Who Appoints Them, What Do they Do? Evidence on Outside Directors from Japan

Reformists argue that Japanese firms maintain inefficiently few outside directors, while theory suggests market competition should drive firms toward their firm-specifically optimal board structure (if any). The debate suggests three testable hypotheses. First, perhaps board composition does not matter. If so, then firm performance will show no relation to board structure, but outsiders will be randomly distributed across firms. Second, perhaps boards matter, but many have suboptimal numbers of outsiders. If so, then firms with more outsiders should outperform those with fewer. Last, perhaps board matter, but market constraints drive firms toward their firmspecific optimum. If so, then firm characteristics will determine board structure, but firm performance will show no observable relation to that structure. To test these hypotheses, we assemble data on the 1000 largest exchange-listed Japanese firms from 1986-94. We first explore which firms tend to appoint outsiders to their boards, and find the appointments decidedly non-random: board composition matters. We then ask whether firms with more outside directors outperform those with fewer, and find that they do not: board composition is endogenous. As we find no robust evidence that board composition affects firm performance during either the thriving 1980s or the depressed early 1990s, we suspect that the optimal board structure may not depend on the macro-economic environment. We note that until recently courts effectively barred shareholder suits in Japan. We speculate that the much higher level of outside directors in the U.S. may have nothing to do with efficiency or monitoring. Instead, it probably reflects the way U.S. courts let firms use such directors to insulate the firm from extortionate but otherwise costly-to-defend self-dealing claims. * Professor of Economics, University of Tokyo, and Mitsubishi Professor of Japanese Legal Studies, Harvard University, respectively. We gratefully acknowledge of financial assistance of the Center for International Research on the Japanese Economy at the University of Tokyo, the John M. Olin Program in Law, Economics & Business at the Harvard Law School, and the Sloan Foundation. Outside Directors in Japan: Page 2 Persistently, reformers, journalists, and law professors claim that firms should increase the outside directors they name to the board. Directors monitor senior managers for shareholders, they explain. Unless independent from those managers, they will not aggressively monitor. Without an economic base outside the firm, they will not be independent. If a firm hopes to protect its shareholders from its managers, it simply must name more outsiders to its board. The claim misses the tradeoffs, of course. What outsiders offer in independence, they sacrifice in expertise. The more independent they be, they less they know about the firm. In turn, the significance of that tradeoff will vary by firm. At some firms, independence will be crucial, and a broad business background may be all the expertise a director needs. At others, no amount of independence will help a director who does not know the details of the firm’s business. If boards matter, then in equilibrium competition should drive firms toward their firmspecifically optimal board composition. In most of the advanced capitalist world, most firms sell their output into competitive industries, buy their supplies from competitive sellers, and raise their funds on competitive capital markets. Facing the inevitable market constraints, those that adopt more efficient governance structures will have higher odds of survival. As a result, in equilibrium firms should move toward their firm-specifically optimal governance structures or die. In equilibrium, they should tend to appoint the number and types of outside directors they need, and no more. Unfortunately, the plaintiffs’ securities bar badly obscures this dynamic in the U.S. An NYSE-listed firm without outside directors is a firm begging for a shareholder suit. Rarely do such suits address real wrongdoing. Almost never do they yield significant recoveries, either to the firm or to its shareholders. Instead, they settle with a trivial remedy to the firm and a large payoff to the plaintiffs’ lawyers. In this world of extortionate litigation, outside directors buy protection. Absent such directors, a U.S. firm would be able to defend against self-dealing claims only at enormous expense. By routing their major business decisions past outside