Short-Termism in Varieties of Capitalism
Hridesh Gajurel
Master of Research; Bachelor of Arts
A thesis submitted for the degree of Doctor of Philosophy at
The University of Queensland in 2020
School of Political Science and International Studies
Abstract
Short-termism seems to be a defining feature of contemporary capitalism. Studies have shown that public firms return most of their profits to shareholders in the form of dividends and share buybacks, leaving little for long-term investment in productive capacities and employees. Besides endangering the long-term future of the firm itself, such short-termism stifles innovation, threatens employment, exacerbates inequality, and hinders economic growth. Many scholars blame the stock market for corporate short-termism as it is associated with ‘impatient capital’ – i.e., footloose portfolio investors. However, anecdotal evidence from the ‘comparative capitalism’ literature indicates that publicly-listed firms in other ‘varieties of capitalism’ like Germany and Japan may not be as short-termist as their Anglo- American counterparts, even though they also face impatient capital in the stock market. Direct empirical comparisons of public firms to confirm national divergence on short- termism are, however, lacking in the literature. I thus set out to compare German and Japanese public firms to American and British public firms using firm-level financial data. I matched firms from different countries by size and industry before comparing them while also controlling for profitability and investment opportunities. What I find is that shareholder payouts (dividends plus share buybacks) are indeed substantially lower in German public firms and lower still in Japanese public firms compared to matched Anglo-American public firms. Although this does not translate into higher real investment in German and Japanese firms, it does nevertheless indicate greater concern for the long-term sustainability of the firm and for the protection of employment. The findings thus suggest that there is much more to short-termism than just the stock market and impatient capital.
Although the structural features of the stock market such as high liquidity, ownership-control separation, real-time pricing, and openness (publicness) that make for impatient capital enable short-termism in public firms, I argue that they do not automatically cause short- termism. Short-termism, I argue, depends on institutions, which mediate the link between short-termism and the stock market. I show how the presence of certain institutions and the absence of others encourages short-termism in the Anglo-American system. On the other hand, I show how institutions in Germany and Japan impede stock-market-based short- termism. In this way, institutional differences help explain national differences in short- termism. A key question remains, however: Why do Anglo-American institutions promote short-termism while German and Japanese institutions restrict it in the first place? Institutions, I argue, are only the means to achieving ends. Ends are prescribed ultimately by
2 power relations and culture (values and beliefs). Power relations and culture together shape business ideology, which, in turn, shapes institutional logics. Institutional logics then determine distributional outcomes such as high shareholder payout (short-termism). In this way, national differences in short-termism may be ultimately explained by national differences in power relations and culture. From this perspective, the ‘shareholder value’ ideology that derives from the dominance of finance capital in Anglo-America and is rooted in a culture of liberalism and individualism ultimately explains why shareholder payout in Anglo-American public firms is substantially higher than in German public firms, which are instead embedded in an ideology of ‘social market economy’ that is shaped by a more even power relation between capital and labour and rooted in a long-standing culture of corporatism and consensus. Moreover, shareholder payout is lowest in Japanese public firms because managers, who tend to be the dominant players, are embedded in a culture of groupism and paternalism. They have little regard for (stock-market-based) shareholders – who they see as outsiders – and view themselves as the custodians of the ‘enterprise community’ charged with ensuring its permanence and protecting its members (mostly employees).
My focus on relatively enduring factors like power relations and culture does not mean that I ignore institutional change, however. Firstly, I argue that institutional change is usually an adjustment of the means (institutions) to changing conditions to achieve the same ends. Ends can change too, however; although less often. Power relations, which shape ends, can change as a result of structural changes (e.g., globalisation) or political changes (e.g., change in government). As the dominant ideology – which expresses the ends – is rooted in both power relations and culture, it too is likely to change when power relations change, but the change in ideology will still have to be consistent with enduring cultural values and beliefs if it is to last. From this perspective, then, regardless of power relations, enduring cultural differences will ensure the continuance of at least some degree of divergence in the foreseeable future. Indeed, I find through my longitudinal empirical comparison of public firms that German and Japanese public firms continue to diverge from Anglo-American public firms, even as globalisation and neoliberalism have tilted power relations increasingly in favour of finance capital since the 1980s.
3 Declaration by author
This thesis is composed of my original work, and contains no material previously published or written by another person except where due reference has been made in the text. I have clearly stated the contribution by others to jointly-authored works that I have included in my thesis.
I have clearly stated the contribution of others to my thesis as a whole, including statistical assistance, survey design, data analysis, significant technical procedures, professional editorial advice, financial support and any other original research work used or reported in my thesis. The content of my thesis is the result of work I have carried out since the commencement of my higher degree by research candidature and does not include a substantial part of work that has been submitted to qualify for the award of any other degree or diploma in any university or other tertiary institution. I have clearly stated which parts of my thesis, if any, have been submitted to qualify for another award.
I acknowledge that an electronic copy of my thesis must be lodged with the University Library and, subject to the policy and procedures of The University of Queensland, the thesis be made available for research and study in accordance with the Copyright Act 1968 unless a period of embargo has been approved by the Dean of the Graduate School.
I acknowledge that copyright of all material contained in my thesis resides with the copyright holder(s) of that material. Where appropriate I have obtained copyright permission from the copyright holder to reproduce material in this thesis and have sought permission from co- authors for any jointly authored works included in the thesis.
4 Publications included in this thesis
No publication included.
Submitted manuscripts included in this thesis
No manuscripts submitted for publication.
Other publications during candidature
No other publications.
Contributions by others to the thesis
No contributions by others.
Contributions by others to the thesis
No works submitted towards another degree have been included in this thesis.
Research Involving Human or Animal Subjects
No animal or human subjects were involved in this research.
5 Acknowledgements
I am truly grateful to my principal supervisor, Professor Stephen Bell, for his invaluable advice, expert guidance, patience, and encouragement. I found my PhD experience to be intellectually stimulating and enjoyable, thanks in no small part to Stephen, who was also always approachable, friendly, and understanding.
I would also like to thank my associate supervisor, Associate Professor Ryan Walter, who provided not only really useful and constructive feedback but also great encouragement.
I am deeply indebted to my wife, Sadi, who not only supported me and our small family tremendously throughout my candidacy, especially after the birth of our daughter, but also provided valuable feedback to improve my work throughout. I really could not have done this without her. I would also like to thank her parents (my parents-in-law) for their kindness and support throughout my PhD studies.
Lastly, I would like to thank my parents for always believing in me, supporting my decisions, and enabling my academic journey.
6 Financial support
This research was supported by an Australian Government Research Training Program Scholarship.
7 Keywords
Financialisation, short-termism, varieties of capitalism, shareholder payout, share buyback, real investment, dominant ideology, power relations, cultural values
Australian and New Zealand Standard Research Classifications (ANZSRC)
ANZSRC code: 940304 International Political Economy (excl. International Trade), 40%
ANZSRC code: 150303 Corporate Governance and Stakeholder Engagement, 40%
ANZSRC code: 160806 Social Theory, 20%
Fields of Research (FoR) Classification
FoR code: 1606, Political Science, 50%
FoR code: 1608, Sociology, 30%
FoR code: 1503, Business and Management, 20%
8 Dedication
To Ma and Daddy, my late grandparents, who passed away during my PhD candidature; and to Gaia, my daughter, who was born during this time.
9
Contents
List of Tables ...... 12 List of Figures ...... 13 List of Abbreviations ...... 14 Introduction ...... 15 The short-termism literature in finance and economics ...... 20 The financialisation literature ...... 23 The ‘comparative capitalism’ literature ...... 26 Chapters ...... 35 Chapter 1 ...... 37 Financialisation and Short-Termism ...... 37 The financialisation of non-financial corporations ...... 39 Profit financialisation and control financialisation ...... 42 Short-termism ...... 46 Managerial pressures and incentives ...... 52 Summary and Conclusion ...... 56 Chapter 2 ...... 59 Stock-Market-Induced Short-Termism and Its Institutional Mediation ...... 59 Short-termism and the stock market ...... 60 The structural features of the stock market ...... 62 The stock market is not a sufficient explanation for short-termism ...... 66 Institutional mediation of stock market pressures ...... 69 Conclusion and research gap ...... 79 Chapter 3 ...... 81 Power Relations, Culture, and Dominant Ideology ...... 81 The deeper roots of capitalist divergence ...... 83 Power relations and institutional design ...... 83 Culture and capitalist divergence ...... 88 Dominant ideology as the expression of power relations and culture ...... 97 Conceptual framework ...... 103
10 Chapter 4 ...... 107 Method for Empirical Study ...... 107 Defining and operationalising short-termism ...... 109 Choice of countries ...... 113 Sample and data ...... 116 Measures ...... 117 Matching ...... 120 Following chapters ...... 121 Chapter 5 ...... 122 Comparing Germany and Anglo-America ...... 122 The proximate drivers of short-termism ...... 125 Hostile takeovers and share-based managerial pay ...... 126 The deeper roots of divergent approaches ...... 131 The German ideology/identity of the ‘social market economy’ ...... 132 The power of labour in Germany ...... 135 Comparing public firms on shareholder payout and real investment ...... 136 Convergence and Institutional change in Germany? ...... 150 Conclusion ...... 157 Chapter 6 ...... 159 Comparing Japan and the West ...... 159 Proximate factors ...... 162 Social embeddedness in the ‘enterprise community’ ...... 169 The ‘employee-favouring’ manager ...... 171 The historical-cultural roots of Japanese practices and norms ...... 174 Comparing shareholder payout and real investment in public firms ...... 182 Institutional change ...... 194 Conclusion ...... 196 Conclusion ...... 199 The important role of the dominant ideology in capitalist divergence ...... 200 Does capitalist divergence really matter? ...... 207 The four main takeaways of this study ...... 210 List of References ...... 213
11
List of Tables
Table 5.1. Average voting share of largest single shareholder and of stable shareholders 127
Table 5.2. International comparison of the composition of CEO pay 130
Table 5.3. Characteristics of German CEOs 130
Table 5.4. Shareholder payout in matched German and UK public firms 138
Table 5.5. Shareholder payout in matched German and US public firms 139
Table 5.6. Regression estimates for shareholder payout in German public firms and matched 140 US and UK public firms respectively
Table 5.7. Real investment in matched German and US public firms 147
Table 5.8. Real investment in matched German and UK public firms 148
Table 5.9. Regression estimates for real investment and of the difference between real 149 investment (capex) and shareholder payout in matched German and US public firms
Table 5.10. Regression estimates for real investment and of the difference between real 149 investment (capex) and shareholder payout in matched German and UK public firms
Table 6.1. Average voting share of largest single shareholder (2004) and of stable shareholders 164 (2006); hostile takeovers completed and attempted (1990-2007)
Table 6.2. Shareholder payout in matched Japanese and US public firms 185
Table 6.3. Shareholder payout in matched Japanese and UK public firms 186
Table 6.4. Shareholder payout in matched Japanese and German public firms 187
Table 6.5. Regression estimates for shareholder payout in Japanese public firms and matched 188 US, UK, and German public firms respectively
Table 6.6. Real investment in matched Japanese and US public firms 189
Table 6.7. Real investment in matched Japanese and UK public firms 190
Table 6.8. Real investment in matched Japanese and German public firms 191
Table 6.9. Regression estimates for real investment and of the difference between real 192 investment (capex) and shareholder payout in matched Japanese and US public firms
Table 6.10. Regression estimates for real investment and of the difference between real 193 investment (capex) and shareholder payout in matched Japanese and UK public firms
Table 6.11. Regression estimates for real investment and of the difference between real 193 investment (capex) and shareholder payout in matched Japanese and German public firms
12 List of Figures
Figure 1.1. Financial assets as a percentage of tangible assets: non-financial corporations, 43 1952–2003, US
Figure 1.2. Interest and dividend income as a percentage of internal funds: non-financial 43 corporations, 1952–2003, US
Figure 1.3. Total financial payments (including interest payments, dividend payouts, and share 44 buybacks) as a percentage of profits before tax: non-financial corporations, 1952–2003, US
Figure 1.4. Averages in US$ (millions) of real investment (capital expenditure), shareholder 50 payout (dividends plus share buybacks), debt, and net income in US public firms
Figure 3.1. Factors shaping distributional outcomes (short-termism) in public firms 104
Figure 5.1. Shareholder payout, dividends, and share buybacks as a percent of total assets in 156 matched German and US firms and matched German and UK firms
Figure 5.2. Real investment: Growth in gross property, plant, and equipment (PPE), capital 157 expenditure, and the difference between capital expenditure and shareholder payout as a percent of total assets in matched German and US firms and matched German and UK firms
Figure 6.1. Shareholder payout and capital expenditure as a percentage of total assets in 198 matched public firms in Japan & the US, Japan & the UK, and Japan & Germany
Figure 7.1. Unemployment rate for Germany, Japan, UK, and USA, 2005-2017 210
13 List of Abbreviations
CME Coordinated market economy
LME Liberal market economy
NFC Non-financial corporation
OECD Organisation for Economic Co-operation and Development
SVO Shareholder value orientation
VoC Varieties of Capitalism
UK United Kingdom
US United States
14 Introduction
Corporate short-termism, or excessive shareholder payout in the form of share buybacks and dividends paid by publicly-listed firms, is widely acknowledged as a pernicious and entrenched feature of contemporary capitalism. Rising shareholder payout by public firms since the 1980s has greatly enriched investors at the expense of employment and wage growth, aggravating economic inequality (Lazonick, 2014; Lin & Tomaskovic-Devey, 2013). Public firms make up a large portion of the private sector: they account for roughly half of all non-residential private investment, sales, and profits and around one-third of private-sector employment in the US, for example (Asker, Farre-Mensa, & Ljungqvist, 2015). Corporate short-termism is thus a serious problem for the wider political economy and society. Unlike Hall and Soskice (2001), for example, who take a neutral position on short-termism, my view is thus that short-termism is negative (in line with the normative position of the ‘financialisation’ literature, for example), and the goal of my research is to investigate the roots of this ‘pathology’.
Corporate short-termism is ultimately a distributional issue: it is about who gets what at the firm level. Corporate short-termism implies that a public firm distributes too much of its internal funds too quickly to shareholders in a way that jeopardises the long-term prospects of the firm itself and, by extension, the prospects of its stakeholders. Shareholders of a public firm – who are usually portfolio investors – are not nearly as concerned about the future of the firm as its employees and other stakeholders (like suppliers and customers) because they can jump ship at the first sign of trouble without suffering much loss; the liquidity of the stock market allows for that. Employees and other stakeholders, on the other hand, often depend on the firm. Corporate short-termism harms employees in particular not only by endangering their employment but also by undermining wage growth and depriving them of training opportunities to enhance skills as managers look for ways to minimise costs in order to maximise short-term ‘shareholder value’. Corporate managers are, in fact, implicated in short- termism as their remuneration is often strongly tied to ‘shareholder value’, which essentially makes them shareholders (at least in Anglo-America). In this sense, from the perspective of the capital-labour distributional conflict, corporate short-termism tilts the outcome heavily in favour of shareholders (including shareholding managers) – especially when compared to post- war ‘managerialism’ – and helps explain the burgeoning gap between the rich and the rest since the 1980s.
15 There has been increasing interest in and concern about corporate short-termism (henceforth ‘short-termism’) since the 1980s among scholars, policymakers, and corporate leaders alike (Biden, 2016; Kay, 2012; Porter, 1991; Turner, 2016). Despite increasing interest and concern, short-termism is, however, still not well-understood. It is often thought that short-termism is caused by ‘impatient capital’ in the stock market and by ‘myopic’ corporate managers looking to maximise the returns on their stock options and shares (which make up a large portion of their remuneration). While stock market pressures and managerial self-interest are certainly part of the story, I argue that these are merely some of the proximate causes and that the roots of short-termism go much deeper. I firstly argue that short-termism depends heavily on the broader institutional setting in which firms are embedded, because institutions (laws, rules, and routinised practices) strongly influence and moderate stock market pressures on public firms. For example, the post-war institutional setting of ‘managerialism’ inhibited stock market pressures on US public firms and allowed them to focus on long-term growth whereas the current institutional setting of financialised capitalism magnifies stock market pressures and encourages US public firms to focus on (short-term) ‘shareholder value’, often at the expense of long-term growth (Lin & Tomaskovic-Devey, 2013; Stockhammer, 2005).
I develop a conceptual framework that delineates not only how institutional settings mediate stock market pressures on firms but also how institutional settings themselves are shaped by dominant ideologies, which, in turn, are shaped by power relations and culture (cultural values and beliefs). I firstly divide the institutional settings of firms into (1) firm-level institutional practices and (2) state-level formal institutions (laws and regulations). Firm-level institutional practices (e.g., CEO selection, use of stock options in managerial pay, board composition, performance metrics, employee ‘voice’, etc.) that directly shape firm-level outcomes are based on the dominant business ideology. The dominant business ideology is, in turn, shaped by power relations within the business field and by wider cultural values and beliefs. As far as state-level laws and regulations are concerned, they influence firm-level outcomes not by shaping firm behaviour directly (like firm-level practices do) but rather by (1) regulating the stock market and the wider economy and (2) by shaping power relations within the business field through corporate governance laws (e.g., shareholder rights and worker rights). State- level institutions are rooted in the dominant political-economic ideology at the national level, which is shaped by national culture and by state-level power relations (which tend to be more dynamic and contested than power relations in the business field). In short, I argue that corporate short-termism can only be adequately understood and explained by considering the
16 institutional settings of public firms (in a proximate sense) and by examining dominant ideologies, power relations, and (national) culture.
The extant literature on short-termism has long overlooked and continues to overlook these broader institutional, ideological, political, and cultural factors and, consequently, struggles to account for national differences in corporate behaviour (as I will elaborate later in this chapter). In other words, the extant literature on short-termism has little to say theoretically or indeed empirically about (potential) national differences in short-termism. Comparative studies are crucial for an in-depth understanding of short-termism and its causes. To this end, I compare corporate behaviour and short-termism across different types of political economies in this study. The ‘varieties of capitalism’ literature suggests that there are essentially two types of (capitalist) market economies: liberal market economies (LMEs) and coordinated market economies (CMEs) (Hall & Soskice, 2001). Firms in LMEs mostly coordinate their activities through competitive markets. Firms in CMEs, on the other hand, coordinate many activities through non-market institutions. In other words, public firms in LMEs and CMEs are embedded in disparate institutional settings. In this study, I thus compare public firms in the US and the UK (the LMEs) with their counterparts in Germany and Japan (the CMEs). Germany and Japan are, moreover, different types of CMEs: Germany represents the typical European CME that is based on legally-enforced non-market institutions whereas Japan represents the typical northeast-Asian CME that is based more on informal social institutions (Amable, 2003; Hall & Gingerich, 2009; Hall & Soskice, 2001; Whitley, 1999). In this sense, notwithstanding the prevalence of non-market institutions, public firms in Germany and Japan also face distinct institutional settings. I thus also compare public firms in Germany and Japan. In this way, I compare Anglo-American, German, and Japanese capitalism in this study in terms of corporate short-termism. This relatively parsimonious selection of countries – which nonetheless covers three key varieties of capitalist economies – allows for in-depth analysis that the multi-layered theoretical framework calls for. For the purpose of in-depth analysis, the four countries are arguably the most extensively discussed and researched in the broader literature and thus come with rich empirical observations to draw from. I use such empirical observations from secondary sources in tandem with the theoretical framework to elucidate the institutional, ideological, political, and cultural roots of national differences in shareholder payout and real investment (in public firms) revealed in my empirical study.
17 I find through empirical comparisons of the financial data obtained from the Osiris database1 that shareholder payouts (dividends plus share buybacks) are substantially lower in German and (especially) Japanese public firms compared to (matched) UK and US public firms. I also find that such disparities in shareholder payout have remained fairly consistent between 2005 and 2017 (the period studied) – indicating a lack of convergence. To ensure that the findings reflect the effects of institutional rather than structural differences on firm behaviour, I match public firms by size and industry before comparing them and I also control for firm profitability and economic conditions. My empirical findings thus clearly show that public firms in the US and the UK focus more on short-term shareholder value than do German and Japanese public firms and that this is largely because of institutional differences – which, in turn, reflect deeper ideological, political, and cultural differences.
A key argument in the short-termism literature is that high shareholder payout leads to reduced real investment, thus damaging the wider economy. My empirical findings actually reveal that high shareholder payout does not translate into simultaneously lower real investment in Anglo- American public firms (compared to German and Japanese firms). Shareholder payout and real investment do not necessarily have a direct inverse relationship – as many scholars assume – largely because new debt can help firms overcome the potential trade-off between the two variables. Given historically low interest rates since 2008, I find, for example, that US public firms have doubled their debt since 2008, which has enabled them to make ever-higher shareholder payouts without reducing real investment. This corporate strategy, however, still indicates short-termism despite the maintenance of real investment. These firms have essentially funded extra shareholder payouts by taking on more debt, which privileges short- term ‘shareholder value’ over the long-term health of the firm. Such debt may compromise future real investment, for example. In Germany and Japan, although lower shareholder payout does not translate into higher real investment, it does nonetheless seem to have enabled German and (especially) Japanese public firms to protect the employment of their regular employees. The main empirical finding of this study is thus that German and Japanese firms continue to be more long-term-oriented and less focussed on (short-term) ‘shareholder value’ than Anglo- American public firms.
1 The financial data is obtained from the Osiris database of Bureau van Dijk. This widely-used global database contains extensive accounting, financial, and descriptive data of publicly-listed firms from various countries. Bureau Van Dijk is a subsidiary of Moody’s.
18 All in all, I show in this study that there are national differences in the behaviour of public firms (especially when it comes to shareholder payout) and that such differences derive from institutional differences and, ultimately, ideological, political, and cultural differences. In other words, corporate short-termism is ultimately rooted in power relations and (national) culture.
In the rest of this introductory chapter, I will point out how three extant literatures that study corporate short-termism struggle to explain the root causes of short-termism and (theoretically) account for the possibility of national differences in corporate short-termism. I will then discuss how I address these research gaps. The three literatures are: (1) the short-termism literature in finance and economics, (2) the ‘financialisation’ literature, and (3) the ‘comparative capitalism’ literature. The first two literatures imply that stock-market-based short-termism is more or less a universal feature of contemporary capitalism. As studies on short-termism in these literatures are mostly based on the analysis of Anglo-American capitalism and tend to be non-comparative (with a few exceptions), they generally do not theorise the possibility of national differences. This is at least partly because of a lack of institutional analysis in these literatures and an over-reliance on structural explanations (e.g., how the stock market makes capital ‘impatient’) and ‘rational choice’ explanations like managerial self-interest (‘agency cost’). I develop a new institutional theory in response to these literatures that shows how institutions mediate the relationship between the stock market and public firms and how this institutional mediation can explain national divergence in the behaviour of public firms – i.e., differences in short-termism. Although the emphasis on the role of institutions is similar to the ‘comparative capitalism’ literature, this new theory also goes beyond this literature: While the comparative capitalism literature highlights the role of institutional arrangements in shaping corporate strategy, its theorising of the relationship between public firms and the stock market remains underdeveloped and largely limited to the concept of ‘impatient capital’, with little theoretical specification of how various (formal and informal) institutions shape the relationship between ‘impatient capital’ and firm behaviour (notwithstanding discussions of how cross-shareholding and ‘blockholders’ reduce the influence of ‘dispersed shareholders’ and the probability of hostile takeovers). More specifically, there is a lack of systematic analyses and theorising of how the various structural features of the stock market combine to create pressures on public firms and how these pressures are mediated by institutions. Moreover, the comparative capitalism literature focusses almost exclusively on institutions (especially formal institutions), which brings its own limitations. Liberalisation of formal institutions in CMEs like Germany and Japan since the 1990s has divided the literature on the
19 issue of whether CMEs are converging towards LMEs like the US and the UK. I argue that this lack of clarity on the issue of convergence is largely due to (1) the paucity of (large-N) empirical studies comparing firm behaviour in different ‘varieties of capitalism’ and (2) the recently-acknowledged ‘gap’ between (formal) institutions and firm behaviour. In this study, I address both these shortcomings by (1) empirically comparing public firm behaviour (in terms of shareholder value and real investment) in different varieties of capitalism from 2005-2017 and (2) constructing a theoretical framework to explain firm behaviour that includes dominant ideologies, power relations, and culture – in addition to formal institutions and firm-level institutional practices.
The short-termism literature in finance and economics The short-termism literature focusses mostly on managers, investors, and the structural features of the stock market through a ‘rational choice’ approach. It has contributed to the understanding of short-termism by providing compelling evidence for the empirical existence of short- termism in Anglo-American public firms. For example, Asker et al. (2015) and Haldane (2015) show that real investment in public firms tends to be significantly lower than privately-owned firms in the US and the UK respectively, which they present as evidence of stock-market- induced ‘short-termism’. Similarly, Gutiérrez and Philippon (2016) reveal that public firms tend to ‘under-invest’ in productive capacities and that short-termism – excessive shareholder payout – is one of the main reasons for this. Another influential empirical study in this area is that of Graham, Harvey, and Rajgopal (2006), who find through surveys and interviews of around 400 corporate executives that many executives forego long-term investment due to stock market and shareholder pressures to boost quarterly earnings and shareholder value. Although most empirical studies in this area focus on Anglo-American firms, there are a few studies with a wider geographical scope. For example, in a study comparing investor short- termism in Japan, Germany, the UK and the US, Black and Fraser (2002) report that investor short-termism exists in all these political economies but varies notably: investors in the Anglosphere tend to undervalue long-term earnings significantly more than investors in Germany and Japan.
This literature has also helped delineate the various structural features of the stock market that induce short-termism in public firms. Scholars point to, for example, the ‘separation of ownership and control’ (Berle & Means, 1932; Jensen & Meckling, 1976), ‘information asymmetry’ between shareholders and managers (Gigler, Kanodia, Sapra, & Venugopalan,
20 2014), and the ‘impatience’ of portfolio investors enabled by the liquidity of the stock market (Barton, Horváth, & Kipping, 2016; Bushee, 2001). I utilise these theoretical perspectives in developing the aforementioned institutional theory of short-termism, which firstly identifies how such structural features of the stock market enable short-termism in public firms and, secondly (going beyond this literature), argues how institutions modify the structural features of the stock market and moderate their effects, making it (theoretically) possible for public firms in different institutional settings to behave differently.
This literature is, however, largely empirical and descriptive: its focus has been on ascertaining the existence of short-termism (an important task nonetheless) rather than on theorising the causes of short-termism. The few theoretical works that exist narrowly focus on proximate causes of short-termism such as stock market and investor expectations (e.g. Jacobs, 1991; Samuel, 2000), the temporal orientation of different types of institutional investors (e.g., Bushee, 1998, 2001), ‘information asymmetry’ between shareholders and managers (e.g. Gigler et al., 2014; Narayanan, 1985; Stein, 1989), and performance measurement in firms (e.g. J. Coates, Davis, & Stacey, 1995; Hayes & Garvin, 1982; Merchant, 1990). One theoretical work that does go beyond proximate structural factors and an exclusive focus on the stock market is that of Laverty (1996, pp. 840-841), who puts the spotlight on managerial decision- making and also recognises organisational and individual-level factors as potentially significant contributors to short-termism. In this way, Laverty (1996) goes somewhat beyond just “materialist and rationalist” explanations for economic phenomena that still dominate much scholarship in this area (Abdelal, Blyth, & Parsons, 2015, p. 3). He also seeks a more holistic explanation of short-termism than other theoretical works: he implies that structures, institutions, agent characteristics and their interactions all need to be taken into account for a deeper understanding of short-termism. Marginson and McAulay (2008, p. 274), in reference to Laverty’s (1996) arguments, do show empirically through manager interviews and surveys that “a limited focus on economic causes…provides an inadequate basis for understanding short-termism”. Theoretical progress in this field has been slow since Laverty (1996) – as Haldane (2015) and Marginson and McAulay (2008) indicate – despite rising interest in short- termism. Importantly, Laverty’s (1996, p. 846) observation that “[t]here has been no exchange between institutional theory and the debate over economic short-termism” still largely holds. Although Laverty (1996) touches on institutional theory when addressing the ‘organisational dimension’, it only plays a peripheral role in his overall analysis, however. A systematic institutional analysis of short-termism is still lacking in this literature, which is surprising given
21 the ostensibly institutional nature of short-termism and the increasing popularity of (new) institutional theory in the social sciences and especially in ‘organisational studies’ (Scott, 2008). This literature – including Laverty (1996) – also tends to overlook political, cultural, and historical factors in its analysis of short-termism. As a result of overlooking the institutional, political, and cultural settings of public firms, it struggles to accommodate the possibility of national (and even historical) differences in short-termism and is largely unable to distinguish between public firms in different varieties of capitalism.
The narrow focus on economic factors in this literature perhaps explains why it employs a narrow definition of short-termism that only includes real investment. Scholars in this literature usually define short-termism as ‘under-investment’ (in terms of real investment), often without including shareholder payout in either the definition or in the operationalisation of ‘short- termism’ (see Asker et al., 2015; Graham et al., 2006; Porter, 1991). For example, the study by Asker et al. (2015), which is a key study in the short-termism literature, completely overlooks shareholder payout in its discussion and operationalisation of short-termism, focussing exclusively on real investment. There are some studies in this literature that see high shareholder payout as a potential cause of ‘under-investment’ among other potential causes (e.g., Gruber & Kamin, 2017; Gutiérrez & Philippon, 2016; Haldane, 2015). Nevertheless, high shareholder payout itself is generally not considered as short-termist (Gao, Harford, & Li, 2013). This may be because this literature is closely associated with the ‘agency theory’ perspective and studies often seem to assume implicitly that the purpose of a public firm is to maximise shareholder value (Asker et al., 2015; Gao et al., 2013). Consequently, there is also little mention of employees and employment when defining and operationalising short-termism – employees are, after all, seen as contractors in ‘agency theory’ (Zajac & Westphal, 2004). In other words, from the viewpoint of this literature, a firm is not short-termist as long as it does not ‘underinvest’ in property, plant, and equipment, even if it underinvests in employees and skills and even if it has a very high level of shareholder payout that exceeds profits and is partly financed by debt. This narrow definition of short-termism based solely on real investment is clearly problematic. According to this narrow definition, my empirical findings would indicate that American firms are significantly less short-termist than Japanese firms because real investment is significantly higher in American firms. When we dig a little deeper, however, there are two problems with this conclusion: (1) I also find that American public firms have increasingly taken on a high level of debt, which has helped finance high shareholder payouts that often exceed net income. Taking on additional debt for high shareholder payouts can
22 hardly be considered a long-term-oriented approach – regardless of real investment. (2) Real investment, as measured in most studies (i.e., capital expenditure or growth in fixed assets), is not always an indication of long-term-orientation. For example, a firm might simply be investing in labour-replacing equipment that helps cut costs in the short-term while laying off employees; or it may be purchasing specialist equipment for a premium price because of a lack of skilled employees; or the firm may be heavily reliant on business acquisitions because of a lack of research and development (Hollingsworth, 1997).
By ignoring shareholder payout and employees and by overlooking the nuances of real investment spending, the narrow definition and operationalisation of short-termism in the finance and economics literature may therefore potentially lead to misleading – or at least incomplete – conclusions. For this reason, I adopt a broader definition of short-termism that is centred on shareholder payout and includes both real investment and employees. I focus on shareholder payout in defining short-termism because it is an unproductive use of firm profits and thus directly undermines the long-term sustainability of the firm. In other words, more shareholder payout means less funds available for (1) real investment, (2) investment in employees, and (3) protection against downturns and future uncertainty. If one were to adopt a stakeholder-oriented or a firm-oriented view of the public firm instead of the shareholder- oriented view, then shareholder payout would be seen as a cost without any direct benefit for the long-term health of the firm – unlike any other spending. But, of course, a moderate level of shareholder payout that does not undermine long-term real investment or investment in employees would be considered acceptable even in the stakeholder view. I use this stakeholder view of short-termism; whereby relatively high levels of shareholder payout would be the foremost criterion of ‘short-termism’. I do not adopt an ‘agency theory’ perspective: As long as managers do not focus on maximising their own pay (or shareholder payout), I do not see firm expansion or investment in employees or the maintenance of large cash reserves during uncertain times as problematic – as all these uses of corporate funds are much more likely to contribute to the long-term health of the firm than shareholder payout.
The financialisation literature The financialisation literature focusses mostly on financial markets, shareholders, and managers through a structuralist lens that takes into account history, power relations, and ideology. This literature can loosely be associated with political economy, the Marxist tradition, post-Keynesian thought, economic sociology, and business history. Its main
23 contribution to the understanding of short-termism has been two-fold. Firstly, it has shown empirically the rise in shareholder payout and financial investment in non-financial corporations at the expense of investment in productive capacities and employees. Secondly, it has emphasised the transformation in corporate strategy brought about by financialisation – particularly the dominance of shareholders and the rise in share-based managerial pay. Importantly, the financialisation literature – much more so than the other literatures – has emphasised the importance of ideology in the transformation of corporate strategy: particularly the rise of ‘agency theory’, the increasing dominance of the ideology of ‘shareholder value maximisation’, and the concomitant adoption of a ‘portfolio view of the firm’. The financialisation literature shows how the adoption of these ideologies and perspectives in Anglo-American capitalism has prompted a substantial increase in shareholder payout accompanied by downsizing, outsourcing, and the embracing of financial investments by non- financial firms. For example, Lazonick and O'Sullivan (2000) and Lazonick (2010, 2014) point out how public firms in the US went from a strategy of ‘retain and reinvest’ in the post-war ‘golden age’ to a strategy of ‘downsize and distribute’ following the rise of ‘agency theory’ and the subsequent dominance of the ‘shareholder value maximisation’ ideology from the 1980s (see also Stockhammer, 2004; Stockhammer, 2005). They have provided valuable empirical evidence of how public firms in the US have increasingly poured their profits into shareholder payouts – and in particular share buybacks – since the 1980s as the ‘shareholder value’ ideology increasingly tightened its grip on the American corporate world. They also highlight the important role played by the increase in share-based managerial pay – particularly stock options – that has helped align managerial interests with shareholder interests as per the dictates of ‘agency theory’ (see also Lin & Tomaskovic-Devey, 2013). G. F. Davis (2013) and G. F. Davis and Kim (2015) similarly highlight the transformation in US corporations brought about by the rise in the ‘shareholder value’ ideology and the accompanying ‘financialisation’ of non-financial corporations (as well as wider society), emphasising in particular how this has resulted in a corporate strategy of downsizing and outsourcing that reduces the firm to its ‘core competence’ (see also Milberg, 2008; Soener, 2015). Besides corporate strategy, this literature has also emphasised the central role played by the ‘market for corporate control’ and the attendant hostile takeovers in kickstarting the ‘shareholder value’ revolution in the 1980s by forcing managers to focus on ‘shareholder value’ (G. F. Davis & Stout, 1992; Lazonick & O'Sullivan, 2000). Key empirical works like those of Orhangazi (2008) and Krippner (2005, 2011) that have looked at historical data spanning a number of decades have provided important empirical evidence of the rise of shareholder payout and financial investments in US
24 public firms, with Orhangazi (2008), in particular, showing how the rise in shareholder payout has come at the expense of real investment – the ‘crowding out’ of real investment. These works demonstrate how corporate managers in the US have shed their older ‘productivist’ attitudes in the post-war era for a new financialised way of thinking, which does not really distinguish between real investment and financial investment; this has blurred what used to be a clear separating line between financial and non-financial corporations.
As much as ideology has played a central analytical role in the financialisation literature, the literature has largely adopted a descriptive approach to ideology, however, and its conception of ideology remains under-theorised: It is not clear (theoretically) exactly what leads to the adoption or non-adoption of certain business ideologies or even how exactly such ideologies shape corporate practices – notwithstanding works from economic sociology like Fligstein (2001), which does partly cover this issue through a ‘political-cultural’ approach. I address this theoretical deficit in the financialisation literature by developing a conceptual framework that sees the dominant business ideology as (1) an intermediate-level factor that shapes firm-level practices by providing field-specific ‘institutional logics’ and (2) is, in turn, shaped by more fundamental factors: power relations and culture (through legitimacy). I utilise some of the same concepts used in Fligstein (2001) – and other key works in economic sociology – in developing this conceptual framework but my approach diverges from such approaches in its broader conception of ‘objectivated’ culture (i.e., national cultural values and beliefs) and in its detailed treatment of power (including the delineation of structural, formal, and cultural power). Overall, I take a more inter-disciplinary approach to theorising firm behaviour and short-termism.
Although the key works in the financialisation literature focus primarily on US public firms, there are, nevertheless, some works in this area that examine national differences. For example, Lapavitsas and Powell (2013, p. 376) find that, besides the US, financialisation has also permeated Germany, Japan, the UK, and France but the “variation arising from institutional, historical and political factors” means that “there is a distinct difference in intensity and outlook [of financialisation]” in Germany and Japan compared to the US and the UK. Specifically, they find that while the proportion of financial assets held by non-financial corporations (NFCs) is more similar in the different varieties of capitalism, NFCs in Germany and Japan are much more reliant on bank loans than NFCs in the US and the UK, with France in the middle. While the study by Lapavitsas and Powell (2013) provides some important findings and some relevant theoretical discussions, it is clear that the financialisation literature lacks appropriate theoretical
25 frameworks to properly explain national differences in the behaviour of public firms. Although Lapavitsas and Powell (2013) privilege a structuralist (largely Marxist) theoretical approach to analyse financialisation, they rely on the institutionalist ‘varieties of capitalism’ literature to explain national differences in the level of financialisation. The ‘varieties of capitalism’ literature is part of a distinct research field generally labelled ‘comparative capitalism’, which has not had much interaction with the financialisation literature – although there are exceptions like Deeg (2012), Dore (2008), and Lazonick (2010). This separation may be because the financialisation literature tends to downplay national differences (e.g., Engelen & Konings, 2010; Strange, 1997) while the comparative capitalism literature inherently emphasises this. Although the two fields have some commonalities (e.g., the focus on ‘shareholder value’), they derive from distinct theoretical influences and represent two separate paradigms with financialisation adopting a more structuralist approach and ‘comparative capitalism’ employing much more of an institutionalist approach.
The ‘comparative capitalism’ literature The ‘comparative capitalism’ literature comes closest out of the three distinct literatures in theorising and explaining national differences in the behaviour of public firms by recognising the important role of institutions in shaping firm behaviour; although, it does so without a systematic theory of how institutions mediate the relationship between public firms and the stock market. The most influential work within the wider ‘comparative capitalism’ literature is the ‘varieties of capitalism’ (VoC) work by Hall and Soskice (2001). Hall and Soskice (2001, p. 8) portray liberal market economies (LMEs) like the US and the UK as prototypical stock- market-based capitalist economies where dispersed shareholders – who are typically ‘portfolio investors’ in financial markets – are the dominant economic actors. As dispersed shareholding in the stock market makes for ‘impatient capital’, firms in LMEs, they argue, tend to focus on short-term ‘shareholder value’. In contrast, firms in ‘coordinated market economies’ (CMEs) like Germany and Japan are characterised by cross-shareholding (mutual shareholding by related firms), family ownership, and reliance on banks for funds, which are all considered sources of ‘patient capital’, allowing firms to look beyond short-term profitability and focus on long-term growth. Although dispersed shareholding through the stock market is seen as the main source of short-termism in LMEs, Hall and Soskice (2001) argue that short-termism is enabled by the wider institutional framework – which is also largely market-based in LMEs. In contrast, just as financing is ‘socially embedded’ in CMEs, so is the wider institutional framework, binding firms to long-term mutual obligations with stakeholders like employees
26 and partner firms. The key assertion of the VoC thesis is thus that “differences in the institutional framework of the political economy generate systematic differences in corporate strategy across LMEs and CMEs” (Hall & Soskice, 2001, p. 16; emphasis added).
The institutional framework delineated by Hall and Soskice (2001, pp. 6-7) consists of “five spheres”: the financial system (corporate governance), the internal structure of the firm, industrial relations, education and training systems, and inter-company relations. Crucially, Hall and Soskice (2001, p. 17) perceive the presence of “institutional complementarities” (coherence and mutual reinforcement) between the five institutional spheres of a political economy, which they claim “reinforces the differences between liberal and coordinated market economies” (also see Amable, 2000; Aoki, 2001; Whitley, 1999). They note that the five institutional spheres are organised largely around market logics in LMEs while, in CMEs, they are based more on socially-embedded practices and relations that go beyond market exchange (see Granovetter, 1985).
Given its market logic that reduces relations between actors to formal contracts (with managers and employees seen as the ‘agents’ of shareholders), the institutional framework in LMEs is more conducive to a shareholder-value-maximisation approach that largely bypasses social considerations like employee welfare, mutual social obligations, and reputation maintenance. The institutional framework of CMEs, on the other hand, fosters a long-term-oriented ‘stakeholder’ approach due to the prevalence of non-market institutions such as collective bargaining, powerful labour unions, employee co-determination, inter-firm collaboration, historical firm-bank relationships, and, in many cases, bipartite or tripartite agreements (between employers, unions, and the state). In fact, both shareholding and employment tends to be more enduring in CMEs than in LMEs because of such socially-embedded institutions (see also Dore, 2000). In turn, the long-term association between the firm on one hand and its large shareholders and employees on the other fosters a common interest in the long-term sustainability and growth of the firm in CMEs. In contrast, the turnover of shareholders, managers, and employees is relatively high in LMEs, owing to the fluidity of market relations and the impersonal nature of their contracts. Shareholders, managers, and employees readily switch firms in LMEs when better economic opportunities arise for them elsewhere. Equally, firms in LMEs frequently lay off their workers and are less hesitant to change managers in search of higher shareholder value. Overall, then, VoC posits that CME firms are more stakeholder-oriented and long-term-oriented than LME firms because of more ‘patient’ capital,
27 stronger employment protections, greater reliance on skilled workers, wider inter-firm collaborations, and a more consensual stakeholder-oriented approach to corporate strategy.
The VoC work by Hall and Soskice (2001) has become the primary source of reference for much of the recent scholarship on capitalist diversity in comparative political economy and its influence has also spread to other research fields (D. Coates, 2015). It has to be noted, however, that this influential work is the culmination of a prolific and fruitful decade of research on national models of capitalism that is collectively known as the ‘comparative capitalism’ literature. This decade-long body of work is a tapestry of rich empirical observations weaved together into cohesive frameworks by scholars from diverse theoretical traditions (including comparative political economy, comparative corporate governance, economic sociology, ‘régulation’ school, business studies, and more). Although there certainly are differences2 between the various approaches (which is to be expected), what is remarkable about this literature is the level of agreement on key issues (at least in the 1990s and early 2000s). A number of common conclusions and insights can be drawn from the literature (confined here to matters concerning short-termism): (1) institutions matter as they constrain and enable economic actions in ways that result in systemic differences in outcomes (such as short- termism) between political economies; (2) a modern capitalist political economy can be successfully organised in more ways than one – in terms of institutional arrangements; (3) all existing capitalist nations can be placed in a continuum between liberal (market-based) capitalism at one end and non-liberal capitalism (with non-market institutions) at the other end; (4) a fairly neat placement on the continuum between liberal and non-liberal capitalism is possible for most nations as there is usually a good degree of coherence (as opposed to internal contradictions) between the various institutions and institutional spheres of a political economy; (5) liberal models of capitalism are associated with short-termism (prioritising short- term shareholder value) while non-liberal models are linked to long-term-orientation (prioritising long-term firm growth); and (6) the different national models of capitalism are likely to remain divergent even with ongoing institutional changes, partly because of comparative advantages in particular economic sectors built over time (Albert, 1993; Amable, 2003; Aoki, 2001; S. Berger, 1996; D. Coates, 2000, 2005; Crouch & Streeck, 1997; Hall &
2 There are, predictably, notable differences between the major works. Some approaches focus directly on national differences (e.g., Amable, 2003; Dore, 2000; Hall & Soskice, 2001) while others focus on differentiating capitalist production regimes, which they subsequently link to nations (e.g., Hollingsworth & Boyer, 1997; Whitley, 1999). Some approaches parsimoniously propose two polar-opposite capitalist models (e.g., Albert, 1993; Hall & Soskice, 2001; Hollingsworth & Boyer, 1997), some propose three (e.g., Coates, 2000; Dore, 2000), and others even more (e.g., Amable, 2003; Whitley, 1999). Reviews of the comparative capitalism literature identify some more differences between the various approaches (see D. Coates, 2005; Jackson & Deeg, 2006).
28 Soskice, 2001; Hollingsworth & Boyer, 1997; Jackson & Deeg, 2006; Streeck, 2010; Streeck & Yamamura, 2018; Whitley, 1999). In sum, the wider comparative capitalism literature – just like the VoC approach – confirms the existence and postulates the continued existence of distinct liberal and non-liberal models of capitalism, depicting the former as prone to short- term focus on ‘shareholder value’ and the latter as leaning towards stakeholders and prioritising the long-term growth of the firm.
Although Hall and Soskice (2001) and other major works in the comparative capitalism literature do not explicitly discuss the presence of the stock market in non-liberal capitalist economies (CMEs) in their main analysis of national differences, portraying them as bank- based systems (perhaps to avoid overcomplicating their ideal-type frameworks), it is not the case, of course, that CME firms do not participate in the stock market.3 Many firms in CMEs – especially large and economically-important firms – are (increasingly) listed on the stock market (Deeg, 2012). Deeg (2005b, p. 15), in fact, goes as far as claiming that the financial system is not (or is no longer) an important element of distinction between CMEs and LMEs. Indeed, public firms tend to be in the minority in both LMEs and CMEs, with privately-held firms making up the vast majority of the private sector – although public firms do account for a bigger slice of the GDP in LMEs compared to CMEs (Asker et al., 2015; Deeg, 2012). Hence, rather than the prevalence of the stock market, the main distinction between LMEs and CMEs is that markets – including stock markets – are usually left unchecked in LMEs while they tend to be more constrained in CMEs by both formal regulations and social norms (D. Coates, 2000; Dore, 2000; Hall & Soskice, 2001). Therefore, in spite of the stock market listing, the institutional setting of public firms in CMEs is still notably more stakeholder-friendly than LME public firms (Cobb, 2016; Gospel & Pendleton, 2003). Specifically, this is because public firms in CMEs still tend to have cross-shareholding (that deter hostile takeovers), greater reliance on banks (that provide ‘patient capital’), greater employee participation and voice, production strategies that depend on highly-skilled workers (which gives workers power), ongoing collaborations with other firms on long-term projects, and strong unions that militate against layoffs (Amable, 2003). Although public firms in CMEs do have dispersed shareholders (who are linked to short-termism), they tend to have less influence and are often given less importance than in LMEs, both due to formal institutions and social norms (Aguilera & Jackson, 2010; Whitley, 1999; Witt & Redding, 2011). Essentially, unlike their counterparts
3 Hall and Soskice (2001, pp. 60-65) do acknowledge the presence and the possible effects of the stock market in CMEs in their discussion of institutional change.
29 in LMEs, public firms in CMEs tend to be embedded in institutional and social contexts that are unlikely to be conducive to the prioritisation of short-term shareholder value.
Liberalisation in CMEs and the gap between institutions and behaviour
Institutional change and, particularly, liberalisation in CMEs from the 1990s not only generated fissures and contestations in a formerly united literature but also revealed theoretical limitations within the comparative capitalism literature. Although the institutional settings of public firms in LMEs and CMEs were widely seen as divergent in the 1990s, developments linked to globalisation, neoliberalism, and financialisation, sparked a lively debate about the ‘convergence’ of CMEs towards the LME model (Dore, 2008; Streeck, 2010; Whitley, 2012; Yamamura & Streeck, 2018). Notwithstanding conspicuous disagreements over ‘convergence’, there was an area of overlap between the proponents and the opponents of the ‘convergence hypothesis’: The general consensus by the mid-2000s was that institutional change was occurring in CMEs in the form of greater liberalisation, prompted not only by globalisation, neoliberalism, and global financialisation but also by the relatively poor economic performance of CMEs in the 1990s – at in the case of Germany and Japan (see also D. Coates, 2005; Lane & Wood, 2012; Streeck & Yamamura, 2018).
Scholars have indeed pointed to substantial liberalisation in CMEs like Germany and Japan, particularly in the critical spheres of corporate governance and employment relations. In regard to corporate governance, studies report a general expansion of the stock market, widespread adoption of international accounting standards (for greater transparency), stronger protection of dispersed minority shareholders, deregulation of stock options and share buybacks, increasing erosion of cross-shareholding, increasing decoupling of long-term firm-bank relations, and, crucially, greater acceptance of ‘shareholder value’ – especially among large public firms (Deeg, 2005a, 2012; Dore, 2005; Enriques & Volpin, 2007; Faust, 2012; Lane, 2005; Lane & Wood, 2012; Vogel, 2018b). At the same time, although such deregulation and liberalisation have expanded options for employers, the government has not forced employers to change through mandatory laws, however (Ahmadjian & Okumura, 2011; Araki, 2009; Börsch, 2007). Industrial relations and employment relations – which traditionally have been the sources of resistance to short-termism – are also being liberalised in CMEs (Palier & Thelen, 2010; Sorge & Streeck, 2018). Baccaro and Howell (2017) find that while formal labour-related institutions might not have visibly changed much between the 1970s and the 2010s in many CMEs, “there have nevertheless been changes in the way institutions
30 function…that has had the effect of greater liberalisation—in the form of greater employer discretion”.
The collected empirical works in Streeck and Thelen (2005) also reveal fairly extensive liberalisation in CMEs. At the same time, even in view of this widespread liberalisation in CMEs, Streeck and Thelen (2005, p. 1) declare: “[W]e join with a large literature that rejects the notion that previously diverse political economies are all converging on a single model of capitalism”. Streeck and Thelen (2005), however, differ from other convergence sceptics who characterise ongoing liberalisation in CMEs as piecemeal, limited, or superficial, representing adjustments but not transformations of the traditional institutional frameworks (e.g., Börsch, 2007; Deeg, 2005b; Hall & Soskice, 2001; Vitols, 2018; Whitley, 2012).4 With the help of a new theory of institutional change, they argue that recent institutional changes (liberalisation) collectively amount to the “gradual transformation” of CMEs – i.e., they are not simply institutional adjustments to changing circumstances that perpetuate old institutional logics (Streeck & Thelen, 2005, p. 9; emphasis added). Although Streeck and Thelen (2005, p. 32) do not explicitly explain why they reject the ‘convergence hypothesis’ despite their insistence on the gradual transformation of CMEs through liberalisation, their reasoning may be inferred from their assertion that “[l]iberalisation…can take many forms”. They give the example of Germany, where “state functions” have been “delegated to civil society” as part of liberalisation, where the collective bargaining system takes over from the state in deciding matters like early retirement (Streeck & Thelen, 2005, p. 32). They see this as “a move back from social rights…to that of industrial rights” (p. 32). In this sense, although more ‘liberalised’, Germany remains distinct from liberal political economies like the US because non-market coordination persists, albeit in a different (more liberal) form. Hall and Thelen (2009, p. 23) also caution against equating liberalisation with convergence, arguing that “[n]ot all changes grouped together under the rubric of ‘liberalization’ produce meaningful ‘convergence’ between coordinated and liberal market economies”. They explicitly specify three reasons for why they believe liberalisation may not amount to convergence between CMEs and LMEs: (1) “liberalization is a multidimensional process”, whereby liberalisation of certain institutions may be offset by the strengthening of other non-liberal institutions; (2) “even measures to ‘liberalize’ a single sphere of the political economy do not all have the same
4 Streeck and Thelen (2005) contend that most scholars’ perceptions of change are often circumscribed by the widely- utilised theories ‘path dependence’ and ‘punctuated equilibrium’ (especially in political science), which they believe privilege long-term institutional continuity by conceptualising institutional change as only occurring meaningfully in rare periods of drastic exogenously-triggered institutional upheaval. They view these theories as inadequate for depicting real institutional change on the ground – which is usually constant, gradual, and endogenous but also collectively transformative.
31 effects” because some changes (e.g., deregulation of hostile takeovers) are more convergence- inducing than others (e.g., stronger minority shareholder protection); and (3) the outcomes of liberalisation can be disparate in different nations because outcomes depend on the wider institutional arrangement (Hall & Thelen, 2009, pp. 22-23).
The need to go beyond institutions
A conclusion that may be drawn from studies on institutional change – i.e., liberalisation in CMEs – is that institutions have changed too frequently, messily, and unevenly for researchers to be able to confidently and neatly apply a blanket rubric like ‘convergence’ or ‘continuing divergence’ to the overall change based solely on observations of (changing) institutions – even despite a clear trend of liberalisation. Indeed, Streeck and Thelen (2005, p. 31) observe no less than five different ways that institutions change: “displacement, layering, drift, conversion and the exhaustion of existing institutions and policies”. This is itself enough reason to expand analysis beyond institutional factors and examine more basic factors like power relations and culture. But more importantly, liberalisation has also emphatically exposed what Streeck and Thelen (2005, p. 11) call the “gap between institution and behaviour” and what Bell (2011, p. 894) calls “agential space”. Empirically, scholars have observed both changes in behaviour in the face of the continuance of formal institutions (e.g., Baccaro & Howell, 2017) and, conversely, changes in formal institutions accompanied by unchanging behaviour (e.g., Börsch, 2007; Inagami, 2009; Sorge & Streeck, 2018). This gap between formal institutions and firm behaviour is problematic for the comparative capitalism literature as much of the literature focusses on formal institutions5, including theoretical works by Streeck and Thelen (2005) and Hall and Thelen (2009) that endeavour to address this gap.6 Both the gap between (formal) institution and firm behaviour and the complexity of institutional change provide compelling reasons to avoid over-reliance on individual (formal) institutions to assess national differences in the behaviour of public firms. Instead, we need to examine more closely the deeper factors that shape political-economic systems – i.e., the forces that shape institutions and firm behaviour. Influential works in comparative political economy do briefly acknowledge the political, cultural, and historical roots of capitalist divergence (e.g., Hall & Soskice, 2001) but there is almost invariably a narrowing of focus to surface-level institutions
5 Formal institutions include laws, regulations, and standardised and formalised practices and may be contrasted with informal institutions like norms, taken-for-granted practices, habits, and common cognitive schemas (Helmke & Levitsky, 2004). 6 While they do touch on the role of power relations in institutional change, partly because critics of the varieties of capitalism approach highlighted the neglect of power relations and politics, power relations continue to play a peripheral role in their theorising.
