ID:JJF00303

Title:

Do foreign institutional investors promote governance improvements
in Japan?

Author:Rehman Mian
Kyoko Nagata

Pages:

29-54

Is Part Of:

Japan Journal of FinanceVol. 35 / No. 1.2
Dec. 2015

Publisher

Japan Finance Association

ISSN:

2186-3792

経営財務研究第 35 巻第 1・2 合併号■論文

Do Foreign Institutional Investors Promote GovernanceImprovements in Japan? ＊Rehman MIAN

（Tokyo Institute of Technology）

Kyoko NAGATA（Tokyo Institute of Technology）
Abstract

In this paper, we investigate whether foreign institutional ownership affects quality of corporate
governance by analyzing equity ownership and investment horizon of foreign investors. While anumber of studies indicate that foreign institutional investors play a significant role in promoting
governance improvements in countries with weaker shareholder protection, there is little evidence
about their impact in countries with strong shareholder rights. In line with extant evidence, ourresults show that foreign ownership is positively associated with corporate governance in Japan,
where shareholder rights are legally better protected than those in other countries like theUnited States, the home of the major institutional investors, but in fact the corporate governancehas been shareholder-unfriendly due to the presence of management-friendly crossshareholders. On the other hand, we do not find evidence that foreign block-holders with longer
investment horizons play a larger role in improving governance although literature suggeststhat such stable owners have greater incentives to actively monitor the firms. Similar evidence
is found for large independent domestic institutions. In contrast, both the equity ownershipand investment horizon of large domestic investors such as banks and insurance companies,
who have potential business relationships with the invested firms, negatively impact corporate
governance. Interestingly, such negative effect of relationship-oriented ownership is more likely
to be mitigated when foreign institutional investors hold large stakes in the firms. Overall, ourresults suggest that foreign equity ownership promotes improvements in corporate governance ofJapanese firms irrespective of their investment horizons.
Keyword：Foreign institutional investors; Domestic Investors; Corporate Governance; Investment
Horizon*We are deeply grateful to Professor Kengo Shiroshita, the managing editor, and two anonymousreferees, for their insightful comments and suggestions that helped in further developing thestudy. We would also like to thank the financial support from Ishii Memorial Securities Research
Promotion Foundation.

29

経営財務研究第 35 巻第 1・2 合併号

１

Introduction

The effect of foreign institutional investors on corporate governance has attracted much attention
in the recent literature. Gillan and Starks（2003）indicate that foreign institutional investors
promote improvements in governance structures through external monitoring. Using international
data on equity holdings, Ferreira and Matos（2008）document that firms with high foreign andindependent institutions have higher firm value and better operating performance due to thearms-length monitoring ability of these investors. Aggarwal, Erel, Ferreira, and Matos（2011）
find a more direct evidence that equity ownership by foreign institutional investors is related toenhancement in the quality of corporate governance in countries with weaker investor protection.
In a similar vein, Garner and Kim（2013）show that foreign investors encourage better corporate
governance practices using a sample of Korean firms. While a number of studies indicate that
foreign institutions play a significant role in promoting governance improvements in countries
where investor protection is weaker than the institutionsʼ home country, less is known about theirimpact in countries like Japan, where shareholder rights are legally strong.
In this paper, we examine the impact of foreign institutional investors on corporate governanceof Japanese firms. Japanese data provides a unique environment for our study in several points.
First, shareholdersʼ rights under Japanese law are among the strongest in the world and are“legally” better protected than the United States, the home of major institutional investors（Goto,
2014）. Shareholders are granted power to alter a corporate charter without the consent of theboard, majority voting for board elections, power to control dividend payments, power to replace
the board of directors, and shareholders access to corporate ballots1. In Spamann（2010）, Japanscored the highest for shareholder protection in 1996 and the fourth highest in 2005. Nevertheless,in fact, the corporate governance has not really been “shareholder-friendly” due to the traditional
ownership structure in Japan, which has been mostly dominated by stable cross-shareholders2.
Goto（2014）argues that “too strong” shareholdersʼ legal rights induce managers to engage in crossshareholding relationships, which in turn, weakens the rights of other shareholders in practice.
Therefore, in Japan, even though shareholdersʼ legal rights are quite strong, it is more likely that
foreign institutional investors have a significant effect on corporate governance. Second, recentchanges in corporate ownership structure along with the reforms in regulatory environment offers
an interesting setting for our study. As briefly discussed above, the corporate ownership structure
was mostly dominated by banks and stable cross-shareholders, and main banks used to have

1

2

30

Kaisha-ho [Companies Act], Law No. 86 of 2005（Japan）[hereinafter JCA], available at http://
www.cas.go.jp/jp/seisaku/hourei/data/CA1_4_2.pdf and http://www.cas.go.jp/jp/ seisaku/hourei/data/
CA5_8.pdf（English translation of JCA as of Dec. 15, 2006）.
For detailed discussion about cross-shareholdings, see for example, Prowse（1992）.

経営財務研究第 35 巻第 1・2 合併号

close business relationships with client firms within keiretsu and acted as the provider of capitaland governance（Prowse, 1992; Aoki, Patrick, and Sheard, 1994; Morck and Nakamura, 1999;
Kaplan and Minton, 1994; Kang and Shivdasani, 1995; Hoshi, Kashyap, and Scharfstein, 1990）.
In 1991, Japanese banks owned 16.3% of the shares listed on the Tokyo Stock Exchange（TSE）.
However, the deregulation of financial markets in the early 2000s resulted in weakening of mainbank influence. For instance, due to the Act on “Limitation on Shareholding by Banks and Other
Financial Institutions” issued in 2001, banks drastically reduce their shareholdings. Coupled withthe reduction in barriers for foreign investors to enter the Japanese market during this period, thedecreased bank ownership has led to a substantial increase in foreign equity ownership during
this period. According to Tokyo Stock Exchange（TSE）, while the bank share ownership fell from
16.3%（1991）to 2.7%（2011）, equity ownership by foreign institutional investors dramaticallyincreased from 5.4% to 22.8% and became one of the major shareholders of Japanese firms. Since
large institutional investors have incentives and potential abilities to monitor and confront firmʼs management（Shleifer and Vishny, 1986; Kang and Stulz, 1997; Gillan and Starks, 2003; Hamao,
Kutsuna, and Matos, 2011）, increase in foreign ownership, especially with the legally strong
shareholdersʼ rights, could be a constructive addition to the transition of Japanese corporate
governance to a more market oriented structure.
In testing the impact of foreign institutional ownership, we use multiple measures to capture
their monitoring incentives. First one is the fraction of the firmʼs total shares outstanding owned
by foreign institutional investors, which is common in the literature. In addition, we use several
alternative measures of investment horizon（ownership stability）of foreign block-holders, since
the incentive and ability of investors to engage in improving governance practices are more likely
to increase with their investment horizon. Bushee（1998）shows that compared to transient
owners, institutions with long-term investments more actively monitor the firms. Stable owners
have greater incentives to engage in monitoring for longer and ongoing basis, and therefore they
may be able to bring about improvements in the quality of corporate governance（Elyasianiand Jia, 2010; Attig, Cleary, Ghoul, and Guedhami, 2012）. In addition, whether the long-term（stable）foreign institutional investors have a more significant effect on governance is likely to be
especially an interesting question in the Japanese setting, given the presence of traditional “stable”
institutional investors. Using Japanese data, Shinozaki, Moriyasu, and Uchida（forthcoming）findthat stable shareholders who receive benefits from long-term business relations have a negative
effect on governance, whereas firms mainly owned by arms-lengths investors including foreign
institutions adopt good governance practices. Coupled with identifying their incremental impact on
the governance of firms from strong shareholder protection market, this study adds new evidence
to the literature by investigating how foreign shareholders with longer investment horizons affectcorporate governance. This study also offers an insight into whether the negative effect of domestic
shareholders with long-term business relations on governance can be mitigated by the increased
presence of foreign institutional shareholders.
Consistent with prior evidence, our results show that the fraction of firmʼs total shares
31

経営財務研究第 35 巻第 1・2 合併号

outstanding owned by foreign investors is positively associated with corporate governance ofJapanese firms, whereas we do not find evidence that foreign block-holders with stable investment
horizons play a larger role in improving corporate governance. Similar results were found forlarge independent domestic institutional investors; their equity ownership has positive effect on
governance but their investment horizon does not have additional effect. In contrast, both theequity ownership and investment horizon of large domestic investors such as banks and insurancecompanies, who have potential business relationships with invested firms, negatively impact
corporate governance. Interestingly, however, the negative effect of relationship-oriented ownershipis mitigated when foreign institutional investors hold large stakes in the firms, suggesting that
foreign block-holders have the ability to confront the traditional relationship-oriented shareholders.
Overall, our results suggest that foreign equity ownership promotes improvements in corporate
governance of Japanese firms.
This paper is organized as follows: Section 2 provides an overview of the previous literature anddevelops the hypothesis. Section 3 describes the sample, variables employed, and their calculations.
Section 4 presents the empirical results. Summary and conclusion are presented in section 5.