directors, however, the firm can dramatically lower the costs it incurs in defending against such claims. In the process, it can effectively insulate itself against the litigation. By exploring the role of outside directors in Japan, we examine the role such directors play in a world without this legalized extortion. Japanese courts have never allowed class-action suits, and until recently maintained filing fees that effectively barred derivative suits as well. Accordingly, by examining the appointment of outside directors there, we can study whether (aside from their litigation-induced role in the U.S.) boards matter: which firms find what kind of outside directors advantageous. By examining the ties between board composition and firm performance in Japan, we can also ask whether -if boards do matter -board structure is endogenous: whether market competition in modern capitalist economies does drive firms toward their firm-specific optimum. Finally, by comparing the relation between board composition and firm performance in the late 1980s and early 1990s, we can ask whether the optimal board composition depends on the macroeconomic environment: whether the boards that facilitated high performance levels in the booming 1980s also did so in the depressed 1990s. We examine the outside directors at the largest exchange-listed Japanese firms -the approximately 1,000 firms listed on Section 1 of the Tokyo Stock Exchange in the late 1980s and Outside Directors in Japan: Page 3 early 1990s. We find: (a) that bankers tended to serve on the boards of smaller firms, more heavily leveraged firms, and firms without a large stock of mortgageable assets; (b) that retired government bureaucrats disproportionately served on the boards of the construction firms specializing in public-sector civil engineering projects; and (c) that outside business executives primarily served on the boards either of construction firms specializing in large business-sector construction projects, or of firms in which the executive’s own firm owned a large equity stake. Consistent with market pressure toward firm-specifically optimal patterns of board composition, we find no robust association between board composition and observable indices of firm performance. Consistent with the lack of any tie between optimal board composition and the macro-economic environment, we also find that this lack of association holds both for the late 1980s and the early 1990s. We begin by reviewing the literature on board composition. (Section I). We explain our data set and variables (Section II). We then ask which firms appoint what kinds of directors (Section III.A.), and what observable effect these directors have on firm performance (Section III.B.). I. Outside Directors -The Literature A. The Reformist Impulse: Reformist intellectuals spare no trees in their paeans to outside directors. Directors work as agents for shareholders, they recite. As agents, they police managers. If themselves “company men,” they lack the independence they need adequately to police. Even less do they have the incentives to push the firm toward “greater corporate morality” or to “apply ethical considerations.” Far better, they conclude, to appoint men not subject to the pressures that come from a lifetime at the firm. Of the “reformers,” retirement plans have been among the most aggressive. CalPERS claims a “substantial majority” of board members should be independent. TIAA-CREF follows. Increasingly, traditionalist organizations acquiesce. The Business Roundtable, for example, writes: It is important for the board of a large publicly owned corporation to have a substantial degree of independence from management. Accordingly, a substantial majority of the directors of such a corporation should be outside (non-management) directors. And as of mid-2002, the New York Stock Exchange even proposed to require that “[i]ndependent directors . . . comprise a majority of a company’s board.” Most large U.S. firms today do name outsiders to the board (a fact that may help explain why the NYSE capitulated to the reformers). According to one study, the fraction of manufacturing firms with a majority of outsiders “rose from 50 percent in 1938, to 61 percent in 1 Peter C. Kostant, Team Production and the Progressive Corporate law Agenda, 35 U.C. Davis L. Rev. 667, 690 (2002). 2 CalPERS, Corporate Governance Core Principles & Guidelines: The United States (1998) (www.calpers_governance.org). 3 TIAA-CREF, Policy Statement on Corporate Governance (2000) (www.tiaa-cref.org/libra/governance). 