Governance through Shame and Aspiration: Index Creation and Corporate Behavior in Japan

Abstract

We study how a stock index can affect corporate behavior by functioning as a source of prestige. After decades of low corporate profitability, the JPX-Nikkei400 index was introduced in Japan in 2014. Each year the index selected 400 large and liquid firms deemed to be best-performing in terms of profitability; membership is considered highly prestigious. We document that index-inclusion incentives have led firms to increase return on equity proportionally by 41%, via higher margins, efficiency, or shareholder payouts, depending on where they had slack, but not by changing investments or accruals. These incentives are driven by the prestige associated with the index, rather than capital-market benefits. Back-of-the-envelope estimates suggest that the index-inclusion incentives accounted for 16% of the average increase in aggregate annual earnings over our sample period and 20% of the growth in aggregate market capitalization. These findings shed light on a novel mechanism by which longstanding corporate behaviors can be transformed.