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Japanese corporate governance

Monday 11 May, 2009

The Japan America Society of Chicago sponsored this event Trends in Japanese Corporate Governance

Drew Edwards (DE) of Advisory Research opened by bringing up the issue that stakeholders (managers & owners) interests are not aligned in Japan because there is not really a Japanese model to incorporate them together.  Historically, pre-World War II, many Japanese owned more securities.  Post-World War II, banks became the providers of capital, so they determined governance.  The result is poor allocations of capital, reflected by poor ROE, which is determined by big pension plans.  Potential changes are deregulation, reduction of crossholdings, increase dividend payouts, more buybacks, hostile takeovers, more shareholder lawsuits, expectations of 8% ROE.

Doug Skinner (DS) of UChicago presented research on accounting in Japan.  Accounting & auditing are low quality, which creates opportunities for window dressing, called earnings management in the US.  The markets lost confidence in them after 2 financial institution collapses in the late 1990’s.  Adoption of western accounting rules (IFRS) has been proposed to make ASBJ more similar to America’s FASB (Financial Accounting Standards Board).  The results have not been as desired.  The problem has been there is not an accounting infrastructure to support the proposed changes.

Kouji Yamada (KY) of JCA Partners in Japan noted there are more CPA’s in Illinois than all of Japan.  There are only 3 accredited business schools in Japan, so it doesn’t look to improve.  There is less labor mobility & tenure is longer resulting in the structural subordination of employees.  The tradeoff is the long-term creditor behavior of the old guard vs. the new short-term equity approach.  The labor markets are changing.  43% of labor contracts are at-will, the highest % in the world.  In a deflationary economy, all are managing costs.  It creates opportunities to reinvest in the business, but that’s not happening.  Japan cannot survive another 15 years of deflation.  The banks are operationally excellent, but there are few companies that create value.  Executives are paid only 9-10X an average wage, so their incentives to change are not high.

Activist investor Mike Levin (ML) brought out that Japanese CEO’s are not paid to take risks, & thus are not good stewards of capital.  They take a creditor approach to make no mistakes.  An “old wise man” verifies the books.  There is a push for independent directors on boards, but with no labor mobility, there is a dearth of them.  A perception exists that if an executive servies on the board of another company, they are less committed to their own company.

Bob Hayward of Kirkland & Ellis noted that Japanese courts held up the use of a poison pill strategy & that the accounting changes together with few CPA’s leads to more restatements.  That could lead to more attacks on non-independent board members.

Q&A :

(DS) Japan has their own version of Sarbanes Oxley (J-SOX), but they need people with expertise to implement it.  The Japanese are still resisting IFRS because they have fundamental differences with western approaches.

To buy cheap & extract value (KY) take dividends out, reinvest in the industry to change industry structure & (ML) change the mindset so that management works for investors & then there will be many more options.

(DE) losing face can be a strategy to promote change or confront management in a private setting so as not to disclose dirty laundry.

My take-I went to b-school in the 80’s when the Japanese were lauded as the examples to follow-in the world.  That was followed by deflation since the 90’s, so that’s been debunked.  Japan is still the 2nd biggest economy in the world, so I’m surprised they haven’t been able to solve these problems.

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