4 Business Roundtable, Statement on Corporate Governance 10 (1999). 5 NYSE Corporate Accountability and Listing Standards Committee, Report, June 6, 2002, at 2. Outside Directors in Japan: Page 4 1961, to 71 percent in 1972, to 83 percent in 1976.” By 1973 the median large manufacturing firm had only 40 percent inside directors, and by 1988 the figure had fallen to a quarter. “Reformers” in Japan champion the same rhetoric. Take the “Corporate Governance Forum” headed by a prominent university president and legal scholar. Declares the Forum, “a majority of the board of directors should be composed of outside directors.” Some politicians propose legislation to require outside directors. And through avenues like the American Chamber of Commerce in Japan, foreigners now routinely put outside directors on this week’s shopping list of changes to demand of Japan. Western scholars often parrot these claims about Japan. Dore, for example, dismisses Japanese boards as “an ‘insider system’ over which shareholders exercise little monitoring control.” Ahmadjian asserts they “rarely play a supervisory role,” few are outsiders, and “many outsiders are not independent.” And quoting a U.K. study, Monks & Minow insist that Japanese boards “represent the interests of the company and its employees” rather than “the interests of shareholders.” B. The Economic Logic: The logic to all this is obscure at best. What outsiders potentially contribute in independence from managers, they sacrifice in camaraderie and knowledge about the firm. Although in some firms the former may outweigh the latter, in others it will not. Given that most firms everywhere raise funds, buy supplies, and sell goods and services in competitive markets, the firms that survive should disproportionately be firms with appropriate governance mechanisms: firms whose boards either could not make a difference, or already approach their firm-specific optimum. Demsetz & Lehn made the point in connection with ownership concentration. Where for fifty years scholars had claimed that the dispersed shareholdings at large U.S. firms let managers ignore shareholder welfare, Demsetz & Lehn found the claim implausible on its face. Firms that 6 Edward S. Herman, Corporate Control, Corporate Power 35 (Cambridge: Cambridge University Press, 1981). 7 Id.; Anup Agrawal & Charles R. Knoeber, Do Some Outside Directors Play a Political Role?, 44 J. Law & Econ. 179, 181 (2001). 8 Japan Corporate Governance Forum, Koporeeto gabanansu gensoku [Principles of Corporate Governance] (1998) (www.jcgf.org/jp). 9 Ronald Dore, Stock Market Capitalism: Welfare Capitalism -Japan and Germany versus the Anglo-Saxons 79 (Oxford: Oxford University Press, 2000). 10 Christina L. Ahmadjian, Changing Japanese Corporate Governance (unpublished, 2001). 11 Robert A.G. Monks & Nell Minow, Corporate Governance 272 (Oxford: Blackwell, 1995). 12 Eugene F. Fama & Michael C. Jensen, Separation of Ownership and Control, 26 J. Law & Econ. 301, 31415 (1983); April Klein, Firm Performance and Board Committee Structure, 41 J. Law & Econ. 275 (1998). 13 On competition in the postwar Japanese capital market, see Yoshiro Miwa & J. Mark Ramseyer, Directed Credit? The Loan Market in High-Growth Japan, __ J. Econ. & Mgmt Strategy __ (forthcoming 2003); on the pre-war capital market, see Yoshiro Miwa & J. Mark Ramseyer, Banks and Economic Growth: Implications from Japanese History, 45 J. Law & Econ. __ (forthcoming 2002). 14 Harold Demsetz & Kenneth Lehn, The Structure of Corporate Ownership, 93 J. Pol. Econ. 1155 (1985). For the application to Japan, see Yoshiro Miwa & J. Mark Ramseyer, Does Ownership Matter? Evidence from the Zaibatsu Dissolution Program, __ J. Econ. & Mgmt. Strategy __ (forthcoming 2003). Outside Directors in Japan: Page 5 raise their funds on competitive capital markets should choose ownership patterns close to their firm-specific optimum or die. If so, Demsetz & Lehn continued, then any attempt to regress shareholder returns on ownership structure will yield insignificant results. And so they found. Although some scholars since have claimed to find such results empirically, they substitute for the empirical quandary a theoretical one: as Jensen & Warner put it, why (if they were right) would "concentration [not be] chosen to maximize firm value"? The Demsetz-Lehn logic applies straightforwardly to board composition. Perhaps at some firms investors will want outsiders who protect against insider misbehavior. Perhaps at others they will want the sophistication and cohesion that an all-inside board brings, and use other means to