RIETI Report November 2006

Analyzing the Role of M&As for Japanese Companies

Despite the cell phone's ubiquity in Japan, mobile connection rates here have ranked globally among the most expensive. The SOFTBANK Group, which in April entered the cell phone business with a roughly $15 billion acquisition of Vodafone K.K. (Vodafone Japan), was expected to shake up mobile pricing when it hit the market, and indeed it did, beyond its own expectations. In late October the new SOFTBANK MOBILE Corp. introduced a flat-rate calling plan and reduced rates with other carriers. This in combination with the October 24 introduction of nationwide mobile number portability (MNP) between carriers set off a stampede of new customers that forced SOFTBANK to briefly suspend its member enrollment operations in the last weekend of October on fears its computers would be paralyzed by the crush of activity. The situation has now been righted and SOFTBANK has joined NTT DoCoMo Inc. and KDDI Corp. among the three major players in the competitive Japanese cell phone arena.

SOFTBANK's acquisition of Vodafone represented a major event in the increasing wave of M&A activity in Japan. RIETI Report spoke with RIETI Faculty Fellow MIYAJIMA Hideaki about his research on the rising prevalence of M&As involving Japanese companies both domestically and internationally.

RIETI Featured Fellow

Dr. Miyajima is Vice Director at the Waseda Institute of Finance and a Professor in Graduate School of Commerce at Waseda University where he has served for the last 20 years. He joined RIETI as a Faculty Fellow in 2002. From 1992-1994 and 2004-2005, Dr. Miyajima was a Visiting Scholar of the Reischauer Institute for Japanese Studies at Harvard University and has been an Adjunct Professor at Chung-Ang University (Seoul) since 2001. Dr. Miyajima has also served since 2001 as a Special Research Fellow in the Policy Research Institute of the Ministry of Finance Japan. An expert in corporate finance, corporate governance and economic history of Japan, he has published numerous works including: "The Impact of Deregulation on Corporate Governance and Finance," in Is Japan Really Changing Its Ways? Regulatory Reform and the Japanese Economy (M. Tilton and L. Carlile, eds.), The Brookings Institution, 1998; Competition for Competitiveness: Business Government Relationships in the Golden Age (with T. Kikkawa and T. Hikino), Oxford University Press, 1999; Changes and Continuity in Japan (with S. Maswood and D. Graham), Routledge Curzon Press, 2002; Nihon keizai hatten no micro bunseki: Sangyo seisaku to kigyo tochi no keizaishi [Microanalysis of the Japanese economy: History of industrial policy and corporate governance], Yuhikaku, 2004; and Corporate Governance in Japan: Institutional Change and Organizational Diversity (with M. Aoki and G. Jackson), Oxford University Press, forthcoming. He received his B.A. in Economics from Rikkyo University M.A., completed Ph.D. course work at the University of Tokyo Graduate School of Economics and earned a Ph.D. in Commerce from Waseda University.

Interview

RIETI: According to your paper, "Understanding the Rapid Increase of M&As: Historical background and the economic role of M&As," M&As played an important role as a corporate growth strategy or as a means of reorganizing business in Japan's M&A boom of the 1930s. Again there appears to be a sharp rise in the number of M&As in this last decade. How does the present M&A boom differ from the one in prewar Japan?

Miyajima: There are several differences. First, in the 1930s M&As were mainly concentrated among Japanese firms. Cross-border deals (M&As involving Japanese companies acquired by foreign companies and vice versa) did not exist in Japan. In the 1990s globalization brought about change in the nature of M&As. Major M&As are now composed of those involving Japanese firms, but Japanese firms also utilize M&As to invest their capital in foreign companies. Conversely, foreign companies have also entered the Japanese market in the form of M&As. This international aspect is a major difference between the 1930s and 1990s.

Second, in the 1930s the stock market was in a boom period, which encouraged M&As. The primary positive factor of the stock market boom on M&A activity was that the stock of a bidder was given high market value, which enabled acquiring companies to raise money for M&As easily. In the 1990s and early 2000s, though the stock market in the IT-related industry somehow boomed, basically it was not otherwise in a boom period and did not especially encourage Japanese M&As.

