaplan and Minton, 1994). The appointed executives aim to intervene in management,
discipline the managers, and even displace the incumbent managers (Kaplan and Minton, 1994;
Kang and Shivdasani, 1995). Through the appointed executives, banks play a pivotal role informulating and implementing the restructuring plans. 7
Two different corporate governance systems are strongly associated with the legal system ofJapan in which the legal protection of shareholders is relatively weak, but the rights of secured
creditors are strongly protected. The weak protection of shareholders leads to concentrated
Claessens et al. (2000) show that widely held corporations in Japan are large andmedium-size corporations, and the exception for small corporations.
7 Morck and Nakamura (1999) are skeptical about the effects of bank executive
appointments. They find that monitoring by banks is more likely to occur in firms in which
the bank's incentives are not aligned with shareholder value maximization.
6

5

ownership, in which shareholders have incentives to monitor the management. Strong creditor
rights allow banks to send executives to the boards of client firms, thereby exerting control overthe management. Consequently, large corporate shareholders and banks play an important rolein Japanese corporate governance.

2.2.

Managerial entrenchment and bankers on firm boards

When bankers arrive at the boards of firms with controlling shareholders, what benefits or
costs do they generally bring to the boards? We consider the benefits of accepting bankers on
firm boards. Bankers on firm boards can have easy access to firm information. Better
information helps the appointing firms to obtain bank loans on better terms, thereby lowering
the costs of monitoring, including the ones of external finance. In addition, bankers on firmboards can send a signal to other banks, public debt markets, and investors that the financial
conditions of the appointing firms are likely to improve. The appointment as a form ofcertification also contributes to a reduction in the costs of external finance. 8
As for the potential costs for bankers on firm boards, conflicts of interest between banks andshareholders, including minority shareholders, generally arise because of different payoff
structures attached to debt and equity. The potential costs of conflicts become serious whenbankers are on firm boards. 9 However, Japanese banks can hold the equity of the firms, inwhich case such a problem is not serious. On the other hand, controlling shareholders have
incentives to maximize the private benefits of control, in which case the interests of controllingshareholders are not likely to be aligned with those of bankers on firm boards. Divergence ofinterest between banks and controlling shareholders becomes serious when bankers are on firmboards. For example, bankers on firm boards argue against management plans that maximize theprivate benefits of control, and even replace the incumbent managers, including executives
previously employed by controlling shareholders, with other executives. As a result, controllingshareholders are reluctant to incur such potential costs, and have incentives to avoid the arrivalof bankers with different interests on their boards. If the cost factors outweigh the benefits ofaccepting bankers on firm boards, controlling shareholders are reluctant to invite bankers on

For the role of bankers on firm boards, see Kroszner and Strahan (2001a, 2001b), andByrd and Mizruchi (2005).
9 Kroszner and Strahan (2001a) show that bankers in the United States tend to avoid
conflicts of interest between banks and shareholders, and not to appear on the boards offirms in which such conflicts of interest are serious. However, Japanese banks are permitted
to have equity of firms, and such a divergence of interest is not serious. Indeed Prowse(1990) shows that, unlike the United States, in the financial keiretsu firms in which large
shareholders are also large debtholders, wealth is not transferred from debtholders toshareholders.
86their boards. Banks are also concerned about the potential costs of conflicts of interest, and haveless incentive to place their executives on the boards of firms with controlling shareholders.

3.

Data, variables, and descriptive statistics
In this section, we describe the sample firms, and provide details on the construction of thevariables in the empirical tests. Then we report the descriptive statistics of the variables.

3.1.

Sample selection

Our sample includes Japanese manufacturing firms listed on the stock exchange. The firms
operate within a fiscal year that ends in March during 1991 through 1995. We choose a sample
period from 1991 to 1995 for two reasons. First, regulation of access to capital markets wascompletely abolished in the late 1990s, and then the dependence on bank loans decreased.
Furthermore, unwinding of cross-shareholding between banks and firms was frequent in the late
1990s (Miyajima and Kuroki., 2008). A shift away from bank loans and the unwinding ofcross-shareholding lead to the dilution of relationships between banks and firms, resulting indecrease in banker appointments. Second, merger and acquisition (M＆A) activities haveincreased since the late 1990s. M＆A activities play a key role in the restructuring of acquired
firms by selling and transferring unprofitable sectors to acquiring firms. 10 Then the role ofbanks in corporate governance diminishes. Given the arguments above, the sample period from1991 to 1995 is well suited to our analyses. 11
We omit firms for which financial statements data from the Nikkei Needs dataset are notavailable continuously during the sample period because of bankruptcy or M＆A. This data
source includes unconsolidated data of income statements and balance sheets for thenonfinancial firms traded on the stock exchange. The resulting sample is 4262 observations forwhich data for all variables in our regressions are available.

3.2.

Banks and controlling shareholders

We focus on executive appointments of main banks because main banks in Japan have close
For a discussion of M＆A activities in Japan, see Miyajima (2007).
It is argued that in the late 1990s bank monitoring is not highly likely to serve as aneffective device for troubled firms. Unhealthy banks do not play an important role in the
restructuring of firms, and instead provide financial assistance excessively to troubled firms
in nonmanufacturing sectors, including construction and real estate. (Peek and Rosengren,2005; Caballero et al., 2008). However, this problem is not serious here because we use dataon manufacturing firms in the early 1990s.
10
11

7

relationship with firms. They often maintain the largest share among financial institutions ofloans to firms, are major shareholders in the firms, and send their executives to firm boards. In
addition, main bank is characterized as the delegated monitor among banks lending to aparticular firm (Sheard, 1989, 1994c). We consider the main bank to be the bank first listed inJapan Company Handbook that contains financial data on all publicly traded Japanesecompanies. 12
In this paper, we concentrate on the controlling shareholders as follows: nonfinancial firmwith more than 20 ％ shareholding as the top shareholder, and the manager serving on theboard as the top shareholder. The cutoff level of control for large corporate shareholder follows
that in La Porta et al. (1999). Voting rates by public shareholders are generally quite low. Thenequity ownership exceeding 50 ％ are not necessary to lock in control. More than 20 ％shareholdings is usually sufficient to control board elections. In our sample, the averageownership of the large corporate shareholders is 0.371 (or 37.1 ％) and the median is 0.346 (or34.6％). Furthermore, figures serving on firm boards as the top shareholders are mainly
founding entrepreneurs or a member of the founder's family and have strong incentives toentrench themselves. 13 This is pronounced for powerful figures serving as the chairman orpresident. Thus, we also include equity ownership by the chairman or president as the top
shareholder (Sheard, 1994b, 1996; Hirota and Miyajima, 2001). The average ownership ofinside owners is 0.123 (or 12.3 ％) and the median is 0.086 (or 8.6％). Data on equity
ownership by large corporate shareholders and inside owners are taken from Kigyo Keiretsu
Soran.

