Governance through Shame and Aspiration: Index Creation and Corporate Behavior in Japan

We study how a stock index can affect corporate behavior by serving as a source of prestige. After decades of low corporate profitability in Japan, the JPX-Nikkei400 index was introduced in 2014. The index selected 400 large and liquid firms deemed to be best-performing in terms of profitability annually; membership was considered highly prestigious. We document that index-inclusion incentives led firms to increase return on equity (ROE) proportionally by 35% on average, through higher margins, efficiency, or shareholder payouts, depending on where firms had “slack,” but not through changing investments or accruals. These incentives are driven by the prestige associated with the index rather than capital market benefits. Back-of-envelope estimates suggest that the index accounted for 23% of the average increase in aggregate annual earnings over our sample period and a 3% increase in aggregate market capitalization. These findings highlight a novel mechanism through which long-standing corporate behaviors can be transformed.