２

Hypothesis Development

Gillan and Starks（2003）indicate that foreign institutional investors have the ability to enforcechanges in governance through direct or in-direct interventions, and therefore, can improve thequality of corporate governance in place. Using international data, Ferreira and Matos（2008）show
that because foreign institutional investors have fewer business relations with the invested firms,
they are effective monitors and are able to exert pressure on firmʼs management which in turnresults in enhanced shareholder value and increased firm performance. Aggarwal, Erel, Ferreira,and Matos（2011）also use an international dataset and find a more direct evidence that equity
ownership by foreign institutional investors is related to enhancements in the quality of corporate
governance in countries with weaker investor protection.
In terms of shareholdersʼ protection, Japan is among the strongest in the world（Spamann,
2010; Goto, 2014）. However, the interests of large relationship-oriented shareholders were more
dominant than minority shareholders（Aguilera and Jackson, 2003）. Main banks have been the
primary monitors and disciplinarians of Japanese firms, where ownership was mostly concentrated
among main banks and stable cross shareholders（Prowse, 1992）. As discussed in extant literature,such traditional system is more likely to prioritize business relationships over shareholder returns.
For example, Weinstein and Yafeh（1998）find suboptimal performance for firms with close mainbank relationships. Similar findings are reported in Kang and Stulz（2000）, Kang and Shivdasani（1999）, and Wu and Xu（2005）. In recent years however, the Japanese firmsʼ ownership structure
witnessed considerable changes due to a series of reforms in the regulation of financial markets（Miyajima and Kuroki, 2007; Hoshi and Kashyap, 2010）. For example, the Act on “Limitation on
Shareholding by Banks and Other Financial Institutions” was issued in 2001, which stipulates that32

経営財務研究第 35 巻第 1・2 合併号

each bankʼs shareholdings should be less than the amount of its Tier 1 core capital. As a result of
decrease in their equity holdings, the influence of main bank weakened. The financial deregulation
also led to a substantial increase in foreign institutional ownership in the early 2000s as seen in
Figure 1, making them one of the major shareholders in Japan. The increase in foreign institutional
ownership brought significant changes in the ownership structure of firms and resulted in a shift
in the balance of power between corporate insiders and outside shareholders（Hamao, Kutsuna,and Matos, 2011）. Therefore, increase in foreign ownership may be a constructive addition to thetransition of Japanese corporate governance from the previously bank dominated to a market
oriented corporate governance structure. Based on the above discussion, we hypothesize that firms
in Japan adopt good governance practices after the increase shareholdings by foreign institutional
investors. More formally:
H1a : Equity ownership by foreign institutional ownership leads to improvements in corporate
governance practices.
Our expectations for the positive impact of foreign institutional investors on the quality ofcorporate governance is based on the assumption that foreign investors are independent and haveno close business relationship with the firms in which they hold equity stakes. In a similar manner,
domestic institutional investors that are not bound by commercial ties may potentially facilitate
better governance practices as reported in Aggarwal, Erel, Ferreira, and Matos（2011）. In contrast,
investors who have business ties with the invested firms are reluctant to challenge managerial
decisions because they are unwilling to lose their business relationships（Brickley, Lease, andSmith, 1988）. Based on their potential business ties, previous research classifies institutional
shareholders as relationship-oriented（potentially passive monitors）and independent（active
monitors）investors（Brickley, Lease, and Smith, 1988; Almazan, Hartzell, and Starks, 2005;
Cornette, Marcus, Saunders, and Tehranian, 2007; Chen, Harford, and Li, 2007; Elyasiani and Jia,
2010）.
Similarly, in the case of Japan, domestic investors can be grouped into “antei kabunushi” or“seisaku toushika” meaning stable shareholders（such as banks and insurance companies）, andmarket investors（Gedajlovic, Yoshikawa, and Hashimoto, 2005）. In addition to their equity stakes,
stable investors usually have commercial ties with the invested firms such as lending, insurance
sales, and other financial transactions. In contrast, since market investors mainly seek to maximize
their financial returns on equity investments, they are independent from business relationships
with the firms in which they hold shares. Shinozaki, Moriyasu, and Uchida（forthcoming）positthat compared to the relationship-oriented stable shareholders, firms mainly owned by foreign andindependent institutional investors tend to adopt good governance practices. Hence, there could
be a large variation in the effectiveness of monitoring performed by investors with and without
having close business relations with the firms. Although our primary focus is on the role of foreign
institutional investors, it would be interesting to further investigate how the relationship-oriented
33

経営財務研究第 35 巻第 1・2 合併号

and independent domestic investors impact the quality of governance. As discussed above, we
propose that the former have a positive effect on corporate governance.
H1b : Domestic investorsʼ type that is less likely to keep business relations with the invested
firms（independent domestic institutions）is positively related to corporate governance.
The increase in foreign institutional shareholdings discussed above may not necessarily meanthat all the foreign institutional investors in Japan actively and efficiently perform a monitoringrole that leads to improvement in governance practices. While some investors could have moreexpertise, information, and incentives to be involved in monitoring firmsʼ management, there
could also exist short-term foreign investors who are less committed to intervene in corporate
governance of individual firms since they may hold or sell equity stakes based on their investment
portfolio rebalancing needs. Davis and Steil（2001）argue that foreign shareholders generally holddiversified portfolios of small stakes in many firms, thereby characterizing them as investors who
actively engage in frequent trading based on information. Such short-term investors are less likely
to influence management, and therefore are not expected to have a significant impact on corporate
governance. In contrast, Bushee（1998）shows that institutions with long-term investments infirms more actively monitor than the transient owners. In a similar vein, Elyasiani and Jia（2010）
argue that institutional investors with stable investment horizons have sufficient opportunities tolearn about the invested firm in addition to greater incentives to effectively and frequently monitor
the firm. Also, Attig, Cleary, Ghoul, and Guedhami（2010）document that institutional investors
with longer investment horizons have expertise and incentives to monitor the management, which
in turn mitigate the agency problems and information asymmetry. Similar arguments are alsopresented in Chen, Harford, and Li（2007）. According to these arguments, foreign institutional
investors with longer investment horizons have efficiencies and ample monitoring incentives,
enabling them to bring about governance improvements.
Figure 1

Proportion of Foreign Shares in Japanese Stock Market

30.0%

25.0%
20.0%
15.0%
10.0%

5.0%
0.0%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Foreign Institutional Investors（Data Source: Tokyo Stock Exchange Website）

34

経営財務研究第 35 巻第 1・2 合併号

H2 : Foreign institutional investors with longer investment horizons are positively associatedwith corporate governance.

