The Value of Prominent Directors: Corporate Governance and Bank Access in Transitional Japan

Although observers urge transitional economies to rely on banks rather than stock markets, in early twentieth-century Japan, large firms did not rely on debt. Instead, they sold stock. To mitigate agency slack, they sometimes recruited prominent investors to their boards. In this context, we use data on cotton-spinning firms to explore the relationship between board composition and profitability. First, firms that hired prominent directors had higher profits in succeeding years. We hypothesize that these directors brought monitoring skills and certifying credibility: they knew what to expect, knew when and how to intervene, and had the reputations necessary to certify firm quality credibly. Second, firms did not further increase their profitability by appointing directors with access to a bank or to spinning technology. We conclude that the firms probably had access to funds and technological assistance without board connections. Successful Japanese firms at the dawn of the twentieth century actively recruited prominent business executives to their boards. Why? What types of directors most effectively contributed to firm success, and what did they bring? Was access to a bank through a director (as opposed simply to high debt levels) associated with higher profitability? In the article that follows, we use evidence from the large cotton-spinning firms to suggest that prominent executives probably raised firm value by bringing basic monitoring and disciplining skills and reputations that enabled them to certify firm quality. Those firms that appointed nationally prominent * Professor of Economics, University of Tokyo, and Mitsubishi Professor of Japanese Legal Studies, Harvard University, respectively. We received helpful suggestions from Stephen Choi, Rui de Figueiredo, Ronald Gilson, Fumio Hayashi, Guy Holburn, Takeo Hoshi, Louis Kaplow, Naoto Kunitomo, John Lott, Tetsuji Okazaki, Eric Posner, Eric Rasmusen, Gary Saxonhouse, Pablo Spiller, Haruhito Takeda, Masayuki Tanimoto, Kazuo Wada, David Weinstein, Mark West, Noriyuki Yanagawa, an anonymous referee, and participants at workshops at the University of California, Berkeley, Harvard University, the University of Michigan, the National Bureau of Economic Research, and Trust 60. We gratefully acknowledge the generous financial assistance of the John M. Olin Program in Law, Economics and Business, Harvard Law School, the University of Tokyo Center for International Research on the Japanese Economy, and the Sloan Foundation. 274 the journal of legal studies directors did earn higher profits than their competitors in subsequent years. Profits did not further increase if a firm appointed a director with banking experience or textile-industry expertise. Apparently, the prominent directors brought business sense and reputational capital but not access to needed credit or technology. We begin by outlining the issues at stake in the debate (Section IA) and summarizing the institutional structure of business in late nineteenth-century Japan (Section IB). In Section II, we use evidence on profitability in cotton spinning to ask which types of directors were most strongly associated with higher profitability among the large, internationally prominent firms. In Section III, we use evidence from prefectural records to check our conclusions against accounts of a more local economy.