3.3.

Appointments of bankers to firm boards

We consider appointments of bankers to be bankers previously employed by main banks
being appointed to the boards of nonfinancial firms during the fiscal year. Banker appointments
are restricted to those in which bankers are selected at the shareholder meetings in June. Data on
banker appointments are obtained from Yakuin Shikihou and Yuka Shoken Hokokusho. The
appointed executives include those in management positions as follows: chairman (kaicho),president (shacho), vice president (fuku-shacho), executive director (senmu), managing director(jomu), and director (torishimariyaku). We do not include appointments of new statutory
auditors who have no voting rights at board meetings. Our definition of executive appointments
is based on other previous studies (Kaplan and Minton, 1994; Hirota and Miyajima, 2001;

This way of identifying the main bank is used in Gibson (1995), and Klein et al. (2002).
Aoki et al. (1994) show that the main bank's monitoring is sensitive to the idiosyncratic
characteristics of owner-managed firms.

12
13

8

Miyajima et al., 2001).
However, Sheard (1994b) suggests that there are two different types among these
appointments. The purpose of one appointment type is intervention in the management of poor
performing firms. Japanese banks send bankers with disciplinary roles to the firms underfinancial distress, and exercise control over management of the appointing firms. Another typeaims at supporting their reemployment of bankers in firms. Banks frequently send their midand late-career directors to firms in normal financial conditions to assist their reemployment. 14
On the other hand, several studies focus on the role of bankers with financial expertise in the
United States (Booth and Deli, 1999; Byrd and Mizruchi, 2005; Guner et al., 2008). Althoughsuch analyses are limited in Japan, bankers that act as disciplinary devices and those that findreemployment in firms are both likely to bring bank loans to the appointing firms through better
information flow from firms to banks. Thus, we concentrate on appointments of bankers withand without disciplinary roles. Unfortunately, we cannot distinguish between these types insystematic ways.
Although some new appointments exchange positions with previously appointed bankers,
we treat replacement and nonreplacement appointments as the same. In addition, we do not
distinguish between single and multiple appointments because multiple appointments in a given
fiscal year are very rare.
Table 1 contains the average values of the variables related to banker appointments in our
sample. This shows that appointments of bankers to firm boards represent 4.6％ (or 195) of ourobservations.

3.4.

Corporate performance measures

We use three corporate performance measures: stock return, return on assets (ROA), andnegative pretax income. Stock return is intended to measure market performance. This isdefined as dividends per share plus stock price at the last day of the fiscal year less stock priceat the last day of the previous fiscal year, divided by stock price at the last day of the previous
fiscal year. Stock price data are taken from Kabuka Soran. ROA is intended to measureaccounting performance. The variable is defined as the ratio of pretax income to the average of
total assets for the previous and current fiscal years. Negative pretax income indicates that firms
face the difficulty of meeting their financial obligations (Kaplan and Minton, 1994). This takes
on a value of 1 if pretax income is negative, and 0 otherwise. The fraction of firms with negative
pretax income is 0.139 (or 13.9 ％), which is higher than in Kaplan and Minton (1994).
Kaplan and Minton (1994) and Morck and Nakamura (1999) do not distinguish between
bankers without disciplinary roles and with disciplinary roles.

149

Some argue that industry-adjusted performance measures, not raw measures are closely
related to executive appointments (Kang and Shivdasani, 1995; Morck and Nakamura, 1999).
Then we recalculate industry-adjusted performance measures for stock return and ROA.
Industry-adjusted performance measures are calculated as raw performance variables lessindustry-average performance values as average values of the industry in each fiscal year. This
captures the degree of deviation of the firm's performance from industry mean performance inthe fiscal year. The code to classify sample firms by industry is obtained from Japan Company
Handbook.

3.5.

Bank relationship measures

Japanese main banks have dual roles as creditors and shareholders. They provide loans tofirms, and obtain equity in the firms. The investments establish close relation between mainbanks and firms. Previous studies find linkage between banker appointments and relationshipmeasures, including loans-asset ratio, and equity ownership (Kaplan and Minton, 1994; Hirota
and Miyajima, 2001). Thus, we need to control for the strength of main bank relationship when
we examine the determinants of executive appointments by main banks.
In our specifications, we include the ratio of the main bank loans to total assets, and equity
ownership by main banks. Data on loans outstanding, and equity ownership of main banks are
obtained from Kigyo Keiretsu Soran.

3.6.

Financial and enterprise keiretsu membership

In empirical analyses, we capture the strength of the corporate group relationship. It is wellknown that there are industrial groups in Japanese economy. These are bank-centered, andenterprise-centered groups. The former groups have strong relationships with main bank andother member firms by way of cross shareholding of equity and production activities. The lattergroups have close relationships with parent firms or affiliated firms as large shareholders
through input or output markets.
We consider the firms to be financial keiretsu members if they are associated with one of theeight financial keiretsu members: Mitsubishi, Mitsui, Sumitomo, Fuyo, DKB (Daiichi KangyoBank), Sanwa, IBJ (Industrial Bank of Japan), and Tokai and main banks of the firms are
identical to one of main banks at the center of the eight financial keiretsu members. We
construct an financial keiretsu dummy variable that has a value of 1 if our strategy identifies thefirm as being associated with a financial keiretsu member, and 0 otherwise. This variable plays amore important role in our analyses. Morck and Nakamura (1999) show that factors that predict

10the appointments of bankers to firm boards are different between keiretsu and independent firms.
The inclusion of the variable helps controls for the difference between financial keiretsu firms
and independent firms. Our financial keiretsu firms constitute 0.328 (or 32.8 ％) of sample
firms. Data on financial keiretsu members come from Industrial Groupings in Japan}.
In addition to financial keiretsu membership, we include enterprise keiretsu membership,
following Kaplan and Minton (1994). We consider the firms to be enterprise keiretsu members
if the firms are associated with one of the following eighteen enterprise members as: Mitsubishi
Material, Mitsubishi Chemical, Nippon Steel, NKK, Sumitomo Metal Industries, Kobe Steel,Mitsubishi Heavy Industries, Hitachi, Matsushita, Toshiba, NEC, Sony, Mitsubishi Electric,
Fujitsu, Toyota, Nissan, Honda and Kintetsu. 15

The enterprise keiretsu dummy variable has avalue of 1 if the firm is associated with an enterprise keiretsu member, and 0 otherwise.
Enterprise keiretsu firms account for 0.141 (or 14.1 ％) of our sample firms. Data on enterprisekeiretsu members are obtained from Industrial Groupings in Japan.

3.7.