Third, in the 1930s financial intermediators for M&As did not exist in Japan. However, during the 1990s amid the increase in M&As, foreign investment banks and other financial intermediators entered the Japanese market and played a significant role in encouraging M&As and Japanese financial intermediators also emerged and promoted them.

RIETI: In an international comparison of M&As from 1990-1999 (Rossi and Volpin, 2004), premiums of target companies are more than 40% in the case of the U.S., UK, South Korea, and northern European countries such as Finland and Sweden, but the premium is minus 1% in the case of Japan. Your recent study also suggests that the mean of acquisition premiums of Japanese companies is 10%. How do you account for Japan's low premium?

Miyajima: Let me at first confirm the facts. Because Rossi and Volpin examined M&As announced between January 1, 1990 and December 31, 1999 and used the Thomson Financial Database of 2000, their findings indicate that in Japan the premium is nearly zero or slightly negative. The premium we estimated for 2000-2005 in the joint paper with Dr. Gregory Jackson is positive; 10% on average. Therefore, the historical tendency of the Japanese M&A market suggests that the premium has been increasing. But Japan's increased premium in the early 2000s is still lower than that of its other counterparts.

Major characteristics of Japanese M&As can explain why Japan's premium is at a very low level. First, M&As in Japan basically occur by way of a friendly takeover rather than a hostile takeover. Also, M&As by takeover bid (TOB) are quite rare. It is common practice among Japanese M&As for the acquiring company to privately negotiate with the shareholders of the target company. There is no competition for the purchase of the target company. Recently there was the case wherein Oji Paper Co., Ltd. entered a TOB against Hokuetsu Paper Mills, Ltd. In this case, Oji intended to commence a tender offer of ¥860 per share, representing an approximately 34% premium. This illustrates that once a company launches a TOB against the target company, the premium is likely to substantially increase. However, such hostile TOBs are thus far still rare in Japan and the main form of M&A is friendly takeover. Therefore the premium stays at a low level.

Another characteristic, related to the first one, is that the major form of M&A is among and between group firms, including subsidiaries. For instance, Sony and NEC, which had several listed subsidiary companies recently decided to acquire a few of them through TOB. In cases like these, as there is no bid tendered by competing acquirers, a premium does not occur. The fact that M&As in Japan are dominated by those among group firms is another reason for Japan's low premium.

RIETI: Japan's world share in M&A activity stands at around 5%-6% of the total value; small relative to the size of its economy. In 2005, Japan's total M&As were reported to be 2,725 as compared with the approximately 10,000 cases in the U.S. Why is Japan's share so small? What are the structural or institutional factors behind this?

Miyajima: The number of Japan's M&A transactions is indeed relatively small in terms of the size of the economy compared to European and American counterparts. Why is it so small is quite a natural question, but before answering this question, we have to think what this small number really means - is the number of Japan's M&As low compared to the optimal level or is the level appropriate? Although the number of M&A transactions is small, it might in fact be an optimal level for the Japanese economy.

There are several factors which prevent Japanese firms from conducting M&As. One is the Japanese corporate governance structure. Particularly, main bank relationships between firms and banks are attributable to the small number of M&As. When a company faces financial distress due to its low profitability or economic shocks in the U.S. or UK, various maneuvers including M&As can be used to support the company. However, in Japan main banks rescue financially distressed firms to help them recover by themselves. Therefore, these companies need not rely on M&As to reorganize their business or to restore their financial soundness.

A second factor is cross-shareholding, which is an implicit contract between banks and firms and among firms themselves. When a bidder tries to acquire a company, it is very difficult to buy the target company's stock under the cross-shareholding system. This might be one impediment to M&A activity. But since 1997 cross-shareholding has been trending downward and due to the banking crisis the Japanese main bank relationship has declined. These institutional changes may be responsible for an increase in M&As since the late 1990s.

