Conflicts Between Parent Company and Non-Controlling Shareholders in Stakeholder-Oriented Corporate Governance: Evidence From Japan

Abstract

When a company establishes subsidiaries with capital provided by a third party, the subsidiaries’ shareholders include the parent company (controlling shareholders) and minority (noncontrolling) shareholders. When shareholders’ interests are divergent, conflicts may arise, causing inefficiencies in the management of the subsidiaries or the corporate group. Such conflicts among shareholders are called principal–principal (PP) conflicts. However, adopting stakeholder-oriented corporate governance, a practice prevalent in Japan, may mitigate such PP conflicts. In fact, many Japanese companies report non-controlling interests in their consolidated financial statements. This paper investigates the influence of PP conflicts in Japanese corporate groups. The availability of nonconsolidated and consolidated financial statements in Japan allows for the comparison of parent companies’ data with those of the corporate group. The results reveal that (1) the larger the minority shareholders ratio (MER), the more the profits shifted to the parent company, and (2) the larger the MER, the higher the growth of the subsidiaries’ sales rates. These results suggest that while the parent company exploits the non-controlling shareholders through profit shifting, it also allocates sales growth opportunities to subsidiaries to mitigate PP conflicts.

Impact of Parent Companies and Multiple Large Shareholders on Audit Fees in Stakeholder-Oriented Corporate Governance

“…Indeed, previous studies analyzing Japanese family firms, where stakeholder-oriented corporate governance is generally in practice, have shown that controlling shareholders in family firms are consistent with stewardship theory and that dividend payout ratios, profitability, and R&D expenditures are higher in family firms [47,48]. Further, previous studies investigating potential conflicts between parent and non-controlling shareholders in Japanese subsidiaries show that although dividends are reduced in subsidiaries, PP conflicts between parent and non-controlling shareholders are not severe, as the subsidiary's sales growth is promoted [21,22]. Moreover, information asymmetries between stakeholders and management are mostly resolved through insider communication [15].…”

“…Under these inter-firm networks, Japanese firms are monitored by banks and cross-holding companies in order to maintain strategic and long-term relationships. As a result, Japanese firms adopt so-called stakeholder-oriented corporate governance, which seeks to achieve goals beneficial to various stakeholders, including non-controlling shareholders [22,34,52,53]. Under stakeholder-oriented corporate governance, the demand for accounting information is small, as the interests among stakeholders are resolved through private channels [15].…”

“…Second, Japanese firms generally adopt a management strategy of spinning off growing businesses into subsidiaries [20]. Furthermore, Japanese listed subsidiaries distribute wealth to non-controlling shareholders through sales and capital gains because the parent company encourages the subsidiary's sales growth for a long-term period [21,22]. Thus, PP conflicts between parent companies and non-controlling shareholders are not serious in Japanese listed subsidiaries [21].…”

“…At the same time, in Japanese firms that adopt a stakeholder-oriented corporate governance, monitoring by banks, employees, or between firms mitigate PP conflicts. In particular, ownership by the parent company leads listed subsidiaries to be managed on a long-term horizon, which tends to increase the sales growth rate of listed subsidiaries [21,22]. Conflicts between controlling shareholders (parent companies) and non-controlling shareholders, or PP conflicts, are not severe in Japanese listed subsidiaries because the growth of listed subsidiaries is also distributed to non-controlling shareholders through capital gains [21,22].…”

“…In particular, ownership by the parent company leads listed subsidiaries to be managed on a long-term horizon, which tends to increase the sales growth rate of listed subsidiaries [21,22]. Conflicts between controlling shareholders (parent companies) and non-controlling shareholders, or PP conflicts, are not severe in Japanese listed subsidiaries because the growth of listed subsidiaries is also distributed to non-controlling shareholders through capital gains [21,22]. In addition, parent companies generally have an incentive to disclose information and reduce the cost of capital [23] for the long-term growth of their listed subsidiaries, and parent companies are likely to require greater audit effort from the auditors of their listed subsidiaries.…”