３

Data and Variables

3.1 Sample
The sample consists of all Japanese publicly traded firms3 with complete data. The data istaken from a number of sources. We obtain firm-specific financial information and shareholdingsʼ
proportion data for both foreign and domestic investors from Nikkei Economic Electronic Database
System Financial Quest（NEEDS FQ）. Individual data for foreign institutional investors,
domestic institutional investors, and other financial institutions such as banks and insurancecompanies, is obtained from the Top 30 Major Shareholders Database in NEEDS FQ. The Top 30
Major Shareholders Database contains individual data for the 30 largest shareholdersʼ common
stock holdings of Japanese securities. In this database, shareholders are classified into individual
investors, non-financial companies, banks, insurance companies, securities, financial holdings, credit
and leasing, funds and trusts, and foreigners. Corporate governance data is taken from NEEDS
Corporate Governance Evaluation System database（NEEDS CGES）. To address the endogeneityof foreign institutional ownership, we obtain data for the constituents of Morgan Stanley Capital
All Country World Index（MSCI）from Thomson Financial. Data for American Depository Receipt（ADR）listings is taken from www.adr.com. The sample period of our study extends from 2008 to
2011. Since the individual data for foreign and domestic individual investors was made available
only after 20034 and it requires a 5 year time span to calculate the investment horizon of foreign
institutional investors, we begin in 2008. We drop financial firms, utility firms, and firms with
unavailable data. This restricts our sample to 10,009 firm-years from 2,831 non-financial firms. In
order to control for the effect of outliers, we winsorize firm level ratios at 1% and 99% levels.

3.2 Corporate Governance Measurement
Our measure of corporate governance, governance score（Gov-Score）, emphasizes on the qualityof firmʼs internal controls and includes 19 attributes from three major dimensions: board structure,3

Firms listed on Tokyo Stock Exchange, Osaka Stock Exchange, Nagoya Stock Exchange, Fukuoka
Stock Exchange, Sapporo Stock Exchange, and Hercules.

4

In the Top 30 Major Shareholders Database, flags representing the stock holdings each investor
type are available after 2003.

35

経営財務研究第 35 巻第 1・2 合併号

ownership concentration and compensation, and disclosure. Each governance attribute consistsof a score between 1 and 5, where a high score indicates improvements in the quality of corporate
governance. The scores are provided by NEEDS-CGES and are formed based on the underlying
value of individual governance attributes. We explain the items comprising each sub-index below.
3.2.1

Board Structure

Empirical evidence points to the significance of board structure in directly monitoring themanagement and imposing effective internal controls that lead to reduction in agency costs andimproved firm performance. In terms of size, previous literature points to a negative relation
between board size and firm performance, depicting that smaller boards are associated with theincreased ability to efficiently coordinate and control the firmʼs management（Yermack, 1996;
Eisenberg, Sundgren, and Wells, 1998）. Furthermore, the effectiveness of boardʼs monitoring
increases when it is composed of independent directors. Boards with outside directors are
considered to be more independent and have greater control over managerial decisions（Famaand Jensen, 1983; John and Senbet, 1998）. In the case of Japan, before 1997, the governancestructure was traditionally characterized by larger boards that mainly comprised of promoted
employees within the firm and directors from firmsʼ main banks or parent company（Miyajima,2007）. Japanese corporate boards primarily engaged in managing, rather than monitoring themanagement. Moreover, the conventional board system included board of directors and thestatutory auditors who were responsible for monitoring the board. Yet, the effectiveness of statutory
auditors in monitoring the board was not guaranteed as they were often chosen from firmʼsemployees（Chernobai and Yasuda, 2013; Shishido, 2007）.
However, since the financial crisis in the late 1990s, firms in Japan began to implement changes
in their board structure by appointing outside directors, introducing the executive officer system,and decreasing the number of board members5 . In addition to the firmsʼ own attempt to implement
governance reforms, country level legal reforms were also introduced. To clearly separate themonitoring and execution functions of the board, the Commercial Law was revised in April 2003
which enabled Japanese firms to choose between the statutory auditor system and a committee
style system similar to that adopted by U.S. listed firms. In addition, the board of directors ofcommittee style companies are mandated to have to three committees, namely, the nominating
committee, audit committee, and the compensation committee. Each committee comprises of atleast three directors with majority being outsiders（Chernobai and Yasuda, 2013）. Similarly, thecompulsory requirement set forth by the Tokyo Stock Exchange in December 2009 to have at least

5

The first notable example of firmsʼ own attempt to reform the board of directors was commenced bySony in 1997. For instance, Sony added outsiders to the board along with reducing the board sizeby adopting executive officer system（Chernobai and Yasuda, 2013）36

経営財務研究第 35 巻第 1・2 合併号

one outside director or auditor further intends to facilitate the independence of corporate boards6.
With respect to the impact of foreign institutional investors on board structure of Japanese firms,
Miyajima（2009）shows that firms with high equity ownership by foreign investors are more likely
to implement governance reforms such as reduction in board size, appointment of outside directors,
and adopting an executive officer system.
Based on preceding discussion, we include several variables related to board structure. The
board structure sub-index covers several attributes that incorporate significant aspects of board of
directors such as board size, independence, and composition. The board structure attributes include
number of board of directors（BRD_NUM）, number of insider directors（J_NUM）, proportion ofoutside directors（IDRTO）, proportion of non-executive outside directors（NEIDRTO）, proportionof auditors among board members（ADTRTO）7, proportion of interlocking directors（EXERTO）8,
committee style system（FLG_COMM）, and frequency of board renewal（TNEED）9. NEEDS-CGES
uses reverse scoring criterion for three board structure attributes: number of board of directors,
number of insider directors, and proportion of interlocking directors. High scores are assigned tosmaller boards, lower proportion of insider executives, higher proportion of outside directors, higher
proportion of non-executive outside directors, committee style system, lower proportion of directors
who hold executive positions in other firms, proportion of auditors among board members, andfrequent board renewals.
3.2.2

Ownership and Compensation

Attributes from ownership and compensation deal with the level and effectiveness of monitoring.
Jensen and Meckling（1976）posit that managerial ownership can help align the interests ofmanagers with that of shareholders and therefore positively affects the firm value. Similarly,
McConnel and Servaes（1990）show that managerial ownership leads to an increase in the value offirm. In the case of Japanese firms, Okabe（2004）argues that equity ownership by directors leads
to an increase in their incentives and positively impacts the performance. In terms of incentive

6

Since 2010, the Tokyo Stock Exchange requires its listed companies to secure at least one“independent director /auditor”（Dokuritsu Yakuin）, which means a director or statutory auditor
who is unlikely to have conflicts of interest with general investors（Tokyo Stock Exchange

7

Securities Listing Regulations, Rule 436-2）（Goto, 2014）.
The presence of auditors provides the board with the means to perform the monitoring role8

efficiently（Aman & Nguyen, 2008）.
Firms may appoint employees from affiliated firms as outside directors（Yoshikawa & McGuire,92008）.
In case of persistent evidence of low firm performance, board renewals may lead to improved firm
performance.

37

経営財務研究第 35 巻第 1・2 合併号

schemes for top managers such as stock options that were first introduced in 1997 in Japan,
Shinozaki, Moriyasu, and Uchida（forthcoming）argue that only one third of the listed firms adopt
such compensation plans. They find that firms in Japan are more likely to adopt stock option plans
when arms-length shareholders such as foreign and domestic institutional investors own a higher
stake. The ownership and compensation sub-index therefore focuses on the shareholding ratio ofoutside directors（IDIR）, CEO stock ownership（CEOOWN）, and stock option plans（SO）.
3.2.3

Disclosure

In the last sub-index of our governance measure, we focus on governance attributes that deal
with the disclosure quality. We include several attributes to capture the quality of firmsʼ disclosures.
We use the number of audit opinions（AOP3）, changes in accounting policies（APCHG3）, earnings
announcement timing（ATRM）, shareholders meeting concentration ratio（AGMC）, disclosure of
executive remuneration（DSC_CMPS_D）, disclosure of total audit fee（DSC_CMPS_A）, usability offirmʼs information（WEBEVL2）, and sufficiency of firmʼs information on its website（WEBEVL3）.
Firms scoring high on disclosure have less audit opinions, less changes in accounting policies,
timeliness of earnings announcement, high shareholder meeting concentration ratio, active
disclosure of executive remuneration and audit fee, and ample information available on firmʼswebsite.
The governance attributes selected in this paper are similar to Aman and Nguyen（2008）,
and Chernobai and Yasuda（2013）. Figure 2 shows average scores of the firm level governanceattributes across the sample period 2008-2011. Respective scores of all governance attributes fromeach sub-index are aggregated to arrive at our measure of corporate governance, the governancescore denoted as percentage（Gompers, Ishii, and Metrick, 2003; Aggarwal, Erel, Ferreira, andMatos, 2011）.
Figure 2

