Two Issues on Japan’s Corporate Governance

Since the Meiji restoration of 1871, the Japanese have appeared to adopt political and economic changes on the terms and at the speed, with which at least their elite feels comfortable. In the absence of such social consensus, much-needed social changes often get stranded. The case in point: Corporate governance in Japan. Since a major improvement in governance disclosure and procedures in 2004, the Japanese elite has been still debating about the amount and urgency of governance reform, which often results in regulatory inadequacies and in a deterioration in a once-strong commitment to bettered governance.

For an outside Japan watcher, the Japanese industrialists learned a wrong lesson from the 2006 Livedoor fiasco. If there is any good lesson to learn from the scandal, it will be the importance of sound internal controls and regulatory oversight, not the need for often-poorly-justified takeover defenses against, in their words, “abusive investors” at home or abroad. Since 2006, an increasing number of Japanese companies have been adopting poison pills and/or entered into cross-shareholding alliances while investors have been voting with their feet on Japan’s preoccupation with defense measures. In 2007, the country’s bourse was the only Asian market to post a loss. The Nikkei fell more than 11%. What is more serious for Japan, the underperforming Japanese financial market would help other Asian cities, such as Shanghai, Hong Kong or Singapore, supplant Tokyo as the region’s financial hub.

However, much of the Japanese establishment appears to be behind Japanese corporations’ response to an often-exaggerated threat. On July 30, 2007, Tokyo High Court ruled in favor of Bull-Dog Sauce Co. by defining U.S. investment fund Steel Partners as "an abusive acquirer" and as a result, opened the way for Nisshinbo Industries Inc. to further strengthen cross shareholdings with Nisshin Seifun Group Inc. to thwart a further move to buy into Nisshinbo Industries by Steel Partners which controlled a 5% stake in the company.

All these prompted Tokyo President Atsushi Saito to warn that Japan’s capital markets would not develop” unless its companies give shareowners adequate information about their activities and ensure that their rights are protected. In a February monthly press session, Mr. Saito, one of a handful of reform advocates in Japan, raised concerns about reverse share splits and new hybrid loans which come with dilutive warrants that can be exercised in the event of an unwanted offer. However, what have allowed such a setback are regulatory inadequacies. Let us take a look at the issues of poison pills and cross shareholdings in Japan (parenthetically, regulatory oversight remains weak in Japan. I am attaching an AFP piece to the bottom of this paper to illustrate the point.)


-. Poison Pill

There are no rules or regulations directly governing poison pills in Japan. Companies usually follow the Defensive Measures Guidelines, which were written by the government almost exclusively for poison pills through the issuance of stock purchase warrants. Since the guidelines are not legally binding, it can be expected that there will be companies which will adopt poison pills that are tailored to address the particular issues associated with management’s needs. The aforementioned reverse share splits and new hybrid loans which come with dilutive warrants clearly represent an attempt by some Japanese companies to skirt the guidelines. The guidelines itself are often inadequate. For instance, the guidelines require the pills to be subject to the annual review of an independent ad hoc committee. However, the guidelines do not require the companies to demonstrate the independence of the third party committee through public disclosure. The companies do not usually disclose sufficient information to allow outsiders to evaluate the independence of the ad hoc committees.

Some poison pill plans feature a proviso allowing the ad hoc committee to activate the pill if it sees the bid as a threat to corporate and shareholder value or if the bid does not meet some – often unspecified -- criteria for the qualifying bid. While most Japanese poison pills follow the guidelines and feature TIDE provisions, some of the plans also authorize the ad hoc committees to renew the poison pills. Since most of these companies adopted poison pills in 2006-07, we have to wait for the next three years to find out whether these pills will be renewed by the committees or by shareholders. There are no downright dead-hands in Japanese poison pills yet, but they feature what would be called an invisible hand.


-. Cross shareholdings

A new round of cross-shareholding alliances in Japan has been often carried as a headline item in financial news outlets in the past two years. In the 1950s-80s, Corporate Japan resorted to cross shareholdings to retain a cozy relationship between financial institutions and their corporate clients. The cozy relationship worked because Japan, albeit a global industrial hub, was basically a locally grounded economy. Companies could be protected from international influence by a group of interlocking shareholders. The system began to crumble, following the collapse of the bubble which forced banks to sell their equity positions in their corporate clients. In the process, foreign ownership of Japanese shares rose to 28% in 2007 from 4.7% in 1990. With the rise of new foreign players in the capital market, Japanese corporations began to form cross-shareholding alliances between themselves, instead of financial lenders, to forestall unwanted takeover bids.