Other control variables

We control for other firm characteristics, including firm size and firm age. Firm size isintended to capture directly the effects of firm size, and captures indirectly the effects of the sizeof firm boards (Kroszner and Strahan, 2001a). This is measured by the logarithm of total assets.
Firm age is included to capture the connection between banker appointments and firm age.
Sheard (1994b, 1997) finds that the older the firm, the fewer presence of bankers on the board,and interprets this as evidence suggesting that banks accumulate internal information aboutolder firms, and accumulated information requires banks not to are on the boards of older firms
to gather new information. This is measured by the logarithm of the years elapsed since theestablishment of the firm.
In addition, after the bursting of the asset price bubble, nonperforming loans drasticallyincreased, and the financial condition of Japanese banks deteriorated. Poor financial conditions
can adversely affect management intervention through banker appointments. 16 Then, we control
for the health condition of the main bank by using stock returns because they are likely tocapture the deterioration in economic performances, including financial conditions. We do not
use nonperforming loans and capital ratios because Japanese banks in the 1990s had strong
incentives to understate nonperforming loans and overstate capital ratios, and the variables are
15 In constructing the enterprise keiretsu dummy variable, Kaplan and Minton (1994) focus
attention on the six large enterprise members: Hitachi, Matsushita, Nippon Steel, Nissan
Motors, Toshiba, and Toyota.
16 Sheard (1997) shows that banks in poor financial conditions cannot intervene in the
management of troubled firms, and implement the business reconstruction.

11

not likely to reflect true values (Peek and Rosengren, 2005).
Finally, our regressions include industry-average performance variables, and time dummy
variables. The industry-average performance variables are intended to help control industry
health conditions (Kang and Shivdasani, 1995; Morck and Nakamura, 1999). We include time
dummy variables to control year-specific effects that could affect allocation of bankers to firmboards.
Summary statistics for these variables are provided in Table 1. In order to obtain robust
results, we remove observations for continuous variables with extreme values. 17

4.

Managerial entrenchment and banker appointments
Table 2 contains probit regression estimates of the determinants of banker appointments.

The dependent variable in all equations has a value of 1 if the banker is appointed to the boardof the firm during the year, and 0 otherwise. In order to avoid the reverse causality problem, allindependent variables are one-period-lagged values. We include one-period-lagged values ofindustry-average performance variables because there can be linkage between the selection of
bankers as new executives at the shareholder meeting in June and industry-average performancefor the previous fiscal year ending in March. Our key variables are equity ownership by large
corporate shareholders with more than 20 ％ shareholdings and equity ownership by inside
owners. The coefficients on the variables are expected to be negative if controlling shareholders
have incentives to protect managers against bankers, and banks are concerned about managerial
entrenchment of controlling shareholders. We do not include the variable for incumbent bankers
on firm boards because we follow Sheard (1994a) who argues that existing former bankers on
firm boards have quite different capacities from newly appointed bankers, and are likely to be
displaced with newly appointed bankers.
Column 1 reports the results for the basic specification without equity ownership bycontrolling shareholders. As for corporate performance measures, the coefficients on theindustry-adjusted stock return and ROA are negative but not significant. The results indicate thatthe appointed bankers are unlikely to have disciplinary roles, but likely to find reemployment
positions in the firms. 18 The less active involvement of banks in the management of poor
performing firms in the early 1990s can be related to the increase of zombie firms in the late
1990s (Caballero et al., 2008). The coefficients on bank loans ratio and bank equity ownershipare positive and significant, suggesting that banker appointments are closely related to the
17 Extreme observations for continuous variables are defined as those for which any one ofthe variables has a value more than four standard deviations away from the mean value.
18 We obtain similar results when two-period-lagged values of corporate performancemeasures are included in our specifications.

12strength of bank relationship. The results are similar to those in Hirota and Miyajima (2001).
The coefficient on firm size is significantly positive, suggesting that bankers are likely to beappointed to larger firms. Interestingly, the coefficient on the industry-average stock return issignificantly positive, indicating that bankers are likely to be appointed to firm boards when theindustry stock performance perform well, on average. 19
Column 2 shows the results for the specification with equity ownership by controllingshareholders. The basic results are similar to those in column 1. The coefficient on
industry-adjusted ROA is negative and significant, and the coefficient on financial keiretsu
membership is positive and significant. More importantly, the coefficient on equity ownershipby large corporate shareholders is negative and significant. This suggests that higher equity
ownership by large corporate shareholders is, less likely are bankers to be appointed to firmboards. In contrast, the coefficient on equity ownership by inside owners is positive but notsignificant. In column 3, we replace industry-adjusted ROA with negative pretax income. The
coefficients on equity ownership by controlling shareholders mirror those in column 2. Whilethe coefficient on equity ownership by large corporate shareholders is negative and significant,the coefficient on equity ownership by inside owners is positive and insignificant. However, thecoefficient on negative pretax income is positive but not significant.
The results of Table 2 for the determinants of banker appointments provide support for our
predictions. Bankers are not likely to be appointed to the boards of firms in which large
corporate shareholders dominate. We interpret this evidence as suggesting that large corporateshareholders have incentives to entrench managers, and banks are afraid of managerial
entrenchment of large corporate shareholders. In contrast, we do not find a significant link
between equity ownership by inside owners and banker appointments. Our results are robust todifferent corporate performance variables including industry-adjusted ROA and negative pretax
income.

5. Managerial entrenchment and banker appointments as disciplinary
devices
As we have shown above, managerial entrenchment of large corporate shareholders has animportant impact on the distribution of bankers to firm boards. Bankers are, ceteris paribus, notlikely to be appointed to firms with large corporate shareholders. However, in legal systems
favorable to banks, the strength of creditor rights predominates. Strong creditor rights can allow

19 This result contradicts the findings of Morck and Nakamura (1999), who show evidence
that banker appointments are strongly associated with higher industry-average stock
performances.

