To discipline managers, various governance measures are being developed. They include stock options, shareholder lawsuits, hostile takeovers, and outside directors. In the literature, some studies have found evidence supporting the introduction of these measures, but others have found evidence opposed. Recently, however, some measures are being required not by stockholders but by the regulatory authorities. For example, the Tokyo Stock Exchange revised its listing standard in 2014 to require that virtually all listed companies appoint outside directors. Furthermore, the council of Japan's Financial Services Agency proposed cooperative banks to appoint outside or independent directors. It is notable that most previous studies have found evidence regarding stock companies, not cooperative companies. The effectiveness of various governance measures may be different between stock companies and cooperative companies. The subject of how to discipline managers of cooperative companies is particularly relevant to the Japanese banking market because cooperative banks play a significant role in the Japanese banking market. Therefore, this paper examines whether the effect of the numbers of directors and outside directors on firm performance varies across stock and cooperative banks in Japan. Our analysis consists of two stages. In the first stage, we estimate the stochastic frontier cost functions for stock and cooperative banks. Then we examine the differences in cost structures and efficiencies between them. In the second stage of the analysis, we seek to clarify the relationship between governance measures (e.g., the number of outside directors) and efficiencies by estimating a regression model. Results in this paper confirm that governance-related variables have a significant effect on cost efficiency for cooperative banks. In contrast, such variables have no significant effect for stock banks. These results suggest that the organizational type of financial institution does matter in terms of what governance measures are effective and needed. For example, as managers at cooperative banks are under weak pressure from owners due to lack of hostile takeover threat, other disciplinary measures, such as mandatory appointment of outside directors, are more desirable to compensate for the weak corporate governance inherent in cooperative institutions. Our results support the current proposals of the FSA's council to encourage cooperative financial institutions to appoint outside board directors as a means for strengthening bank governance.
