Business in Japan: Message in a Bottle of Sauce

BUSINESS IN JAPAN

Message in a bottle of sauce

Nov 29th 2007
From The Economist print edition

IT WAS not a storm in a teacup but a battle over a bottle of sauce. The fight during 2007 for Bull-Dog Sauce, a Japanese condiment-maker with 27% of the sauce market, cast into sharp relief the conflict between no-holds-barred Anglo-Saxon capitalism and the traditional Japanese approach to corporate governance.

The supposed villain of the piece was Steel Partners, an American investment fund that since 2000 has invested more than $3 billion in some 30 Japanese companies. Having built up a 10% stake in Bull-Dog, Steel launched a takeover bid in May, offering to buy all outstanding shares in the company for around $260m, a 20% premium over the share price at the time. Bull-Dog's management opposed the bid. “Why us?” lamented the firm's managing director, Masaomi Tamiya. Steel was accused of being a “greenmailer”—a predator that buys a large share in a company, threatens to take it over and then agrees to drop its bid and sell its stake back to the company at a hefty premium. Warren Lichtenstein, Steel's boss, insisted that Steel had a long-term commitment to Bull-Dog. But on a visit to Tokyo to meet Bull-Dog's management, he made matters worse by saying he planned to “educate” and “enlighten” Japanese managers about American-style capitalism.

At its shareholder meeting in June, Bull-Dog proposed to enact a “poison pill” defence that involved issuing three new shares for every existing share to all shareholders—except Steel, which would instead receive cash, diluting its original stake. Mr Lichtenstein gave warning that the poison pill could set a dangerous precedent and deter investment in other Japanese companies. But that, of course, was the whole idea. The poison-pill motion was passed, and although Steel mounted a legal challenge, Bull-Dog's right to use the device was upheld by the courts. So the foreign investors were thwarted, but at great cost to Bull-Dog, which said it expected to make a loss of ¥980m ($8.3m) for the year to March 2008, rather than the previously forecast profit of ¥500m.

The Bull-Dog saga was a litmus test for attitudes to shareholder capitalism. Those who believe that companies should be run to maximise the returns to shareholders thought that shareholders should have accepted Steel's generous offer; but those who hold the traditional Japanese view that companies are social communities, not baubles to be bought and sold, disapproved of Steel's treatment of a venerated 105-year-old company.

Both sides have a point. Japanese companies have neglected their shareholders for too long. But, says Gerald Curtis, a Japan-watcher at New York's Columbia University, Steel's “heavy-handed, flat-footed approach” has made it more difficult for others to argue that companies should pay more attention to their shareholders. “A lot of Japanese in the business and financial community are mainly mad at Steel because they make it more difficult for Japan to do what it has to do,” says Mr Curtis.

For one thing, Japanese firms tend to sit on piles of money: the cash and securities they hold amount to 16% of gross domestic product, compared with a long-term average in America of around 5%. And Japanese companies' average return on equity is only around 9%, compared with 14-17% in America and Europe. Under a previous set of rules, dividend payments were taxed whereas capital gains were not, so Japanese investors were more interested in share-price gains than in dividends; but those rules no longer apply. And the proportion of Japanese shares held by foreign investors has increased hugely, from 5% in 1990 to 28% now. Both these changes have increased the pressure on companies to use any excess cash to increase dividends, or to buy back shares to boost prices.

Foreign investors have been demanding this for years, but domestic investors are now following suit. A pioneer in this field was Japan's most famous activist investor, Yoshiaki Murakami, a colourful and controversial figure who in July was found guilty of insider trading and sentenced to two years in prison. Although Mr Murakami plainly went too far, he helped make the case for a greater emphasis on shareholder returns. Japan's Pension Fund Association, a quasi-governmental body that oversees investments worth more than $100 billion, said this year that it would press firms to pay higher dividends and would vote against directors of companies making inadequate returns.

Another example of an investor exerting pressure involves Sparx Group, a Japanese investment fund that was the largest shareholder in Pentax, a camera-maker. In April Pentax changed its mind over an agreed takeover offer from another Japanese firm, Hoya, the world's biggest producer of optical glass, and ousted the company's president who had devised the deal. But Sparx, along with other investors, felt that being bought by Hoya would be the best option for Pentax as well as for its shareholders, so it got the ousted president reinstated, prompting the Pentax board to resign. The deal went ahead on improved terms. Sparx prevailed by handling the situation delicately. “That's their style—not to put up a loudspeaker,” says David Marra of A.T. Kearney.

