Corporate Finance and Governance: Japan-Europe Comparisons

First, Jenny CORBETT, Professor at Australian National University and CEPR Research Fellow, made the following comments on the results of the academic conference on September 13 and the first half of the September 14 session.

Regarding corporate governance in Japan and Europe, many reports were made on the results of research that examined whether or not the structure of boards has an impact on corporate performance that can be statistically discerned. From that work, we concluded that there is no one optimum corporate governance system.

Corporate governance systems are intimately related to the design of financial markets, takeover rules, and overall financial market regulations. Clearly, the package of these changes adds up to considerably more than individual changes themselves. There was a lively debate on which system needs to be changed first.

Next, Professor Marc GOERGEN of Sheffield University made the following presentation.

The history of takeover regulations goes back to 1968 when the UK City Code on Takeovers and Mergers was established. The code served as a model for Europe and some countries in Asia in formulating similar codes.

The City Code has various characteristics including the mandatory bid rule, the principle of equal treatment of shareholders, and the neutrality of the board of directors. But the most important of them all was the fact that the code is enforced not by the courts but by an expert panel called the Takeover Panel.

The EC has worked to come up with legal rules on takeover bids since the 1980s. The initial idea was to introduce the break-through rule, which is similar to the mandatory bid rule, but it faced stiff opposition from some European countries and was not approved. Because of this, the break-through rule was not incorporated into the takeover regulations the EU adopted in 2004.

Many changes have taken place in Japan over the past 20 years. First, changes took place in the structure of ownership, and the existence of foreign shareholders started attracting attention while the presence of Japanese financial institutions as shareholders receded. Also, there was an increasing unwinding of cross-shareholdings, and the number of cases in which Japanese companies became majority shareholders declined. Further, there was a massive increase in M&A activity, and as recent developments, there were a certain number, or a small number, of hostile bids.

Japan adopted the Delaware Model when formulating its own legal rules. This is because, first, Japanese decision-makers often study at U.S. law schools and lawyers, judges, and economic bureaucrats are more familiar with the U.S. system than with the British one. Second, the Delaware Model allows managers to use anti-takeover devices as long as they make sense in terms of protecting companies. In a way, the Delaware Model is more in line with the Japanese stakeholder system.

Reform of takeover regulations must be considered within the broad context of the reform of the entire corporate governance system. The regulations that will be introduced in the EU member states over the next few years will have varying effects on the structures of ownership and control in these countries. Even when exactly the same regulations are introduced, it is unclear what results they will produce in each of these countries.

Next, KUSAKABE Satoshi, former director of the Industrial Organization Division, Economic and Industrial Bureau of the Ministry of Economy, Trade and Industry, made the following presentation.

Reform in the economic system in Japan started in the mid-1990s. Its basic concept is to increase the organizational and legal options that are available to managers and also to strengthen the market mechanism that will determine the success or failure of these attempts. The two goals are to be achieved simultaneously.

Expansion in organizational rules is aimed at creating an environment where it will become easy for corporate organizations to carry out a variety of reforms in order to meet changing economic conditions. Reform related to the reorganization of corporate structure involving the anti-trust law, the corporate law, the tax system, and the bankruptcy law was carried out to expand the range of options and to reduce costs.

With respect to the expansion of options, various regulations were eased, public-interest projects were opened to the public, and the regulations in the electric power, financial and communications industries were reformed as part of the mechanism of selection and elimination that would be made possible by strengthening the function of the market. The structure of corporate governance has been diversified on the premise that the market, in the end, will determine what governance structure is finally chosen.

This series of developments made friendly takeovers easier to attempt. On the other hand, the rules concerning hostile takeovers were not properly prepared. Various countries have improved these rules gradually in the midst of the waves of mergers and acquisitions.

The guidelines formulated by the Ministry of Economy, Trade and Industry and the Ministry of Justice did not adopt the British-style mandatory bid rule. This was a result of the consideration of the possible side effects on friendly takeovers. The ministries presented two options to companies in considering anti-takeover measures. One of them was the introduction of independent, outside board directors, instead of the board alone making the decisions as in the U.S. The other was a system of taking defensive measures with the approval of shareholders, as practiced in Europe.

