Prof. Katuyuki Kubo: “CEO Compensation in Japan”

1. Introduction- The purpose of this paper is to examine recent changes in executive compensationin Japan. We will focus mainly on three topics. First, we review recent changes in theinstitutional framework for executive pay. In particular, we discuss the new rules ondisclosure of executive compensation, which require firms to disclose the salaries oftheir presidents if their pay exceeds a certain amount after 2010. However, this newrule is not applicable to most presidents as the threshold, US$ 1 million, is higher thanthe salary of most executives.

Second, we describe changes in the level of presidents’ salaries, using a sample of179 firms that is taken from the Nikkei 225 Stock Index between 2000 and 2007. Asindividual compensation of presidents is not disclosed, we adopt the Kubo and Saito(2008) calculations and show rapid increases in presidents’ salaries after 2000.

Third, we examine change in pay/performance sensitivity (PPS), which shows therelationship between presidents’ wealth and firm performance, and attempt to examinewhether presidents have a financial incentive to maximize shareholders’ value. It isshown that this pay/performance sensitivity has been increasing during this period.However, this pay/performance sensitivity is much smaller than in the U.S. In other
words, presidents in Japan have much smaller financial incentive to maximize
shareholders' value compared to their American counterparts.

There are several reasons why it is important to examine executive compensation inJapan. First, it might explain differences in firm behavior between Japan and othercountries. It is often considered that the behavior of Japanese firms is different fromthat of their Western counterparts (Abegglen and Stalk, 1985; Aoki, 1988). At thesame time, top managers are considered to have little incentive to maximizeshareholders’ value. Instead, they emphasize employees’ interests, as shown in aquestionnaire survey by Yoshimori (1995). By examining executive compensation, wemight be able to explain the behavior of these firms.

Second, it is of importance to generate stylized facts on executive compensationoutside the UK and U.S., where there has been relatively more research on thissubject. International differences in corporate governance practices have receivedincreasing attention during the 1990s. In particular, many scholars have focused onthe differences in ownership structure and monitoring mechanisms.However, thereare relatively few international comparisons of top executive compensation (Abowdand Bognanno, 1995; Conyon and Murphy, 2000; Kaplan, 1994). There are severalreasons why it is important to generate stylized facts on executive compensation in
different countries. To start with, there are complementarities between executivecompensation and the various monitoring mechanisms. By establishing stylized factson international differences, we may be able to understand the interaction betweeninstitutions and the financial incentives of top managers. Another reason is theglobalization of the managerial labor market. For example, the increasing number offoreign-born presidents in Japanese companies, including Mr. Carlos Ghosn at NissanMotor has attracted interest from academics and practitioners regarding relativedifferences in executive compensation between Japan and other countries. To
understand international differences in managers’ financial incentives, it is importantto establish stylized facts on executive compensation under different environments.

……

6. Discussion
Our results raise a number of interesting questions. One of the most fundamental iswhy pay/performance sensitivity is low. There are several possible explanations.

First,it might be the case that there is little need to motivate top directors because they arewell monitored by banks. The role of the ‘main bank’ or company group (keiretsu) incorporate governance in Japan has been much debated. Some emphasize positiveaspects of the main bank relationship in helping firms in financial distress (Aoki andPatrick, 1994; Hoshi et al., 1990), while others show that there is no positive effect onfirms with a main bank relationship (Hanazaki and Horiuchi, 2000). Kato (1997)shows that compensation of top managers of the firms that belong to financial keiretsu
is 21% lower than that in firms without such a relationship. He suggests that banksplay an important role in monitoring top management, preventing them from

It should be noted that our sample and the U.S. sample are not completely comparable.Firms in the U.S. sample are larger than those in our sample.
receiving excessive salaries. Murase (1998) shows managers’ bonuses are more likelyto decrease when firm performance deteriorates in a firm with larger ownership byfinancial institutions. In addition, the proportion of directors’ bonuses to their totalcomposition is smaller if an ex-bank officer is on the board of directors (Abe et al.,2005). As the directors’ bonuses are considered to be more performance related, itimplies that directors have less financial incentive to maximize performance. Abe et al.suggest that managers in a firm with bank directors on boards are closely monitored
by their main banks. Therefore, their effort would be greater even without financialincentive. These studies suggest that main banks play some monitoring role indirectors’ compensation.

Second, top managers are not expected to maximize shareholders’ interest.
Questionnaire surveys show that managers do not emphasize shareholders’ value;rather they maximize the interest of various stakeholders, such as employees(Yoshimori, 1995). Kubo (2003) emphasizes that there are several similarities indirectors’ compensation and employees’ wages. Both directors and employees arepaid monthly wages and bonuses. Both a director’s salary and an employee’s wage areaffected by the firm’s performance, such as its sales and profits. Thus, Kubohypothesizes that directors’ salaries are determined jointly with employees’ wages.

Consistent with this discussion, Kubo finds a positive and significant relationshipbetween employees’ wages and directors’ salaries. He suggests that his result isconsistent with the idea that top managers are managing the firm to maximizeshareholders’ interest.

Kubo – Presidents Compensation in Japan-2011

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