monitor and constrain their managers. Perhaps at still others board composition will not matter. Given market pressures, firms without outsiders will necessarily tend to be those where outsiders would bring few gains. Put otherwise, the benefit that legal scholars and reformers claim would accrue from more outsiders are $20 bills on sidewalks. Those firms that could benefit from outside directors will generally already have them. Those without are firms outsiders could not likely improve. Because the firms for which board composition matters will have boards approaching their firm-specific optimum, board composition should bear no observable relation to firm performance. Consistent with this endogeneity, the literature to date does not identify a positive association between outside directors and firm performance. Although some studies do find a positive association, others find the association negative. Most studies reviewing the literature -Hermalin & Weisbach, for example, or Romano and Bhagat & Black -simply find no relationship between observed performance and board composition. After a “meta-analytic” study of the results, Dalton, et al. conclude: “board composition has virtually no effect on firm performance.” 15 Michael Jensen & J. Warner, The Distribution of Power Among Corporate Managers, Shareholders, and Directors, 20 J. Finan. Econ. 3 (1988). 16 Though largely ignored in the “reformist” legal literature, this endogeneity to board composition is central to such econometric studies as Marion Hutchinson, An Analysis of the Association Between Firms’ Investment Opportunities, Board Composition, and Firm Performance (unpublished, 2002); Anup Agrawal & Charles R. Knoeber, Firm Performance and Mechanisms to Control Agency Problems between Managers and Shareholders, 31 J. Fin. & Quant. Anal. 377 (1996); Chenchuramaiah T. Bathala, & Ramesh P. Rao, The Determinants of Board Composition: An Agency Theory Perspective, 16 Managerial & Dec. Econ. 59 (1995); Randolph Beatty & Edward J. Zajac, Managerial Incentives, Monitoring, and Risk Bearing: A Study of Executive Compensation, Ownership, and board Structure in Initial Public Offerings, 39 Adm. Sci. Q. 313 (1994). 17 Positive effects: e.g., Barry D. Baysinger & Henry N. Butler, Corporate Governance and the Board of Directors: Performance Effects of Changes in Board Composition, 1 J. Law, Econ. & Org. 101 (1985); Mahmoud A. Ezzamel & Robert Watson, Organizational Form, Ownership Structure and Corporate Performance: A Contextual Empirical Analysis of UK Companies, 4 Brit. J. Mgmt. 161 (1993); James A. Brickley & Christopher M. James, The Takeover Market, Corporate Board Composition, and Ownership Structure: The Case of Banking, 30 J. Law & Econ. 161 (1987); David Mayers, Anil Shivdasani & Clifford W. Smith, Jr., Board Composition and Corporate Control: Evidence from the Insurance Industry, 70 J. Bus. 33 (1997). Negative effects: e.g., Idalene F. Kesner, Directors’ Stock Ownership and Organizational Performance: An Investigation of Fortune 500 Companies, 13 J. Mgmt. 499 (1987); Agrawal & Knoeber, supra note (1996); Klein, supra note (insiders on key committees bring valuable information); Stanley C. Vance, Corporate Governance: Assessing Corporate Performance by Boardroom Attributes, 6 J. Bus. Res. 203 (1978). 18 Benjamin E. Hermalin & Michael S. Weisbach, Boards of Directors as an Endogenously Determined Institution: A Survey of the Economic Literature, Fed. Res. Bank N.Y. Policy Rev. (forthcoming), at 6; Roberta Romano, Less is More: Making Institutional Investor Activism a Valuable Mechanism of Corporate Governance, 18 Yale J. Reg. 174, 192-95 (2001); Roberta Romano, Corporate Law and Corporate Governance, 5 Indus. & Corp. Change 277 (1996); see also Sanjai Bhagat & Bernard Black, The Uncertain Relationship Between Board Composition Outside Directors in Japan: Page 6 C. The U.S.-Japan Contrast: 1. Misleading stereotypes. -And yet, the contrast between the U.S. and Japan remains: exchange-listed U.S. firms have many outsiders on their boards; Japanese firms have few. The contrast poses the obvious preliminary puzzle: why do firms in the two countries appoint directors with such different backgrounds? The most obvious candidates are the easiest to dismiss. First, the U.S.