Shareholders' meetings next year will be decisive as to which of the two options Japanese companies will choose. I hope that a new system of corporate governance will be created by changing and improving the stock exchange rules, the disclosure rules, and the TOB rules.

Next, Mr. OKITSU Makoto, Chairman and Representative Director of Teijin Ltd., made the following presentation.

The argument that one characteristic of Japanese corporations, namely that banks have become majority shareholders through cross-shareholding and imposed management discipline, does not necessarily apply to most companies. It is true that banks provided capital for growth during the period of Japan's rapid economic expansion, but they did not necessarily impose managerial discipline. Rather, it was competition that provided this discipline. And we cannot say that mergers and acquisitions will invariably lead to this discipline, no matter how frequent they may become. In that sense, I consider corporate governance and corporate performance to be two separate things.

The fact that corporate managers worked closely together with their employees in the midst of grinding poverty after World War II served to diminish the sense that companies belong to their shareholders. And since the shareholders of listed companies can exit at any time, managers have to work to keep the interests of shareholders and other stakeholders in balance.

We always consider mergers and acquisitions as one of the ways of achieving business and corporate reorganization. Basically, however, we have friendly takeovers in mind, and we believe that hostile takeovers constitute only a small part of all M&As. In terms of how to handle hostile takeovers, from the standpoint of those of us who are entrusted with corporate management, we have to say the first priority is the management of the company.

In-house directors know more about their company than independent, outside directors. In most cases, independent, outside directors do not own shares in the company to which they are appointed, but in-house directors do, identifying themselves in some cases closely with their shareholders.

Many diversified companies have some of their business operations in the red and others in the black. When a company has some lines of business in the red but still shows a profit as a whole, it cannot dismiss employees in the unprofitable businesses alone because of its relations with the labor unions.

There are many companies in Japan which, if we take them over and sell their money-making businesses while letting unprofitable ones go bankrupt, will enable us to sufficiently recover the takeover cost. It is necessary to consider doing something about this.

Next, Paul SHEARD, Managing Director and Chief Economist Asia of Lehman Brothers Japan Inc., made the following presentation.

Corporate governance is a mechanism that ensures the efficient allocation of funds raised by the financial system from the household sector to the productive sector. The better corporate governance, the stronger and more efficient the financial system will be. In other words, corporate governance is not an independent system.

There is no one perfect corporate governance system. Its policy and societal objective is to find a right balance that will minimize the costs and maximize the benefits.

Japan's system of corporate governance has undergone a gradual but important evolution. The corporate control market has evolved from a closed system to one that is more open and competitive.

Changes in corporate governance in Japan have been taking place in a very challenging economic environment. After the collapse of the bubble economy, Japan slipped into a deflationary spiral for some 10 years. They have been interacting with those changes, partly dispersing them and partly contributing.

We haven't reached the end of the project of Japan's corporate governance. It is necessary for policy makers as well as those involved in the project to continue to focus on facilitating the transition from the old traditional system to a new one. But in that context, it is necessary to preserve as much as possible of the good features of the traditional system, such as the cooperative relations between labor and management.

Hostile takeovers have an important place in any system. But they are a very small subset of corporate governance and may be a necessary evil. They are prone to happen at very big arbitral opportunities arising from changing ownership.

When there is an implicit contractual agreement between labor and management, those attempting a hostile takeover may deny the existence of such an agreement and may expropriate wealth from the stakeholders. In order to resolve these problems, it is necessary to make such an implicit contract much more explicit; for instance, by changing the seniority-based payment system to a pay-for-performance system.

The new committee structure is a very interesting new development. This system needs to be nurtured and the role of outside directors should be enhanced.

Corporate governance will function smoothly if there is mobility in the labor market, in particular in the management market. This is because, if managers can exit from the companies, they will less stubbornly resist the reforms and mergers and acquisitions their companies really need.