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November 1, 1991

eCONOMIC
GOMMeNTORY
Federal Reserve Bank of Cleveland

Why U.S. Managers Might Be More
Short-run Oriented Than the Japanese
by Gerald H. Anderson

r l decade ago, some business analysts
began to accuse U.S. managers of concentrating too much on current profits
and too little on enhancing their firms'
long-run prospects. The implication of
this alleged corporate myopia is that
American companies would gradually
become less competitive and less profitable relative to their foreign counterparts
(particularly Japanese firms), which are
thought to be more long-run oriented.
Excessive concern with the current quarter's bottom line may lead managers to
take actions that hamper a company's
long-run profitability, such as delaying
maintenance, trimming customer service,
raising prices, deferring new product
development, and cutting employee training. All of these can eventually weaken a
firm's ability to compete, but if the pressure for current profitability is high
enough, such tactics may seem necessary.
In an efficient market, where outside investors are as aware of a firm's prospects as management, a manager could
not raise a company's share price by instituting policies that increase current
reported earnings at the expense of
longer-run profitability. However, both
intuition and substantial empirical
evidence indicate that an information
gap exists, with management being better informed about a company's prospects than outside investors.
This article examines the alleged differences between U.S. and foreign business perspectives by asking whether

ISSN 0428-1276

American managers are indeed more
shortsighted than their foreign counterparts and, if so, why. Because Japanese
managers are often held up as paragons
of long-run perspective, this essay
focuses on differences between U.S.
and Japanese business practices.
• Are We More Shortsighted?
The view that American managers
focus more on short-term goals than do
the Japanese appears to have become
conventional wisdom. In 1985, more
than 1,000 corporate executives, trade
unionists, and independent economists
from 28 countries ranked Japan first
and the United States twelfth among 22
industrialized nations when asked to
what extent those countries' firms focus
on long-run goals. A more recent survey further strengthens that view. In
1990, when the same question was put
to 1,800 executives from 34 countries,
Japan maintained its number one ranking, but the United States fell to twentyfirst among 23 industrialized nations.
Surveys of U.S. and Japanese business
executives reveal the same pattern. A
1984 study found growth to be more
important to Japanese managers, while
Americans were much more concerned
with current share price. And when
the chief executive officers of the 500
largest Japanese and American corporations were asked to rank nine business
objectives in order of importance to
their own firms, similar results were obtained. The Japanese gave increased
market share top priority, while that

American managers have been accused
of opting for strategies that enhance
short-term profits at the expense of
long-run competitiveness. One implication of this allegation is that U.S. firms
will lose ground in the world marketplace to those that have patiently pursued long-term strategic objectives. This
article compares U.S. and Japanese
business practices and finds that American managers are indeed myopic relative to their foreign counterparts, that
this divergence in perspectives stems
from rational responses to different
business environments, and that
adopting the Japanese way of doing
business is not necessarily the best
strategy for the United States.

goal placed third on the Americans' list.
Capital gains for stockholders was
ranked second by the Americans but ninth
by the Japanese, and new product ratio
(the ratio of sales from relatively new
products to sales from older products)
placed seventh among U.S. executives
but third among the Japanese.5
• Evidence from R&D Allocations,
Pricing, and Profits
If there is a difference in the goals that
U.S. and Japanese managers set for
their companies, it should be reflected
in patterns of research and development
(R&D) spending as well as in data on

prices and current profits. Indeed, this
appears to be the case.
While both groups have similar ratios of
R&D expenditures to sales revenue, the
Japanese emphasize basic research on
new technologies and the development of
new products — efforts not likely to pay
off until well into the future. Americans,
on the other hand, lean toward research
aimed at improving and updating existing products — efforts likely to show a
quicker return (see footnote 5, p. 44).
The divergence in perspectives is also
evidenced by sharply different pricing
responses to changes in costs. Over the
1980-1989 period, unit labor costs in
the manufacturing sector (measured in
dollars) rose 6.8 percent in the United
States and 50.0 percent in Japan. Because labor cost constitutes such a large
share of total manufacturing expenses,
American firms probably improved their
cost position substantially relative to their
Japanese competitors. That advantage appears to have presented U.S. firms with
an opportunity to greatly increase their
price competitiveness and thereby gain
market share in international markets.
But in an apparent bid to expand their
current profits, American firms generally
raised export prices by considerably
more than 6.8 percent over this ten-year
period. In contrast, the Japanese raised
prices by much less than 50.0 percent on
average, sacrificing current profits in an
apparent attempt to maintain or to increase their market share.
Japanese companies also record much
lower current profits than similarly sized
American firms. Two recent studies comparing U.S. and Japanese multinational
corporations found that net profit as a percentage of total assets is less than half as
much in Japan, while net profit as a percentage of sales is about one-third that of
American firms.
Lower current profits can be consistent
with a drive for growth and increased future earnings. A company may be willing
to accept lower prices and profit margins
to achieve greater market share, or it may
find its profits down because current
spending is high for new product devel-

