Economists have long argued that when companies are insulated from competition and are unmonitored, their managers may not be motivated to maximize the profit of the firm and instead may choose to enjoy the “quiet life.” But are the economists right? Left to their own devices, do managers really prefer the quiet life? A new paper empirically tests this quiet life hypothesis with Japanese data. The results are consistent with the hypothesis: Without competition or monitoring, managers do seem to put off hard decisions.



Kenneth Andersson for HBR

In competitive markets, managers have a strong incentive to give their best effort. But economists have long argued that when companies are insulated from competition, their managers may not be motivated to maximize the profit of the firm and instead may choose to enjoy the “quiet life.” Similarly, without sufficient monitoring by owners of the firms or the stock market, managers might be tempted to enjoy the quiet life instead of making hard decisions or taking on difficult tasks.

But are the economists right? Do managers really work less hard without competition and monitoring? Left to their own devices, do managers really prefer the quiet life?

My recent paper, coauthored with Naoshi Ikeda and Sho Watanabe of Tokyo Institute of Technology, empirically tests this quiet life hypothesis with Japanese data. We employ cross-shareholder ownership — in which a company has interlocking stock ownership with other firms or banks with which the firm has close business ties — as the proxy variables of the strength of a manager’s defense against market disciplinary power. The idea is that, under interlocking shareholding, one firm would not demand, as a shareholder, that the other firm maximize its profit nor vote against the firm’s management even in a case of poor performance, because doing so would harm the business relationship between them.

We examine the effect of this proxy variable on manager-enacted corporate behaviors, and find that entrenched managers who are insulated from the disciplinary power of the stock market avoid making difficult decisions such as large investments, R&D, and business restructurings. However, when the managers are monitored by institutional investors and independent directors, they tend to make difficult decisions more aggressively. Taken together, our results are consistent with the quiet life hypothesis. Without competition or monitoring, managers do seem to put off hard decisions.

Our results are consistent with a previous study, by Marianne Bertrand and Sendhil Mullainathan, which found something similar using U.S. data. The study explored the effects of a state anti-takeover law in American manufacturing from 1976 to 1995 and found that, for companies with head offices located in the states where anti-takeover laws were passed, there were decreases in factory construction or closures, lower profits and productivity, and increases in worker wages. Thus, the quiet life problem is not specific to Japanese firms.

However, we are concerned that the impact of the quiet life problem of Japanese managers is more significant and persistent than in the U.S. For decades, Japan has suffered from low corporate profitability, low economic growth, and poor stock market performance. Despite unprecedented and prolonged monetary policy meant to boost the economy, capital investment in the corporate sector has remained stagnant. When we compare capital investment, M&A, and R&D of the firms with high cross-shareholding (the highest one-third of firms) with those of similar firms from the remaining listed firm group, the high cross-shareholding firms invest roughly 9% less than similar firms annually, which is a significant difference. Since our method of matching similar firms controls for industry, firm size, profitability, growth opportunity, cash holding, and leverage, it is not likely that the difference is caused by the difference in profitability or growth opportunity of the two groups.

Historically, cross-shareholding with business counterparties is considered by business practitioners to have positive effects on business through the development of mutual trust and commitment among the participating firms. That might be true in some cases, but our research suggests the negatives outweigh the positives. One example of this is Nissan, which faced business and financial difficulties in the late 1990s, but succeeded in increasing its profit margin by nearly 10% from 1998 to 2003, by conducting large-scale restructuring, including resolving cross-shareholding with most of its suppliers and related companies. Nissan rearranged business relations with them under the strong leadership of Carlos Ghosn, CEO of Nissan from 1999 to 2017.

Interlocking ownership with other firms in an industry might seem attractive for managers. However, such an arrangement might provide room for the managers to entrench themselves, and thus to enjoy the quiet life, at the expense of both shareholders and customers. Our study indicates that an appropriate degree of discipline from the market is an essential element for the future growth of corporations.