-Japan contrast does not reflect an inactive Japanese equity market, for the Japanese market is active. Japanese firms raise not just debt but equity, and raise the two types of funds in about the same proportions as U.S. firms. When observers claim Japanese firms are more heavily levered, they primarily capture accounting differences. Corrected for those differences, writes Stewart Myers, U.S. firms have a book-debt/asset ratio of 33 percent where Japanese firms have 37 percent. U.S. firms have a market-debt/asset ratio of 23 percent where Japanese firms have 17. Second, Japanese managers do not promote employee welfare over shareholder returns. Instead, Japanese firms maintain incentives structured directly to induce their managers to augment shareholder gains. Abe, Kaplan, and Kaplan & Minton, for instance, all find top executive tenure in Japan tied to firm performance. All else equal, executives who earn shareholders large returns do better. Those who fail to earn them do worse. Third, Japanese executives do not ignore corporate-control-market incentives, for they face a thriving market in corporate control. Although tender offers are rare, they have long been possible. Yet for managerial incentives, what matters is not the number of takeovers, but the potential for them. Indeed, if potential raiders could acquire a firm readily enough, in equilibrium they seldom would -for managers would manage in ways that did not make themselves a target. What is more, in Japan mergers and asset sales are common. In 1994, Japanese firms engineered 1,917 mergers and 1,153 sales of all or substantially all their assets. Crucially, mergers and asset sales move productive assets to their most productive use as effectively as tender offers. Fourth, the government has not used regulation to soften capital market constraints. Although for years it purported to ration funds, for most of the last half-century firms have raised and Firm Performance, 54 Bus. Law. 921 (1999) (no strong relation between board composition and perfornance, but suggesting small number of independent directors may be beneficial). 19 Dan R. Dalton, et al., Meta-Analytic Reviews of Board Composition, Leadership Structure, and Financial Performance, 19 Strategic Mgmt. J. 269, 278 (1998). To similar effect, see Romano, supra note (1996), at 287: “No matter variable is used to measure performance, virtually all studies find that there is no significant relation between performance and board composition.” 20 Stewart C. Myers, Capital Structure, 15(2) J. Econ. Perspectives 81, 83 (2001). 21 Yukiko Abe, Chief Executive Turnover and Firm Performance in Japan, 11 J. Japanese & Int’l Econ. 2 (1997); Steven N. Kaplan, Top Executive Rewards and Firm Performance: A Comparison of Japan and the United States, 102 J. Pol. Econ. 510 (1994); Steven N. Kaplan & Bernadette A. Minton, Appointments of Outsiders to Japanese Boards: Determinants and Implications for Managers, 36 J. Finan. Econ. 225 (1994). 22 A point ignored by Curtis Milhaupt & Mark West, Institutional Change and M&A in Japan: Diversity through Deals, in Curtis J. Milhaupt, ed., Global Markets, Domestic Institutions: Corporate Law and Governance in a New Era of Cross-Border Deals (New York: Columbia University Press, forthcoming 2003). 23 Kosei torihiki iinkai, ed., Kosei torihiki iinkai nenji hokoku [Fair Trade Commission Annual Report] 181 (Tokyo: Kosei torihiki iinkai, 1994). Outside Directors in Japan: Page 7 their money in competitive markets at competitive rates. The capital market restrictions it imposed simply did not bind. Even as early as the 1970s, firms borrowed at market rates. 2. Shareholder suits. -Perhaps, however, the puzzle is not why Japanese firms have so few outside directors. Perhaps the puzzle is why U.S. firms have so many. And although we do not purport to test the hypothesis, perhaps the explanation lies in the way outsiders help insulate U.S. firms from shareholder nuisance suits. For most of the last half-century, Japanese firms faced few such suits. Since the 1970s, U.S. firms have faced them regularly. An American lawyer purporting to “represent” all shareholders can often do so by finding one shareholder who will nominally speak for all, either in a class action or in a derivative suit. The obvious settlement game follows: in exchange for letting the dependents keep class or corporate recoveries at trivial levels, the lawyer pockets a large fee. Busy courts routinely approve. Under Japanese civil procedure, lawyers can represent only the specific plaintiffs who appoint them rather than any purported class, and until recently owed such large filing fees on any derivative suits that they filed almost none. The U.S. suits do not produce shareholder gains. Instead, as the settlement game suggests, they produce gains only for the plaintiffs’ bar. Romano, for example, finds that “while most