32 when assessing both capitalist divergence and potential convergence (Bruff, 2008; Crouch, 2005; Crouch & Farrell, 2004; Faust, 2012).
Institutions are but “distributional instruments” or means to achieving particular ends (Mahoney & Thelen, 2009, p. 8). In other words, every institution – formal or informal – is based on underlying “institutional logics” that reflect the institution’s purpose – the end it is designed to achieve (Thornton, Ocasio, & Lounsbury, 2012, p. 2; emphasis added). For example, share buybacks, hostile corporate takeovers, and share-based managerial pay (institutions associated with financialisation) all share the same institutional logic of ‘shareholder value maximisation’ – their end goal (Fligstein, 2001; Lazonick & O'Sullivan, 2000). Institutions can also regularly change with changing circumstances (e.g., globalisation, new laws, or technological advancements) as means often need to change to achieve the same ends; but the underlying ‘institutional logics’ that reflect the end goal tend to persist7 (Thornton et al., 2012). For example, the institutional logic of ‘shareholder value maximisation’ has undergirded the institutional setting of US public firms since the 1980s in more or less the same form despite numerous changes in individual institutions (Lazonick, 2014). Importantly, Hollingsworth and Boyer (1997, p. 2) and Thornton et al. (2012) argue that firm-level institutions and practices tend to be based on similar “institutional logics” (similar ends), which makes the institutions of the business field within a nation coherent and cohesive (cf. Amable, 2003; Aoki, 2001; Hall & Soskice, 2001). Moreover, business fields in different varieties of capitalism tend to have divergent and often incompatible institutional logics – which helps explain capitalist divergence (see Faust, 2012; Fiss & Zajac, 2004; Hollingsworth & Boyer, 1997; R. E. Meyer & Llerer, 2010; Streeck, 1996). Redding and Witt (2015, p. 179), for example, observe “variance in executive rationale across five major economies – Germany, Hong Kong, Japan, South Korea, and the United States” – based on interviews with corporate managers, which they equate with national variance in “institutional logic[s] guiding managerial action”. Therefore, a better way to assess potential divergence in the behaviour of public firms in different nations than simply evaluating formal institutions would be to examine the deeper forces that shape the institutional logics of the business field (in addition to examining formal institutions). In this study, I develop a theoretical framework that delineates
7 Institutional logics tend to persist until the ends themselves change due to changes to power relations and culture. Power relations and culture tend to be durable, but they can change – especially power relations; culture tends to be relatively enduring given various reinforcing factors.
33 how power relations and culture within a nation shape the dominant business ideology that, in turn, shapes institutional logics of the business field.
I distinguish firm-level institutional practices (i.e., institutions of the business field) from state- level formal institutions (laws and regulations) in the theoretical framework. In other words, the framework recognises that there can be ‘gaps’ between formal institutions and firm-level institutional practices for several reasons – loose enforcement, loopholes, regular changes to laws and regulations, etc. At the same time, it also recognises that some formal institutions – especially long-standing ones that address rights and obligations – can strongly influence firm- level practices, primarily by shaping firm-level power relations, which can shift the institutional logics of the business field. As far as institutional logics of state-level formal institutions are concerned, they would be somewhat different from the institutional logics of firm-level institutional practices. This is because institutional logics (i.e., the dominant business ideology) are based on both power relations and culture: Even though the institutional logics of both formal institutions and firm-level practices would be rooted in the same national culture, power relations can, however, be different at the business-field level and at the state level (cf. Fligstein, 2001; Friedland & Alford, 1991; Thornton et al., 2012). This is especially the case in democracies, where workers make up the majority of the voting public. At the same time, given that capital tends to own or strongly influence ‘civil society’ organisations like the media and educational institutions in a capitalist democracy, it can counter the structural power of workers through ‘cultural power’ – i.e., ideational ‘hegemony’ (Femia, 1981; Lukes, 2004). It can also influence (state-level) governance more strongly than labour through means like lobbying or ‘regulatory capture’ given its superior resources (Culpepper, 2010; Dal Bó, 2006). In addition, global financialisation has increased the structural power of capital as it can influence governments through the (perceived) threat of capital flight (Bell, 2013). As power relations at the state level are highly contested, based on multiple factors, and unstable, formal institutions are also more erratic and unstable than firm-level practices, which tend to be based on more stable power relations. This itself may partly explain the gap between formal institutions and firm-level practices. Therefore, while it may be still be instructive to consider formal institutions – especially the long-standing ones that shape power relations – focus is best placed on firm-level institutional practices where possible when explaining firm-level outcomes like shareholder payout, which is what I do in this study. Importantly, while the conceptual framework includes both state-level and firm-level institutions, it sees power and
34 culture, especially as expressed in the dominant business ideology, as the ultimate source of national differences in firm behaviour and firm-level outcomes.
In this way, I aim to make theoretical contributions to the three literatures discussed above by building on the concepts and findings from all three literatures. I thusly also construct a bridge between the three distinct bodies of work that have divergent approaches but similar empirical concerns – namely, short-termism. This means that my approach is necessarily inter- disciplinary.
Chapters The next chapter – Chapter 1 – delves into financialisation and short-termism and provides some of the key concepts as well as the background for the theoretical development in the following chapters. Chapter 2 involves the development of a new theory of the institutional mediation of stock market pressures on public firms. I also turn to the history of the US public firm to show how this theory can explain how the emergence of short-termism in public firms is tied to the institutional transition from post-war ‘managerialism’ to financialisation and ‘shareholder value orientation’. Chapter 3 incorporates this institutional theory into a wider framework that delineates how power and culture shape institutional logics – and thus firm behaviour – by shaping the dominant business ideology. Chapter 4 presents an overall empirical comparison of (matched) public firms in CMEs and LMEs while also discussing the methodology used for the empirical study. Chapter 5 delineates institutional, ideological, political, and cultural differences between German capitalism and Anglo-American capitalism that helps explain the empirical differences between German and (matched) Anglo-American public firms in terms of shareholder payout and real investment. It also discusses institutional change in Germany and presents an empirical analysis of convergence between German and Anglo-American public firms in terms of shareholder payout and real investment. Chapter 6 discusses continuing institutional, ideological, political, and (especially) cultural differences between Japanese capitalism on one hand and German and Anglo-American capitalism on the other, which helps explain notable differences in shareholder payout and real investment in their respective public firms, both overall and over time. Chapter 7 concludes by (1) discussing the implications of national differences in short-termism, (2) highlighting the ideological nature of the very conception of the public firm, (3) discussing how and to what extent German and Japanese capitalism may be qualitatively distinct from Anglo-American capitalism, and (4) summarising the contribution of this study to the literature.
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Chapter 1 Financialisation and Short-Termism
Financialisation denotes the ubiquity and dominance of financial institutions, actors, and ideas in the twenty-first century (Epstein et al., 2006). The term ‘financialisation’ has become a catchword not only in the academic literature but also in the popular media (see Foroohar, 2016). It is no accident that this academic jargon has so rapidly permeated the lay vocabulary. Financialisation is, after all, a defining feature of contemporary capitalism – along with ‘globalisation’ and ‘neoliberalism’ – and a transformative force that has substantially altered the political-economic landscape in advanced economies since the 1980s – most notably in the US and the UK (Krippner, 2011; Lapavitsas & Powell, 2013; Magdoff & Foster, 2014). This institutional transformation has helped channel virtually all the economic gains of the past four decades (particularly in the US) towards investors, investment fund managers, and corporate executives, which has translated into stagnant wages, growing inequality, insecure employment, and burgeoning household debt (Bell & Keating, 2018; Lazonick, 2014; Lin & Tomaskovic-Devey, 2013).
Financialisation is all-encompassing in the sense that financial actors and institutions exert both structural power and ideational power (see Lukes, 2004) over the state, non-financial corporations (NFCs), and households – the entire political economy (Bayliss, Fine, & Robertson, 2017; Van der Zwan, 2014). This structural power of financial actors derives from their control of financial capital coupled with their ability to move it freely in the global financial market, which enables them to dictate the terms of investment in a largely liberalised political-economic environment (Bell, 2013). This structural power is reinforced by ideational power, whereby the logics of ‘finance’ have become ‘common sense’ in a highly rationalised global political economy (Bruff, 2008; Krippner, 2011; Scott & Meyer, 1994). In other words, financialisation has become institutionalised in society and internalised by social actors to such an extent that it now operates through what Giddens (1984, p. 37) calls the “practical consciousness” of social actors in a ‘taken-for-granted’ manner.
37 This study is not about the full spectrum of the very broad phenomenon of financialisation as alluded to above; it focusses on the financialisation of Non-Financial Corporations (NFCs) – the engines of capitalism – and the resulting short-termism. It is, nevertheless, important to commence with the acknowledgement of the all-encompassing nature of financialisation so as to make sense of the ease with which financial institutions, actors, and logics have come to dominate NFCs and turn their focus away from production towards the quick enrichment of ‘impatient’ shareholders and corporate executives, endangering the future prospects of these firms as well as the wider economy, all to the acquiescence of a permissive state and an unalarmed polity (Fligstein, 2001; Lazonick, 2014). As detrimental as it may be to the political economy, financialisation has slowly become entrenched over time and has now become the “new normal”, meaning that policymakers and citizens alike have likely become desensitised to its adverse consequences because of their everyday immersion it in (Lazonick, 2017, p. 217). Only with a bird’s-eye view that surveys a wide span of history and geography can one truly get a sense of the damaging changes brought about by financialisation to the political economy (and, by extension, to society). This chapter paints a picture of the spread and entrenchment of financialisation (in regard to NFCs), describes how it hinders the investment and production process through short-termism, and puts it in a historical context in order to reveal its institutional nature (which is further examined in the next chapter).
This chapter will focus on financialisation in the US, for two reasons. First, the US is the archetype of financialised capitalism: it is, arguably, where financialisation started and hegemonically spread to other advanced economies; moreover, symptoms of financialisation are strongest in the US compared to other advanced economies8 (Arrighi, 1994; Lapavitsas & Powell, 2013; Maxfield, Winecoff, & Young, 2017; Streeck, 2010). Secondly, and more practically, scholars first noticed and started studying the trend of financialisation in the US and, perhaps consequently, the bulk of the financialisation literature – especially the influential earlier works – have focussed exclusively on the US (e.g. Krippner, 2005; Lazonick & O'Sullivan, 2000; Lin & Tomaskovic-Devey, 2013; Milberg, 2008; Orhangazi, 2008). Largely limiting the discussion to the US in this chapter will help paint a clear conceptual picture of financialisation – its properties and effects – and set the scene for comparative analysis of different varieties of capitalism in the following chapters.
8 The UK has a similar level of financialisation as the US and an almost identical institutional framework makes the UK analytically very close to the US, at least compared to other advanced economies; thus, much of the analysis in this chapter will be largely applicable to the UK as well (Hall & Soskice, 2001; Konzelmann, Fovargue-Davies, & Schnyder, 2012; Lapavitsas & Powell, 2013).
38 In this chapter, I first discuss the general trend of financialisation and its emergence. I then look at the implications of the development of a finance mentality in NFCs before turning to ‘shareholder value orientation’ and shareholder payout in NFCs. I then turn my attention to ‘short-termism’ in NFCs and its causes, examining the role of managerial incentives and hostile takeovers. Finally, I provide a summary and a conclusion to end the chapter.
The financialisation of non-financial corporations The post-war period of the 1950s and 1960s in the United States ushered in what is, in hindsight, called the “golden age” of production-based capitalism, where manufacturing was thriving, and NFCs burgeoned to enormous size by retaining and reinvesting their hefty profits (Lazonick & O'Sullivan, 2000). The manufacturing industry’s share of the GDP was about a third of GDP during this golden period while the contribution of the non-productive rentier industries – finance, insurance, and real estate (FIRE) – was about half of that of manufacturing (Krippner, 2005). By the turn of the century, however, in terms of the share of GDP, the FIRE industries together had overtaken and comfortably surpassed manufacturing. Production had been in rapid decline since the 1970s and finance was in the ascendancy, buoyed by favourable institutional and political climates (Duménil & Lévy, 2011; Krippner, 2011). Financial deregulation in the 1980s and 1990s, culminating in the landmark repeal in 1999 of the Glass-Steagall Act of 1933 that had separated commercial banking from investment banking in the US, opened up a field of opportunities for traditional financial institutions such as banks to make unprecedented profits: profits from ‘boring’ commercial banking increasingly paled in comparison to those from ‘casino-style’ investment banking (Bell & Hindmoor, 2015). By the mid-2000s, the financial sector accounted for about one- third of all corporate profits in the US – up from one-tenth only twenty-five years prior – despite employing less than 5 percent of the US workforce (Foroohar, 2016).
Although this ballooning of the financial sector – and the relative shrinking of the productive sector – represented a transformation of the economy, Arrighi (1994) notes in his seminal work that this is not unique in history: the financial sector’s relative size has been in flux since the very dawn of capitalism, expanding vigorously during the height of the economic prowess of superpowers like Genoa, the Netherlands, and Great Britain. He observes that each one of these ‘economic superpower’ epochs consisted of an initial ‘material expansion’ – a phase of rapid production-based economic growth triggered by a wave of innovation – followed by ‘financial expansion’, where increasing international competition dried up profits
39 in the productive sector and capitalists turned to financial sources of profit, bloating the financial sector, until a new economic superpower emerged, and the cycle continued. In this sense, for Arrighi (1994), the current expansion of the financial sector is part of a repeating pattern with the US now at the helm as the latest hegemon with waning industrial production making way for financialisation. This argument of financial expansion resulting from productive decline – with capitalists supplementing productive income with financial income – is a common one in the political economy literature, spanning different schools of thought, albeit with their own paradigmatic take on it (Lapavitsas, 2011). Krippner (2005, 2011), in her influential analysis of the rise of financialisation in the US that filled the empirical void in the literature, does not disagree with this argument but does stress that the rise of financialisation was essentially a political process, instigated and catalysed by financial deregulation, a monetary policy of high interest rates, and a massive build-up of government debt in the 1980s in the US.
Although the size of the financial sector has increased significantly in the past four decades while that of the productive sector has relatively declined, the financial sector expansion was not in isolation from the productive sector; on the contrary, much of the financial sector growth derived from the productive sector – though not necessarily from production (Krippner, 2005). Lazonick (2017, p. 3) notes that the financial sector, through share buybacks in the stock market alone, has “extracted trillions of dollars from business corporations” over the last three decades. Financial deregulation – most notably in the 1980s – and an ideological shift in the corporate world from “retain and reinvest” to “downsize and distribute” enabled financial institutions and actors to continuously extract massive value from NFCs – through the stock market, hefty M&A fees, fund management fees, etc. (Lazonick & O'Sullivan, 2000, p. 17). Although the share prices – and thus the market value – of NFCs have, on average, trended upwards since the 1980s, contributing to the growth of the financial sector, NFCs were simultaneously downsizing and divesting many of their production-related arms (G. F. Davis, 2013). This phenomenon that seems perplexing at first glance can be explained, upon closer examination, by a radical change in the approach of NFCs to profitmaking: they started turning to financial investment – rather than productive investment – for profit.
Krippner (2011, p. 4) defines financialisation as “the tendency for profit making in the economy to occur increasingly through financial channels rather than through productive activities” – echoing Arrighi (1994) – and goes on to identify two related processes as the
40 manifestation of financialisation: (1) the rapid expansion of the financial sector and (2) the increasing reliance of NFCs on financial rather than production-based income. Indeed, although most of the large US corporations that spearheaded the material expansion of the golden age survived the profit crisis of the 1970s, they were forced to turn to other means of profit to compensate for the loss of revenue from lower productive returns (Marglin & Schor, 1991). Incidentally, in the late 1970s and the 1980s the US government greatly raised the interest rate – up to twenty percent at times – in its fight against high inflation, presenting profit-starved non-financial corporations with a welcome new avenue to earn relatively easier, quicker, and surer profit through a novel source: financial investment (Krippner, 2011). The greater reliance on financial investment – and less on production – also meant a stronger negotiating position against labour unions for the NFCs, which translated into higher profits through lower costs (Lin & Tomaskovic-Devey, 2013; Silver, 2003). Furthermore, there was increasingly intense pressure on executives at NFCs to generate short-term profits in the 1980s as financial deregulation had created a hostile takeover movement that would target any listed firm with weak earnings performance (Lazonick & O'Sullivan, 2000). Unsurprisingly, many NFCs started relying on financial income for short-term profits and the practice, which was rare in the 1950s and 1960s, became institutionalised. As Krippner (2011, p. 56) notes:
Although the interest rate shock delivered to the economy in the 1980s has not persisted to the present, the broader shift in the orientation of nonfinancial firms that it helped to bring about has proven a durable feature of a transformed economic environment.
Even the traditional standard-bearers of productive capitalism – the powerhouses of manufacturing – strongly diverted their attention to finance, increasingly directing large proportions of their profits to financial activities at the expense of real – productive – activities (Orhangazi, 2008). For instance, by 2004, General Motors was reporting that two- thirds of its quarterly profits derived from its financial arm – GMAC – while Ford was reporting a loss in its automotive operation but an income of over $1 billion largely from its financial operations (Hakim, 2004). In fact, such financialisation has become widespread among US manufacturing corporations. L. E. Davis (2016) reports that the financial assets of the median manufacturing corporation in the US grew from 25 percent of total assets in 1980 (similar level to 1950, 1960, and 1970) to just over 40 percent by 2000 and just over 50 percent by 2014.
41 Profit financialisation and control financialisation Although the likes of Krippner (2011), Lapavitsas (2011), and Epstein et al. (2006) frame financialisation mostly as the expansion of the financial sector and greater reliance of NFCs on financial income, it is important to emphasise that the financialisation of NFCs is not limited to the offering of financial services to customers or making financial investments. It is, in fact, much more than that. As Milberg (2008, pp. 422-423) describes:
This new focus is not just the provision of financial services as part of the corporations’ product lines, but the increase in the share of assets of the firm that are financial and the increased use of firm profits to raise shareholder returns, through dividend payments, share buy-backs and even through mergers and acquisitions.
According to Nölke and Perry (2007) and Deeg (2009), there are two aspects of financialisation: (1) profit financialisation, where profit in NFCs derives increasingly from financial rather than productive channels – i.e. from financial investment rather than real investment (as described above) – and (2) control financialisation, where shareholders and the stock market, through their strong influence over managers, make NFCs prioritise short- term shareholder value over long-term growth. While profit financialisation might have developed alongside control financialisation rather than being a product of it, the two related phenomena did take off around the same time in the 1980s. Importantly, the rationale behind profit financialisation – turning to a quicker and easier source of profit compared to production – is consistent with the logic of ‘maximising shareholder value’ that is associated with control financialisation (Lazonick & O'Sullivan, 2000; Orhangazi, 2008).9 Although not using these particular terms, Orhangazi (2008, p. 863) also points to these dual processes of financialisation occurring in NFCs and holds them responsible for the “negative relationship between real investment and financialisation” because both control and profit financialisation divert funds away from real investment – towards shareholder payout and financial investment respectively.
There are a number of empirical studies on both profit and control financialisation in the literature – with some studies examining them together. These studies are often based on macro-level financial data of mostly US-based NFCs (G. F. Davis & Kim, 2015; Soener, 2015). In these empirical studies, profit financialisation is usually – following the lead of
9 The macroeconomic environment also played a role in the emergence of profit financialisation, as Krippner (2005) has observed: NFCs turned to financial investments during 1980s when the economic climate was uncertain and interest rates were high. Therefore, control financialisation might not necessarily be the main cause of profit financialisation; nevertheless, profit financialisation does serve the purpose of control financialisation well.
42 Orhangazi (2008) – operationalised as ‘financial income’ of NFCs – which includes income from interest and shares in other firms – and control financialisation as ‘financial payment’ by NFCs – which includes dividend payouts, share buybacks, and, in some studies, interest payments (e.g. Akkemik & Özen, 2013; Baccaro & Howell, 2017; Barradas, 2017; Lapavitsas & Powell, 2013; Maxfield et al., 2017). Such empirical studies have generally found a rise in both profit and control financialisation over the last couple of decades – most strongly in the US. In regard to profit financialisation, Figure 1.1 shows a sharp rise in financial assets as a percentage of tangible assets since the mid-1980s and Figure 1.2 shows a rise in financial income as a share of internal funds for NFCs in the US. Indicating control financialisation, Figure 1.3 shows an abrupt climb in financial payments as a percentage of profits in the 1980s in NFCs in the US (the dips in the early 2000s in Figures 1.2 and 1.3 likely reflect the effects of the financial crash after the burst of the ‘dot-com bubble’).
Figure 1.2. Financial assets as a percentage of tangible assets: non-financial corporations, 1952–2003, US. Reprinted from Orhangazi (2008).
Figure 1.3. Interest and dividend income as a percentage of internal funds: non-financial corporations, 1952–2003, US. Reprinted from Orhangazi (2008).
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Figure 1.4. Total financial payments (including interest payments, dividend payouts, and share buybacks) as a percentage of profits before tax: non-financial corporations, 1952–2003, US. Reprinted from Orhangazi (2008).
Before we turn to control financialisation, it is important to point out a pertinent and significant institutional implication of profit financialisation: it signals a turn away from ‘productivist’ logics – where a firm’s goals and actions revolve around production – and suggests that NFCs have increasingly become mere vehicles of wealth maximisation for investors (G. F. Davis, 2013; Dore, 2000, 2005; Milberg, 2008). Although shareholders have always been considered the primary beneficiaries, NFCs were not nearly as devoted to financial interests in the ‘golden age’ as they are now. Back then, in what is also called the era of ‘managerial capitalism’, the long-term success of the firm itself was considered paramount and the key sign of success was the growth of the firm in both size and market share, which meant that the focus was on production (Lazonick, 2018; Stockhammer, 2004). Firm growth was not necessarily limited to a single product market. As G. F. Davis, Diekmann, and Tinsley (1994) note, in search of ever- greater firm growth, NFCs had started branching out from their core product line into related product markets in the 1920s (through mergers and acquisitions) and, by the late 1960s, they were venturing into unrelated product markets in the widespread conglomerate movement, which saw NFCs grow into behemoths by 1980. However, even in the relentless quest for firm growth in the era of ‘managerial capitalism’, NFCs rarely ventured into the financial realm despite its potential to bestow quick and easy profits on the cash-rich conglomerates. It took a paradigm shift from the productivist logic to the logic of finance brought about by financialisation in the 1980s for NFCs to start embracing the financial sector – and they have continued on this path ever since (Krippner, 2005). In the new pursuit of shareholder value maximisation, NFCs, including the traditional standard-bearers of American capitalism like General Electric, General Motors, and Ford, are now blurring the line between being a
44 production-based firm and being a financial firm. G. F. Davis (2013, p. 284) even goes as far as to claim that the corporation itself, as an institution and an icon of production, is in decline:
Ironically, much of the blame for the decline of the corporation belongs to the success of the shareholder capitalism movement in the United States, which effectively reduced the corporation from an institution to a “nexus of contracts.” The dominance of finance has come at the expense of the corporation.
Behind the retreat from production by nonfinancial corporations is the financial mindset of top executives, whose “portfolio view of the firm” (Orhangazi, 2008, p. 868) reduces the corporation to a collection of assets to be invested for the highest possible return in the shortest possible time, without too much concern for the long-term health of the company (Cobb, 2016; Crotty, 2006). A company’s employees – its traditional lifeblood – have come to be seen as ‘resources’ to be hired and fired as per the dictates of the logic of finance (Clark, 2009). When executive decision-makers compare investments involving these ‘resources’ to financial investments with short-term earnings as the sole criterion, the latter prevail more often than not. Lin and Tomaskovic-Devey (2013, p. 1293) note a trend of non- financial corporations being led by executives with financial backgrounds; and “for top executives with financial backgrounds, investment in the financial market is functionally equivalent to investment in production and sales but with the advantages of higher capital liquidity, lower transaction costs, and more flexible labour costs.” Milberg (2008) reports that traditional production-based corporations have contracted out most of their production to suppliers in low-wage countries and have shrunk to their ‘core competence’, all the while using the profit thus generated to enhance shareholder value through financial investments, higher dividends, and share buybacks. Many household names in the corporate world have shrunk to a size that belies their status. G. F. Davis and Kim (2015, p. 210) call this the “Nikefication” of the corporation, which is the widespread use of contractors for manufacturing and distribution, with the parent company reduced to nothing more than marketing and branding. G. F. Davis (2013, p. 290) predicts that the modern corporation as we know it might soon disappear altogether as it has become inconsequential: “The public corporation in the United States is now unnecessary for production, unsuited for stable employment and the provision of social welfare services, and incapable of providing a reliable long-term return on investment.”
45 Short-termism Although profit financialisation explains part of the puzzle of rising share values despite dwindling production, control financialisation is linked to both share value and declining production in a more direct manner (Barradas, 2017; Lazonick & O'Sullivan, 2000). Control financialisation manifests as ‘short-termism’, which is when corporate executives focus on the maximisation of short-term shareholder value, often at the expense of the long-term health of the firm (Haldane, 2015). More specifically, ‘short-termism’ is the excessive payment of dividends and/or the unnecessary repurchase of shares by a firm, both of which immediately boost shareholder value (share price) but simultaneously reduce corporate funds available for real investment (i.e., investment in productive capabilities) and for other uses of funds that promote the long-term health of the firm.10 Although much of the literature on short-termism in finance and economics focusses on real investment in defining short- termism, other literatures like the financialisation literature and the comparative capitalism literature focus instead on shareholder payout (dividends and share buybacks) and the prioritisation of short-term ‘shareholder value’ over firm growth (Deeg, 2012; Gospel & Pendleton, 2003; Hall & Soskice, 2001; Lazonick, 2014; Stockhammer, 2005). These latter literatures also see shareholder payout as potentially coming at the expense of real investment but they do not limit their scope to real investment: they also see excessive shareholder payout as undermining employment, wages, and worker skills (Amable, 2003; G. F. Davis & Kim, 2015; Hollingsworth & Boyer, 1997; Lin & Tomaskovic-Devey, 2013). In other words, the short-termism literature in finance and economics overlooks employees while the financialisation literature and the comparative capitalism literature do not. My definition of ‘short-termism’ aligns more closely with the latter literatures and is thus broader than the finance and economics literature. I define ‘short-termism’ as excessive shareholder payout that comes at the expense of the long-term health of the firm – i.e., at the expense of real investment, employment, worker skills, and other factors that may undermine the long-term health of the firm. I thus consider real investment to be an important factor in contributing to the long-term health of the firm but not the only factor. Importantly, my foundational assumption in defining short-termism is that the firm exists to serve its stakeholders and not
10 Financial payout means a loss of funds for the firm while financial investments stay within the firm and can even, through the financial income generated, fund real investment, as is the case for smaller firms that find it hard to secure funds from outside (Barradas, 2017; Tori & Onaran, 2017).
46 just its shareholders – unlike much of the literature in finance and economics, which sees shareholders as the sole ‘principals’ of the firm (Zajac & Westphal, 2004).
A particularly blatant form of short-termism is the share buyback. A share buyback is simply the repurchase of its own shares by a public firm. When this is done in the open market – as is the case with most buybacks – it represents an attempt by the firm to artificially inflate its share price (see Almeida, Fos, & Kronlund, 2016). Importantly, share buybacks in the open market are not disclosed as they happen (in the US) and thus investors in the stock market cannot attribute the resulting spike in the share price to the share buyback, making it the preferred device of corporate managers to manipulate the share price without giving the appearance of manipulation. As Lazonick (2014, p. 51) notes, this seemingly deceptive practice was legalised in the US in 1982:
Companies have been allowed to repurchase their shares on the open market with virtually no regulatory limits since 1982, when the SEC [the U.S. Securities and Exchange Commission] instituted Rule 10b-18 of the Securities Exchange Act...In essence, Rule 10b-18 legalized stock market manipulation through open-market repurchases.
Lazonick and O'Sullivan (2000, p. 23) write: “For many major US corporations stock repurchases have now become a systematic feature of the way in which they allocate revenues and a critically important one in terms of the amount of money involved.” Lazonick (2014, p. 48) points to some startling findings to reveal the extent of short-termism in NFCs in the US:
Consider the 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012. During that period those companies used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock, almost all through purchases on the open market. Dividends absorbed an additional 37% of their earnings. That left very little for investments in productive capabilities or higher incomes for employees.
Milberg (2008, pp. 435-436) further reports: “[D]ividend payments and share buy-backs have risen steadily (with cyclical fluctuations) as a share of internal funds in the non-financial corporate sector, taking off in the early 1980s from a plateau of around 20 per cent and reaching about 90 per cent by 2006.”
Gruber and Kamin (2015) observe that NFCs engage in share buybacks not for the purpose of ‘strengthening the balance sheet’ – as some scholars contend – but rather for the purpose of enhancing shareholder value. Similarly, Lazonick (2017) refutes the claims by some scholars that NFCs conduct buybacks when they judge their firms to be undervalued in the stock
47 market or when there are ‘excessive’ funds to spare by pointing to the massive rise in both the size and frequency of buybacks. Almeida et al. (2016) find that many public firms conduct large unplanned buybacks to artificially boost the share price when their quarterly earnings fall below analyst expectations11 – and that this comes at the expense of real investment.
A more conventional approach to enhancing share value is the management of dividends. Orhangazi (2008) reveal that dividend payments have also been on the rise in NFCs since the 1980s. What is striking is the extent to which firms go to maintain dividend payments. A large number of firms, in fact, issue new shares to fund dividend payments (Grullon, Paye, Underwood, & Weston, 2011). There is also the widespread trend of smoothing dividends irrespective of company performance with many firms continuing to maintain dividend payments even when running at a loss, which Haldane (2015) notes is a historical anomaly.
The trade-off between shareholder payout and real investment
The enormous amount of internal funds spent by NFCs on buybacks and dividends may have translated into lower real investment. Fiebiger (2016) shows that average yearly growth in gross fixed investment in US NFCs went from almost 9 percent in the 1950s and 1960s to 6 percent between 1980 and 2007 – a decline of 30 percent. After the turn of the century, when shareholder payout became particularly pronounced, average yearly growth in gross fixed investment averaged 4.3 percent between 2000 and 2007 and just below 2 percent between 2008 and 2013 – representing an almost 60 percent decline compared to the figure for the 1950s and 1960s (Fiebiger, 2016). Orhangazi (2008) uses firm-level data to show how the rise in financial payouts (shareholder payouts plus interest payments) between 1973 and 2003 likely contributed to a decline in real investment in NFCs in the US during the same period. In fact, real investment has been chronically low in the US – and in other advanced economies – not only since the GFC but also well before that (Artica, Brufman, & Martinez, 2017; OECD, 2015; Summers, 2014). According to the IMF (2016), even despite relatively healthier growth of the US economy in recent years – after a very slow recovery from the GFC – and low levels of unemployment, the weakness in real investment in NFCs has persisted and is likely to continue as a long-term trend. Gutiérrez and Philippon (2016) and
11 Quarterly earnings surprise, even earnings being slightly below expected levels, can have severe consequences for a public firms; often, firms are punished by the market – through a major drop in the share price – which can cause much anxiety among shareholders and threaten the employment of the CEO – which is why CEOs try to prevent a surprise as much as possible, even if it means sacrificing profitable real investment (Graham et al., 2006).
48 Gruber and Kamin (2015) compare the decline in real investment12 to economic models – Tobin’s Q – and conclude that this decline (at least in part) is a case of under-investment rather than a lack of profitable investment opportunities. Their macro-level assertion is reinforced by micro-level survey-based evidence13 from Bailey and Godsall (2013) and Graham et al. (2006), who find that corporate managers often reject prospective projects with positive net present value (NPV) – considered a reliable measure of future profitability (Bierman & Smidt, 2012) – because of pressures and incentives to focus on short-term shareholder value.
At the same time, high shareholder payout does not automatically lead to lower real investment as non-financial corporations can take on additional debt to pay for real investment and even shareholder payout. This is particularly relevant to the post-GFC period, when interest rates have dropped to near-zero and have remained historically low. Lynch (2019) notes in The Washington Post that “a decade of historically low interest rates [after the GFC] has allowed companies to sell record amounts of bonds to investors, sending total U.S. corporate debt to nearly $10 trillion, or a record 47 percent of the overall economy”. Cheap debt may thus have allowed public firms in the US to bypass the trade-off between shareholder payout and real investment that may be present in more ‘normal’ times when interest payment (cost of capital) is an important consideration (Lei & Zhang, 2016). This is indeed suggested by the financial data of US public firms.14 As shown in Figure 1.4, debt (total debt in the balance sheet) has grown sharply in US public firms (non-financial firms) in the post-GFC period and this seems to have helped maintain ever-higher shareholder payouts (dividends and share buybacks) without a substantial decline in real investment growth.
As Figure 1.4 shows, average debt in non-financial public firms in the US has more than doubled between 2004 and 2017, from $817 million in 2004 to $2,084 million in 2017 (see axis on the right for debt values). This steep and linear rise in debt appears to have helped finance an even steeper growth in shareholder payouts from 2009, with average shareholder payout rising from $174 million in 2009 (which is below the average net income of $261 million for 2009) to $444 million by 2015 (which is much greater than the average net income of $302 million for 2015). The sharp rise in shareholder payouts is actually in
12 Gutiérrez and Philippon (2016) examine underinvestment in US publicly-listed corporations and Gruber and Kamin (2015) do the same for publicly-listed corporations in the G7 economies. 13 Bailey and Godsall (2013, p. 1) base their findings on a global survey of 1,038 corporate executives “representing the full range of industries and company sizes”. Graham et al. (2006, p. 27) survey “401 senior financial executives of U.S. companies”. 14 See Chapter 4 for details on data collection and method.
49 lockstep with an equally sharp rise in real investment (capital expenditure) from 2009 to 2012. Growth in real investment tapers off after 2012, however, even as shareholder payout continues its steep rise until 2015, leading to the formation of a notable gap between the two as a consequence. The two variables again move parallelly from 2015 (maintaining a large gap); however, they both decline slightly.
$600 $2,000 $550
$500 $1,500 $450
$400
$1,000 $350
$300
$250 $500
$200
$150 $- 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Capital expenditure Shareholder payout Debt Net income
Figure 1.4. Averages in US$ (millions) of real investment (capital expenditure), shareholder payout (dividends plus share buybacks), debt (secondary axis on the right), and net income in US public firms listed before 2005 (n=1,174 firms).15 Data source: Bureau van Dijk.
Notwithstanding the period between 2012 and 2015 (and perhaps the year 2007), Figure 1.4 thus reveals that changes in shareholder payout and real investment have largely been in lockstep, contradicting the common view – especially in the financialisation literature – that shareholder payout and real investment have an inverse relationship (see also Gruber & Kamin, 2017). This is also echoed by Fiebiger (2016, p. 355), who notes: “A prevalent concern of the shareholder value literature is that share buy-backs necessarily crowd-out productive investment. That concern overlooks the fact that financing for stock repurchases has been mainly from borrowing instead of profits”. Figure 1.4 indeed shows that profit (net
15 See Chapter 4 for details on sample selection and method. This sample of US public firms is the same as that used in the later comparative empirical chapters.
50 income) has been less relevant in funding both shareholder payout and real investment as profit has been lower than both variables after 2005 (except in 2009). Hence, the relationship between shareholder payout and real investment is not straightforward, largely because of the ability of public firms to take on additional debt. In other words, the impact of shareholder payout on real investment is moderated by debt.
Taking on debt to maintain shareholder payout is still a form of short-termism, however, regardless of the maintenance of real investment. Debt ultimately has to be repaid and is likely to come at the expense of real investment or employment in the future. It could also come at the expense of shareholder payout, but this is less likely as US public firms tend to prioritise shareholder payout (Hall & Soskice, 2001; Lazonick, 2017). In this sense, US public firms may still be called short-termist despite the maintenance of real investment. In fact, the majority of the additional debt taken on by US NFCs seems to have gone towards shareholder payout rather than real investment – especially since 2012. Indeed, this is confirmed by L. E. Davis (2016, p. 136), who finds “a declining correlation between NFC borrowing and fixed investment since the 1970s, [indicating] that—despite rising average debt holdings—new borrowing is less strongly channelled into fixed investment”. There cannot be a clearer act of short-termism than taking on additional debt to further boost already-high shareholder payouts. Even the fact that shareholder payout is consistently higher than net income in Figure 1.4 (except for 2004 and 2009) is a clear sign of short-termism in US public firms as it indicates that they regularly pay out more than they earn (see also Lazonick, 2014).
Short-termism and downsizing
The rapid rise in the share of internal funds directed to share buybacks and dividend payments has also gone hand-in-hand with downsizing and restructuring, with NFCs – as aforementioned – being stripped down to their “core competence” (Milberg, 2008, p. 421). In fact, for a significant and growing number of companies, it goes well beyond downsizing to core competence: many companies collapse after unsustainable payouts to shareholders for a number of years. Lazonick (2017, p. 3) notes that “[o]ver the past three decades, in aggregate, U.S. stock markets...have extracted trillions of dollars from business corporations in the form of stock buybacks” and that this “legalized looting of the U.S. industrial corporation” has curtailed real investment in NFCs and jeopardised their future income stream from production to a degree that, “[e]very once in a while, as documented in our research, a
51 company that has done massive buybacks over a period of years hits a financial wall” (p. 26). The average age of large nonfinancial corporations has shrunk significantly since the turn of the century from above forty years to about fifteen years (Jo & Henry, 2015). G. F. Davis (2013, p. 292) reports that the number of public corporations dropped by more than half from 1997 to 2008 and that, “[m]any of the most powerful American corporations have either disappeared or stopped being identifiably “American.” Of the Dow Jones 30 firms in 1973, only seven are left in the index”.
This rampant culture of short-termism has even alarmed prominent investors, corporate managers, and business-friendly policymakers, who fear that short-termism might put capitalism itself in irreversible peril (see Barton, 2011; Haldane, 2015; Kay, 2012). Michael Porter (1991), the renowned business scholar, was one of the first to sound the alarm on short-termism by pointing out how the widespread corporate obsession with share price fluctuations and short-term financial returns had seriously compromised the health and competitiveness of the US economy through concomitant underinvestment in production. Larry Fink, the CEO of BlackRock – the largest investment firm in the world – recently penned a concerned letter to corporate managers, warning them of the increasingly perilous culture of short-termism:
While we’ve heard strong support from corporate leaders for taking…a long-term view, many companies continue to engage in practices that may undermine their ability to invest for the future. Dividends paid out by S&P 500 companies in 2015 amounted to the highest proportion of their earnings since 2009. As of the end of the third quarter of 2015, buybacks were up 27% over 12 months. We certainly support returning excess cash to shareholders, but not at the expense of value- creating investment…Today’s culture of quarterly earnings hysteria is totally contrary to the long- term approach we need…Over the past few years, we’ve seen more and more discussion around how to foster a long-term mindset. While these discussions are encouraging, we will only achieve our goal by changing practices and policies, and CEOs of America’s leading companies have a vital role to play in that debate. (Fink, as cited in Turner, 2016)
Managerial pressures and incentives Corporate managers are, of course, the ones who make the decisions to divert ever-increasing proportions of corporate funds towards share buybacks and dividends and also the ones who choose to forego long-term real investment to do so. In this sense, they are the agents through which financialisation and shareholder value orientation become manifest in the form of short-termism. However, during the post-war period of ‘managerial capitalism’, managers
52 used to choose the opposite of short-termism: they reinvested profits heavily towards firm growth at the expense of shareholder value. It was because new pressures and incentives emerged with the advent of financialisation and the shareholder value revolution that the pivot from ‘empire building’ to ‘managerial myopia’ transpired.
The hostile corporate takeover has become a constant looming threat to corporate managers in financialised capitalism. Financial deregulation in the 1980s engendered a ‘market for corporate control’, which enabled aggressive investors to buy out ‘undervalued’ public firms (those featuring comparatively lower short-term returns) in order to achieve higher short-term shareholder value (Lazonick & O'Sullivan, 2000). There was a frenzy of takeovers in the 1980s not seen since the lead-up to the Great Depression that got even the market-friendly policymakers in the Reagan-Bush era worried (Auerbach, 2013). Hostile takeovers often resulted in the wholesale replacement of the management team with a new team of short- termist managers – often with finance backgrounds – who were indoctrinated in and proven performers of ‘shareholder value maximisation’:
These takeovers also placed managers in control of these corporations who were predisposed towards shedding labour and selling off physical assets if that was what was needed to meet the corporation’s new financial obligations and, indeed, to push up the market value of the company’s stock. For those engaged in the market for corporate control, the sole measure of corporate performance became the enhanced market capitalization of the company after the takeover. (Lazonick & O'Sullivan, 2000, p. 18)
The wave of hostile takeovers in the 1980s, through both the replacement of long-term- oriented managers by short-termist ones and the creation of fear among other managers of being replaced for not ‘maximising shareholder value’, contributed greatly to a culture of short-termism by discouraging managers from making long-term real investments, fearing that weaker short-term returns may make the firm undervalued in the stock market, attracting “corporate raiders” on the lookout for undervalued firms (Stein, 1988, p. 61). The constant threat of hostile corporate takeovers, therefore, is a key driver of short-termism.
Moreover, despite the claim by the proponents of such takeovers – such as agency theory scholars (see Eisenhardt, 1989) – that the disciplining of managers leads to better firm performance, Deakin and Hughes (1997, p. 6) report that “economic evidence of the beneficial effects of hostile takeovers is elusive”; and it remains elusive (Hughes, 2014).
53 As Lazonick (2014, p. 53) points out, there are also enormous pecuniary incentives for corporate managers to engage in short-termism, especially through the liberal use of share buybacks:
...there is a simple...explanation for the increase in open-market repurchases: the rise of stock-based pay. Combined with pressure from Wall Street, stock-based incentives make senior executives extremely motivated to do buybacks on a colossal and systemic scale…Consider the 10 largest repurchasers, which spent a combined $859 billion on buybacks, an amount equal to 68% of their combined net income, from 2003 through 2012…During the same decade, their CEOs received, on average, a total of $168 million each in compensation. On average, 34% of their compensation was in the form of stock options and 24% in stock awards. At these companies the next four highest-paid senior executives each received, on average, $77 million in compensation during the 10 years—27% of it in stock options and 29% in stock awards.
Stock options and stock-based pay have been an increasingly substantial part of executive pay since the 1970s. Agency cost theory, which emerged as a major discourse in academia, business, and policymaking in the 1970s in the US, posited that managers had interests that diverged from shareholders in that they were focussed more on growth while shareholders were more interested in profit. This was indeed the case during the era of post-war ‘managerial capitalism’ in the US, where ‘empire-building’ managers grew their firms into gigantic conglomerates, which compromised the overall efficiency of the firm and squeezed profit despite earning greater revenue (Eisenhardt, 1989; Jensen & Meckling, 1976; Stockhammer, 2005). This recognition quickly brought about changes in regulations and practices in the US in the 1970s and 1980s – when powerful financial actors influenced policymaking – giving shareholders greater powers to dictate to corporate managers (Dallas, 2012; Konzelmann, Wilkinson, Fovargue-Davies, & Sankey, 2010). At the same time, large institutional investors such as retirement funds, mutual funds, and insurance firms became more active in the stock market – often investing through investment fund managers that sought short-term shareholder value maximisation. All this added to the power of shareholders through their large concentrated shareholding – as opposed to the more dispersed shareholding previously (Bushee, 1998; Lazonick & O'Sullivan, 2000). In a liberal deregulated atmosphere that was highly supportive of ‘shareholder value orientation’, powerful shareholders made telling changes to manager compensation to ensure that managers’ interests were increasingly aligned with theirs – with ‘shareholder value maximisation’ rather than firm growth being the key goal (Stockhammer, 2005).
54 In an empirical study examining the link between shareholder value orientation (SVO) and executive pay, Shin (2013, p. 535) finds that “executive compensation has played an important role in providing incentives for top managers to make strategic decisions that conform to the shareholder value maximisation principle”.16 One of the main ways that shareholders have achieved success in bending public firms more and more to their demands is by awarding corporate managers with a greater percentage of shareholder-value-related pay – stock options, stock awards, and performance bonuses based on share value metrics such as earnings-per-share (EPS) ratio. This is part of the compensation package, which makes executives focus more on share value than on firm growth through real investment (Cobb, 2016; Duménil & Lévy, 2011; Lazonick & O'Sullivan, 2000; Lin & Tomaskovic-Devey, 2013; Stockhammer, 2004). Van der Zwan (2014, p. 109) notes:
Although meant to empower shareholders in the face of self-maximizing managers, shareholder value policies—in particular, incentive pay—have enabled top-level managers to enjoy unprecedented degrees of wealth. Due to the shift away from salaries to stock options, executive pay has risen exponentially since the 1980s. CEO’s of the largest corporations now earn several hundred times higher incomes than the average worker.
The employment security of top executives in Liberal Market Economies (LMEs) has, at the same time, become increasingly vulnerable as their performance is scrutinised more closely by shareholders and company boards. Simultaneously, manager autonomy – which was high during the managerial era before the 1970s in the US – has been increasingly eroded by pressures both from inside the company – shareholders and the board – and outside – investors and financial analysts (Mizruchi & Marshall, 2016). CEO turnover is now often related to share-value performance with CEOs being replaced even when the negative performance is not firm-specific and is rather at the industry-level or, to a lesser extent, market-level (Jenter & Kanaan, 2015). CEO tenure has been shortening since the 1980s (Kaplan, 2008; Mizruchi, 2013). CEO turnover in large listed companies is at record high levels (Smith, 2016). The current performance evaluation and incentive system for CEOs of listed corporations thus encourages short-termism at the expense of investment in the long- term. A comprehensive review of the UK stock market found a similar pattern to the US due to similarities in corporate practices, laws, and culture (Konzelmann et al., 2012). In the UK, Kay (2012, p. 79) observes:
16 Based on compensation data for 290 CEOs from non-financial US public firms for the period of 1996–2006.
55 The modal tenure of a corporate chief executive is in the range 3–5 years. Many, probably, most, important decisions about the performance and activities of a large, complex business will have consequences extending well beyond that period. And the incentive scheme is generally asymmetric in nature: it rewards good performance but the punishment for poor performance is, at worst, (compensated) loss of office. An incentive scheme which pays out during the term of office of the executive is thus biased against long-term decision making.
In sum, managerial pressures and incentives appear to be play major roles in the spread and persistence of short-termism that threatens the future of NFCs by eroding long-term horizons and real investment.
Summary and Conclusion The emergence of financialisation in the 1980s was a watershed for capitalism. The post-war ‘golden age’ of ‘managerial capitalism’ that revolved around a productivist logic of reinvesting profits for long-term firm growth came to an end with the economic crisis of the 1970s. Amidst the crisis, the rise of individualist neoliberal ideology and policy – coupled with the rise of ‘agency cost’ theory – set in motion the ‘shareholder value revolution.’ This shifted the purpose of the public corporation from being centred around the advancement of the firm itself to being defined by its ‘fiduciary duty’ to the shareholder.
The productivist logic of the golden age had largely limited the domain of non-financial corporations to productive industries. However, the growing influence of the logic of finance with the arrival of financialisation in the 1980s redefined the non-financial corporation as a generic vehicle for the enrichment of shareholders – rather than an institution of production. This paradigm shift meant that the financial market came to be seen as functionally equivalent to the product market in regard to corporate strategy. This realignment of corporate strategy resulted in a transition from the principle of ‘retain and reinvest’ to that of ‘downsize and distribute’ and mass layoffs and extensive outsourcing ensued. This, in turn, defanged unions and eroded the negotiating power of workers, making shareholders even more dominant. The public corporation of old, associated with the sprawling industrial complex, secure lifelong employment, social welfare provisions, and a constantly improving standard of living for workers, became well and truly consigned to the history books.
56 Managers who were steeped in the old productivist logic17 and were reluctant to abandon it in favour of the logic of finance were simply swept aside by the frenzy of the hostile takeover movement and replaced by champions of the shareholder value revolution – usually outsider CEOs with a finance background. Moreover, the reconfiguration of managerial pay to include a large proportion of share-based pay (including stock options) ensured that the managers that remained did not veer from their fiduciary duty to the shareholder – which, of course, became a self-serving ‘duty’.
As financialisation swept away ‘managerial capitalism’ and its tenet of ‘firm growth’, the mantra of ‘shareholder value maximisation’ took hold and soon became entrenched in the corporate world in the US and UK. Subsequently, as public firms sought to provide the best possible returns for their shareholders, the stock market turned into an arena of fierce competition, with firms bidding to outdo one another with ever-higher quarterly earnings, dividends, and share buybacks. In particular, the share buyback soared in popularity among corporate managers as a quick and simple tool to covertly boost the share price at any time. By the turn of the century (and well into the second decade of the new century), public firms were pouring more than half of their yearly profits into share buybacks alone – and with dividends, virtually their entire yearly profits.
The channelling of profits towards shareholder payouts (share buybacks and dividends) coupled with the entrenchment of the logic of finance in corporate strategy has, of course, come at the expense of real investment, employment, wage growth, productivity, and innovation. By engaging in such short-termism, corporate managers have undermined the welfare of many of the stakeholders of the firm – including long-term shareholders. Prominent voices in business, government, and academia have expressed grave concerns that rampant short-termism in the corporate world has put capitalism itself in jeopardy.
As the next chapter will elaborate, the root of the problem of short-termism goes much deeper than corporate managers or even shareholders. The stock market itself is held responsible for short-termism by many scholars – with evidence. However, even the stock market, while a necessary condition, does not provide a sufficient explanation for short- termism. As I will elaborate in the next chapter, we need to consider the role of institutions and ideologies for a more complete and compelling explanation of short-termism –
17 Most managers in the post-war era would have had technical backgrounds and climbed to the top via several intermediate production-related positions but, by the 1980s, top managers had become separated from the rest of the organisation and lacked technical knowledge related to production (Porter, 1991).
57 something that scholars of short-termism have, surprisingly, mostly overlooked so far. This will then lead to the question of whether public firms (public NFCs) in different varieties of capitalism – which operate in distinct institutional and ideological settings – display disparate levels of short-termism despite the commonality of being exposed to the stock market.
58 Chapter 2 Stock-Market-Induced Short-Termism and Its Institutional Mediation
‘Short-termism’ also goes by another name in the literature: ‘managerial myopia’ (Laverty, 2004, p. 949). For many scholars and practitioners, the blame for short-termism sits squarely on the shoulders of corporate managers – the final decision-makers of the firm. Managers today are admittedly easy scapegoats given their sizeable share-based pay, massive bonuses tied to short-term shareholder value, and their considerable accumulation of stock options (Kaplan, 2008; Shin, 2013). It is not surprising, therefore, that corporate managers have been reproached by policymakers, scholars, and even fellow corporate leaders for endangering not only the long-term health of their own firm and the welfare of its stakeholders but, collectively, also the very future of capitalism itself.
In their own defence, managers tend to point their finger at the stock market and its merciless devaluation of any firm that does not single-mindedly pursue short-term shareholder value (Bailey & Godsall, 2013; Graham et al., 2006). Notwithstanding the enormous financial benefits managers derive from short-termism, there is some merit to their defence. As will be elaborated later in this chapter, stock market pressures in contemporary (financialised) capitalism do tend to leave firms with little choice but to succumb to short-termism. Empirical studies have indeed found strong evidence connecting the stock market to short- termism (e.g., Asker et al., 2015; Haldane, 2015). A US survey of four hundred chief financial officers found that 80 percent said they would “at least moderately mutilate” their firms in order to meet stock market expectations by “[c]utting the budgets for research and development, advertising, and maintenance and delaying hiring and new projects” (Mitchell, 2008, p. 1). My main argument in this chapter is that even the stock market does not appear to be a sufficient explanation for short-termism; though it does seem to be a necessary condition. The history of the US public corporation suggests that the institutions associated with financialisation and shareholder value orientation (SVO) are ultimately responsible for short-termism (Lazonick & O'Sullivan, 2000, p. 17).
This chapter is divided into four sections. The first section discusses the link between the stock market and short-termism and presents existing empirical evidence that ties short-
59 termism to the stock market. The second section delineates the structural features of the stock market that promotes short-termism in public firms. The third section revisits the history of the public corporation in the US to illustrate the institutional mediation of the link between the stock market and short-termism. The concluding section delineates the need to analytically separate the structure of the stock market from the institutions of financialisation and SVO in order to better understand the separate contribution of both to short-termism as well as to appreciate how they might combine to produce short-termism in firms.
Short-termism and the stock market Although part of the literature on short-termism equates it with ‘managerial myopia’ and holds corporate managers responsible, there are nevertheless scholars as well as practitioners who see the stock market as the root of short-termism (see Barton, 2011; Dallas, 2012; Haldane, 2015; Kay, 2012; Porter, 1991). Graham et al. (2006, p. 38) surveyed 401 senior financial executives of US companies and report:
That participation in the earnings game is pervasive may not be surprising, but that the majority of companies are willing to sacrifice long-run economic value to deliver shortrun earnings is shocking. Yet, these actions are not even considered to be a problem by many CFOs. Companies sacrifice long-term value in response to intense pressure from the market to meet expectations and to avoid the severe negative market reaction when earnings are not on target.