Another factor which may discourage M&As is the Japanese corporate structure. Each company has its own corporate culture and the competitive edge tends to depend on its firm-specific skills. A company may opt against a merger with another company in light of its firm-specific skills and different corporate culture. Some M&As failed due to the opposition of the company stakeholders. Also, based on the differences between two firms, possible acquired targets are hesitating to carry out M&As.

However, the Japanese M&A environment has become favorable since the late 1990s. In 1997 the ban on holding companies was lifted and other regulatory reforms have subsequently followed. By establishing a holding company, two companies can be integrated with each other without losing their independency. Using this new scheme, corporate identity can for the most part be maintained, as compared to a complete merger in the previous form.

So, getting back to the question, is the existing level of M&As far below the optimal level or is it appropriate? This is difficult to answer but I understand that the competitive edge of Japanese firms in the manufacturing sector and other service sectors lies in firm-specific skills and long-term intra-firm and inter-firm relationships. Both are very important factors toward Japan's economic growth. Taking this into account, the possibility of increasing firm value in Japan through M&A is likely to be much lower than with European or American counterparts. If this conjecture is right, the current small number of M&A transactions is not a bad thing. It is not inappropriate in terms of economic efficiency or economic welfare.

RIETI: How do you plan to move forward with your study on M&As?

Miyajima: We are conducting a great deal of empirical studies and have completed 70%-80% of our work on why M&As have occurred in Japan since 1990. We followed several hypotheses raised by existing literature focusing on supply shocks and stock market factors of M&A activity, which is called the market driven hypothesis. And we estimated the M&A determinant functions in Japanese firms. This aspect of the study will soon be completed.

The next step of our empirical study is what types of M&A really increase firm value? There are many types of M&A - a large company merging into a small company or two companies of similar size in a leading industry attempting to merge into one another. Also, there are horizontal or complementary types of M&A. For example, Bandai Co., Ltd., a leading toy manufacturer, merged into Namco Limited, a video game developer. To analyze what types of M&A actually increased firm value, we seek to estimate the CAR (Cumulative Abnormal Return - the sum of the differences between the expected return on a stock and the actual return), which indicates market response to the M&A announcement. We will also estimate long-term M&A results using accounting measures. We have had numerous cases of M&As since the end of the 1990s. Accordingly, pre-M&A and post-M&A performance can now be compared in order to figure out the type of M&A likely to increase firm value.

The last point to be tested is that, once we find that M&As undoubtedly raise profitability or market value of the bidder and the acquired firm, we will explore the main resources of increasing profitability or market value. There are several possible factors - one is increasing market power and another is cost-saving after M&As, including R&D costs, marketing costs, or other indirect costs. In addition, we plan to stress the point that knowledge and know-how are transferred from a bidder to the target. Suppose there are two firms - one highly profitable with growth opportunities and the other not. A firm with high profitability is likely to have a high level of know-how or operational knowledge. Once two companies merge, a high level of know-how transfers to the target firm, which leads to an increase in its firm value. This will be verified systematically as well as by case study methodology.

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EVENTS INFORMATION

Brown Bag Lunch Seminars

All BBLs run 12:15 - 13:45, unless otherwise stated.

11/28
Speaker: HOSHINO Asako, Corporate Vice President, Nissan Motor Co., Ltd.
Topic: "Marketing Reform at Nissan Motor" (in Japanese, Not for quotation)

12/04
Speaker: MATSUMOTO Oki, President & CEO, Monex, Inc.
Topic: "Future of Asset Formation in Japan" (in Japanese, Not for quotation)

12/15
Speaker: Richard BALDWIN, Professor of International Economics, Graduate Institute of International Studies, Geneva
Topic: "Multilateralising Regionalism: How to make regionalism less damaging to the multilateral trade system"

For a complete list of past and upcoming BBL Seminars, http://www.rieti.go.jp/en/events/bbl/index.html


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Analyzing the Role of M&As for Japanese Companies

MIYAJIMA HideakiFaculty Fellow, RIETI

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