Individual Governance Attributes

38

2009

GM
C
̲C
M
PS
D
SC
̲D
̲C
M
PS
̲A
W
EB
EV
L2
W
EB
EV
L3

A

G3

T
RM

D
SC

A

A

P3
A

PC
H

O

SO

N

IR

W
O

ID

2008

CE
O

ID
RT
N
O
EI
D
RT
O
A
D
T
RT
O
EX
ER
FL
T
O
G̲
CO
M
M
T
N
EE
D

U
M

J̲
N

BR
D

̲N

U
M

5.00004.50004.00003.50003.00002.50002.00001.50001.000020102011

経営財務研究第 35 巻第 1・2 合併号

3.3 Ownership Proportion
We use ownership proportion for the period 2007 to 2011 since we investigate the impactof ownership on the future level of corporate governance from 2008 to 2011. We measure theproportion of foreign institutional ownership as the sum of the holdings of all foreign institutions
in a firmʼs stock divided by the total number of shares outstanding at the end of each fiscal
year. We also include the proportion of foreign institutional ownership in our analysis as anindicator variable by splitting the sample into quartiles: the highest quartile of foreign ownership,
representing the largest stakes of foreign institutional investors, is coded as one whereas foreign
ownership quartiles other than the highest are coded as zero.
The proportion of domestic ownership is measured as the ratio of sum of the holdings of domestic
institutional investors and other financial institutions such as banks and insurance companies, tothe number of shares outstanding at the end of each fiscal year. The domestic ownership therefore
includes shareholdings by securities companies, financial holdings, credit and leasing, funds andtrusts, banks, and insurance companies.

3.4 Ownership Investment Horizon
We use multiple measures to distinguish between investors with short-term and long-term
investment horizons. The first measure is the institutional ownership persistence（IOP）. Following
Elyasiani and Jia（2010）, we define IOP for an institutional investor（including banks andinsurance companies）in a firm as the ratio of the average ownership proportion to the standard
deviation of the ownership proportion over a 5 year period including the sample year. We measure
IOP by using interim data10 for the individual institutional block-holders11 in a specific firm. For
instance, IOP for each institutional investor in 2008 is calculated using 10 interims, from thefirst fiscal interim of 2004 to the second interim of 2008. The value of IOP is high if an investorʼsshareholding is stable across a 5 year period. IOP for a firm is then calculated as the average IOP
across all the institutional and financial block-holders in the firm.
For the second measure of investment horizon, we follow Bohren, Priestley, and Odegaard（2005）and Elyasian and Jia（2010）, and use the maintain-stake-points duration method. Ourmaintain-stake-points duration measure is the number of interims in which an investor is among
the largest shareholders of a specific firm out of 10 interims. If an investor holds a high proportionof shares for many interims during a 5 year period including the sample year, the maintain-stakepoints duration measure will be high. Maintain-stake-points duration for a firm is calculated as

10
11

Quarterly data for individual institutional investors is not available in the Major Shareholders
Database.
Investors among the top 30 largest shareholders.

39経営財務研究第 35 巻第 1・2 合併号

the average maintain-stake-point durations across all the institutional and financial block-holders.
Furthermore, for the third measure of investment horizon, we also use the stable investment
duration variable. We define the investment duration to be stable if an individual institutional or
financial investor stays as the largest shareholder of a firm for 3 consecutive years（six interims）.
Unlike the maintain-stake-points duration, this measure accounts for the number of investors
instead of the number of interims. The higher the number of investors with consecutive presence
in a firmʼs largest shareholders category, the higher the value（stable）on investment duration
variable will be and vice versa.

3.5 Control Variables
Following Ferreira and Matos（2008）and Aggarwal, Erel, Ferreira, and Matos（2011）, we control
the effect of several firm specific variables in our regressions. These variables include natural log
of total assets（Firm Size）, one year annual sales growth（Sales Growth）, ratio of total liabilities
to total assets（Leverage）, ratio of sum of cash, deposits, and marketable securities to total assets（Cash Holdings）, ratio of annual change in fixed assets plus depreciation to total assets（Capital
Expenditure）, ratio of market value of total assets to book value of total assets（Market-to-Book）,
operating income to total assets（ROA）, research and development expenses to total assets（R&D
expenses）, plant, property, and equipment to total assets（PPE）, foreign sales to net sales（Foreign
Sales）, and the ratio of number of shares held by special few shareholders to the total numberof shares outstanding（Close）. Similar to institutional ownership proportion, we use the control
Table 1

Summary Statistics

This table shows the summary statistics of governance score and ﬁrm characteristics for the period 2008-2011.
Governance score that increases with increase in the quality of corporate governance. Firm characteristics include;
the proportion of foreign institutional ownership, domestic ownership, investment horizon measure of foreign
institutional investors (IOP), cash holdings, capital expenditures, R&D expenses, dividends, ROA, ﬁrm size, sales
growth, leverage, market-to-book ratio, PPE, and foreign sales. Refer to Appendix table A1 and A2 for variable
deﬁnitions.

Governance Score
Foreign Institutional Ownership
Domestic Ownership
IOP Foreign Ownership
Cash Holdings
Capital Expenditure
R&D Expenses
Dividends
ROA
Firm Size
Sales Growth
LeverageMarket-to-Book
PPE
Foreign Sales
Close

40

N
9,451
10,00910,0099,451
10,00910,00910,00910,00910,00910,00910,00910,00910,00910,00910,00910,009Mean
0.42260.08830.18130.13070.15090.01690.01480.01100.070510.4309
0.02830.4692
1.02790.25662.2006
0.5388Std. Dev
0.16220.11070.12800.13270.1346
0.15640.02650.01180.0763
1.51851.45720.22020.54340.18189.57010.154425th
Percentile
0.30000.00790.07690.00000.0555‑0.00680.00000.00440.03709.4116‑0.10220.29740.76790.11740.00000.4220Median0.40470.04300.15910.13480.11420.01620.00350.00840.064410.2777‑0.0106
0.46840.92220.23130.00000.532075th
Percentile
0.52500.13210.26700.23860.20180.04710.01940.01430.1005
11.2766
0.05950.63751.13430.36360.00000.6550

経営財務研究第 35 巻第 1・2 合併号

Table 2

Correlation Matrix

All variables are deﬁned in Appendix table Al and A2.
1. Foreign Ownership
2. Domestic Ownership
3. Firm Size
4. Sales Growth
5. Leverage
6. Cash7. Capital Expenditures
8. Market-to-Book
9. ROA
10. R&D
11. PPE
12. Foreign Sales
12. Close

1
1.000
0.380
0.581
0.020
‑0.162
0.008
0.026
0.333
0.164
0.201
‑0.1770.141‑0.145

2

3

4

5

6

7

8

9

10

11

12

13

1.000
0.644
‑0.0060.050‑0.253
0.040
0.102
0.045
0.145
‑0.001
0.112‑0.505

1.000
0.009
0.144
‑0.303
0.081
0.154
0.065
0.143
0.001
0.130
‑0.328

1.000
0.007
0.009
0.018
0.045
0.055
‑0.001‑0.029
0.003
0.012

1.000
‑0.422‑0.0240.061‑0.178‑0.141
0.162‑0.015‑0.1111.000‑0.035
0.087
0.105
0.047
‑0.333‑0.021
0.182

1.000
0.000
0.275
‑0.022
0.089
0.014
0.051

1.000
0.299
0.119
‑0.121
0.077‑0.0221.000‑0.009
0.096
0.048
0.163

1.000
‑0.1160.185‑0.0881.000‑0.0310.004

1.000‑0.0981.000

variables for the period 2007 to 2011.
Table 1 shows the summary statistics of governance score, equity ownership of foreign anddomestic investors, investment horizon variable, and firm characteristics over the period of 2008
to 2011. In addition, Table 2 reports Pearson correlations. In general, the variables are not highly
correlated. The largest correlation is between foreign institutional ownership and firm size, andbetween domestic ownership and firm size（ρ =0.644）.