13

banks to enforce protected rights effectively through appointments of bankers to the boards ofpoor performing firms, even those in which controlling shareholders dominate.
To investigate whether bankers with disciplinary roles are appointed to firms with
controlling shareholders, we need to identify banker appointments with disciplinary roles
among total banker appointments. Unfortunately, we cannot pick up the appointment type insystematic ways. Thus, because the appointments of bankers with disciplinary roles are sensitive
to poor corporate performance, we define appointments with disciplinary roles as those in which
the appointing firms report an interest coverage ratio (the ratio of operating profits to interest
payments) of less than 1 at the end of the previous fiscal year. This implies the inability to coverinterest payments out of current operating income. On the basis of this strategy, theappointments of bankers as disciplinary devices are 1.8％ (or 76) of our sample firms. Notethat the appointing firms include both those that are temporarily under financial distress, andthose that are seriously troubled. However, bankers are not likely to find reemployment
positions in troubled firms, and then banker appointments to such firms are plausibly considered
to be those with disciplinary roles.
Table 3 reports the probit regression estimates, in which dependent variable has a value of 1
if the banker with disciplinary role is appointed to the board of the firm during the year, and 0
otherwise. Column 1 contains the results for the specification without equity ownership bycontrolling shareholders. The coefficients on industry-adjusted stock return and ROA are
negative and significant. The coefficients on bank loans ratio and bank equity ownership are
positive and significant. The coefficient on firm size is positive and significant. While thecoefficient on industry-average stock return is significantly positive, the coefficient on
industry-average ROA is significantly negative. Column 2 contains the results for the
specification including equity ownership by controlling shareholders. The coefficient on equity
ownership by large corporate shareholders is negative and significant, but the size of thecoefficient is smaller than one in column 2 of Table 2. This suggests that in a legal environment
favorable to banks, strong creditor rights support the appointment of bankers to the boards ofpoor performing firms, but managerial entrenchment of large corporate shareholders outweighs
the strength of creditor rights, thereby leading to a lower likelihood of bankers being appointed
to poor performing firms with large corporate shareholders. More importantly, the coefficient onequity ownership by inside owners is negative and significant. This is similar to the results in
Sheard (1994b, 1997) and Hirota and Miyajima (2001). While inside owners are not concerned
about banker appointments in normal times, they are aware of bankers with disciplinary roles
serving on firm boards. The regression in column 3 yields similar results to those in column 2.
The coefficient on negative pretax income is positive and significant. Both the coefficients onequity ownership by large corporate shareholders and by inside owners are negative and14

significant.
However, we need to show one caveat for our results. We do not distinguish between firmsthat do not accept bankers on their boards and those that receive bankers without disciplinary
roles. In the regressions, we give both types a value of 0 for the dependent variable. Thus, we
exclude from our sample observations of firms that accept bankers without disciplinary roles.
However, a problem emerges in the removal of the observations. Given that bakers are not
likely to be appointed to firms with large corporate shareholders, exclusion of observations offirms that accept bankers without disciplinary roles can introduce sample selection bias. Indeed,
we conduct the analyses with the dependent variable taking a value of 1 if bank send theexecutive with disciplinary role to the firm board, and 0 if firms does not accept the executive,
and find a larger coefficient on equity ownership by large corporate shareholders. To conserve
space, we do not report this result.
In this section, we present results for the impact of managerial entrenchment of controllingshareholders on appointments of bankers as disciplinary devices to the boards of poor
performing firms. Even bankers with disciplinary roles are not likely to be appointed to theboards of poor performing firms with controlling shareholders. As a consequence, firms inwhich large corporate shareholders dominate are not likely to accept bankers on their boards
irrespective of the role of the appointing bankers. In addition, inside-owner-controlled firms are
not likely to accept bankers with disciplinary roles on the boards, suggesting that firms withinside owners protect the managers against appointment of bankers as disciplinary actions, andthen entrench management. Taken together, managerial entrenchment of controllingshareholders constrains bankers with disciplinary roles from serving on firm boards.

6.

Robustness checks
In previous sections, we find that managerial entrenchment of large corporate shareholders

curbs the appointments of bankers to firm boards. However, if executive appointments of large
corporate shareholders have an influential impact on those of banks, our results can suffer fromstatistical bias. To examine whether simultaneous equation bias adversely affects our estimatedcoefficients, we study the determinants of each executive appointment, conditional on the othertype of executive appointment. Here we use the seemingly unrelated bivariate probit model tocheck the robustness of our results. 20
Like banks, large corporate shareholders play an important role in corporate governance of
their affiliated firms and subsidiaries. In particular, they send their executives to the boards of
20 Kaplan and Minton (1994) estimate the bivariate probit model, and conclude that director
appointments of nonfinancial firms do not affect director appointments of banks.

15

owned firms, replacing incumbent executives, including inside and outside members of theboards, with their new executives (Kang and Shivdasani, 1995, 1997). Like banker
appointments, we consider executive appointments of large corporate shareholders to be
executives previously employed by large corporate shareholders with more than 20 ％shareholdings as the top shareholders. In our sample, executive appointment of large corporateshareholders occurs in 13.7％ (or 583) of our sample firms. 21 This implies that in comparison
with banks, large corporate shareholders pay increased attention to the owned firms. In addition,
executive appointments of large corporate shareholders also include ones that exert control overmanagement as well as ones for reemployment of large corporate shareholder executives(Sheard, 1994b). Following previous sections, we need to identify executive appointments oflarge corporate shareholders with disciplinary roles because executive appointments of large
corporate shareholder executives with disciplinary roles could have a substantial effect on thoseof bankers with disciplinary roles. We define as executive appointments of large corporateshareholders with disciplinary roles those in which the firm's stock return is in the lowest
one-fourth for each industry at the end of the previous fiscal year. This strategy follows Kangand Shivdasani (1995) and Kaplan and Minton (1994) in which blockholders or nonfinancial
firms discipline managers for poor stock price performances. Like banks, the appointing firms
include those that are both temporarily and seriously troubled. On the basis of this scheme,
executive appointments of large corporate shareholders as disciplinary devices occur in 3.2％
(or 136) of our sample firms.
In the equations in which the dependent variable is appointments of bankers, theindependent variables used are identical to those in previous analyses. In the equations in which
the dependent variable is executive appointments of large corporate shareholders, we use
industry-adjusted stock return of firms, industry-adjusted ROA, and negative pretax income ascorporate performance variables. Equity ownership by large corporate shareholders is intended
to control for the difference of equity ownership. In addition, following Kaplan and Minton(1994), we include financial and enterprise keiretsu member variables. Firm size, firm age,industry-average stock return, industry-average ROA, and time dummy variables are intended tocontrol for other characteristics. 22
Table 4 contains the results for the seemingly unrelated bivariate probit model. Panel A
presents the results for the determinants of executive appointments of banks, and Panel B shows
the results for the determinants of executive appointments of large corporate shareholders.
Dependent variables for columns 1 and 2 take on a value of 1 if the firm accepts the banker on
21 Kang and Shivdasani (1996) show that in 60 of 100 outside president succession cases,
the sending company is the firm's largest shareholder.
22 Sheard (1997) finds that older firms are not likely to have a president from nonfinancial
firms.