Similarly, in February another Japanese investment fund, Ichigo Asset Management, successfully persuaded shareholders in Tokyo Kohtetsu, a steel company, to reject a merger with Osaka Steel. This was the first time that shareholders in a Japanese company had ever rejected a merger plan already approved by the two companies' boards. Ichigo, which held a 13% stake in Tokyo Kohtetsu, approved of the logic of the deal but felt that the proposed share-swap short-changed Tokyo Kohtetsu's shareholders.

Some foreign activist investors are also taking a more subtle approach. The Children's Investment fund (TCI), for instance, which has a 10% stake in J-Power, an electrical utility, earlier this year pressed the company to triple its year-end dividend. TCI's boss, Christopher Hohn, began his letter to shareholders by apologising for writing to them out of the blue, then carefully explained why he thought that J-Power needed to do better. The company responded with a letter of its own, and in June TCI's resolution was defeated. “TCI trod carefully and decided to lose round one gracefully,” says Mr Marra approvingly. Investors who recognise that Japan is still getting used to a more activist approach (rather than treating Japanese firms in the same way they would treat American ones) will reap benefits in the long term, he says.

Japanese managers may not find it easy to switch their attention to shareholder value, but the trend towards greater shareholder activism is clear. This year around 30 companies have faced shareholder resolutions, double the 2006 figure. Many of them demanded higher dividend payouts. All such resolutions were defeated, notes Steven Thomas of UBS, an investment bank, but in many cases companies subsequently introduced their own resolutions to increase dividends by a smaller amount, in effect meeting the activists halfway. Japan is gradually coming to appreciate the benefits that activist investors can provide, says Shoichi Niwa of RECOF, a specialist mergers-and-acquisitions consultancy.

Learning to love M&A
Japanese firms are also changing their attitudes towards M&A. The pace is picking up (see chart 3) and the nature of the deals is changing. For most of the past decade, says Mr Niwa, M&A deals involved mainly domestic firms as they restructured and spun off non-core subsidiaries. But then the merger activity spread to the core businesses themselves, with consolidation in a number of industries including oil, steel, banking, insurance, pharmaceuticals and retailing. In the past two years Japanese firms have also made more acquisitions abroad. These are not the trophy assets of the late 1980s, but strategic purchases by Japanese firms to make themselves more globally competitive: Nippon Sheet Glass bought Pilkington, Japan Tobacco bought Gallaher and Toshiba bought Westinghouse, for example.

Changes in Japan's corporate law acted as catalysts. In 1999 it became possible to buy other firms using shares; in 2000 it became easier for companies to spin off non-core divisions. Accounting rules were also changed, forcing companies to produce consolidated statements and disclose cashflow figures and making it harder to hide poorly performing subsidiaries. Another rule change requires companies to list assets at market value, which makes it easier to work out whether a company's market capitalisation is lower than the value of its assets (not uncommon in Japan). “There have been very drastic changes in this area in the past ten years—more drastic than anything seen before,” says Mr Niwa.

With each change, the rate of deal-making picks up. The latest one, which took effect in May, covers “triangular mergers” in which a foreign firm uses its own shares, via a Japanese subsidiary, to buy a Japanese firm. The first triangular deal, the takeover of Nikko Cordial by Citigroup, was announced in October. “Things are getting bought and sold in a way we didn't see in the 1980s and 1990s,” says Mr Thomas. Managers used to regard M&A as a sign of weakness, unnecessary for “good” companies. “But now they understand that M&A can be a good thing, that this is a standard part of the corporate toolbox,” he explains. Admittedly, the average level of M&A as a proportion of GDP, at around 3%, is much lower than that in America or Britain, at about 10%, but it is a lot higher than Japan's figure in 1991, when it was just 0.4% of GDP.

A bigger concern is that M&A activity is not playing its proper part, which is to make companies more efficient. That is because acquired companies often continue to be run as distinct firms within a firm, and the usual cost savings from laying off staff do not materialise because Japanese firms rarely sack people. Similarly, the opportunity to save money by replacing two brands with a single one is not always taken. “Companies have a face problem,” explains Katsumi Ihara, the head of Sony's electronics division. Employees and customers have strong attachments to companies and brands and want them to live on, which hinders M&A, he says.

Mr Marra points out that the average takeover premium paid in America is 25%, which reflects the cost savings that the buyer hopes to achieve. In Japan, the average premium is zero. “You don't pay anything because you're not going to do anything,” says Mr Marra. Instead, staff numbers are reduced by natural attrition, and brands live on.

