Academic journal article Journal of Risk and Insurance

Organizational Structure and Performance: Evidence from the Nonlife Insurance Industry in Japan

Academic journal article Journal of Risk and Insurance

Organizational Structure and Performance: Evidence from the Nonlife Insurance Industry in Japan

Article excerpt

ABSTRACT

This study examines the impact of organizational structure on firm performance, incentive problems, and financial decisions in the Japanese nonlife (property-casualty) insurance industry. Stock companies that belong to one of six horizontal keiretsu groups have lower expenses and lower levels of free cash flow than independent stock and mutual insurance companies. Keiretsu insurers also have higher profitability and higher loss ratios than independent insurers. With a limited sample size, there is some evidence that mutual insurers have higher levels of free cash flows, higher investment incomes, and lower financial leverage than their stock counterparts. Overall, empirical evidence suggests that each structure has its own comparative advantage.

INTRODUCTION

More than 60 years ago, Berle and Means (1932) and Coase (1937) pioneered a stream of research focusing on the relationship of the structure of a firm's "property rights" with its real activities. Alchian and Demsetz (1972), Jensen and Meckling (1976), Mayers and Smith (1981, 1986), and Fama and Jensen (1983) continued this research by addressing incentive conflicts between contracting parties; their focus was on manager and owner activities in different ownership and organizational structures. Since then, other research has documented effects of the firm's relation between the firm's choice of organizational structure and real activities.

Mayers and Smith (1981) study the impact of organizational structure on real activities in the U.S. insurance industry, which displaces perhaps the broadest range of organizational forms of any major industry. Stock companies in the insurance industry separate the functions of managers, stockholders, and policyholders. Mutual companies merge the owner and customer functions; that is, policyholders both supply capital and are residual risk bearers. These two types of organizational structure make it possible to examine operational efficiency and incentive problems (see Mayers and Smith, 1981, 1986, 1988, 1992, 1994). Although several empirical studies conclude that stock companies are more efficient than mutual companies, some theoretical analysis and empirical evidence suggest potential benefits of the mutual form of organization. In fact, the survival of both organizational forms indicates that each form has its own particular advantages (Mayers and Smith, 1988).

Other researchers have studied the relation between organizational structure and economic variables in the industrial firms of Japan. The financial environment of Japanese firms provides researchers with an ideal institutional setting to test various aspects of financial theory that have been developed in the United States (Kang and Stulz, 1996). Specifically, many Japanese companies have close ties to a "main bank," which not only provides a company with debt financing, but also owns a substantial amount of the firm's equity (Nakatani, 1984). This corporate structure is known as the financial or horizontal keiretsu. Prowse (1992) and Berglof and Perotti (1994) posit that the financial keiretsu, with its extensive cross-shareholdings, makes for one of the most complex governance structures. Because there are also man), Japanese companies that are relatively independent of these horizontal corporate networks, researchers can use the Japanese market as a "controlled" experimental design to examine aspects of corporate financial behavior.

Our purpose is to build on the research by Berle and Means (1932), further developed by Coase (1937), Alchian and Demsetz (1972), and Jensen and Meckling (1976), among others. We investigate the impact of organizational structure on firm performance, incentive problems, and financial decisions in nonlife insurance companies in Japan. (1) We believe our findings can shed additional light on the theoretical and empirical issues related to the organizational structure for several reasons. …

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