16

the board, and 0 otherwise in the bank equation, and take on a value of 1 if the firm accepts theexecutive of large corporate shareholder on the board, and 0 otherwise in the large corporateshareholder equation. Dependent variables for columns 3 and 4 take on a value of 1 if theinterest coverage ratio of the firm accepting the banker on the board takes on a value less than 1
at the end of the previous fiscal year in the bank equation, and the appointed firm's stock returnis in the lowest one-fourth for each industry at the end of the previous fiscal year in the large
corporate shareholder equation.
In the bank equation of column 1, while the coefficient on equity ownership by large
corporate shareholders is negative and significant, the coefficient on equity ownership by inside
owners is positive but not significant. Turning to the results for large corporate shareholders, theestimated coefficient on industry-adjusted stock return is negative but not significant. This result
is not consistent with the findings of Kang and Shivdasani (1995) and Kaplan and Minton(1994), who find that the nonroutine president turnover of blockholders and director
appointments of nonfinancial firms are sensitive to stock return. The coefficient on
industry-adjusted ROA is negative but not significant. The coefficient on equity ownership bylarge corporate shareholders is significantly positive. The coefficient on firm size is significantly
negative, suggesting that large corporate shareholders are likely to send their executives tosmaller firms. The result is in contrast with that of the bank equation, suggesting that larger
firms are likely to receive bankers on their boards. These results show that firms with different
size are likely to accept different executives on their boards. The coefficient on financial
keiretsu membership is positive but insignificant. Given that Kaplan and Minton (1994) present
results that director appointments of nonfinancial firms are strongly related to financial keiretsu
membership variable, our findings probably suggest that large corporate shareholders offinancial keiretsu member firms have less than 20 ％ shareholdings. The coefficient onenterprise keiretsu membership is significantly positive, indicating that enterprise keiretsu
member firms are likely to receive the executives from parent firms or affiliated firms withmore than 20％ shareholdings. Column 2 provides the results from the specification withnegative pretax income, and shows similar results to those in column 1. In the bank equation ofcolumn 2, while the coefficient on equity ownership by large corporate shareholders is
significantly negative, the coefficient on equity ownership by inside owners is positive andinsignificant.
In columns 3 and 4 in which the dependent variables are executive appointments of banks
and large corporate shareholders as disciplinary devices, the results in columns 3 and 4 of PanelA mirror those in columns 2 and 3 of Table 3. In the bank equations, the coefficients on equity
ownership by large corporate shareholders and equity ownership by inside owners are
significantly negative. As for the results of large corporate shareholders in columns 3 and 4, the17coefficients on industry-adjusted stock return are significantly negative, and the coefficients onequity ownership by large corporate shareholders are significantly positive. The coefficients onfirm age are significantly positive. The coefficients on enterprise keiretsu membership are still
significantly positive. The coefficients on industry-average stock return are significantly
negative.
There is one caveat to the results for executive appointments of large corporate shareholders.
For the dependent variable in columns 1 and 2, if executives of large corporate shareholders are
not appointed to the firms, we label with a value of 0 both firms with large corporateshareholders that send no executives and firms without large corporate shareholders. Given thatbankers are not likely to be appointed to firms with large corporate shareholders, we do not finda negative relation between banker appointments and equity ownership by large corporateshareholders when we use the sample excluding observations of firms without large corporateshareholders. Then we rerun the probit model for a single equation by focusing on the sample
limited to firms with large corporate shareholders. Although the results are not reported in thispaper, we obtain similar results to those in columns 1 and 2 of Panel B. Furthermore, columns 3
and 4 face similar problems to those in the analyses of Section 5. The dependent variables in thelarge corporate shareholder equations have a value of 0 for firms without large corporateshareholders, and firms with large corporate shareholders, including firms that do not accept
executives of large corporate shareholders and firms that receive executives of large corporateshareholders without disciplinary roles on their boards. Then, we conduct a single equation
analysis based on the sample restricted to firms with large corporate shareholders, and obtain
similar results to those in columns 3 and 4 of Panel B.
In Table 4, we estimate the seemingly unrelated bivariate probit model to check therobustness of our findings. The results provide support for our predictions that managerial
entrenchment of controlling shareholders alters the distribution of bankers to firm boards, andbankers are not likely to be appointed to firms with controlling shareholders. Moreover, likebanks, some executive appointments of large corporate shareholders increase with poor stock
performance. We conclude that banks and large corporate shareholders play an important role incorporate governance.

7. Post-appointment performances: banks and large corporateshareholders
Previous results show that bankers are not likely to be appointed to the boards of firms inwhich controlling shareholders dominate. When we limit ourselves to appointments withdisciplinary roles, our results are robust. In this section, we focus attention on post-appointment

18

performances of firms that receive executives with disciplinary roles on the boards. If suchexecutives play an important role in disciplining the managers of firms with poor corporate
performances, the performance of the appointing firms should change as a result.
We follow Kaplan and Minton (1994), and estimate abnormal performance in the aftermathof executives appointments of banks and large corporate shareholders by year. 23 Abnormal
performance is estimated for each fiscal year, ranging from year+1 (one year from executive
appointments) to year+4 (four years from executive appointments). 24 In regressions in which thedependent variables are corporate performances for year t, the executive appointment dummy
variable in year 0 as the base year is included. The coefficient on the appointment dummy
variable captures the average difference in corporate performance between firms that receive
executives with disciplinary roles on their boards and firms that do not. We use four corporate
performance measures; asset growth rate, employment growth rate, sales growth rate, and stock
return. The former three are calculated as the annual change in log difference.
To capture the effects of other characteristics for each dependent variable, we need to use
different set of independent variables in different specifications. In the specification in which
the dependent variable is asset growth rate, the independent variables are the sales growth rate,cash flow ratio (cash flow defined as the after-tax income plus depreciation allowance lessdividends, divided by total assets), leverage (the ratio of total debt to total assets), and firm size(the logarithm of total assets). In the specification in which the dependent variable is theemployment growth rate, we use as independent variables the logarithm of real annual average
wage (nominal annual average wage, divided by value-added deflators), sales growth rate, cash
flow ratio, leverage, and firm size. In the specification in which the dependent variable is thesales growth rate, the independent variables include employment growth rate, growth rate ofdepreciable assets, leverage, and firm size. In the specification in which the dependent variable
is stock return, independent variables are the logarithm of market value (stock price times total
shares outstanding), and book to market ratio (the ratio of total capital at book values to market
value). 25 To avoid the reverse causality problem, one-period-lagged values of all independent
Kaplan and Minton (1994) show that after the executives of banks and nonfinancial firms
arrive at the boards of the appointing firms, the firms' performances do not decline, butrather, they improve modestly. Morck and Nakamura (1999) use event study analysis, andconclude that executives appointed by banks play an essential role in restructuring andearnings recovery of the appointing firms. Hirota and Miyajima (2001) and Miyajima et al.
(2001) study the performances of firms that received new bankers on their boards in theearly 1990s, and provide support for the results in Kaplan and Minton (1994) and Morck andNakamura (1999).
24 We focus on firms with a fiscal year that ends in March, and shareholder meetings in such
firms are generally held in June. When new outside directors are selected at the shareholder
meetings in June, 1993, year+1 corresponds to March, 1994 and year+2 is March, 1995.
25 For the linkage between stock return, market value, and book to market ratio, see, e.g.,
Fama and French (1995).
23