Mr Niwa is more optimistic. Japan is now at the beginning of a new era of “fully fledged M&A”, he says, which will go beyond mere asset-shuffling to more radical restructuring. Japanese managers have spent the past decade getting used to the idea of M&A. “Now, at last, M&A is not something odd but a normal part of business.” There have even been a few attempts at hostile takeovers, something that was previously unheard of in Japan's cosy corporate culture.

Hostile intent
When in August 2006 Oji Paper, Japan's biggest paper firm, tried to take over Hokuetsu Paper, a smaller rival, it was the first hostile bid by one blue-chip firm for another. Oji's bid made commercial sense: in an industry lumbered with overcapacity, it seemed a better idea to buy Hokuetsu, which had just invested huge sums in new equipment, than to splash out on updated equipment itself. But Oji's move was widely criticised, and the bid was blocked when Nippon Paper, the industry's number two, bought a stake in Hokuetsu, the value of which has since declined. Had Oji's bid succeeded, “it would have set a fantastic precedent,” says Mr Thomas. But hostile bids still seem to be regarded as taboo—though a recent survey by Japan's Cabinet Office found that 66% of companies said they were interested in pursuing M&A, and a further 6% said they would consider making a hostile bid if necessary.

A precedent would be a good thing, since it would help to convince Japanese firms of the merits of a more dynamic approach to M&A, says Marc Goldstein of Institutional Shareholder Services (ISS), a research firm. He cites Renault's alliance with Nissan, which convinced Japanese bosses that selling a big stake to a foreign firm could be a good idea, and also illustrated, in the person of Carlos Ghosn, that foreign managers could use their expertise to turn a Japanese company around. “There always needs to be a success story to convince corporate Japan of the merits of foreign practices,” says Mr Goldstein.

Similarly, he says, a successful triangular merger might change attitudes towards foreign takeovers. At the moment, many Japanese firms are worried that the new triangular-merger law will lead to an outbreak of hostile takeovers by foreign buyers. The law was delayed for a year after a campaign by Keidanren, Japan's conservative big-business association, which gave companies time to put in place defensive measures, such as poison pills and cross-shareholdings with other companies—a once common practice that had been in decline for many years (see chart 4). Yet the new rules make it almost impossible to pull off a triangular merger without the approval of the target firm's management. And the big foreign firms that are most likely to take advantage of the new law would prefer to do friendly deals anyway, says Mr Goldstein, otherwise the Japanese firms they acquire will be difficult to run.

But there is no question that attitudes on things like mergers and shareholder value are changing, even if they still stop far short of Anglo-Saxon enthusiasm. According to figures from the Cabinet Office, the proportion of Japanese companies that describe themselves as “shareholder-focused” increased to 40% this year from 33% in 2002, and the proportion describing themselves as “worker-focused” fell from 18% to 13%. In other areas of corporate governance, too, Japanese companies have shifted towards a more Anglo-Saxon approach, but in a way that respects traditional Japanese sensibilities.

In 2002 the commercial code was amended to give Japanese companies a choice of two models for corporate governance: the traditional Japanese system with statutory auditors and an alternative committee-based system, modelled on the American approach, which involves separate audit, remuneration and nomination committees with a majority of outside directors. This was the most explicit example of the government's efforts to encourage Japanese companies to adopt a more American style of corporate governance.

But although several large companies immediately adopted the new system—including Sony, Hitachi, Toshiba, Hoya, Nomura and Nikko Cordial—very few others followed suit. Of the 1,750 companies in the Tokyo Stock Exchange's first tier, only 100 or so have adopted it. Still, many have gone for something in-between, sticking with the Japanese system but appointing more outside directors to their boards. Around one-third of Japanese companies now have outside directors.

The Japanese definition of “outsider” is not necessarily one that foreigners would recognise. One survey found that 30% of outside directors came from partner companies, 18% from other companies in the same keiretsu, 16% from a parent company and 5% from the company's “main bank”. True, some Japanese companies—Sony is a notable example—have installed genuinely independent outside directors on their boards. But others, such as Toyota, still do not have any outside directors at all.

In this aspect of corporate governance, as in many others, Japan has shifted towards a more American approach, but has retained many elements of the traditional Japanese way of doing things. “Japan sees a new thing and says: ‘Hold on, we don't do that’,” says Mr Thomas. “Then it says: ‘Oh, it's not so bad—but let's do it in a Japanese way’.”