Empirical studies do indicate a preference for short-termism from investors in the stock market. Based on an investigation of whether firms with higher capital expenditure or those with higher dividend payments and share buybacks are rewarded with higher share price by the stock market, the OECD Business and Finance Outlook (OECD, 2015, p. 46) reports: “On balance there is a clear investor preference against capital spending companies and in favour of short-termism”. Black and Fraser (2002) find in an international study that stock market investors universally tend to undervalue long-term returns (although the extent of this ‘investor short-termism’ differs by country). Similarly, Miles (1993) analyses share price data of firms listed on the UK stock market to find that the discounting of future cash flows of firms – which indicates how much investors prefer short-term returns over long-term returns – is excessive and consequently pressures firms to focus on the short-term. Moreover, Liljeblom and Vaihekoski (2009) report from a survey of a range of firms that stock market investors tend to discourage long-term real investment by demanding significantly higher rates of return on such investment compared to all other types of investors (government, co-
60 operatives, and family owners) – except private equity investors, who require similarly high returns.
Predictably, the common underlying assumption (explicit in some cases and implicit in others) in studies on short-termism is that it is created by the short-termist pressures from the stock market (Asker et al., 2015). Even scholars who hold managers responsible deem stock market pressures on managers to be a key source of ‘managerial myopia’ – although they may say that managers succumb too easily to these pressures (e.g. Dallas, 2012; Graham et al., 2006; Laverty, 2004; Stein, 1988). In spite of this widely-acknowledged association of corporate short-termism with the stock market in the literature, empirical evidence of a clear connection between the two was lacking until recently. It could not be established that it was indeed the stock market that was responsible for short-termism in firms because the operationalisation of short-termism in empirical studies (method and measures used) did not rule out confounding factors such as the possibility of diminishing investment opportunities for firms, which could just as easily have led managers to decrease real investment and to return excess cash to shareholders in the form of dividends and share buybacks – a common claim in the economics and finance literatures (Artica et al., 2017; Cordonnier & Van de Velde, 2015; Fay, Guénette, Leduc, & Morel, 2017; Gruber & Kamin, 2017).18
Recognising this gap in the extant literature and the importance of establishing a clear link between short-termism and the stock market, Asker et al. (2015) set out to test for the difference in real investment between public firms and (matched) private firms in the US. Asker et al. (2015, p. 343) declare two important findings:
We first show that private firms invest substantially more than do public ones on average, holding firm size, industry, and investment opportunities constant. This pattern is surprising in light of the fact that a stock market listing gives firms access to cheaper investment capital. Second, we show that private firms’ investment decisions are around four times more responsive to changes in investment opportunities than are those of public firms.
18 Empirical studies – in which confounding factors cannot be ruled out – have operationalised short-termism as (i) the undervaluing of future returns by stock-market investors (e.g. Black & Fraser, 2002; Graham et al., 2006; Liljeblom & Vaihekoski, 2009; Miles, 1993); (ii) the growing influence of short-term-oriented shareholders on firms (e.g. Barton, 2011; Bushee, 2001; Croce, Stewart, & Yermo, 2011; Hughes, 2014; Porter, 1991); (iii) the use of accounting-based metrics tied to share value to assess firm and manager performance along with the use of future-discounting techniques for real investment (e.g. Carr & Tomkins, 1998; J. Coates et al., 1995; Gigler et al., 2014; Hayes & Garvin, 1982); and (iv) underinvestment, as determined by comparing actual real investment of public firms with expected real investment, calculated using Tobin’s Q18 (Gruber & Kamin, 2017; Gutiérrez & Philippon, 2016).
61 They also find that real investment declines noticeably after private firms get listed on the stock market. Haldane (2015, pp. 72-73) conducts a similar empirical investigation of the public-private real investment gap in the UK and reports a similar finding:
Relative to the median sector, private firms in the sectors of manufacturing; transport, storage and communication; financial intermediation; real estate; health and social work; and community services exhibit positive multipliers on their investment relative to quoted [public] firms, with multipliers ranging from 4 to 15. These results suggest, overall, that UK private firms tend to plough back between four and eight times more of their profits into their business over time than publicly held firms.
The definition and operationalisation of short-termism in these two empirical studies, however, only includes real investment and excludes shareholder payout – which I have argued is the primary measure of short-termism, with real investment being only a secondary measure (see the introductory chapter). Notwithstanding the exclusion of shareholder payout in the operationalisation of short-termism (which might be because of the difficulty of obtaining data for shareholder payout in privately-held firms) these findings of Asker et al. (2015) and Haldane (2015) still reveal a clear connection between the stock market and an important aspect of short-termism: under-investment. Their findings defy the common assumption (particularly in economics and finance) that the principal role of the stock market in the economy is to aid firm growth – and, by extension, economic growth – by readily supplying (virtually unlimited amounts of) funding to public firms for real investment. They establish that, on the contrary, the stock market hinders firm growth by undermining real investment.19
The structural features of the stock market Much of the literature on short-termism has so far focussed on the existence of short-termism and its link to the stock market (see above). However, a systematic analysis of the (structural) mechanism behind stock-market-induced short-termism is lacking. In other words, it is largely unclear how the stock market causes short-termism in public firms. With the aim of achieving a better understanding of short-termism, I now examine the structural features of the stock
19 Their findings are thus in line with the “pecking order” theory of Myers (1984, p. 576), which posits that public firms first turn to retained earnings, then to low-risk debt, then to high-risk debt, and only then to equity issuance (in the stock market) for funding real investment. Barclay and Smith (2005, p. 8) also report that there is “considerable support” for pecking order theory in the literature. Hughes (2014) observes that, in reality, the stock market serves other purposes rather than the funding of real investment in firms: it enables founders and early investors to cash in on the firm’s success by exiting through an IPO and it enables a market for corporate control, which disciplines managers towards adherence to an approach of ‘shareholder value maximisation’.
62 market that are behind short-termism.20 Many of the structural features that I identify below have been examined separately in the literature (as factors behind short-termism) but not together. As we will see, these structural features need to be considered together to properly understand how the stock market encourages21 short-termism in public firms as their interaction rather than their isolated effect is the key to explaining short-termism (or lack thereof) in public firms – i.e., these structural features are interdependent.
I will discuss later how each structural feature of the stock market can be modified by institutions (e.g., the structural feature can be restricted by a law) and the modification of one structural feature can change the effects of other structural features on public firms as the structural features are interdependent. In this way, as I will explain in detail later, institutions can moderate the extent of stock-market induced short-termism in public firms. For example, later in the chapter, I will look at how the institutional setting in the post-war period – the ‘managerial era’ – in the US shaped the structural features of the stock market in a way that inhibited short-termism in public firms. However, in order to first demonstrate how the structural features of the stock market enable short-termism in public firms, I will focus here on the contemporary institutional setting of US, which is associated with short-termism. It is nevertheless important to remember that the structural features described below are not fixed as their manifestation, form, and strength depends on institutions.
How the structural features of the stock market enable short-termism
Firstly, the stock market is characterised by dispersed shareholding, meaning that shareholders tend to have an ‘arm’s-length’ relationship with the firm, which makes for ‘impatient’ shareholders who have little long-term commitment to the firm (Hall & Soskice, 2001). Indeed, in the contemporary stock market, much shareholding is through agents (e.g., fund managers), which further reinforces the arm’s length nature of the relationship (Hughes, 2014). Dispersed shareholding is accompanied by information asymmetry22 between shareholders and managers. This results from the inability of shareholders to monitor the firm (because of their arm’s- length relationship) and prompts the establishment of frequent financial reporting – such as quarterly reporting of profits and other financial outcomes – as dispersed shareholders are
20 This breakdown of the structural features of the stock market in order to explain its propensity to induce short-termism in firms is a novel contribution to the short-termism and financialisation literatures, as far as the author is aware. 21 As will be explained later, these structural features enable but not cause short-termism in public firms as short-termism also depends on institutions. 22 ‘Information asymmetry’ means that dispersed shareholders possess much less information than managers about the capabilities and prospects of the firm (Gigler et al., 2014).
63 generally interested in short-term returns. Frequent financial reporting due to information asymmetry, and KPIs linked to this, in turn, pressures managers to focus on short-term financial performance (Gigler et al., 2014; Gourevitch & Shinn, 2010).
The stock market also entails the separation of ownership and control. As dispersed shareholders do not possess the ability to directly enact changes within the firm (as owner- managers of private firms do) dissatisfaction with the short-term financial performance of a firm generally prompts ‘exit’ rather than ‘voice’ type attempts to change the firm (Berle & Means, 1932; D. Coates, 2014). Dispersed shareholders can, of course, exit fairly quickly due to the high liquidity of the stock market (Vitols, 2018). The fact that willing sellers of shares have little trouble finding buyers (high liquidity) means that if enough shareholders are dissatisfied with short-term financial performance as presented in the quarterly reports or with returns, mass exit can follow – which managers fear (in contemporary capitalism at least).
Managers’ preoccupation with the threat of mass exit is, of course, because of a structural feature of the stock market that is associated with markets in general: the price mechanism. Exit by disgruntled shareholders can cause the share price to plummet if a substantial number of shares get sold. A significant decline in share price is seen to reflect (in contemporary US capitalism at least) poor corporate performance and can often lead to the manager’s dismissal (Fischer & Merton, 1984; Graves & Waddock, 1990; Manne, 1965). The price mechanism of the stock market also plays another important role in providing real-time market valuation of the firm, which means that virtually every major decision of the manager can have an almost immediate impact on the share price of the firm, making managers potentially anxious about every decision that does not conform to the ‘shareholder value maximisation’ principle, including decisions to make real investments (see Bailey & Godsall, 2013; Graham et al., 2006; Shin, 2013).
Relatedly, the fact that the stock market does not discriminate as to who can and cannot buy shares means that anyone who is willing to buy shares for the given price can do so. This openness (or publicness) of the stock market enables a “market for corporate control” and, concomitantly, hostile corporate takeovers, which threaten managers with a loss of employment if they do not focus on maximising short-term shareholder value (G. F. Davis & Stout, 1992, p. 606).
The share buyback is a good example of how the structural features of the stock market combine to produce short-termism (share buybacks are indicators of short-termism – see last
64 chapter). Specifically, the virtually limitless liquidity of the stock market allows corporate managers to repurchase practically as many shares as they like; and the price mechanism then acts to boost the share price – the larger the buyback the bigger the boost to the share price. Information asymmetry also plays a role here: the lack of public information about the occurrence of the buyback (in the US at least) can give the impression of an ‘organic’ rise in the share price, which investors tend to perceive as the market signalling an improvement in the firm’s performance – which, in turn, generally results in a multiplier effect with more investors purchasing the firm’s shares, sending its price even higher (Lazonick, 2014). In this way, the structural features of the stock market incentivise corporate managers to conduct share buybacks to boost shareholder value (where manager incentives are based on the share value).
All in all, the various structural features of the stock market (dispersed shareholding, information asymmetry, separation of ownership and control, liquidity, real-time market valuation, and openness) combine to induce short-termism in public firms by pressuring managers to focus on short-term shareholder value and by incentivising share buybacks.23
Firms not listed on the stock market (private firms), of course, do not face such short-termism pressures as: (i) shareholding is concentrated rather than dispersed, which makes shareholders more committed to the firm in the long-run (Hall & Soskice, 2001) and restricts share buybacks (Andriosopoulos & Hoque, 2013); (ii) information asymmetry is minimal as concentrated shareholders (‘blockholders’) monitor firms regularly, which leads to greater familiarity with the firm and less uncertainty, making real investment less risky (Gourevitch & Shinn, 2010); (iii) separation of ownership and control is much narrower as blockholders or owner-managers tend to be involved in the major decisions of the firm, which deters immediate exit from the firm upon dissatisfaction (Aguilera & Jackson, 2003; Berle & Means, 1932); (iv) liquidity is much more limited, making shareholder exit time-consuming and laborious, which in turn makes shareholders more ‘patient’ in regards to firm strategy and performance; plus, low liquidity also restricts the ability of the firm to conduct share buybacks (Hughes, 2014); (v) real-time market valuation is not available for private firms, making share price evaluation a lengthy, costly, and rare process, giving managers greater freedom to make real investments that might come at the expense of short-term shareholder value (Monks & Minow, 2011); and (vi) openness is less problematic as blockholders are likely to be hesitant to sell their stake in
23 It is important to stress that it is the combination of the various structural features that makes the stock market short- termism-inducing. Any one structural feature alone may not induce short-termism by itself; on the contrary, it may even reduce short-termism.
65 the firm given their relatively closer relationship with the firm and their long-term commitment (Aguilera & Jackson, 2003; Clark, 2009; Gospel & Pendleton, 2003). In addition, ‘corporate raiders’ looking to execute hostile corporate takeovers tend to base their takeover decisions on the ‘undervaluation’ of firms in the market but as the market valuation of a private firm cannot readily be assessed and as such firms are not so easily resold for profit because of liquidity and price evaluation problems, private firms will not be as attractive as public firms for hostile corporate takeovers (G. F. Davis & Stout, 1992; Fligstein & Brantley, 1992).
Therefore, compared to public firms, private firms are more likely to have a long-term approach that focusses on firm growth rather than on short-term shareholder value. These structural differences between public firms and private firms (in relation to the market) is likely to explain (at least partly) the short-termism found in public firms by the likes of Asker et al. (2015) and Haldane (2015) – who do not identify the structural features of the stock market that enable short-termism in a systematic way like I do here. In fact, Asker et al. (2015) sees short-termism as an ‘agency cost’ resulting from the separation of ownership and control, blaming managers and largely ignoring the various short-termist pressures coming from the stock market.
The stock market is not a sufficient explanation for short-termism The structure of the stock market, however, does not by itself explain the rampant short- termism that is entrenched in the contemporary corporate world (in the US and the UK at least). While the structure of the stock market enables short-termism in public firms, it might not necessarily cause it. Lee, Shin, and Stulz (2016) reveal how public firms in industries with high growth potential markedly turned more short-termist in the mid-1990s despite the structure of the stock market remaining virtually the same – and investment opportunities remaining plentiful. They report that before the mid-1990s, capital in the stock market used to flow to industries with the best growth opportunities as the firms in these industries used to raise capital to fund growth-oriented real investment – indicating that the stock market then was relatively supportive of real investment and long-term growth. But after the mid-1990s, as these very firms were increasingly using funds for share buybacks instead of real investment, capital ceased to flow to industries with high growth potential. In fact, they find negative correlation between high growth potential and both capital flows and real investment since the mid-1990s. Evidently, while the structure of the stock market remained the same, “[t]he magnitude of repurchases change[d] fairly dramatically in the mid-1990s” and real investment concurrently declined – seemingly marking the turning point towards rampant short-termism (Lee et al.,
66 2016, p. 21). This short-termist turn by firms with high growth potential in the context of an unchanging stock market structure indicates that there is yet another missing piece to the puzzle of stock-market-based corporate short-termism.
What the likes of Asker et al. (2015) and Haldane (2015) overlook (or fail to discern) when attributing short-termism to the stock market is the analytically separate impact of institutions24 on this connection. A similar investigation to theirs might not have found stock-market-induced short-termism in an earlier historical period with a disparate institutional environment – such as the post-war ‘golden age’ of managerial capitalism. Indeed, in an effort to verify that public firms’ relatively (compared to private firms) weak responsiveness to investment opportunities they had found in their study was not a historical anomaly, Asker et al. (2015, p. 365) find, to the contrary, that public firms in the US were, in fact, much more responsive to investment opportunities before the 1980s. This prompts them to qualify that low responsiveness to investment opportunities “has been a feature of public-firm behavior since the 1980s” (emphasis added). However, they do not attempt to explain why public firms were much more responsive to investment opportunities before the 1980s even though they were listed on the stock market.
The structure of the stock market induces short-termism in public firms only insofar as managers are forced or incentivised to succumb to such short-termist pressures. In other words, although the stock market may cause a fall in the share price, how much managers are affected by this price decline and what actions they take in response go beyond the scope of (the structural features of) the stock market itself. Indeed, the missing link between the stock market and corporate behaviour and short-termism is a set of institutions (laws, regulations, norms, and practices) that further shape the details of corporate behaviour (Aguilera & Jackson, 2003; Hall & Soskice, 2001). In this way, institutions mediate stock-market-based short-termism.
The institutional setting of public firms consists of (external) institutions related to the stock market as well as (internal) institutions concerning the corporate governance of the firm (see Deakin & Hughes, 1997; Hughes, 2014). Certain institutions related to the stock market can heighten the preoccupation of corporate managers with share value (e.g., hostile corporate takeovers) while other institutions can relieve such pressures (e.g., regulation prohibiting
24‘Institution’ is construed here both as structural institution – such as laws and regulations – and ideational institution – a coherent set of beliefs and ideas that are widely held and are reinforced actively by incentives and norms and reproduced passively by socialisation and internalisation (P. L. Berger & Luckmann, 1991; DiMaggio & Powell, 1983). Importantly, institutions – both structural and ideational – are “rules, norms, or operating procedures that shape agents’ behaviour” (Bell, 2012, pp. 667-668).
67 hostile corporate takeovers) (Schneper & Guillén, 2004; Stein, 1988). An important point to make here is that, since the structure of the stock market has a given propensity to induce short- termism in public firms (e.g., by enabling hostile corporate takeovers), the deregulation of the stock market, ceteris paribus, is likely to intensify short-termism pressures on public firms as its short-termism-inducing structure would be left unchecked. Therefore, an institutional setting in which the stock market is unregulated (liberalised) is likely to induce greater short- termism in public firms – especially if corporate governance institutions do not guard against short-termism. In turn, corporate governance institutions strongly influence the extent to which managers prioritise short-term shareholder value or, conversely, how much they focus on the long-term health of the firm (Campbell, 2007; Dallas, 2012; Fligstein & Brantley, 1992; Gourevitch & Shinn, 2010). For example, if a large portion of managerial renumeration consists of share-based pay, they are more likely to pay greater attention to short-term shareholder value (Lazonick, 2014; Shin, 2013). Also, if dispersed shareholders are afforded greater power (relative to other stakeholders) through corporate law, they can pressure managers to focus on short-term shareholder value (Cobb, 2016; Schneper & Guillén, 2004). In this way, the institutions surrounding the stock market either intensify or reduce short- termism pressures on corporate managers and corporate governance institutions and in turn determine the extent to which managers are affected by those pressures and take actions to alleviate them (by prioritising short-term shareholder value).
A largely unregulated stock market, therefore, is likely to induce short-termism in public firms when it is accompanied by a corporate governance regime that prescribes ‘shareholder value maximisation’. This is reflected in the findings of Asker et al. (2015) and Haldane (2015), who reveal the extent of short-termism in the US and the UK respectively – both of which are (in the present era) liberal market economies where the stock market is largely unregulated and corporate governance revolves around shareholder value maximisation (Amable, 2003; D. Coates, 2014; Gourevitch & Shinn, 2010; Hall & Soskice, 2001). On the other hand, if the short-termism-inducing tendencies of the stock market are regulated (e.g., by restricting hostile corporate takeovers and share buybacks) and if there are intervening corporate governance institutions that promote firm growth and a “stakeholder-oriented” approach (as opposed to a shareholder-oriented approach), short-termism in public firms may be minimised (Jackson, 2005b, p. 419; Schneper & Guillén, 2004) – more on this later.
It can thus be said that while a particular institutional setting may constrain stock-market-based short-termism (henceforth, ‘short-termism’), a different type of institutional setting may enable
68 or even magnify it (Bell, 2011). It follows that institutional change from an institutional setting that is inimical to short-termism towards one that is conducive to it could lead to a rise in corporate short-termism even as the structural features of the stock market outlined above remain largely unchanged. The following account of comprehensive institutional change in the US from ‘managerial capitalism’ to financialisation in the context of a largely unchanged stock market structure helps elucidate this mediating role of institutions when it comes to stock- market-based corporate short-termism. The transformed relationship between the stock market and public firms following the institutional change points strongly to the possibility that the link between short-termism and the stock market is contingent on the prevailing institutional setting.
Institutional mediation of stock market pressures Berle and Means (1932), in their classic work, were one of the first to document the growing prevalence of the stock market in the US since the early twentieth century: the stock market had become an important part of American capitalism by the 1920s – the stock market crash did precipitate the Great Depression after all. Importantly, on the key difference between private and public firms, Berle and Means (1932) had observed that the stock market entailed a separation of ownership and control in public firms, which gave managers almost total control of the firm. This aspect of the relationship between the stock market and the corporation – i.e. the separation of ownership and control – was maintained well into the ‘golden age’ and explains the permissiveness of the ‘retain and reinvest’ post-war era that allowed managers to play ‘empire-builders’ and make massive real investments (which was enabled by the corporate governance institutions and associated managerial incentives of the time, as will be elaborated later). All this helped in expanding firms into gigantic but inefficient conglomerates, all without much shareholder interference (Lazonick & O'Sullivan, 2000; Monks & Minow, 2011). However, the profit squeeze that resulted from the inefficient empire-building, exacerbated by the worsening macroeconomic conditions in the 1970s and 1980s, urged shareholders – which increasingly included large institutional investors – to start taking greater control of their firms (Graves & Waddock, 1990). This also played into the hands of powerful financial actors, who helped enact new laws and regulations that gave rise to financialisation and ‘shareholder value orientation’ (Bell & Hindmoor, 2015; Dallas, 2012; Stockhammer, 2004).
Financialisation involved wholesale institutional changes that made the corporate environment fertile for short-termism. These institutional changes were supported by the ‘shareholder value’
69 revolution that precipitated a shift in corporate ideology from ‘managerial capitalism’ (which prioritised real investment and firm growth) to ‘shareholder value orientation’ – which proclaimed the enrichment of shareholders as the one and only legitimate purpose of the corporation (Lazonick, 2017; Lin & Tomaskovic-Devey, 2013). Importantly, this shift from managerial capitalism to shareholder value orientation (SVO) also entailed a transfer of power from managers to shareholders (Fligstein & Freeland, 1995). ‘Agency theory’ (see Eisenhardt, 1989; Jensen & Meckling, 1976) played a pivotal role in justifying both the institutional changes of financialisation and the turn towards SVO (Dobbin & Jung, 2010). Essentially, it posited that managers had wasted corporate funds by playing ‘empire-builders’ and building cumbersome and inefficient conglomerates and that they needed to be ‘disciplined’ by the stock market, particularly through a ‘market for corporate control’ (G. F. Davis & Stout, 1992).
There were thus several key institutional changes that came with financialisation and SVO that induced short-termism in public firms via the stock market: (i) the rise of institutional investors, (ii) the takeover movement, and (iii) the shift towards share-based managerial pay. The following passages describe, firstly, how the relevant institutions of managerial capitalism had mediated the structural features of the stock market to enable a long-term-oriented ‘retain and reinvest’ approach and then how, after each of the aforementioned key institutional changes occurred, the same structural features of the stock market started suppressing real investment and promoting short-termism instead – revealing how the same stock market structure can produce opposite outcomes when coupled with differing institutional contexts.
The rise of institutional investors
In the era of managerial capitalism (before the arrival of financialisation), the stock market’s structural features of dispersed shareholding, information asymmetry, and separation of ownership and control had combined with regulations restricting the presence of large institutional investors (e.g., pension funds, insurance funds, and mutual funds) in the stock market to produce not only oblivious but also relatively powerless shareholders (Fligstein & Freeland, 1995). Although Zeitlin (1974) has shown that many firms listed on the stock market in the 1950s and 1960s did have controlling shareholders (with more than 10 percent ownership) in the form of institutional investors, it is also clear from his study that small individual shareholders still made up the vast majority of shareholding in the stock market and that institutional investors played a much smaller role compared to the post-1970s period of financialised capitalism. Small individual investors had little commitment and power to
70 interfere in corporate strategy and, as they usually were long-term shareholders (compared to contemporary investors), they acquiesced in the expansive programs of corporate managers that involved plenty of long-term-oriented real investment (Graves & Waddock, 1990; Lazonick & O'Sullivan, 2000). Managerial incentives at the time – for example, managerial reputation based on market share and firm size and managerial pay composed largely of base salary with negligible share-based pay – promoted firm growth rather than shareholder value orientation (Stockhammer, 2004).
Notwithstanding widespread selling caused by major negative news about a particular firm or the broader economy, occasional exit from the firm by a few dissatisfied shareholders would not substantially dent the share price through the market’s price mechanism as shareholders normally only held a minute fraction of the equity of a public firm. In addition, the fact that public firms in the managerial era generally did not focus on providing competitive returns on the stock market (as they do now) and that there were few short-term ‘traders’ constantly searching for higher rates of return in the stock market meant that corporate managers rarely had to fear its liquidity (shareholders switching firms) – or indeed its openness as hostile corporate takeovers were also regulated (more on this later) (Mizruchi & Marshall, 2016).
The gradual lifting of restrictions on institutional investors (pension funds and insurance firms) towards the end of the managerial era – on top of institutional changes to the pension system25 – meant that more and more large institutional investors entered the stock market and started owning an increasing proportion of the equity of public firms (Kahle & Stulz, 2017; Zorn, Dobbin, Dierkes, & Kwok, 2004). Lazonick and O'Sullivan (2000, pp. 16-17) point to regulatory change that allowed institutional investors to invest in the stock market, which was seen as relatively risky at the time:
[T]he inflationary conditions of the 1970s meant that, under current regulations, pension funds and insurance companies could no longer offer households positive real rates of return. The regulatory response was ERISA – the Employee Retirement Income Security Act (1974) – which, when amended in 1978, permitted pension funds and insurance companies to invest substantial proportions of their portfolios in corporate equities.
25 Pensions went from being direct income from corporations to an accruing pool of funds that were to be invested in bonds and stocks. As G. F. Davis (2013, p. 286) reports: “The standard employer-based pension plans that prevailed after World War II provided a guaranteed income in retirement, giving employees little direct reason to worry about the stock market. Since the advent of the individually based 401(k) in 1981, however, most future retirees have invested their retirement savings in US corporate stocks and bonds.”
71 These regulatory changes triggered a flood of institutional investors into the stock market. Graves and Waddock (1990, p. 76) report: “In 1949 institutions owned 12 percent of the shares listed on the New York Stock Exchange…In 1984, institutional investors held about 60 percent of all shares of U.S. corporations”.
By their very nature (pooling of separate funds into one large investment fund), institutional investors generally held a much larger portion of equity in public firms than small individual investors. This had a different effect on the structural features of the stock market compared to small retail investors. Firstly, being more heavily invested in public firms, institutional investors had a greater need to monitor firms and they had the resources to do so as well, thus reducing information asymmetry (Bushee, 1998; Monks & Minow, 2011). Zorn et al. (2004, p. 277) recount:
Firms were, by their own account, relatively insulated from investor preferences in the 1960s and 1970s. Individual investors rarely had time to scrutinize firms, but with the proliferation of institutional investors and stock analysts, large firms now had many scrupulous overseers.
Secondly, their size – coupled with laws that empowered shareholders – meant that institutional investors were able to have a greater say in corporate governance matters – thus narrowing the separation of ownership and control (Graves & Waddock, 1990; Monks & Minow, 2011). This meant that, as shareholders, institutional investors were not only more familiar and more involved with public firms they invested in, but they also held greater power to interfere in matters of corporate governance and strategy. As a consequence, dissatisfaction with the firm was now more likely to make these shareholders agitate for change rather than simply exit the firm – and the demanded change would, of course, be towards greater ‘shareholder value orientation’ (G. F. Davis & Stout, 1992; Dobbin & Jung, 2010; Fligstein & Brantley, 1992).
At the same time, the high liquidity of the stock market allowed even institutional investors with large equity ownership to exit a firm instantly if they so desired. As such, an exit would cause the price mechanism to drastically drop the share value of the firm (compared to individual investors). Institutional investors thus held substantial ‘structural power’ over managers, who became more constrained in their ‘empire-building’ in response to this threat (Bell, 2013; Kahle & Stulz, 2017). Furthermore, the openness of the stock market allowed “activist institutional investors” to become avid participants in hostile corporate takeovers, both as sellers and ‘raiders’ – as such, takeovers became deregulated in the era of financialisation (G. F. Davis & Stout, 1992, p. 610). As previously discussed, the hostile corporate takeover
72 movement introduced intense pressures on managers to maximise short-term shareholder value. (The role of institutional investors in the takeover movement is discussed later).
In sum: Institutional restrictions on large institutional investors in the era of managerial capitalism had meant that the stock market’s structural features of information asymmetry and separation of ownership and control had worked in favour of real investment, allowing managers the freedom to act as empire-builders by reinvesting heavily in the firm. However, institutional change in the shape of deregulation led to the dominance of institutional investors in the stock market and this reduced both information asymmetry and the separation of ownership and control. Low information asymmetry and narrow separation of ownership and control are generally the characteristics of private firms that tend to support long-term real investment by increasing shareholder familiarity with the firm and by giving shareholders a voice – as aforementioned (Asker et al., 2015; Gourevitch & Shinn, 2010). When these characteristics occur in public firms, however, they can have an altogether opposite effect due to the presence of the other structural features of the stock market. Greater difficulty in selling equity and lack of regular information about the market value of their firm makes shareholders of private firms automatically more long-term-oriented, which means that shareholder monitoring and influence are directed more at ensuring firm growth (Aguilera & Jackson, 2003). In contrast, the high liquidity of the stock market coupled with its real-time valuation of firms makes shareholders of public firms noticeably more uncommitted, myopic, and impatient. Thus, in public firms, shareholder scrutiny and control are directed more at maximising short-term shareholder value (Aguilera & Jackson, 2003; Gigler et al., 2014). In this way, the decrease in information asymmetry and the narrowing of the separation of ownership and control brought about by the rise of institutional investors in the stock market exacerbated short-termism pressures on the managers of public firms.
The takeover movement
In the era of managerial capitalism, corporate managers were relatively secure in their employment, which was itself part of a larger trend of lifelong (or, at least, long-term) employment in large public firms (Lazonick & O'Sullivan, 2000; Mizruchi & Marshall, 2016). With secure employment and a lack of shareholder interference, corporate managers were relatively unrestrained in making massive real investments and playing empire-builders – as the reputation of managers was based on firm growth (Stockhammer, 2004). Corporate managers of the post-war ‘golden age’ thus presided over unprecedented corporate expansions
73 that branched out into ever newer product markets, turning previously specialised corporations into sprawling ‘conglomerates’ (G. F. Davis et al., 1994). Dispersed shareholders in the era of managerial capitalism were so fragmented, oblivious, and powerless that the inefficiency of disjointed conglomerates that increasingly undermined firm profitability went largely unchecked (Graves & Waddock, 1990; Jensen & Meckling, 1976). Declining profitability was then widely attributed to deteriorating economic conditions rather than on managerial actions (Useem, 1993).
The tide started turning against corporate managers with two major institutional developments. The first development was the aforementioned rise of large institutional investors that increased scrutiny on managers and enabled greater shareholder interference in corporate strategy. The second notable development was the parallel advent of ‘agency theory’ in academia that not only documented the trend of inefficient empire-building but also blamed managers for poor profitability (and shareholder value) and advocated for the disciplining of managers through the stock market (see G. F. Davis & Stout, 1992; Eisenhardt, 1989). For example, Manne (1965) argued that managers were ultimately responsible for poor firm performance and that a weak share price reflected bad management. Similarly, a highly influential paper by Jensen and Meckling (1976) – considered the founding of ‘agency theory’ – argued that the sole task of corporate managers is to maximise shareholder value (as they were agents to shareholders, who were the only principals) and that managers who do not do so ought to be disciplined by the efficient ‘market for corporate control’.
Following the rapid diffusion of ‘agency theory’ in both business and policymaking circles, regulatory changes were made that enabled a ‘market for corporate control’ (Zorn et al., 2004). Anti-trust laws in the US – particularly the Clayton Act and the Glass-Steagall Act – had thwarted hostile corporate takeovers by regulating mergers and acquisitions and by preventing financial institutions from participating in the stock market (Fligstein & Freeland, 1995). However, as Fligstein and Freeland (1995, p. 35) report, institutional changes triggered a particularly frenzied takeover movement in the 1980s:
Another factor behind the merger [takeover] movement of the 1980s was state intervention that created changes in the regulatory environment. The Reagan administration weakened antitrust laws in the 1980s by lifting many existing restrictions, giving the green light to all types of mergers, including vertical, horizontal, and conglomerate forms. At the same time, they substantially reduced corporate taxes, thereby providing capital for the merger movement. These actions, when combined with the finance conception of control that had arisen in the 1960s and the undervalued corporate
74 assets of the 1970s, led to an explosion of merger [takeover] activity. Although the mergers of the 1980s were sometimes implemented by management, they helped to strengthen the power of financial markets over the industrial organization.
These takeovers – many of which were hostile corporate takeovers by ‘corporate raiders’ (usually institutional investors and investment banks) – forced previously firm-growth-oriented and ‘productivist’ managers to adopt the logics of finance and to focus on maximising shareholder value.
[Institutional investors and investment bankers] used the finance conception of control to force managers to reorganize firms financially or risk becoming victims of the market for corporate control…As a result, the 1980s witnessed an increase in shareholder activism…particularly among large, institutional shareholders. (Fligstein & Freeland, 1995, p. 36)
One of the main triggers for hostile takeovers was a perceived weakness in the share price of a firm, which was, of course, based on short-term profits and on shareholder payouts. Corporate raiders were on the lookout for such ‘undervalued’ public firms with the aim of taking over and reorganising them (from ‘retain and reinvest’ to ‘downsize and distribute’) in order to boost short-term returns and shareholder payout to achieve a spike in the share price, which would then enable them to sell their shares for a handsome profit (G. F. Davis & Stout, 1992; Lazonick & O'Sullivan, 2000). Corporate raiders often replaced growth-oriented managers with outside managers (usually with finance expertise) versed in the art of ‘shareholder value maximisation’ (Fligstein & Freeland, 1995). ‘Shareholder value maximisation’ often entailed an approach of ‘downsize and distribute’ with the ultimate goal of enhancing the financial rate of return for shareholders by focussing on the firm’s ‘core competence’ and freeing massive funds to boost shareholder value (Lazonick, 2017; Milberg, 2008; Zorn et al., 2004).
The potential loss of employment through the ever-present threat of hostile corporate takeovers meant that corporate managers had more reasons to fear sudden exits by dissatisfied institutional shareholders – facilitated by the stock market’s liquidity. Such exits would cause the price mechanism to send the share price sharply downwards, inviting the attention of ever- watchful corporate raiders. This also heightened the structural power of activist institutional shareholders who would agitate for shareholder value maximisation.
Hence, the openness of the stock market, which rarely used to be a cause for concern for managers because of the protections afforded by anti-trust laws and by restrictions on powerful institutional investors, quickly became a source of concern about the threat of hostile corporate takeovers. The takeover movement precipitated the reversal of real investment, the reduction
75 of fixed assets, and the laying-off of employees on one hand and catalysed the channelling of corporate funds towards shareholder payouts on the other (Auerbach, 2013).
In this way, while the institutional arrangements of the managerial era had acted as a buffer between the short-termist tendencies of the stock market and the firm-growth agenda of corporate managers, the institutional change and deregulation that came with financialisation and neoliberalism stripped away such protections for managers, turning the formerly innocuous liquidity, price mechanism, and especially openness of the stock market into sources of constant threats from corporate raiders, forcing managers to abandon their ‘retain and reinvest’ program in favour of a ‘downsize and distribute’ agenda – thus engendering short-termism.
Share-based managerial pay
Further institutional change came in the form of changed corporate remuneration schemes. Before stock options became popular as a form of managerial pay in the 1980s, managers were mostly paid a base salary and a relatively small yearly bonus (Frydman & Jenter, 2010). This meant that their material interests diverged from the interests of shareholders: while shareholders desired efficiency and a high rate of return on their capital, managers wanted to be empire-builders by reinvesting in the firm to both enhance their reputation and to guard their employment by securing the firm’s future (Stockhammer, 2004). Given the separation of ownership and control and information asymmetry they had with dispersed and fractional shareholders in the managerial era, managers were able to play empire-builders without any material risks to their employment or their take-home pay, even if they made inefficient real investments with weak rates of return – which they did regularly during the conglomerate movement of the 1950s and 1960s (Fligstein & Freeland, 1995; Jensen & Meckling, 1976; Zorn et al., 2004). However, as their pay started being tied to the share price in the late 1970s (as financialisation and SVO were emerging), such real investments increasingly became materially more costly for managers – through lost opportunity to grow their wealth in the stock market. Frydman and Jenter (2010, p. 81) document dramatic changes in managerial pay from the era of managerial capitalism to the era of financialisation:
From 1936 to the 1950s, CEO compensation was composed mainly of salaries and annual bonuses…[However, there was a] surge in stock option compensation starting in the early 1980s. The purpose of option compensation is to tie remuneration directly to share prices and thus give executives an incentive to increase shareholder value… the frequency of option grants remained too small to have much of an impact on median pay levels until the late 1970s…During the 1980s [when
76 financialisation was growing] and especially the 1990s [when financialisation became entrenched], stock options surged to become the largest component of top executive pay… Option compensation comprised only 20% of CEO pay in 1992 but rose to a staggering 49% in 2000. Thus, a significant portion of the overall rise in CEO pay is driven by the increase in option compensation.
Stock options were ideal instruments to tie manager interest with shareholder interest. As Lazonick and Shin (2019, p. 70) note:
Also since the 1980s, the most important components of senior executives’ total compensation have been modes of stock-based pay in the form of stock options and stock awards. This stock-based pay is structured to incentivize executives to make corporate-allocation decisions that will boost the stock prices of the companies that employ them and reward them for achieving this objective.
G. F. Davis and Stout (1992), Dobbin and Jung (2010), Fligstein and Freeland (1995), Mizruchi and Marshall (2016), and Zorn et al. (2004) all point to 'agency theory' as the instigator of major changes to managerial pay: from being weakly tied to shareholder value to being strongly tied to it – especially through stock options. Shin (2013, p. 541) recounts how ‘agency theory’ scholars took issue with a lack of connection between pay and performance – in terms of shareholder value – in the post-war managerial era and accordingly advocated for closer shareholder-manager (principal-agent) incentive alignment:
An influential study by Jensen and Murphy [in 1990] reported that the pay-performance sensitivity was too low; CEO compensation increased by a mere $3.25 for every $1,000 increase in shareholder wealth. Citing this result, agency theorists called for greater pay-performance sensitivity and more effective incentive alignment, most notably by using stock options and other equity-based compensation plans.
Institutional investors warmed to the idea that corporate managers could be incentivised – rather than just coerced – to focus on maximising shareholder value:
From the early 1980s, stock options were championed by leading institutional investors…Organizations representing institutional investors, such as the Council of Institutional Investors (CII), soon got into the act. Institutional fund managers repeated the mantra that stock options would align executive and shareholder interests. (Dobbin & Jung, 2010, p. 36)
In this way, as additions of stock options without the reduction of base salary served the interests of managers and as boards of directors – who represented institutional investors – also sought to align the interests of managers and shareholders, stock options took off as a major component of managerial pay (Frydman & Jenter, 2010). Just as agency theorists had intended, this had the desired effect of turning managers into shareholders, thus bridging the separation
77 of ownership and control by unifying the ‘agent’ and the ‘principal’ (while ignoring other stakeholders). More and more, managers sought to boost shareholder value – in order to expand their own wealth – instead of growing the firm through real investment. As frequent hostile corporate takeovers made managerial employment more precarious (as aforementioned) and as the average tenure of corporate managers shortened significantly, the focus of corporate managers in regard to shareholder value turned decidedly towards the short-term (Barton, 2011; Jenter & Kanaan, 2015; Mizruchi, 2013). An ideal way for managers to boost short-term shareholder value was, of course, the share buyback. After the deregulation of share buybacks in 1982, managers increasingly took advantage of the liquidity and price mechanism of the stock market and their information asymmetry with stock market investors to covertly26 conduct share buybacks, which grew progressively to consume about half of the firm’s yearly profits by the early 2000s – a proportion of income that used to go to real investment in the managerial era (Lazonick, 2014; Sakinc, 2017).
Thus, by turning managers into shareholders, agency theorists – considered to be the founders of the financialisation and SVO movements – were able to overcome the agency problem that came with the separation of ownership and control, which was, for Berle and Means (1932), a seemingly intrinsic part of the stock market. For dispersed shareholders, finally having a fellow shareholder (manager) at the helm changed the structural features of the stock market from being inimical to short-term shareholder value to being favourable to it. Stockhammer (2004, p. 738) shows that this alignment of manager and shareholder interest “leads to a reduction in the growth rate desired by firms”, resulting in short-termism.
In summary, key institutional changes that accompanied financialisation and ‘shareholder value’ revolution led to a surge in stock-market-based corporate short-termism. The stock market structure had largely allowed for a long-term-oriented firm-growth approach in the era of managerial capitalism until the late 1970s. This was mostly because (i) shareholding was dispersed and fractional, (ii) there was a clear separation of ownership and control, and (iii) there were barriers (such as anti-trust laws) guarding against the threatening openness of the stock market. At the same time, the other short-termism-inducing structural features of the stock market – its liquidity, price mechanism, real-time firm valuation, and information asymmetry – were also neutered as they generally required large and powerful shareholders (or organised shareholders) for their short-termist effects to materialise. The emergence of
26 There is no disclosure requirement for open-market share buybacks in the US like there is in other advanced economies like Australia, the UK, Germany, and Japan (Sakinc, 2017).
78 financialisation transformed the relationship between the stock market and public firms through major institutional changes: the rise of institutional investors, the takeover movement, and the shift towards share-based managerial pay. Together, these institutional changes made shareholders significantly more powerful by greatly narrowing the separation of ownership and control, enabling them to both directly and indirectly intervene in corporate strategy to make firms maximise shareholder value, even at the expense of long-term real investment. Greater shareholder power and interference, in turn, activated and intensified the short-termism effects of the other structural features of the stock market – its liquidity, price mechanism, real- time firm valuation, openness, and information asymmetry.
All in all, while the institutions of managerial capitalism had created a buffer between public firms and the short-termism-inducing tendencies of the stock market, financialisation and SVO not only stripped away the buffer through deregulation (of institutional investor restrictions, hostile corporate takeovers, and share buybacks) but also introduced new institutions (such as share-based managerial pay and laws empowering shareholders) that heightened and entrenched short-termism in public firms. In this way, the structural features of the stock market were mediated and shaped differently by institutions linked to financialisation and SVO compared to the institutions of managerial capitalism. Specifically, the institutions of financialisation and SVO mediated the structural features of the stock market in ways that heightened short-termism pressures on public firms.
Conclusion and research gap In this chapter, I have shown that the structural features of the stock market and the institutional context in which stock markets operate are analytically separate. These separate constructs are conflated in the literature on short-termism, which lacks a systematic and explicit identification of the various structural features of the stock market as presented in this chapter. Even the studies that claim a link between short-termism and the stock market (e.g., Asker et al., 2015; Black & Fraser, 2002; Haldane, 2015) do not analytically separate the structural features of the stock market and the institutions associated with financialisation and SVO. This means that these studies may well be misinterpreting the short-termism effects of the institutions of financialisation and SVO as the short-termism effects of ‘the stock market’ per se. The stock market (structure) itself does not always produce short-termism in public firms; it depends on the institutional context. As described in the foregoing historical account, public firms in the post-war managerial era were quite supportive of real investment and the stock market was
79 thus not associated with short-termism. Therefore, it is wrong to claim that the stock market itself produces short-termism. Short-termism is more dependent on the institutional setting – i.e., on the institutional mediation of the structural features of the stock market.
To confirm whether institutional differences between public firms indeed results in differences in short-termism, I conduct an empirical study (presented in later chapters) comparing public firms in different (national) institutional settings. While the historical account presented in this chapter did this to a degree and argued that the occurrence of short-termism depends on the institutional setting, a comparative empirical study that quantitatively compares stock-market- based short-termism in disparate institutional settings in the same time period would provide stronger evidence. This can be done by comparing short-termism in stock-market-listed firms (public firms) in different varieties of capitalism, which are known to have distinct institutional settings (Hall & Soskice, 2001). The institutional setting is based on financialisation and SVO in LMEs and on wider stakeholder concerns in CMEs. By comparing short-termism in LMEs and CMEs, it would also be possible to find out whether institutions of financialisation and SVO are, in fact, associated with short-termism – as hinted by the foregoing historical account. This kind of study is surprisingly lacking in the literature. The main empirical aim of this study, therefore, is to compare short-termism in public firms in different varieties of capitalism – namely, Germany, Japan, the US, and the UK. In the next chapter, I develop an explanatory framework that helps explain the findings of the empirical study by not only pointing to institutional differences but also by examining the ideological, political, and cultural roots of institutional differences. In other words, the framework will help illuminate the institutional, ideological, political, and cultural roots of national differences in the behaviour of public firms – in particular, differences in the extent of short-termism.
80 Chapter 3 Power Relations, Culture, and Dominant Ideology
Many scholars in the fields of finance, economics, and business tend to view the stock market as the source of corporate short-termism. If short-termism did follow mainly from stock market listing, the extent of short-termism in public firms in different political economies (nations) should be quite similar. However, this may not actually be the case. The comparative capitalism (CC) literature suggests that public firms in LMEs like the US are often strongly associated with short-termism while their counterparts in CMEs like Germany are not (Jackson & Deeg, 2006). The CC literature indicates that this is because public firms in LMEs and CMEs face disparate institutional settings: they face market-based settings in LMEs and more non-market (negotiated and coordinated) settings in CMEs. In LMEs, the institutionally-promoted prioritisation of shareholder value at the firm level combines with unregulated short-termist tendencies of the stock market – like hostile takeovers and share buybacks – to produce systemic short-termism (as described in chapters 1 and 2). In contrast, the less market-oriented institutional settings of CMEs are said to inhibit corporate short- termism, both by regulating the short-termist tendencies of the stock market (like hostile takeovers and share buybacks) and by encouraging public firms to focus on long-term firm growth and wider stakeholder interests rather than on short-term shareholder value (Hall & Soskice, 2001). In this sense, in line with the conclusions of my argument in the previous chapter, the CC literature indicates that short-termism depends on the institutional setting of public firms.
Although institutions play a key role in determining the extent of short-termism in public firms, institutions are not enough to explain short-termism because they are not the root cause of short-termism. Institutions are but means to ends. The ends we are concerned with in this study are essentially distributional outcomes – e.g., the maximisation of shareholder payout at the expense of employees and other stakeholders (i.e., short-termism). I argue in this chapter that the ends that institutions are based on are shaped by power relations and culture through the dominant ideology (the dominant ideology being the field-specific interaction of power relations and culture). In other words, I argue that power relations and culture – via the dominant ideology – are the ultimate source of short-termism. In this sense, national
81 differences in power relations and culture help explain national differences in both institutions and short-termism.
I also argue that power relations and culture shape both state-level formal institutions and firm-level institutional practices by shaping the dominant economic ideology of the state and the dominant business ideology of the business field within a country respectively. State-level formal institutions (laws and regulations) are, of course, designed to influence firm-level practices but they may not always be effective in doing so for various reasons (e.g., weak enforcement and loopholes), especially if the dominant economic ideology at the state-level is incongruent with the dominant business ideology within the business field. I argue that it is primarily through their effects on power relations that formal institutions (e.g., corporate governance laws) influence firm-level practices and thus distributional outcomes like short- termism.
All in all, I argue in this chapter that power relations and culture together shape the dominant ideology (at the state level and the firm level), which shapes institutions and practices, which, in turn, determine distributional outcomes in public firms – i.e., the occurrence and extent of short-termism. All these factors are brought together in a conceptual framework at the end of the chapter with the aid of a visual model.
This chapter is structured as follows: I first discuss how efficiency-based functionalist approaches to institutional analysis like those of Hall and Soskice (2001) have been critiqued for overlooking power relations and then discuss how power relations shape institutions while also outlining the relevant sources of power. Then I delve into how sociologists have also critiqued functionalist and structuralist views of economic action and how cultural values and beliefs influence institutions. I then review how the few works in the comparative capitalism literature that include cultural factors have approached it. Next, I delineate how the dominant business ideology is the field-specific expression of power and culture that directly shapes institutions by defining institutional logics. I then point out the distinction between formal (state-based) institutions and firm-level institutional practices, discussing how gaps can exist between formal institutions and firm behaviour (i.e., firm-level practices) and also how formal institutions can shape institutional logics by shaping power relations. I conclude by presenting (in visual form) the overall conceptual framework and summarising it.
82 The deeper roots of capitalist divergence Hall and Soskice (2001, p. 18) argue that “institutional practices of various types should not be distributed randomly across nations” and that “nations with a particular type of coordination in one sphere of the economy should tend to develop complementary practices in other spheres as well”. Hancké, Rhodes, and Thatcher (2009, p. 280) note that this “notion of complementarity has been central to VoC”. Hall and Soskice (2001, p. 17) define institutional complementarity in this way: “[T]wo institutions can be said to be complementary if the presence (or efficiency) of one increases the returns from (or efficiency of) the other”. They further argue that this efficiency benefit of institutional complementarity leads to ‘comparative institutional advantage’ in the sectors of the economy that advanced capitalist nations already specialise in. Crucially, Hall and Soskice (2001) claim that such ‘comparative institutional advantage’ explains the persistence of institutional differences between CMEs and LMEs. In other words, both CMEs and LMEs maintain their distinct (and complementarity-laden) institutional framework because it gives them competitive advantage in certain sectors of the global economy. In this way, Hall and Soskice (2001) see efficiency as the root of capitalist divergence over time.
Power relations and institutional design This post-hoc “functionalist” reasoning that claims to explain national institutional divergence on the basis of efficiency and ‘comparative institutional advantage’ has been one of the most critiqued aspects of the VoC approach (Hancké et al., 2009, p. 276). Although it is generally acknowledged (explicitly or implicitly) that efficiency is an important criterion, many scholars contend that it is not the only (or even the main) criterion for institutional design, continuity, and change (Streeck, 2010). Perhaps the most common critique of this functionalist bias of the VoC approach is that it eschews social conflict and power relations in favour of “strategic co- ordination” (Hall & Gingerich, 2009, p. 452), implying a ‘unitarist’ view whereby the stakeholders of a firm coordinate on the basis of a mutual interest in efficiency (see Fox, 1966). Howell (2003, pp. 110-112) notes that “this image is difficult to square with the reality of capitalist economic development” and that the “absence of any real place for conflict or the exercise of power in the framework of Varieties of Capitalism is remarkable”. Pontusson (2005, p. 164) also ‘complains’ that “the VoC approach theoretically privileges considerations pertaining to efficiency and coordination at the expense of considerations pertaining to conflicts of interest and the exercise of power”.
83 Knight (1992, p. 40) argues that institutions are distributional instruments (means) based first and foremost on power relations and that their ‘efficiency’ is defined by how much they benefit the powerful:
[T]he main goal of those who develop institutional rules is to gain strategic advantage vis-à-vis other actors, and therefore, the substantive content of those rules should generally reflect distributional concerns. The resulting institutions may or may not be socially efficient: It depends on whether or not the institutional form that distributionally favours the actors capable of asserting their strategic advantage is socially efficient.
This may explain why a conspicuously inefficient institutional practice like the share buyback that contributes to short-termism and hinders firm growth is more widespread in the US than in Germany: share buybacks exclusively benefit shareholders at the expense of other stakeholders and shareholders tend to have significantly greater power over the firm in the US than in Germany (Hughes, 2014). Remarkably, share buybacks are construed as an efficient use of corporate funds by analysts who subscribe to the ‘shareholder value’ ideology (Lazonick, 2014). In this sense, in a political economy where shareholders are highly dominant, the very definition of efficiency tends to reflect almost exclusively the interests of shareholders. Thus, it can be said that power relations essentially define how institutions may be deemed efficient and effective: institutions are considered efficient and effective if they attain the politically-prescribed distributional ends in a timely manner and with minimal costs to the powerful. On the other side of the same coin, institutions thusly deemed efficient and effective might be the very opposite – costly – to weaker stakeholder groups (e.g., when firms downsize and lay off workers to ‘maximise’ short-term profits and shareholder value – seen as ‘efficient’ in LMEs).
In recognition of the important role of power and conflict in institutional design, Amable (2003, p. 9) adjusts his initially functionalist position: “Leav[ing] aside the simple functionalist argument according to which institutions are designed and adopted for efficiency reasons”, he asks, like Knight (1992): “[H]ow do we define efficiency, or, for whom are institutions supposed to be efficient?”. In answering this crucial question, Amable (2003, pp. 9-10) recognises that power relations and politics are at the heart of institutions:
[I]nstitutions are the expression of a political compromise…Rather than optimal solutions to a given problem, institutions represent a compromise resulting from the social conflict originating in the heterogeneity of interests among agents…What we consider to be different economic ‘models’ are therefore based on specific social compromises over institutions.
84 Fiss (2008, p. 390) also sees “institutionalization as a process that is innately political, reflecting the relative power and interests of coalitions of actors”. Therefore, a key consideration in the analysis of institutional logics is the relative power of different actor groups, grouped by common interests – e.g., workers, dispersed shareholder, ‘blockholders’, managers, creditors, etc. The ends – institutional logics – behind institutions (the means) will ultimately reflect the interests of actor groups according to their relative power (see Fiss & Zajac, 2004). It may thus be said that power relations shape the ‘institutional logics’ of institutions by prescribing the distributional ends for institutions to attain (Thornton et al., 2012). As the institutional arrangements of public firms would be built on politically- prescribed institutional logics (e.g., shareholder value maximisation or firm growth), capitalist divergence would be a reflection of comparative differences in power relations between capitalist nations (see also Gourevitch & Shinn, 2010).