A 2007 study by the Daiwa Institute of Research, a research arm of Daiwa Securities, indicated that 5.6% of Japan’s bourse was locked in cross-shareholdings in fiscal 2006, at least 2.11% of which is between what local media dub “friendly [or stable] investors.” According to the study, three big corporations, Toyota Motor Corp. , Matsushita Electric Industrial Co. and Nippon Steel Corp., led the increase in cross shareholdings between friendly companies.

In response to what they described as a hostile takeover threat from Arcelor Mittal, Japan’s three steelmakers, Kobe Steel, Ltd., Nippon Steel Corporation and Sumitomo Metal Industries have since Oct. 2007 strengthened their cross shareholdings alliance. By the end of fiscal 2006, their cross shareholdings have involved into a circular shareholding arrangement that could be only found in Korea’s chaebol. In 2007, Nippon and Sumitomo respectively spent JPY 100B to boost Nippon's stake in Sumitomo Metal to 9% from 5% and Sumitomo's stake in Nippon to 4% from 1.81%. Sumitomo also controlled 5.1% of Nippon and 1.71% of Kobe. In February 2008, Sumitomo Metal agreed to issue JPY 49.6B worth of its shares to Sumitomo Corporation and to purchase JPY 15B worth of Sumitomo Corporation shares to strengthen their cross-shareholding ties. In the same month, Nippon Steel Sumitomo Corporation said they would will spend about $63 million apiece to raise their stakes in coke producer Mitsui Mining Co.

The ever-complex tripartite steel alliance may have more significant governance implications because it is not just meant to ward off hostile takeover bids, but also to better position the companies in the raw-material and the end market because it includes product-sharing and joint purchase arrangements.

It is also setting the tone for cross holdings in Asia’s steel industry. In 2006, South Korea’s steelmaker POSCO entered into a cross shareholding alliance with Nippon Steel. The two companies are currently implementing 14 R&D projects involving a total of 5K engineers on both sides of the Sea of Japan. Emboldened by its alliance with the Japanese steelmaker, POSCO in April 2007 decided to sell about 872K common shares, or 1% of treasury stock, to Hyundai Mipo Dockyard, a unit of the Hyundai Heavy Industries Group, and to buy a 1.9% stake in Hyundai Heavy Industries, the conglomerate's flagship unit, from Hyundai Mipo Dockyard Co., Ltd. With the stock swap, POSCO is now enmeshed in the complex web of circular shareholdings of the Hyundai Heavy Industries Group. Japan’s JFE Holdings Inc. and Korea’s Dongkuk Steel Mill Company Limited took the lead taken by Nippon and POSCO last year and formed a cross shareholding alliance.

Since they are often more than an excessive defense, the cross shareholdings weigh down on the companies’ shares. Since February, shares of Sumitomo Corporation fell more than more than 30%, incurring 16 billion yen in latent losses. Sumitomo Metal fell by 12%, Kobe 6% and Nippon Steel 11%.


Japanese firm rapped over Sony, Toyota 'acquisition' claims: official
27 January 200822:42
Agence France Presse
Japanese authorities have ordered a little known firm to correct its claim that it had bought controlling stakes in a clutch of corporate giants including Sony and Toyota Motor, officials said Monday.

Teramento Corp., reportedly capitalised at 1,000 yen (9.3 dollars), raised eyebrows on Friday as it announced "acquisitions", together worth 188 billion dollars, of majority stakes in some of the nation's leading companies.

It claimed it had bought 51 percent of Sony Corp., Toyota Corp., Nippon Telegraph and Telephone Corp. (NTT), Mitsubishi Heavy Industries Ltd., Fuji Television Network Inc. and Astellas Pharma Inc.

The company, which is registered in Kawasaki City near Tokyo and involved in IT and other businesses, made the claim in filings with the Financial Services Agency's electronic information disclosure system after the market close Friday.

The filings prompted the agency to launch a probe as the total value of the deals would be some 20 trillion yen (188 billion dollars), nearly one quarter of Japan's national budget.

The agency "judged the claim about the (acquisition of the) 51 percent stakes is false and ordered the company to correct its reports," said an inspector at the regional financial bureau supervising Kawasaki.

Teramento was ordered to correct the filings by 5:15 pm (0815 GMT) on Monday when the electronic disclosure system halts for the day, the official said.

The company had not submitted a correction as of late morning, he said, adding that failure to obey the order was punishable by imprisonment of up to one year or fines of up to one million yen.

The mass-circulation Yomiuri Shimbun quoted Teramento's representative as saying: "I run an IT company but live on doing part-time jobs. I didn't know what I filed would be made public as they are."