Creative norm destruction: the evolution of nonlegal rules in Japanese corporate governance.

• Jurisdiction: United States
• Date: 01 June 2001
• Author: Milhaupt, Curtis J.

This Article analyzes the origins, persistence, and current evolution of a series of nonlegal rules (norms) that have played an important role in Japanese corporate governance. The central features of the governance environment examined here include: (1) the main bank system, in which banks voluntarily restructure loans to some distressed borrowers, (2) a social distaste for hostile takeovers, (3) implicit promises of employment stability, and (4) belief systems about the proper role and structure of the board of directors.

I show that, despite virtually ubiquitous claims to the contrary, these norms do not enjoy a long history of practice in Japan, but rather emerged only in the immediate postwar period. I hypothesize that they emerged for two reasons: First, they served as a low-cost substitute for a troubled formal institutional environment beset by the "transplant effect" that imperils legal reform in transition economies today. Second, they provided private benefits to the small number of interest groups that emerged intact from World War II. The flow of private benefits to norm adherents explains the persistence of the norms despite clear evidence of their inefficiency over the past decade.

I demonstrate that current models of norm reform, which emphasize the role of exogenous shocks, the workings of norm entrepreneurs, and increased information, explain why the norms of Japanese corporate governance are currently evolving.

Finally, extrapolating from Japan's experience, I suggest how norm analysis can contribute to the two most pressing questions in comparative corporate governance today: whether law matters to corporate governance and whether diverse systems of corporate governance are converging toward the Anglo-American model. As to both questions, closer attention to norms reveals shortcomings in the existing literature. Specifically, the empirical model underlying the "law matters" literature is shown to be inconsistent with historical experience and overly attentive to formal rules enforced by courts. Bold claims that we are witnessing rapid convergence toward a shareholder-centered ideology, which in turn will drive convergence of corporate law and practices, are only partially supported by the Japanese experience to date. Rather than the "end of history" for corporate law, we are witnessing an ongoing struggle to align the formal and informal components of the governance regimes of many transition economies, including Japan's.

INTRODUCTION

As this Symposium attests, the role of norms in the corporation has only recently attracted the attention of legal scholars.(1) This is curious, given the depth of analysis previously devoted to the role social norms play in governing collective behavior among cattle ranchers, diamond merchants, sumo wrestlers, and other exotica.(2) The importance, if not the novelty, of these well-studied groups pales in comparison to the corporation, arguably the most ingenious private organization ever devised.

Perhaps even more curiously, social norms have been virtually ignored in the comparative corporate governance debates of the past decade. The omission of norms from this body of literature is particularly stark. It is now widely recognized, for example, that legal protections for minority investors are a key variable in determining patterns of corporate ownership and finance around the world. Yet the literature to date (which ironically has been dominated by economists) displays a rather naive fixation on formal legal protections and judicial enforcement to the exclusion of other alternatives. To take another example, analysis of complements and substitutes has been used powerfully to explain major phenomena in comparative corporate law, including the stickiness of institutional change and the unintended consequences of legal transplants. But this conceptual framework has not been brought to bear on the interaction between legal and nonlegal rules in the governance of firms. Perhaps most glaringly, for all the recent discussion of global convergence on a shareholder-centered model of corporate governance, there have been remarkably few careful examinations of the linkage between corporate norm shifts and changes in corporate law and practice.

As a modest step toward filling these gaps in the literature, in this Article I examine the creation, persistence, and evolution of a series of highly complementary, nonlegally enforceable practices that shaped postwar corporate governance for large Japanese firms. I examine four central features of the governance environment: (1) the "main bank" system and its role in corporate monitoring, (2) the absence of an external market for corporate control, (3) the structure and role of Japanese boards, and (4) the lifetime employment system. Examining these components of Japanese corporate governance is certainly not novel. Analyzing them as norms, however, yields some fresh insights into how nonlegal rules interacted with the legal system during the heyday of Japanese corporate governance, why the norm-based system persisted long after evidence of its inefficiency emerged, and how (or whether) Japan is currently adapting to a shareholder-centered ideology of corporate governance. Most interestingly, Japan's experience with corporate norms--which as we shall see is intimately related to its three experiences as a transition economy--sheds light on a current debate about the role of law in corporate governance. This debate is itself an outgrowth of the past decade of institutional disarray in many transition economies of Eastern Europe and Asia.

This Article has two principal aims: First, to contribute to the limited store of primary research on norms by analyzing their role in the governance of firms in the world's second largest economy. Primary research on norms of all types is in short supply, but research on the operation of norms among organizations is virtually nonexistent.(3) The second aim is to draw attention to the lack of norm analysis in comparative corporate governance scholarship. The Article does so by illustrating, based on the Japanese experience, how norm analysis contributes to the two most interesting questions in comparative corporate governance today: Do legal differences explain cross-country differences in corporate ownership and finance, and are corporate governance systems converging?

The Article is organized as follows: Part I describes four norms that are intimately connected to Japanese corporate governance practices in the postwar period. Part II demonstrates, despite numerous claims to the contrary, that each of these norms first emerged in the postwar period and represents a break with past practices. This insight provides important clues about the origins and durability of the norm-based system. I hypothesize that the new norms emerged as both low-cost substitutes for legal rules in the institutional turmoil of the immediate postwar period and as a fount of private benefits for the few organized groups left intact after the war and Allied occupation. Normative corporate governance, I argue, was a postwar Japanese invention understandable through the lenses of transaction cost economics and public choice theory. Part III explores the ongoing evolution of the postwar norms of Japanese corporate governance, reflecting shifts in the relative costs of using legal versus nonlegal rules, reconfigurations of the players in Japanese corporate governance, increased information, and the workings of norm reformers, including those within the government. Drawing on the creation and destruction of nonlegal rules in corporate Japan, Part IV highlights the contribution of norm analysis to the two key debates in comparative corporate law scholarship today.

Before proceeding, a definition and two caveats are in order. One of the principal problems with norm analysis is the lack of agreement on the definition of the term. In this Article, I have adopted Richard Posner's definition: a norm is "a rule that is not promulgated by an official source, such as a court or a legislature, nor enforced by the threat of legal sanctions, yet is regularly complied with."(4) This definition does not require that a rule be internalized as a preference(5) or that it be deeply rooted in the culture that complies with it. Unlike many other definitions in use, it does not place particular emphasis on social enforcement, thus highlighting the possibility that norms can be self-enforcing if compliance generates private benefits. The first caveat is that, for reasons made clear below, several of the rules I am about to discuss fall marginally outside that definition because they depend in some way on the government for promulgation or enforcement. I have included them because their informal character substantially outweighs the support they draw from the state and because the intermeshing of norms and state-generated rules is one of the key themes emerging from our inquiry. The second caveat is that these norms apply only to the governance of large, publicly held firms.

1. FOUR NONLEGAL RULES OF JAPANESE CORPORATE GOVERNANCE

   The stylized account of Japanese corporate governance for large firms contains several key features: the "main bank" system, in which banks are said to perform the key monitoring role over their client firms; the concomitant absence of an external market for corporate control; employee-dominated boards that focus on day-to-day management rather than monitoring; and the lifetime employment system, in which certain employees enjoy implicit promises of career-long job stability. This Part examines the normative features of these arrangements. My point here is not that law is irrelevant to Japanese corporate governance.(6) Rather, it is to highlight the distinction between institutions (endogenously generated, self-enforcing informal rules, including beliefs) and law,(7) and to show how important the former are...