The idea that power relations shape distributional ends and thus the underlying institutional logics of institutions is actually consistent with Hall and Soskice (2001) – although they do not explicitly recognise it. They describe how the concentration of power at the top (in the hands of shareholders and managers) in LMEs translates into unilateral decision making that consistently revolves around the logic of shareholder value maximisation. On the other hand, the relatively more even power distribution in CMEs like Germany (due to institutions like ‘co- determination’, ‘works councils’, collective bargaining, and powerful unions) makes for a more ‘consensual’ approach, whereby corporate strategies adopt a logic of sustainability and growth (of the firm) that promotes the interests of a greater range of stakeholders. For example, the standard institutional practice in public firms is that of laying off workers to protect short-term shareholder value in LMEs, compared to compromising short-term shareholder value to protect workers and to maintain product market share in CMEs (see also Gospel & Pendleton, 2003; Gourevitch & Shinn, 2010; Jackson, 2005b). Another example of institutional logics being shaped by power relations concerns power differences between ‘blockholders’ (large committed shareholders like partner firms and founding families) and dispersed minority shareholders (who are generally ‘portfolio investors’ looking for short-term returns). It is widely suggested in the comparative capitalism literature that ‘blockholder’ power is associated with institutions aimed at firm growth whereas power in the hands of minority shareholders is associated with institutions promoting short-termism – e.g., share buybacks, hostile takeovers, and share-based managerial pay (Aguilera & Jackson, 2010; Cobb, 2016; Gourevitch & Shinn, 2010; Hall & Gingerich, 2009; Hughes, 2014). Patient ‘blockholders’
85 normally have more power than dispersed minority shareholders in CMEs whereas, in LMEs, the opposite is generally the case (Cobb, 2016; Gourevitch & Shinn, 2010).
Sources of power
I will now address the sources of power that determine power relations. In a direct sense, power generally derives from ‘formal power’ and ‘structural power’. By formal power, I mean power designated to social actors (particular stakeholders) by higher-level institutions. As Elinor Ostrom (2009, p. 58) observes in her seminal work: “All rules [institutions] are nested in another set of rules [institutions] that define how the first set of rules [institutions] can be changed.” She then goes on to identify different levels of institutions (ordered from lowest to highest level): “operational rules”, “collective-choice rules”, and “constitutional-choice rules” (p. 58; emphasis original).27 The higher institutional levels concern “who is eligible to be a participant and the specific rules to be used in changing [lower-level] rules”. In this way, ‘collective-choice rules’ and ‘constitutional-choice rules’ give power to select participants over others who are not ‘eligible’ to participate in institutional design (of lower-level institutions like firm-level practices). Hence, the social setting of the political economy consists of rule makers and rule takers, with the former exercising formal power over the latter. In regard to the public firm, examples of ‘collective-choice’ institutions would be corporate governance institutions like the ‘annual general meeting’ (AGM) in LMEs, where shareholders make decisions over the structure of the firm (which itself determines the distribution of power at the firm-level), managerial performance and remuneration, top-level corporate strategy, and key firm objectives (distributional ends). This formal power of shareholders (to make such key decisions in AGMs) would, in turn, derive from ‘constitutional-choice’ institutions (that sit at an even higher level) such as laws prescribing minority shareholder rights – which, in LMEs, strongly favour minority shareholders (Aguilera & Jackson, 2003; La Porta, Lopez-de-Silanes, & Shleifer, 1999; Monks & Minow, 2011). ‘Constitutional-choice’ institutions (national laws) can give power to different groups in different countries, of course. For example, while corporate governance law in the US mandates that the entire board of directors act exclusively as representatives of shareholders and shareholder only (thus giving shareholder exclusive formal power), the national law of co-determination in Germany, by contrast, requires worker representation in the supervisory boards of public firms (Roe, 2011). As far as changes in formal power are concerned, they would, of course, result from changes in laws and regulations
27 In fact, she claims that this hierarchical order can go on infinitely, with a ‘metaconstitutional’ level coming after the ‘constitutional-choice’ level.
86 (higher-level institutions). This happens, for example, when new laws are passed by the government or when the courts change the interpretation of existing laws (La Porta et al., 1999).
Unlike institutional (formal) power that derives from rules and regulations, structural power derives from the structural context and the dependency of other social actors: for example, when social actors possess resources that other social actors depend on and the social actors with the resources are in a position to threaten the removal of those resources (Bell, 2013; Lukes, 2004). For example, financial investors (capital) are said to possess structural power over governments in a globalised financial market because they can threaten to take their investments abroad if governments do not create a favourable investment environment for them – e.g., by reducing taxes and deregulating the labour market (see Bell, 2013). Similarly, stock- market-based shareholders have structural power over corporate managers as their exit can hurt the share price of the public firm and strong unions have structural power over managers and owners as they can potentially harm firm profits by organising long-lasting strikes.
Structural power can change (increase or decrease) as a result of changes in structural conditions. An example of the impact of structural conditions on structural power is globalisation and global financialisation making ‘capital flight’ much easier compared to ‘labour flight’, consequently expanding the structural power of shareholders of public firms while simultaneously weakening labour and labour unions (Lin & Tomaskovic-Devey, 2013; Milberg, 2008). Structural power can also be curtailed or reinforced by the aforementioned higher-level institutions (that designate formal power). For example, as La Porta et al. (1999) observe, large ‘blockholders’ naturally tend to have greater structural power than dispersed minority shareholders, which is one of the reasons why laws in LMEs strongly protect minority shareholders in the name of fairness, curtailing the structural power of ‘blockholders’. Co- determination, of course, is an example of a law that curtails the structural power of shareholders over workers (deriving from the ownership of the means of production). There is yet another source of power besides formal and structural power that is more subtle and diffuse: ‘cultural power’. I will elaborate the concept of ‘cultural power’ below in the section on culture. Let me just point out for now that cultural power operates less through force and more through ideas and ideologies that become dominant in society through their internalisation by the masses – who are often not conscious of the power implications of such ideas and ideologies. Usually, cultural power is possessed by those who already have structural and formal power in society as such groups are best placed to influence the media, educational institutions, and the state through their political and financial resources (Femia, 1981; Lukes, 2004). Although
87 culture can influence power relations (and vice versa), power is still conceptually separate from culture, however, as power can have non-cultural (e.g., structural) sources – as discussed above.
In many ways, therefore, formal power, structural power, and cultural power accompany and reinforce one another, which makes power relations relatively enduring despite the seeming potential of democratic politics to restructure power relations in wider society and in the business world (Lukes, 2004). Nevertheless, structural changes like globalisation and historical events like wars and crises can bring about changes in power relations. Although such changes are usually gradual such as the changes in power relations in favour of capital due to globalisation, they can also be sudden and substantial like the change in power relations in favour of labour immediately following the second world war in Japan – as a result of the deliberate breaking up of large family shareholders (zaibatsu) and the removal of their representative managers by the American Occupation and the sudden emergence of a radical and large labour movement (Gordon, 1988; Tabb, 1995).
Culture and capitalist divergence Power relations certainly help explain institutional design and capitalist diversity but are not sufficient explanations by themselves. This is demonstrated by the fact that even though workers in Japan are not protected by the state or by strong unions like they are in Germany and are thus not as ‘powerful’ as German workers, they nonetheless are treated like ‘family’ (at least in large ‘core’ firms) and enjoy many of the benefits that German workers enjoy (like long-term employment) – in contrast to almost powerless US workers (Pontusson, 2005). Many scholarly observers of the Japanese political economy turn to the cultural distinctness of Japan as an explanation for this, often citing Japanese ‘collectivism’ or ‘groupism’ that turns a firm into a ‘community’ where ‘paternalistic’ managers look after employees – contrasted with the ‘individualistic’ US, where firms are seen as a ‘nexus of contracts’ (see Dore, 2000; Hamilton & Biggart, 2001; Witt & Redding, 2009). Culture is thus another important part of the explanation for institutional diversity among varieties of capitalism.
Another line of critique of functionalist views of institutions in the literature (besides the more common ‘power’-related critique) is that functionalist views that emphasise efficiency overlook the key role of culture in institutional design, stability, and change, and in defining ‘efficiency’. Many scholars – primarily in the ‘sociological institutionalism’ tradition – argue that the idea of ‘efficiency’ itself is a ‘social construct’ (see Scott & Meyer, 1994; Swedberg
88 & Granovetter, 2001). As Fligstein (2001, p. 190) puts it: “Efficiency is socially constructed rather than constructed by markets…And there may be many ways to organize ‘efficiently’”. J. W. Meyer and Rowan (1977, p. 341) reveal in their seminal work that while organisational institutions may give the impression to social actors that they exist to enhance the efficiency or effectiveness of practical tasks, such institutions are often based on “myths” that can even “buffer activity from efficiency criteria and produce ineffectiveness” (J. W. Meyer & Rowan, 1977, p. 360). Furthermore, DiMaggio and Powell (1983) delineate in their influential work how institutional arrangements are adopted by firms not necessarily for efficiency reasons but for ‘coercive’, ‘mimetic’, and ‘normative’ reasons based primarily on legitimacy concerns. Legitimacy, in turn, is based on cultural values and beliefs (P. L. Berger & Luckmann, 1991). Taken together, scholars in the ‘sociological institutionalism’ tradition have argued that “institutional forms and procedures used by modern organizations…should be seen as culturally-specific practices, akin to the myths and ceremonies devised by many societies, and assimilated into organizations, not necessarily to enhance their formal means-ends efficiency” but as a result of cultural practices guided by legitimacy concerns (Hall & Taylor, 1996, pp. 946-947). Pierson (2007, p. 319) observes that sociologists “have marshaled considerable empirical material casting doubt on the validity of assuming that institutional designers, as a rule, are motivated exclusively or even predominantly by instrumental concerns”. Thus, sociological institutionalism emphasises the “cultural-cognitive” (Scott, 2008, p. 74) basis of institutions, which are seen to be steeped in cultural values, beliefs, and ideas.
Culture in comparative capitalism
In spite of its important role in institutional design, serious consideration of culture is surprisingly missing from the ‘varieties of capitalism’ literature. Bruff (2008, p. 2) criticises the literature for eschewing the cultural roots of institutions and insists that “varieties of capitalism can be analysed adequately only with recourse to a discussion of culture”. However, the relatively slim attention given to culture in VoC is not due to a lack of recognition that culture plays an important role in capitalist divergence. On the contrary, Hall and Soskice (2001, p. 13; emphasis added) acknowledge the “role that culture can play in the strategic interactions of the political economy”. Specifically, they recognise that culture, understood as “shared understandings…rooted in a sense of what it is appropriate to do in [different] circumstances”, leads social actors to choose a particular institutional design from various possibilities or multiple equilibria (p. 13). In this sense, they recognise that culture, at least partly, explains institutional differences between advanced political economies. However, in
89 the main thrust of their analysis, they revert to the ‘rational choice’ view that existing institutional differences between advanced capitalist nations, rather than being shaped by cultural differences, are explained by efficiency-based ‘institutional complementarities’ and the resulting ‘comparative institutional advantages’.
There are nevertheless influential works in the wider comparative capitalism literature that have more to say about the role of culture in institutional design than the VoC approach. An example is the “social systems of production” approach of Hollingsworth and Boyer (1997, p. 2; emphasis added) who argue that within “social systems of production” (capitalist political economies),
…institutions, organizations, and social values tend to cohere with each other…While each of these components has some autonomy and may have some goals that are contradictory to the goals of other institutions with which it is integrated, an institutional logic in each society leads institutions to coalesce into a complex social configuration. This occurs because the institutions are embedded in a culture in which their logics are symbolically grounded.
Hence, Hollingsworth and Boyer (1997) see culture as shaping the ‘institutional logics’ behind the institutional frameworks of advanced capitalist nations. Despite the importance they give to culture, Hollingsworth and Boyer (1997) do not, however, specify cultural values and beliefs in their main theoretical framework that could be used to differentiate advanced capitalist nations – their framework still largely remains at the level of institutions.
Ronald Dore (1987, 1997, 2000, 2001) is one of the few prominent scholars in the comparative capitalism field who points to specific cultural values, beliefs, and dispositions in explaining capitalist divergence. Dore (1997, p. 27), however, deliberately eschews the term ‘culture’ – which he says scholars of comparative capitalism “fear” – and “speak[s] of ‘behavioural dispositions’” that he is careful to qualify as “central tendencies” rather than universal cultural traits. He identifies three ‘behavioural dispositions’ that distinguish the Japanese from the ‘Anglo-Saxons’. He observes, firstly, that “Anglo-Saxons behave in ways designed to keep their options open” whereas “Japanese are much more willing to foreclose their options by making long-term commitments” (p. 28). He then identifies another difference between the two that he says, “[p]ut starkly…is a difference in the selfishness/altruism dimension” (p. 29). The third characteristic that differentiates the two cultures, he argues, is that the Japanese have more of a “productivist ethic” than ‘Anglo-Saxons’, who are, unlike the average Japanese, comfortable with the idea of financial speculation for wealth creation. He provides empirical observations to support the distinct ‘behavioural dispositions’ and notes that “Anglo-Saxon
90 capitalism and Japanese capitalism are different systems, with different integrating principles [institutional logics]” (p. 30). Importantly, he associates such differences in ‘behavioural dispositions’ between the Japanese and the ‘Anlgo-Saxons’ with both differences in the consideration of stakeholder interests (especially the interests of workers) in corporate decision-making and disparities in the time horizon of corporate strategy – i.e., short-term- orientation versus long-term-orientation (see Dore, 1987; Dore, 2000).
There are, of course, also works in the broader literature (e.g., the ‘cross-cultural psychology’ literature) that differentiate nations by cultural values like the widely-cited work of Hofstede (2001), who identifies five ‘cultural dimensions’ including those directly relevant to short- termism like ‘short-term orientation versus long-term orientation’, ‘individualism versus collectivism’, and ‘power distance explain this’. Hofstede (2001, p. 34; emphasis added) argues that such cultural values tend to be stable and durable and that their “stability can be explained from the reinforcement of culture patterns by institutions that themselves are the products of the dominant cultural value systems”. Several empirical studies have linked such ‘cultural dimensions’ to national differences in corporate governance practices (see Aguilera & Jackson, 2010). Schwartz (2007), who is another influential scholar in the ‘cross-cultural psychology’ literature, has shown how cultural values are directly relevant to ‘varieties of capitalism’, providing evidence that LMEs and CMEs are associated with different cultural values (see also Trompenaars, 1993).
Cultural power
One major work on capitalist diversity that not only specifies cultural variables but also addresses the relationship between culture and power (‘authority relations’) is that of Whitley (1999). Culture and power are rarely considered together in the comparative capitalism literature or even the sociological institutionalism literature – which is based on a cultural approach but has been critiqued for overlooking power relations (Fiss, 2008; Hall & Taylor, 1996). Whitley (1999, p. 51) sees “norms governing trust and authority relations” as “crucial” in that “[v]ariations in these conventions result in significant differences in the governance structures of firms…and prevalent patterns [institutional logics] of work organization, control, and employment”. He then distinguishes between “different types of business system” based on the level of “[t]rust in formal institutions” and the presence of one of “paternalist authority”, “communitarian authority”, or “contractarian authority” (p. 60). He sees, for example, ‘paternalist’ authority shaping the business systems of China and Japan, ‘communitarian’
91 authority shaping the systems of Scandinavia and continental Europe, and ‘contractarian’ (formal-contract-based) authority shaping the system of ‘Anglo-Saxon’ countries. The important implication of this is that culture also shapes power relations (see also Hamilton & Biggart, 2001). Culture shapes perceptions around what is an acceptable or appropriate level of inequality – in both power relations and material outcomes. For example, Anglo-American liberalism is more likely to construe inequality as an acceptable – or even inevitable – outcome of ‘liberty’ (perhaps even necessary for progress), whereas German corporatism or Scandinavian egalitarianism would make inequality less acceptable, mobilising institutions to correct for such unacceptable levels of inequality (Amable, 2003; Lehmbruch, 2005). On the other hand, Japanese paternalism would entail a greater acceptance of inequality in power relations but relatively less acceptance of inequality in material outcomes (Dore, 1987; Yamamura, 1997).
Culture prescribes power relations between particular roles in society. For example, the Confucian doctrine, which is widely followed in Japan, specifies four hierarchical relationships in society based on duty, loyalty, and paternalism: lord and subject, father and son, husband and wife, and elder and younger sibling (Dore, 1987; Morishima, 1984). Similarly, the ‘property rights’ view in Anglo-America (and the West generally) could be said to imply a hierarchical relationship between ‘property holder’ (i.e., ‘owner’ of the means of production) and worker with its contemporary offshoots – the ‘shareholder sovereignty’ view and ‘agency theory’ – implying hierarchical relationships between the shareholder on one hand and the manager and workers on the other (Araki, 2009; Moore, 1993). Indeed, given the relative lack of acceptance of the ‘shareholder sovereignty’ view and ‘agency theory’ in Germany and Japan, for example, there is little acceptance of a hierarchical relationship between shareholders on one hand and managers and workers on the other in these CMEs (see Ahmadjian & Okumura, 2011; Dore, 2000; Fiss & Zajac, 2004; Lehmbruch, 2005; Streeck & Yamamura, 2018). Thus, the power relations between shareholders, managers, and workers in public firms are partly shaped by cultural values and beliefs (about ‘authority relations’ and equality). In this sense, cultural values and beliefs themselves can be sources of power and may, in some cases, counter other forms of power (i.e., formal and structural power).
Besides the implications of pre-existing culture on power relations, dominant groups also promote certain values and beliefs (ideas) – including traditional cultural values and beliefs – that reinforce their dominance through various means. Such promoted values and beliefs can imbue such dominant groups with ‘cultural power’ – on top of structural power and formal
92 power (see above) – if they become widely accepted and internalised. Lukes (2004, p. 13) conceives of cultural power as “internal constraints” and argues that “[t]hose subject to it are led to acquire beliefs and form desires that result in their consenting or adapting to being dominated, in coercive and non-coercive settings”. Antonio Gramsci’s famous concept of ‘hegemony’ further encapsulates this type of power (Morton, 2007). Gramsci postulates that:
The masses…are confined within the boundaries of the dominant world-view, a divergent, loosely adjusted patchwork of ideas and outlooks, which, despite its heterogeneity, unambiguously serves the interests of the powerful, by mystifying power relations, by justifying various forms of sacrifice and deprivation, by inducing fatalism and passivity, and by narrowing mental horizons…The reigning ideology moulds desires, values and expectations in a way that stabilizes an inegalitarian system. (Femia, 1981, pp. 44-45)
Such cultural power of capital (deriving from the ‘dominant world-view’), which encourages workers to accept that the interests of capital are in their own interest, enables capital to counteract the structural power of workers in democratic politics to a degree. This kind of power has also been described as “symbolic violence” by Pierre Bourdieu (the influential French social theorist), whereby prevailing ideas that tend to inequitably tilt distributional outcomes in favour of the dominant class are deceptive “instruments of domination” (Swartz, 1997, p. 82).
Gramsci further observes that the cultural power of capital permeates wider society because capital often controls “‘civil society’, the ensemble of educational, religious, and associational institutions”, which shape the society-wide ‘dominant world-view’ (Femia, 1981, p. 24). Moreover, cultural power of capital is often augmented by its ability (courtesy of its superior resources) to directly influence political parties through political donations, lobbying, and other avenues of influence – i.e., through ‘regulatory capture’ (Dal Bó, 2006). Relatedly, as Culpepper (2010) points out, the perceived ‘expertise’ of managers and corporate lobbyists also gives them a form of cultural power, whereby they are invited to give their input on policymaking and legislative processes, enabling them to influence laws and regulations. Bourdieu conceives of such expertise and credentials as ‘cultural capital’ – which he sees as a source of power in his cultural-political approach (Swartz, 1997).
Workers also possess cultural power in certain political economies. The cultural belief (and national identity) of ‘social market economy’ in Germany, for example, gives a degree of cultural power to labour, which, in turn, legitimises ‘co-determination’ laws – i.e., their cultural power supports their formal power (Haselbach, 1997; Kinderman, 2005; Lehmbruch, 2005).
93 Similarly, the ideology of the ‘enterprise community’ in Japan and the attendant paternalistic values among ‘insider’ managers and boards gives Japanese workers in large public firms a kind of cultural power, which partly compensates for their relative lack of formal and structural power when it comes to employment protection and benefits (Araki, 2009; Gotoh & Sinclair, 2017; Inagami, 2009).
All in all, cultural values and beliefs shape institutional logics by defining the social legitimacy of the distributional ends that institutional logics are based on. In other words, distributional ends (including the distribution of power) that are in line with common cultural values and beliefs held by stakeholders will be considered legitimate – and thus be more likely to be adopted by firms – while distributional ends that defy such values and beliefs are less likely to be adopted. For example, the stakeholders of US firms are likely to accept as legitimate the distributional end (institutional logic) of ‘shareholder value maximisation’ as they are imbued with the cultural values of ‘individualism’ and ‘achievement orientation’ (Kasser, Cohn, Kanner, & Ryan, 2007; Schwartz, 2007). In contrast, stakeholders of Japanese firms are likely to question the legitimacy of ‘shareholder value maximisation’ due to their communitarian cultural values while being more likely to be comfortable with ‘productivist’ logics that prioritise the health of the firm – which they see as their ‘community’ (Dore, 2000; Schwartz, 2007).
Cultural explanations of institutional design, however, are generally not sufficient explanations on their own (just like power relations). Upon reviewing different approaches to explaining organisational practices in different nations, Hamilton and Biggart (2001, p. 469) argue that “cultural arguments seize on such general, omnipresent value patterns as to make it difficult to account for historical and societal variations occurring within the same cultural area”. Nevertheless, for Hamilton and Biggart (2001, p. 460), who still think of culture as an important factor in institutional design, this overgeneralisation problem can be overcome by considering culture alongside power relations – a “political economy” approach that, for them, provides the “best explanation” of comparative institutional differences (p. 445). This goes beyond the aforementioned ‘cultural power’ in that while the concept of ‘cultural power’ has to do with how culture influences power relations, we are talking here about how culture and power together shape firm behaviour. To better understand capitalist divergence, we need to look at how power relations and culture interdependently shape institutional logics – and thus firm behaviour – through the field-specific ‘dominant business ideology’.
94 Before I elaborate on the combined effect of power and culture, however, let me point out that my approach aims to overcome the analytical problems of cultural determinism and overgeneralisation by (1) treating culture as an external constraint (or enabler) that influences action through social legitimacy and (2) by recognising that cultural effects depend on the situation – i.e., the extent of a cultural effect depends on other factors like power relations, structural conditions, and functional considerations. The need to overcome determinism and overgeneralisation in cultural analysis cannot be emphasised enough as these hurdles have arguably often led to the abandonment of cultural analyses in favour of rational and historical analyses in the social sciences over the past few decades; though culture is making a comeback (Abdelal et al., 2015; Phillips & Reus-Smit, 2020).
Culture as external and situational
Firstly, a ‘background’ approach to culture is necessitated by the “‘loose coupling’ between culture and action” (Swidler, 1986, p. 280). As a social actor is an amalgam of personal traits, general human traits, and cultural traits, it is scientifically impossible to separate out the effect of culture on action when we conceptualise the effect of culture as coming internally from social actors (cf. Scott, 2008; Scott & Meyer, 1994). For example, it is analytically problematic to say that the internal cultural value of collectivism leads Japanese managers to protect employment as saying so implies overgeneralisation and cultural determinism. Some Japanese managers may actually be individualistic. Also, it is difficult to assess the motivations of individuals as they may be influenced by a variety of motivations. It is thus more fruitful to view cultural values and beliefs as external or “objectivated” constraints on social actors, with social legitimacy providing the incentive to follow cultural values and beliefs in social action (see P. L. Berger & Luckmann, 1991, p. 78). Construing cultural influences as external constraints minimises the confounding effects of personal values and beliefs while still capturing the (internal) cultural part of individuals – as the objectivation of (national) cultural values is after all the externalisation of the (internal) cultural part of the individuals of a society (Zucker, 1977). Thus, it would be more appropriate to say that the (external) cultural value of collectivism encourages Japanese managers to protect employment rather than saying that their (internal) cultural value of collectivism shapes their actions (of employment protection).
Furthermore, even though such ‘objectivated’ culture can act as an external constraint on individual decisions and actions, it is not necessarily imposed by any particular actor (P. L.
95 Berger & Luckmann, 1991). Searle (2010, p. 155) calls the force behind such externalised cultural constraints “background power” (or, interchangeably, “network power”) – in the sense that “society can exercise power over its members” – and equates such cultural constraints with “what is regarded as appropriate…or permissible” by society. Thus, the presence of any particular enforcers (other social actors) is not required for culture to influence action. Conceptualising culture as external societal constraints in this way overcomes overgeneralisation and cultural determinism in analysing the behaviour of social actors (e.g., managers) as external constraints can potentially be defied and often tend to be defied by a minority of nonconforming individuals.
Cultural effects are also situational. The degree of influence of cultural values and beliefs on action depends on power relations, structural and material conditions, and the task at hand. Practices that do not carry a high degree of (cultural) legitimacy can still exist, even for a considerable period of time, if (1) the social actor has a lot of power or (2) culturally appropriate practices are too (materially) costly or (3) the associated task calls for such practices (e.g., necessary ‘dirty work’). For example, it might not be possible for struggling businesses to uphold communitarian or consensual values to the same extent as comfortably profitable businesses both because of their structural condition (low profit margins in the context of high competition) and because of their economic function (i.e., their raison d'être is economic after all). Moreover, businesses where power relations too strongly favour shareholders are less likely to uphold collectivist values to the same extent as businesses where power relations are more equal, regardless of culture. Indeed, when shareholders dominated in pre-war Japan, Japanese firms were significantly less generous to their employees than they are now, although they were still more generous than similar American firms of the time because of the long-standing culture of paternalism (Gordon, 1988; Moriguchi, 2000; Tabb, 1995; Yamamura, 1997). In this way, conceptualising cultural effects as situational – i.e., constrained by other factors like power relations, material conditions, and functional considerations – overcomes the problem of overgeneralisation in cultural analysis identified by Hamilton and Biggart (2001).
I would like to conclude this section on culture by briefly discussing cultural change. As I argued earlier, power relations are relatively durable, but they can nevertheless be suddenly transformed by both historical upheavals (e.g., crises) and gradual structural change (e.g., globalisation). In this sense, power relations are more immediately dependent on institutions, which means that ‘off-path’ institutional change can have immediate repercussions for power
96 relations. This is because power relations are in some senses external to the individual in that they depend on social enforcement – except for culturally-prescribed inequality and authority relations between social roles (i.e., only a type of cultural power). By contrast, culture exists simultaneously both in externalised, objectivated, and ‘reified’ form and in socialised, internalised, and habitualised form in the individual as well, these two forms of culture being mutually-dependent (P. L. Berger & Luckmann, 1991; Giddens, 1984). Therefore, cultural values and beliefs tend to be particularly resilient during sudden historical transitions (e.g., crisis and revolution) and also relatively resilient during more gradual structural change (e.g., industrialisation), evolving with such changes without losing their essence (Hofstede, 2001; Westney, 2013). Inglehart and Baker (2000, p. 49) show through a comprehensive global study that national cultural values and beliefs tend to evolve with economic development – becoming more secular, rational, tolerant, post-materialistic, spiritual (in a non-religious sense), and happiness-oriented – but that the “influence of traditional value systems is unlikely to disappear, however, as belief systems exhibit remarkable durability and resilience”. Traditional values and belief systems, they show, shape cultural evolution in a path-dependent manner such that the imprint of traditional national values on contemporary national culture is unmistakeable:
A history of Protestant or Orthodox or Islamic or Confucian traditions gives rise to cultural zones with distinctive value systems that persist after controlling for the effects of economic development. Economic development tends to push societies in a common direction, but rather than converging, they seem to move on parallel trajectories shaped by their cultural heritages. We doubt that the forces of modernization will produce a homogenized world culture in the foreseeable future. (Inglehart & Baker, 2000, p. 49)
They also find that, as far as cultural clusters are concerned, national cultural values are significantly more resilient and visible than sub-cultures (e.g., religious sub-cultures) within a nation, highlighting the mutually-reinforcing relationship between national institutional frameworks (including both formal and informal institutions) and national cultural values (see also Hofstede, 2001).
Dominant ideology as the expression of power relations and culture An important starting point for the construction of a political-cultural framework is to recognise that firms operate in an ‘organisational field’ – the business field – that has its own institutional logics (see DiMaggio & Powell, 1983; Fligstein, 2001; Hamilton & Biggart, 2001; Swartz, 1997). Given the economic function of the business field, its goals, processes,
97 authority relations, and theories (ideas) are bound to be different from say the educational field, the health field, the kinship field, the government field, or the non-profit organisational field – i.e., the institutional logics of the business field will be different from other fields (Pache & Santos, 2013). Thornton (2004, p. 2) defines institutional logics as “the axial principles of organization and action [reflected in] cultural discourses and material practices prevalent in different institutional or societal sectors”. The institutional logics of a field is shaped by the overarching ideology of the field, which specifies – explicitly or implicitly – the purpose of the field and the general approach to attaining that purpose (Thornton et al., 2012). Just as the overarching ideology of the educational field will concern matters such as the purpose of education and what pedagogical approach is considered appropriate for that purpose, the overarching ideology of the business field will concern the purpose of business and how best to achieve that purpose (P. L. Berger & Luckmann, 1991). Thus, the overarching ideology of a field (e.g., business) defines the ends that are to be attained through institutions – the means. Institutional logics connect the ends and the means by shaping institutions according to the ideology. In this sense, institutional logics are both embodied in institutions and represent the overarching ideology. As Thornton et al. (2012, p. 149) put it, “institutional logics while embodied in material practices are also symbolic constructions that guide the production and reproduction of institutional practices”.
There, however, rarely exists unanimity among the various participants in a field when it comes to defining the purpose of a field and methods to achieve that purpose because of divergent interests (Swartz, 1997). There tend to be multiple ideas and discourses competing to become the dominant ideology of the field (Lehmbruch, 2005). Different actors vie to advance their ideology to the position of dominance because, as Swidler (1986, p. 280) notes, “an ideology serves interests through its potential to construct and regulate patterns of conduct”. In this competition of ideologies, the most powerful and resourceful actors, of course, usually establish the dominant ideology in the field so as to be able to advance their interests – whatever they may be. In his detailed “cultural-political” analysis of the evolution of financialisation and ‘shareholder value orientation’ in the US, Fligstein (2001, p. 15) observes: “Fields…contain collective actors who try to produce a system of domination in that space. To do so requires the production of a local culture [dominant ideology] that defines local social relations between actors”. The ideology of ‘shareholder value orientation’ that dominates in Anglo-American capitalism, for example, “has a fundamentally political dimension, as it contains normative beliefs about the distribution of power in a corporation
98 and in society” (2010, p. 1241). As Hamilton and Biggart (2001, pp. 460-461) note, such “principles of domination [dominant ideologies]…provide guides, justifications, and interpretive frameworks for social actors in the daily conduct of organizational activity” that ultimately tilt the distributional outcomes in favour of the dominant actors. Dominant ideologies are, therefore, a product of power relations that both guide (through institutional logics) and justify institutional design.
Dominant ideologies are, however, more than a crude and blatant expression of power relations – as might be construed by materialist or simple structuralist explanations (Abdelal et al., 2015). As emphasised by sociological institutionalists, social legitimacy (justification) is crucial in institutional design (see above). Dominant ideologies ultimately have to be justified and explained by reference to wider cultural values and beliefs, especially in a democracy (P. L. Berger & Luckmann, 1991; DiMaggio & Powell, 1983). Fligstein (2001, p. 168), when addressing the ‘shareholder value’ ideology in the context of capitalist divergence, observes that the “social world provides the intellectual justification for a certain view of the corporation [dominant ideology], and different actors use that view to justify acting in terms of that view”. In this sense, “field-level [institutional] logics are shaped by, but distinct from, the [cultural] logics of the interinstitutional system” (Thornton et al., 2012, p. 148). In their seminal work28 on the ‘sociology of knowledge’, Peter Berger and Thomas Luckmann (1966/1991, pp. 201-204) detail this process, explaining how there are different levels of legitimation for institutional design, with the wider culture (‘symbolic universe’) providing the final level of legitimation – on top of the legitimation furnished by the field- specific dominant ideology:
Symbolic universes [national cultures] constitute the [final] level of legitimation. These are bodies of theoretical tradition that integrate different provinces of meaning and encompass the institutional order in a symbolic totality…Now, however, all the sectors [fields] of the institutional order are integrated in an all-embracing frame of reference, which now constitutes a universe in the literal sense of the word, because all human experience can now be conceived of as taking place within it… All the lesser legitimating theories [field-specific ideologies] are viewed as special perspectives on phenomena that are aspects of this world.
Therefore, an ideology of the business field needs to make sense as a ‘special perspective’ of wider culture and cannot be divorced from general cultural beliefs and values if it is to last.
28 The concept of ‘fields’ actually derives from the work of P. L. Berger and Luckmann (1991) and was first used by DiMaggio and Powell (1983) in their own seminal work, using the term ‘organisational fields’.
99 This does not mean that there is a deterministic relationship between ideology and wider culture; rather, it is a matter of compatibility between the ideology and wider ‘cultural background’ – as discussed above. The extent to which an ideology becomes dominant and how long it can maintain such dominance will depend partly on how compatible it is with wider cultural values and beliefs. In other words, deeper cultural values and beliefs need to be treated as “secondary factors” that indirectly influence institutional design and behaviour by supplying legitimacy to field-specific dominant ideologies, which, in turn, directly influence institutional design and behaviour (Hamilton & Biggart, 2001, p. 460). As Swidler (1986, pp. 273, 279) has shown, while there is only a “loose coupling” between behaviour and deeper cultural values and beliefs (which she puts under “tradition” and “common sense”), “explicit ideologies directly govern action”. Nevertheless, “ideological movements are not complete cultures, in the sense that much of their taken-for-granted understanding of the world and many of their daily practices still depend on traditional patterns [i.e., deeper cultural values, beliefs, and habits]”. In sum, field-specific dominant ideologies reflect power relations and rely on wider culture both for stability – i.e., through legitimacy – and for their tacit assumptions. Moreover, dominant ideology has a more direct relationship with power whereas its relationship with wider culture is more subtle but just as important.
The effects of external influence and structural conditions
External influence and structural conditions are other important influences on dominant ideology. Firstly, in regard to external influences, international ideas and trends exert pressures on (state-level) dominant ideologies to change towards a ‘global standard’, especially in today’s hyper-globalised world (Carr & Harris, 2004; Djelic & Quack, 2008; J. W. Meyer, Boli, Thomas, & Ramirez, 1997). The ‘global standard’ itself, of course, tends to be a reflection of international power relations – i.e., the Anglo-American model (Djelic, 2001; Dore, 2009). However, unless international influences change local power relations, it is unlikely that foreign ideas and practices are going to be adopted if they are not already compatible or can be made compatible with existing institutional logics, not only because they would face stiff resistance from dominant local players but also because they would lack legitimacy (both cognitive and normative) and would disrupt existing ‘institutional complementarities’ (S. Berger, 1996; Hall & Thelen, 2009). It could thus be said that international ideas and trends may be used to update that part of the ideology that concerns the approach (method of attaining ends) – in the hope of making it more effective at attaining the prescribed ends – without altering the ends themselves, which form the core of the
100 ideology. For example, Japan has long faced international pressures to comply with ‘global standards’ of corporate governance (Inagami, 2009). However Japanese public firms have been selective in adopting global standards and the powerful employer association, ‘Keidanren’, has successfully resisted many proposed changes along American lines (Culpepper, 2010; Vogel, 2018a). They chose to adopt parts of the ‘global standard’ – like international accounting standards – that were largely compatible with the dominant ideology and did not significantly alter the traditional model (Araki, 2009). At the same time, adoption of ideologically incompatible parts of the ‘global standard’ was limited in Japan (Araki, 2009). For example, most firms did not adopt a system of ‘outsider’ directors to represent shareholder interests despite strong pressures as it was seen as being incompatible with the ‘employee-favouring’ and consensus-based approach of Japanese firms and the high level of discretion that Japanese managers generally enjoy (Ahmadjian & Okumura, 2011; Buchanan & Deakin, 2009). Most firms that did adopt it did it in a way that did not significantly impact the usual manner of business – e.g., they picked ‘outsider’ directors who they knew were likely to go along with insider boards (Araki, 2009; Inagami, 2009). Indeed, German public firms have also followed a similar pattern of adapting international trends and practices in ways that made them compatible with their existing dominant ideology and institutional logics (Börsch, 2007; Jürgens, Naumann, & Rupp, 2000). For example, despite intense pressures from investors and politicians alike to adopt Anglo-American ‘shareholder value’ ideology, German firms adopted it mostly symbolically (superficially) and largely in areas (e.g., transparency and investor relations) that had minimal impact on existing institutional logics (see Börsch, 2007; Faust, 2012; Fiss & Zajac, 2004). Therefore, while international influences are relevant, their impact depends on their compatibility with power relations, culture, dominant ideology, and existing institutional arrangements (Hall & Thelen, 2009; Hollingsworth & Boyer, 1997).
Structural conditions also influence the dominant ideology by both presenting opportunities and limiting possibilities (Swidler, 1986; Thornton et al., 2012). This is similar to how structural conditions limit the relevance and applicability of culture, as discussed above. For example, an ideology of ‘enterprise community’ that favours employees through ‘lifetime employment’ is not feasible in a highly competitive laissez faire atmosphere where firms have low profit margins and the vicissitudes of the market demand flexibility for survival – indeed, this was the case in Japan before WWI (Gordon, 1988). In sum, the dominant ideology in any variety of capitalism depends on power relations and wider culture, is
101 constrained by structural conditions, and selectively feeds off of international trends in a way that updates its approach without necessarily altering its ends – unless these factors impact power relations.
The role of the state
Although the business field may not be ideologically identical to the state given its field- specific functions, theories, discourses, and authority relations, it nevertheless falls under the jurisdiction of the state (Friedland & Alford, 1991; Steinmetz, 2018; Thornton et al., 2012). The state is an actor that can perform an integrating role that brings institutional design in the business field more in line with wider cultural expectations – especially in democracies (Polanyi, 1957). The state can do so through laws, regulations, and policies (formal institutions) that constrain institutional design in the business field. Therefore, although I have so far characterised the institutional setting of (public) firms as one coherent set of institutions with a single underlying institutional logic, it makes more sense to analytically separate it into two sets of institutions with somewhat different logics: (1) institutional practices of the business field and (2) state-enforced formal institutions (laws and regulations). The former would be based on the dominant ideology of the business field while the latter would more or less reflect dominant ideology at the state level, which too would be rooted in – but not determined by – wider culture (Friedland & Alford, 1991; Steinmetz, 2018). Like the dominant business ideology, the dominant economic ideology of the state would be based on state-level power relations, wider culture, functional considerations (which would be different from business), structural possibilities, and external influences. Politics can change frequently in democracies and thus the dominant economic ideology of the government and the influence of difference interest groups can also change frequently, resulting in a collection of laws, regulations, and policies (formal institutions) that are a hodgepodge of different logics based on divergent ideologies. Importantly, this distinction in ideology and thus institutional logics between state-level formal institutions and firm-level institutional practices means that there can be ‘gaps’ between (formal) institutions and corresponding firm-level practices, as highlighted by Streeck and Thelen (2005). Such gaps between state-based formal institutions and their corresponding firm-level practices can exist because of (1) weak enforcement and loopholes, (2) ambiguity and vagueness in the writing of laws and regulations allowing for multiple interpretations and thus ‘wiggle room’, (3) time lag between legislation and application, and (4) frequent changes to laws and regulations prompted by changing power relations at the state level or changing circumstances (Araki,
102 2009; Hall & Thelen, 2009; Helmke & Levitsky, 2004; Jackson, 2005a; La Porta, Lopez-de- Silanes, Shleifer, & Vishny, 2000; Streeck & Thelen, 2005). At the same time, despite the presence of many factors that can create and maintain gaps between formal institutions and firm-level institutional practices, formal institutions can change firm-level practices in the business field if they are able to change firm-level power relations in a way that would alter the dominant business ideology and thus the institutional logics at the firm level. As aforementioned, laws and regulations can directly confer power on certain groups, or they can constrain structural power. Thus, the key mechanism through which formal institutions influence firm-level practices and even the dominant business ideology is through their effects on the distribution of power at the firm (or field) level. Besides this mechanism of influence, formal institutions can also indirectly influence firms by regulating structures that are linked to firms – e.g., by regulating the stock market. It is important to remember though that only formal institutions that are able to change the institutional logics of firm-level institutional practices by changing power relations either directly or indirectly can influence distributional outcomes in firms in any meaningful way. This is because firms can maintain existing distributional outcomes through other means even if laws and regulations alter specific firm-level practices. For example, I find that UK public firms still maintain high levels of shareholder payout despite strong regulations on share buybacks as they are still able to pay high dividends, whereas US public firms do so largely through share buybacks given lax regulations on buybacks in the US (I present this finding in Chapter 5). Besides changes to power relations, the changes in firm-level institutional practices instigated by such formal institutional changes that bring new opportunities or threats are likely to be limited to changes in means without changes to the prevailing institutional logics (ends) – i.e., dominant business ideology.
Conceptual framework Drawing on the arguments and discussions in this chapter and the last, I now present the conceptual model of the forces shaping the distributional outcomes (extent of short-termism) in public firms in different varieties of capitalism – see Figure 3.1. I will briefly summarise my arguments from this chapter and the last, which will help delineate the conceptual model. Firstly, the structural features of the stock market exert pressures on firms to maximise short- term shareholder value, but the institutional settings of public firms moderate this pressure. Formal institutions like laws and regulations can directly modify the structural features of the stock market (e.g., by restricting hostile takeovers or by requiring quarterly reporting) or
103 influence firm-level corporate governance (e.g., shareholder rights, requirement for ‘outside’ directors, or employee codetermination). Institutional practices can also moderate stock market pressures (e.g., through share-based managerial pay, finance-oriented decision- making, insider or outsider boards, insider or outsider managers, cross-shareholding, collective bargaining, etc.).
National culture
State-level power Firm-level power relations relations
External Dominant economic Dominant business Structural influences ideology ideology conditions
State-level formal Firm-level
institutions institutional practices
The institutional setting of firms
Stock market Distributional outcomes
pressures (extent of short-termism)
Figure 3.1. Factors shaping distributional outcomes (short-termism) in public firms.
Formal institutions derive from the dominant economic ideology at the state level – which depends on the governing party and the power of different interests (e.g., labour, capital, foreign investors, etc.). Formal institutions are legitimated by the wider culture and are often based on prevalent cultural values and beliefs. Certain formal institutions (e.g., certain corporate governance institutions) can also derive from global ‘best practice’ institutions but such ‘best practice’ institutions tend to be adopted only if they are compatible with national
104 culture and the existing institutional framework or if they can be made compatible through modifications; otherwise, such global practices will only be instituted superficially if they are adopted at all – e.g., if there are strong international pressures to adopt them. Formal institutions influence the institutional logics of firm-level institutions (practices) largely through their impact on firm-level power relations. Besides their impact on firm-level power relations, the more direct effect of formal institutions on firm-level practices (e.g., share buyback regulations) would be limited to a change in means without a corresponding change in ends (logics) and thus would have little impact on distributional outcomes (e.g., shareholder payout). Importantly, formal institutions are not always effective in changing firm-level institutions and practices because of weak enforcement, loopholes, ambiguity and vagueness, and time lags.
Firm-level institutional practices derive from the dominant ideology of the business field that represents the field’s institutional logics. The dominant business ideology specifies – explicitly or implicitly – both the purpose of business (end) and the general approach to attaining that purpose (means), with institutions being its task-specific manifestations. Therefore, distributional outcomes like short-termism (excessive shareholder payout) ultimately depend on the dominant business ideology. The dominant business ideology reflects, firstly, power relations at the firm level. Such power relations are shaped by formal institutions (e.g., corporate governance laws), structural conditions (e.g., globalisation), and cultural values and beliefs. The dominant business ideology is also rooted in wider (national) culture, which provides it with legitimacy and basic (tacit) assumptions. It is further constrained by structural conditions, which determine what is possible and what is not.
Institutional change is also intrinsic to this conceptual framework. Institutions change when (1) they are no longer perceived to be effective in attaining the ends prescribed by the dominant ideology, (2) when power relations change due to structural or (state-level) political change, resulting in changes in ends (and thus in the dominant ideology), and (3) when their normative legitimacy is eroded by changes in cultural values and beliefs – which tend to be slow to change because of constant reinforcement by a myriad of institutions, norms, and habits. In other words, while convergence between different varieties of capitalism is theoretically possible, it is highly unlikely because, even if power relations become more similar, cultural differences are likely to persist (Dore, Lazonick, & O'Sullivan, 1999).
The next chapter is the beginning of the empirical section and it will elaborate the method for the empirical study. The following two chapters will be specific country comparisons, where I
105 will utilise the framework developed here to explain empirical differences in shareholder payout and real investment between public firms in different nations – i.e., why Anglo- American public firms are more short-termist than German and Japanese public firms. The conceptual framework helps explain why there are national differences in distributional outcomes in public firms – particularly, shareholder payout, which is my main measure of short-termism. In other words, I will point to institutional, ideological, political, and cultural differences between the different varieties of capitalism to explain differences in distributional outcomes (shareholder payout). I will also explain how these different factors might affect real investment – which is one of many indicators of short-termism (but does not indicate short- termism by itself, as I will elaborate). Specifically, in Chapter 5, I will describe the institutional, political, and cultural differences between German and Anglo-American capitalism to help explain empirical differences in shareholder payout and real investment between German public firms and (matched) US and UK public firms. In Chapter 6, I will do the same for Japan, comparing it with the US, the UK, and Germany.
106 Chapter 4 Method for Empirical Study
The purpose of my empirical study is to (1) confirm that stock-market-based short-termism depends on institutions – with these, in turn, shaped by power relations and culture; (2) to confirm the validity of the ‘varieties of capitalism’ thesis for public firms – that public firms in different ‘varieties of capitalism’ can be notably divergent in their behaviours and thus outcomes; and (3) to examine whether CMEs are converging towards LMEs by examining firm-level outcomes – particularly shareholder payouts (dividends and share buybacks) – that indicate convergence in firm behaviour. Besides serving to test my argument from Chapter 2 that short-termism in publicly-listed firms depends on institutions, the empirical study also contributes important evidence to the literature. There is, in fact, a paucity of this kind of empirical research in all the three literatures that study corporate short-termism: the short- termism literature in finance and economics, the financialisation literature, and the comparative capitalism literature. Comparative empirical research comparing public firm behaviour in different nations using (large-N) firm-level data is lacking in the business and finance literature on short-termism as well as the financialisation literature. The comparative capitalism literature has many empirical studies that undertake national comparisons, of course, but they mostly rely on anecdotal evidence, institutional comparison, and macro-level data; there is a lack – and a great need – of comparative studies using large samples and firm- level data.
In fact, quantitative empirical analyses based on matched public firms – which reveal the effects of institutional differences by controlling for structural differences – are lacking in both the comparative capitalism literature and the financialisation literature. Such a study would truly be a valuable addition to both these literatures. In fact, the findings of this study provide valuable firm-level (large-N) evidence for issues that are at the heart of all three literatures. For the finance and economics literature on short-termism, it confirms whether it is crucial to consider institutional (and, by extension, ideological, political, and cultural) factors in examining short-termism. The study also reveals whether the financialisation literature can continue to downplay national differences or whether such differences are an important part of the financialisation narrative (at least as far as ‘control financialisation’ in
107 non-financial corporations is concerned)29. Finally, the study not only tests the very foundation of the comparative capitalism literature by examining to what extent institutions matter (when it comes to short-termism) but also provides crucial clarification regarding whether CMEs are converging towards LMEs as a result of the liberalisation of formal institutions.
Specifically, I compare shareholder payout and real investment in matched public firms in Germany, Japan, the US, and the UK. I operationalise shareholder payout as the combination of (yearly) dividends and share buybacks. For real investment, I use two measures: (1) growth in gross property, plant, and equipment (PPE) and (2) capital expenditure (I explain this in greater detail later). I firstly construct matched samples by matching public firms from one country with public firms from another country by size (total assets) and industry (GICS 8-digit code). This important matching technique enables me to compare ‘apples to apples’, which is important given the structural differences (in firm size and industry composition) between different countries. I additionally control for investment opportunities (using sales growth as a proxy measure) and profitability, which further ensures that the findings reflect the impact of institutional differences rather than structural (and economic) disparities. Since matching only allows me to compare two countries at a time, I firstly compare German public firms to matched US and to matched UK public firms (in Chapter 5) and then compare Japanese public firms to matched US, UK, and German public firms (in Chapter 6).
This chapter details the method of the empirical study. Findings are presented in the next two chapters. This chapter is structured as follows: I first define short-termism, recognising that it can be a subjective and vague concept as demonstrated by its varied conceptualisation in different literatures. I then explain my choice of countries for this comparative empirical study while also explicating why I will treat the US and the UK as one Anglo-American model in my discussions even though I compare them separately with Germany and Japan in the empirical study. I then briefly discuss the structural and economic context for this study and how it might provide the background for the interpretation of the findings (I control for some important structural and economic factors in the empirical study but not all). Next, I turn to the methods used for the empirical study: I describe data collection, accounting practices in the different countries, sample selection, measures used for variables, considerations regarding cross-country comparisons of value and inflation, and the important
29 See Deeg (2012).
108 matching procedure I use in comparing public firms in different countries. I conclude by briefly outlining what I will do in the two empirical (country-comparison) chapters that follow.
Defining and operationalising short-termism I define short-termism essentially as relatively high shareholder payout, which can potentially come at the expense of the long-term health of the firm – i.e., at the expense of real investment, employment, and worker training.30 Different literatures have conceptualised short-termism in somewhat different ways (explicitly or implicitly). Scholars in the finance and economics literature usually define short-termism as ‘under-investment’ (in terms of real investment), often without including shareholder payout in either the definition or the operationalisation of ‘short-termism’ (see Asker et al., 2015; Graham et al., 2006; Haldane, 2015; Porter, 1991). There are nevertheless some studies in this literature that treat high shareholder payout as a potential cause of ‘under-investment’ among other potential causes (e.g., Gruber & Kamin, 2017; Gutiérrez & Philippon, 2016). The financialisation literature (on non-financial corporations) does not always use the term ‘short-termism’, with the term ‘financialisation’ (or more precisely ‘control financialisation’) itself implying short-termism in many cases, which scholars conceptualise largely in terms of high shareholder payout and financial investment by non-financial corporations (Lazonick, 2014; Orhangazi, 2008; Soener, 2015).31 Some studies like Orhangazi (2008) include both shareholder payout and real investment (in addition to financial investment) in their study of financialisation and examine if high shareholder payout has ‘crowded out’ real investment, finding this to be the case for the US (for the period 1973-2003) – although, the conclusion is tentative as the author notes that establishing a direct link between shareholder payout and real investment is difficult for several reasons (e.g., as debt is an alternative source of funds). The comparative capitalism literature suggests that short-termism largely results from ‘dispersed shareholders’ or ‘impatient capital’ in the stock market and its version of short-termism invariably involves a focus on short-term ‘shareholder value’, with LMEs like the US and the UK being associated with short-termism and CMEs like Germany and Japan with stakeholder- orientation and firm growth (Amable, 2003; Dore, 2000; Hall & Soskice, 2001; Whitley,
30 Employment, wages, and worker training are not part of the empirical comparison, however, given the difficulty of obtaining firm-level data for these variables. I do nevertheless refer to secondary sources to discuss these variables where relevant in the empirical chapters that follow. 31 Many of the studies on financialisation that study shareholder payout (‘control financialisation’) also study financial investment (‘profit financialisation’) by firms as part of the larger financialisation phenomenon (Deeg, 2012).
109 1999). Shareholder value is not always linked to real investment in this literature’s conceptualisation of short-termism, however. As far as real investment is concerned, the focus is on the type of real investment rather than on ‘under-investment’ as such (Amable, 2003; Hall & Soskice, 2001; Hollingsworth, 1997). For example, Hollingsworth (1997) notes that US firms tend to invest in labour-replacing ‘specialist’ technology suited to mass production strategies whereas German and Japanese firms tend to invest in labour-enhancing ‘generalist’ technology appropriate for quality-oriented and diversified production strategies. Similarly, Hall and Soskice (2001) point out that CMEs like Germany and Japan tend to focus on ‘continuous innovation’ whereas LMEs like the US and the UK focus on ‘radical innovation’.
My conceptualisation and operationalisation of short-termism, therefore, essentially as relatively high shareholder payout, is closer to the comparative capitalism literature and the financialisation literature than the finance and economics literature. More specifically, I treat shareholder payout as the central variable when it comes to short-termism, with real investment representing an important but not central variable because relatively low real investment might not always indicate short-termism (as limited funds might be used to protect employment during a downturn, for example) but relatively high shareholder payout can be said to always represent short-termism as it involves a reduction of available funds without any direct long-term benefit to the firm. In other words, while relatively low real investment might simply indicate alternative long-term-oriented uses of limited funds like investment in employees or the creation of cash reserves to guard against future uncertainty, high shareholder payout always comes at the expense of the long-term health of the firm through reductions in one or more of: (1) real investment, (2) long-term-oriented business acquisitions, (3) protection of valued employees, (4) hiring of skilled workers and worker training, or (5) reserves to guard against insolvency during economic shocks and downturns. As far as the relationship between shareholder payout and real investment is concerned, I thus see the two variables as only loosely related (inversely), whereby low (high) shareholder payout is only somewhat likely to result in high (low) real investment as there are many other long-term-oriented uses of (limited) funds as well (cf. Gruber & Kamin, 2017). In the case of relatively low shareholder payout (i.e., low short-termism), how retained profits are utilised by firms would also depend on the context, with periods of economic slowdown or high uncertainty – which applies to all the countries for most of the period studied here (2005- 2017) – more likely to be accompanied by the prioritisation of employment protection and
110 the maintenance of cash reserves rather than the prioritisation of real investment. Given the tentative link between shareholder payout and real investment, I will not directly analyse the relationship between the two variables (which is difficult to do in a quantitative study anyway). Instead, I will present findings relating to the two variables separately and discuss them largely separately in the upcoming empirical chapters. Rather than just focus on shareholder payout, the reasons I am also including real investment in my analyses are: (1) real investment has been used as the sole measure of short-termism in the finance and economics literature, (2) it is a crucial variable in any form of capitalism as it has major macro-level and micro-level implications for economic dynamism, productivity, growth, and innovation, and (3) it serves to confirm whether there is any clear and tight relationship between real investment and shareholder payout (based on a simple analysis of the directional relationship of the two variables). On this last point, my findings do confirm that the relationship between shareholder payout and real investment is weak at best because (1) despite substantially higher shareholder payout than German public firms, US and UK public firms have about equal levels of real investment overall and (2) real investment in Japanese public firms is significantly lower than in US and UK (as well as German) public firms despite much lower shareholder payout.
