RIETI-CARF Policy Symposium

What Financing Mechanisms and Organizations of Business Entities Best Facilitate Innovation?

Information

Session 3: "Entrepreneurs' Perspective: What facilitates their innovation?"

In this session, Erik VERMEULEN (University of Tilburg) gave a report titled "Joint Ventures, Innovation, and Entrepreneurship." Following this report, YANAGAWA Noriyuki (Graduate School of Economics, the University of Tokyo) pointed out various issues concerning the impact of the distribution of control rights on innovation based on theoretical perspectives and empirical research. Furthermore, Leo GOLDSCHMIDT,(European Corporate Governance Institute), brought up issues pertaining to the disclosure of information and ensuring of transparency in non-listed companies. Professor Vermeulen gave a summary of the contents of the aforementioned presentations while Mr. Goldschmidt added comments about the disclosure of information of non-listed companies.

Assessment of New Forms of Business in Japan

As already mentioned, recent legal reforms have enabled new forms of business in Japan and have broadened the options for those considering starting an enterprise. In the past, in launching an enterprise, partners were required to establish a general partnership in order to contribute human resources and were not granted limited liability. And when they sought limited liability, they needed to establish a company, thus giving rise to inefficiencies. In the future, the merits of both sides may be enjoyed.

An examination of the organizations of business entities in Europe and the U.S. shows that the corporation was the most favored form of business entity in the U.S. in 2000. But the LLC compared favorably with the corporation in 2003. Today, in terms of small companies, LLCs probably outnumber corporations (Figure 7-P.5 [PDF:352KB] ). In Britain also, the LLP is rising in popularity.

In this respect, Japan is heading in the right direction. But as Mr. Quek pointed out, the drawback of Japan's LLP law is that the J-LLP must abide by a number of rules in order to receive pass-through tax treatment. For example, even though all partners have an obligation to participate in the management of partnership affairs, there is some ambiguity under the law in the case of foreign partners. Furthermore, such ambiguity will likely develop into questions about the nature of obligations to participate in the management of partnership affairs, whether or not it would be adequate to appoint a director, and the necessity of actually participating in such management.

Another problem is that LLPs cannot be converted into corporations. For this reason, the LLP is not a suitable form of organization for enterprises that may need VC funds in the future. The conversion of an LLP into a LLC also calls for the cumbersome procedure of newly starting the LLC after liquidating the LLP. The issue of disclosure of information and ensuring transparency concerning LLPs is also vital.

Disclosure of Information and Ensuring Transparency

Although the importance of disclosure of information for publicly traded companies has been widely discussed, discussions of the importance thereof for privately held companies are very rare. As Professor Kobayashi pointed out, disclosure of information is crucial for closed forms of business entities because younger companies require external funds and to that end they need to be trusted by the suppliers of such funds.

There are two types of information that closely held companies should disclose in ensuring transparency. The first type of information is financial information. Publicly traded companies are required to disclose such information, but privately held companies too are gradually being obligated to do so. This gap will narrow over the long term. It is not advisable to consider exempting privately held companies from this obligation. In reality, there have been cases in which the relaxation of this obligation for newly listed innovative companies ended in disasters, leading to market dysfunctions of for these companies.

The other type of information is non-financial information. This mainly consists of information concerning corporate governance, such as shareholders' rights, obligations, and the nature and method of voting. However, it should be noted that just as the forms of business entities are wide-ranging, such information differs considerably among companies. With respect to information to be disclosed by privately held companies, there is a question of whether such disclosure is targeted at partners or at outsiders in general. Nevertheless, in the case of internal disclosure, such as to partners and shareholders, information should be disclosed regardless of whether the company is publicly traded or privately held.

The merit of disclosing information is that just as information is required in order for companies to make appropriate decisions, information is needed to discharge accountability to shareholders, staff, and third parties specified by law. If the quality of information disclosed is good, the relevant company can indicate sound corporate strategies at general meetings of shareholders and other meetings. And good management decisions produce huge profits, thus leading to stable long-term management. The sharing of information by insiders and outsiders would lead to the alleviation of friction.

The demerit of disclosing information is that it involves expenses both directly and indirectly. Direct costs consist of the cost of preparing and auditing information to be disclosed, or the cost of disclosure itself. Since it is necessary to prepare information for managing a company, such expenses need to be borne. Although the check function is not absolutely necessary for management, most of the privately held companies are now obligated to undertake it. The dissemination of information has become less costly than before due to the widespread use of the Internet and other systems. Also, information can be disclosed in a limited manner by restricting the right to access a site. Even though the initial cost needs to be borne for launching the system, once the system is established, the challenge thereafter would involve ways of curbing running costs.

In addition, there is the cost of information leakage. Since this affects the competitiveness of companies, large companies too face this problem. However, there is a disparity in the power of resistance between large companies and young companies in the event of a leak. Likewise, there is the cost associated with the risk that private lives would be invaded. In particular, since most of the privately held companies are run by families, high levels of personal feelings and sensitivity are involved concerning disclosure and leak of information.

In conclusion, the disclosure of information is vital for both publicly traded and privately held companies. The merits of disclosure more than make up for the demerits thereof. Nevertheless, the demerits must be considered. In particular, the problem of information leaks and the invasion of private lives are crucial issues for small companies. The resolution of these issues hinges on the creativity of each company. However, there is a way to resolve these issues, and when such a resolution is found, the arguments made by privately held companies against disclosure will likely be refuted.