opment, employee training, customer
service, and distribution-network expansion. Short-run earnings may also
fall when a firm is incurring the startup costs associated with plant and
equipment expansion.
Lower current profits relative to sales
and assets tell us nothing about the returns that Japanese stockholders are
reaping compared to investors in American corporations. Japanese firms tend to
be more highly leveraged than their
American counterparts, which increases
their profit as a percentage of equity relative to U.S. firms. More important, however, is the fact that the return to stockholders does not depend on current return
to book equity, but on factors such as dividends per share, share-price appreciation,
and tax rates on dividends and capital
gains. Economic theory suggests that
share price depends on the expected size
and certainty of future earnings, while
share appreciation is based on changes in
those expectations after a share has been
purchased. Stock market participants can
be expected to respond to all of these considerations in a way that will equalize the
expected after-tax, risk-adjusted rate of
return on U.S. and Japanese stocks purchased at the same time. But such equality would provide no information about
the relative growth rates of sales or profits of Japanese and American businesses.
• Are These Differences
in Behavior Irrational?
It would be hard to believe that Japanese managers are generally brighter
and more capable than American managers. It would also be difficult to
accept that U.S. managers, as a group,
behave in an irrational way. How, then,
can one explain Japan's greater emphasis on long-run profitability?
The answer can be found in both camps'
rational responses to differences in shareholder relationships, attitudes toward employment tenure, and sources and costs
of capital, as well as in other characteristics of the Japanese economy that encourage corporations to grow.

Shareholder Relationships. In both
Japan and the United States, there is little overlap between management and
ownership of large corporations. However, a key difference in this relationship exists between the two countries.
In the United States, the primary relationship between a major shareholder
(such as a pension fund or mutual
fund) and a corporation is one of financial investment: Stockholders will
readily sell their shares if an alternative
investment appears more promising.
In Japan, by contrast, large stockholders
tend to come from the ranks of a company's suppliers, customers, and bank
lenders. Thus, in addition to their
financial investment, stockholders have
other important relationships with the
firm that are intimately tied to its longrun success. Because stockholding is a
public affirmation of the important relationships that exist among Japanese
firms, major shareholders typically do
not invest with an eye to near-term
earnings, but rather to solidify a longterm profitable association.
U.S. managers must monitor current
profits closely, because a drop in either
profits or near-term profit expectations
generally causes share prices to fall. In
Japan, however, large shareholders
would not respond negatively to a temporary downturn in profits, so management is free to take a longer-run view.
The apparent shortsightedness of American shareholders, rather than implying irrationality, may be a reasonable response
to the greater gap in the United States between information available to management and information available to stockholders. Consider a decline in current
profits that stems from actions that are
likely to enhance a company's future
earnings. In Japan, large stockholders are
"insiders" who know this to be the case;
thus, they will not be disturbed by the
downturn. In contrast, American stockholders are "outsiders" who might interpret the drop-off as a bad omen for future
earnings. Although management can
publicly explain the reasons behind the
decline, stockholders are likely to remain