My conceptualisation of real investment is thus also more in line with the comparative capitalism literature. This literature displays a more nuanced understanding of real investment that is more empirically-grounded than the short-termism literature in finance and economics, where real investment is treated more simplistically and theoretically. This nuanced view of real investment also recognises that some types of real investment are more long-term-oriented than others. For example, Hollingsworth (1997) points out that real investment in US public firms tends to be labour-replacing and aimed at maximising short- term profits whereas real investment in Germany and Japan are more labour-enhancing and aimed at long-term firm growth. Relatedly, US public firms tend to focus on relatively expensive business acquisitions given their comparative lack of skilled labour and German and Japanese firms tend to focus on internal real investment given their availability (and even slack) of skilled labour (see also Amable, 2003). Moreover, compared to their German and Japanese counterparts, US managers of public firms also tend to be more impatient with the performance of different product lines, with relatively frequent divestments in product lines accompanied by relative frequent business acquisitions (Carr & Tomkins, 1998; Jacoby, 2005). US firms also tend to use higher ‘hurdle rates’ for real investment and prioritise real
111 investments with short ‘payback periods’ (Carr & Tomkins, 1998; Segelod, 2000). In other words, US public firms tend to be more short-term-oriented in their real investment strategies. However, such differences in real investment strategies are difficult to discern from financial data obtained from financial reports of firms (the kind of data I use). I do use two different measures of real investment and this does allow us to get a sense of differences between firms when it comes to a focus on business acquisitions versus a focus on internal real investment – as ‘growth in gross PPE’ includes business acquisitions while ‘capital expenditure’ does not. However, besides such basic differences, it is not possible to see the more nuanced differences mentioned above with a large-N quantitative study such as this and thus it is difficult to tell whether real investment is more short-term or long-term oriented. Therefore, even when the real investment spending of a firm is short-term-oriented compared to another firm, this would not be captured by the data in financial reports (e.g., capital expenditure or growth in fixed assets). This is all the more reason to be cautious in linking real investment (or lack thereof) to short-termism. Nevertheless, lack of real investment is a potential indicator of short-termism – although only in some cases and not in others. If shareholder payout is relatively high while real investment is relatively low, then this can be taken as a stronger indication of short-termism than a case where shareholder payout is relatively high but real investment is also relatively high. In this sense, my findings indicate that US and UK public firms are not as short-termist as the financialisation literature suggests because even though their shareholder payout is relatively high (especially US firms), their real investment is still on par with German and higher than Japanese public firms. At the same time, as shown in Chapter 1, this is likely due to cheap debt in the post-GFC period, which has enabled US firms in particular to avoid having to make the choice between shareholder payout and real investment (as they can borrow cheaply to spend on shareholder payout without compromising real investment). UK public firms have taken on less debt than US public firms (as per the financial data from Osiris) and this perhaps also explains why shareholder payout is lower in UK public firms compared to US public firms; although it is still significantly higher than German and Japanese public firms (as we will see in the following chapters). Whether US public firms would choose shareholder payout or real investment if forced to make that choice by higher cost of capital remains to be seen. Hall and Soskice (2001), among others, suggest that US and UK firms are unlikely to compromise short-term shareholder value and so real investment might be the one sacrificed when they are forced to choose (see also Graham et al., 2006; Jackson & Deeg, 2006).
112 Choice of countries I will be comparing publicly-listed non-financial corporations in Germany, Japan, the US, and the UK using firm-level financial data. I have chosen to study these particular countries because: (1) the US is the archetypical LME with power relations strongly favouring dispersed shareholders, a non-interventionist state, and an ‘individualistic’ culture; and it can be used as a baseline for short-termism – as per Asker et al. (2015) (also see previous chapters); (2) The UK is a relevant case not only because it can also be used as a benchmark for short-termism following the empirical findings of Haldane (2015) but also because it shared its economic environment (being in the same EU economic region) with Germany during the study period (2005-2017), minimising structural differences when comparing their public firms; moreover, the UK is a somewhat different LME given the influence of the EU on its formal institutions (even after Brexit due to ‘path-dependence’) like stronger regulations on share buybacks and given that it is perhaps a less extreme case of market- orientation than the US as indicated by higher levels of social welfare and a significantly smaller stock market (Bell & Hindmoor, 2015; Kim, Schremper, & Varaiya, 2005; Konzelmann et al., 2012); (3) Germany is considered to be the archetypical CME with state- enforced formal institutions playing a key role in the maintenance of non-market institutions and with labour both legally and structurally strong (through strong sector-based unions) (Goyer, 2011; Hall & Soskice, 2001); and (4) Japan is a notably different type of CME than Germany as its non-market institutions are maintained more by culture than by formal institutions and workers tend to have less formal and structural power (especially in terms of union power) but still benefit from favourable cultural values and business ideology (Araki, 2009; Dore, 2000; Jackson, 2005b; Pontusson, 2005). Therefore, the choice of countries covers a range of different varieties of capitalism while still remaining parsimonious for detailed analysis of the extent of short-termism in their public firms.
The US and the UK as one Anglo-American model
Although I separate US public firms and UK public firms in empirical comparisons with German and Japanese public firms and present separate findings for US and UK public firms, I nevertheless treat the US and the UK as one common model (the ‘Anglo-American’ system) in my discussions in the empirical chapters, while still pointing out differences between the two countries where relevant. I believe their treatment as one (Anglo-American) model is appropriate here as public firms in both countries have been shown to be short-termist by
113 Asker et al. (2015) and Haldane (2015) respective – making both countries benchmarks for short-termism. Indeed, this is also in line with how these two political economies are treated in the comparative capitalism literature: The US and the UK are rarely distinguished in the comparative capitalism literature and tend to be treated almost as one and the same, even being used interchangeably in comparison with the likes of Germany and Japan (e.g., Amable, 2003; Dore, 2000; Gospel & Pendleton, 2003; Hall & Soskice, 2001; Hollingsworth & Boyer, 1997; Whitley, 1999). For example, Amable (2003, p. 20) finds that while LMEs, as a group, are already “highly homogenous” when it comes to political-economic institutions, the US and the UK, as a pair, are even more so. The institutional settings of US and UK public firms have been quite similar since at least the 1980s, when the neoliberal revolution and the ‘shareholder revolution’ transpired almost concurrently in both countries (Bell & Hindmoor, 2015; Fligstein, 2001; Konzelmann et al., 2012; Stockhammer, 2004). Moreover, there has been no meaningful political-economic institutional change since the 1980s that has deviated from the prevailing shareholder-oriented and market-based institutional logics in either country; thus, they continue to be similar (Baccaro & Howell, 2017; Bell & Hindmoor, 2015; Konzelmann et al., 2012; Mallin, 2011). In the key institutional areas concerning short-termism – stock market regulations, corporate governance, institutional investor characteristics, managerial pay, management techniques, and labour relations – the US and the UK are thus virtually indistinguishable, with minor exceptions (see Amable, 2003; Carr & Tomkins, 1998; Culpepper, 2010; Fernandes et al., 2013; Frege & Kelly, 2013; Hall & Gingerich, 2009). Whatever differences exist between the two generally pale in comparison to their common differences with arguably any other country, including others in the Anglosphere like Australia and Canada (Bell & Hindmoor, 2015; Konzelmann et al., 2012). The UK’s involvement with the EU has had some impact on these institutional similarities, perhaps the most relevant being differences in share buyback regulations and the fact that the UK now uses the international IFRS accounting system while the US uses the US-GAAP, which is a not a large difference though as I will elaborate later (Forgeas, 2008; Kim et al., 2005). Nevertheless, they remain very similar when it comes to the key characteristics of ‘shareholder value orientation’ in public firms, the use of markets for coordination by public firms, and the level of liberalisation in the economy (Bell & Hindmoor, 2015; Hall & Gingerich, 2009; Hughes, 2014).
114 The structural and economic context
The structural and economic context cannot be ignored in a period of unusual structural conditions that were not only historically anomalous but also geographically varied (even though investment opportunities have been technically controlled for in the main analyses). The period between 2005 and 2017 – the period analysed by this study – contained (1) the deep recession of 2008 that affected countries differently, (2) the Euro crisis that most strongly affected Germany and the UK, (3) a long deflationary period in Japan that is unique in the modern period, (4) a vote for Brexit in the UK that, among other things, had an instant and massive effect on the market exchange rates of the British pound and the Euro, and (5) a post-GFC environment of historically loose monetary policy where interest rates were so low for so long that public firms – at least in the US – were borrowing funds for shareholder payouts (Baldwin & Teulings, 2014; Bell & Hindmoor, 2015; Lei & Zhang, 2016; OECD, 2018a). Furthermore, if all advanced economies have indeed been witnessing ‘secular stagnation’ (long-term anaemic growth) as a result of structural and demographic changes – as many prominent macroeconomists suggest – then real investment might have been suppressed in all economies, and particularly in ones where public firms tend to be more risk- averse and stability-oriented like in Germany and Japan (see Baldwin & Teulings, 2014; Summers, 2015). Even though I control for investment opportunities with the proxy measure of sales growth when comparing firms (see below), this measure is after all a backward- looking (historical) measure of investment opportunities that does not necessarily reflect future uncertainties associated with wider economic and structural conditions. Of course, future uncertainty plays an important role in real investment decisions – especially large long-term investment decisions that may include moving into new product lines. This is also particularly likely to affect firms that are more risk-averse. As German and Japanese public firms are generally considered to be more stability-oriented (risk-averse) and more interested in large long-term investments in new product lines than Anglo-American public firms (with Anglo-American firms focussing more on ‘core competence’), future uncertainty may thus have affected real investment in German and Japanese public firms more than in Anglo- American public firms (Börsch, 2007; Jackson, 2005b; Vogel, 2006). Moreover, the availability of cheap debt, which enables firms to bypass the trade-off between shareholder payout and real investment, may have encouraged higher real investment in Anglo-American public firms than would otherwise be the case (in periods of more ‘normal’ interest rates). Indeed, cheap debt may also have enabled Anglo-American public firms in particular to make
115 higher shareholder payouts than would otherwise be the case – given their focus on ‘shareholder value maximisation’ (Lazonick, 2017).
Sample and data I use firm-level financial data for thirteen consecutive years (panel data for 2005-2017) from a comprehensive international database of public firms – the Osiris database of Bureau van Dijk – to operationalise real investment and shareholder payout. Bureau van Dijk is a comprehensive database of global companies and financial market information that is widely used and is considered one of the most reliable sources of firm-level financial data, especially in a global context. It is a part of Moody’s (since 2017). I conduct cross-sectional analyses from the panel data using firm-year (i.e., yearly figure for a given variable for each firm) as the unit of analysis to test for differences in short-termism between different varieties of capitalism over the whole period analysed – 2005 to 2017. In addition, to assess convergence, I analyse longitudinal (time-series) data from 2005 to 2017, using the firm as the unit of analysis. I chose 2005 as the starting point for two main reasons: (1) data for key variables like shareholder payout and capital expenditure (real investment) were missing in the Osiris database for a significant number of non-US firms before 2005 (especially for Germany, which had relatively few public firms to begin with) and (2) the accounting standards for public firms in the different countries studied had become harmonised for all countries (and had completely converged for Germany and the UK by 2005), enabling the reliable comparison of financial data.
In regard to accounting standards, European public firms were required to adopt the International Financial Reporting Standards (IFRS) by 2005 (PricewaterhouseCoopers, 2009). Japanese public firms can now choose between the Japanese GAAP, IFRS, and the US GAAP (GAAP stands for Generally Accepted Accounting Principles). Before 2011, Japanese public firms largely used the Japanese GAAP, which was already ‘equivalent to IFRS’ by 2004 (IASB, 2004). US public firms use the US GAAP. There has been a major concerted effort by the respective accounting boards – FASB and IASB – to ‘converge’ the US GAAP and the IFRS since 2002 while ‘harmonisation’ efforts had been going on since the 1960s (FASB, n.d.; Forgeas, 2008). Among the minor differences that remained by 2005 between the different accounting standards (e.g., the expensing or capitalising of R&D into intangible assets and the potentially different treatment of asset impairment), I have avoided using such items in this study. In any case, given that I am only making judgments of difference between
116 varieties of capitalism based on clear and consistent differences (rather than small differences) that are robust across a number of different analyses and variables, any differences in accounting standards are likely to have only negligible effects on the findings of this study.
Regarding sample selection, I first selected all public firms from Germany, Japan, the US, and the UK from the Bureau van Dijk database and subsequently filtered them according to the following criteria: (1) only firms that were listed before 2004 so as to keep a consistent panel structure; (2) only non-financial firms and firms not in the real estate or utilities sector (the utilities sector can have a large government presence); (3) only firms that did not have missing data for key variables – real investment, shareholder payout, total assets, and operating revenue – for more than one year (if only one year out of the 11 years has missing data, then it is filled in by the previous year’s value)32; and (4) only firms that did not display extreme fluctuations in total assets (greater than 300 percent growth in a year or 150 percent growth in multiple years). I followed Schwellnus and Arnold (2008) and Asker et al. (2015) in making these decisions on sample selection. From of 11, 429 non-financial publicly-listed firms from Germany, Japan, the US, and the UK contained in the Bureau van Dijk database, there are 3,807 firms in the final sample. The final sample for each country is shown along with the findings in the empirical chapters that follow.
Measures One way to ensure greater harmonisation in cross-country comparisons is to compare ratios and growth rates as opposed to actual values – which is why comparative studies tend to use ratios for their main analyses (e.g., Asker et al., 2015; Faccio, 2010; Gal, 2013; Michaely & Roberts, 2012; Schwellnus & Arnold, 2008). Therefore, most of the empirical analyses I perform use ratios and growth rates. For real investment, I utilise two variables: (1) annual changes in gross property plant, and equipment (gross PPE) and (2) capital expenditure33. The capital expenditure measure only captures within-firm additions to PPE while gross PPE
32 The filling-in of missing values with previous year’s value was done for well below 1 percent of all the data points for the key variables in the full sample. This is unlikely to have impacted the results overall not only because so few data points were replaced but also because the flat annual growth rate for the filled-in year is balanced out by the change in the following year. 33 Capital expenditure data (called ‘additions to fixed assets’ for non-US firms in the Osiris database) is missing for a large enough number of non-US firms (especially German and UK firms) until around 2007 (by which time even most non-US firms have such data); therefore, analyses based on capital expenditure only start from 2007. The reason that data is missing seems to be that capital expenditure data comes from the statement of cash flows, the reporting of which was less standardised and available than the balance sheet and the income statement before the mid-2000s. Bureau van Dijk states in its user guide that the statement of cash flows have been harmonised and made consistent between countries.
117 growth also captures changes in assets from acquisitions. Asker et al. (2015) observe that both measures need to be taken into account as the approach to real investment may differ by size and industry. Both measures of real investment are scaled by total assets – as proxy for size. Findings on real investment presented in the following chapters are robust to using different variables for real investment – net PPE and fixed assets (including intangibles). For shareholder payout, I combine annual dividends and share repurchases34 (buybacks) – although I do examine dividends and share buybacks separately in some analyses (which I will specify). I also scale shareholder payout (dividends plus share buybacks) by total assets when comparing public firms. The proxy I use for investment opportunities is annual growth in operating revenue – as in Asker et al. (2015) and Michaely and Roberts (2012), who note that it is a widely used and well-established measure of investment opportunities in the literature. Moreover, I utilise the return-on-assets (ROA) ratio as a proxy for profitability (ROA is also a widely-used measure for this purpose) both to control for profitability in regression analyses and to test for sensitivity of shareholder payout to profitability (cf. Asker et al., 2015). I construct ROA in the standard manner as net income by the average of total assets (i.e., the average of beginning-of-year and end-of-year total assets).
Measures in common currency values
Although I mostly use the aforementioned ratios and growth rates in my main analyses of real investment and shareholder payout (short-termism), comparing values for individual variables in a common currency (US$) can nevertheless be instructive – especially when used alongside comparisons of ratio and growth (cf. Faccio, 2010). Comparing individual values (US$) is arguably the ‘purest’ way to compare variables – i.e., without transforming variables with either other variables (in the case of ratios) or its own previous values (in the case of
34 Just like for the capital expenditure data that also comes from the statement of cash flows, share buyback data becomes reliably available for all countries from 2007 (before this, data is missing for a large enough number of German and British firms). Therefore, analyses based on shareholder payout and share buybacks do not start until 2007 (except for analyses based on dividends as a separate variable – as this data is available for the whole period). In certain cases, I have filled in ‘0’ where there was missing data for share buybacks but data for capital expenditure existed, indicating that the statement of cash flows – where capex data is located – was accessed but no share buybacks were observed. Due to strict disclosure requirements for share buybacks – particularly in non-US countries – it is highly unlikely that share buybacks conducted would not be recorded in the statement of cash flows. Furthermore, a majority of public firms (usually smaller firms) – including US firms but especially non-US firms – do not conduct any share buybacks in most years; thus, missing value for share buybacks is a proxy for a lack of buybacks when other data from the statement of cash flows (like capital expenditure) has been recorded. Moreover, Bureau van Dijk indicates in its user guide for the Osiris database that share buyback data (unlike dividend data) are among those that they leave as missing when there is no value for that year in the relevant financial statement. The finding in this study that share buybacks are lower in CMEs than LMEs is consistent with strong anecdotal evidence which points to a widespread trend of share buybacks in LMEs (especially in the US) but a lack of such a trend in CMEs (Gruber & Kamin, 2017). It is also consistent with the fact that regulations are more stringent and disclosure requirements stronger for share buybacks in CMEs – which should act as deterrents against buybacks compared to the US (see Kim et al., 2005).
118 growth rates). US$ values can also reveal the base levels of variables (i.e., where the countries start out in 2005 in terms of total assets or PPE). Importantly, growth rates and ratios can hide certain relevant information: for example, even when the US$ value of one variable (e.g., capital expenditure) is consistently higher in firm A compared to firm B, the growth rate of that variable (capital expenditure growth) or its ratio with another variable (e.g., capital expenditure scaled by total assets) might be no different for the two firms (or even less for firm A) – as growth rates and ratios depend on the denominator (e.g., last year’s capital expenditure for growth rate and total assets for ratio). In this way, comparisons of US$ values can be instructive when done alongside comparisons of growth rates and ratios. Where I do compare values in US$, the findings need to be interpreted with caution, however, because averages of US$ values tend to be disproportionately influenced by size (thus they are more reflections of larger firms than smaller firms). Growth rates and ratios are therefore still preferred for the main analyses but comparing absolute values will help reveal some of the information lost in growth rates and ratios and thus help in the interpretation of the findings. To make the comparison of absolute values across countries more reliable, I convert local currencies using purchasing power parity (PPP) conversion rates to US$ amounts. Local currencies are converted using time-series PPP rates from the Penn World Table in constant 2011 US$ (see Feenstra, Inklaar, & Timmer, 2015).35 I use the output-side GDP deflator for the PPP – which takes into account producer prices. PPP rates are used because market exchange rates for currencies can have extreme fluctuations that are also based on currency-trading in financial markets and thus market-exchange-rate-converted amounts tend to be less representative of real prices than PPP rates (see Feenstra et al., 2015; OECD, 2012).
Controlling for inflation and outliers
It is also important to control for inflation for the scaled variables and growth rates that I use for the main variables – real investment, shareholder payout, operating revenue, and net income. Controlling for inflation (or deflation) is important as changes in nominal values may be mistaken for growth – especially for the real investment variable ‘growth in gross PPE’. Thus, I use real local currency values of the key variables for growth rates and ratios: I deflate local currency values for all years for the aforementioned key variables by the country-specific GDP deflator obtained from the World Bank database (using 2015 as the
35 PPP conversion rates were downloaded from ggdc.net/pwt.
119 base year for prices).36 There is also the issue of outliers – which can be problematic with ratios and growth rates derived from firm-level data because of sharp annual fluctuations in firm-level variables like real investment and shareholder payout, especially in smaller firms (Schwellnus & Arnold, 2008). Therefore, following Asker et al. (2015), I winsorise ratios and growth rates by 0.5 percent at both tails of the distribution.
Matching Matching firms in different countries (and varieties of capitalism) by industry and size before comparing them is necessary as the characteristics of the full sample of public firms – as a whole – varies substantially by country, making direct full-sample comparisons less meaningful (Austin, 2011; Michaely & Roberts, 2012).37 For example, export- and manufacturing-oriented firms make up a much larger proportion of public firms in Germany and Japan compared to the US and the UK. Also, in regard to number and size, not only are there more than five times as many public firms in the US and Japan as there are in Germany but the average public firm in Germany (in the full sample) is also considerably larger than the average public firm in the US and Japan, for example. Therefore, comparing the country averages of financial variables (such as real investment) of public firms in the full sample is not very meaningful when the average public firm in one country is notably distinct – e.g., in industry and size – from the average public firm in another country. Colloquially put, we would be ‘comparing apples to oranges’. It is well known that different industries have different real investment needs. Thus, for example, comparing average real investment between (unmatched) German public firms and US public firms would bias the result in favour of Germany simply because Germany has a substantially higher proportion of public firms in the manufacturing sector, which inherently has high real investment requirements. Moreover, small public firms might face different sets of opportunities and threats than large public firms – which are usually more active internationally and have greater public visibility – and thus may have different patterns of real investment and shareholder payout just by virtue of greater international exposure and public visibility (see Asker et al., 2015). Matching ensures that we are ‘comparing apples to apples’. Specifically, the matching
36 While some authors use industry-specific deflators (e.g., Gal, 2013; Schwellnus & Arnold, 2008), price indices at the most aggregated levels are often considered the most reliable. The Eurostat-OECD Methodological Manual on Purchasing Power Parities states that price indices “at the level of GDP are the most reliable with smaller error margins” (OECD, 2012, p. 35). The empirical study that perhaps most closely resembles this one (i.e., Asker et al., 2015) also uses the country-level GDP deflator. 37 The comparative analyses of short-termism among varieties of capitalism based on matched samples presented here (and in the following chapters) represent a novel empirical contribution to the literature on comparative capitalism as well as the literature on short-termism (as far as I am aware from my wide-ranging research).
120 procedure finds a match (similar firm) for a public firm in one country’s sample (e.g., Germany) in another country’s sample (e.g., the US).38 In the matching criteria used here, the two firms would be matched exactly by industry (the full 8-digit GICS industry code) and closely39 by size – as represented by total assets. I match firms at the start of the study period (2005) by their 2005 total assets and keep the same matched pairs for subsequent years, which keeps the sample structure intact for the entire study period (2005-2017). This is important as we are also interested in assessing convergence and differences over time. Moreover, I match without replacement (the same firm cannot be matched again) and thus my matched samples have an equal number of firms for both sides.40 These are my criteria for matching in the country-to-country matching of public firms in the empirical chapters that follow.
Following chapters In the next chapter, I delineate the institutional, ideological, political, and cultural differences between German public firms and Anglo-American public firms and present my empirical findings comparing German public firms to matched UK public firms and matched US public firms on shareholder payout and real investment. I present both cross-sectional findings (for the whole period of 2007 to 2017) and longitudinal findings (time-series analysis). Furthermore, I also discuss institutional change in Germany and assess whether German public firms are converging towards the Anglo-American model. In the following chapter, I do the same for Japan while also differentiating Japan from Germany and comparing Japanese public firms and German public firms in terms of shareholder payout and real investment.
38 Firms that cannot be matched – i.e., do not have similar firms in the other sample – are discarded for the matched analyses (they are retained in the full-sample analyses). Usually, most public firms in a sample tend to find a match in the other sample (given that the other sample has more public firms) with some firms that are peculiar to the sample discarded. Details and specifics of the matching procedure will be given in the relevant sections below and in the following chapters. 39 A calliper is used to match firms by total assets. The calliper is essentially a range within which the size of the matched firm must fall in relation to the size of the firm being matched. The calliper here is applied to the log of total assets. The exact calliper used will be specified in the relevant tables and figures in this chapter and the following chapters. 40 Here I diverge from Asker et al. (2015), who match by firm-year in multiple years for a number of firms and with replacement (matching multiple firm to one firm) – they are not concerned with trends and convergence matters.
121 Chapter 5 Comparing Germany and Anglo-America
Hall and Soskice (2001) arguably rest their entire ‘varieties of capitalism’ (VoC) thesis on the difference between the Anglo-American political economy (the US and the UK) and the German political economy – considered to be the exemplars for the ‘liberal market economy’ and the ‘coordinated market economy’ respectively. Further, the VoC thesis rests not only on the divergence between these exemplars at a particular point in time – i.e., when VoC was conceived – but also on their continuing divergence. Given the importance of this specific comparison to the ever-burgeoning VoC literature and to the wider comparative capitalism literature (see Chapter 3), the empirical comparison of Germany and Anglo-America serves as an appropriate starting point for the empirical country comparisons. Although the main claim of the VoC thesis concerns (national) innovation and specialisation,41 the assumption that Anglo-American firms (LMEs) are short-term-oriented while German firms (CMEs) are long-term-oriented nevertheless lies at the heart of the thesis – upon which the main claims are built.42 This important assumption of VoC and the wider comparative capitalism literature regarding the differences in short-termism between Anglo-America and Germany have rarely been put to an empirical test using ‘large-N’ firm-level data. In fact, the matched-sample analysis I present – where I compare German public firms with matched US and UK public firms (matched by industry and size) while controlling for structural factors like investment opportunities – tests the very foundation of VoC and comparative capitalism: the assumption that national institutions shape political-economic outcomes. In line with institutional theory, I have also argued in Chapter 2 that short-termism should depend on the (national) institutional setting of public firms rather than purely on stock market listing as institutions mediate the structural features of the stock market (like information asymmetry and the ownership-control separation) and shape the responses of firms to stock market pressures. The implication of this argument is that stock-market-listed (public) firms in institutionally
41 The claim is that LME firms are good at radical innovation and thus specialise in new high-tech industries whereas CME firms are good at continuous incremental innovation and specialise in pre-existing medium-tech industries. 42 Indeed, Hall and Soskice (2001) and other comparative political economists like Amable (2003) see financing and corporate governance – the sources of short-termism in LMEs and long-term-orientation in CMEs – as the central institutional sphere in the ‘institutional hierarchy’, around which the other institutional spheres of the political economy revolve (i.e., internal firm structure, worker training, inter-firm relations, and industrial relations).
122 divergent political economies like Germany and Anglo-America should display disparate levels of short-termism43.
In order to assess the extent of short-termism in German public firms, I use US and UK public firms as the ‘benchmarks’ for short-termism – based on Asker et al. (2015) and Haldane (2015), who show that public firms are indeed short-termist in the US and the UK respectively. I assess the extent of short-termism in German public firms by comparing real investment and shareholder payout (from 2005 to 2017) in (1) German public firms and matched US public firms and (2) German public firms and matched UK public firms. I match German firms to US and UK firms by industry and size: exactly by industry – same 8-digit GICS code – and closely by size44. Moreover, I also control for investment opportunities at the firm level.45 All this ensures that we are comparing ‘apples to apples’, which, in turn, allows a fairly pure test of the impact of institutional differences on firm behaviour by minimising the confounding effects of structural factors known to affect real investment and shareholder payout (Asker et al., 2015; Michaely & Roberts, 2012). I perform both cross- sectional (whole-period) analyses and longitudinal (time-series) analyses – to assess convergence – on the matched samples.
Overall, I find that German public firms are indeed less short-termist than both their American and British counterparts. They have also remained divergent over time. Importantly, German public firms diverge from US public firms and UK public firms in quite similar ways.46 This finding supports the aforementioned VoC thesis. Further, it validates my main argument in Chapter 2 that short-termism is a product of shareholder-oriented institutional settings rather than purely a consequence of stock market listing: i.e., institutions clearly moderate stock market pressures. The findings are also consistent with deeper national differences in power relations, culture, and ideology between the US, the UK, and Germany – as I will show.
43 I define short-termism as excessive shareholder payout by public firms at the expense of the long-term health of the firm – i.e., at the expense of real investment (as well as employment, worker training, etc). As there is no ‘objective’ measure of excessive shareholder payout and under-investment, short-termism is best operationalised by comparing firms – as Asker, Farre-Mensa, and Ljungqvist (2015) and Haldane (2015) have done (they compare real investment in public firms and private firms). 44 For both the Germany-US matched sample and the Germany-UK matched sample, I use a calliper of 0.5 of the log of 2005 total assets (in million US$) to match the firms closely on size. 45 I use sales growth (operating revenue growth) as the proxy for investment opportunities, as is common in the literature – based on evidence of the appropriateness of such a proxy (see Asker et al., 2015). 46 This also confirms that the minor accounting differences between the US-GAAP system used by US firms and the IFRS system used by German and UK firms did not impact the Germany-US comparison in any significant way (Forgeas, 2008).
123 In this chapter, I point to institutional, ideological, political, and cultural differences between Germany and Anglo-America to help explain: (1) why there is such a large disparity in short- termism (as measured by shareholder payout) between German and Anglo-American firms; (2) why there is no major difference between them in overall real investment; (3) why capital expenditure – which represents internal real investment – is (somewhat) higher in German firms than Anglo-American firms whereas growth in gross property, plant, and equipment (PPE) – which also includes business acquisitions – is somewhat higher in Anglo-American firms; (4) why German firms spend notably more on real investment than on shareholder payout while US firms actually spend (slightly) more on shareholder payout than on real investment (and UK firms spend only slightly more on real investment than on shareholder payout); and (5) why there has not been any noticeable convergence between German firms and Anglo-American firms despite the increasing internationalisation of financial markets and the extensive globalisation of product markets. All in all, this chapter shows that Anglo- American public firms remain substantially more shareholder-value-oriented in their behaviour (distributional outcomes) than German public firms, which is consistent with persisting national differences in dominant ideologies, culture, and (especially) power relations. Notwithstanding small differences in real investment, substantial disparities in shareholder payout indicate that Anglo-American public firms are more short-termist than German public firms. As I explained in the previous chapter, shareholder payout is a more appropriate and direct measure of short-termism than real investment because shareholder payout always comes at the expense of potential uses of funds that could improve the long- term health of the firm – whether that be real investment, research and development, hiring, employee training, or the maintenance of a reserve as buffer against future downturns. On the other hand, low real investment does not necessarily mean short-termism as the firm may instead be spending on research and development (R&D), on hiring skilled workers, or on employee training, or it may be acting cautiously due to future uncertainty. Also, there are different kinds of real investment, including those that are short-term-oriented and those that are necessitated by the lack of internal R&D and a lack of skilled workers (as I will discuss later). Such types of real investment are hardly indicators of long-term-orientation – in fact, just the opposite: they may represent the cost of being short-term-oriented in the first place (e.g., lack of R&D and lack of skilled workers). In short, shareholder payout is a much more straightforward measure of short-termism than real investment.
124 The rest of this chapter is structured as follows. First, I revisit themes from chapters 1 and 2 to briefly highlight the key proximate drivers of short-termism; but, unlike the foregoing chapters (which focus exclusively on the US), I specifically compare the Anglo-American system with the German system in regard to such drivers – namely, hostile takeovers and share-based managerial pay – with a focus on corporate managers: the main decision-makers in firms. This section elucidates how the ideology of ‘shareholder value maximisation’ is central to short-termism. I then utilise the theoretical framework developed in chapter 3 to look specifically at deeper cultural and political factors that make the German system inimical to ‘shareholder value orientation’ and conducive instead to ‘stakeholder’ orientation – compared to the Anglo-American system. After thusly having delineated the key elements of the stakeholder-oriented German system that make it divergent from the Anglo-American system, I look specifically at how this translates into disparities in (1) shareholder payout, including dividends and share buybacks, and (2) real investment, including capital expenditure and growth in gross PPE, and the gap between real investment and shareholder payout (at the firm-level). This is also where I present the cross-sectional findings on these particular measures. I then conclude the chapter by discussing institutional change in Germany and presenting longitudinal findings (in time-series graphs covering the period 2007 to 2017) that show a lack of convergence between German public firms and Anglo- American public firms, especially in terms of shareholder payout.
The proximate drivers of short-termism As elaborated in the first two chapters, the extent of short-termism in public firms depends on the interaction of the stock market and the broader institutional settings of public firms. When left unchecked, the stock market is capable of exerting intense short-termist pressures on public firms to maximise shareholder value – which can be attributed to the combination of its various structural features: dispersed shareholding, separation of ownership and control, information asymmetry, high liquidity, real-time price information, openness to takeovers, and intense competition47 among firms in the stock market (see chapter 2). Stock market investors are famously ‘impatient’ as they are usually portfolio investors interested solely in maximising their wealth – rather than being committed to a particular firm – and tend to jump ship when they perceive that a firm is not maximising short-term shareholder value compared
47 Unlike the product market where competition is limited by the specificity of the product or service, all firms compete on the same dimension in the stock market: shareholder returns. In this sense, competition is much more intense in the stock market.
125 to other firms in the stock market (Hughes, 2014). This ‘impatience’ is exacerbated by the fact that shareholding in modern capitalism is usually overseen by full-time fund managers and traders who assess their portfolios on a day-to-day basis in an effort to maximise its overall value (Barton et al., 2016; Gospel, Pendleton, & Vitols, 2014). Their incentive structures also strongly reward short-term performance (Kay, 2012). There is thus great pressure on public firms to constantly maximise shareholder value. Corporate managers of public firms strongly feel and respond to this intense pressure from the stock market when corporate governance is shareholder-oriented (see Segelod, 2000). The Anglo-American system, of course, is highly shareholder-oriented (Gospel & Pendleton, 2003; Hall & Soskice, 2001). In contrast, according to current conjecture in the literature, in stakeholder-oriented systems like those of Germany, corporate managers can largely ignore stock market pressures to maximise shareholder value and focus instead on firm growth and wider stakeholder interests – which generally goes against the principle of short-term shareholder value maximisation (Dore, 2000; Jackson, 2005b; Stockhammer, 2005).
Hostile takeovers and share-based managerial pay The shareholder-oriented Anglo-American corporate governance system has both deterrents and incentives to induce managers to focus on maximising shareholder value instead of firm growth and wider stakeholder interests. A key deterrent to straying from the principle of shareholder value is the unremitting threat of hostile takeovers – which is when ‘corporate raiders’ take a controlling stake in ‘undervalued’ firms against the wishes of management and replace existing managers with experts at extracting maximum shareholder value, often by downsizing (Lazonick & O'Sullivan, 2000; Useem, 1993). The institutional settings of Anglo-American public firms are conducive to hostile takeovers as shareholding tends to be dominated by dispersed shareholders – portfolio investors – who are not committed to the firm (i.e., are ‘outsiders’) and are thus more interested in boosting their portfolio value in the short-term than in resisting a hostile takeover of a firm by ‘corporate raiders’ – e.g., other firms, financial firms, and hedge funds (see chapters 1 and 2; Culpepper, 2010; Gospel et al., 2014). As this chapter shows, the German system is, in contrast, inimical to hostile takeovers not because of any particular law or regulation – minority shareholder rights in German are, in fact, nearly as strong as the US and the UK – but rather because of the typical characteristics of shareholding in German public firms (Culpepper, 2010; La Porta, Lopez- de-Silanes, Shleifer, & Vishny, 1998). Shareholding in German firms (1) tends to be highly concentrated; (2) consists of significant proportion of cross-shareholding by other firms for
126 strategic rather than profit-making reasons;48 (3) features institutional investors like German pension funds and insurance funds that are more strongly regulated to be long-term-oriented (unlike similar institutional investors in Anglo-America); and (4) involves less-regulated institutional investors like mutual funds that are usually part of a German bank with longer- term interest in the firm (Börsch, 2007; Fichtner, 2015). Taken together, these features of shareholding in German public firms give structural power to ‘insider’ blockholders who are committed to the firm. The most important of these features when it comes to preventing hostile takeovers is the presence of stable blockholders with high concentrations of share ownership (Börsch, 2007; Culpepper, 2010). This is also where the difference between German and Anglo-American public firms is most striking, with blockholders normally holding much larger proportions of shares in German public firms than in US or UK public firms – see Table 5.1. Many blockholders in German public firms tend to be founding families, whose shareholding tends to be very stable (Andres, 2008). The strong presence of ‘insider’ blockholders and long-term stable shareholders dissuades ‘corporate raiders’ (usually Anglo-American institutional investors) from launching a hostile takeover bid and discourages short-term-oriented portfolio investors in general from investing in German public firms, which reinforces stable shareholding – as Goyer (2011) has shown.49
Table 5.1. Average voting share of largest single shareholder and of stable shareholders (in 2004 and 2006 respectively). Source: Culpepper (2010)
Largest shareholder voting share Stable shareholders’ voting share
Germany 35% 45%
UK 10% 12%
USA 11% 8%
There is, of course, another important deterrent to hostile takeovers in Germany: the power of labour. The primary methods of extracting shareholder value from ‘undervalued’ firms used by ‘corporate raiders’ – downsizing, restructuring, and high shareholder payout – are likely to
48 Indeed, despite a major attempt by the Schroeder government to unravel cross-shareholding in Germany in the early 2000s by reducing capital tax on such shareholdings from 50 percent to 0 percent in order to encourage foreign investment and make the German economy more vibrant after the economic fallout from reunification, few firms sold their shares in partner firms, revealing that their interests were more strategic than financial (Börsch, 2007). 49 The two hostile takeovers that did take place in Germany involved firms – Mannesmann and Krupp – that were atypical of German public firms because of their dispersed shareholding (Börsch, 2007; Goyer, 2011).
127 meet strong resistance in the formal and structural power of labour, both within the firm (co- determination) and in the form of powerful labour unions that are not only adept at mobilising workers when needed (which is relatively rarely) but are also well-connected to politics and wider civil society (Bhankaraully, 2019; Börsch, 2007; Frege & Kelly, 2013; Hall & Soskice, 2001). Indeed, as Börsch (2007, p. 67) reports, the only two hostile takeovers since the 1990s in Germany – those of Thyssen by Krupp (which was more strategic than financial anyway) and of Mannesmann by Vodafone, which “provoked public outcry” while the “[p]olitical reactions from almost all quarters of the political spectrum…were also negative, including central government reactions”. It is, therefore, not surprising that hostile takeovers are much more common in the US and the UK than in Germany (Goyer, 2011). Culpepper (2010) reports that there were only 3 hostile takeovers completed (and 5 attempted) between 1990 and 2007 in Germany whereas the UK saw 45 hostile takeovers (97 attempted) and the US witnessed 55 hostile takeovers (162 attempted) in the same period.
Share-based managerial pay and managerial tenure
A key incentive in shareholder-oriented corporate governance systems for maximising shareholder value is managerial pay that is strongly tied to short-term shareholder value – which is seen as aligning the interest of the agent (the manager) with the interest of the principal (the shareholder) from the lens of ‘agency theory’ – a dominant and influential concept in academia, policymaking, and business circles in Anglo-America since 1970s (see Jensen & Meckling, 1976; Lazonick & O'Sullivan, 2000). On top of direct payments of shares, such managerial pay typically includes a large proportion of stock options – which incentivise managers to maximise shareholder value so that they can cash in their stock options after a sharp rise in shareholder value (Shin, 2013). Although there is no requirement to cash in the stock options in the short-term, a trend of shorter tenures and eroding employment security for managers in Anglo-American firms encourages them to adopt a myopic view (Jenter & Kanaan, 2015; Kay, 2012). Mizruchi and Marshall (2016, p. 153), for example, report “a decline in mean CEO tenure of between 24% and 30% between the early 1980s and the early 2000s” in the US. Moreover, Jenter and Kanaan (2015) find that there is a strong trend of CEOs being let go for reasons unrelated to their personal performance (e.g., wider market downturns) in the US.
In addition to managerial lay-offs, opportunities (and incentives) to switch firms are plentiful in Anglo-America, where the ‘market for managers’ is highly developed and active, whereas
128 such a market is relatively dormant in Germany – partly because highly active employer associations promote collaborative (rather than competitive) relationships between firms in Germany (Culpepper, 2010; Goyer, 2011). German managers thus tend to have comparatively long tenures and secure employment compared to their Anglo-American counterparts, usually staying in the same firm until retirement or further promotion to the top- most board in the same firm (Börsch, 2007). Glunk, Wilderom, and Ogilvie (1996) observe that, “[c]ompared with Anglo-Saxon managers, there is less job hopping and more firm loyalty among German managers…[and the] average tenure [of managers] in Germany is eight years, while it is only three in American firms”. Goyer (2011) reports that such managerial trends and cross-country differences between Anglo-America and Germany have been largely stable over time (see also Börsch, 2007). Such long and stable tenures of German managers combine with relatively low share-based pay to discourage (short-term) shareholder value maximisation. In fact, share-based pay of German managers constitutes, on average, a much smaller proportion of total managerial pay than that of Anglo-American managers. In an international comparison of CEO pay, Fernandes et al. (2013) find that payments in shares and stock options comprise only 10 percent of CEO pay in German public firms compared to 30 percent in UK public firms and 39 percent in US public firms (see Table 5.2).50
There are also other characteristics of German managers that that make them less inclined to maximise shareholder value. Firstly, they are more socially embedded in the firm compared to their Anglo-American counterparts. Their long tenures fosters closer relationships with workers, committed blockholders, and other stakeholders like suppliers and customers, which, in turn, makes them identify more with ‘insiders’ and stakeholders than with dispersed shareholders (Dore, 2000; Goyer, 2011; Roe, 2011). A vast majority of German managers are actually themselves ‘insiders’ – promoted from within the firm – and are likely to have spent more than five years in the same firm before attaining their position – see Table 5.3.
50 The actual realised gains on stock options are likely to be substantially higher than the estimated fair value of stock options that has likely been used by Fernandes et al. (2013), making the US and UK figure potentially much higher (Hopkins & Lazonick, 2016). Also, the high mean total pay of German CEOs compared to UK and US CEOs is likely explained by the fact that the average German public firm is significantly larger than the average UK public firm or the average US public firm – as per my firm-level data for 2006 (using total assets and operating revenue as proxies for size in the full samples).
129 Table 5.2. International comparison of the composition of CEO pay in 2006. Source: Fernandes, Ferreira, Matos, and Murphy (2013)
No. of CEOs Average total Bonuses & Shares & (public firms) pay (m US$) Base salary others stock options
Germany 106 3.6 39% 51% 10%
UK 561 2.9 42% 28% 30%
USA 1,648 5.5 28% 33% 39%
In addition to their social-embeddedness, German managers are also usually technically oriented rather than financially oriented (Glunk et al., 1996). They often have technical degrees (and many hold a PhD) in areas like chemistry, engineering, medicine, and physics (Dore, 2000; Goyer, 2011). In contrast, Anglo-American managers are more likely to have non-technical backgrounds like finance, business management, and marketing (Börsch, 2007; Goyer, 2011). Indeed, many studies have found that Anglo-American managers tend to focus on the financial aspects of the firm while German managers prioritise its non-financial aspects like product strategy, inter-firm collaboration, firm growth, and employment protection (see Carr & Tomkins, 1998; Culpepper, 2010; Glunk et al., 1996; Jürgens et al., 2000; Witt & Redding, 2011).
Table 5.3. Characteristics of German CEOs (n=34 for insider/outsider and firm tenure for both years; for educational background, n=41 for 1998 and n=38 for 2009). Source: Goyer (2011).
German CEOs 1998 2009
Insider 85% 82% Insider/Outsider Outsider 15% 18%
0-5 years 12% 26% Firm tenure before being CEO Over 5 years 88% 74%
These backgrounds and characteristics of German managers combine to instil a firm-centred and stakeholder-oriented view as opposed to a shareholder-oriented view. Surveys and interviews of German managers reveal their inclination to view the shareholder – especially the ‘outsider’ shareholder – not as the ‘principal’ with an exclusive claim to the firm (like
130 Anglo-American managers view them) but rather as a ‘first among equals’ with other stakeholders (particularly employees and creditors) also having a legitimate claim over the firm (see Börsch, 2007; Faust, 2012; Jürgens et al., 2000; Witt & Redding, 2009). In sum, stock market pressures, the constant threat of hostile takeovers, share-based managerial pay, and short tenures encourage managers of Anglo-American public firms to maximise short- term shareholder value; on the other hand, social-embeddedness, a technical (rather than financial) focus, and the reassuring presence of large ‘insider’ blockholders (to dissuade hostile takeovers) enable managers of German public firms to resist short-termist pressures from the stock market and prioritise firm growth and wider stakeholder interests.
The deeper roots of divergent approaches Besides the relative lack of the threat of hostile takeovers and the relative paucity of managerial institutions promoting shareholder value orientation, there are, of course, deeper roots to the stakeholder orientation of German managers. Whereas in the Anglo-American system the entire purpose of the public firm is to maximise shareholder value with whatever means necessary, in the German system – which Streeck and Yamamura (2018, p. 2) call the “German consensus economy” – the firm serves multiple purposes besides growing shareholder wealth: employment security, technical excellence, skill development (in partnership with the state, unions, and other firms), and the simultaneous advancement of the interests of other stakeholders including employees, creditors (banks), and customers (Börsch, 2007; Glunk et al., 1996; Jürgens et al., 2000; Streeck & Yamamura, 2018). In this sense, the German public firm is more expansive and socially embedded than its Anglo- American counterpart (Granovetter, 1985; Porter, 1991; Vogel, 2018b). Nonetheless, despite its multifaceted and inclusive nature, the German firm is still, first and foremost, a profit- seeking capitalist enterprise; or, put more aptly, a distinctly German expression of a capitalist enterprise that is highly effective at making and sustaining profit precisely because it happens to be long-term-oriented, consensual, and technically proficient due to its embeddedness in a particular kind of political and cultural context (Kinderman, 2005; Streeck, 1997, 2010). German capital (including the blockholder), like capital everywhere, is still interested in maximising its own financial interests, but, in the German political-economic system, it faces important constraints on short-term profit-maximisation: political constraints in the form of powerful labour and cultural constraints that may be summed up as the ideology/identity of the ‘social market economy’ (see Bruff, 2008; Hassel, 2015; Kinderman, 2005). The ideology/identity of the ‘social market economy’ may be considered the cultural root of the
131 dominant ideologies at both the state level and in the business field in Germany. The dominant ideology at the state level that is based on the broader cultural model of the ‘social market economy’ is that of ‘neo-corporatism’, where labour, capital, and the state engage in tripartite agreements – with the state usually consulting both unions and employer associations when crafting new laws and regulations (Streeck, 2005; Whitley, 2005). The dominant ideology at the state level may, of course, be a more conservative or progressive version of ‘neo-corporatism’ depending on the government of the day but the basic tenet of the ‘social market economy’ like corporatism, consensus, egalitarianism, and a strong state would be more or less maintained (Bonefeld, 2012; Kinderman, 2005). At the firm level, the dominant business ideology that is rooted in the broader cultural model of the ‘social market economy’ may be called ‘stakeholder orientation’ or, more specifically (to Germany), the ‘codetermined stakeholder model’ – given the strong ‘voice’ of labour in corporate decision- making that separates it from other stakeholder-oriented CMEs like Japan (Jackson, 2005b). I will now elaborate on this broader German ideology/identity of ‘social market economy’ and contrast it with its Anglo-American counterpart – the ‘free market’ economy – that is behind the dominant business ideology of ‘shareholder value orientation’ and the dominant economic ideology (at the state level) of economic liberalism (Amable, 2003; Kasser et al., 2007).
The German ideology/identity of the ‘social market economy’ ‘Social market economy’ refers to a political economy that “is both ‘social’ (fair/just) and a ‘[capitalist] market’” (Kinderman, 2005, p. 438). The ideology holds wide political appeal in Germany, where both “Left and Right…endorse the ‘social market economy’ from within their own normative vocabularies — much like an ‘overlapping consensus’” (Kinderman, 2005, p. 439). Indeed, the ideology has deep influence in politics and on policymaking. As Kinderman (2005, p. 438) remarks: “The prominence and currency of ‘social market economy’ discourse in Germany is astounding; it would be no exaggeration to say that it is hegemonic as far as economic and social policy is concerned”. This is because it is at once an ideology and a national identity. Haselbach (1997, p. 158) observes that “[t]he ‘social market economy’ constitutes in part West Germany’s self-consciousness; it forms the specific ‘identity’ of the West German people…The ‘social market economy’ constitute[s] the founding myth of West Germany”. It is, in fact, said to have its roots in the “Bismarckian welfare state” of the late nineteenth century – considered the first welfare state (Börsch, 2007; Hassel, 2015, p. 108; Seeleib-Kaiser, 2015). Moreover, “[t]he tale of the ‘‘social
132 market economy’ is referred to almost every day, somewhere in a German newspaper or political statement; it has become part of the national memory’” (Haselbach, 1997, p. 161).
This German ideology/identity of ‘social market economy’ has long been contrasted with Anglo-American capitalism, which is wedded to a divergent ideology (and identity) of the ‘free market’ (see Albert, 1993; Carr & Tomkins, 1998; Glunk et al., 1996; Harvey, 2007; Porter, 1991; Schonfield, 1965; Streeck, 1997). Despite numerous structural and institutional changes over the years, both these ideologies have maintained their grip on their respective political economies (Harvey, 2007; Haselbach, 1997; Hassel, 2015). Indeed, these two divergent but enduring ideologies/identities go hand-in-hand with deep-seated and stable cultural values and beliefs (D. Coates, 2005; Fligstein, 2001). Kasser et al. (2007, pp. 8-18), for example, show that Anglo-American ‘free market’ capitalism is linked to cultural values of “self-interest, financial success, and competition”, which, in turn, “oppose and potentially undermine people’s concern for…promoting the welfare of others in the broader community”. Schwartz (2007) confirms that the Anglo-American version of capitalism is indeed linked to such cultural values by examining correlations between specific cultural values (derived from his extensive cross-cultural research) and the ‘varieties of capitalism’ index developed by Hall and Gingerich (2004/2009) – where Germany ranks high in strategic coordination in both corporate governance and labour institutions whereas the US and the UK rank joint bottom on both measures (out of 20 advanced economies). He reports:
Compared with societies characterized by more strategic collaboration among actors [such as Germany], more competitive, market-driven societies [like the US and the UK] show a stronger cultural preference for self-assertive mastery of human and natural resources rather than relating harmoniously to them. More market-driven societies also show a relative preference for allocating roles and resources hierarchically and unequally as the way to motivate and elicit cooperative behaviour rather than cultivating their members’ understanding of mutual interests. Finally, the culture in these societies encourages individuals less to pursue their own ideas and intellectual directions independently. (Schwartz, 2007, p. 56)
Importantly, Schwartz (2007, p. 55) also finds that “Americans attribute less importance to Universalism…than all the other national groups [with the UK close behind the US]”. He defines ‘universalism’ as a “concern for the welfare of others in the broader community” (p. 55). In contrast, Germany’s score for ‘universalism’ is one of the highest: higher than the
133 UK, and much higher than the US. The same goes for ‘harmony’51, ‘egalitarianism’52, and ‘intellectual autonomy’53: Germany ranks high while the Anglo-American pair ranks low (see Schwartz, 2007, pp. 53-55). Taken together, Anglo-American cultural values of ‘self-interest, financial success, and competition’ and the dominant ideology/identity of ‘free market’ capitalism minimise political and cultural constraints to ‘shareholder value maximisation’ in the Anglo-American system. On the other hand, German cultural values of ‘universalism’, ‘harmony’, ‘egalitarianism’, and ‘intellectual autonomy’, coupled with the prevalent ideology/identity of “social market economy”, create constrains on shareholder value maximisation by safeguarding the social legitimacy of stakeholder rights – particularly, worker rights (see also Aguilera & Jackson, 2010; Gannon & Pillai, 2015; Trompenaars, 1993). Commenting on efforts by some German employers to liberalise the German political economy, Kinderman (2005, p. 436) notes: “German employers remain hesitant to publicly question the legitimacy of workers’ collective interest representation…Despite their serious problems, unions continue to be too powerful and their social legitimacy too entrenched for outright attacks”. This is also echoed by Faust (2012), Börsch (2007), and Bruff (2008) in their analysis of the persistent liberalisation attempts of the advocates of ‘shareholder value’ in Germany (spearheaded by the financial sector) that has largely failed to dislodge labour from power even when there were widespread perceptions of the need for greater labour market flexibility around the turn of the century (due to sluggish economic growth and high unemployment following reunification in the early 1990s). In other words, the ideology/identity of the ‘social market economy’ gives cultural power to workers in Germany, making for greater equality between capital and labour in power and distributional outcomes compared to Anglo-America, where the ideology/identity of the ‘free market’ gives little support to workers and reinforces the structural power of capital (see Chapter 3).
Streeck (1997, p. 197) calls these constraints to shareholder value maximisation in the German capitalist economy “beneficial constraints”, a term which has double meaning: (1) they benefit workers and the society at large (compared to the Anglo-American model) and (2) they benefit capital in the long-run by enabling a stable and globally competitive production regime. In this way, the ideology/identity and the associated cultural values of the ‘social market economy’ as well as the attendant power of labour constrain short-term
51 “According to the Harmony orientation, groups and individuals should fit harmoniously into the natural and social world, avoiding self-assertion aimed at exploiting or changing it.” 52 “The Egalitarianism orientation emphasizes socializing individuals to accept others as morally equal, to transcend selfish interest, and to cooperate voluntarily with others out of an understanding of long-term mutual interests.” 53 “Intellectual autonomy…encourages individuals to pursue their own ideas and intellectual directions independently.”
