Improved corporate governance at Japanese firms coupled with better public policy can “lead to a magnificent revival” in the country’s economy, according to James K. Glassman, who delivered the 2002-’03 Mansfield American-Pacific Lecture, jointly sponsored by Keizai Koho Center.
Speaking at Keidanren Kaikan in Tokyo last week, Glassman applauded Japan’s economic “miracle” over the last half century, but emphasized that present public policy is deficient and is harming Japan unnecessarily. He added, however, that he is an optimist and that there is no serious impediment to a revival.
Taking as his initial example Enron, the disgraced Texas-based power firm, Glassman pointed to the company’s successes — earnings per share leaping from 9 cents in 1989 to $1.47 in 2000 and the company trading at a price-to-earnings ratio of 41 — before detailing its dizzying decline.
And why did the company collapse? Because executives at Enron were caught promoting a massive deception, said Glassman, resident fellow of American Enterprise Institute for Public Policy Research, who writes a weekly column on financial issues for The Washington Post.
After it was learned that Enron had lost $600 million in the third quarter, after the firm restated earnings for previous years — reducing profits by another $600 million — and after it became clear that the $14 billion in loans on the balance sheet should have read closer to $40 billion, “investors reacted with appropriate brutality,” Glassman said.
The bankruptcy — the company slid from a valuation of $80 billion to zero — was the worst in terms of assets in United States corporate history.
But while the U.S. media expected an “erosion of confidence” among investors, Glassman said, the opposite was the case: Net inflows of new money by small investors to stock mutual funds in January and February were a healthy $24 billion, January was the best month for stock mutual fund purchases in 18 months and the Dow Jones Industrial Average was up 4 percent in the first quarter. All evidence of general investor confidence.
“The response of investors was rational and discriminating,” Glassman said. “They killed Enron, but they remained in the stock market.” And that should not come as a surprise as the market has bounced back despite numerous setbacks over the past 20 years, he added.
Most important, he said, is the lesson that the Enron scandal provides us with: “The U.S. financial system’s stability . . . is based on essential principles of strong corporate governance and transparency and rooted in high levels of democratization.
“This system, unfortunately, stands in contrast to that of Japan,” he pointed out, “where corporate governance and transparency are relatively weak, stock is not broadly held by the public, capital is often allocated for political purposes, sick firms are frequently kept alive . . . and the government sometimes intervenes directly in the market.”
Defining corporate governance as a corporate structure that enshrines certain values: transparency and consistency of accounting rules; an independent board of directors; voting protections for minority shareholders; and a lack of barriers to takeovers, Glassman said, “A way to summarize these factors is that they align the interests of management with the interests of shareholders.”
Citing a study by the National Bureau of Economic Research, which concluded that “firms with weaker shareholder rights earned significantly lower returns, were valued lower, had poorer operating performance,” Glassman concluded that corporate governance is a desirable value for a company.
Referring again to Enron — which investors decided had been guilty of violating corporate governance norms of truthful disclosure before any government investigation had even been opened — Glassman said the outcome had been inevitable: “Investors pronounced the sentence: capital punishment.”
The situation in Japan, however, is very different.
In its 2001 “opacity index,” PricewaterhouseCoopers ranked countries according to corporate governance criteria. The U.S. scored 36, Britain was 38 and Singapore came in at 29. Japan’s score, however, was 60, putting it behind countries such as Peru, with 58, Mexico, 48, and Greece, 57.
“The barriers to strong corporate governance in Japan remain,” Glassman said. “A lack of transparency in much accounting; difficulty in effecting takeovers; a lack of accountability when things go wrong; a system of interlocking ownership that renders clarity for outsiders nearly impossible; and, in general, the lack of alignment between the interests of shareholders and management.”
Without this transparency, small investors will continue to shy away from the stock market — in contrast to the U.S., where more than half of families own shares — and continue to sink their savings into postal savings accounts and bank deposits.
“For the past decade, stagnation has haunted Japan. Your current recession is now in its 17th month, with rates of unemployment unseen in a half-century,” he said. “This stagnation hurts not just the people of Japan, but those of developing Asia, the U.S. and the rest of the world.”
But, he added, “the trend of decline cannot be sustained — for social and political reasons, if no other — and it will end.”
“Yes, deflation is a plague, but it could end tomorrow if the government announced serious inflation targets,” he said. “Japan’s stagnation can end quickly, and I think it will.”
There is a caveat, though.
“That does not mean, however, that Japan’s economy will reach its full potential,” he said. “It cannot if it lacks strong corporate governance and democratized markets. This is the time to lay the foundations.”
Dismissing the argument that cultural differences between Japan and the U.S. mean such changes are not possible here, Glassman concluded that just as the U.S. learned managerial leadership skills from Japan when it was on the way up, there is no reason why the reverse should not be true today.
Hiroshi Endo, Keizai Koho Center managing director, raised two areas in response to Glassman’s speech, pointing out that revisions to Japan’s company law that are presently before the Diet mean that firms will have to choose among three alternatives; either naming at least half of the statutory auditors from outside; adopting a U.S.-style system of having more than two outside directors; or a version that falls somewhere between both systems.
“If a firm introduces the U.S. system, the right to dispose of profits can be transferred to the board of directors from a shareholders’ meeting,” Endo said. “The rationale for that is said to be that the U.S. system has precedence when it comes to corporate governance, but I’d like to take issue with that as I don’t think the U.S. system would have precedence over corporate governance.
“Mr. Glassman believes that Japanese corporate governance is weak,” he added. “He believes the U.S. system is more advantageous and better than the Japanese system, but I think what is important is the application and operation as well as the attitude of the board, not the system itself.”
Turning to the democratization of finance and the broad dispersal of shares among the public, Endo agreed that more people should hold stakes in companies as the Japanese market has become dominated by foreigners, but that it is a question of the system, in which Japanese generally do not like investing in stocks, rather than a cultural problem as Glassman had suggested.
Endo also pointed out that the lack of entrepreneurship in Japan is due to the relative scarcity of people wealthy enough to provide sufficient funds to venture capital.
“Unless this problem of the system is resolved, the democratization of finance in Japan will not be able to make fast progress,” he said.
Glassman responded by saying, “It is important not to rely too much on what political prescriptions the government wants to lay down. Corporations should take steps to improve corporate governance on their own, immediately. Nothing should hold companies back.
“There is absolutely no reason why the Japanese should not lead the world in entrepreneurship,” he added.
Answering a question from Yoshihiko Wakumoto, special adviser to the Japan Foundation’s Center for Global Partnership and formerly an adviser to Toshiba Corp., who said a company’s worth is determined too much by its short-term stock prices, Glassman said the effects of good corporate governance practices can be seen in the short term.
Masahiro Utada, senior adviser to the board of Ajinomoto Co., expressed his belief that while a different approach to corporate governance may be effective in the U.S., Japanese companies are operating with long-term perspectives and principles, such as their responsibility to their employees and their society, as well as corporate profits.
Glassman’s counter was that while patience is needed, a more rational and realistic model is needed in Japan to ensure profits for shareholders; this does not mean, however, that a company can ignore its responsibilities.
“If a company pollutes, or treats its staff poorly, it won’t do well in terms of profits,” he said. “A firm has an incentive to behave as a good corporate citizen.”
In reply to a final question from Yoshikazu Miyabe, senior corporate adviser to Mitsubishi Plastics, Inc., concerning setting inflation targets, Glassman agreed that Japan’s problems are far from easy to solve, but setting an inflation target of between 2 percent and 3 percent could be effective — particularly as the solution of Japanese governments to date, public works spending, has proved “frankly not very effective.”
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