Executive Pay and Succession in Japan: Divergent Effects of Foreign and Domestic Ownership

We study the effect of ownership structure on executive pay and succession in Japanese corporations. We find differences in the effects of domestic and foreign ownership that are based on the nature of owners' relationships with mana gers. Foreign ownership reduces executive pay and enhances the likelihood of executive succession when firms underperform. Domestic ownership has no effect. Our results suggest that foreign owners exercise governance according to an agency theory logic of favoring explicit controls, while domestic owners do not favor explicit controls in keeping with a stewardship theory logic of empowerment. 3 Corporate governance is defined as " the ways in which suppliers of finance to corporations assure themselves of getting a return on their investments " (Shleifer & Vishny, 1997: 737). Two diametrically opposed governance models have been used in strategy research to describe the relationship between owners and managers: agency theory (Jensen & Meckling, 1976) and stewardship theory (Davis, Schoorman, & Donaldson, 1997). Agency theory's key assumptions are that managers pursue their self-interest when their goals diverge from those of owners and that explicit control structures are needed to curb potential managerial opportunism. In stewardship theory, in contrast, goal alignment and trust between owners and managers is assumed, and empowerment-not controls-are the means to motivate managers to subordinate narrow self-interest and take decisions that are in the best interests of shareholders. Agency and stewardship logics represent two alternate approaches whereby owners attempt to ensure appropriate returns on investment. Prior research suggests that relationships between managers and shareholders in Japanese corporations are structured by a stewardship theory logic of cooperative goal alignment (Davis et al., 1997; Lee & O'Neill, 2003). Japanese national culture favors a collectivist orientation wherein personal goals are subordinated to collective goals (Davis et al., 1997). This orientation reduces potential goal incongruity and facilitates the trust necessary for fostering a stewardship relationship. The stewardship logic, however, is likely the case only for domestic owners such as other Japanese companies and financial institutions. Domestic owners typically have ties with a firm arising from supply, financial, keiretsu, or cross-ownership links that facilitate the trust necessary for stewardship-based governance (Gerlach, 1992). Foreign owners, such as individuals, corporations, and financial institutions from outside of Japan, lack the long-term cooperative relationships and trust enjoyed by domestic owners. As market investors, foreign 4 owners are likely to adopt an agency theory logic that emphasizes the divergent goals of self-interested managers …