134 shareholder value maximisation while simultaneously enabling the creation of long-term shareholder value – which benefits committed shareholders (Bell, 2011; Gourevitch & Shinn, 2010; Goyer, 2011; Roe, 2011). Therefore, in light of these cultural and political constraints, we may even say that the primary purpose of the German public firm is to optimise (rather than maximise) long-term shareholder value. I will now examine power relations in Germany in greater detail, which should further elucidate why German firms are limited to optimising – rather than maximising – shareholder value.
The power of labour in Germany German firms are constrained in serving shareholder interests because of legally-enforced worker representation in company decision-making called ‘codetermination’: the centrepiece of the German ‘social market economy’ (Börsch, 2007; Faust, 2012; Jürgens et al., 2000, p. 54; Roe, 2011). Crucially, workers are represented in the ‘supervisory board’ of German firms, which supervises the ‘management board’ (Werder & Talaulicar, 2011). This two- board structure is distinct from the corporate governance system in Anglo-America, where there is only one ‘board’ – i.e., the shareholder-representing ‘board of directors’ – that includes the manager but not workers, resulting in ‘unilateral’ decision-making in the exclusive interest of the shareholder (Aguilera & Jackson, 2003; Hall & Soskice, 2001; Jürgens et al., 2000; Mallin, 2011). By law, German public firms – which have their own legal designation (‘AG’: public stock company)54 – are required to have worker representatives on the supervisory board besides also having worker-elected ‘works councils’ at the ‘plant-level’ that are powerful enough to have the veto over strategic decisions, including layoffs and restructuring (Börsch, 2007; Werder & Talaulicar, 2011). Public firms with over 2,000 employees are, in fact, required to have at least 50 percent worker representation on supervisory boards; although, the chair of the board, who has the deciding vote, tends to be a shareholder representative – often the equity-holding bank (Börsch, 2007; Werder & Talaulicar, 2011). In smaller public firms, employees still have a large presence (normally holding at least more than a third of the seats) on the supervisory board. Worker representatives on supervisory boards are often also union officers or at least tend to have the backing of powerful unions (Börsch, 2007; Bruff, 2008; Werder & Talaulicar, 2011). In this way, workers in German firms have considerable formal power (co-determination) and structural power (union-backing). The structural power of labour in Germany also derives
54 Private firms are designated the form of ‘GmbH’: limited liability company.
135 from the reliance of firms on high levels of worker skills attained through the sophisticated vocation training in Germany – as the strategy of German firms tends to be that of product differentiation (quality) rather than cost leadership (price competition) (Hollingsworth, 1997; Sorge & Streeck, 2018). This is in addition to the (‘hegemonic’) cultural power workers and unions derive from the dominant ideology/identity of ‘social market economy’ and the prevailing cultural values discussed above. Workers derive such cultural power both through a Foucauldian kind of “background power” described by Searle (2010, p. 155) that derives from the power of norms (as in the above example of the advocates of shareholder value being afraid to question the legitimacy of co-determination) and through the political process – whereby cultural norms and values influence politics and policymaking (Lukes, 2004; Steinmetz, 2018). The political system in Germany is already of a consensual nature due to its system of proportional representation and coalition-based government, which Iversen and Soskice (2006) have shown tends to be more labour-friendly than business-friendly in addition to being more stable policy-wise (see also Gourevitch & Shinn, 2010). Indeed, the ‘conservative’ Christian Democratic Union (CDU), which has been in power for over a decade – twice with the centre-left Social Democratic Party (SPD) in a ‘grand coalition’ – has long been a staunch defender of the ‘social market economy’ (Börsch, 2007; Deeg, 2012; Sorge & Streeck, 2018). In this way, a supportive culture and a favourable polity translate into concrete power for labour with continued protection of its formal power through ‘co- determination’ (Baccaro & Howell, 2017; Faust, 2012). In contrast, the majoritarian political system in Anglo-America tends to favour capital over labour while the ‘hands-off’ political ideology of neoliberalism that has long been dominant lends little support to workers, who are already quite powerless – both due a lack of formal institutions like co-determination and due to the loss of structural power from extensive de-industrialistion and deunionisation in recent decades (Baccaro & Howell, 2017; Frege & Kelly, 2013; Gourevitch & Shinn, 2010; Iversen & Soskice, 2006).
Comparing public firms on shareholder payout and real investment I have thus far described how and why Anglo-American managers are guided by the logic of ‘shareholder value maximisation’ while German managers are guided by the logic of ‘codetermined stakeholder orientation’. Importantly, I have delineated how these divergent approaches are rooted in institutional arrangements shaped, in turn, by distinct dominant ideologies, cultural values, and power relations that are specific to each system. This explains the pervasiveness and the relative stability of the divergent approaches within each system
136 (Hollingsworth & Boyer, 1997). In this sense, these approaches are largely generalisable to public firms in each system. Therefore, we can expect particular patterns of shareholder payout and real investment within each system given the distinctive ideologies and logics. In the following section, I delineate how the shareholder-value-oriented approach of Anglo- American firms and the (codetermined) stakeholder-oriented approach of German firms impact shareholder payout and real investment before presenting my findings on these measures of short-termism (shareholder payout being the primary measure and real investment a secondary measure of short-termism as detailed in earlier chapters). My empirical findings below do indeed reflect the influences of the divergent approaches on shareholder payout and real investment.
Shareholder payout
Firstly, the effect of the institutional impetus to maximise shareholder value on shareholder payout is fairly straightforward: it simply leads to high shareholder payouts in the form of dividends and share buybacks because such payouts are the surest and fastest way to boost shareholder value in the short-term (Driver, Grosman, & Scaramozzino, 2019; Lazonick & O'Sullivan, 2000). Among the two components of shareholder payout, share buybacks can have the advantage of flexibility, timing, and covertness over dividends (Isaksson & Çelik, 2013). While dividends tend to be paid at the end of a period (e.g., end of the year) and are often pre-announced, share buybacks can potentially be conducted at any time, in any amount, and without public disclosure (Vermaelen, 2005). However, the approval and disclosure requirements for share buybacks differ by country. In fact, the share buyback is one area where meaningful institutional differences exist between the US and the UK. Although share buybacks were legalised in the early 1980s in both countries, stricter regulations in the UK make approval and disclosure of buybacks more cumbersome than in the US, where buybacks are largely deregulated. Kim et al. (2005) note that, while share buybacks only need board approval and only need to be disclosed in end-of-term financial reports in the US, public firms in the UK need approval from their shareholders; there is an 18-month limit after the approval; no more than 15 percent of total shares may be repurchased; and share buybacks need to be disclosed as soon as they are conducted (next morning at the latest). Thus, whereas US firms can (given board approval) conduct share buybacks whenever they want, and purchase as many shares as they want for however long they want, all the while giving the impression to the public that the resulting increase in share price is organic (i.e., not artificially inflated through buybacks), UK firms not only have
137 greater hurdles for approval, amount, and timing but also do not have the benefit of disguising the buyback as an organic rise in share price. In fact, the UK is closer in share buyback regulation to Germany than the US: although share buybacks were only made legal in Germany in 1997, approval and disclosure requirements are quite similar to the UK (see Kim et al., 2005). Nevertheless, true to their shareholder value orientation, UK firms still spend significantly more than German firms on share buybacks, as my findings show – see Table 5.4. Whereas German firms spend 0.16 percent of their total assets on share buybacks, UK firms spend almost four times more: i.e., 0.60 percent of their total assets. Average spending on buybacks in dollar terms55 is $4.9 million for German firms and $48.8 million for matched UK firms.56 This is a striking disparity in share buybacks between German and UK firms given their regulatory similarities, which underscores the influence of deeper institutional, political, and cultural differences on firm behaviour. UK firms, in fact, spend significantly more on dividends than German firms as well. Whereas German firms spend 2.03 percent of their total assets on dividends, UK firms spend 2.85 percent (see Table 5.4). In dollar terms, UK firms spend almost double the amount that German firms do on dividends: $144 million to $75 million respectively.
Table 5.4. Shareholder payout in matched German and UK public firms, 2007-2017 (n=2,376 firm years of 216 matched firms). Source: author’s calculations from Osiris data. *p<.01 (t-test).
Germany UK Difference Scaled by total assets
Mean 2.03% 2.85% Dividends (%) -0.8%* (SD) (.04) (.03) Mean 0.16% 0.60% Share buybacks (%) -0.4%* (SD) (.01) (.02) Mean 2.33% 3.52% Shareholder payout (%) -1.2%* (SD) (.04) (.04)
In constant 2011 US$ (million)
Mean $74.7 $143.8 Dividends ($) -$69* (SD) (391) (801) Mean $4.9 $48.8 Share buybacks ($) -$44* (SD) (48) (426) Mean $87.3 $192.1 Shareholder payout ($) -$105* (SD) (428) (1078)
55 I use the purchasing power parity (PPP) conversion rates (output-side GDP) from the Penn World Table (9.1) to convert nominal local currency values to constant 2011 US$ values (see Feenstra et al., 2015). 56 The difference between the scaled value and the dollar value is that the scaled value controls for firm size using total assets as indicator of firm size; larger firms have a disproportionate influence on the dollar value average.
138 US firms spend vastly more on share buybacks than matched German firms; much more so than UK firms (see Table 5.5). In the Germany-US matched sample, while German firms spend 0.2 percent of their total assets on share buybacks, US firms spend 13 times that – 2.6 percent. In average dollar values, German firms spend $10 million while US firms spend a staggering $178 million – almost 18 times greater – on share buybacks. US firms, as expected, prioritise share buybacks over dividends for shareholder payouts and this translates into more similar levels of dividends between them and German firms. In fact, as a percentage of total assets, German firms spend more on dividends than US firms – 2.3 percent to 1.4 percent – but this is reversed in dollar value terms with German firms spending $104 million and US firms spending $173 million: the average dollar value disproportionately reflects the patterns of larger firms more while the ratio value (scaling by total assets) controls for firm size.
Table 5.5. Shareholder payout in matched German and US public firms, 2007-2017 (n=3,146 firm years of 286 matched firms). Source: author’s calculations from Osiris data. *p<.01 (t-test).
Germany USA Difference Scaled by total assets Mean 2.3% 1.4% 0.9%* Dividends (%) (SD) (.04) (.03) Mean 0.2% 2.6% Share buybacks (%) -2.4%* (SD) (.01) (.06) Mean 2.5% 4.1% Shareholder payout (%) -1.6%* (SD) (.04) (.07)
In constant 2011 US$ (million) Mean $104 $172 -$68 Dividends ($) (SD) (449) (1022) Mean $10 $178 -$168* Share buybacks ($) (SD) (145) (872) Mean $113 $351 -$237* Shareholder payout ($) (SD) (480) (1720)
In the end, no matter the channel used, both US and UK firms spend substantially more on total shareholder payout than German firms. In the Germany-US matched sample, German firms spend 2.5 percent while US firms spend 4.1 percent of their total assets on total shareholder payout; $113 million and $351 million respectively in dollar terms. In the Germany-UK matched sample, German firms spend 2.3 percent while UK firms spend 3.5 percent of their total assets on overall shareholder payout; $87 million and $192 million respectively in dollar terms. While proximate formal institutions like buyback regulations
139 explain some of these differences, such clear and large disparities in such a blatant expression of shareholder value orientation (shareholder payout) serve only to highlight the deeper institutional, political, and cultural divergence between the German system and the Anglo- American system.
To account for the possibility that shareholder payout may be lower in German firms than in US and UK firms because differences in the profitability of the firms, I conducted regression analyses for the two country comparisons controlling for a standard measure of profitability – ROA (return on assets) (cf. Asker et al., 2015). The results, shown in Table 5.6, confirm that the aforementioned findings are robust to the consideration of profitability. Keeping profitability constant, shareholder payout as a percentage of total assets is 1.8 percent lower in German firms compared to matched US firms and 1.1 percent lower compared to matched UK firms – largely in line with the findings presented above (i.e., 1.6 percent lower in Germany than the US and 1.2 percent lower in Germany than the UK). In sum, the above findings reveal that German public firms are less shareholder oriented than (matched) US and UK public firms.
Table 5.6. Regression estimates for shareholder payout in German public firms and matched US and UK public firms respectively; 2007-2017. Source: author’s calculations from Osiris data.
DV: Matched sample Shareholder payout (scaled by (1) Germany-USA (2) Germany-UK total assets) B (S.E.) B (S.E.)
German -.018* (.002) -.011* (.002)
Profitability (ROA) .073* (.005) .005* (.001)
R2 .103 .051 R2 change (German) .024* .018* No. of observations 3,146 2,376 No. of firms 286 216 *p<.01. Operating revenue growth (investment opportunities), year fixed effects, and industry fixed effects are included in both the models (not reported).
140 Real investment
A high proportion of internal corporate funds spent on shareholder payout may come at the expense of business investment (Orhangazi, 2008). However, as share value (price) is also based on ‘fundamentals’ – i.e., profitability – firms need to invest to generate streams of profit – which, in turn, also fund regular shareholder payouts (Haldane, 2015). Indeed, stock market analysts – who tend to have a strong influence on share prices by influencing investor perceptions – tend to base their evaluations of firms on short-term profits (quarterly earnings); and managers in the US and the UK have been known to take extreme steps to meet the earnings expectations of analysts, including the rejection of clearly profitable long- term investment opportunities (see Graham et al., 2006; Haldane, 2015). US CEOs have, in fact, been scolded by prominent corporate leaders like Larry Fink of BlackRock and Dominic Barton of McKinsey & Company for obsessing over quarterly earnings (see Barton, 2011; Turner, 2016). Managers of Anglo-American firms are thus constantly on the look-out for investment opportunities to boost quarterly earnings (Gigler et al., 2014; Narayanan, 1985).
Types of real investment preferred by Anglo-American and German firms
Real investments come in different forms but not all forms are equal when seen through the lens of ‘shareholder value maximisation’. As investors in the stock market tend not to be familiar with the inner workings and capabilities of firms to properly evaluate the future profitability of real investments they tend to heavily and excessively discount the future returns of long-term real investments, especially in the US and the UK where shareholding is dominated by ‘outsiders’ – dispersed portfolio investors (Black & Fraser, 2002; Miles, 1993; OECD, 2015). In addition, investment in large long-term projects can substantially reduce internal funds, leaving less for shareholder payouts and for financial investments that start generating profits immediately (Orhangazi, 2008). Therefore, stock market investors tend to prefer short-term investments that can start generating good returns immediately over long- term investments with slower returns that may nevertheless generate higher returns in the long-term. Bushee (2001, p. 207), for example, finds that “[dispersed shareholding] is associated with an over- (under-) weighting of near-term (long-term) expected earnings, and a trading strategy based on this finding generates significant abnormal returns”. This collective aversion to long-term investment of portfolio investors translates into general buying and selling patterns in the stock market that punish firms (in terms of share price) that invest in the long-term (see OECD, 2015; Stein, 1989). This, in turn, strongly encourages
141 shareholder-value-oriented corporate managers to focus mostly on short-term investments with quick and clear financial returns that are above a pre-defined ‘hurdle rate’ (Bushee, 2001). Prospective investment opportunities are then evaluated against this ‘hurdle rate’ using financial discounting techniques such as ‘net present value’ and ‘required rate of return’ that are biased not only against long-term investments but also against investments that have strategic rather than financial advantages (Bierman & Smidt, 2012; Hayes & Garvin, 1982; Narayanan, 1985; Ryan & Ryan, 2002; Segelod, 2000). Stakeholder-oriented managers in Germany, on the other hand, are much less inclined to base their real investment decisions on strict financial criteria, preferring rather their own judgments and the input of relevant employees (while still consulting financial calculations) so as to align real investments with broader strategic goals (see Bhankaraully, 2019; Börsch, 2007; Carr & Tomkins, 1998; Glunk et al., 1996; Gospel & Pendleton, 2003; Porter, 1991). Carr and Tomkins (1998, p. 224) report from extensive case studies of real investment decisions that “UK and US companies are, on average, placing approximately three times as much emphasis on the financial calculus as those in Germany”.
Given their penchant for real investments that have clear-cut financial returns, have short payback periods, and start making profit immediately, it is not surprising that shareholder- value-oriented Anglo-American managers prefer business acquisitions to internal product development: business acquisitions come with ready-made products that can start generating profits almost immediately while internal projects can take time to break even (though they might have greater long-term benefits). As Hollingsworth (1997, p. 296) observes:
…because of the heavy emphasis American managers place on the performance of their firms’ prices on the stock exchanges, there is heavy emphasis on the rate of return on investment as the key performance indicator. Thus, American firms, more than those in any other country, resort to acquisitions and mergers in order to influence quarterly and annual reports, but tend to underinvest in new plants, products, and skills.
Systemic sources of real investment preferences
The focus on business acquisitions in Anglo-American public firms, however, does not simply derive from a combination of shareholder value maximisation and financial decision- making. In fact, there are deeper systemic reasons for this focus. These systemic causes relate to what Hollingsworth and Boyer (1997) call “social systems of production”, which is based on an ecological view of a national system of production. By taking this approach,
142 Hollingsworth (1997) is able to distinguish the particular strengths and weaknesses of the Anglo-American system and of the German system when it comes to production and innovation. Essentially, he argues that the Anglo-American system (and especially the US system) is generally better than the German system at creating new markets (products and services) through radical innovation because of its (1) vast venture capital market, (2) extensive research links between universities, government departments, and firms, (3) flexible labour market where relevant experts can easily be prised away from other firms (which also relates to the lack of industry-level collective bargaining that equalises wages across the industry), and (4) generalist education system that fosters creativity and entrepreneurship (see also Amable, 2003). Due to this particular configuration that encourages the commercialisation of new innovative ideas through venture capital financing, much of this innovation is concentrated in smaller start-ups. Indeed, given the prevailing cultural values of self-interest, financial success, and competition, innovative entrepreneurs are more likely to pursue profitable new ideas on their own – through a new start-up – rather than within large public firms that are likely to extract most of that value and transfer it to dispersed shareholder anyway (Kasser et al., 2007). Labour market fluidity thusly deprives public firms of internal innovative capacities. Moreover, there is a relative lack of technical skills in the Anglo-American system due to its generalist focus in education and a less- developed vocational training system (Thelen, 2004). There is also little incentive both for workers to acquire firm-specific skills and for firms to train workers due to fluid labour markets and a lack of long-term commitment on both sides (Dore, 2000; Hall & Soskice, 2001). Besides having few capacities for the type of radical innovation that takes place in start-ups, Anglo-American public firms are thus also less adept at improving and refining products (compared to German firms). As a result of this, combined lack of innovative and quality-enhancing capabilities, Anglo-American public firms tend to focus on cost leadership strategies of scaling products through mass production rather than strategies of product differentiation (through quality). In this way, the typical strategy of Anglo-American public firms is based on buying existing businesses and product lines (plus patents) and then scaling them through mass production processes. This strategy is, however, expensive as it involves buying ready-made product lines that come with a price premium (compared to in-house development) and it involves the purchase of various types of specialist labour-saving equipment for mass production – e.g., an assembly line – to produce price-competitive products (Hollingsworth & Boyer, 1997). In this way, even the short-term-oriented cost-
143 leadership strategies of Anglo-American public firms can incur high levels of real investment (both business acquisitions and spending on property, plant, and equipment).
German public firms, on the other hand, are better at advancing and refining established markets and products with their focus on quality that utilises high levels of skills and technical knowledge derived from an education system that emphasises technical mastery. This is supported by a “high-competence norm” that “translates into a ‘no-nonsense production culture’ with high standards and high demands for discipline in order to deliver high-quality work in all types of organizations” (Glunk et al., 1996, p. 105). However, the relative paucity of venture capital in Germany, fewer commercialisation opportunities for university academics, and less focus on financial success and competition, translates into a less vibrant start-up culture (Hall & Soskice, 2001; Schwartz, 2007; Whitley, 1999). This, in turn, means a strategy centred on business acquisitions is systemically less attractive for German firms than for Anglo-American firms (see also Amable, 2000; Dore, 2000; Hall & Soskice, 2001; Roe, 2011; Whitley, 1999). For this reason and because of the ready availability of highly-skilled workers and technical expertise, German public firms tend to prioritise in-house product development and refinement so as to compete on quality rather than price.
These patterns within the Anglo-American and German systems thus translate into divergent preferences when it comes to real investment. Anglo-American public firms focus on business acquisitions as well as on capital expenditures on labour-saving and cost-cutting specialist equipment needed for mass production and cost leadership strategies. German firms, on the other hand, invest in generalist equipment suitable for a strategy of ‘diversified quality production’ and make capital expenditures for continuous ‘small-step’ innovation for a product differentiation strategy (Sorge & Streeck, 2018). German firms nevertheless also tend to make strategic business acquisitions to complement their existing product lines and services – which is somewhat different from the business acquisitions of Anglo-American public firms, which instead have a financial focus and tend to be limited to ‘core competence’ areas (Börsch, 2007; Milberg, 2008). Although this tells us that Anglo- American public firms and German public firms prioritise different kinds of real investment, it does not, however, give a clear indication of potential differences between Anglo- American firms and German firms when it comes to the overall level of real investment spending. The real investment strategies of Anglo-American firms can be expensive even if short-term oriented (as discussed) while the long-term focus of German firms, the relative
144 lack of reluctance to invest in large in-house projects, and their diversification strategies also require substantial expenses – although more in internal capital expenditure. However, besides the drivers of real investment, real investment spending is also impacted by constraints on real investment. I have already discussed how the high shareholder payout of Anglo-American firms, their short-term-oriented financial decision-making, their narrow focus on ‘core competence’ (i.e., aversion to diversification), and their lack of capacity for in- house continuous innovation can impede overall real investment (also see chapters 1 and 2). But what about German public firms? If there are fewer constraints to overall real investment in the German system compared to the Anglo-American system, we might expect overall real investment to be higher in German public firms compared to similar Anglo-American firms. Notwithstanding their focus on long-term firm growth, there are actually many potential deterrents to real investment in the German system too – though these are less talked about in the comparative capitalism literature. In fact, many of these deterrents have to do with the very stakeholder orientation that promotes firm growth in German firms.
Constraints on real investment in the German system
Potential constraints on real investment in German public firms derive from the following: (1) the need for consensus on major investment spending decisions from multiple stakeholders – managers, shareholders, creditors, and workers (supervisory board, works councils, and unions) – that concomitantly involves a more time-consuming, rule-based, and bureaucratic decision-making process (Börsch, 2007; Roe, 2011); (2) the inability to easily divest of product or service lines once committed to because of codetermination and powerful unions and thus the need to invest carefully (Bhankaraully, 2019; Börsch, 2007; Faust, 2012); (3) the need to save for a rainy day (downturns) rather than spend on extra real investment because of the need to protect employment during market downturns – especially in volatile and uncertain times (Hall & Soskice, 2001); (4) investment on a smaller number of generalist equipment rather than on various types of specialist equipment because of an abundance of in-house skills and because of a focus on product differentiation rather than on mass production (Hollingsworth, 1997; Sorge & Streeck, 2018); (5) a relative lack of urgency to meet short-term earnings expectations of analysts compared to Anglo-American firms (Faust, 2012; Gospel & Pendleton, 2003); (6) hostility of internally powerful labour (supervisory board and works council) towards labour-replacing equipment (Streeck, 1996); and (8) the ability of ‘insider’ blockholders and creditors (banks) to curb ‘agency costs’ associated with expansion-oriented but less-profitable real investment by restraining managers, who “have a
145 well-known propensity to expand firms in ways that do not benefit shareholders, but rather favour themselves (and incumbent employees)” (Roe, 2011, p. 72). In this way, the same factors that promote long-term firm growth in German public firms – employment protection, worker power, high skills, and the monitoring by ‘insiders’ like blockholders and banks – can also constrain overall real investment.
Hence, while German public firms would not be expected to underinvest in comparison to their Anglo-American counterparts, there is, at the same time, no compelling reason to expect them to substantially out-invest Anglo-American public firms either – especially when both business acquisitions and capital expenditure are considered. The key difference between them, therefore, lies not necessarily in the amount of real investment but rather in its type and temporal orientation: Anglo-American public firms generally prefer external, financially- sound, immediately-profitable, highly-specialised, labour-saving, and cost-cutting investments in ‘core competence’ areas to maximise shareholder value, while German public firms prioritise longer-term, in-house, diversified, generalist, incremental (quality- enhancing), and employment-saving investments to grow and expand the firm. It turns out, as the findings below reveal, these notably divergent strategies tend to produce relatively similar levels of real investment overall. The differences that do exist are small compared to the disparities in shareholder payout (discussed above). These smaller differences nevertheless highlight the divergence in approach that I have discussed. As Table 5.7 shows, growth in property plant and equipment (PPE) – which includes business acquisitions – is somewhat higher in the US compared to German firms (matched by industry and size): US firms spend 2.6 percent of their (beginning-of-year) total assets on this measure of real investment while German firms spend 2.2 percent. Internally-focussed capital expenditure, on the other hand, is somewhat higher in Germany: 4.2 percent in German firms compared to 3.9 percent in US firms. In terms of average dollar values, however, US firms spend more than German firms on both measures: $183 million compared to $113 million in gross PPE growth and $333 million to $264 million in capital expenditure. As differences in average dollar values are more representative of differences between larger firms, greater capital expenditure in larger US firms may be reflecting their aforementioned mass production strategies that tend to require various types of labour-saving specialist equipment. Importantly, these differences in real investment pale in comparison to what I call the ‘short-termism measure’: the difference between real investment (capital expenditure) and shareholder payout. As Table 5.7 shows, while German firms spend 1.7 percent more of their total assets on capital expenditure
146 (capex) than on shareholder payout, US firms actually spend more on shareholder payout than on capital expenditure – by 0.1 percent of their total assets. In dollar value terms, German firms spend $151 million more on real investment (capex) than on shareholder payout whereas US firms spend $17 million more on shareholder payout than on real investment (capex).
Table 5.7. Real investment in matched German and US public firms; 2005-2017 for growth in gross PPE (n=4,004 firm years of 286 matched firms) and 2007-2017 for capex (n=3,146 firm years of 286 matched firms). Source: author’s calculations from Osiris data. *p<.01 (t-test).
Germany USA Difference Scaled by total assets Mean 2.2% 2.6% Gross investment (PPE growth) -0.4% (SD) (.06) (.06) Mean 4.2% 3.9% Capital expenditure (capex) 0.3% (SD) (.04) (.04) Mean 1.7% -0.1% Capex minus shareholder payout 1.8%* (SD) (.05) (.07)
In constant 2011 US$ (million)
Mean $113 $183 -$70 Gross investment (PPE growth) (SD) (2456) (1707) Mean $264 $333 -$69 Capital expenditure (capex) (SD) (1034) (1744) Mean $151 -$17 $167* Capex minus shareholder payout (SD) (626) (1191)
This divergent pattern is also largely mirrored in the UK-Germany comparison – although there are some disparities in the magnitude of the differences compared to the US-Germany analysis. As Table 5.8 shows, the difference in gross PPE growth between UK and German firms is larger and significant with UK firms spending 2.39 percent of their total assets on gross PPE growth compared to 1.42 percent for Germany. In contrast, German firms spend slightly more on capital expenditure than UK firms: 3.97 percent and 3.85 percent of total assets respectively. In dollar terms, UK firms are ahead of German firms on gross PPE growth – $81 million to $47 million – but behind on capital expenditure – $194 million to $209 million. These differences in real investment between German and UK firms are again dwarfed by the disparity in the ‘short-termism measure’. German firms spend 1.6 percent more of their total assets on real investment (capex) than on shareholder payout while UK firms spend only 0.3 percent more on real investment. The difference in the ‘short-termism measure’ is even more conspicuous in dollar terms: German firms spend $122 million on
147 average more on real investment (capex) than on shareholder payout whereas UK firms only spend $1.8 million more on real investment than shareholder payout. Notwithstanding the relatively small differences in the amount spent on real investment, the divergence in shareholder orientation between Anglo-American and German public firms is laid bare in this ‘short-termism measure’.
Table 5.8. Real investment in matched German and UK public firms; 2005-2017 for growth in gross PPE (n=3,024 firm years of 216 matched firms) and 2007-2017 for capex (n=2,376 firm years of 216 matched firms). Source: author’s calculations from Osiris data. *p<.01 (t-test).
Germany UK Difference Scaled by total assets
Mean 1.42% 2.39% Gross investment (PPE growth) -0.97%* (SD) (.07) (.07) Mean 3.97% 3.85% 0.12% Capital expenditure (capex) (SD) (.03) (.04) Mean 1.64% 0.32% Capex minus shareholder payout 1.3%* (SD) (.05) (.05)
In constant 2011 US$ (million)
Mean $46.5 $81.2 -$34.7 Gross investment (PPE growth) (SD) (965) (1219) Mean $209 $194 $15.3 Capital expenditure (capex) (SD) (986) (1015) Mean $121.9 $1.8 $120* Capex minus shareholder payout (SD) (614) (872)
There is, of course, the possibility that the differences in real investment and in the short- termism measure may be (partly) due to differences in investment opportunities in the respective economies. For example, it may be argued that the higher shareholder payout in Anglo-American firms compared to (matched) German firms could be due to differences in investment opportunities, whereby a relative lack of investment opportunities might have encouraged Anglo-American firms to ‘return more money to shareholders’ (Isaksson & Çelik, 2013). Given this possibility, I estimate and run a regression analysis on real investment (both measures) and on the short-termism measure holding investment opportunities constant. I use operating revenue growth as the proxy for investment opportunities – as is common in the literature (Asker et al., 2015). The results of estimating the regression are shown in table 5.9 for the Germany-US matched sample and in table 5.10 for the Germany-UK matched sample.
148 Table 5.9. Regression estimates for real investment and of the difference between real investment (capex) and shareholder payout in matched German and US public firms; 2005-2017 for growth in gross PPE and 2007-2017 for capex. Source: author’s calculations from Osiris data.
(2) Capital (3) Capex minus (1) Gross investment DV expenditure shareholder payout (scaled by total assets):
B (S.E.) B (S.E.) B (S.E.) German -.004 (.002) .003 (.001) .019* (.002) Investment .000 (.000) .000 (.000) .000 (.000) opportunities
R2 .020 .048 .041 R2 change (German) .001 .002* .022* No. of observations 3,718 3,146 3,146 No. of firms 286 286 286 *p<.01. Year and industry fixed effects included. These findings are also robust to using net PPE or fixed assets. They are also robust to using Tobin’s q and annual GDP growth (country) as proxies for investment opportunities, plus also controlling for ROA (profitability).
Table 5.10. Regression estimates for real investment and of the difference between real investment (capex) and shareholder payout in matched German and UK public firms; 2005-2017 for growth in gross PPE and 2007-2017 for capex. Source: author’s calculations from Osiris data.
(2) Capital (4) Capex minus (1) Gross investment DV expenditure shareholder payout (scaled by total assets):
B (S.E.) B (S.E.) B (S.E.) German -.009* (.003) .001 (.001) .013* (.002) Investment .051* (.005) .013* (.003) .000 (.005) opportunities
R2 .077 .121 .059 R2 change (German) .004* .000 .016* No. of observations 2,808 2,376 2,376 No. of firms 216 216 216 *p<.01. Year and industry fixed effects included. These findings are also robust to using net PPE or fixed assets. They are also robust to using Tobin’s q and annual GDP growth (country) as proxies for investment opportunities, plus also controlling for ROA (profitability).
The regression results do not alter the aforementioned findings: German firms (represented by the dummy variable ‘German’ in the tables) have slightly lower gross PPE growth than US firms and lower growth than UK firms. At the same time, German firms have slightly
149 higher capital expenditure than both US and UK firms. The ‘short-termism measure’ also shows that German firms spend substantially more on real investment (capex) than shareholder payout compared to both US and UK firms even when controlling for investment opportunities.
All in all, the cross-sectional findings (both on real investment and on shareholder payout) indicate that although German firms may not invest more than Anglo-American firms, they do nevertheless spend substantially more on real investments than on shareholder payouts while Anglo-American firms spend about the same on both. From the perspectives of the likes of Asker et al. (2015) and Haldane (2015), who respectively label US and UK public firms short-termist purely on the basis of the magnitude of real investment, the similarity in real investment levels between Anglo-American public firms and German public firms may be enough to call German public firms short-termist as well; short-termist for different (stakeholder-oriented) reasons, however, in light of the foregoing discussions. However, if we were to broaden our definition of short-termism to align more with the likes of Lazonick and O'Sullivan (2000), Orhangazi (2008), Milberg (2008), G. F. Davis and Kim (2015), and Van der Zwan (2014), as well as the wider financialisation and political economy literatures, which invariably link shareholder payout – and real investment – to short-termism, then the large disparity in the ‘short-termism measure’ discussed above indicates that German public firms are less short-termist than Anglo-American public firms. Finally, if we were to consider the comparative capitalism literature’s focus on ‘shareholder value’, stakeholder interests, and the overarching logic of firm behaviour as a way to evaluate short-termism in a more holistic manner (e.g., Dore, 2008; Faust, 2012; Goyer, 2011; Hall & Soskice, 2001), then we may also say that German firms, which clearly show less concern for maximising shareholder value, are less short-termist than Anglo-American firms
Convergence and Institutional change in Germany? I now look at the important institutional changes that have occurred in Germany since the 1990s to examine potential drivers of any convergence. Although many institutional changes have, of course, also occurred in Anglo-America (not least because of the 2008 financial crisis), what scholars nevertheless unanimously agree is that these changes have, by and large, preserved the essence of the LME model and the attendant ‘shareholder value orientation’ (Baccaro & Howell, 2017; Gospel et al., 2014; Whitley, 2012). For this reason and also because the ‘convergence debate’ has concentrated on the potential convergence of
150 Germany towards the LME model and not the other way around (see chapter 3), I will focus on the institutional change in Germany.
The general consensus from virtually all analysts of institutional change in Germany is that the key labour institutions that distinguish Germany from Anglo-America – co-determination in firms and powerful unions at the organisational-field and national levels – remain largely intact despite liberalisation in many areas of the political economy (e.g., Boyer, 2015; Frege & Kelly, 2013; Hall & Thelen, 2009; Hassel, 2015; Lane, 2005; Sorge & Streeck, 2018; Vitols, 2018). The impetus for liberalisation originated largely in the widespread perception in the 1990s and 2000s that Germany had become the ‘sick man of Europe’ as it could not shake off a sluggish economy and high unemployment following reunification in the early 1990s (Börsch, 2007; Bruff, 2008). So widespread was the acceptance of the need for greater liberalisation that it was the centre-left Green-SPD coalition government that spearheaded liberalisation efforts to attract foreign investment by making German businesses more transparent, accountable, and responsive to investors (Kinderman, 2005). They passed reforms such as the repeal of capital gains taxes, the ‘Hartz’ reforms (I to IV), and others that sought to wind down cross-shareholding, reduce the power of blockholders, diminish the influence of banks, internationalise accounting practices, make the labour market – especially temporary work – more flexible, and liberalise stock market regulations (Börsch, 2007; Unger, 2015; Werder & Talaulicar, 2011). In fact, even labour supported many of the changes – especially around transparency – by forming a ‘transparency coalition’ with dispersed investors partly because many corporate issues that were supposed to go through the supervisory board were being discussed in private by managers and blockholders including banks (Gourevitch & Shinn, 2010; Roe, 2011). However, as with any liberalisation effort carried out by a centre-left government, especially with labour at the table, liberalisation is likely to be conditional and likely to protect labour. That is largely what happened and thus the key pillar of the German model – codetermination – persists, preserving the formal power of labour (Faust, 2012).
At the same time, scholars observe that competitive pressures from globalisation and deindustrialisation in many areas of the economy (largely due to cheaper labour in eastern Europe) has eroded the structural power of labour via deunionisation and the threat of offshoring and outsourcing (Baccaro & Howell, 2017; Bruff, 2008; Jackson, 2005b). This has forced labour into agreeing to bear the majority of the costs for the adjustment of the German model to new structural circumstances by accepting lower wage growth, reduction in work
151 time, early retirement, and greater use of temporary work agencies in exchange for (continuing) secure employment (e.g., Baccaro & Howell, 2017; Kinderman, 2005; Palier & Thelen, 2010; Sorge & Streeck, 2018). As Palier and Thelen (2010) and Baccaro and Howell (2017) report, this has also led to a ‘dualisation’ that has divided the labour market into ‘core’ labour – concentrated in export-oriented industries – and ‘peripheral’ labour – situated largely in the service sectors and in temporary work agencies increasingly employed by the export-oriented industries to save costs (see also Faust, 2012; Hassel, 2015). Unlike the ‘periphery’ where protections have become weaker for workers, the ‘core’ that has largely witnessed continuity – in wages, tenure, security, co-determination, and high-end vocational and firm-specific training – and this has been the key to the perpetuation of the highly competitive German model of ‘diversified quality production’ (Hassel, 2015; Sorge & Streeck, 2018; Vogel, 2018b). Sorge and Streeck (2018), who had originally coined the term ‘diversified quality production’ (‘DQP’) and theorised the concept to describe the German model – with ‘institutional complementarities’ as a key tenet of the model – admit that they had originally overestimated the importance of the role of institutional complementarities in sustaining the German system of ‘diversified quality production’. They are now of the view, with the benefit of hindsight, that DQP has been sustained even with the relative liberalisation of many institutional aspects of the German model because the institutional pillars of DQP like co-determination, vocational training, and the institutional focus on quality have endured. Therefore, the stakeholder-oriented and quality-focussed logic behind production persists, although perhaps in a somewhat moderated form as managers have become more mindful of ‘shareholder value’ than they used to be – still notably less so than Anglo-American managers, however (Faust, 2012). Boyer (2015, p. 219) notes, for example, that “Germany’s success from 2010 to 2014 is due to the reforms which successfully adapted Rhenish capitalism to the new international and European context, while still preserving or even reinforcing mechanisms that ensure the specialisation in high-end goods”. He further argues that the enduring German model “derives its resilience from an ability to reform without sacrificing its logic” (2015, p. 202) – a theme also echoed in other accounts (e.g., Faust, 2012; Hassel, 2015; Sorge & Streeck, 2018).
There have been changes as well – but also continuities – in corporate governance. The massive costs and adjustments relating to reunification of West and East Germany in the early 1990s and ever-deepening globalisation – especially financial globalisation – have led to important changes but changes have been institutionally-filtered: (1) large banks have
152 divested from non-financial companies and have started focussing on investment banking like Anglo-American banks, but cross-shareholding by non-financial firms largely persists despite financial incentives to divest (repeal of capital gains tax) due to a typically German reason: strategy rather than finance (Börsch, 2007; Culpepper, 2010); (2) mutual funds and hedge funds – domestic and foreign – that are after ‘shareholder value’ have become more active in the stock market but such activity remains much lower than in Anglo-America or indeed in other CMEs like France (Deeg, 2012; Goyer, 2011); (3) public firms have become more transparent in reporting financial information because of international investor pressures and changes to the accounting system (from local GAAP to IFRS in 2005) but this has had little visible effect on firm behaviour (Börsch, 2007; Faust, 2012); (4) although stock options had started becoming more popular in German firms just before the GFC, new laws and regulations were introduced in 2009 to reverse this and link manager pay to longer-term performance (Werder & Talaulicar, 2011); (5) the market for managers has become more active and thus there are more ‘outsider’ CEOs in public firms now but, again, the pace of change in this area has been much slower than other comparable countries like Japan and France (Culpepper, 2010; Goyer, 2011); and (6) there has been a significant increase in cross- border merger and acquisition (M&A) activity (largely inside the EU) but as, Hassel (2015, p. 118) notes:
There is still no active market for corporate control [in Germany]…Compared to the 1990s when the trend towards an Anglo- Saxon corporate governance structure took off, the 2000s saw a backlash. Among the 100 largest firms in Germany, the share of firms who were owned by large blockholders increased, while firms with a majority in dispersed shareholders declined.
The changes taken together have meant that even though ‘patient capital’ in the form of bank finance has less influence and although the demands for shareholder value has grown louder from new and old actors, the (still) inactive market for corporate control, new constraints on share-based managerial pay, the continuing reliance of industries on skill-heavy quality-based production, and (especially) the persistence of co-determination has meant that ‘shareholder value’ has only had limited influence on public firm behaviour in Germany. As Goyer (2011) has shown, Germany has attracted fewer short-term-oriented institutional investors than other CMEs like France, indicating that its institutional environment is still relatively inimical to short-term shareholder value maximisation (also see Gospel et al., 2014). All in all, while shareholder value has certainly made some inroads within German public firms, changes have largely been limited to those that have smaller effects on the overall corporate strategies
153 and stakeholder orientation of public firms (Börsch, 2007; Deeg, 2012; Hassel, 2015). This is reflected in the longitudinal findings. As figure 5.1 shows, German public firms, compared to (matched) US and UK public firms, have had little change in shareholder payout since 2010 – right after the financial crisis.
Remarkably, German firms have maintained a highly consistent gap with the UK in (total) shareholder payout for the entire study period (see the top right graph in figure 5.1). A significant gap with the US in this regard is also maintained throughout with the gap widening sharply between 2010 and 2016 (see the top left graph in figure 5.1). Share buybacks have, on average, remained low in German firms throughout the period and this has resulted in an enormous gap with US firms (see middle left graph in figure 5.1). On the other hand, the gap between German and UK firms on share buybacks is relatively small after the GFC – with UK firms generally spending somewhat more. Just before the GFC, UK firms spent a lot more on buybacks (see middle right graph in figure 5.1). Given the huge gap between US and German firms on buybacks, German firms have actually spent slightly more on dividends throughout the period (see bottom left graph in figure 5.1). On the other hand, given the smaller gap on buybacks between German and UK firms, UK firms have consistently spent more on dividends than German firms since the GFC – although German firms spent more in two years prior to the GFC (see bottom right graph in figure 5.1). Overall, however, both US and UK firms have consistently spent more on total shareholder payout (buybacks plus dividends) than German firms with the post-GFC gap particularly wide between German and US firms. Regarding real investment, there is no clear trend on both gross PPE growth and capital expenditure, as figure 5.2 shows. While both US and UK firms display higher growth in gross PPE than matched German firms after 2005 and up to 2008, there is no clear and consistent difference thereafter, although perhaps UK firms have seen somewhat greater growth than German firms between 2014 and 2017 (see topmost graphs in figure 5.2). Both US and UK firms are remarkably inseparable from German firms when it comes to capital expenditure, at least until 2013 (see middle graphs in figure 5.2). The ‘short-termism measure’ (‘capital expenditure – shareholder payout’) shows German firms being less short-termist than UK firms and substantially less short-termist than US firms throughout the study period – see figure 5.2. While German firms have consistently spent more on real investment than on shareholder payout, US firms have spent more on shareholder payout than on real investment since 2010 (see bottom left graph in figure 5.2).
154 The gap between real investment and shareholder payout is consistently greater in German firms than UK firms but not as large as compared to the US (bottom left graphs in figure 5.2).
Shareholder payout Shareholder payout (Germany & USA) (Germany & UK) 6% 5%
5% 4%
4% 3% 3%
2% 2%
1% 1% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Germany USA Germany UK
Share buybacks Share buybacks (Germany & USA) (Germany & UK)
4% 2%
3%
2% 1%
1%
0% 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Germany USA Germany UK
Dividends Dividends (Germany & USA) (Germany & UK) 4% 4%
3% 3%
2%
2% 1%
0% 1%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Germany USA Germany UK
Figure 5.1. Shareholder payout (dividends + share buybacks), dividends, and share buybacks as a percent of total assets in matched German and US firms (143 each) and matched German and UK firms (108 each).
155 Gross PPE growth Gross PPE growth (Germany & USA) (Germany & UK) 6% 6%
5% 5% 4% 4% 3% 3%
2% 2% 1% 1% 0% 0%
-1% -1%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Germany USA Germany UK
Capital expenditure Capital expenditure (Germany & USA) (Germany & UK) 6% 6%
5% 5%
4% 4%
3% 3% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Germany USA Germany UK
Capital expenditure - shareholder payout Capital expenditure - shareholder payout (Germany & USA) (Germany & UK)
3% 3%
2% 2%
1% 1%
0% 0%
-1% -1%
-2% -2% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Germany USA Germany UK
Figure 5.2 . Real investment: Growth in gross property, plant, and equipment (PPE), capital expenditure, and the difference between capital expenditure and shareholder payout as a percent of total assets in matched German and US firms (143 each) and matched German and UK firms (108 each).
156 Though there has been significant liberalisation in Germany, although some traditional pillars of the German model like banking have become more akin in some ways to the Anglo- American model, and though a society valuing universalism has protected some (‘core’ workers) at the expense of others (‘peripheral workers’), the German system has nonetheless preserved the central features that made it a successful ‘social’ alternative to Anglo-American liberal capitalism: with Germany based more on quality and consensus (Sorge & Streeck, 2018). The assessment of Hall and Thelen (2009, p. 268), for example, of the overall changes in the German political economy is that “the reforms made in a number of realms, including industrial relations, vocational training and social policy, do not signal a shift to the Anglo- Saxon model so much as they point to the development of new forms of dualism and labour market segmentation.”
Conclusion As Modell Deutschland was humming along in the 1980s, attracting the admiring gazes of prominent Anglo-American scholars like Porter (1991), sudden reunification between West and East Germany meant that it had to adjust to a post-reunification reality that no advanced economy has had to face while concurrently confronting rapid globalisation that no advanced economy has escaped from unscathed. Limiting deindustrialisation and maintaining a ‘social market economy’ in a globalised neoliberal world is by itself a remarkable feat but doing so in such a challenging context is even more so. A transformed environment requires evolution and Germany has evolved to meet the new challenges without losing much of its essence – something that cannot be said for many other coordinated market economies (see Schneider & Paunescu, 2012). As Hassel (2015, p. 127) puts it:
The transformation of the German model towards a more liberal one therefore is undeniable, but in essence it remains ‘German’…The transformation of the German model is therefore not primarily a process of converging on a liberal, Anglo-Saxon, model. It is a transformation in its own right.
In other words, Germany has become more globalised economically, politically, socially, and culturally like every other country, but its distinctive ‘social market economy’ remains conspicuously German. The verdict on Germany given the findings and the discussions in this chapter, therefore, is that it remains a distinct capitalist model from the Anglo-American model, particularly in terms of shareholder payout – the main indicator of how much a public firm is focussed on short-term ‘shareholder value’ and the key measure as far as inequality and employment are concerned. More broadly, this chapter has also shown that (national)
157 institutional differences really matter when it comes to the behaviour of public firms despite the commonality of the stock market.
158 Chapter 6 Comparing Japan and the West
The key actor when it comes to short-termism is undoubtedly the manager of the public firm. Managers decide how much of the firm’s yearly profits to pay out to shareholders, how much of it to reinvest in the firm for future growth (real investment), and how much of it to invest in employees. There are three important considerations regarding such managerial decision- making: (1) the types of constraints on managerial decision-making and whose interests they represent (shareholders, employees, the state, etc.) and (2) to what extent such constraints limit managerial discretion (‘agential space’). The extent of short-termism will depend on these two aspects.
Constraints on managers that favour dispersed shareholders are very strong in Anglo- American public firms due to an active ‘market for corporate control’ and due to the power of institutional investors. In Germany, on the other hand, constraints on managers deriving from labour are much stronger, and they exist alongside constraints deriving from dispersed shareholders, ‘blockholders’, and creditors as part of a corporatist system (see last chapter). This means that managerial discretion is low in Anglo-American public firms and perhaps even lower in German public firms. In this sense, the extent of short-termism can be said to depend strongly on structural and institutional constraints on managers.
In Japanese public firms, by contrast, structural and institutional constraints deriving from both capital and labour are relatively weak. Hostile takeovers are virtually absent and there are (relatively) few legal constraints on firms as such. In other words, Japanese managers appear to enjoy relatively high levels of discretion. Although Japanese managers face weaker structural and (formal) institutional constraints, they still face strong social and cultural constraints, however. These social and cultural constraints on Japanese managers turn them into ‘employee-favouring’ rather than ‘shareholder-favouring’ decision-makers. It is the consideration of such social and cultural constraints that helps explain my comparative empirical findings on Japan. Indeed, without social and cultural considerations, it is hard to explain why Japanese public firms have lower shareholder payout than even (matched) German public firms – and substantially lower payout than (matched) US and UK public firms. As Ronald Dore et al. (1999, p. 117) put it: “Japan's economic institutions are deeply
159 socially embedded…By contrast, Germany's system derives its strength from its firm legal entrenchment”. In fact, social and cultural factors also help explain why real investment is lower in Japanese public firms than in (matched) German, US, and UK public firms (even when controlling for investment opportunities). Social and cultural constraints are slow to change and, accordingly, I find that Japanese public firms continue to diverge strongly from their Anglo-American counterparts, even after two decades of stagnant economic growth and the resulting liberalisation of formal institutions.
I would like to note that the analysis here marks an important departure from much of the literature on Japanese capitalism. While the early literature on Japanese capitalism tended to overemphasise culture (e.g., Abegglen, 1958; Morishima, 1984; Murakami, 1984), much of the contemporary literature neglects it (e.g., Lechevalier, 2014; Moriguchi, 2000; Streeck, 2005; Thelen & Kume, 2005). On one hand, the earlier cultural analyses were often overly- deterministic explanations that eschewed historical, political, and functional factors behind Japanese capitalism and, consequently, failed to explain historical and sectoral variation (Hamilton & Biggart, 2001). On the other hand, contemporary non-cultural analyses overlook affective and normative aspects that (1) have shaped the ideological foundations and the institutional logics of Japanese capitalism, (2) are behind many of its (otherwise puzzling) ‘idiosyncrasies’, and (3) have long prompted bureaucrats and managers alike to consciously and deliberately steer Japanese capitalism away from excessive ‘Westernisation’ to preserve its “Japaneseness” (Dore, 2001; Lehmbruch, 2005; Yamamura, 1997, p. 351; emphasis added). Steven Vogel (2018a, p. 83) notes that “[w]hile scholars have debated whether [the institutions of Japanese capitalism] were rational or cultural, in practice they had both instrumental and normative foundations”. I thus take a more balanced approach by including but not privileging cultural factors, following close observers of Japanese capitalism like Ronald Dore (1997, 2000), Steven Vogel (2006, 2018a), and Kozo Yamamura (1997). Furthermore, I emphasise a dynamic approach, which recognises that the influence of cultural factors depends on the situation: i.e., the influence of specific cultural values is neither constant nor universal and is constrained by political, structural, and functional factors, with the strength of the constraints depending on the situation. This approach overcomes the limitation of conventional treatments of cultural factors that struggle to explain historical and sectoral differences. I also treat cultural values and beliefs as ‘objectivated’ background variables that influence institutions indirectly by providing legitimation for dominant
160 ideologies that, in turn, shape institutions more directly (see the theoretical framework developed in Chapter 3).
Importantly, power relations are also strongly influenced by culture in Japan. Power tends to be concentrated in the hands of managers (and ‘insider’ boards) for two key cultural reasons. Firstly, the prevalence of the cultural value of ‘paternalism’ means that the moral duty of managers rather than legally-enforced labour representation (as in Germany) tends to be relied on for the welfare of employees. Many Japanese workers do belong to enterprise unions and there are yearly rounds of enterprise bargaining that do give some structural power to workers but enterprise unions are often co-opted by management (as they are usually sponsored by the firm itself) and thus employees of Japanese public firms do not possess nearly as much power as employees in German public firms – who have strong legal rights of ‘co-determination’. Secondly, dispersed shareholders are generally considered ‘outsiders’ vis-à-vis the ‘enterprise community’ and this ‘outsider’ status combines with negative cultural attitudes towards ‘money-mindedness’ to put shareholders towards the bottom of the corporate hierarchy. This is ensured largely through informal institutions and practices that bypass relatively strong shareholder rights in formal law (which was mostly written by the American Occupation after WWII and is preserved partly to attract foreign investment). These cultural approaches and patterns thus concentrate power in the hands of managers and ‘insider’ boards in Japanese public firms. This does not necessarily mean, however, that distributional outcomes exclusively reflect the interests of managers. As I describe later, Japanese managers are known to forego higher pay in the name of protecting the employment of ‘regular’ employees and are also known to abide by a wider expectation that the dispersal in pay between workers and managers should not be too large (in contrast to the US). They also consider themselves the custodians of the enterprise community charged with ensuring its ‘permanence’. In this way, unlike in the contemporary Anglo-American system, where managerial power generally translates into higher managerial pay (through higher shareholder payouts) at the expense of workers in the context of an individualistic, competitive, and liberal culture, managerial power in Japan has more collectivistic and egalitarian implications for distributional outcomes in the context of a distinct paternalistic and communitarian culture. In fact, as I will elaborate, German managers have been found to be more individualistic and liberal-minded than Japanese managers (but still less so than Anglo-American managers), meaning that stakeholder-orientation in German public firms depends more on legal enforcement (i.e., co-determination laws).
161 The rest of the chapter is structured as follows. Firstly, I examine the relative lack of (formal) institutional constraints and incentives in Japan that prompt managers to focus on ‘shareholder value’ – particularly, the relative lack of hostile takeovers and share-based managerial pay. Then I address other important proximate factors that, in general, militate against ‘shareholder value orientation’ in Japan in favour of employee orientation, focussing on informal institutions (norms). I then turn to investigating the cultural and historical roots of Japanese capitalism, which will give us a better sense of the potential for short-termism in Japanese capitalism. The cultural and historical analysis will also tell us why Japanese capitalism has not changed much in practice even though it has been liberalised since the 1980s. This is followed by the empirical findings. I present findings relating to both shareholder payout and real investment while also presenting longitudinal findings on convergence (or lack thereof). I find that shareholder payout is much lower in Japanese public firms than (matched) Anglo-American firms and lower even than (matched) German public firms. On the other hand, real investment is the opposite: it is lower in Japanese public firms than its Western counterparts. Nevertheless, when it comes to the gap between shareholder payout and real investment, Japanese public firms tend to spend more on real investment than shareholder payout compared to Anglo-American public firms – indicating that Japanese firms are less short-termist. Also, I find that Japanese public firms continue to diverge from their Anglo-American counterparts in shareholder payout as well as the gap between real investment and shareholder payout. In the concluding section, I make an ‘educated guess’ about the future of Japanese capitalism.
