What Most Affects A Firm' s Costs: Internal or External Factors, or Both?

The main purpose of this study is to investigate what kind of internal and external factors most affect a firm' s costs. We consider governance structure and business diversification strategy as internal factors and regulation and competition as external factors. By using 358 observations comprised of Japanese firms from public utility and manufacturing industries from 1989 to 2002, we estimate the translog cost function. The main findings are as follows: (i) The governance factor has an important effect on a firm' s cost structure. As the ratio of foreign shareholders increases and there is more dependence on one main bank, the costs of a firm decrease. (ii) The rate of increase in total costs for diversification is relatively low. A 1% increase in business segments leads to only a 0.1 or 0.2% increase in total costs. (iii) The regulation factor does not affect the cost structure. (iv) Compared with the regulation factor, the competition factor shows a quite clear effect on a firm's cost reduction. Overall, our empirical result suggests that governance structure as an internal factor and competition as an external factor are especially important for cost reduction.