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LESSONS FROM AMERICA

Educators school Japan in global management

by Takashi Kitazume

Japanese executives should look at the introduction of new U.S.-modeled rules on corporate governance as an opportunity to increase the value of their companies, rather than fret over the negative costs of compliance, an American accounting professor told a recent symposium in Tokyo.

Another expert said that some adjustments in the U.S. economy will be unavoidable in coming years, urging Japan to rely more on its consumers — instead of export demand — to propel the nation’s growth.

These were among the various suggestions offered by U.S. business school educators during a June 8 symposium in Tokyo, organized by Keizai Koho Center under the theme “Perspectives on management in a global context.”

Frederick Choi, a professor of accounting and international business at New York University’s Stern School of Business, said the U.S. experience shows that there are ways for companies to cut the costs of complying with internal control rules, which were tightened in the United States in the wake of the Enron and WorldCom scandals.

The so-called J-SOX, or the Japanese version of the U.S. Sarbanes-Oxley Act of 2002, is scheduled to take effect in April 2008, following Japan’s series of high-profile accounting frauds in recent years, including those at Seibu Railway, Kanebo and Livedoor. Given the limited time before the implementation deadline, concern is rising among Japanese firms about the compliance costs.

Like its controversial U.S. original, the J-SOX — an informal name for a new legislative framework enacted in June 2006 as an amendment to the Securities and Exchange Law — requires all listed companies to prepare internal control reports on a consolidated basis. The management has to evaluate their company’s internal control over financial reporting, and in turn its external auditors must attest to the management’s evaluation, Choi pointed out.

In the U.S., “the major issue has been striving to achieve the proper balance between the costs and benefits of implementing SOX,” Choi said.

“The general consensus is that the cost of compliance has been extraordinarily high. It’s estimated that companies spend on average $4.4 million during the first year of implementation,” he said, noting that it’s a huge burden on smaller companies and non-U.S. companies thinking of entry into the U.S. capital market to raise funds.

This problem has been “compounded by the lack of specific implementation guidance” on the part of U.S. financial regulators and the vague wording of the law as to what needs to be checked, the professor noted. With U.S. company managers worried about being sued for errors in SOX compliance, “the tendency has been to control everything — whether it needs to be controlled or not,” he said.

Smart compliance

One of the lessons from the U.S. experience, Choi said, is that compliance costs can be reduced by “redefining” what needs to be controlled — “to ensure that the reviews of internal control are truly risk-based and focus on significant control weakness” that could affect financial statements.

Choi also urged Japan to consider delaying the implementation deadline for smaller companies, which then can learn from the experience of their larger counterparts.

This is particularly important because Japan has only 17,000 certified public accountants, Choi said, noting that even in the U.S., which has 330,000 CPAs, auditing firms are complaining that they don’t have enough staff to do proper jobs.

“My fear is that unless some accommodation is given to smaller companies, many will not be able to meet the deadline, and if they do, they would not be able to do a credible job in evaluating their internal controls,” he said. “If that happens, I think the J-SOX will lose its credibility and more importantly, the objective of J-SOX, which is to enhance the international reputation of Japan’s financial markets, may suffer.”

The U.S. experience also shows that there are benefits associated with SOX, which studies show include greater attention of top company management to accounting issues, improvement in internal control effectiveness and the positive reaction of financial markets, he said.

But the biggest potential benefit will be achieved only if companies approach the new rules in a positive light — to use SOX implementation “as an opportunity to review all of their operating and reporting procedures,” and enhance their return on investments, Choi stressed.

“One way to reap returns from these controls is to set a proper tone at the top by having the very top management signal that accurate and transparent financial reporting is valued. This in turn will lead to a better investor rating of the company, which could reduce its cost of capital,” he said.

Another idea is to “genuinely strengthen” the membership of the executive board, Choi noted. Once the J-SOX is implemented, board members have to start playing dual roles — one of trusted adviser to the management on policies, and the other as “independent monitors to safeguard the interests of shareholders,” he said.

This will reduce potential costs of litigation, Choi said, adding that Japanese firms must brace for an onslaught of shareholder suits in the future now that roughly 30 percent of Japanese equities are in the hands of foreign investors, who are very vocal on corporate governance issues.

Recovery from within

Roberto Rigobon, an associate professor of international economics at the Massachusetts Institute of Technology’s Sloan School of Management, meanwhile, said some “adjustments” in the U.S. economy will be unavoidable — although it is not yet clear when. He warned such a development would result in a massive reduction in American consumer demand, and that no economy in the world will be safe from its impact.