Proximate factors
Hostile takeovers
We saw in the last chapter that the threat of hostile takeovers is much weaker in Germany than in the US and the UK, freeing German managers from the pressure of having to focus incessantly on short-term shareholder value like US and UK managers. We also saw that the low threat of hostile takeovers in Germany is largely due to extensive cross-shareholding among public firms, which makes it much harder for ‘corporate raiders’ to secure the large number of shares needed to control a firm. This also used to be the case in Japan: “…in the 1960s, when the prospect of capital liberalization raised fears of wholesale takeovers by powerful American firms, a pattern of cross-shareholding was developed” (Dore, 2000, p. 34). These shareholding networks were part of enterprise groups called ‘keiretsu’, many of
162 which were based neither on common ownership (e.g., family ownership) nor on vertical integration (e.g., customer-supplier relations) but were rather horizontal groupings “cutting across sectors” (Hall & Soskice, 2001, p. 34). This idiosyncratic feature of Japanese capitalism, according to Yamamura (1997, p. 341), cannot be explained by economics alone:
Many economists seek the reasons for this horizontal grouping in purely economic terms. Their efforts, however, cannot be successful unless it is realized that, in the final analysis, these keiretsu are based on Japanese group-orientation and the need to identify themselves within a group.
These horizontal keiretsu had roots in the family-owned zaibatsu of the pre-war period, which were broken up and ‘democratised’ by the American Occupation through the stock market. In addition, managers of the zaibatsu were also removed.
However, the bursting of the “bubble economy” that had built up in the 1980s due to easy lending, prompted tighter regulations on banks in the 1990s that forced them to sell their shares in Japanese firms, triggering a wider unravelling of cross-shareholding (Vogel, 2006, p. 23). This unravelling of cross-shareholding, according to Culpepper (2010, p. 116), “was not an intentional decision, on the part of either companies or government officials” but was rather brought upon them “by the short-term challenges posed by the economic crisis”. Regardless, the average stable concentration of shareholding in Japanese public firms fell from 38 percent to 27 percent between 1997 and 2006, compared to a much smaller decrease from 48 percent to 45 percent in German public firms in the same period (see Culpepper, 2010, p. 37). Remarkably, despite the collapse in stable shareholding (cross-shareholding), there have been fewer hostile takeovers in Japan than in Germany, even though Japan hosts a much larger stock market (Jackson, 2005b; Vogel, 2018a). Germany’s stock market represents 4 percent of the world stock market capitalisation whereas the Japanese stock market accounts for 13 percent, the second largest in the world – behind the US (47 percent) but ahead of the UK (8 percent) (Kim et al., 2005). The Japanese system, therefore, could be considered more divergent from the Anglo-American system than even Germany when it comes to the ‘market for corporate control’ (i.e., hostile takeovers) – see Table 6.1. And this has not changed in the two decades following unprecedented liberalisation around the turn of the century. Vogel (2018, p. 95) reports that, given the general lack of interest in hostile takeovers in Japan, “the legal structure for a market for corporate control is still not in place”.
163 Table 6.1. Average voting share of largest single shareholder (2004) and of stable shareholders (2006); hostile takeovers completed and attempted (1990-2007). Source: Culpepper (2010)
Largest shareholder Stable shareholders’ Hostile takeovers voting share voting share Completed Attempted Germany 35% 45% 3 5 Japan 17% 27% 1 4 UK 10% 12% 45 97 USA 11% 8% 55 162
A financial system like that of Japan, where the legal code is relatively friendly to investors, where cross-shareholding is not strong, and where the stock market is increasingly becoming a barometer of performance and prestige, should be fertile ground for hostile takeovers (Miyajima, 2007). Indeed, in order to “avoid charges of being heisateki (clannishly exclusive) from the foreign investment community”, Japanese bureaucrats have bent over backwards since the 1980s to ensure that “company law is based on an international standard [of] shareholder sovereignty”, whereby firms can, in principle, only reject hostile takeovers on the basis of shareholder interest (Dore, 2009, pp. 134, 140). Why then have there been so few hostile takeovers in Japan? To be sure, Japanese firms have at their disposal various takeover defences; but US firms have similar defences too, as Japan’s takeover laws are based on the same “Delaware standard” that is available to US firms (Culpepper, 2010, p. 27; Hayakawa & Whittaker, 2009).
One of the key reasons for the lack of hostile takeovers is, simply put, the “norm against hostile takeovers in Japan”, which inhibits both financial and non-financial firms from attempting unsolicited takeovers of Japanese firms (Culpepper, 2010, p. 122). Dore (2007, p. 388) reviews existing deterrents to hostile takeovers in the Japanese system and concludes that “[s]till the major protection is ‘the business culture’” and, given the entrenchment of this culture, “fear of takeover seems not yet to be a widespread factor in management decision- making”. Moreover, this norm or culture is not limited to the corporate sector. Vogel (2018, pp. 95-96) observes that “the courts [in Japan] have supported takeover defences in several key cases [and] this has deterred hostile takeover attempts in subsequent years” (see also Hayakawa & Whittaker, 2009). Furthermore, the Ministry of Economics, Trade and Industry (METI) has actively sought to help firms fight hostile takeovers by “put[ting] together
164 guidelines for the implementation of hostile takeover defences, arguing that Japanese firms needed a proper mechanism to defend themselves against hostile bids” (Ahmadjian & Okumura, 2011, p. 257). Although official support is helpful in maintaining the norm against hostile takeovers, it is the powerful peak employer association in Japan, ‘Keidanren’, that is the chief enforcer of the norm. In a speech on behalf of ‘Keidanren’, the CEO of Canon expressed the following:
Any decent executive will think that the company belongs to its employees, to its customers, and to serve the local community and society. At least in Japan they will…They will not entertain the thought of M&A for profit of the moment. Whether it be foreign or domestic capital, we should not tolerate raiders who destroy the public essence of companies and become a nuisance for honest shareholders. They should be shut out of the market. The Nippon Keidanren [the peak employer association] will not shirk from this task. (Inagami, 2009, p. 176)
‘Keidanren’ overpowered foreign investors who were seeking to influence the METI guideline – which would set the standard in Japan – by taking advantage of its close ties with METI and made sure the guideline adopted “the principle that not all takeovers were to be allowed in the new regime of corporate control…[especially those based on] the market logic of maximizing shareholder value.” (Culpepper, 2010, p. 138). In this way, “[m]oves toward creating a ‘market’ for corporate control in Japan have been fiercely resisted” (Hayakawa & Whittaker, 2009, p. 89).
Although “a new era appeared to be dawning” in Japan with extensive liberalisation from 1997 to 2003 and with unprecedented hostile takeover attempts in the wake of such liberalisation, it turned out to be a false dawn for investors, who had underestimated the staying power of the Japanese ‘business culture’ and the attendant sentiment against ‘shareholder value’ (Hayakawa & Whittaker, 2009, p. 70). Besides hostile takeover attempts, even shareholder activism – extracting shareholder value through ‘voice’ – has largely failed in Japan, “[d]espite the strong formal rights of shareholders under Japanese law” (Jackson, 2005a, p. 129). Vogel (2018, pp. 93-94) recalls that institutional investors “achieved modest returns from activist strategies in the early 2000s, but their efforts subsequently stalled. Moreover, [they] failed in their broader effort to reorient the business strategies of the target firms”. Buchanan, Chai, and Deakin (2020, p. 43) empirically show that hedge fund activists who had been successful in their strategies of extracting shareholder value in the US failed to do so with such activism Japan: Compared to similar Japanese firms that were not hedge fund targets, activist target firms did not improve any of the standard measures of ‘shareholder
165 value’ – shareholder payout (dividends), return on assets, return on equity, reduction of cash reserves, reduction in long-term investment, higher labour productivity and greater wage intensity. On the contrary, the target firms of activist funds performed worse in terms of stock market valuation than non-target firms. For Buchanan et al. (2020, p. 45), the result of shareholder activism in Japan has generally been the opposite of the US because “the principle of managing a company primarily for the benefit of shareholders was simply not acceptable to public opinion” (see also Gotoh & Sinclair, 2017). In fact, the sudden rise in aggressive investor behaviour (largely from foreign investors) in the early and mid-2000s actually “encouraged firms to rebuild cross-shareholdings to ward off the threat of hostile takeover bids”, especially as the economy had finally started showing signs of recovery (Araki, 2009, p. 225). “Cross-shareholdings decreased up to 2005, but bounced back in 2006 and 2007” (Araki, 2009, p. 225). Therefore, compared to Anglo-America, the threat of hostile takeovers continues to be low in Japan because of both cross-shareholding and the norm against hostile takeovers, enabling managers to focus on long-term “enterprise value”, a concept that is increasingly used in Japan “in deliberate contradistinction to ‘shareholder value’ to indicate a lingering attachment to the notion that Japan has a different gentler form of capitalism” (Dore, 2007, p. 389). This attachment to the “community firm” and the “lack of general acceptance of the shareholder primacy model” were, according to Buchanan et al. (2020, pp. 36, 47), only reinforced by the financial crisis of 2008: the legitimacy of the US model evaporated, liberalisation pressures eased, and the long-time defenders of the Japanese model felt vindicated. Indeed, as Gotoh and Sinclair (2017, p. 1043) note, an “anti-neoliberal backlash” since the late 2000s has ensured that Japan remains “anti-liberal” and “anti-free market”.
Managerial pay
Besides hostile takeovers and shareholder activism, share-based managerial pay schemes – especially stock options – have been central to the entrenchment of ‘shareholder value orientation’ in Anglo-American firms and to the accompanying short-termism (see chapters 1 and 2). In Japan, stock options were deregulated in 1997 and further liberalised in 2002 during the liberalisation frenzy of the ‘lost decade’ (Miyajima, 2007). However, “actual usage of stock options is still rather limited”, with 43 percent of firms indicating “no intention to introduce [stock options]”, compared to the 30 percent who say they plan to introduce them or have already done so (Miyajima, 2007, p. 332). Jacoby (2005, p. 147) finds
166 that, whereas 97 percent of US firms use stock options, only 19 percent of Japanese firms use them; and a further 10 percent consider using them.57 Moreover, “when Japanese companies do offer stock options, they account for a trivial portion of total compensation” (Jacoby, 2005, p. 147). Similarly, Vogel (2018a, p. 99) reports that, although some Japanese firms have “allocated stock options to top executives,…the coverage and the scale of these allocations [remain] modest in comparison to the United States”. Hence, like German firms, Japanese firms utilise share-based managerial pay – particularly stock options – only sparingly compared to US and UK firms.
In fact, even the overall remuneration of the average Japanese manager tends to be quite low by Western (including German) standards (Jacoby, 2005; Vogel, 2006). The disparity between managerial pay in Japan and the US, for example, is illustrated by the fact that, in 2012, the CEO of Toyota earned $2m whereas the CEO of Ford earned ten times that amount ($21m); even the CEO of General Motors, who was the lowest-paid of the top 200 highest-earning CEOs in the US, earned five times that amount ($11m), which, in turn, was higher than the $10m earned by the highest-paid CEO in Japan – Carlos Ghosn of Nissan (Salazar & Raggiunti, 2016). Managerial pay in Japan is modest partly because managers are not seen as separate from employees in the way that Anglo-American managers are. Notwithstanding the functional hierarchy within the firm, managers are just as much a part of the ‘enterprise community’ as employees (Murakami, 1984; Whittaker, 2020). Dore (2000, p. 24) describes how, unlike in the Anglo-American system, where (often externally-hired) managers maximise their compensation package through extensive negotiation of formal contracts before their appointment,
[w]hen a Japanese CEO is appointed…with almost 100 percent probability from inside [the firm]…there is [little] negotiation…[a]s throughout his career, he would be paid by scales devised by the firm’s personnel office (representing a consensual view within the firm of a fair structure).
In this way, managerial pay schemes in Japan are little more than “extensions of those negotiated for junior managers by the [enterprise] union” (Dore, 2000, p. 25). Pay is more or less pre-determined according to the company-wide salary scale that extends from entry-level workers to the president of the company. The executive would have gradually climbed up that pre-determined pay scale while rising in rank from an entry-level position at a pace that too would have been structured according to age seniority (Dore, 2000). The firm’s
57 Jacoby (2005) surveyed 229 Japanese public firms and 145 US public firms (i.e., these many firms responded to the survey after surveys were mailed to all public firms in the relevant stock exchanges in each country).
167 “seniority-plus-merit wage [system]” – called ‘nenko’ – is usually based on a mix of age, rank, educational attainment, and achievement while skill-sets and job specifications are given little weight unlike in Western systems (Moriguchi & Ono, 2006, p. 155). Although the weight given to merit has grown in recent years, the pay structure still remains markedly distinct from the Anglo-American market-based system and even the German system – though to a lesser extent (Araki, 2009; Vogel, 2006; Whittaker, 2020).
There is an expectation in the ‘enterprise community’ that the wage dispersal between the lowest-paid workers and the highest-paid executives be kept to a reasonable and “ethical” level (Vogel, 2006, p.121). The salary of the company president (the highest executive position), for example, is on average 11.3 times than that of an entry-level graduate – a much lower ratio than the typical dispersion in Anglo-American firms (Dore, 2000). Moreover, Inagami (2009, p. 179) shows that executive remuneration and employee wages grew at “roughly the same rate” from 1960 until the early 2000s in large Japanese firms.58 In US public firms, by contrast, Lin and Tomaskovic-Devey (2013, p. 1301) find that growth in managerial pay has substantially outstripped growth in worker pay since 1970. Similarly, Bebchuk and Grinstein (2005) find that executive pay doubled between 1993 and 2003 in the US while worker pay stagnated. Salazar and Raggiunti (2016, p. 721) argue that “Japanese CEOs [are] paid considerably less than their American” counterparts because of the “the tying of executive pay to worker welfare in the context of a culture of intolerance towards excessive executive compensation”. Indeed, this assertion is confirmed by other experts on Japanese capitalism, who point to both egalitarian norms and a culture of “productivism [that] militates against” purely financial motives (e.g., Dore, 2000, p. 8; Jacoby, 2005; Vogel, 2006). In the absence of compelling ‘rationalist and materialist’ explanations for this disparity in managerial pay between Japanese and Western managers, Ahmadjian and Okumura (2011, pp. 252, 264) also point to the cultural factors behind this difference:
One element [of Japanese capitalism] that is unlikely to change significantly is CEO compensation. While American and European executives have been criticized for excessive compensation, CEO salaries in Japan have remained relatively modest. Social norms around pay levels remain strong, and CEOs of many companies seem to believe that claiming too much in compensation would be unethical and demotivating to employees. The relatively low pay of CEOs may also simply reflect the highly collective nature of Japanese management, and the fact that CEOs do not deserve
58 Executive pay outpaced worker pay for a brief period in the early 2000s, which Inagami (2009, p. 179) puts down to possibly “abnormal” figures.
168 disproportionate credit or blame for their companies’ performance. (Ahmadjian & Okumura, 2011, p. 264)
Keeping in line with such “relatively egalitarian distribution of rewards between regular employees and top managers, and the social norms associated with these”, managerial salaries are, in fact, the first to be cut or held back when a firm has to go through a period of wage restraint in Japan (Jackson, 2007, p. 306). Vogel (2006, p.121) reports that “[w]age increases from 1990 to 2004 varied inversely by rank, for both men and women, with the highest increases going to entry-level workers and the lowest increases going to senior managers”. He further observes that the ratio of wages for managers over entry-level workers actually fell “from 3.29:1 for men and 3.33:1 for women in 1990 to 3.12:1 for men and 3.05:1 for women in 2004” (Vogel, 2006, p.122). This is a world apart from the US system, where, instead of managerial pay being tied to worker pay in the name of equity, there is instead a “tying of executive pay to the pay of other ‘peer’ executives, engineering an upward leapfrogging game in CEO compensation” (Lin & Tomaskovic-Devey, 2013, p. 1289).
Social embeddedness in the ‘enterprise community’ Differences between Japanese and Anglo-American managers in regard to short-termism are also related to the extent of ‘social embeddedness’ in the firm. Being socially embedded in the firm can act as an affective and normative constraint against short-termism as long-term familiarity with its people and identification with the firm itself tends to instil an interest in the long-term health of the firm and a sense of duty towards the firm community (Boivie, Lange, McDonald, & Westphal, 2011; J. P. Meyer & Allen, 1991). If managers expect to remain in the same firm for a long time, there is an added rational constraint against short- termism as well. We saw in the previous chapter that Anglo-American managers – many of whom are externally-hired ‘outsiders’ – tend to be less socially embedded than German managers and also tend to have shorter expected tenure. Japanese managers, it is fair to say, are even more socially embedded than German managers and have even longer expected tenure. Dore (2000, p. 24) describes how the career track of Japanese managers within the firm does not end after becoming the “executive managing director”: the next step is the ‘vice-president’, followed by a four-year term as ‘president’ (when company privileges become lifelong), after which comes the position of ‘chairman’, and finally the lifelong position of ‘advisor’. Aspirationally at least, careers in the same firm can thus be truly lifelong in Japan. Moreover, Dore (2007, p. 391) notes that “[i]n large Japanese companies…there is no sign of any fundamental change in the bureaucratic career patterns
169 which have become so firmly conventionalized”. German executives, on the other hand, tend to move on to positions outside the firm after retirement – such as senior positions in employer associations (Jackson, 2005b; Vogel, 2006). Anglo-American mangers, in contrast, rarely last long even in the managerial position, both because of a highly active ‘market for executive talent’ and because shareholders – who strongly influence hiring and firing – tend to be rather impatient (Jenter & Kanaan, 2015; Mizruchi & Marshall, 2016).
Japanese managers are also likely to identify more strongly with the ‘enterprise community’ than German and (especially) Anglo-American managers (Araki, 2009; Witt & Redding, 2009; Yamamura, 1997). Firstly, it is extremely rare for Japanese firms to hire executives externally. In fact, even after the liberalisation frenzy around the turn of the century, Dore (2007, p. 394) notes that there is still “no sign of the development of an external labor market for executive talent”. Secondly, most managers would have started at the entry-level graduate position as mid-career hiring is also rare for management-track careers (Dore, 2000; Jacoby, 2005). This means that by the time managers are appointed, they would have spent a good portion of their lives within the same enterprise community. In their long career leading up to the management position, they would have been systematically rotated through several departments and branches of the firm and given various roles – which would have served to develop firm-specific knowledge, internalise the distinct company culture, and strengthen identification with the ‘enterprise community’ (Jacoby, 2005; Streeck, 1996). They would have also gone through “socialisation programs” as new employees and would have eventually come to internalise what Sugimoto (2014, pp. 98-99) calls “the family metaphor”:
An enterprise expects its employees to cultivate close internal relationships, develop family-like warmth and order, and regard the company as a centre of their lives, more important than their own families. Intriguingly, when speaking of their company to outsiders, many employees call it uchi (our house or home) …Whether one calls such immersion complete commitment or total exploitation, this Japanese management technique focuses on moralistic indoctrination…Within this framework, corporations invest heavily in socialisation programs for their employees.
Further down the career path they would have gone through several “resocialization sessions…for low and middle managers” (Sugimoto, 2014, p. 99). Neither their German counterparts nor their Anglo-American counterparts would have gone through such ‘socialisation’ processes and ‘moral indoctrination’ programs – indeed, it is doubtful they would have accepted it, say Streeck (1996) and Dore (2000). Japanese workers have long been accustomed to “moral” education and training being administered upon them by
170 “paternalistic” managers and bureaucrats, to an extent not seen in the West (Dore, 2010; Kinzley, 2018, pp. 3-5; Yamamura, 1997, p. 346). Therefore, while the social embeddedness of German managers develops largely from the long time spent at the firm and the attendant familiarity with the firm and its people, the embeddedness of Japanese managers tends to involve added affective and normative dimensions that are deliberately cultivated over many years. “Generalist” Anglo-American managers, on the other hand, tend to be both aloof from “shop-floor workers” (with the cultural class distinction being particularly sharp in the UK) and generally unfamiliar with the “shop floor” itself – unlike in Japan, where managers tend be closely acquainted with the shop floor and just as much a part of the ‘enterprise community’ as the shop-floor workers (Dore et al., 1999, pp. 103-106).
The ‘employee-favouring’ manager Strong social embeddedness of Japanese managers in the firm community translates into a concern for the employees who make up the ‘enterprise community’. As Dore (2000, p. 10) observes: “[T]he stakeholder which is of overwhelming importance to a Japanese manager is the community of sha-in, the ‘members of the enterprise community’: the firm’s regular employees who, like himself, joined the firm, mostly at a very early age”. Japanese managers, having experienced it themselves, are thus defenders of Japan’s famous “lifetime employment”59 – which most Japanese public firms (80 to 90 percent) say they are still committed to despite chronic economic stagnation (see Araki, 2009; Jackson, 2007, p. 282). Management’s commitment to (especially regular) workers and their ‘lifetime employment’ is demonstrated by the fact that Japanese managers often do their utmost to protect employment, laying off workers only as an absolutely last resort (see Boyer, 2014). Vogel (2006, p. 116) reports that Nissan’s “Revival Plan” of 1999 was “one of the most aggressive restructuring schemes in recent Japanese history, yet even Nissan managers did not consider laying off workers”. He quotes an executive from NEC – which also had aggressive restructuring plans – as saying: “We could not lay off workers in Japan. This is not due to the law, but to social responsibility. We have 150,000 workers, and most of them have families. We have to think about them” (Vogel, 2006, p. 116). Though laws against dismissals are relatively strong in Japan (especially in court precedents and rulings), they are less a cause of
59 “Lifetime employment” does not simply refer to the duration of employment (i.e., long-term employment) but also everything that goes with it like “biannual bonuses, housing and family allowances, health insurance and pensions, retirement benefits, and medical, athletic and recreational facilities” – i.e., “corporate welfarism” that is one of the most generous in the world (Moriguchi, 2000, p. 64). The duration of employment itself is nevertheless the most important aspect of ‘lifetime employment’ as everything else depends on it, of course (Jackson, 2007; Vogel, 2006).
171 strong employment protection and more a reflection of wider “expectations [and] social norms” (Moriguchi & Ono, 2006, p. 162).
To be sure, large Japanese firms tend to prioritise their “regular employees” when it comes to employment protection, with both “management and enterprise unions see[ing] nonregular employees as ‘shock absorbers’ against fluctuating economic circumstances” (Araki, 2009, p. 239). Unsurprisingly, therefore, economic stagnation since the early 1990s has triggered a substantial rise in non-regular workers with public firms being forced to recruit many more fixed-contract and part-time workers – who also get fewer benefits – at the expense of hiring more ‘regular’ workers (Sako & Kotosaka, 2012; Sugimoto, 2014). Gordon (2017) reports that while the total number of ‘regular’ workers in Japan remained constant from 1982 to 2012 at around 33 million – attesting to their steadfast protection by firms – the number of ‘non-regular’ workers tripled in the same period from 7 million to 20 million. ‘Dualism’ is thus very much part and parcel of the Japanese system and has been the go-to method – along with voluntary early retirement – of protecting ‘lifetime employment’ for regular employees since at least the 1930s (Moriguchi, 2000; Moriguchi & Ono, 2006). In this sense, the institutionalised methods of protecting ‘core’ employees are no different than in post- reunification Germany (see the last chapter). Importantly, what distinguishes Japanese capitalism from Anglo-American capitalism, however, is that public firms give primacy to employment protection – including the protection of non-regular employees – rather than to ‘shareholder value’. Although they prioritise the protection of regular workers, firms nevertheless aim to protect the employment of non-regular workers as well; though they do not go to the same great lengths for non-regular workers as they do for regular workers (see Boyer, 2014). Jackson (2005b, p. 424), for example, finds that Japan had the lowest rate of “employment adjustment” out of the dozen countries studied (including US, UK, and Germany); plus, Japanese firms were only 32 per cent as likely as US firms to cut employment by 10 percent or more in 2001 while German firms were 56 per cent as likely (as US firms). Furthermore, among the Japanese firms that engaged in employment adjustment, the adjustment was “overwhelmingly benevolent” in that “54 per cent of reductions were by early retirement, 29 per cent by hiring freeze, 5 per cent by transfer, another 5 per cent by spin-off, and only 4 per cent through layoffs” (Jackson, 2005b, p. 425). It is a testament to the employee-oriented approach of Japanese firms that the unemployment level in Japan, even during the worst years of the ‘lost decade’, barely crossed 5 percent:
172 Japanese firm practices imply that corporations have absorbed some of the cost of economic stagnation, with the net effect of preserving employment at relatively high levels. Unemployment rose steadily from 2.1 percent in 1991 to 5.5 percent in 2003 (compared to 6.0 percent in the United States and 9.5 percent in Germany) before dropping off to 4.7 percent in 2004. Yet Japan’s unemployment rates remained remarkably low given its dismal economic performance during this period. (Vogel, 2006, pp. 119-120)
In fact, despite economic stagnation, “average job tenure for regular workers actually increased from 10.9 years in 1990 to 12.1 years in 2004” (Vogel, 2006, p. 119).
The stakeholder-orientation of Japanese managers is often thought to be similar to that of German managers (e.g., Gospel & Pendleton, 2003; Hall & Soskice, 2001). Distributional outcomes are indeed more favourable for stakeholders in both Japanese and German firms when contrasted to outcomes in Anglo-American firms (as we will see later). Relative similarity in outcomes, however, does not necessarily mean similarity in managerial attitudes, beliefs, and preferences – especially given that German managers are compelled to be stakeholder oriented by powerful employees in a way that Japanese managers are not (see Araki, 2009, p. 224; Dore et al., 1999; Jackson, 2005b). Witt and Redding (2009, pp. 867, 875) find through “ethnographic interviews” of German and Japanese managers that there are indeed “more differences than similarities in terms of executive rationale”. German managers are notably more market-friendly and “considerably more positive about flexibility and liberalization in the labor market than their Japanese counterparts” (Witt & Redding, 2009, p. 876). In another similar study, Witt and Redding (2011, p. 122) find that, more so than German managers (and much more so than American managers), Japanese managers see the well-being of employees as the “the raison d’eˆtre of the firm”. Japanese managers were also unique in subscribing to “the idea of permanence of the company” – taking a (very long- term) generational view of the firm (Witt & Redding, 2011, p. 117). Furthermore, “Japanese executives were most emphatic about the need of firms to contribute to and be accepted by society (Witt & Redding, 2011, p. 121). These attitudes and beliefs of Japanese managers have deep historical-cultural roots:
This emphasis on the usefulness of the firm to society is reminiscent of Tokugawa-era management thought among Japanese merchant houses. Under the Tokugawa shogunate (1603–1868), merchants were under pressure to justify the value of their activities to society, and merchant house constitutions consequently underscored the importance of working for the public good. (Witt & Redding, 2011, pp. 121-122)
173 As I will elaborate below, this pressure on business derives from the social stigma against money-mindedness in Japan that was particularly pronounced during the Tokugawa era but still survives today. Relatively modest managerial pay and the dedication of managers to non- financial ‘moral’ goals – such as employment protection – can also be seen to be partly influenced by this stigma. Other cultural factors such as group-orientation and Confucian ethics have also long influenced managerial ‘rationale’ in Japan (Hazama, 1992). In fact, the many social and cultural constraints of Japanese capitalism outlined above are similarly rooted in the cultural history of Japan. I will now delve into enduring cultural values and beliefs in Japan that are related to the various features of Japanese capitalism discussed thus far. Such cultural values and beliefs have certainly changed over time but they have done so more in form (application) than in substance (essence) (Yamamura, 1997). These enduring cultural values and beliefs will help paint a clearer picture of the dominant business ideology in Japan – by exposing its cultural roots – and thusly give us a sense of the core institutional logics of Japanese capitalism. This, in turn, will enable us to judge the potential for short- termism in Japanese capitalism.
The historical-cultural roots of Japanese practices and norms In Japan’s path to capitalist modernity, there were many crossroads where multiple equilibria were possible, and the roads that were taken – consciously or unconsciously – were often those that would not have been taken in the US, the UK, or Germany. As deep-rooted cultural values and beliefs partly influenced the choices made, by determining the social legitimacy of each possible choice, modern Japanese capitalism ended up being quite distinct from contemporary Western (especially Anglo-American) capitalism (Lehmbruch, 2005). Indeed, Peter Berger (1988) thinks that Japan might have defied the long-held assumption that capitalist modernity and individualism go hand-in-hand and that it might have even produced an alternative collectivistic version of capitalist modernity.
Japan and the West (Germany, UK, and US) have origins in distinct “mother” civilisations: the ancient Sinitic/Confucian civilisation in the case of Japan and the ancient Greco- Roman/Christian civilisation in the case of Germany, Britain, and America (Hamilton & Biggart, 2001; Inglehart & Baker, 2000; Murakami, 1984, p. 289). Moreover, unlike most of its Asian neighbours, no part of Japan was ever colonised by a foreign power (Murakami, 1984). Therefore, Japan was arguably more culturally, institutionally, and structurally independent from the West at the commencement of industrialisation than any other (large)
174 nation has been. Even Western influence in Japan was negligible just before the start of industrialisation – it had, after all, been closed off to the outside world for over 200 years (Varley, 2000). As Inglehart and Baker (2000, p. 49) show, “a society's cultural heritage” tends to leave unmistakeable imprints on capitalist modernity through ‘path dependence’. It would thus be fair to say that Japan’s distinctive cultural heritage has had a major influence on its modernisation. In this sense, Japan’s divergence from the Anglo-American system has an added cultural layer compared to Germany’s divergence from the Anglo-American system. I look below at some of the key aspects of Japan’s cultural heritage (as far as short- termism is concerned).
Profit with purpose
Firstly, I will look at the generally low opinion of money-mindedness and profit-making for its own sake in Japan. Dore (1997, p. 29) notes how, in Japan, “[s]pending one’s life in the speculative purchase and sale of financial claims is [considered] bad”. When the CEO of a global company like Canon publicly – and on behalf of the peak employer association – calls hedge funds a “nuisance” and strongly censures them for obsessing over the “profit of the moment” and undermining the “public” nature of corporations, he is echoing a long-held view in Japan that money-mindedness and ‘profit without purpose’ are reprehensible (Inagami, 2009, p. 176). This attitude against money-mindedness can be traced back to at least the Tokugawa era (1603-1868) and its official caste system (Varley, 2000). Hunter (2006, p. 61) notes that “social appraisal of commercial activity and profitmaking was a relatively negative one, as members of the merchant class had been designated as the lowest of the four main strata of Tokugawa society”. Commerce and the pursuit of profit were considered “a degrading and generally parasitic way of life”, especially by the elite samurai, who were indoctrinated in the anti-individualistic and anti-commerce doctrine of Confucianism (Hazama, 1992; Moore, 1993, p. 237). Members of the elite caste – the samurai – were thus neither inclined nor allowed to engage in any kind of productive activity (Kinzley, 2018; Varley, 2000). Such restriction continued even as many samurai became impoverished (partly) due to a lack of military activities during the peaceful Tokugawa period (1603-1868) while merchants, who supplied the loans to sustain the increasingly extravagant lifestyles of the idle samurai, became rich (Moore, 1993). There was thus a remarkable contrast in Tokugawa Japan where much of the highest caste was relatively poor and many in the lowest caste were relatively rich (Varley, 2000). This also meant that status and prestige came to be associated less with wealth and more with (Confucian) education,
175 which the Tokugawa shogunate had strongly urged the samurai to pursue – which they did (Dore, 2010; Morishima, 1984).
Compared to the Japanese elite, members of the English nobility had embraced commerce and profit-seeking well before the industrial revolution; since at least the fifteenth century (Moore, 1993; Polanyi, 1957). Comparing the social standing of the bourgeoisie in Prussia and England, Moore (1993, p. 37) observes: “In nineteenth-century Prussia the members of the bourgeoisie who became connected with the aristocracy generally absorbed the latter’s habits and outlook. Rather the opposite relationship held in England”. Nevertheless, even if business was not embraced as in in England, it was not seen in a negative light in Germany (Prussia) like it was in Japan – hence the connection with the aristocracy (Lehmbruch, 2005). In America, commerce was championed from the very outset and industrialists were seen as “folk heroes” (Dore, 1997, p. 29; Moore, 1993). As Morishima (1984, p. 91) notes: “In America money-making was one of the most effective methods of achieving social respectability, but in Japan…people were well aware of the trade-off relationship between money-making and social respect”.
In light of the low status of commerce in Japan, prominent capitalists felt compelled to publicly declare the moralistic and nationalistic purpose of business (Hunter, 2006; Kinzley, 2018). Government bureaucrats and capitalists alike “agreed that factories should be a moral community, and industrialists were under pressure to demonstrate this to legitimize capitalism in the new order” (Whittaker, 2020, p. 384). In spite of such efforts, the stain on commerce and money-mindedness largely persisted, nevertheless. While capitalists had become the social and political elite in Anglo-America by the early twentieth century, “the business class was still socially and politically inferior to the elite that ruled Japan…The social stigma on business continued…[and capitalists kept] fighting the battle against aristocratic anticommercial attitudes” (Moore, 1993, p. 288).
Anti-commercial attitudes were palpable in the highly nationalistic period of the interwar years, when widespread and intense anti-capitalist sentiment prevailed on both sides of the political spectrum (Moore, 1993; Morishima, 1984). As Moore (1993, p. 290) points out, “anti-capitalist radicalism was a major component in the Japanese version of fascism while in Germany it was no more than a secondary current” (see also Dore et al., 1999). To be sure, Japanese employers, “to appease the critics of huge profits earned during the First World War, [voluntarily] instituted numerous welfare and fringe-benefit programmes” but this was not enough to assuage the anti-capitalist fervour. When the government bureaucracy started
176 taking increasing control of the economy from the early 1930s with the advent of war, anti- capitalist sentiment turned into concrete action and shareholders were deliberately targeted: Dividends were controlled, shareholder representatives on corporate boards were replaced by employees (insider managers), and the stock market itself was shut down (Dore et al., 1999; Okazaki, 1994). In addition to institutional and structural changes, the economic ideology that increasingly became dominant involved the “rejection of the profit motive” (Lehmbruch, 2005). This is not to say that large shareholders were powerless: Their enormous wealth and political connections enabled them to gain many concessions out of the government during the wartime economy and they even profited from the war itself (Moore, 1993). The hammer blow for the shareholders, however, came after Japan’s defeat in the war, when the American Occupation – partly drawing from the widespread anti-capitalist sentiment that burst forth in a massive labour movement – confiscated the shares of large shareholder and ‘democratised’ them through the reopened stock market (Tabb, 1995). This was to be a defining moment in the history of Japanese capitalism. Japanese public firms turned into ‘employee favouring’ ‘enterprise communities’ with the removal of dominant shareholders (Dore, 2000; Dore et al., 1999).
Japanese business ideology and practice finally became congruent and coherent with the cultural background of anti-commercial attitudes (Ahmadjian & Okumura, 2011). Since then, the Japanese have mostly expressed pride – rather than antagonism – towards their employee- oriented business ideology and practice (helped in no small measure no doubt by its success at the world stage) and have been reluctant to change it towards the American shareholder model despite intense pressures from many sides (Araki, 2009; Buchanan et al., 2020; Gotoh & Sinclair, 2017; Tabb, 1995). Even Japanese managers, who would get a huge pay rise if they adopted the American model – with its stock options and share-based pay – continue to resist it (Culpepper, 2010; Inagami, 2009). And in so doing, they keep referring to the moral purpose of the firm and keep condemning the ‘shareholder value’ model based on the “profit of the moment”, just like Japanese managers did generations ago at the start of industrialisation (Inagami, 2009, p. 176; Lehmbruch, 2005). Shareholders may now have greater social legitimacy than merchants did during the Tokugawa era (although the difference was probably not that large until the 1990s) but money-mindedness and purely financial motives still irk the Japanese – including CEOs of highly globalised firms like Canon and Toyota (Ahmadjian & Okumura, 2011; Carr & Tomkins, 1998; Jacoby, 2005). As Gotoh and Sinclair (2017, p. 1038) note, “difficulties in promoting commercial morals”
177 persist in contemporary Japan, demonstrating a remarkable continuity of Tokugawa-era morality and cultural values (at least in this matter).
Vertical group structure and groupism
More broadly, Japan may be defined as a vertical group-hierarchy system where social identity and allegiance runs vertically – i.e., the Japanese tend to identify with their work group, enterprise union, company, enterprise group, and nation (Streeck, 2005). While this grouping may also apply to Western political economies at a cursory level, Western economies are better characterised as having “horizontal” (rather than “vertical”) integration, where identification and loyalties are along class lines and occupational, social, and religious categories that cut across firms, making for an active “civil society” – especially in Germany (Lehmbruch, 2005, p. 65). In the vertically-integrated Japanese society, on the other hand, identification with cross-society groupings is weak and, consequently, civil society is relatively weak as well (Lehmbruch, 2005; Streeck, 1996; Thelen & Kume, 2005). Instead, Japanese workers and managers tend to identify themselves with their organisation. Indeed, it is not at all uncommon for an enterprise union leader at a large firm (such unions being the predominant form in Japan) to go on to a managerial position within the firm; in fact, such union positions are often seen as training for a managerial role – usually in the human resources department of the corporation (Dore, 2000; Jacoby, 2005; Sugimoto, 2014).
The lack of horizontal identification and association in Japan is partly because of the relative homogeneity of Japan and partly because of a historically dominant social pattern called the ‘ie’ – ‘house’ – that was characterised by self-sufficient, independent, and solidaristic farmer- warrior groups distinct from social groupings in other major civilisations (Murakami, 1984; Streeck & Yamamura, 2005; Yamamura, 1984). In the ie, there was no strict division of labour between farmers and warriors like in other civilisations (Europe, China, India, etc.) and it was based on “fictitious kinship”, whereby status within the group was not closed off either by kinship or by occupation.60 In this sense, the ie was a “balance of two almost contradictory principles, homogeneity and functional efficiency” (Murakami, 1984, p. 312). Importantly, one of the central features of the ie group or community was its “collective goal
60 Although there existed an official caste system during the Tokugawa era (1603-1868), Murakami (1984) notes that many commoners were still able to secure positions in the prestigious state bureaucracy and, as Morishima (1984) points out, even intermarriage between the elite caste and the lower castes was common, especially when the members of the lower castes came from educated backgrounds (which many increasingly did over the period) – with education serving as the currency of status rather than caste itself, signifying more of a meritocracy – as per the dictates of Confucian orthodoxy – than a strict division of castes like in India (see also Dore, 2010).
178 of [the] ‘eternal continuance and expansion of the group’” (Murakami, 1984, pp. 302, 306). As with the ie, “Japanese companies have historically [also] placed top priority on their organisational survival and perpetuation…unlike American peers that focus on financial success and shareholder returns” (Gotoh & Sinclair, 2017, pp. 1037-1038). Indeed, Murakami (1984, p. 356) sees many parallels between the post-war Japanese public firm and the ie: “As we see it today, the Japanese management system is clearly a variant of ie-type organization”.
The historical dominance of the ie system could well be partly responsible for the prevalence of “group-orientation” in Japan that is commonly said to underpin the ‘enterprise community’ and the wider vertical group system (Murakami, 1984; Yamamura, 1997, p. 341). According to the stylised categories developed by Hazama (1992, p. 99), the Japanese model of capitalism (and the general social pattern in Japan) is characterised by “mutual-help groupism” while the Anglo-American model is characterised by “self-help individualism” and the German model by “mutual-help individualism” (see also Carr & Pudelko, 2006; Dore, 2001; Gannon & Pillai, 2015). In this sense, collectivism in Japan is of a different kind than in Germany, which is still ultimately based on individualism, though of a more collaborative sort than Anglo-American individualism (see Dore, 2000; Streeck, 1996, 2005). Of course, as Hazama (1992, p. 101) puts it, “[w]hen you have groupism…and an individual belongs to a plurality of groups, the problem arises of determining which of the groups one considers (or should consider) the most important”. For Hazama (1992), the distinguishing feature of Japanese groupism is that, unlike in China and Korea where the family generally comes first, followed by the firm, and then the nation, the ranking of groups in Japan is generally top-down, with the nation61 ranking highest, followed by the ‘enterprise community’, and only then the family. This easily lends to the kind of nationalistic and communitarian capitalism that prevails in Japan, where individual interest is equated with those of the firm and the nation (Dore, 2001; Hazama, 1992; Morishima, 1984).
Groupism is often accompanied by “ingroup bias” (Brewer, 1999, p. 429). In fact, Triandis (2018) shows that ingroup bias tends to be stronger in collectivistic societies like Japan than in individualistic societies like Anglo-America. As Brewer (1999, p. 429) notes, ingroup bias does not always mean hostility towards the outgroup but it does usually mean “preferential
61 The emperor, whose lineage is unbroken since ancient times and who is still seen as the direct descendant of the Shinto sun god – Amaterasu – is the symbol who brings out deep nationalism in the Japanese – with ultranationalism not uncommon even in contemporary times (Varley, 2000).
179 treatment of ingroup members”. Ahmadjian and Okumura (2011) and Dore (2000) point out that (dispersed) shareholders – especially foreign shareholders – are firmly in the ‘outgroup’ from the perspective of ‘insider’ managers and corporate boards of Japanese ‘enterprise communities’. Moreover, ‘universalism’ – which can potentially promote the recognition of the ‘rights’ of dispersed shareholders – is also one of the weakest in Japan among advanced economies, which is not surprising for a vertically-oriented society (Schwartz, 2007). In sum, therefore, both Japanese groupism and its vertical group-hierarchical system militate against ‘shareholder value’ in favour of employee and managerial welfare. In fact, Gotoh and Sinclair (2017, p. 1038) go as far as claiming that “the core of Japanese corporate governance [is] in-group favouritism”.
Confucian ethics
The “distinctiveness of Japan” also has to do with the cultural ideals of benevolence, loyalty, harmony, and paternalism, which are associated with Confucianism (Dore, 1987; 1997, p. 19; Kinzley, 2018). Confucianism has been the moral orthodoxy in Japan since at least the Tokugawa era, when the Tokugawa shogunate embraced it as the sole moral and intellectual doctrine – partly to reinforce its own hegemony given Confucianism’s focus on hierarchy, loyalty, and harmony (Dore, 2010; Varley, 2000).62 Moreover, the samurai – members of the official elite class – were strongly urged to pursue Confucian education in the absence of military activities during the peaceful Tokugawa era (1603-1868), which transformed their ‘warrior ethic’ into a ‘public service ethic’:
In ‘pacifying’ the samurai class Confucian education also modified its arrogance and contemptuous lack of concern for the welfare of the lower classes, and did do something to breed a sense of paternal responsibility [and a] ‘deep sense of the public interest’. (Dore, 2010, p. 300)
The Meiji ‘oligarchs’ and bureaucrats who would transform Japan through their efforts to technologically ‘catch up’ with the West were from this elite samurai class steeped in Confucian ethics, as were the managers of large enterprises, both state and private (Moore, 1993; Morishima, 1984; Varley, 2000). Samurai were made managers of large firms almost by necessity given the complexity of large firms and given that they were the only educated class at the time (Morishima, 1984; Westney, 2013; Yamamura, 1997). Confucian moral education was to be made compulsory for children only in the late 1800s (Dore, 2010). There
62 Confucianism had actually arrived in Japan as early as the sixth century (A.D.) and had even been incorporated into Japan’s first constitution and its first major social policy – the ‘Taika Reforms’ (which was a remarkably egalitarian land reform) – in the 600s (Morishima, 1984; Varley, 2000).
180 was thus initially a noticeable difference between large firms run by samurai managers and smaller firms run by uneducated entrepreneurs from ‘commoner’ backgrounds, with the samurai-managed firms often engaging in “industrial paternalism” and voluntarily providing welfare benefits and extensive training to their employees, even as workers (especially blue- collar) did not necessarily reciprocate with their loyalty until the 1920s (Gordon, 1988; Moriguchi, 2000; Yamamura, 1997, p. 345).
The insertion of Confucianism into Japanese capitalism was also a deliberate effort and it was done in conscious contrast to the liberal economic ideology of Anglo-America (Gordon, 1988; Lehmbruch, 2005; Tabb, 1995).
[P]olitical and social elites set out to and succeeded in creating a Japanese-style economic ideology built upon their understanding of the Japanese past and its moral ideas rather than upon Western notions of economic and organizational theory…The emphasis on harmony and moral community was tied to ancient assumptions of Confucian moral economy. Reformers and ideologues of the Meiji era and beyond consciously used Confucian moral language.…The morally based ideals of harmony and moral community. (Kinzley, 2018, pp. 3-5)
Let us now very briefly look at the core tenets of Confucianism. The foundational principle of Confucianism is that “the natural affection existing between relatives within one family [is] the cornerstone of social morality” and that it is only when “the natural human affection found within the family [is] extended freely beyond the confines of the family, both to non- family members and to complete strangers, that human nature [reaches] perfection and the social order [is] appropriately maintained” (Morishima, 1984, p. 3). This involves not only benevolence and harmony but also duty, loyalty, paternalism, and deference to seniors (by age) – as the hierarchy of the family that is based on mutual obligation also becomes the model of all hierarchical relations within society (Dore, 1987; Morishima, 1984; Yao, 2000). Such qualities espoused by Confucianism and internalised by generations of Japanese through education and socialisation, are reflected in everyday behaviour in Japan, including in business (Gannon & Pillai, 2015; Gotoh & Sinclair, 2017). While surface-level behaviours of the Japanese may not necessarily mirror their inner values and beliefs, especially given the well-understood distinction between the outer self (tatemae) and the inner self (honne) in Japan, as I have emphasised in Chapter 3, ‘objectivated’ national culture generally constrains behaviour regardless of inner beliefs and values (P. L. Berger & Luckmann, 1991; Schwartz, 2006; Sugimoto, 2014).
181 Comparing shareholder payout and real investment in public firms
Shareholder payout
I will now turn to my comparative empirical findings and discuss how they reflect the institutional features and culture of Japanese capitalism discussed above, which are centred around the business ideology of the ‘enterprise community’. Given their continuing concern for employee welfare, employment protection, and “the long-term value of the corporation”, Japanese managers unsurprisingly continue to focus more on product market share, sales growth, and employment itself as indicators of success than on ‘shareholder value’ (Inagami, 2009, p. 169). Indeed, Araki (2009, p. 247) reports from a survey that only 26 percent of firms indicated that they “paid special consideration to the shareholders in management decision-making”. While financialisation has already become entrenched in the Anglo- American system, it has been slow to spread in Japan (Fligstein, 2001). Jacoby (2005, pp. 145-147) finds from interviews and surveys of a large number of US and Japanese public firms that:
[T]he top department in the United States was finance, followed, in order by marketing, production, planning/strategy, and HR…Finance is not the top function in Japan, nor does it dominate HR [unlike the US]. Rather, the planning department, which specializes in corporate organization from a strategic rather than a financial perspective, holds the largest share of power, and its share is gaining. In other areas as well, no strong evidence exists to support claims of a trend toward financialization of corporate strategy in Japan.
One of the main ways that financialisation has prompted Anglo-American managers to boost shareholder value is through restructuring, by selling off less profitable departments and product lines, by contracting out many functions to less costly locations, and by downsizing and laying off workers in large numbers (G. F. Davis, 2013; Lazonick & O'Sullivan, 2000; Milberg, 2008). Of course, given the global nature of financialisation, there have also been pressures on Japanese employers to do the same, especially as many Japanese firms had overinvested during the ‘Bubble’ years of the 1980s when loans were both easy to obtain and were relatively cheap (Lechevalier, 2014; Vogel, 2018a). Where there have been shareholder pressures to restructure, however, Japanese firms have often made it “look as if they were cutting workers” by transferring them on to their subsidiaries or even creating ‘spin-offs’ or joint ventures for relocating workers (Vogel, 2006, p. 117). Unlike Anglo-American firms, which tend to adopt a strategy of laying off workers to boost ‘shareholder value’, Japanese
182 firms actually decrease shareholder payout when they have to reduce employment. Jackson (2005b, p. 423) points out that, in Japan, “very few firms [have] redistributed wealth by reducing employment while raising dividends”. On the contrary, firms usually pay “bonuses [that] are linked to the company’s overall profitability” (as well as performance and rank) – paid “twice a year [and] equivalent to 2-6 months’ salary” (Mouer & Kawanishi, 2005, p. 81). These bonuses – which all regular white-collar and blue-collar workers receive – are, in a sense, no different than dividends in that they are also discretionary, customary, and regular; and they are but one more indication of how Japanese firms are “employee- favouring” rather than “shareholder-favouring” (Dore, 2000, p. 9; Moriguchi & Ono, 2006). Indeed, as my empirical findings show below, shareholder payout in Japanese public firms is not only lower than matched US public firms and UK public firms but also matched German public firms – see tables 6.2, 6.3, and 6.4 below.
As Table 6.2 shows, dividends, share buybacks, and total shareholder payout are all substantially lower in Japanese public firms than in US public firms matched in firm size (total assets) and industry (GICS 8-digit code). Japanese firms pay, on average, 1.1 percent of their total assets as yearly dividends while US firms pay 1.6 percent. In dollar (PPP) terms, Japanese firms pay on average $26 million in yearly dividends compared to $63 million for matched US firms. The difference is especially pronounced in share buybacks: Japanese firms spend 0.4 percent of their total assets on buybacks per year whereas matched US firms spend 2.5 percent. In dollar terms, yearly buybacks are at $15 million for Japanese firms compared to $94 million for US firms. This enormous gap in buybacks is not because of difference in laws. Kim et al. (2005) note that share buybacks were liberalised in 1997 to an extent that buyback laws are now virtually the same as the US. Whereas Japanese firms required approval at shareholder meeting before 1997, they can now simply repurchase with board approval and there are no restrictions on the amount that can be approved (though buybacks cannot be made in the last week of the financial year). Disclosure requirements are however stricter in Japan than in the US, with details of buybacks required by the Tokyo Stock Exchange on the day of the purchase. This means that though Japanese firms may not be able to conduct buybacks as covertly as US firms, they are still just as free as US firms to buy back their shares. Given the large gap in buybacks and significant disparity in dividends as well, the total shareholder payout is much lower in Japanese firms than in matched US firms: 1.5 percent of total assets in Japan to 4.2 percent in the US. In dollar terms, yearly
183 shareholder payout in Japanese firms stand at $41 million per year while the amount for matched US firms is $157 million – close to four times that of matched Japanese firms.
Table 6.2. Shareholder payout in matched Japanese and US public firms, 2005-2017 (n=12,870 firm years of 990 matched firms). Source: author’s calculations from Osiris data. *p<.01 (t-test).
Japan USA Difference Scaled by total assets Mean 1.1% 1.6% Dividends -0.5%* (SD) (.01) (.03) Mean 0.4% 2.5% Share buybacks -2.1%* (SD) (.02) (.05) Mean 1.5% 4.2% -2.7%* Shareholder payout (SD) (.02) (.07)
In constant 2011 US$ (million)
Mean $26 $63 -$37* Dividends (SD) (208) (548) Mean $15 $94 -$79* Share buybacks (SD) (207) (977) Mean $41 $157 -$116* Shareholder payout (SD) (389) (1407)
The gap in shareholder payout is not as wide between Japanese public firms and matched UK public firms but it is nonetheless substantial – see Table 6.3. The amount paid in yearly dividends by UK firms is more than twice that of matched Japanese firms when measured as a percentage of total assets – 2.8 percent in the UK to 1.3 percent in Japan. In dollar terms, dividend payouts by UK firms are almost three times that of matched Japanese firms in dollar (PPP) amounts – $54 million in the UK to $19 million in Japan. In terms of share buybacks, UK firms and Japanese firms are more evenly matched: 0.5 percent in the UK and 0.4 percent in Japan as a percentage of total assets and $15 million in the UK and $7 million in Japan in dollar terms. Buyback laws are more restrictive in the UK than in Japan, requiring approval from shareholders (not just the board) and having tighter limits while also having equally cumbersome disclosure requirements (Kim et al., 2005). Overall, though, total shareholder payout in UK firms is double that of Japanese firms as a percentage of total assets – 3.5 percent to 1.7 percent – and more than double in dollar terms – $69 million to $26 million.
184 Table 6.3. Shareholder payout in matched Japanese and UK public firms; 2007-2017; n=3,256 firm years of 296 matched firms. Source: author’s calculations from Osiris data. *p<.01 (t-test).
Japan UK Difference Scaled by total assets Mean 1.3% 2.8% -1.5%* Dividends (SD) (.01) (.03) Mean 0.4% 0.5% Share buybacks -0.1%* (SD) (.01) (.02) Mean 1.7% 3.5% Shareholder payout -1.8%* (SD) (.02) (.07)
In constant 2011 US$ (million)
Mean $19 $54 -$35* Dividends (SD) (112) (297) Mean $7 $15 -$8* Share buybacks (SD) (69) (101) Mean $26 $69 -$43* Shareholder payout (SD) (389) (1407)
German firms are said to be just as stakeholder oriented as Japanese firms in much of the ‘varieties of capitalism’ literature (e.g., Gospel & Pendleton, 2003; Hall & Gingerich, 2009). However, this has not yet been verified through large-N comparison of public firms matched by size and industry. I have argued in this chapter that Japanese firms are even more stakeholder oriented – especially in terms of employee-orientation – than German firms, particularly in managerial preferences and beliefs. This is indeed confirmed by the results. As Table 6.4 shows, shareholder payout in German public firms is significantly greater than matched Japanese public firms.