suits settle, the settlements provide minimal compensation.” Instead, the “principal beneficiaries of the litigation . . . appear to be attorneys, who win fee awards in 90 percent of settled suits.” Outside directors matter in this game, because Delaware courts (the most common jurisdiction for exchange-listed firms) usually dismiss conflict-of-interest claims against firms that route contested decisions past outsiders. Suppose a shareholder alleges a senior managerial conflict-of-interest. If the board presented the transaction to nominally disinterested outsiders, the shareholder bears the burden of proving that the deal was so egregiously bad as to constitute “waste.” If instead the board had no outsiders, the burden of proof shifts and the defendant must prove that the transaction was “intrinsically fair.” Put more realistically, in conflict-of-interest claims Delaware courts generally hold that boards with outside directors win. Boards without them lose. Given all this, perhaps U.S. boards do not appoint the outside directors they do because outside directors monitor more independently. Perhaps they appointment them to insulate the firm from extortion. Importantly for our project, during the 1980s Japanese law effectively barred this legalized extortion. As a result, the data on Japanese directorships let us explore board composition in an environment uncluttered by plaintiffs’ securities suits. In turn, this lets us ask two questions. First, 24 Miwa & Ramseyer, supra note (Directed Credit). 25 Mark D. West, Why Shareholders Sue: The Evidence from Japan, J. Legal Stud. 351 (2001). 26 Roberta Romano, The Shareholder Suit: Litigation without Foundation?, 7 J. Law, Econ. & Org. 55, 60 (1991). 27 J. Mark Ramseyer & Minoru Nakazato, Japanese Law: An Economic Approach 146 (Chicago: The University of Chicago Press, 1999) (class actions); West, supra note (derivative suits) 28 Romano, supra note, at 84. See also Janet Cooper Alexander, Do the Merits Matter? A Study of Settlements in Securities Class Actions, 43 Stan. L. Rev. 497 (1991); Reinier Kraakman, Hyun Park & Steven Shavell, When Are Shareholder Suits in Shareholder Interests?, 82 Geo. L.J. 1733 (1994). 29 See, e.g., 8 Del. § 144; Fliegler v. Lawrence, 261 A.2d 218 (Del. 1976); see generally Robert C. Clark, Corporate Law ch. 5 (Boston: Little Brown, 1986); Romano, supra note (1996), at 284. Note, however, that the evidence on whether outside board membership deters filings is ambiguous. See Romano, supra, at 294-95. Outside Directors in Japan: Page 8 does board composition matter? Are outsider appointments random? If not, which firms find outside directors most advantageous, and which find them least? Second, if board composition often does matter, is it endogenous? Do firms with more outsiders outperform their rivals? Or does market pressure instead push firms toward their optimal board composition? II. The Data A. Introduction: To study the determinants and effect of outside director appointments, we assemble information on all non-bank firms listed on Section 1 of the Tokyo Stock Exchange (the largest firms). We collect financial data from 1986 to 1994, and board composition in 1985. We then use the data to determine which firms appointed what kinds of directors (Section III.A.), and what observable effect those directors had on firm performance (Section III.B.). We exclude banks from this data set, and explore the question of outside director appointments to bank boards elsewhere. B. Sources: We take our basic financial data from the Nikkei NEEDS data base. We then add several additional variables: from the Nikkei QUICK data base, we collect information on bank loans at firms; from the Kabushiki toshi shueki ritsu we obtain shareholder returns; from work by Asako, Kunimori, and others, we obtain Tobin’s Q; and from the Kigyo keiretsu soran we collect information on board composition and the presence of a dominant shareholder. C. Variables: With this data, we construct the following variables: 1. Performance variables. -Q: Tobin’s Q for TSE-listed manufacturing firms (not the whole data set), averaged over 1986-90 and 1990-94. ROI: Total annual shareholder returns on investment (annual rate of appreciation in stock price plus dividends received) for 1985-90 and 1990-95. Operating-Income/TA: The ratio of a firm’s operating income (#95 of the Nikkei NEEDS data base) to total assets (#89) for each year, averaged over 1986-90 and 1990-94. Ordinary-Income/Eq: The ratio of a firm’s ordinary income (operating plus nonoperating income, less non-operating expenses [such as interest]; #110) to equity (#78) for each year, averaged over 1986-90 and 1990-94. 