To protect itself from the impact, Japan should consolidate its recovery by relying more on its consumers, rather than on overseas demand that has supported the ongoing growth, Rigobon said.

“Japan has to look a bit more inward than outward” and try to boost the purchasing power of its consumers, he said. And this is not the time for the Bank of Japan to raise interest rates or for the government to raise the consumption tax, he added.

While Japan may no longer rely on exports to the U.S. market as heavily as it did in the past, given the expansion of its trade with the rest of East Asia — in particular China — those Asian economies will also not be free from the impact of a bust in U.S. growth, Rigobon said. It will be “wishful thinking” to hope that China will be growing at 10 percent to 12 percent a year in the face of a U.S. recession, he added.

Hideaki Miyajima, a professor at Waseda University’s School of Commerce who served as moderator of the symposium, pointed out that emphasis on domestic demand and consumer spending may pose a policy dilemma for the Japanese government because the yen will remain weak against major currencies if the BOJ is to keep the short-term interest rates low so as not to negatively impact personal consumption.

Deregulation problems

Victor Stango, an associate professor of economics for the Tuck School of Business at Dartmouth College in New Hampshire, discussed how policymakers should respond to problems triggered by financial services deregulation.

The vibrancy of the U.S. housing market over the decade up to 2005 — when prices shot up to a degree comparable to Japan’s bubble boom of the late 1980s — has been partly attributed to deregulation in the financial industry, including decontrol on prices, relaxation of entry restrictions and innovations in services to high-risk borrowers, he said.

Since 2005, U.S. housing prices have fallen, inventories have gone up and residential construction has slowed, leading to an increase in nonperforming loans that caused several banks to fail, Stango noted.

While it is still not clear whether this is the beginning of a sustained recession caused by dramatic reduction in housing demand, concerns over the situation have led to a debate on policy options, he said.

The options, according to Stango, include interest-rate control to protect borrowers, restricting the terms of lending, bailout for troubled borrowers and banks, as well as improving disclosure rules.

Interest-rate control would induce lenders to think differently about which consumers to lend to, Stango said. “Capping interest rates at a certain level would mean that a lender who previously had been lending to a high-risk consumer would now be unwilling to lend. . . . This is something that would lead to a reduction in the supply of credit . . . and we need to think about that effect” if such a policy is to be introduced, he noted.

Financial assistance to borrowers in default and the failing banks, on the other hand, “will certainly be helpful in the short term” but that would in effect insure lenders against making bad loans and might encourage more risk-taking by these lenders, thereby making things worse, he said.

“When things go bad, policies that regulate these lenders by constraining prices, or bailing out consumers or banks in trouble, may in fact have unintended consequences that make things worse . . . at least potentially,” he noted, adding that effective disclosure and consumer education are ultimately the best means to achieve the policy goals.

Business education

Amir Ziv, a professor and vice dean at the Columbia Business School, observed that while business education appears to be flourishing in Japan as more and more universities open MBA programs, many executives at Japanese companies say an MBA degree is not highly valued and does not guarantee promotion.

As a possible explanation for these seemingly inconsistent situations, Ziv said Japanese managers may have an old, traditional view of business education that focused on the teaching of technical skills — which can in fact be taught by the companies themselves. That, he added, is only a part of business education today.

He said business education should be “education for life” to “provide future managers or current managers with the skill that will be used throughout their career,” adding that the skills that needed to be instilled in managers consist of three layers.

The first level is technical skills, or the ability to solve a given problem, and these are necessary but are not enough, he said.

The second layer — decision-making skill — is important but still not sufficient “because even if you’re making the best decisions, you have to make sure that people around you are following your decisions and agreeing to your decisions,” he said.

This is why leadership needs to be taught at the business schools, Ziv said. “We teach them the skills of communication and persuasion . . . and how to make sure that people will follow them,” he said.

Dawn Iacobucci, a marketing professor at the Wharton School of the University of Pennsylvania, discussed new developments in marketing in the U.S.

The latest information technology has given businesses the capability to capture all kinds of data on their customers, but the question is what to do with the data, she said. While experts all see the potential, the efforts being made in terms of the use of such data are still primitive, she noted.

Companies are also looking at the potential use of the rapidly expanding social networking Web sites, but it is not clear what impact this new phenomena could have on their business, Iacobucci noted.