19

variables are included in the four specifications. All regressions include a set of industry dummy
variables, and a set of time dummy variables.
Table 5 reports the results for post-appointment performances of firms that receive
executives of banks and large corporate shareholders as disciplinary actions on their boards. 26
The appointment variables correspond to those in columns 3 and 4 of Table 4. Panel A contains
the results for the post-appointment performance of banks. The asset growth rate in year＋2 andyear+4 are significantly negative. The employment growth rate in year＋1 and year+2 aresignificantly negative. 27 The results can be interpreted as indicating that the appointed bankers
play an important role in restructuring, such as asset disposal and employment reduction.
However, in all four years after appointments of bankers to firm boards, the sales growth rateand stock return are not statistically significant. Taken together, bankers appointed to poor
performing firms play an important role in restructuring firms rather than improving earnings
performance. 28
Panel B contains the results for the post-appointment performance of large corporateshareholders. The asset growth rate in year＋1 is significantly negative but in year+2 issignificantly positive. The results can be interpreted as suggesting that assets are accumulated in
the aftermath of asset disposal. The employment growth rate in year＋1 is significantly negative.
Results for asset growth rate and employment growth rate show that the appointed executives oflarge corporate shareholders play an essential role in the restructuring of the appointing firms.
More importantly, the sales growth rate in year+3 is significantly positive. The stock return inyear+1, year+2, year+3, and year+4 are significantly positive. After the firms accept theexecutives of large corporate shareholders on their boards, earnings performance and stock
performance improve. Large corporate shareholders occupy more essential role in improving
corporate performances.
Table 5 present the results for post-appointment performances after the executive
appointments of banks and large corporate shareholder. In the aftermath of executive
appointments of banks and large corporate shareholders, the appointing firms dispose of assets
We define extreme values for all continuous variables as those that have values morethan four standard deviations from the mean, and remove these variables from our sample.
In addition, to avoid a decrease of sample size with time, corporate performance variablesfrom 1996 to 1999 are included.
27 One argue that the coefficient in year＋1 face the reverse causality problem because theappointment variable and corporate performance variable correspond to the same fiscal year.
However, in empirical tests, we use data on executive appointments at June of the fiscal
year and performance variables at March of the fiscal year. Consequently, the endogenous
problem is not serious.
28 Hirota and Miyajima (2001) provide similar results by focusing on firms under financial
distress. They show that in comparison with oil price shocks (1975-1982), macroeconomic
conditions prevent earnings performance from improving after bankers arrive at firm boardsin the early 1990s.
26

20

and reduce employment. The results for asset sales are consistent with those reported by Kangand Shivdasani (1997), who find that the asset contradiction likelihood increases with the equity
ownership by main bank and blockholders. In addition, for employment reduction, the results
are the same for banks and large corporate shareholders, but more pronounced in banks. Thesefindings are also consistent with those in Kang and Shivdasani (1997), who show that thelikelihood of decrease in employment is positively related to equity ownership by the main bank.
More importantly, for large corporate shareholders, sales growth and stock return of theappointing firms rebound. As a consequence, we conclude that banks and large corporateshareholders exert disciplinary control over management, and then play an important role in thecorporate performance of appointing firms.

8.

Conclusion
We investigate whether managerial entrenchment of controlling shareholders has an

essential impact on the allocation of bankers to the boards of nonfinancial firms. To enjoy
private benefits of control, controlling shareholders generally have incentives to protect the
management against other investors. Consequently, strong incentives for controllingshareholders to entrench managers do not permit bankers to serve on firm boards. We use dataon Japanese manufacturing firms from 1991 to 1995 to test the hypotheses.
We find that bankers are not likely to be appointed to firms with large corporateshareholders. Higher equity ownership by large corporate shareholders, then lower the
likelihood of bankers being appointed to the boards of firms with large corporate shareholders.
The results show that large corporate shareholders have incentives to entrench managers to
pursue the private benefits of control attached to higher ownership, and banks are also
concerned about the potential costs of conflicts of interest between banks and large corporateshareholders. Furthermore, we focus on the appointments of bankers with disciplinary roles as
indicators of the strength of creditor rights. Although the results for large corporate shareholders
hold, firms with inside owners are not also likely to receive bankers with disciplinary roles on
their boards. Higher equity ownership by inside owners, then lower probability of bankers being
appointed to the boards of firms with inside owners. The results show that inside owners have
incentives to protect managers against bankers with disciplinary roles.
To check the robustness of our findings, we use the seemingly unrelated probit model bygathering information on executive appointments of large corporate shareholders. We confirm
the stability of our results for the impact of managerial entrenchment of large corporateshareholders on banker appointments to firm boards. In addition, we find that some executive
appointments of large corporate shareholders increase with poor stock performance, suggesting21

that the executive exerts essential control over the management of the appointing firms. Finally,
after the executives of both banks and large corporate shareholders with disciplinary roles arrive
at firm boards, asset divesture, and employment reduction increase. In particular, executive
appointments of large corporate shareholders play a key role in sales growth, and stock return
performance. Given the results above, banks play a central role in exercising corporate
governance over firms without large corporate shareholders, and large corporate shareholders
serve as disciplinary monitors through the exercise of voting rights attached to securities.
Consequently, managerial entrenchment of large corporate shareholders establishes thesubstitution of role of corporate governance system between banks and large corporateshareholders.

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25

Table 1:
Descriptive statistics for characteristics of Japanese manufacturing firms, 1991-1995
Variables
Appointments of bankers to firm boards
Industry-adjusted stock return of firms

Mean
0.046

MedianStd.dev.