30 Yoshiro Miwa & J. Mark Ramseyer, Financial Malaise and the Myth of the Misgoverned Bank, in Milhaupt, supra note. We also ignore a firm’s purported keiretsu affiliation, for reasons explained more fully in Yoshiro Miwa & J. Mark Ramseyer, The Fable of the Keiretsu, 11 J. Econ. & Mgmt. Strategy 169 (2002). 31 Nikkei QUICK joho, K.K., NEEDS (Tokyo, Nikkei QUICK joho, as updated); Nikkei QUICK joho, K.K., QUICK (Tokyo, Nikkei QUICK joho, as updated); Nihon shoken keizai kenkyu jo, ed., Kabushiki toshi shueki ritsu [Rates of Return on Common Stocks] (Tokyo: Nihon shoken keizai kenkyu jo, updated); Toyo keizai, ed., Kigyo keiretsu soran [Firm Keiretsu Overview] (Tokyo: Toyo keizai, as updated); Kazumi Asako, et al., Setsubi toshi to tochi toshi: 1977-1994 [Investment in Equipment and Investment in Land: 1977-1994, in Kazumi Asako & Masayuki Otaki, eds., Gendai makuro keizai dogaku [Contemporary Economic Dynamics] (Tokyo: University of Tokyo Press, 1997) (see this article for an explanation of the Q data). 32 Q is “multiple Q,” given the consideration which the compilers gave to the impact of real estate prices on corporate performance. See Asako, et al., supra note. Outside Directors in Japan: Page 9 Growth: The annual growth rate, in percentage, of a firm’s total assets, averaged over 1986-90 and 1990-94. 2. Board composition variables. -As of April 1985: Former bankers: The number of directors (or executive directors) on the board with a past career at a bank. Former other firm: The number of directors (or executive directors) on the board with a past career at another firm (other than a bank). Former government employee: The number of directors (or executive directors) on the board with a past career in government. Concurrent banker: The number of directors (or executive directors) on the board with a concurrent position at a bank. Concurrent other firm: The number of directors (or executive directors) on the board with a concurrent position at another firm (other than a bank). Total outside directors: The sum of the above directors (or executive directors). 3. Control variables. -Board Size: The number of directors (or executive directors) at a firm in 1985. Dominant S/h: 1 if any shareholder held 25 percent or more of the firm’s stock in 1985; 0 otherwise. Top 5 Lenders: The fraction of the firm’s debt in 1986 and 1990 from the 5 institutions lending the firm the largest amounts. Volatility: The variance of the ratio of a firm’s operating income (#95) to total assets (#89) over 1986-90 and 1990-94. Total Assets: The average total assets of a firm (#89) over 1986-90 and 1990-94, in million yen. Tangible Assets/TA: The average ratio of a firm's tangible assets (#21) to total assets (#89) over 1986-90 and 1990-94. Sales/TA: A firm’s average sales (#90) over 1986-90, divided by its average total assets (#89), over 1986-90. Bank Debt/TA: The sum of a firm’s short(#46) and long-term (#47, 63) borrowings divided by its total assets (#89), averaged over 1986-90 and 1990-94. Industry dummies: Dummy variables for affiliation in the construction, trade, service and finance (but excluding banks), utilities (including transportation and real estate), light industry, chemical, machinery, and metals industries. We include selected summary statistics in Tables 1 and 2. [Include Table 1 about here.] [Include Table 2 about here.] D. The Regressions: We first explore the determinants of outside director appointments. Toward that end, we regress the number of outside directors of each type (both directors at any rank and executive 33 For this and other director variables, the data cover those directors who, after serving in management elsewhere, are named to the board within 3-4 years of joining a given firm. Outside Directors in Japan: Page 10 directors) on the board in 1985 on firm financials and industry affiliation. Because rational firms will choose their governance structure with an eye to their anticipated needs, we use 1986-90 financial data. Because by all accounts firms rarely change their basic board structure, we collect board composition data only for one year. Second, we study the effect of board composition on firm performance. We do this by regressing performance in two separate periods on (i) the number of outside directors of each type, (ii) various firm financials, and (iii) industry dummies. To check for robustness, we use several distinct measures of performance. III. Outside Directors -the Discussion A. Who Appoints Them?