https://www.wsj.com/articles/SB102305622058226640　

 

By Nicholas Benes　　　June 3, 2002 12:01 am ET

The Japanese government says it is trying to promote foreign direct investment into Japan. Each year, bureaucracies such as the Ministry of Economy, Trade and Industry and Japan External Trade Organization prepare policy statements with a motley range of themes spanning local tax exemptions, international schools, easier visas, changes in mindset and providing greater access to market information. Accurately, FDI is seen as a key source of the capital and know-how that is needed to restructure and revitalize Japan’s economy.

But none of these measures hit the spot among foreign investors. If you ask 10 foreign executives what is needed to boost FDI, almost all of them will respond: facilitating mergers and acquisitions by improving legal infrastructure and establishing more effective corporate governance. They won’t talk much about access to visas or schools. They will talk about access to deals, which in this case means acquisitions of companies that are still relatively healthy in addition to the bankrupt ones that no one else wants.

To both economists and us in the business trenches, it is common sense that acquisitions are essential. In any country, surges in FDI often take place after an initial boom in acquisitions, which sets up many foreign entrants with an initial beachhead — a “funnel,” as it were, into which they can the pour large amounts of follow-on expansion capital for the next decade.

There are two preconditions for this to happen: Structuring transactions under the Commercial Code must become easier; and corporate governance must improve, encouraged by pressure and proposals from shareholders. Only this can cause Japanese managers to consider selling the firm before it is too late. But there is a disconnect between public vows to “promote FDI” and the reality of lawmaking.

A case in point is the amendments to Japan’s Commercial Code that made possible a wide range of tax-free reorganization transactions. The 1999 stock swap rules conferred two huge advantages on an acquirer. First, if two-thirds of a quorum of shareholders agree, the acquirer can “squeeze out” the remaining minority shareholders and force them to accept its stock as consideration or be bought out in cash at fair value. Second, the buyer can offer swapping shareholders the option of “rolling over” their tax basis and deferring capital gains taxation.

However, these advantages are not available to foreign acquirers. Foreign companies can propose stock swaps, but their deals will be burdened by increased costs and hassle. The Japanese sellers will have to pay tax immediately even though they have received no cash. To generate cash in order to pay this tax, they will have to sell a major portion of the shares they receive in the swap. Because of the tax and the risks that arise from receiving shares not cash, they will require a higher price. But the buyer can afford this less because sales by the sellers to pay taxes may put downward pressure on its share price. The buyer also has to worry about the future hassle and risks of dealing with minority holders that it cannot “squeeze out,” including the possibility that disclosure to them may result in leaks to its competitors.

It would have been easy to draft the stock swap legislation so as to permit foreign companies and selling Japanese shareholders to enjoy its benefits. All that was needed was to require that the acquired Japanese company or its successor to submit to jurisdiction in Japan for shareholder suits and disclosure requirements under the Commercial Code, and to make provision for “triangular mergers” to facilitate using foreign stock as consideration.

Supposedly, the Ministry of Justice left out foreign acquirers in order to “protect Japanese minority shareholders.” But dissenting minority shareholders have the right to be bought out for cash in any event, and the new stock swap provisions make no pretense at doing more than this to protect minority shareholders.

For instance, under the new law Japanese acquirers can offer totally illiquid “holding company” stock to minority investors in previously listed (and hence liquid) but undervalued shares. Many domestic stock swap deals fit this pattern, wherein a large controlling Japanese shareholder is taking a listed affiliate “private.” Dissenting minority shareholders are faced with a profoundly unappetizing choice between sale for cash at a low price or receiving illiquid shares (and too few of them) in a company that will give them no voice and much less disclosure going forward.

As any investment banker knows, “squeezing out” and tax-free treatment are the sort of powerful devices that drive M&A transactions. Foreign companies are very eager to employ stock swaps in the Japanese market in just the same manner that Kyocera did when it acquired AVX in the U.S. in 1994. But they are finding that only Japanese companies can use these weapons in tandem, and no other “squeeze-out” mechanisms are available.

Japan should focus on “protecting minority shareholders” not in order to justify exclusionary stock-swap legislation that was ramrodded through the Diet so that a few firms like Sony could execute reorganizations they had already inked. Rather, it should do this for the nation’s own good: to improve corporate governance and hence also FDI by actually protecting the rights of minority shareholders.

Of course, sometimes in order to protect rights you have to create them in the first place. M&A Consulting, Inc. President Yoshiaki Murakami’s effort to appoint independent directors at Tokyo Style and increase the dividend payout has highlighted the fact that under the present code less than 1% of all shareholders investing on the Tokyo Stock Exchange have the right to make such proposals. About three-tenths of one percent, to be more exact.

Not surprisingly, in Japan there are only a few shareholder proposals made to public companies each year — a mere few percent of the number in the U.S. Yet bureaucrats and lawmakers reforming the Commercial Code presently do not plan to lower the hurdle for qualifying to submit proposals. (Now, this is 1% of the stock, or more than 300 units — often more than $3 million. This compares with $2,000 in the U.S.)

This is a double disconnect. The showcase of reforms to the Commercial Code is the promotion of “independent outside directors” to lead board committees for audit, nominations and compensation. By definition, director candidates nominated by the incumbent president’s team (who controls boards in Japan) are unlikely to be very “independent.” As in most countries, they will tend to be friends beholden to the managers. So who is expected to nominate the independent directors to serve on these new committees if it is not shareholders submitting proposals for director candidates? Will it be the 0.3% of investors who are mainly financial institutions or suppliers which often have conflicts, and who never submit proposals at present?

How serious can policy makers be about improving corporate governance with independent directors and committees if they do not make the most obvious single change that would ensure that truly “independent” directors will be nominated and elected? As is, they talk about protecting minority shareholders yet do not allow them to make proposals to shareholder meetings. How real is their commitment to promoting FDI, given that only pressure from investors and attention to shareholder value can motivate Japanese executives to consider M&A options while there is still time to save the company? Can all those FDI policy vows be serious, if lawmakers do not level the playing field so that foreign companies can use stock swaps too?

Mr. Benes is president of JTP Corporation, an investment bank specializing in merger and acquisition advisory services.