－0.018－0.0300.198

Industry-adjusted ROA－0.003－0.003

0.039

Negative pretax income

0.139Bank loans ratio

0.046

0.032

0.050

Equity ownership by banks

0.040

0.046

0.013

Equity ownership by large corporate shareholders

0.371

0.346

0.126

Equity ownership by inside owners

0.123

0.086

0.082

Firm size

10.97710.855

1.320

Firm age

3.957

3.951

0.301

－0.072－0.0790.173

Stock return of banks
Financial keiretsu membership

0.328

Enterprise keiretsu membership

0.141

Industry-average stock return－0.102－0.107

0.155

0.034

0.031

0.200

Industry-average ROA

The table reports mean values, median values, and standard deviations for 4262 observations of Japanese manufacturing firms witha fiscal year that ends in March, from 1991 to 1995. Financial statements data are obtained from the Nikkei Needs Financial dataset.
Banker appointments have a value of 1 if new executives previously employed by main bank are appointed to the boards ofnonfinancial firms, and 0 otherwise. Main bank is defined as the bank first listed in Japan Company Handbook. Data on banker
appointments come from Yakuin Shikihou and Yuka Shoken Hokokusho. Stock returns of firms and banks are defined as dividends
per share plus stock price at the last day of the fiscal year less stock price at the last day of the previous fiscal year, divided by stock
price at the last day of the previous fiscal year. Industry-adjusted stock return of firms is calculated as each firm's stock return lessthe industry-average stock return. Return on assets (ROA) is defined as pretax income, divided by the average of total assets for theprevious and current years. Industry-adjusted ROA is calculated as each firm's ROA less industry-average ROA. Negative pretax
income has a value of 1 if pretax income is negative, and 0 otherwise. The bank loans ratio is the share of main bank loans
outstanding to total assets. Equity ownership by banks is the share of equity ownership by main bank. Equity ownership by large
corporate shareholders is the ratio of equity ownership held by the nonfinancial firm that has more than 20 ％ shareholdings as the
top shareholder. Equity ownership by inside owners is the ratio of equity ownership held by the president or chairman as the top
shareholder. Data on main bank loans, equity ownership by main bank, equity ownership by large corporate shareholders, and equity
ownership by inside owners come from Kigyo Keiretsu Soran. Firm size is defined as the logarithm of total assets. Firm age is thelogarithm of the years elapsed since establishment. Financial keiretsu membership takes on a value of 1 if the firm is one of theeight financial keiretsu members, and 0 otherwise. Enterprise keiretsu membership takes on a value of 1 if the firm is one of theeighteen enterprise keiretsu members, and 0 otherwise. Data on identification of financial and enterprise keiretsu membership comefrom Industrial Groupings in Japan and Japan Company Handbook. Industry-average variables for stock return of firms and ROA
are the average values of the industry in the fiscal year.

26

Table 2:
Managerial entrenchment and banker appointments to firm boards
Independent variables
Industry-adjusted stock return of firms
Industry-adjusted ROA

(1)

(2)

(3)

－0.139(0.179)－1.464(1.022)－0.118(0.180)－1.824*(0.977)－0.154(0.181)0.072***(0.028)－0.044(0.115)－0.551(0.344)0.096(0.071)1.517***(0.606)－1.667(2.292)2.887***(0.669)9.539**(3.860)－1.155***(0.273)
1.183(0.942)0.054*(0.028)－0.028(0.113)－0.531(0.349)0.126*(0.074)1.645***(0.614)－2.377(2.308)0.147(0.103)3.081***(0.641)9.485**(3.901)－1.137***(0.276)1.071(0.941)0.057**(0.029)-0.028(0.114)－0.538(0.347)0.131*(0.074)
1.607***(0.609)－1.364(2.299)No. of observations

4262

4262

4262

Pseudo R2

0.050

0.065

0.063

Negative pretax income
2.826***(0.668)16.113***(3.118)Bank loans ratio
Equity ownership by banks
Equity ownership by large corporate shareholders
Equity ownership by inside owners
Firm size
Firm age
Stock return of banks
Financial keiretsu membership
Industry-average stock return
Industry-average ROA

The table reports probit regression estimates for 4262 observations of Japanese manufacturing firms from 1991 to 1995. The
dependent variable takes on a value of 1 if new executives previously employed by main bank are appointed to the boards ofnonfinancial firms, and 0 otherwise. Definitions of independent variables are provided in Table 1. One-period-lagged values of the
independent variables are included in the regressions. All regressions include a set of time dummy variables. ***, **, and * indicate
significance at the 1％, 5％, 10％ levels, respectively. Standard errors in parentheses are robust to heteroskedasticity.

27

Table 3:
Managerial entrenchment and banker appointments to firm boards as disciplinary devices
Independent variables
Industry-adjusted stock return of firms
Industry-adjusted ROA

(1)

(2)

(3)

－0.963***(0.289)－9.255***(1.081)－0.965***(0.292)－9.234***(1.088)－1.059***(0.276)

0.108***(0.040)0.199(0.170)0.422(0.484)－0.024(0.110)2.264***(0.850)－14.528***(0.377)2.780***(0.825)12.030**(5.915)－0.913**(0.368)－5.868*(3.169)0.080*(0.042)0.163(0.178)0.512(0.498)－0.029(0.111)2.400***(0.867)－14.854***(3.789)0.582***(0.126)3.390***(0.797)
10.463**(5.830)－0.877**(0.368)－6.038*(3.107)0.074*(0.041)
0.149(0.181)0.407(0.467)－0.022(0.109)2.049**(0.818)－9.235**(3.823)

No. of observations

4262

4262

4262

Pseudo R2

0.174

0.185

0.156

Negative pretax income
2.612***(0.814)17.774***(5.218)Bank loans ratio
Equity ownership by banks
Equity ownership by large corporate shareholders
Equity ownership by inside owners
Firm size
Firm age
Stock return of banks
Financial keiretsu membership
Industry-average stock return
Industry-average ROA

The table reports probit regression estimates for 4262 observations of Japanese manufacturing firms from 1991 to 1995. The
dependent variable takes on a value of 1 if new executives previously employed by main bank are appointed to the boards ofnonfinancial firms that experience an interest coverage ratio (the ratio of operating income to interest payments) of less than 1 at theend of the previous fiscal year. Definitions of independent variables are provided in Table 1. One-period-lagged values of the
independent variables are included in the regressions. All regressions include a set of time dummy variables. ***, **, and * indicate
significance at the 1％, 5％, 10％ levels, respectively. Standard errors in parentheses are robust to heteroskedasticity.

28

Table 4:
Managerial entrenchment and banker appointments to firm boards: robustness checks
Panel A: Banks
Independent variables
Industry-adjusted stock return of firms
Industry-adjusted ROA

(1)

(2)

(3)

(4)

－0.118(0.180)－1.823*(0.977)－0.154(0.181)－0.960***(0.290)－9.241***(1.088)－1.054***(0.275)

Negative pretax income
Bank loans ratio
Equity ownership by banks
Equity ownership by large corporate shareholders
Equity ownership by inside owners
Firm size
Firm age
Stock return of banks
Financial keiretsu membership
Industry-average stock return
Industry-average ROA

2.888***(0.668)9.550**(3.856)－1.151***(0.271)
1.181(0.943)0.054*(0.028)－0.028(0.113)－0.531(0.349)0.126*(0.074)1.643***(0.612)－2.377(2.308)29

0.147(0.103)3.082***(0.640)9.500**(3.900)－1.134***(0.273)1.069(0.942)0.057**(0.028)－0.028(0.114)－0.538(0.347)0.131*(0.074)1.606***(0.608)－1.364(2.298)2.788***(0.823)12.297**(5.941)－0.891**(0.367)－5.897*(3.171)0.081**(0.041)0.160(0.177)0.526(0.496)－0.032(0.111)2.393***(0.868)－14.792***(3.773)0.582***(0.126)
3.396***(0.795)10.628*(5.858)－0.862**(0.367)－6.057*(3.109)0.074*(0.040)0.146(0.181)0.414(0.460)－0.024(0.109)2.042**(0.819)－9.202**(3.813)

