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The present study investigates the influence of main industrial banks, capital markets, and international audit firms on earnings manipulations in Japan using a sample of firms listed on Japanese stock exchanges. A modified Jones model is used to measure earnings management using discretionary accruals as proxy, and the findings suggest that the main industrial banks continue to play a primary role in Japan's system of corporate governance. However, global capital markets and international accounting standards may be slowly eroding this influence. This may have significant implications for international investors and policy makers as Japan continues through a protracted economic recession.
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INTRODUCTION
The Japanese business model is unique and has been described as "Criss-Crossed Capitalism" in the popular business press (Economist, 2008). At the center of this model are the main industrial banks, which play a primary role in Japan's system of corporate governance. Previous research has attempted to describe this relationship between the "Main Bank" and cooperative firms in terms of the scope of this relationship. Douthett and Jung (2001:137) contend that the Main Bank has historically played an important monitoring role within the group. In particular, within the "Keiretsu" (Japanese for "web") System, the Main Bank has functioned both as a creditor and shareholder and therefore had strong incentives to become informed about the affiliated firms and their investment opportunities. It used this information to ensure that efficient choices were made. Fan and Wong (2002:16) reported that, unlike other East Asian firms that were typically family-controlled, Japanese firms were institutionally owned, with principal control held by the Main Banks within industrial groups. Japanese ownership structures also differed from their East Asian peers in the degree of control exercised by the Main Banks. However, Weinstein and Yafeh (1998) questioned the long-term viability of the Japanese system in free markets, as the Main Bank made use of its monopoly power to lend capital at significantly higher than market interest rates.
These previous studies mentioned above all provide evidence of the unique economic bond that exists between Japanese firms and their Main Banks. Postwar Japan has seen the dominance of a relatively strong relationship between Japanese firms and their affiliated industrial banks and a correspondingly weak relationship with financial markets (Aoki...