skeptical because they have no opportunity to confirm the facts for themselves.
A drop in share prices entails several disadvantages for a firm's managers, including increased capital costs, a heightened
possibility that disaffected shareholders
will participate in a proxy fight to wrest
control of the company from its current
managers, and a reduction in the potential
price of a hostile takeover.
Employment Tenure. Large Japanese
firms have a more permanent relationship with their employees than is common in major American companies.
Because changing employers is not
only less common but also more difficult for employees of large Japanese
firms than for their American counterparts, workers and middle managers in
Japan have greater incentives to push
for policies that will both enhance a
company's long-run health and create
opportunities for promotion. Moreover,
senior managers, having come up
through the ranks in a company, tend to
identify more with their employees
than is common in America. In fact, it
has been said that the mission of a
Japanese firm is to survive so that it
can fulfill its social obligation to provide employment for its workers, while
American firms exist to generate
profits for their shareholders. Because
Japanese senior managers do not have
to face pressures from stockholders for
near-term profitability, they can pursue
growth policies that are in the long-run
interest of their employees.
Sources and Costs of Capital. Japanese
companies seem to have benefited over
the years from a lower cost of capital relative to U.S. firms, especially before the
mid-1980s.'2 Lower capital costs facilitate a long-run business outlook by reducing the pressure on managers to choose
investments with fast payoffs.
In recent decades, dividends and interest rates for bank loans have been much
lower in Japan than in the United
States, partly because of governmental
controls on savings-deposit interest
rates and on capital outflows. These re-

strictions have been progressively
eased over the last several years,
decreasing, and perhaps eliminating,
this source of Japan's capital cost
advantage.
Nevertheless, the cost of capital is still
probably lower in Japan than in the
United States for two reasons. First, as
noted above, Japanese businesses often
borrow from banks that are large stockholders in the company, reducing the risk
that management will make decisions
that are detrimental to lenders. As a
result, agency costs of borrowing should
be lower in Japan. Second, investors' expected bankruptcy costs are also lower,
because Japanese firms' lenders and
major stockholders are usually related
companies that have a stake in a troubled
firm's success; thus, they are likely to step
in and support a company experiencing
difficulties. Even the Japanese government will sometimes intervene on behalf
of an ailing firm.
Other Factors. Most Japanese firms
associate in large groups called keiretsu.
Ties of loyalty among keiretsu members
result in mutual support during hard
times, even when such action is costly.
For example, group members might pay
higher prices to buy from a troubled
member than they would have to pay to
an outsider. This loyalty makes it easier
for Japanese executives to take risks and
to focus on long-run goals rather than on
near-term profitability.
In addition, the rapidly growing Japanese
economy, which has expanded much
faster than that of any other industrialized
country since World War II, has forced
the nation's companies to keep pace in
order to maintain domestic market share,
which is critical for competitiveness. Loss
of market share often means that a firm
loses economies of scale, the ability to
finance R&D, and name recognition and
prestige among its customers relative to
its competitors. Thus, Japan's economy
has created an environment in which a
firm's survival depends on rapid expansion and where the negative consequences of shortsighted policies become apparent more quickly than in
the United States.

• Conclusion
This essay offers several explanations for
why the Japanese might focus on longerrun goals than we do. The divergence in
perspectives, if true, may represent a rational response to differences in such factors as employee tenure and patterns of
corporate ownership. It is not my intention to imply, however, that the United
States should wholly adopt the Japanese
way of doing business, since some practices that foster a long-run management
view also entail disadvantages.
Fear of a hostile takeover, for example,
encourages U.S. managers to place
greater emphasis on current profits and
share prices. Policymakers could pass
laws to prevent such takeovers, but this
would eliminate what many believe to be
an important source of market discipline
on corporate management.
Consider also the so-called lifetime employment system. This practice greatly
reduces the likelihood of layoffs or dismissals, but also makes it difficult for a
worker who leaves a firm to find
another employer. Although being
effectively tied to a single employer
throughout one's career may encourage
devotion to that firm's survival and
growth, it also substantially constricts
personal freedom. Moreover, it constrains the efficiency and flexibility
that an economy obtains from the geographic and job mobility of its workers.
Finally, consider the keiretsu. Close
association and interlocking ownership
of firms reduce the risks faced by group
members and also avoid much of the information gap between firms and large
stockholders that exists in America. But
a keiretsu also concentrates tremendous
economic power in the hands of a few
executives — an outcome that most
Americans would probably consider to
run counter to the national interest.