Table 4:
Continued
Panel B: Large corporate shareholders
Independent variables
Industry-adjusted stock return of firms
Industry-adjusted ROA

(1)

(2)

(3)

(4)

0.220
(0.146)－0.075(0.758)0.207(0.144)－4.067***(0.337)－0.702(1.255)－4.075***(0.340)3.597***(0.151)－0.072***(0.025)－0.033(0.095)0.035(0.064)0.411***(0.077)－0.656(0.537)－2.845(2.015)－0.056(0.086)3.601***(0.151)－0.074***(0.025)－0.031(0.095)0.036(0.064)0.413***(0.077)－0.656(0.538)－3.124(2.054)3.064***(0.253)－0.004(0.043)0.284*(0.161)0.103(0.107)0.438***(0.125)－1.967**(0.946)0.016(3.221)－0.008(0.137)3.074***(0.254)－0.007(0.043)0.290*(0.161)0.108(0.107)0.440***(0.125)－1.980**(0.946)－0.000(3.335)ρ

－0.010－0.009－0.123－0.078p-value(0.899)(0.911)(0.387)(0.544)

No. of observations

4262

4262

4262

4262

Negative pretax income
Equity ownership by large corporate shareholders
Firm size
Firm age
Financial keiretsu membershipEnterprise keiretsu membership
Industry-average stock return
Industry-average ROA

The table reports seemingly unrelated bivariate probit estimates for 4262 observations of Japanese manufacturing firms from 1991 to 1995.
Panel A contains results for the determinants of executive appointments of banks. Panel B contains results for the determinants of executive
appointments of large corporate shareholders. The dependent variables in columns (1) and (2) take on a value of 1 if new executives previously
employed by main bank are appointed to the boards of nonfinancial firms, and 0 otherwise in the bank equation, and take on a value of 1 if
new executives previously employed by large corporate shareholders with more than 20 ％ shareholdings are appointed to the boards ofnonfinancial firms, and 0 otherwise in the large corporate shareholder equation. The dependent variables in columns (3) and (4) take on a valueof 1 if new executives previously employed by main bank are appointed to the boards of nonfinancial firms that experience an interest
coverage ratio (the ratio of operating income to interest payments) of less than 1 at the end of the previous fiscal year, and 0 otherwise in thebank equation, and take on a value of 1 if new executives previously employed by large corporate shareholders with more than 20 ％shareholdings are appointed to the boards of nonfinancial firms that experience a stock return that is in the lowest one-fourth for each industry
at the end of the previous fiscal year in the large corporate shareholder equation. Definitions of independent variables are provided in Table 1.
One-period-lagged values of the independent variables are included in the regressions. All regressions include a set of time dummy variables.
***, **, and * indicate significance at the 1％, 5％, 10％ levels, respectively. Standard errors in parentheses are robust to heteroskedasticity.

30

Table 5:
Corporate performances in the aftermath of executive appointments
Panel A: Banks
Asset growth

Employment growth

Sales growth

Stock return

Year + 1－0.012(0.010)－0.019**(0.008)－0.010(0.009)－0.020(0.024)

No. of observations

4404

4366

4351

4349

－0.018*(0.009)－0.025**(0.010)－0.016(0.010)－0.021(0.024)

4397

4353

4364

4347

－0.009(0.008)－0.012(0.008)0.007(0.011)－0.034(0.025)

4387

4348

4372

4331

－0.022***(0.009)－0.007(0.005)－0.013(0.010)－0.008(0.036)

4388

4344

4363

4314

Year + 2
No. of observations
Year + 3
No. of observations
Year + 4
No. of observations

31

Table 5:Continued
Panel B: Large corporate shareholders
Asset growth

Employment growth

Sales growth

Stock return

Year + 1－0.015**(0.007)－0.012**(0.005)－0.004(0.008)0.037*(0.021)

No. of observations

4303

4273

4251

4311

Year + 2

0.016**(0.008)0.004(0.004)0.003(0.008)0.044*(0.023)

No. of observations

4297

4258

4263

4298

Year + 3

0.002(0.007)0.003(0.006)0.016*(0.009)0.055**(0.025)

No. of observations

4288

4255

4276

4279

Year + 4

0.005(0.008)0.002(0.004)0.012(0.009)0.038*(0.021)

No. of observations

4293

4254

4270

4259

The table reports corporate performances in the aftermath of executive appointments of bankers and large corporate shareholders. Dependent
variables are the total asset growth rate, employment growth rate, sales growth rate, and stock return. Results in the table show coefficients andstandard errors from regressions of corporate performances against dummy variables for executive appointments of bankers and large
corporate shareholders as disciplinary devices. Executive appointments of banks as disciplinary devices take on a value of 1 if new executives
previously employed by main bank are appointed to the boards of nonfinancial firms that experience an interest coverage ratio (the ratio of
operating income to interest payments) of less than 1 at the end of the previous fiscal year, and 0 otherwise. Executive appointments of large
corporate shareholders as disciplinary devices take on a value of 1 if new executives previously employed by large corporate shareholders withmore than 20 ％ shareholdings are appointed to the boards of nonfinancial firms that experience a stock return that is in the lowest one-fourthfor each industry at the end of the previous fiscal year. In the specification in which the dependent variable is the asset growth rate, theindependent variables are the sales growth rate, cash flow ratio (cash flow defined as the after-tax income plus depreciation allowance lessdividends, divided by total assets), leverage (the ratio of total debt to total assets), and firm size. In the specification in which the dependent
variable is the employment growth rate, independent variables are the logarithm of the real annual average wage (nominal annual average
wage, divided by value-added deflators), sales growth rate, cash flow ratio, leverage, and firm size. In the specification in which the dependent
variable is the sales growth rate, the independent variables are the employment growth rate, growth rate of depreciable assets, leverage, andfirm size. In the specification in which the dependent variable is the stock return, the independent variables are the logarithm of market value(stock price times total shares outstanding), and book to market ratio (the ratio of total capital at book values to market value). To avoid adecline in sample size over time, corporate performance variables from 1996 to 1999 are added to basic sample. One-period-lagged values of
the independent variables are included in the regressions. Because observations of extreme values for continuous variables are removed, thenumber of observations varies in any regression. All regressions include a set of industry dummy variables and a set of time dummy variables.
***, **, and * indicate significance at the 1％, 5％, 10％ levels, respectively. Standard errors in parentheses are robust to heteroskedasticity.

32