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Unstash the cash! Corporate governance reform in Japan

Japanese corporations hold a very high level of cash on their balance sheets compared to those in other advanced countries. Such excessive corporate savings are likely to be holding back growth by preventing a more efficient use of resources. This column presents recent research showing that improving corporate governance would help unlock Japan’s corporate savings, exit deflation, and revive growth. Comprehensive corporate governance reform should be a key component of Japan’s growth strategy.

Cash holdings by Japanese companies are very high compared to other G7 countries. As it can be seen in Figure 1, the average ratio of cash and cash equivalent holdings to market capitalisation of Japanese listed companies during 2004-2012 was above 40%, compared to values in the 15-27% range in other G7 countries. Such high cash holdings coexist with a negative contribution of private investment to growth in the last few years and with falling real wages in the face of positive labour productivity growth for most of the last two decades. In this context, Japan’s high cash holdings are likely to be holding back both potential and short-term growth.

Figure 1. Listed companies' cash and cash equivalents holdings (% of market capitalization; Average between 2004 and 2012)

Sources: Bloomberg. 

Why are corporate cash holdings so high in Japan?

The literature has highlighted various determinants of firms’ cash holdings, but there is no overwhelming support for a unified theory. Opler et al. (1999) find that firms tend to hold more cash when they are smaller, when they have more volatile cash flows, and invest more. Previous studies have also emphasised that, in the absence of strong corporate governance, managers might have a preference for much higher levels of cash holdings compared to those which would maximise shareholders’ value. A cross-country analysis carried out by Dittmar et al. (2003), for example, concludes that corporate cash holdings in countries in which shareholder rights are not well protected are twice as much as those in countries with good shareholder protection.

Existing literature also suggests that Japan has lower corporate governance scores compared to other advanced countries. For example, the Firm Level Governance (FLG) index developed by Aggarwal et al. (2010) – which summarises governance attributes covering board composition, audit quality, shareholder rights, and ownership structure and compensation – shows that Japan’s corporate governance performance is low compared to other advanced countries, both in terms of level and progress made in recent years (Figure 2).

Figure 2. Firm-level governance index (An increase of this index signals an improvement in corporate governance)

Sources: "Does Governance Travel Around the World?Evidence from Institutional Investors".

Corporate governance reform as a tool to ‘unstash’ Japan’s corporate savings

The above discussion suggests that the link between governance and excessive cash holdings highlighted by Dittmar et al. (2003) might be particularly relevant for Japan. In a recent IMF Working Paper (Aoyagi and Ganelli 2014), we test this assumption using a panel of about 3,400 Japanese firms. The dependent variable is the stock of cash and cash equivalents in percentage of market capitalisation, which is regressed on variables expected to impact corporate cash holdings. The effect of corporate governance in the study is captured by the ‘Proprietary Bloomberg Score’, an index which ranges from 0.1 for companies that disclose a minimum amount of governance data to 100 for those that disclose every data point collected by Bloomberg.

  • A key finding of the paper is that better corporate governance can help unlock Japan’s excessive corporate savings. Regardless of the specific estimation method used, the corporate governance indicator that we use always has a negative sign, suggesting that improving corporate governance would reduce corporate cash holdings in Japan. The coefficient is also significant at the 10% level for fixed effects estimation and at the 1% level for random effects and Arellano-Bond estimations.
  • The estimated impact of improving corporate governance on cash holdings in Japan is sizeable. We calculate by how much cash holdings could be reduced for a representative Japanese firm if the index were to improve from the firms’ panel average of 38.9 to the G7 (excluding Japan and Germany) average of 49.1, the maximum in Japanese firms’ panel of 62.5, and the theoretical maximum value that the index could take of 100. The estimated reductions in the cash-to-market capitalisation ratio range from about 1 to about 23 percentage points.

In interpreting the estimates discussed above, it is important to keep in mind that they refer only to first-round effects of improving corporate governance on cash holdings. If firms use the reduction in cash to finance increases in wages and investment, this will stimulate the economy and help Japan exit from deflation. A higher inflation environment, in turn, will make hoarding cash less attractive, giving further incentives to firms to reduce cash holding beyond the amount captured in the regressions.