As a percentage of total assets, shareholder payout in German firms is 2.5 percent compared to 1.4 percent in Japan. In dollar terms, German firms spend $166 million on shareholder payout compared to the $102 million that similar Japanese firms spend. This difference is explained by the gap in dividend payment. Annual dividends are 2.2 percent of the total assets of German firms while they are 1.0 percent of the total assets of matched Japanese firms. In dollar terms, German firms pay $127 million while Japanese firms pay $62 million in yearly dividends. In other words, German firms pay out double the amount that similar Japanese firms do in yearly dividends. When it comes to share buybacks, however, German and Japanese firms are indistinguishable: German firms spend 0.2 percent of total assets on
185 buybacks and Japanese firms spend 0.3 percent; in dollar terms, they spend $39 million and $40 million respectively. Share buyback regulation in Germany is even more restrictive than the UK in terms of approval, amount, timing, and disclosure, meaning that German firms are notably more constrained than Japanese firms in conducting share buybacks (Kim et al., 2005). The parity in buybacks despite the relative lack of restrictions in Japan is striking.
Table 6.4. Shareholder payout in matched Japanese and German public firms; 2007-2017; n=3,168 firm years of 288 matched firms. Source: author’s calculations from Osiris data. *p<.01 (t-test).
Japan Germany Difference Scaled by total assets Mean 1.0% 2.2% Dividends -1.2%* (SD) (.01) (.04) Mean 0.3% 0.2% Share buybacks 0.1%* (SD) (.02) (.05) Mean 1.4% 2.5% Shareholder payout -1.1%* (SD) (.02) (.04)
In constant 2011 US$ (million)
Mean $62 $127 -$65* Dividends (SD) (403) (547) Mean $40 $39 $1 Share buybacks (SD) (387) (474) Mean $102 $166 -$64 Shareholder payout (SD) (389) (1407)
To confirm that the national differences observed in shareholder payout were not simply the result of differences in profitability between firms, I conducted regression analyses for each of the three country comparisons controlling for a standard measure of profitability – ROA (return on assets) (cf. Asker et al., 2015). The results shown in Table 6.5 confirm that the aforementioned findings are robust to the consideration of profitability. Keeping profitability constant, shareholder payout as a percentage of total assets is 2.5 percent lower in Japanese firms compared to matched US firms, 1.6 percent lower compared to matched UK firms, and 1.0 percent lower compared to German firms – largely in line with the findings presented above. All differences are also statistically significant (p < .01). In sum, the findings together show that Japanese public firms are less shareholder oriented than (matched) German public firms, even less so than British public firms, and much less so than American public firms – as far as shareholder payout is concerned.
186 Table 6.5. Regression estimates for shareholder payout in Japanese public firms and matched US, UK, and German public firms respectively; 2005-2017 for the Japan-US sample and 2007-2017 for the Japan-UK and the Japan-Germany samples. Source: author’s calculations from Osiris data.
DV: Matched sample Shareholder payout (scaled by total assets) (1) Japan-USA (2) Japan-UK (3) Japan-Germany B (S.E.) B (S.E.) B (S.E.)
Japanese -.025* (.001) -.016* (.001) -.010* (.001)
Profitability (ROA) .151* (.004) .113* (.005) .004* (.001)
R2 .192 .237 .052 R2 change (Japanese) .038* .043* .024* No. of observations 12,870 3,256 3,168 No. of firms 990 296 288
*p<.01. Operating revenue growth (investment opportunities), year fixed effects, and industry fixed effects are included in all the models (not reported).
Real investment
Although the ‘comparative capitalism’ and ‘financialisation’ literatures tend to equate short- termism with ‘shareholder value’, the finance, business, and economics literatures tend view short-termism more directly in terms of real investment (e.g., Asker et al., 2015; Haldane, 2015). More specifically, for the latter, relatively lower real investment in firms indicates short-termism. In other words, the finance, business, and economics literatures are less concerned with whether corporate funds are used to pay shareholders or to protect employment in defining short-termism. Relatively lower real investment resulting from either shareholder payout or employment protection (or indeed wages and worker benefits) are deemed short-termism. With this in mind, let us now see where Japanese firms stand in terms of short-termism as defined by the finance, business, and economics literatures.
The findings show that real investment is significantly lower in Japanese public firms compared to matched US public firms but, at the same time, Japanese firms spend more of their funds on real investment than on shareholder payout compared to US firms (i.e., the gap between real investment and shareholder payout is greater in Japanese public firms) – see Table 6.6.
187 Table 6.6. Real investment in matched Japanese and US public firms; 2005-2017; n=12,870 firm years of 990 matched firms. Source: author’s calculations from Osiris data. *p<.01 (t-test).
Japan USA Difference Scaled by total assets Mean 1.9% 3.2% Gross investment (PPE growth) -1.3%* (SD) (.06) (.07) Mean 3.6% 5.0% Capital expenditure (capex) -1.4%* (SD) (.03) (.05) Mean 2.1% 0.8% 1.3%* Capex minus shareholder payout (SD) (.04) (.08)
In constant 2011 US$ (million)
Mean $42 $81 -$39* Gross investment (PPE growth) (SD) (573) (679) Mean $135 $138 -$3 Capital expenditure (capex) (SD) (1309) (941) Mean $94 -$18 $112* Capex minus shareholder payout (SD) (961) (1045)
Growth in property plant and equipment (PPE) – which includes business acquisitions – is 3.2 percent of total assets in US public firms compared to 1.9 percent in Japanese firms. In dollar terms, it is $81 million in US firms and $42 million in Japanese firms. Internally- focussed capital expenditure is also significantly greater in the US: 5.0 percent in US firms compared to 3.6 percent in Japanese firms. In dollar terms, however, US firms and Japanese firms are more evenly matched in capital expenditure: $138 in US firms compared to $135 in Japanese firms. This disparity in the two measures of capital expenditure indicates that larger public firms in Japan – who tend to be overrepresented in average dollar value measures – are more evenly matched with US public firms when it comes to capital expenditure. Notwithstanding lower real investment overall, the findings show that Japanese firms spend substantially more on real investment (capital expenditure) than on shareholder payout compared to similar US firms. As Table 6.6 shows, Japanese firms spend 2.1 percent more of their total assets on capital expenditure (capex) than on shareholder payout, while US firms spend 0.8 percent more on capital expenditure than on shareholder payout. In dollar terms, Japanese firms spend $94 million more on real investment (capex) than on shareholder payout whereas US firms actually spend $18 more on shareholder payout than on real investment (capex) – indicating that larger US public firms are more short-termist than smaller ones. Therefore, while Japanese firms appear to be more short-termist than US firms
188 when only real investment is considered, they actually become less short-termist than US firms when the gap between real investment and shareholder payout is used as the measure of short-termism. Similar differences, in fact, also exist between Japanese public firms and UK public firms – see Table 6.7.
Table 6.7. Real investment in matched Japanese and UK public firms; 2005-2017 for gross investment (n=3,848 firm years of 296 matched firms); 2007-2017 for the other measures (n=3,256 firm years of 296 matched firms). Source: author’s calculations from Osiris data. *p<.01 (t-test).
Japan UK Difference Scaled by total assets Mean 1.5% 2.7% Gross investment (PPE growth) -1.2%* (SD) (.05) (.07) Mean 2.8% 4.0% -1.2%* Capital expenditure (capex) (SD) (.03) (.04) Mean 1.1% 0.5% 0.6%* Capex minus shareholder payout (SD) (.04) (.05)
In constant 2011 US$ (million)
Mean $20 $43 -$23* Gross investment (PPE growth) (SD) (133) (239) Mean $41 $54 -$13* Capital expenditure (capex) (SD) (127) (143) Mean $16 -$16 $32* Capex minus shareholder payout (SD) (116) (322)
Real investment in Japanese firms is also generally lower than German firms but the pattern is different relative to the Japan-US and Japan-UK comparisons – see Table 6.8. Growth in property plant and equipment (PPE) is 2.3 percent of total assets in German public firms compared to 1.7 percent in matched Japanese firms. In dollar terms, annual growth in gross PPE is $257 million in German firms and $129 million in Japanese firms. Capital expenditure is 4.4 percent in German firms compared to 3.1 percent in Japanese firms. In dollar terms, however, Japanese firms actually outspend German firms in capital expenditure: $382 in German firms compared to $392 in Japanese firms. This disparity in the two measures (ratio and dollar value) indicates that larger public firms in Japan – who tend to be overrepresented in average dollar value measures – are more evenly matched with larger German public firms when it comes to capital expenditure. Unlike the US and UK comparisons, however, German firms are not much different from Japanese firms in the gap between real investment and shareholder payout – when it is measured as a percent of total assets. As Table 6.8 shows,
189 Japanese firms spend 1.7 percent more of their total assets on capital expenditure (capex) than on shareholder payout, while US firms spend 1.9 percent more on capital expenditure than on shareholder payout. In dollar terms, however, the difference is greater as Japanese firms spend $290 million more on real investment than shareholder payout while this amount is $216 for German firms. In other words, it seems that larger German firms are more short- termist than their Japanese counterparts when it comes to the difference between real investment and shareholder payout.
Table 6.8. Real investment in matched Japanese and German public firms; 2005-2017 for gross investment (n=3,744 firm years of 288 matched firms); 2007-2017 for the other measures (n=3,168 firm years of 288 matched firms). Source: author’s calculations from Osiris data. *p<.01 (t-test).
Japan Germany Difference Scaled by total assets Mean 1.7% 2.3% Gross investment (PPE growth) -0.6%* (SD) (.04) (.06) Mean 3.1% 4.4% Capital expenditure (capex) -1.3%* (SD) (.03) (.04) Mean 1.7% 1.9% -0.2% Capex minus shareholder payout (SD) (.03) (.05)
In constant 2011 US$ (million)
Mean $129 $257 -$128 Gross investment (PPE growth) (SD) (1270) (1884) Mean $392 $382 $10 Capital expenditure (capex) (SD) (2511) (1549) Mean $290 $216 $74 Capex minus shareholder payout (SD) (1837) (1200)
To account for the possibility that these differences in real investment between Japanese firms and US, UK, and German firms might have been driven by differences in investment opportunities, I conducted regression analyses for each of these comparisons while controlling for investment opportunities, using sales growth as the proxy for investment opportunities as is common in the literature (Asker et al., 2015). The regression results shown in tables 6.9 and 6.10 for the Japan-US and Japan-UK comparison respectively confirm the findings presented above – i.e., the aforementioned findings are robust to holding investment opportunities constant. Both capital expenditure and growth in gross PPE are significantly lower in Japanese firms compared to matched US and UK firms (by about the same
190 magnitude as above). The same is true for the short-termism measure – the gap between real investment (capex) and shareholder payout: Japanese firms spend more on real investment than shareholder payout by a significant margin compared to both US and UK firms. The findings for the Japan-Germany comparison also remain largely the same when investment opportunities are held constant – see Table 6.11.
Table 6.9. Regression estimates for real investment and of the difference between real investment (capex) and shareholder payout in matched Japanese and US public firms; 2005-2017 for growth in gross PPE and 2007-2017 for capex. Source: author’s calculations from Osiris data.
(2) Capital (3) Capex minus (1) Gross investment DV: expenditure shareholder payout (scaled by total assets) B (S.E.) B (S.E.) B (S.E.) Japanese -.012* (.002) -.013* (.001) .012* (.002) Investment .001 (.000) .000 (.000) .000 (.000) opportunities
R2 .058 .076 .066 R2 change (Japanese) .004* .012* .004* No. of observations 12,870 12,870 12,870 No. of firms 990 990 990
*p<.01. Firm-level operating revenue growth is used as proxy for investment opportunities. Country’s annual GDP growth, firm’s ROA, year fixed effects, and industry fixed effects are included (not reported).
There remains a small difference (statistically insignificant at the p < .01 level) in gross PPE growth and a similarly small difference in the ‘short-termism measure’ (i.e., gap between real investment – capex – and shareholder payout) while the difference in capital expenditure is greater with Japanese firms spending less (by 1.1 percent of total assets) than German firms on capital expenditure even when controlling for investment opportunities (sales growth). To sum up the findings: Japanese firms spend significantly less than matched Anglo-American firms on both measures of real investment – PPE growth and capital expenditure – while they spend significantly less than matched German firms on capital expenditure but the difference is smaller in gross PPE growth (which also includes business acquisitions unlike capex).
In sum, the findings reveal that real investment in Japanese public firms tends to be significantly lower than Anglo-American firms and German firms. At the same time, Japanese firms can be said to be less short-termist than Anglo-American firms if shareholder
191 payout is also considered as they tend to spend more on real investment than on shareholder payout compared to Anglo-American firms.
Table 6.10. Regression estimates for real investment and of the difference between real investment (capex) and shareholder payout in matched Japanese and UK public firms; 2005-2017 for growth in gross PPE and 2007-2017 for capex. Source: author’s calculations from Osiris data.
(2) Capital (3) Capex minus (1) Gross investment DV: expenditure shareholder payout (scaled by total assets) B (S.E.) B (S.E.) B (S.E.) Japanese -.007* (.002) -.011* (.001) .005* (.002) Investment .017* (.002) .005 (.002) .002 (.002) opportunities
R2 .075 .119 .098 R2 change (Japanese) .002* .018* .002* No. of observations 3,848 3,256 3,256 No. of firms 296 296 296
*p<.01. Firm-level operating revenue growth is used as proxy for investment opportunities. Country’s annual GDP growth, firm’s ROA, year fixed effects, and industry fixed effects are included (not reported).
Table 6.11. Regression estimates for real investment and of the difference between real investment (capex) and shareholder payout in matched Japanese and German public firms; 2005-2017 for growth in gross PPE and 2007-2017 for capex. Source: author’s calculations from Osiris data.
(2) Capital (3) Capex minus DV (1) Gross investment (scaled by total expenditure shareholder payout assets): B (S.E.) B (S.E.) B (S.E.) Japanese -.004 (.002) -.011* (.001) -.003 (.002) Investment .054* (.006) .014* (.004) .028* (.006) opportunities
R2 .069 .111 .117 R2 change (Japanese) .001 .022* .001 No. of observations 3,744 3,168 3,168 No. of firms 288 288 288
*p<.01. Firm-level operating revenue growth is used as proxy for investment opportunities. Country’s annual GDP growth, firm’s ROA, year fixed effects, and industry fixed effects are included (not reported).
192 There are a number of likely factors behind the relatively lower level of real investment in Japanese public firms. The first and perhaps the main factor is the employee-favouring nature of Japanese firms that makes employment protection of regular employees the primary goal. As Vogel (2006), Jackson (2007), and Boyer (2014) have pointed out, Japanese firms tend to cut all other flexible costs – like real investment – before they cut employment. As domestic demand has dwindled since the 1990s and as international competition has intensified in the export sector (e.g., Korea and China), they have had to rely more and more on cutting costs to maintain the ‘lifetime employment’ system for regular employees (Lechevalier, 2014; Vogel, 2006). Real investment was bound to suffer in this environment. Another factor relating to the costs of protecting employment is the cost of the wage bill for the protected employees. This cost has only increased with time in Japan due to the ageing population. As Whittaker (2020, p. 392) notes: “Baby boomers, who had provided a competitive advantage in their youth with low wages in the 1960s, [are] now in their 50s, and much more expensive in terms of wage costs”. While Japanese firms are less reluctant to let go of non-regular workers, they have kept virtually all their regular workers, most of whom are now in the older age bracket (Gordon, 2017; Sako & Kotosaka, 2012). At the same time, Japan has had to face low economic growth and deflationary pressures almost constantly since the early 1990s, which has prompted Japanese firms to maintain large reserves to protect employment and maintain the wage bill in uncertain times (Aoyagi & Ganelli, 2014; Inagami, 2009). Aoyagi and Ganelli (2014) indicate that such large corporate savings are likely to have hindered both shareholder value and real investment. Japanese firms nevertheless appear to insist on holding on to cash reserves: Araki (2009, p. 247) reports from a survey of Japanese firms that “corporate planning directors and HRM directors – not just union leaders – support the view that profits should not be primarily distributed to shareholders but evenly distributed across shareholders, employees, internal reserves, and business investments”.
Another key factors behind lower real investment in Japanese firms is likely to be subcontracting. There are many vertical keiretsu (enterprise groups) in Japan, which are usually made up of companies that frequently contract out to each other in terms of product development; in fact, customer firms even provide funds to suppliers to develop products and services (Tsuru, 1996; Vogel, 2006). These relationships are, moreover, not limited to members of the enterprise group as large firms tend to have numerous suppliers – many of them medium and small enterprises – with whom they have long-term relationships (Dore, 2001; Sugimoto, 2014). As Tabb (1995, p. 147) puts it:
193 Japan has far too much subcontracting and rather too little in-house production compared with the American norm…The Japanese, rather than cutting a supplier off when a less-expensive alternative appears, helps them learn to be more competitive, perhaps lending their own experts to offer technical advice, coming through with a low-cost loan for state-of-the-art equipment, or training the subcontractors' workers.
This is also part of the “lean production” that Japan is known for, where a seamless link is maintained between firms and their suppliers (Streeck, 1996, p. 138). In this way, rather than investing within the company itself, Japanese firms tend to fund – or support through low- interest loans – real investment in supplier firms. Dore (2001, pp. 426-428) calls this “the disaggregation of factory production” in Japan while calling the ties between Japanese customer and supplier firms “relational contracting”, whereby firms tend to have long-term and loyal relationships that is only party based on market relations. In this way, the real investment amount of any one large firm can be deceptively low as investment tends to flow to its many suppliers in the complex network of firms, which is effectively one large vertically integrated entity. This is different from the supply chains of Anglo-American firms, however, as the relations between firms in such supply chains tend to be based more on market relations (Milberg, 2008). Another reason that real investment may be lower in Japanese firms than Anglo-American firms at least is that, like German firms, they tend to rely more on worker training and generalist equipment rather than business acquisition and specialist equipment for mass production (Hollingsworth, 1997). Based on direct observations and survey data, Jacoby (2005, p. 168) reports that, compared to US firms, “Japanese firms are more inclined to ‘make’ talent and technology than to buy them through mergers and acquisitions”.
Institutional change It is not the case, of course, that ‘shareholder value’ has not made any inroads in Japan; it has (see Dore, 2009). Chronic economic stagnation since the early 1990s has greatly eroded the credibility and legitimacy of the Japanese model, especially in the eyes of foreign investors, who became increasingly vociferous (Culpepper, 2010; Miyajima, 2007). In the late 1990s and early 2000s, foreign investors found allies in the emboldened liberal wing of the long- dominant Liberal Democratic Party and in liberal-minded bureaucrats of the influential Ministry of Economy, Trade, and Industry (METI) (Culpepper, 2010; Vogel, 2018a). This liberal coalition sought to bring US-style corporate governance to Japan because the “traditional” Japanese style of governance was said to be outdated and out of sync with
194 “global standards” of good governance (Buchanan & Deakin, 2009, p. 36; Gourevitch & Shinn, 2010; Miyajima, 2007). In the “traditional” Japanese system, the entire corporate board consists of insiders and there exists no clear separation between supervision and management. In contrast, in the newly proposed system, there would be “outsider” directors representing the interests of shareholders that would be tasked with, among other things, “the monitoring of appointments and executive compensation” (Dore, 2007, p. 274; Inagami, 2009). However, the powerful employer association (Keidanren) and the defenders of the traditional model (from the Diet and from the bureaucracy) were successful in gaining major concessions to the reform, whereby the ‘global standard’ of US-style ‘outsider director’ system was not only watered down but was also made entirely optional (Buchanan & Deakin, 2009; Inagami, 2009; Vogel, 2018a). This meant that although a new (but not radically new) type of corporate governance emerged in Japan and was even adopted by some prominent companies like Sony, it was adopted only by a minority of listed firms and many heavyweights of Japanese capitalism like Toyota and Canon largely eschewed the new system (Ahmadjian & Okumura, 2011; Buchanan & Deakin, 2009). There were nevertheless wider changes it brought about, particularly in the separation of executive and monitoring functions and inclusion of ‘outsider directors’ but usually in superficial (formal) ways that did not undermine the core of the traditional ‘enterprise community’ model. The appearance of a new way of thinking about corporate governance altered the perceptions about the place of outside shareholders within the ‘enterprise community’ but, given its low rate of adoption and dilution, its effects were far from revolutionary:
During the 1990s and early 2000s, attitudes of corporate executives transformed dramatically, as they came to see shareholders less as criminal elements and more as an important constituency. This is not to say that Japanese managers came to subscribe to the mantra taught in US business schools that the sole objective of the firm is to maximize shareholder value. While a few firms were very explicit in noting shareholder value as one of their primary goals, most of the others took a weaker stance, promoting shareholders from last in line of the list of stakeholders to closer, if not equal, in status to employees and customers. (Ahmadjian & Okumura, 2011, p. 261)
Therefore, it could be said that the changes have brought Japan closer to the German model – where the shareholder is considered an important stakeholder – rather than the Anglo- American model where the shareholder is supreme. Indeed, this can be observed in my longitudinal empirical findings where I compare shareholder payout and real investment over time – see Figure 6.1. The findings offer a clear indication that Japanese public firms have neither converged with their Anglo-American counterparts nor have they been converging
195 when it comes to shareholder payout. The gap in shareholder payout between Japanese firms and US firms starts out wide and remains wide, with only the GFC bringing the two closer temporarily (see top left graph in Figure 6.1). The gap in shareholder payout between Japanese and UK public firms starts out wider but narrows somewhat after the GFC but maintains the same significant gap consistently after 2009 (see middle left graph in Figure 6.1). The graphs also show that the disparity in real investment (capex) is smaller between Japanese firms and both US and UK firms compared to the disparity in shareholder payout (see top and middle graphs on the right side of Figure 6.1). That the gap in real investment has been maintained consistently throughout the period studied (2005-2017). When looked at side by side, the two graphs at the top (Japan-US comparison) and the two graphs in the middle (Japan-UK comparison) in Figure 6.1 also reveal that while Japanese firms have clearly spent more on real investment (capital expenditure) than on shareholder payout, the same cannot be said for US and UK firms. Figure 6.1 also shows that, shareholder payout and real investment (capex) are almost equally higher in German firms than in Japanese firms (see bottom graphs in Figure 6.1). The bottom graphs also show that both German and Japanese firms have consistently spent more on real investment (capex) than on shareholder payout. In sum, these findings support my general argument that capitalist systems are unlikely to converge in the short to medium term because of divergent institutional logics.
Conclusion The combination of high efficiency and high equity that was achieved by the post-war Japanese model in the relative absence of a welfare state was indeed unique and was admired by neoliberal Americans and social-democratic Europeans alike (at least until the 1990s). In many ways, the post-war Japanese model, especially when it dovetailed with the structural conditions of the international political economy from the 1960s to the 1980s, reflected an almost ideal balance between risk-taking and prudence, competition and collaboration, hierarchy and homogeneity, freedom and intervention, flexibility and security, and shareholder-orientation and employee-orientation. Somehow, Japan had found that perfect balance – as perfect a balance as any capitalist system could find. However, with the burst of the ‘bubble’ in the early 1990s and parallel changes in the domestic political economy (e.g., ageing) and international political economy (e.g., the rise of China and South Korea), the same balance that had kept diverse interest groups satisfied could no longer be sustained.
196 Shareholder payout Capital expenditure (Japan-US) (Japan-US)
6% 7%
5% 6% 5% 4% 4% 3% 3% 2% 2%
1% 1%
0% 0%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Japan USA Japan USA
Shareholder payout Capital expenditure (Japan-UK) (Japan-UK)
6% 6%
5% 5%
4% 4%
3% 3%
2% 2%
1% 1%
0% 0%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Japan UK Japan UK
Shareholder payout Capital expenditure (Japan-Germany) (Japan-Germany)
5% 6%
4% 5% 4% 3% 3% 2% 2%
1% 1%
0% 0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Japan Germany Japan Germany
Figure 6.1. Shareholder payout and capital expenditure as a percentage of total assets in matched public firms in Japan & the US (n=990), Japan & the UK (n=296), and Japan & Germany (n=288).
197 Japan had to choose how to distribute the pie that was no longer growing at a pace to keep everyone happy. Forced to choose winners and losers after decades of avoiding that uncomfortable choice, the question analysts were asking in the 1990s was whether it would choose shareholders or employees. Calls grew louder for Japan to choose shareholders like the Americans (as the American system was outperforming all others) or risk being left behind on the international economic stage. Bureaucrats and politicians were increasingly signalling a turn towards shareholders and even employers appeared to be reluctantly doing so by restructuring and accepting ‘shareholder value’ as one of its goals. However, a spate of unprecedented hostile takeover attempts in the early 2000s that threatened the previously unquestioned authority and stability of management reminded employers of the potential brutality of a shareholder-oriented political economy. The bursting of the ‘dot-com bubble’, major corporate scandals (e.g., Enron), and the great financial crisis of 2008 further eroded the social legitimacy of the American shareholder-oriented model, empowering the defenders of the traditional Japanese model. Japanese firms more or less stuck with the post-war model – to be sure, by reinforcing its ‘shock absorbers’ and by appeasing vociferous foreign shareholders with some real and some token changes – and accepted a lower level of performance than the post-war era. This acceptance no doubt was based partly on the preservation of the status quo that protected management and managerial discretion, partly on the awareness of the unavoidable structural problems of ageing and international competition, partly on nationalistic pride in its once-envied model, and partly on the reluctance to cause suffering on workers (and suppliers) who lacked the kind of welfare support that many Europeans enjoyed. In other words, though structural conditions might have changed drastically, the largely unchanged institutional logics of Japanese capitalism – reinforced by enduring power relations, ideologies, and cultural values – continue to guide its evolution. The system thus adjusts where possible to maintain the institutional core of the model and particularly the distributional outcomes linked to the model. As long as Japanese capitalism can maintain its relatively low unemployment rate and employment security, it will likely keep diverging from Anglo-American capitalism. All in all, short-termism does not appear to be on the horizon in the land of the rising sun. Importantly, it remains a distinct model of capitalism compared to the Anglo-American model and arguably even the German model.
198 Conclusion
I have shown in this study that Anglo-American public firms (especially in the US) are notably more short-termist compared to German and Japanese public firms. This is not just because of ‘impatient capital’: German and Japanese public firms also face impatient capital in the stock market but shareholder payouts in German and (especially) Japanese public firms are still substantially and consistently lower than (matched) Anglo-American public firms. Anglo-American public firms make excessive shareholder payouts – often their entire yearly profits – because their institutional settings (beyond just the stock market) encourage and even force them to maximise ‘shareholder value’. In other words, the institutional settings of public firms in the US and the UK are based on the dominant ideology of ‘shareholder value maximisation’. On the other hand, the institutional settings of German and Japanese public firms are based on distinct dominant ideologies that are more stakeholder-oriented, with a particular emphasis on employees. As a result, German and Japanese public firms produce disparate distributional outcomes compared to Anglo-American public firms. These distributional outcomes are less favourable to shareholders (e.g., lower shareholder payout) and more favourable to employees (e.g., greater employment security). As German and Japanese public firms spend substantially less money on shareholder payouts than Anglo- American public firms, they have more money left over to protect employment, hire and train skilled workers, and focus on long-term growth. Lower shareholder payout does not translate into higher real investment in German and Japanese public firms, however. This is nevertheless consistent with the dominant ideologies and approaches in German and (especially) Japanese public firms: because they value employees rather than viewing them purely in terms of cost (like Anglo-American firms do), they are less prone to purchasing expensive labour-replacing equipment; and because they rely more on worker skills and knowledge for innovation, they are less likely to depend on costly business acquisitions to stay competitive. In this sense, employees are more valued in all aspects and practices within German and Japanese public firms, whether it be distributional matters or operational matters. It is part of the underlying principle that German and Japanese public firms go by. In the end, therefore, what a public firm does in its various operations and functions – including shareholder payout and real investment – will generally follow the central logic that guides the firm as a whole: the dominant ideology.
199 In this concluding chapter, I take a closer look at the dominant ideology. I focus on the dominant ideology in this final chapter because it captures, in many ways, the essence of a firm as well as the essence of a particular variety of capitalism. The dominant ideology includes the conception of the public firm: what it stands for and whom it is meant to serve. The conception of the public firm is nationally-specific – influenced by power relations and culture – and has profound effects on distributional outcomes. After discussing national differences in the conception of the public firm and what it means, I explore national differences in the dominant economic ideology (at the society level), which also has major implications for capitalist divergence. I argue that the dominant economic ideology of a nation determines the extent to which the economic sphere is separated from the social sphere in that nation, which, in turn, has implications for distributional outcomes. After the section on dominant ideology and its implications for capitalist divergence, I turn to the question of whether capitalist divergence among advanced economies really matters in a hyper- globalised world where capitalist commonality is increasingly emphasised by many scholars. In this section, I point out specific distributional implications of capitalist divergence, especially for workers. As part of this, I present unemployment data for each country, which suggests an important macro-level implication of capitalist divergence. I then conclude this final chapter by pointing to the four main takeaways of this study.
The important role of the dominant ideology in capitalist divergence The dominant ideology is arguably the best stand-alone predictor of distributional outcomes like shareholder payout and employment protection in public firms (when existing structural conditions are accounted for). Institutions that affect distributional outcomes are generally too numerous, varied, and transient for any one institution to predict major distributional outcomes like shareholder payout accurately. The existing power distribution is also not sufficient by itself as culture needs to be considered alongside it for a more accurate prediction and vice versa. This is demonstrated by the Japanese context, where labour does not have much power compared to the German context but gets similarly favourable (or even more favourable) distributional outcomes. The distributional outcomes in public firms in Japan and Germany – and the Anglo-America for that matter – are thus best captured by the dominant business ideology: the ‘enterprise community’ ideology in Japan, the ‘corporatist stakeholder ideology in Germany, and the ‘shareholder value’ ideology in Anglo-America. As aforementioned, the dominant ideology is shaped by both power relations and culture while also serving as the organising principle (institutional logics) for the various institutions
200 that make up the broader institutional setting. It thus embodies in one construct the key factors that shape firm behaviour in a given structural context.
I will discuss the roles of both the dominant business ideology within the business field and the dominant economic ideology at the state level in shaping capitalist divergence over time. Firstly, I discuss the dominant business ideology in terms of the disparate conceptions of the public firm in Germany and Japan compared to Anglo-America, which has distributional consequences. I also discuss the lack of convergence in the conception of the public firm (especially since the GFC) and what that means for capitalist divergence over time. In discussing state-level economic ideology, which has implications for capitalist divergence in a broader sense (beyond public firms), I turn to Karl Polanyi’s (1957) argument about the centrality of the dominant economic ideology – particularly the doctrine of economic liberalism – in determining the extent to which the economic sphere is separated from the social sphere (i.e. social morality). I argue that the economic sphere in Germany and Japan may be less separated from the social sphere compared to Anglo-America because of the reluctance to fully embrace the ideology (doctrine) of economic liberalism.
The dominant business ideology and capitalist divergence
The stock market is a defining feature of modern capitalism. The rationale that is often cited for the existence of the stock market is that it provides financing for firm growth. Yet public firms, especially large established ones, sparingly use the stock market for financing purposes (Hughes, 2014). Capital raising from the stock market generally comes last in the “pecking order” of financing with retained earnings and debt prioritised before equity offerings in the stock market (Fama & French, 2002; Myers, 1984, p. 2). In spite of the minor role played by stock market investors in the financing of firms, the dominant conception of the public corporation in Anglo-America still considers stock-market-based shareholders to be the ‘owners’ of the firm in the same way that entrepreneurs are considered owners of their firms (Monks & Minow, 2011). The clear distinction between private firms, which generally depend on owners, and public firms, which do not, is ignored by this view (unlike in Germany, for example). Furthermore, the dominant conception of the public firm (in Anglo- America) not only sees managers of public firms as ‘agents’ with a ‘fiduciary duty’ to shareholders but also regards employees who might have spent their entire working lives at a public firm as ‘contractors’ who can be let go with little hesitation in the name of ‘shareholder value’ (Boatright, 1994; Dobbin & Jung, 2010). Such a view has enabled
201 thousands of job cuts that might not have otherwise been made, and it has exacerbated rising inequality and employment insecurity due to downsizing, offshoring, and outsourcing in the name of ‘shareholder value maximisation’ (G. F. Davis, 2013; Lazonick & O'Sullivan, 2000; Milberg, 2008).
This shareholder-oriented conception of the public firm is, however, just one among many possible perspectives (Konzelmann, Chick, & Fovargue-Davies, 2020). Dore (2005, p. 437) calls this the “‘relativist view’ of corporate governance”. As previously discussed, the perspective of ‘shareholder sovereignty’ that is dominant in the Anglosphere does not have the same legitimacy in ‘non-liberal’ political economies like Germany and Japan. More recently, however, the Anglo-American perspective – which is considered the “global standard” in corporate governance – has made inroads in Germany and Japan. Shareholders are now considered ‘first among equals’ in Germany while, in Japan, shareholders have risen from the lowest rungs to almost equal standing with other stakeholders like employees (Ahmadjian & Okumura, 2011; Dore, 2005; Faust, 2012; Inagami, 2009, p. 167). Such changes to the dominant conception of the public firm have followed a rise in the power of foreign (Anglo-American) institutional investors in both these political economies (Gospel et al., 2014). For example, Hayakawa and Whittaker (2009, p. 48) point out that, “[i]n fiscal 1994, foreigners held 8.1 percent of shares listed on the five major Japanese stock exchanges but in 2007 they held 27.6 percent”. Fichtner (2015) and Goyer (2011) similarly report that shareholding by foreign investors has increased significantly in Germany since the 1990s. The uncertainty surrounding lacklustre economic performance in the 1990s and the parallel investor-led ‘dot-com’ boom in the US led the German and Japanese government to view foreign investment as a potential saviour, prompting them to make their institutional environment more inviting for foreign investors (Börsch, 2007; Dore, 2007; Lechevalier, 2014). Many of the institutional barriers to (dispersed) shareholder power like cross- shareholding, insider boards, bank financing, and collective bargaining were directly or indirectly weakened while the share of foreign investors kept rising (Dore, 2007; Seeleib- Kaiser, 2015). It was no longer tenable for (insider) managers of public firms to side with workers and banks while treating dispersed shareholders as money-minded speculators who contribute nothing to the firm – a view that was especially prevalent in Japan (Ahmadjian & Okumura, 2011). Many employers – especially in Japan – were reluctant to cede control to (foreign) shareholders but they had to increasingly appease them as foreign shareholders were ascendant (Araki, 2009; Fiss & Zajac, 2004). Then came a succession of crises within
202 American capitalism, starting with the ‘dot-com’ crash and culminating in the calamitous financial crisis of 2008. Defenders of the corporatist stakeholder ideology in Germany and champions of the ‘enterprise community’ ideology in Japan, whose appeal to traditional values of consensus and collectivism had seemed anachronistic around the turn of the century (during weak economic performance), suddenly found their voices again. It was plainly evident, they would say, that financial speculation and the relentless drive to maximise shareholder value had precipitated the downfall of American capitalism (Inagami, 2009; Unger, 2015). The preservation of the stakeholder model, with a few necessary tweaks, rather than convergence towards the liberal Anglo-American model seemed like the best way forward – perhaps the only way forward – for Germany and Japan.
What my empirical findings have shown is that, even if it was the case that German and Japanese had been converging towards the Anglo-American model up to mid-2005 (which my study does not cover but anecdotal evidence points to), they have maintained their distance from the Anglo-American shareholder model since then, at least as far as shareholder payout is concerned. In other words, neither their conception of the public firm (dominant ideology) nor the actual behaviour of public firms (in terms of shareholder payout) have come close to converging with the Anglo-American model (see also Redding & Witt, 2015). Changes in power relations in favour of foreign investors seems to have prompted gradual moves towards somewhat higher shareholder payout, but the general view that the public firm is a public institution (in Germany) and an ‘enterprise community’ (in Japan) rather than the property of investors does not seem to have been altered a great deal by institutional changes (see Araki, 2009; Buchanan et al., 2020; Fiss & Zajac, 2004; Hassel, 2015). Indeed, it seems that the liberalisation of formal institutions in Germany and Japan since the 1990s was the result of a deliberate strategy to attract foreign investment by the respective governments of Germany and Japan rather than a transformation of business ideology (Börsch, 2007; Culpepper, 2010; Goyer, 2011; Inagami, 2009). Especially in Japan, the state appears to have been more eager to embrace the Anglo-American model (or at least give such an impression to foreign investors) than business. This is also suggested by the fact that many of the formal institutional changes did not bring about corresponding changes in firm behaviour (in both Japan and Germany) and that many of the firm-level changes were surface-level ‘cosmetic’ changes to the traditional stakeholder model that gave the appearance to increasingly vociferous foreign investors that the firms were taking ‘shareholder value’ more seriously (Fiss & Zajac, 2004; Inagami, 2009; Vogel, 2006). The
203 actual changes like the increase in temporary and non-regular workers and relative stagnation in wages is arguably explained less by changes to the traditional model and more by external structural change – particularly rising competition in global product markets from the likes of Korea, China, and other rising Asian economies (Boyer, 2014, 2015; Sorge & Streeck, 2018). Indeed, unions have largely gone along with many of the changes and the core of the model – including quality-based-production, long-term orientation, and the protection of ‘regular workers’ – remains largely intact in both Germany and Japan (Araki, 2009; Baccaro & Howell, 2017; Börsch, 2007; Vogel, 2006, 2018a).
In this sense, what has happened in Germany and Japan is consistent with my argument in this study that the dominant business ideology – i.e. the prevailing conception of the public firm – that guides both institutional design and change (change in means to attain the same ends) is rooted in both power relations and culture. As power relations have changed in favour of foreign investors in Germany and Japan, the dominant business ideology has become more accommodating of the interests of (dispersed) shareholders, leading to institutional changes and firm-level outcomes (shareholder payout) that are somewhat more favourable to shareholders (Redding & Witt, 2015). At the same time, the changes have been limited and largely consistent with older institutional logics: Even though there have been substantial changes to employment patterns (greater dualism) and relative wage stagnation, these changes were less about increasing shareholder value and more about protecting the long-term sustainability of the firm (Börsch, 2007; Vogel, 2006, 2018a). Cultural values and beliefs, which are slow to change, constrain sudden and major changes in the dominant business ideology – which is rooted in both power relations and wider culture. The cultural values of corporatism and consensus-orientation in Germany and groupism and paternalism in Japan seem to have played important roles in protecting the traditionally dominant business ideology in German and Japanese public firms by imbuing them with legitimacy while simultaneously undermining the legitimacy of the purely individualistic ideology of ‘shareholder sovereignty’ (Redding & Witt, 2015; Witt & Redding, 2009).
As Peter Berger and Thomas Luckmann (1991) note in The Social Construction of Reality, legitimation has both a ‘normative’ dimension and a ‘cognitive’ dimension. While cultural values of consensus-orientation and groupism provided the normative legitimacy for the stakeholder models in Germany and Japan respectively, the seismic events of the 2000s that revealed major flaws in the Anglo-American model provided the necessary ‘cognitive’ legitimacy to the stakeholder models. In fact, the German model, which seemed to be in
204 greater danger of converging towards the shareholder model than the Japanese model by the mid-2000s, got an extra boost in cognitive legitimacy with its widely-lauded economic performance during the post-GFC recovery and the Euro crisis (Boyer, 2015). Therefore, even if power relations keep changing gradually in favour of foreign investors in Germany and Japan, their stakeholder model is unlikely to morph into a shareholder model any time soon as cultural values do not change rapidly.
The dominant economic ideology and capitalist divergence
The degree to which the institutional logics of the economic sphere is separated from the institutional logics of the social sphere (i.e., social morality) may itself be different in Germany and Japan than in the Anglosphere (cf. Friedland & Alford, 1991; Redding & Witt, 2015). Karl Polanyi (1957) argued that market societies (capitalist economies) represent a decoupling of the social sphere and economic sphere – unlike non-market societies that were prevalent for most of human history where the economy was integrated with society and the state. At the same time, he observed that the expansion of markets also tends to produce a “double movement” due to the “clash of the organizing principles of economic liberalism and social protection”, whereby society, often through the state, tries to guard against the social dislocation and instability resulting from increasing marketisation of land and labour – i.e., the conversion of land and labour into “fictitious commodities” (Polanyi, 1957, pp. 132-134). This suggests that it is possible for different capitalist (market) economies to have different degrees of overlap between the social and economic spheres in two ways: (1) if marketisation has been less extensive in the first place and (2) if the extent of state intervention to re- integrate the economic and social spheres after extensive marketisation (‘double movement’) has been greater.
Polanyi (1957, p. 135) emphasises the centrality of economic ideology in shaping the separation between economy and society: he points squarely at the doctrine of “economic liberalism” as the driver of the marketisation and the conversion of land and labour into “fictitious commodities”. Moreover, he portrays the “double movement” as an ideological battle between “economic liberalism”, which seeks to subjugate society to the dictates of the market, and “collectivist” ideology in its “variety of forms”, which aims at re-integrating the economic sphere with the social sphere (Polanyi, 1957, pp. 145-150). From this ideological point of view then, the economic ideology embraced by a nation (and its state) is key to determining the extent of overlap between the economic sphere and the social sphere – i.e.,
205 an overlap between market mentality and social morality. Notwithstanding the rise and fall of different economic ideologies within a nation (e.g., Keynesianism and neoliberalism in Anglo-America), the Anglosphere has always embraced ‘economic liberalism’ more closely than Germany and Japan, which have often been consciously against economic liberalism and have thus been called ‘non-liberal’ economies (see Lehmbruch, 2005).
Represented largely by Adam Smith and neoclassical economics, the Anglo-American version of ‘economic liberalism’ emphasises: (1) the “concept of the Economic Man”, whose rational self-interest and profit-seeking form the basis of economic organisation, (2) “self- regulating” markets with state intervention limited only to the maintenance of the market mechanism, and (3) “the application of the freedom of contract”, which means, in practice, the erosion of “noncontractual relations between individuals” (Polanyi, 1957, pp. 43, 163).63 The embrace of economic liberalism in the Anglosphere has thus meant a relatively wide separation between economic rationale and social morality and, consequently, (1) a general acceptance of shareholders and managers acting purely in their own self-interest, (2) the lack of state regulation protecting labour from the vicissitudes of the market, and (3) widespread disgruntlement in the face of increasing precarity, inequality, and indebtedness (Duménil & Lévy, 2011; Lazonick & O'Sullivan, 2000). On the other hand, “the theoretical foundation of the post-war German social market economy” is “ordoliberalism” – a more social and statist version of economic liberalism that gained prominence in Germany in the 1920s and became the dominant economic doctrine in the post-war period, guiding economic policymaking and economic thinking generally (Bonefeld, 2012, p. 633; Lehmbruch, 2005). Bonefeld (2012, p. 634) notes that, despite its emphasis on markets as the ideal way to organise an economy, German ordoliberalism has been seen as “a progressive alternative beyond left and right” and “socially responsible”, “in contrast to neoliberal ideas of free markets”. Ordoliberalism critiques the central role played by “greed” in laissez-faire liberalism and calls for a “human economy of self-responsible social enterprise”, which, at the same time, is neither state- planned nor centred on a welfare state (Bonefeld, 2012, p. 634). “The designated purpose of ordoliberal social policy is to ingrain entrepreneurship, private property and the free price mechanism into the fabric of society to prevent the proletarianisation of social structures” – i.e., a greater overlap of the social and economic spheres compared to Anglo-American economic liberalism (Bonefeld, 2012, p. 634). Concerning Japan, Dore (2001, p. 434) sums
63 Of course, Polanyi (1957, p. 149), who passed away in 1964, was not to know that after a Keynesian interlude, which he considered an Anglo-American version of the “collectivist…countermovement”, a resurgent economic liberalism in the form of ‘neoliberalism’ would once again increasingly dominate Anglo-American thinking from the 1970s (Harvey, 2007).
206 up the “common syndrome” in Japanese political economy as “generalised dutifulness”, which guides relations not only between employers and employees but also customers and suppliers and makes for relationships that often defy the market logic of individual self- interest. Moreover, Dore (2001, p. 433) observes that:
The Japanese…have never really caught up with Adam Smith. They have never managed actually to bring themselves to believe in the invisible hand. They have always insisted—and teach in their schools and their ‘how to get on’ books of popular morality—that the butcher and the baker and the brewer need to be benevolent as well as self-interested…They most commonly say: benevolence is a duty.
It therefore seems that while the Anglo-American economic sphere has been decoupled from wider society and its morality, the economic spheres in Germany and Japan are more integrated into the social sphere and thus retain some of the moral aspects of society. This integration has largely been enforced by the state and ‘civil society’ associations in the case of Germany (Streeck, 2005). In the Japanese political economy, on the other hand, the economic sphere has arguably always been less separated from the social sphere compared to its contemporaneous Anglo-American and even German counterparts (Lehmbruch, 2005; Yamamura, 1997). Indeed, the very goal of industrialisation and marketisation when it was first initiated by the Meiji bureaucracy in Japan in the late 1800s was not economic development for its own sake – as was the case in Anglo-America and (to a lesser extent) Germany – but rather technological ‘parity’ with the West for the purpose of military defence and international standing (Moore, 1993; Varley, 2000). Business norms and practices in Japan have always been more or less intertwined with nationalism and communitarian values and continue to be to this day (Gotoh & Sinclair, 2017; Kinzley, 2018). The greater integration of economy and society in Japan manifests, for example, as the norm against hostile takeovers, the norm against high executive pay, family-like relations within firms, strongly-felt managerial obligation to protect employment, and loyalty-based non-market relations with suppliers (see Buchanan et al., 2020; Dore, 2001; Gotoh & Sinclair, 2017).
Does capitalist divergence really matter? How much capitalist divergence matters is ultimately a matter of perspective. Milanovic (2020), for example, puts German and Japanese capitalism in the same ‘liberal’ category as Anglo-American capitalism when comparing them with the likes of China. Other scholars critique the very focus on capitalist divergence, arguing that the issue of national capitalist divergence is dwarfed by the drastic and unprecedented financialisation of global capitalism
207 since the 1980s – which they see as an irresistible equalising force that makes all capitalist political economies dance to the tune of global finance (see Baccaro & Howell, 2017; D. Coates, 2005; Engelen & Konings, 2010; Jessop, 2011; Strange, 1997). National differences in distributional outcomes, political-economic institutions, and culture have indeed faded over time, especially in advanced economies (see Inglehart & Baker, 2000; Streeck, 2010). At the same time, we also know that advanced capitalist economies have not converged completely. In fact, it is just as easy to find scholars who argue that national differences continue to matter (e.g., S. Berger & Dore, 1996; Boyer, 2015; Gotoh & Sinclair, 2017; Hassel, 2015). This lack of agreement over the relevance of capitalist divergence in a hyperglobalised world is captured by the lively debate in the literature about whether the concept of “variegated capitalism” is more appropriate than the “discrete” categories implied by “varieties of capitalism” (see Hay, 2020, p. 302; Peck & Theodore, 2007, p. 733; Streeck, 2010, p. 38). Are workers truly better off in German and Japanese capitalism than in the Anglo-American version? The ‘variegated capitalism’ perspective would be inclined to answer in the negative whereas the ‘varieties of capitalism’ view would lean more towards the affirmative. In many ways, the answer depends on how broadly or how closely one looks at capitalist divergence. Divergence among the four capitalist economies studied here will undoubtedly appear trivial from a broad historical perspective but, at the same time, it should be clear from the foregoing discussions that national differences do make a real difference in the everyday lives of workers. For example, in terms of well-being, workers in public firms in Japan and Germany have greater employment security, partly because substantially lower shareholder payout than Anglo-American public firms allows Japanese and German public firms to protect employment.
As Figure 7.1 shows, national differences in unemployment levels are indeed consistent with national differences in shareholder payout.64 Japan, which has the most employee-favouring public firms and where shareholder payout is the smallest, has consistently had the lowest unemployment rate out of all the four countries. Notably, the impact of the 2008 global financial crisis (GFC) on unemployment was much milder in Japan than in the UK and (especially) the US. The unemployment rate in Japan has been stable throughout, never going
64 There are, of course, many structural and institutional differences besides firm-level outcomes that contribute to differences in such macro-level outcomes (e.g., demographics, government actions and policies, growth model, etc.). Nevertheless, public firms make up a large enough portion of the economy in all of the four countries to make a substantial impact on national employment patterns. In 2005, the market value of all the public firms (in the country) as a percentage of national GDP was 42 percent for Germany, 96 percent for Japan, 120 percent for the UK and 130 percent for the US (The World Bank, 2020).
208 above 5 percent for the whole period, even at the height of the GFC when “[t]he country’s industrial production dropped considerably” (Akram, 2019, p. 405). This is all the more remarkable given that the Japanese economy experienced prolonged stagnation since the 1990s: Real GDP growth averaged a mere 0.8 percent between 1995 to 2016 (Akram, 2019).
11%
10%
9%
8%
7%
6%
5%
4%
3%
2% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Germany Japan UK USA
Figure 7.1. Unemployment rate for Germany, Japan, UK, and USA, 2005-2017. Source: OECD.
Figure 7.1 also shows Germany experiencing a sharp decline in unemployment from 11 percent in 2005 (which was partly due to the lingering effects of reunification and labour market integration in Europe) to 5 percent in 2012, with the GFC only slightly interfering with this decline in unemployment. Unemployment keeps dropping in Germany after 2012 in a linear but more gradual fashion. Germany has had lower unemployment levels than the US and the UK throughout the post-GFC period (after 2009). In contrast to Japan and Germany, the UK and the US witness big jumps in unemployment after the GFC: from 6 percent in 2008 in both countries to 8 percent and 9 percent in 2009 respectively. Moreover, high unemployment persists for both countries until at least 2013 (when it is 7 percent in both countries). All in all, Japan and Germany have experienced greater employment stability and less unemployment (post-GFC for Germany) than the US and the UK.
209 At the same time, wage growth has not been much better in Germany and (especially) Japan compared to the US and the UK; although, Germany has seen somewhat higher wage growth than both the US and the UK (OECD, 2018b). According to the OECD Employment Outlook, average annual real wage growth between 2007 and 2017 in Germany has been 1.2 percent compared to 0.1 percent for Japan, negative 0.3 percent for the UK, and 0.5 percent for the US (OECD, 2018b). The weakness in wage growth in Japan in particular may be explained by the fact that (1) its economy has been stubbornly sluggish since the 1990s and (2) it has faced increasing competition in export markets from its Asian neighbours like South Korea and China, prompting export-oriented Japanese firms to control wages, which has wider effects as collective (enterprise) bargaining in Japan (called shunto or the ‘spring offensive’) usually follows the lead of large export-oriented corporations (Akram, 2019; Lechevalier, 2014; Vogel, 2018a). Furthermore, notwithstanding differences in state welfare provisions, non-regular workers are also not much better off in Germany and Japan than in the US and the UK in terms of employment security and wages (Gordon, 2017; Palier & Thelen, 2010; Sako & Kotosaka, 2012). In fact, the dualism that exists in Germany and (especially) Japan can be construed as social inequality – gender inequality in the case of Japan and (partly) ethnic inequality in the case of Germany (Mouer & Kawanishi, 2005; Palier & Thelen, 2010; Sugimoto, 2014; Unger, 2015).
In the end, there are enough differences as well as similarities between German and Japanese capitalism on the one hand and Anglo-American capitalism on the other to argue either that ‘capitalism is capitalism’ or that national differences matter. In my view, and as should be clear from this study, capitalist divergence does matter and should not be dismissed out of hand because such divergence does have important implications for the everyday well-being of workers, even if the differences are not dramatic.
The four main takeaways of this study (1) Institutional theory should pay greater attention to the analytical distinction between structures and institutions and how institutions tend to mediate structural effects to shape distributional outcomes. Corporate short-termism is not simply caused by ‘impatient capital’ in the stock market; rather it is the wider institutional setting that mediates and shapes the structural features of the stock market and determines the extent of short-termism in public firms.
210 (2) Although distributional outcomes in firms (like shareholder payout) may be explained by proximate factors like institutions in a descriptive and static sense, they cannot be properly understood if their ideological, political, and cultural roots are left unexamined and unspecified. When examining these deeper roots, it is best to treat ideology as an intermediate-level and field-specific factor that defines institutional logics while itself being shaped by power relations and culture (through legitimacy).
(3) Empirically, shareholder payout is substantially lower in German public firms and lower still in Japanese public firms compared to (matched) Anglo-American public firms; however, this does not translate into higher real investment – with real investment, in fact, substantially lower in Japan. German and Japanese firms are also distinct – although not to the same extent as Anglo-American firms. This study thus challenges the typology of ‘varieties of capitalism’ – Germany and Japan do appear to be quite distinct varieties of capitalism even if both are more stakeholder-oriented than Anglo-American capitalism. This study is, of course, not the first to point to the distinction between Germany and Japan (cf. Amable, 2003; Pontusson, 2005). Importantly, the longitudinal empirical analysis has also shown that both German and Japanese public firms have not converged and are not converging (in any substantial manner) towards Anglo-American public firms when it comes to shareholder payout – at least since the GFC.
(4) As far as institutional change (including liberalisation) is concerned, it usually reflects the adjustment of means (institutions) to changing conditions to achieve the same ends rather than a change in the institutional logics (i.e., ends) of business practices. Ends can change too, however; although more gradually. Change in ends is usually brought about by change in power relations due to structural change (e.g., globalisation) or political change (e.g., change in government). Culture is the slowest to change as it tends to be constantly reinforced by a myriad of institutions, norms, and habits; if it does change, such change is likely to be generational and unlikely to be sudden. As business ideology is rooted in both power relations and culture, it too is likely to change when power relations change, but the new ideology will still have to be consistent with enduring cultural values and beliefs if it is to last. From this perspective, convergence between Japanese and German capitalism on one hand and Anglo-American capitalism on the other is likely to be slow, if it happens at all. Globalisation and neoliberalism have changed power relations in favour of capital in all varieties of capitalism. In this sense, shareholder payout is likely to increase gradually everywhere from disparate starting positions but, as all varieties of capitalism move parallelly
211 due to similar changes, German and Japanese capitalism are likely to maintain their distance from Anglo-American capitalism. Indeed, this is what I find through my longitudinal empirical comparison of firms.
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