４

Empirical Results

4.1 Foreign Institutional Ownership and Corporate Governance
Similar to Aggarwal, Erel, Ferreira, and Matos（2011）, this section contains results from panel
regressions that examine whether foreign institutional ownership leads to corporate governance ina country like Japan. For the panel regression analysis we use the firm level corporate governancescore（Gov-Score）as the dependent variable. The main independent variable is the proportion offoreign institutional ownership. To capture the effect of foreign institutional ownership on future
governance, all independent variables are lagged by one year. We use year and industry fixed effects
in order to account for the macroeconomic and industry effects. For the industry fixed effects, we
use industry dummies based on the 2-digit Nikkei Medium Classification industry code. FollowingPetersen（2008）, t-statistics are computed using standard errors corrected for clustering at thefirm level. Results are presented in Table 3. In column（1）, we report regression results for theeffect of foreign institutional ownership on corporate governance using the composite governancescore（Gov-Score）. The results in column（1）suggest that governance score is positively associatedwith foreign ownership, significant at 99% confidence level. The results are in accordance with our
predictions and suggest that foreign institutional investors play a significant role in improving
corporate governance even in markets where the shareholders are well protected by law. Control
41

経営財務研究第 35 巻第 1・2 合併号

Table 3Foreign Institutional Ownership and Corporate GovernanceThis table shows estimates of regressions of proportion of foreign institutional investors on corporate governance. The
dependent variables include governance score along with individual governance attributes（board size, stock option
plans, and CEO ownership）at time t. The main independent variable is one year lagged foreign ownership. We estimate
probit regression for the dependent variable “stock options” since it is a binary variable that takes the value one if ﬁrms
have stock option plans. Control variables are lagged by one period. Refer to Appendix table A1 and A2 for variable
deﬁnitions. All models report estimates of industry ﬁxed-eﬀects regressions with year dummies. All ratios are
winsorized at the 1% and 99% levels. Standard errors are estimated with clustered errors at the ﬁrm level. t-statistics（z-statistics in the case of stock options in column 3）are presented in brackets. Superscripts *, **, and *** indicate
signiﬁcance at the 10%, 5%, and 1% conﬁdence levels, respectively.
Foreign Ownership（t-1）
Firm Size（t-1）
Sales Growth（t-1）
Leverage（t-1）
Cash Holdings（t-1）
Capital Expenditures（t-1）
Market-to-Book
（t-1）
ROA
（t-1）
R&D Expenses（t-1）
PPE（t-1）
Foreign Sales
（t-1）
Close
（t-1）

Observations
R-squared/Pseudo R-squaredYear
Industry

Gov-Score

Board Size

Stock Options

CEO Ownership

0.200***（5.475）0.00672***（2.683）‑0.0226**（‑2.377）‑0.0770***（‑5.273）‑0.0313（‑1.260）
0.0700***（2.846）0.0604***（8.717）
0.276***（6.123）0.776***（5.488）‑0.122***（‑7.164）‑0.000388*（‑1.690）0.0349*（1.885）0.0604**（2.059）‑0.0387***（‑15.77）‑0.00342（‑0.547）0.00486（0.446）0.0105（0.618）‑0.0281（‑1.591）‑0.0110**（‑1.967）‑0.00943（‑0.300）‑0.257**（‑1.985）‑0.0173（‑1.382）‑0.000229（‑1.012）‑0.0152（‑1.109）

1.246***（4.289）‑0.0340（‑1.463）‑0.0873（‑0.954）‑0.384***（‑2.777）‑0.402*（‑1.717）0.129（0.539）0.319***（5.524）‑0.282（‑0.668）
5.095***（3.965）‑0.805***（‑4.858）‑0.00291（‑1.412）‑0.0211（‑0.118）‑0.00998（‑0.121）0.0134**（2.250）0.0497**（2.184）‑0.226***（‑6.481）0.423***（6.822）0.301***（4.897）0.0878***（5.831）0.565***（4.833）‑0.394（‑1.219）0.0236（0.545）‑0.000766（‑1.518）0.0148（0.316）

9,451
0.247
Yes
Yes

9,451
0.211
Yes
Yes

9,451
0.094
Yes
Yes

9,451
0.164
Yes
Yes

variables have their expected signs.
In line with Aggarwal, Erel, Ferreira, and Matos（2011）, we also examine the relation between
foreign institutional ownership and a number of individual governance attributes12. We examine
three individual governance attributes from board structure and ownership and compensation. We
focus on board size, stock option plans, and CEO ownership. Results are reported in column（2）1242Aggarwal, Erel, Ferreira, & Matos (2011) argue that governance indices and ratings have received
numerous criticism over its methodological shortcomings.

経営財務研究第 35 巻第 1・2 合併号

though column（4）. For stock options we estimate probit regressions since it is a binary variable
that takes the value one if firms have stock option plans and zero otherwise. We find that foreign
ownership is positively and significantly associated with board size and stock option plans. The
results in column（2）show that foreign institutional ownership increases the efficiency of decision
making and internal control through smaller boards. The findings in column（3）suggest that firms
in Japan are more likely to adopt stock option plans when foreign institutional investors own ahigher stake. However, we do not find any relationship between foreign institutional ownership andCEO ownership in column（4）. Overall, we provide evidence that firms are more likely to improve
corporate governance when they have a higher proportion of foreign ownership.

4.2 Control for Endogeneity
So far, the initial findings of our study depict that foreign institutional ownership leads tobetter corporate governance in Japan. However, We cannot rule out the possibility that foreign
institutional ownership and corporate governance may be jointly determined and the positive
relationship between foreign institutional investors and corporate governance could be the outcomeof reverse causality. As in Leuz, Lins, and Warnock（2010）, foreign institutional investors may
have strong preferences for firms with improved corporate governance and therefore, may lead to a
positive association without a causal effect stemming from foreign institutional investors. Although,we use lagged measures of foreign institutional ownership to mitigate the simultaneity issues, thepossibility that foreign investors may also be attracted to firms with expected future governanceimprovements still raises a concern（Aggarwal, Erel, Ferreira, and Matos; 2011）. To address
this endogeneity problem, we run the two-stage least squares（2SLS）regressions where we use
instrumental variables for foreign institutional ownership.
To select the appropriate instrumental variable, we follow the previous literature and consider
variables that are associated with the foreign institutional ownership, but are uncorrelatedwith corporate governance. As the first instrument for foreign institutional ownership, we use
membership of sampled firms in the Morgan Stanley Capital International All Country World
Index（MSCI）. We use indicator variable that takes the value of one if a firm is a constituent of
the MSCI in the previous year and zero otherwise. Ferreira and Matos（2008）and Leuz, Lins,
and Warnock（2010）show that foreign investors are more likely to invest in firms with MSCI
membership. This also holds for our sample as firms with MSCI membership have an average
proportion of foreign institutional ownership of 23.8%, while non-members have an averageownership of 7.1%. In terms of governance, MSCI members have an average governance score of
50.7% while non-members have an average governance score of 41.3%. The instrument appears
to be valid. For the second instrument of foreign institutional ownership, we use the firmʼs listingon the American Depository Receipt（ADR）. We use a dummy variable that takes the value of one
if a firm has an active ADR in the previous year and zero otherwise. Kang and Stulz（1997）show
that ADR increases the probability of investment by foreign investors. Firms with ADRs have an
43

経営財務研究第 35 巻第 1・2 合併号

Table 4Foreign Institutional Ownership and Corporate Governance: Two-Stage Least Squares

This table shows estimates of two-stage least squares（2SLS）regressions. Column（3）through（4）report results of the second-stage
regressions where the dependent variable is the governance score （Gov-Score）. The main independent variable is the foreign
institutional ownership at year t instrumented by one year lagged Morgan Stanley Capital International（MSCI）dummy in column（1）and American Depository Receipts（ADR）dummy in column（2）.In column（3）,the proportion of foreign institutional investors
is instrumented using both MSCI and ADR dummies. Control variables are lagged by one period. Refer to Appendix table A1 and A2
for variable deﬁnitions. All models report estimates of industry ﬁxed-eﬀects regressions with year dummies. All ratios are winsorizedat the 1% and 99% levels. Standard errors are estimated with clustered errors at the ﬁrm level. t-statistics are presented in brackets.
Superscripts *, **, and *** indicate signiﬁcance at the 10%, 5%, and 1% conﬁdence levels, respectively.
1st Stage