• Footnotes
1. See Kenneth A. Froot, Andre F. Perold,
and Jeremy C. Stein, "Shareholder Trading
Practices and Corporate Investment Horizons," National Bureau of Economic Research, Working Paper Nc. 3638, March 1991
(especially pp. 29-36, which report evidence
of an information gap, obstacles to narrowing that gap, and further citations).
2. See EMF Foundation, Report on International Competitiveness, 1985.
3. See IMD International and World Economic Forum, The World Competitiveness
Report, 1990.
4. See Toyohiro Kono, Strategy and Structure of Japanese Enterprises. New York:
M.E. Sharpe, Inc., 1984, pp. 53-55.
5. See Tadao Kagono et al., "Mechanistic
vs. Organic Management Systems: A Comparative Study of Adaptive Patterns of
American and Japanese Firms," in Kazuo
Sato and Yasuo Hoshino, eds., The Anatomy
of Japanese Business. New York: M.E.
Sharpe, Inc., 1984, pp. 32-37.
6. Appreciation of the yen relative to the
dollar caused the Japanese increase. Japan's
manufacturing unit-labor costs measured in
yen actually fell more than 8 percent between 1980 and 1989.
7. See J. Haar, "A Comparative Analysis of
the Profitability Performance of the Largest
U.S., European and Japanese Multinational
Enterprises," Management International Review, vol. 29, no. 3 (1989), pp. 5-18; and James
C. Abegglen and George Stalk, Jr., Kaisha, The
Japanese Corporation: How Marketing,
Money, and Manpower Strategy, Not Management Style, Make the Japanese World PaceSetters. New York: Basic Books, Inc., 1985.

9. See Kagono et al., "Mechanistic vs. Organic Management Systems," pp. 36-37.
10. Hostile takeovers are much more common
in the United States than in Japan. According
to a recent study, about 10 percent of Fortune
500 companies were taken over in the 1980s
in transactions that began as hostile, while in
Japan very little hostile activity was noted
(see footnote l,p. 25).
11. This relationship, often described as lifetime employment, has developed only since
the end of World War II and is common in
only the largest and most successful Japanese
firms (affecting fewer than one-third of the
country's workers). Moreover, because Japanese companies often require employees to
retire at a younger age than is typical in the
United States, "lifetime" is a relative term.
While lifetime employment encourages managers to take a long-run view, it also reduces
their freedom to make staffing-level reductions that might enhance profitability. See
Kono, Strategy and Structure, pp. 318 -20;
Robert H. Hayes, "Why Japanese Factories
Work," Harvard Business Review, vol. 59
(July/August 1981), pp. 63-64; Kagono et
al., "Mechanistic vs. Organic Management
Systems," p. 34; and Clyde V. Prestowitz, Jr.,
Trading Places: How We Are Giving Our Future to Japan and How to Reclaim It. New
York: Basic Books, Inc., 1988, p. 304.
12. See George Hatsopoulos, The Gap in the
Cost of Capital: Causes, Effects, and Remedies. Boston: Thermo Electron Corporation,
1985. For an opposing view, see Carliss Y.
Baldwin, "The Capital Factor: Competing for
Capital in a Global Environment," in Michael
E. Porter, ed., Competition in Global Industries. Boston: Harvard Business School
Press, 1986, pp. 185-223.

13. Some of the large outflows of long-term
capital from Japan during the last decade may
represent a portfolio adjustment by investors
who had been prevented from acquiring as
many foreign assets as they would have in the
absence of controls. See Reuven Glick, "Japanese Capital Flows in the 1980s," Federal
Reserve Bank of San Francisco, Economic
Review, Spring 1991, pp. 18 -31.
14. See William Osterberg, "The Japanese
Edge in Investment: The Financial Side,"
Federal Reserve Bank of Cleveland,
Economic Commentary, March 1, 1987.
15. See Prestowitz, Trading Places, pp.
293-306.

Gerald H. Anderson is an economic advisor at
the Federal Resenv Bank of Cleveland. The
author benefitedfrom comments by Patricia
Beeson, John Erceg, Erica Groshen, Joseph
Haubrich, Edward Montgomery, William
Osterberg, and Mark Sniderman, and from research assistance by Susan Byrne and Ann
Dombrosky.
The views stated herein are those of the
author and not necessarily those of the Federal
Resen'e Bank of Cleveland or of the Board of
Governors of the Federal Resene System.

8. See Kono, Strategy and Structure, p. 61.

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