Academic journal article Journal of Financial Management & Analysis

Long-Term Employment Contracts in Japanese Companies and the Corporate Profitability in the Post Economic Bubble Era*

Academic journal article Journal of Financial Management & Analysis

Long-Term Employment Contracts in Japanese Companies and the Corporate Profitability in the Post Economic Bubble Era*

Article excerpt

Introduction

During the post-war economic miracle in Japan, the practices of long-term employment contracts and seniority-based promotions (SBP) helped to explain the superior competitive performance of Japanese companies. However, after the burst of the economic bubble, some ofthe costs associated with the long-term employment contracts became more evident making it difficult for the companies to maintain this traditional practice. With the slowdown in the economy the presence of large number of long tenured employees overshadowed the positive effects of long-term employment policy. In this study, we try to find out when and how the disparity between the changes in economic environment and long-term employment policy can harm the profitability of companies.

Long-term employment policy can have a number of advantages for the companies, mainly in the areas of education, training and improving employees' firmspecific skills'. In addition, it helps to reduce turnover, absenteeism and waste by creating a highly productive and motivated workforce2. Previous studies have acknowledged the advantages of this traditional practice in the forni of employee commitment, loyalty, devotion and mutual empathy (Peters and Waterman3; Sethi, et al.,4; Fujiwara5; Milgrom and Robert6; Tsuda7). However, less attention has been paid to the costs associated with such employment contracts. Ai anal /sis of the costs related with the long-term employment policy may help to understand how to use this system for the positive value creation. In this paper, we address this issue by analyzing what types of costs are associated with the long-term employment policy and how these costs can increase with the changes in the other environmental factors.

Prelude

We propose that some of the costs are present within the long-term employment policy, while others are due to a disparity between the system and changes in the economic environment. About the former, Kandel and Pearson8 theoretically suggest that costs associated with the long-term employment policy can become more evident in the subsequent years of implementation, when the number of long-tenured, highly paid employees increases in the company. About the latter, Sullivan and Peterson9 predict that a continued growth and expansion of firms is necessary to maintain the long-term employment contracts with the employees.* It is especially difficult to fulfill the functional prerequisites of long-teim employment contracts when the proportion of senior employees in a company is large.

A crucial contributor to die ·. ostL concealed in the long-term employment policy is the gradual increase in the number of long-tenured, highly paid employees. We explain it as an increase in the average employment tenure (AET) of workers in a company. A higher AET may increase the costs related to the functional prerequisites of the system. For instance, due to a steeper earningtenure profile of long tenured employees, the rate of pay increase is higher in the latter half of employment tenure1 ' . This implies that a higher AET level in a company may create the additional payment to the senior workers. A related issue is that this system uses seniority as an absolute standard for promotion.** As companies promote their employees on the basis of seniority, the average cost of wages for the company rises. On the other hand, with an increased AET level, the cost of maintaining the employment security would be much higher than with a lower AET. An increase in the AET level may also increase the intensity of other negative aspects. These include decreased employee performance because of the job security, low flexibility to alter the number of employees in case of changes in labor demand, diminished ability of the company to replace unproductive workers and difficulty creating large numbers of new positions for SBP. Though the AET level in a company may increase gradually by following the long-term employment policy, this increase remains invisible while the company is regularly hiring new employees. …

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