1st Stage

1st Stage

2nd Stage

2nd Stage

2nd Stage

Foreign
Ownership

Foreign
Ownership

Foreign
Ownership

Gov-Score

Gov-Score

Gov-Score

0.643**（2.094）

Predicted Foreign（MSCI）
Predicted Foreign（ADR）
Predicted Foreign（Combined）
MSCI
（t-1）
ADR
（t-1）
Firm Size（t-1）
Sales Growth（t-1）
Leverage（t-1）
Cash Holdings（t-1）
Capital Expenditures（t-1）
Market-to-Book
（t-1）
ROA
（t-1）
R&D Expenses
（t-1）
PPE
（t-1）
Foreign Sales
（t-1）
Close
（t-1）

Observations
R-squared
F-test of Instruments
Hansen Over-identiﬁcation
p-valueYear
Industry

0.0396***（5.478）0.0388***（26.34）‑0.0161**（‑2.507）‑0.107***（‑11.37）
0.0354**（2.060）‑0.000848（‑0.0492）
0.0551***（12.56）
0.0637*（1.784）‑0.0153（‑0.181）‑0.0551***（‑5.553）0.000131（0.896）0.00506（0.446）

0.0526***（6.030）0.0397***（26.22）‑0.0147**（‑2.332）‑0.110***（‑11.64）0.0346**（2.002）‑0.00391（‑0.228）0.0580***（12.62）
0.0631*（1.771）‑0.0437（‑0.513）‑0.0537***（‑5.457）
0.000183（1.242）0.00804（0.704）0.0302***（3.957）0.0407***（4.368）0.0371***（24.42）‑0.0139**（‑2.197）‑0.107***（‑11.42）0.0334*（1.947）‑0.00145（‑0.0846）
0.0542***（12.29）0.0666*（1.870）‑0.0530（‑0.626）‑0.0534***（‑5.437）0.000156（1.065）0.00682（0.603）

9,451
0.506
30.010***

9,451
0.506
36.361***

Yes
Yes

Yes
Yes

1.394***（4.875）1.029***（4.309）‑0.0125（‑0.941）‑0.0146（‑1.343）‑0.0291（‑0.802）‑0.0494*（‑1.833）
0.0722***（2.893）0.0332*（1.711）0.248***（5.165）0.774***（5.438）‑0.0979***（‑3.986）‑0.000437*（‑1.874）
0.0317*（1.695）‑0.0449***（‑3.645）‑0.000869（‑0.0815）
0.0536（1.580）‑0.0779***（‑2.946）
0.0753***（3.030）‑0.0126（‑0.702）0.205***（4.321）0.764***（5.348）‑0.0558**（‑2.346）‑0.000557**（‑2.364）0.0271（1.455）‑0.0291***（‑2.840）‑0.00753（‑0.735）
0.0133（0.454）‑0.0640**（‑2.477）
0.0738***（2.963）0.00969（0.630）0.226***（4.855）0.769***（5.423）‑0.0763***（‑3.461）‑0.000499**（‑2.144）0.0293（1.578）

9,451
0.510
27.250***

9,451
0.239

9,451
0.245

9,451
0.244

Yes
Yes

Yes
Yes

Yes
Yes

3.821**
0.050
Yes
Yes

average governance score of 56% while firms without ADRs exhibit an average governance scoreof 41.5%. Regarding the proportion of foreign institutional investors, firms having ADRs have an
44

経営財務研究第 35 巻第 1・2 合併号

average proportion of foreign institutional ownership of 27% while non-members have an averageownership of 8%. Thus, MSCI and ADR do not seem to be correlated with our dependent variable.
Similar instruments are used in Nguyen（2012）.
Table 4 presents the two-stage least squares regressions. Column（1）and（2）present the resultsof the first stage regressions that use the foreign institutional ownership as the dependent variable.
MSCI is explanatory variable of interest in column（1）while ADR in column（2）. The independent
variables are lagged by one year. The first stage results in column（1）and（2）indicates that both
MSCI and ADR are positively and significantly associated with foreign ownership. Moreover, theF-tests indicate that MSCI and ADR are significant instruments with robust F-values greaterthan 30（MSCI）and 36（ADR）. The second stage results, reported in column（4）and（5）, showthat the predicted foreign institutional ownership is significant in explaining the improvements ingovernance. The results reported in Table 4 support our initial findings that foreign institutional
ownership leads to better governance in Japan and suggest that endogeneity is unlikely to explain
this relationship. In addition, we also examine the joint effect of the instruments where the resultsfrom first and second stage regressions are presented in column（3）and（6）. Even though our
results remain unchanged, MSCI and ADR appear to be endogenous. The Hansen over-identification
test indicates that the hypothesis of absence of correlation between the instruments and the error
term in the second stage is rejected, and therefore, it is inappropriate to simultaneously instrument
foreign institutional ownership with MSCI and ADR.

4.3 Foreign Institutional Ownership, Domestic Ownership and Corporate Governance
Next, we analyze the impact of domestic investors on the quality of corporate governance as well
as examine whether the positive relation between corporate governance and foreign institutional
ownership is affected after considering the impact of domestic ownership. According to the results
reported in column（1）of Table 5, domestic ownership negatively affects corporate governance,
the coefficient is significant at 99% confidence level. In column（2）, we use the proportion ofboth foreign ownership and domestic ownership in the same regression. We find that, even after
controlling the effect of domestic ownership, our results do not change and show a strong positive
relation between foreign institutional ownership and corporate governance. In terms of Japanese
governance structure, the negative effect of domestic investors on the governance score can beassociated with the potential business relations between such investors and the invested firms.
Since, only independent investors have the ability to efficiently monitor a firmʼs management（Brickley, Lease, & Smith, 1988; Almazan, Hartzell, & Starks, 2005）, commercial ties with theinvested firms may compromise the active monitoring role of domestic investors. Consequently,
investigating the governance role of domestic investors in aggregate may lead to significantly
biased results, the reason being, not all the domestic investors have close business relations withthe firms in which they invest.
We next classify the domestic investors into two groups according to the degree of their business45

経営財務研究第 35 巻第 1・2 合併号

Table 5

Foreign Institutional Ownership, Domestic Ownership, and Corporate GovernanceThis table shows estimates of regressions of impact of domestic ownership on corporate governance. The dependent
variable is governance score at time t. The main independent variables in column（1）and（2）are domestic ownershipand foreign ownership. In column（3）, the independent variables are relationship-oriented investors and independent
domestic institutional investors. We use indicator variable for the highest quartile of one year lagged foreign ownershipas independent variable in column（4）.Control variables are lagged by one period. Refer to Appendix table A1 and A2
for variable deﬁnitions. All models report estimates of industry ﬁxed-eﬀects regressions with year dummies. All ratios
are winsorized at the 1% and 99% levels. Standard errors are estimated with clustered errors at the ﬁrm level.
t-statistics are presented in brackets. Superscripts *, **, and *** indicate signiﬁcance at the 10%, 5%, and 1% conﬁdence
levels, respectively.
[1]

[2]

‑0.109***（‑3.670）0.200***（5.443）‑0.109***（‑3.720）0.0201***（7.847）‑0.0274***（‑2.846）‑0.104***（‑7.240）‑0.0337（‑1.368）
0.0673***（2.706）
0.0732***（10.86）
0.306***（6.812）0.789***（5.508）‑0.137***（‑7.908）‑0.000345（‑1.519）0.00640（0.326）0.0114***（4.064）‑0.0237**（‑2.489）‑0.0808***（‑5.503）‑0.0400（‑1.605）
0.0678***（2.755）
0.0612***（8.727）
0.296***（6.566）
0.782***（5.533）‑0.125***（‑7.300）‑0.000398*（‑1.732）
0.00579（0.299）

9,451
0.241
Yes
Yes

9,451
0.250
Yes
Yes

Foreign Ownership（t-1）
Domestic Ownership（t-1）
Relationship-oriented（t-1）
Independent（t-1）
High Foreign
（t-1）

[3]

[4]