The main policy implication of our study is that comprehensive corporate governance reform should be part of Japan’s growth strategy. In this light, the Japanese government’s plan is a step in the right direction. The current reform plan for corporate governance reform includes strengthening audit and monitoring functions and encouraging companies to nominate independent outside directors by using a “comply-or-explain” approach, which requires firms that choose not to have independent outside directors to issue a report to shareholders explaining why.

Another important reform was the introduction in February 2014 of a Stewardship Code aimed at increasing fiduciary responsibilities of institutional investors. Such a code – which has already been adopted on a voluntary basis by about 127 institutional investors, including most of the largest Japanese asset managers – is expected to encourage investors to push managers in investee companies to maximise shareholders’ value. Furthermore, on 24 June, the Japanese government announced plans to create a corporate governance code for firms to complement the recently introduced Stewardship Code for institutional investors. Adopting both codes, as was done for example by the UK, would create synergies by encouraging the management of both institutional investors and of companies in which they invest to cooperate in maximising returns for shareholders.

In our paper, we make the point that, despite the positive developments described above, since our empirical analysis suggests that the gains from improving corporate governance could be large, reforms aimed at discouraging excessive corporate savings could be more ambitious. In particular, expanding the use of outside directors beyond current plans and reinforcing their independence would help. The proportion of independent outside directors out of all directors in listed companies was only 9% in 2013 in Japan, compared, for example, to 70% in the US, 50% in the UK, and 30% in South Korea (Miyajima 2012).

Most other advanced countries require a substantial number of outside directors either in a mandatory way (more than half of the board in the US, more than one quarter of the board in Korea) or under a ‘comply-or-explain’ approach (e.g. more than half of the board in the UK, an ‘appropriate number’ in Germany, and half of the board in France). However, the current plan in Japan is to introduce a requirement under a comply-or-explain approach for only one outside director. Considering the experience of other countries, we therefore suggest that there is scope in Japan for expanding the use of outside directors beyond current plans. Other suggested measures include encouraging board diversity – given the low share of female directors in Japan and evidence that companies with more female board directors have better governance and outperform those with the least (Catalyst 2007).


As stressed in the 2014 IMF Article IV Report on Japan, implementing corporate governance reforms to unlock Japan’s corporate savings should be a key component of Japan’s strategy to revive growth and exit deflation. In this column, we have presented recent empirical research in support of this argument and discussed some policy implications.

Authors' note: The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.


Aoyagi, C, and G Ganelli (2014), “Unstash the Cash! Corporate Governance Reform in Japan,” IMF Working Paper 14/140 Washington: International Monetary Fund.

Aggarwal, R, I Erel, M Ferreira and P Matos (2010), “Does Governance Travel Around the World? Evidence from Institutional Investors,” Fisher College of Business Working Paper No. 2009-008 (Ohio: the Ohio State University)

Catalyst (2007), “The Bottom Line: Corporate performance and women’s representation on boards”, 15 October

Dittmar, A, J Mahrt-Smith, and H Servaes (2003), “International corporate governance and corporate cash holdings,” Journal of Financial and Quantitative Analysis 38, 111-133.

Kinoshita, N (2013), “Legal Background to the Low Profitability of Japanese Enterprises”, Center on Japanese Economy and Business Working Papers No.316 (New York: Columbia University)

Miyajima, H (2012), “Pros and Cons of Mandating the Appointment of Outside Directors: Based on new empirical testing”.

Nakajima, K (2013), “Ko-pore-to gabanansu to kigyou no genkin hoyu” (Corporate Governance and Companies’ Cash Holdings), Securities Analysts Journal 2013.6 (Tokyo: The Securities Analysts Association of Japan)

Opler, T, L Pinkowitz, R Stulz, and R Williamson (1999), “The Determinants and Implications of Corporate Cash Holdings,” Journal of Financial Economics, Vol. 52, pp 3–46.

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