Executive compensation and independent directors in Japan

Following the example of the United States, Japanese companies have been appointing more independent outside directors in recent years. Independent outside directors are regarded as playing a key role in determining executive compensation and other managerial oversight functions. Prior research mostly supports this idea with respect to U.S. corporations. However, some studies are more skeptical. Therefore, in response to a prior study on U.S. corporations by Chhaochharia and Grinstein (2009), this paper takes a sample of 322 Japanese non-financial corporations in the TOPIX 500 index that met certain criteria and analyzes the effect that having more independent directors has had on executive compensation. However, unlike in prior studies, we did not observe a statistically significant effect. In fact, we saw that executive compensation levels were affected more by the structure of executive remuneration that is determined across a company as a whole than by the composition of its board of directors.


Executive Compensation and Independent Directors in Japan
Takashi BUI a) Abstract: Following the example of the United States, Japanese companies have been appointing more independent outside directors in recent years. Independent outside directors are regarded as playing a key role in determining executive compensation and other managerial oversight functions. Prior research mostly supports this idea with respect to U.S. corporations. However, some studies are more skeptical. Therefore, in response to a prior study on U.S. corporations by Chhaochharia and Grinstein (2009), this paper takes a sample of 322 Japanese non-financial corporations in the TOPIX 500 index that met certain criteria and analyzes the effect that having more independent directors has had on executive compensation. However, unlike in prior studies, we did not observe a statistically significant effect. In fact, we saw that executive compensation levels were affected more by the structure of executive remuneration that is determined across a company as a whole than by the composition of its board of directors.
Keywords: independent director, executive compensation, corporate governance, board control

Introduction
Following the example of the United States, Japanese companies have been rapidly adding independent directors, as suggested by the Corporate Governance Code released in June 2015. The ratio of companies listed on the First Section of the Tokyo Stock Exchange having two or more independent directors, which was 21.5% in 2014, had risen to 93.4% by 2019 (Tokyo Stock Exchange, 2019).
The practice of having independent directors started in the U.S. in 2003. Having external directors to provide oversight of management has existed in the U.S. since the 1950s. The reasoning behind it is that outside directors should be able to provide appropriate management oversight and assessment because they do not have a direct vested interest in the management of a company. This is particularly important in the setting of executive compensation (Fama, 1980;Fama & Jensen, 1983). However, the Sarbanes-Oxley Act was enacted in 2002 after it was realized that legislation needed to be overhauled to strengthen corporate governance in the wake of such incidents as the 2001 accounting fraud at Enron, which had several outside directors on its board (Maruyama, 2006). In response, the New York Stock Exchange (NYSE) tightened its definition of what constitutes the "independence" of outside directors and started to require that independent directors hold the majority of the board seats of listed companies.
Although some hold the opinion that outside directors and independent directors facilitate the appropriate oversight and assessment of management because it is difficult for management to affect their decisions, others believe that these directors are of limited use because they are appointed by management and because, compared with inside directors, it is more difficult for them to obtain inside information about the company (Duchin, Matsusaka, & Ozbas, 2010;Jensen, 1993). Therefore, some prior studies have conducted empirical analyses of the impact of outside directors and independent directors on executive compensation levels at U.S. corporations (Boyd, 1994;Core, Holthausen, & Larcker,1999). It has been pointed out that analyzing the impact of the board's composition on executive compensation poses the endogenous problem of whether executive compensation is actually affected by the board's composition or whether it is in fact affected by other, unobservable factors (Hermalin & Weisbach, 2003). Therefore, Chhaochharia and Grinstein (2009)  However, Guthrie, Sokolowsky, and Wan (2012) were critical of this study, saying that outliers in the sample had had a major impact on the analytical results, and they asserted that excluding these outliers from the analysis would actually mean that the negative impact of the increase in independent directors that was caused by the legislation would no longer be statistically significant.
It therefore remains inconclusive as to whether independent directors have an impact on executive compensation at U.S. companies. Furthermore, although some studies have been done on whether outside directors have an impact on executive compensation at Japanese companies, few have considered the effectiveness of independent directors (Arikawa, 2004;Basu, Hwang, Mitsudome, & Weintrop, 2007;Miyajima & Ogawa, 2012;Sakawa & Watanabe, 2009). Therefore, this paper follows the research of Chhaochharia and Grinstein (2009)  Because the Corporate Governance Code requiring listed companies to appoint at least two independent directors was announced in June 2015, we assumed that companies that did not have at least two independent directors prior to June 2015 had to increase their independent directors due to the regulatory change. We obtained the data on the number of independent directors at each company from Bloomberg.
Other factors besides the number of independent directors could also affect the level of executive compensation, including the size of the company, corporate performance, and the CEO's influence. This is why Chhaochharia and Grinstein (2009)  if a company is a "Company with a Nominating Committee, etc." or a "Company with an Audit and Supervisory Committee," it needs to have at least two independent directors (Takahashi, 2016). As a result, we excluded from the sample 23 companies that became companies with a nominating committee and 77 companies that became companies with an audit and supervisor committee during the observation period. We also excluded from the sample 15 firms that delisted during the observation period and 1 firm for which we could not obtain earnings data because it went public in 2011. The final sample consisted of 322 firms, and the number of observations was 1,932. Table 1 gives descriptive statistics for each variable for the companies in the sample. Those companies that had at least two    Table 2 gives that analytical results of the fixed-effects model  Sales it *Dummy Before t ) 0.246*** 5.16

Discussion
Although the coefficient for Dummy Noncomliant i )*Dummy After t ) was not statistically significant, it was negative. However, as we can see from Figure 2, the mean for average compensation of inside directors at Non_comply firms is actually rising (the coefficient is negative because the increase is smaller than at Comply firms). Since     year. In fact, Softbank's ROA is lower than that of either NTT Docomo or KDDI, but it has had a higher proportion of stock compensation in its compensation structure, which makes the average compensation of its inside directors the highest among the three companies. In other words, the compensation structure was the determining factor.

Conclusion
Following up on Chhaochharia and Grinstein (2009) executive compensation rose during the observation period at firms that increased their number of independent directors following the regulatory change. This suggests that regulations for appointing independent directors do not serve to lower executive compensation. In other words, the recent trend of Japanese firms' appointing independent directors is not due to this practice's success in the U.S. in strengthening supervision of management, but rather is due to institutional isomorphism (Aizawa, 2018). key topic for a future study could be to analyze which factors affect each company's compensation structure. However, under the existing disclosure regulations, companies only disclose limited information on how they determine compensation, so it is difficult to find out the specifics of how compensation is set, and the decisionmaking process involved. We thus anticipate a strengthening of the disclosure regulations regarding how compensation is determined to improve the transparency of information on executive compensation.