Do foreign institutional investors promote governance improvements in Japan?

In this paper, we investigate whether foreign institutional ownership affects the quality of corporate governance by analyzing equity ownership and the investment horizon of foreign investors. While a number of studies indicate that foreign institutional investors play a significant role in promoting governance improvements in countries with weaker shareholder protection, there is little evidence about their impact in countries with strong shareholder rights. In line with extant evidence, our results show that foreign ownership is positively associated with corporate governance in Japan, where shareholder rights are legally better protected than those in other countries like the United States, the home of the major institutional investors, but in fact, the corporate governance has been shareholder-unfriendly due to the presence of management-friendly cross-shareholders. On the other hand, we do not find evidence that foreign block-holders with longer investment horizons play a larger role in improving governance although literature suggests that such stable owners have greater incentives to actively monitor the firms. Similar evidence is found for large independent domestic institutions. In contrast, both the equity ownership and investment horizon of large domestic investors such as banks and insurance companies, who have potential business relationships with the invested firms, negatively impact corporate governance. Interestingly, such a negative effect of relationship-oriented ownership is more likely to be mitigated when foreign institutional investors hold large stakes in the firms. Overall, our results suggest that foreign equity ownership promotes improvements in the corporate governance of Japanese firms irrespective of their investment horizons.