Financial and Product Market Integration: Responses of Japanese Firms

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Abstract and Key Results

* Growing financial and product market integration has resulted in increased pressures for changes in most developed economies. We investigate the impact of these twin drivers on changes effected by Japanese firms between 1986 and 1999.

* Specifically, we examine (1) how shareholdings by market investors and foreign investors and (2) export ratio impact outcomes in the form of efficiency increases, dividend payout, and leverage change.

* We also investigate whether the relationships differ between keiretsu and nonkeiretsu firms.

* Ownership by market investors was positively associated with efficiency increases and decreases in firm leverage. In addition, firm export ratio played a key role in motivating Japanese firms to increase their efficiency and firm leverage. Moreover, these relationships were more pronounced in non-keiretsu than keiretsu firms.

Key Words

Restructuring, Financial market integration, Product market integration, Strategies of Japanese firms, Keiretsus, Ownership structure, Market investors

Introduction

Economic history is replete with examples of business cycles where extended periods of growth are followed by stagnation and decline. Survival of firms during such periods of change depends on their ability to adjust their strategies in response to changing economic realities, particularly those related to economic downturns. This process of adjustment typically involves significant organizational and strategic changes (Bowman/Singh 1993). Unfortunately, firms often fail to undertake such changes (Bethel/Liebeskind 1993), failure that can be attributed to organizational inertia resulting from existing relationships, existing mindsets, and governance mechanisms (Goodstein/Boeker 1991). Under such circumstances, changes, when undertaken, are generally the outcome of considerable external pressures. The 1970s and 80s were periods of unprecedented growth for Japanese companies with several Japanese firms attaining positions of global dominance in their industries. With pundits predicting the ascendance of Japan as the dominant global economic power, the strategies, management systems, and governance practices of Japanese firms attracted significant attention among both scholars and practitioners.

The 1990s, in contrast, represented a period of economic stagnation for Japan. With dwindling growth opportunities at home and resurgent foreign competition, Japanese firms faced a situation where they needed to make significant changes to remain competitive. Unfortunately, many firms found it difficult to make the necessary changes--due, in part, to factors such as the rigidities imposed by keiretsu relationships, life-term employment practices, and corporate mindsets that emphasized growth over profitability. The relative lack of shareholder activism and the absence of a market for corporate control further resulted in firms often sticking to the status quo.

In this study we seek to examine the impact of two major developments in the global economy, namely, product market integration and financial market integration on Japanese corporations. The process of globalization has involved the relatively free flow of products, services, and capital across borders (Bartlett/Ghoshal 2000). These flows and the resultant integration of markets made firms in most developed economies increasingly susceptible to intense global competition. In addition, firms have been forced to respond to the expectations of integrated financial markets. In this paper, we investigate the extent to which Japanese firms have responded to these twin forces of product market and financial market integration. In the process, we hope to shed some light on how external pressures triggered changes in Japanese companies. Further, given that the keiretsu system is a key distinguishing feature of the Japanese industrial system, we also investigate the differences between keiretsu and non-keiretsu firms in how they responded to these two forces. …