‑0.187***（‑5.708）
0.106***（4.409）0.0152***（5.291）‑0.0317***（‑2.859）‑0.0968***（‑5.819）‑0.0309（‑1.030）
0.0423（1.464）0.0626***（7.999）0.340***（6.337）0.803***（4.889）‑0.145***（‑7.355）‑0.000425*（‑1.808）
0.00815（0.364）‑0.196***（‑5.333）
0.0506*（1.885）0.0254**（2.499）0.134**（2.132）0.0116***（4.008）‑0.0288***（‑2.616）‑0.0908***（‑5.462）‑0.0338（‑1.137）
0.0423（1.478）0.0575***（7.303）0.352***（6.568）0.776***（4.753）‑0.142***（‑7.274）‑0.000477**（‑2.008）0.0110（0.489）

7,634
0.274
Yes
Yes

7,634
0.280
Yes
Yes

High Foreign（t-1）× Relationship-oriented（t-1）
Firm Size（t-1）
Sales Growth（t-1）
Leverage（t-1）
Cash Holdings（t-1）
Capital Expenditures（t-1）
Market-to-Book
（t-1）
ROA
（t-1）
R&D Expenses
（t-1）
PPE
（t-1）
Foreign Sales
（t-1）
Close
（t-1）

Observations
R-squared
Years
Industry

relationships with the firms. These groups include: domestic investors that are likely to havebusiness ties with the invested firms（relationship-oriented）, and investors that are independent
from close business relationships（independent）. Relationship-oriented domestic investors include
46

経営財務研究第 35 巻第 1・2 合併号

banks and insurance companies, whereas securities companies, financial holdings, credit andleasing, funds and trusts are treated as independent type of institutional investors 13（Brickley,
Lease, and Smith, 1988; Chen, Harford, and Li, 2007; Almazan, Hartzell, and Starks, 2005;
Shinozaki, Moriyasu, and Uchida, forthcoming）. We are interested to investigate whether the
impact of domestic investors on governance is different for the two categories of investors. According
to column（3）of Table 5, the coefficient of relationship-oriented domestic ownership is negative andsignificant at 99% level, suggesting that such investors negatively impact the quality of corporate
governance. In contrast, the results in column（4）depict that independent domestic institutional
ownership is positively associated with corporate governance. This indicates that investors improve
the quality of governance when they are independent of close relationships with the firms in which
they hold equity stakes.
Moreover, in column（4）of Table 5, we report results for the relation between foreign ownershipand corporate governance after controlling the effect of relationship-oriented investors andindependent domestic institutional investors. The results remain unchanged. Although, we findthat the negative impact of relationship-oriented domestic investors is reversed if firms have ahigher ratio of foreign ownership as shown by their interaction term in column（4）. The results on
the interaction term suggest that increased foreign ownership mitigates the negative influence ofrelationship-oriented domestic investors. Since large foreign investors have the ability to importcorporate governance mechanisms in the invested firms（Aggarwal, Erel, Ferreira, & Matos 2011;
Hamao, Katsuna, & Matos, 2011）, they may influence the association between relationship-oriented
domestic investors and corporate governance by using voting power or pressurizing management
to make amendments in the event of decisions that negatively affect shareholder value. Overall,
our findings suggest that foreign institutional investors are effective in improving governance evenwhen the shareholder protection is stronger in the portfolio firmʼs country.

4.4 Investment Horizon of Foreign Institutional Investors and Corporate GovernanceIn this section, we investigate the impact of foreign institutional block-holdersʼ investment
horizon on corporate governance. We include our first investment horizon measure（IOP）in
our analysis as an indicator variable that equals one if firms have above-median IOP and zerootherwise. Column（1）of Table 6 provides the results on the relation between investment horizonof foreign block-holders and corporate governance. Regression estimates shown in column（1）suggest that corporate governance is positively and significantly related to investment horizon oflarge foreign institutional investors. The results imply that corporate governance improves with the13

We use Top 30 Major Shareholders database for the classification of domestic investors based on
their relationship sensitivity, because it offers a straightforward segmentation of overall domestic
investors into relationship-oriented and independent institutional ownership.

47

経営財務研究第 35 巻第 1・2 合併号

Table 6

Investment Horizon of Foreign Institutional Investors and Corporate GovernanceThis table shows estimates of regressions of impact of investment horizon of foreign institutional investors on corporate governance.
The dependent variable in all models is the governance score at time t. The main independent variable in column（1）is the indicatorvariable for investment horizon of foreign institutional investors. In column（2）and（3）, we use additional measures of foreign
institutional investorsʼ horizon; maintain-stake-points and stable investment duration. Column （4） through （6） include both theproportion and investment horizon of foreign institutional investors. Control variables are lagged by one period. Refer to Appendix
table A1 and A2 for variable deﬁnitions. All models report estimates of industry ﬁxed-eﬀects regressions with year dummies. All ratios
are winsorized at the 1% and 99% levels. Standard errors are estimated with clustered errors at the ﬁrm level. t-statistics arepresented in brackets. Superscripts *, **, and *** indicate signiﬁcance at the 10%, 5%, and 1% conﬁdence levels, respectively.
[1]
IOP
（t）
Maintain-Stake-Points（t）0.0103**（2.038）Stable Duration
（t）

[2]

0.0110**（2.190）

Sales Growth（t-1）
Leverage（t-1）
Cash Holdings（t-1）
Capital Expenditures（t-1）
Market-to-Book
（t-1）
ROA
（t-1）
R&D Expenses
（t-1）
PPE
（t-1）
Foreign Sales
（t-1）
Close
（t-1）

Observations
R-squaredYear
Industry[4]0.00292（0.577）0.00270（1.444）0.0139***（6.043）‑0.0263***（‑2.728）‑0.0954***（‑6.652）‑0.0231（‑0.943）0.0687***（2.768）0.0717***（10.75）0.282***（6.307）0.784***（5.468）‑0.132***（‑7.691）‑0.000335（‑1.481）0.0357*（1.910）0.0138***（6.000）‑0.0261***（‑2.711）‑0.0950***（‑6.627）‑0.0228（‑0.930）
0.0688***（2.771）0.0716***（10.74）0.281***（6.290）0.783***（5.467）‑0.132***（‑7.673）‑0.000335（‑1.479）
0.0356*（1.908）0.0141***（6.228）‑0.0257***（‑2.672）‑0.0961***（‑6.688）‑0.0246（‑1.003）0.0703***（2.828）0.0711***（10.64）0.284***（6.348）0.780***（5.437）‑0.133***（‑7.734）‑0.000355（‑1.558）
0.0330*（1.762）0.196***（5.301）0.00646**（2.515）‑0.0227**（‑2.383）‑0.0760***（‑5.199）‑0.0306（‑1.238）
0.0698***（2.837）0.0604***（8.712）0.275***（6.108）0.776***（5.489）‑0.121***（‑7.150）‑0.000387*（‑1.687）
0.0349*（1.887）

9,451
0.239
Yes
Yes

9,451
0.239
Yes
Yes

9,451
0.238
Yes
Yes

9,451
0.247
Yes
Yes

Foreign Ownership（t-1）
Firm Size
（t-1）

[3]

[6]

[5]

0.00325（0.643）0.196***（5.278）0.00644**（2.507）‑0.0227**（‑2.378）‑0.0759***（‑5.193）‑0.0305（‑1.233）
0.0698***（2.837）0.0604***（8.713）0.275***（6.103）0.776***（5.489）‑0.121***（‑7.145）‑0.000387*（‑1.686）
0.0349*（1.887）‑0.00143（‑0.755）
0.00695***（2.743）‑0.0228**（‑2.388）‑0.0780***（‑5.342）‑0.0318（‑1.280）0.0696***（2.830）0.0605***（8.745）0.276***（6.125）0.778***（5.501）‑0.122***（‑7.164）‑0.000380*（‑1.657）
0.0362*（1.952）0.00695***（2.743）

9,451
0.247
Yes
Yes

9,451
0.247
Yes
Yes

investment horizons by foreign institutional investors. Our results are consistent with the previous
literature（Elyasiani & Jia, 2010; Attig, Cleary, & Guedhami, 2010; Chen, Harford, & Li, 2007）and
indicate the active monitoring role played by large long term foreign institutional investors.
We next use two additional measures for the investment horizon of foreign institutional blockholders. Column（2）of Table 6 shows the estimates for maintain-stake-points duration method
where the variable enters as an indicator that equals one if firms have above-median values
on maintain-stake-points and zero otherwise. According to the results, the coefficient on the48

