Reasons behind the poor earning power of Japanese firms

Hyeog Ug Kwon

20 October 2015



Japanese firms invest in research and development (R&D) on a level comparable to that of their US counterparts (Griliches and Mairesse 1985). They possess a high-quality workforce and receive decent management practice scores for organisational and human resource management. Yet, they fall significantly behind US firms when it comes to earning power.

Figure 1 below, which I calculated along with Kim Young Gak (Senshu University School of Economics), plots the average ratio of operating income to sales for Japanese, US, and South Korean listed companies from 1955 to 2006. As it shows, the operating income ratio of Japanese firms never surpassed that of US firms over the entire 50-year period, and trended downward until 2003.

Figure 1. Average operating income to sales ratio

Why do Japanese firms have poor earning power?

One of the reasons behind Japanese firms’ poor earning power is their corporate structure whereby the chief executive officer (CEO) is the one who is responsible for corporate management. To verify whether the CEO is attributable to Japanese firms’ poor earnings performance, I examined performance fluctuations of Japanese and US firms before and after a change in company leadership.

  • Empirical analysis conducted by Izumi and Kwon (2015) shows that both Japanese and US firms suffer corporate performance decline leading up to the forcible replacement of the CEO, and that the replacement results in performance recovery for US firms but not for Japanese firms.

Figure 2. Return on assets before and after corporate leadership change

Figure 2 shows the changes in the return on assets (ROA) for Japanese and US firms before and after a corporate leadership change. If performance decline is attributable to external factors at the industry or corporate level, it may be able to be recovered without a leadership change. To deal with this possibility, I employed a matching approach for the analysis. I chose firms with no forcible leadership change experience that share similar characteristics with those that have undergone forcible leadership change, and compared the performance of the two groups.

  • The results strongly indicate that CEOs of US firms aim to maximise corporate performance, while CEOs of Japanese firms prioritise long-term corporate survival.

This hypothesis is verified by results showing that US firms substantially cut down on the scale of assets and workforce to increase return on assets following leadership changes, whereas Japanese firms tend to work on reducing liabilities. Despite excelling in technologies, organisational management, and human resource management, Japanese firms seem to have lower earning power because CEOs, who are responsible for corporate management, do not prioritise profit maximisation. Such tendency leads to a loss of shareholders’ equity and inefficient usage of firm resources, causing a major negative macroeconomic impact.

What should be done to foster earning power?

The secret of Japanese firms’ strength has been described as lifetime employment, seniority-based wages, and company-specific labour unions. These elements of Japanese strength are on the premise of long-term corporate survival. To safeguard them, Japanese firms have demonstrated a tendency to choose CEOs from within their own ranks who are familiar with the company and have a risk-averse stance, or from their immediate stakeholders (creditors, parent companies). As long as this tendency continues, Japanese firms are less likely to reach their full potential and generate earnings which can measure up to their performance. To improve Japanese firms’ performance and pull them out of the ‘lost two decades’, it is necessary to carry out the following reforms:

  • First, just as US CEOs would opt to cut jobs to boost corporate performance after leadership changes, Japanese firms must have a flexible labour market and other complementary systems such that their CEOs can execute management rights with responsibility.
  • Next, the US has a labour market for CEO resources who specialise in business management, whereas there is hardly such a labour market in Japan.

The presence of a labour market for management specialists sets the US far ahead of Japan in terms of the scale of human resources pool for potential company leaders. This could negatively affect corporate performance after leadership changes. A CEO moving on to another company after leading the first company’s recovery from poor business performance is normally a one-off case. There is hardly any such case of company leaders moving on to another business. There is a problem seen with firms such as the Sony and Sharp Corporations, which both selected a new CEO from within their own ranks following a business downturn.

  • Finally, many banks are reluctant to approve high-risk, high-return investments because their primary goal is the collection of debts.

It should also be noted that it is difficult for boards of directors, which comprise only of insiders, to be independent and pursue profit maximisation in company management. The Companies Act has been amended to encourage the appointment of outside directors to overcome the above-mentioned issues. Through these system reforms, it is necessary to overhaul the Japanese firms’ shareholder structure, which is based on cross-shareholding with main financing banks, and the structure of their boards of directors.

Authors’ note: This column was reproduced with permission from the Research Institute of Economy, Trade and Industry (RIETI).


Griliches Z and J Mairesse (1985), “R&D and productivity growth: Comparing Japanese and US manufacturing firms”, NBER working paper No.1778.

Izumi A and Kwon H U (2015), “Change in Corporate Performance after Forcing Out CEOs: Comparison between the United States and Japan,” RIETI Discussion Paper Series 15-J-032.



Topics:  Industrial organisation Productivity and Innovation

Tags:  Japanese firms, firms’ performance, corporate performance, profit maximisation

Professor at the College of Economics, Nihon University; Faculty Fellow, RIETI