経営財務研究第 35 巻第 1・2 合併号

explanatory variable of interest is positive and significant. Based on the widely used measures ofinvestment horizon, IOP and maintain-stakes-points duration, we find that foreign block-holders
with longer horizons improve governance, but insignificant results with the third measure ofinvestment horizon, the stable investment duration in column（3）.
Next, we investigate whether foreign block-holdersʼ investment horizon has significant impact on
governance improvements even after controlling for the equity ownership by foreign investors. We
report the results in column（4）through（6）of Table 6. Consistent with our previous findings, thefigures in column（4-6）depict that foreign ownership is positively and significantly associated withcorporate governance. In contrast, the coefficients on all three investment horizon measures IOP,
maintain-stake-points, and stable investment duration are found to be insignificant.
Although not tabulated here, we also perform additional tests. First, we divide the overall sample
into long and short investment horizon quartiles and conduct regressions for each subsample
using the foreign institutional ownership as the main explanatory variable. We find that foreign
ownership positively and significantly impacts corporate governance in firms with longer
investment horizons. Interestingly, similar results are found for firms with shorter investment
horizon; the coefficient on foreign institutional ownership is positive and significant. Second,
we estimate regressions by adding an interaction term between foreign institutional ownershipand the indicator variable for long investment horizon. The coefficient on the interaction term isfound to be insignificant. These results indicate that foreign institutional ownership is associatedwith governance improvements irrespective of their investment horizon in the portfolio firms. We
predicted that stable（long-term）foreign investors have greater impact on governance because
investors with long investment horizons are more likely to have expertise and incentives tomonitor the management, which in turn mitigate the agency problems. However, the evidence
suggests that equity ownership by foreign investors is a main driver of governance improvements
in Japanese firms. It is possible that these results may have been affected by the data limitationsof this study. Since the data of all the individual foreign institutional shareholders is not readily
available, we measure the investment horizon of foreign institutional investors by using only the
top largest shareholders. Although, our objective of using investment horizon is to account for boththe length and size of foreign shareholding, this limitation, to some extent, may affect the results ofinvestment horizon of foreign institutional investors.
We next examine the relation between investment horizon of domestic block-holders andcorporate governance. Column（1）of Table 7 shows the results on the association between
investment horizon of large relationship-oriented domestic investors and corporate governance.
Based on the reported results, we find a negative association between the investment horizon oflarge relationship-oriented domestic investors and corporate governance. Furthermore, as reported
in column（2）, we find no evidence for the effect of large and stable independent domestic investors
on governance. Moreover, in column（3）, we control the effect of the relationship-oriented domestic
ownership and find that both their ownership proportion and investment horizon negatively affectcorporate governance. For the large independent domestic institutional investors, the findings are
49

経営財務研究第 35 巻第 1・2 合併号

Table 7

Investment Horizon of Domestic Investors and Corporate GovernanceThis table shows estimates of regressions of impact of investment horizon of domestic institutional investors on
corporate governance. The dependent variable in all models is the governance score at time t. The main independent
variable in column（1）is the indicator variable for investment horizon of relationship-oriented domestic investors. The
main independent variable in column（2）is the indicator variable for investment horizon of independent domestic
investors. Column（3）and（4）include both the proportion and investment horizon of relationship-oriented and independent investors. Control variables are lagged by one period. Refer to Appendix table A1 and A2 for variable deﬁnitions.
All models report estimates of industry ﬁxed-eﬀects regressions with year dummies. All ratios are winsorized at the
1% and 99% levels. Standard errors are estimated with clustered errors at the ﬁrm level. t-statistics are presented inbrackets. Superscripts *, **, and *** indicate signiﬁcance at the 10%, 5%, and 1% conﬁdence levels, respectively.
[1]
Relationship-oriented IOP（t）
Independent IOP（t）‑0.0242***（‑4.818）

Relationship-oriented
（t-1）

[2]

‑0.00285（‑0.530）

Sales Growth（t-1）
Leverage（t-1）
Cash Holdings（t-1）
Capital Expenditures（t-1）
Market-to-Book
（t-1）
ROA
（t-1）
R&D Expenses
（t-1）
PPE
（t-1）
Foreign Sales
（t-1）
Close
（t-1）

Observations
R-squaredYear
Industry‑0.138***（‑4.250）[4]‑0.00604（‑1.119）0.0195***（7.954）‑0.0339***（‑3.061）‑0.112***（‑6.822）‑0.0287（‑0.954）0.0462（1.585）0.0698***（9.263）0.354***（6.626）0.833***（5.061）‑0.149***（‑7.521）‑0.000430*（‑1.822）0.0244（1.123）0.0191***（7.727）‑0.0341***（‑3.062）‑0.112***（‑6.797）‑0.0241（‑0.797）
0.0554*（1.888）0.0720***（9.556）
0.358***（6.641）0.823***（4.995）‑0.156***（‑7.893）‑0.000441*（‑1.870）0.0366*（1.689）0.0208***（8.336）‑0.0346***（-3.123）‑0.110***（-6.713）‑0.0369（‑1.221）0.0390（1.343）0.0679***（8.994）0.355***（6.632）0.804***（4.909）‑0.149***（‑7.463）‑0.000399*（‑1.719）0.00283（0.126）0.0819***（3.440）0.0144***（4.953）‑0.0316***（‑2.836）‑0.101***（‑6.017）‑0.0187（‑0.627）
0.0553*（1.895）0.0676***（8.735）0.342***（6.353）0.834***（5.041）‑0.150***（‑7.627）‑0.000463*（‑1.929）0.0405*（1.877）

7,634
0.266
Yes
Yes

7,634
0.261
Yes
Yes

7,634
0.271
Yes
Yes

7,634
0.265
Yes
Yes

Independent（t-1）
Firm Size
（t-1）

[3]
‑0.0181***（‑3.561）

similar to foreign institutional investors. This suggests that the equity ownership is a significant
determinant of governance improvements for investors who are independent of close relations
with the firms in which they hold equity stakes. In an untabulated analysis, we also examine
the investment horizon of both relationship-oriented and independent domestic investors using
maintain-stake-points and stable investment duration variables and obtain similar results.

50

経営財務研究第 35 巻第 1・2 合併号

５

Summary and Conclusion

We investigate the relationship between equity ownership by foreign institutional investors andcorporate governance. Using a sample of Japanese firms, we compliment the evidence presented inprevious studies and show that foreign institutional investors are beneficial in improving corporate
governance even when the shareholder protection is stronger than the portfolio firmʼs country. In
an attempt to alleviate the endogeneity of foreign institutional ownership, we employ two-stage
least squares（2SLS）regressions and get qualitatively similar results. This suggests that foreign
institutional investors not only have preferences to invest in firms with strong governance, but theyalso affect the quality of corporate governance. We also examine the governance role played by thedomestic investors, and find that while investors having potential business relationships with theinvested firms（relationship-oriented）negatively impact corporate governance, the association ispositive for investors without close business ties（independent）. Hence, there is a large variationin the effectiveness of monitoring performed by domestic investors with and without close business
relations with the firms. However, we find that presence of large foreign institutional investors
are more likely to reverse the negative influence of relationship-oriented domestic investors on
governance, thereby change the way how such domestic investors affect the quality of corporate
governance.
Unlike previous studies on the association between foreign ownership and governance, we
explore whether the investment horizon of large foreign institutional investors has additional effectin improving the quality of corporate governance. Although literature suggests that owners withlong-term investments more actively monitor the firms, we do not find evidence that foreign blockholders with stable investment horizons play a larger role in improving corporate governance.
Results are similar for independent domestic institutional investors, whereas investment horizonsof relationship-oriented domestic investors negatively impact corporate governance. These results
suggest that in terms of investors who are independent of close business relations with the invested
firms, the proportion of ownership is a significant determinant of governance improvements.
In this paper, while we were able to confirm that equity ownership by foreign institutional
investors promotes corporate governance improvements in Japan, we have not yet completely
uncovered the governance effect of foreign investorsʼ investment horizon because of data limitations.
Future research should revisit this issue with alternative measures that may better reflect each
investorʼs investment style.
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54