https://www.wsj.com/articles/SB110142694999483889

By Nick Benes　　Nov. 26, 2004 12:01 am ET

When Prime Minister Koizumi made a major commitment to open up the country to more foreign direct investment in early 2003, Japan finally seemed to be changing. Then this year the country’s media and the major business group, Nippon Keidanren, invented the threat of a massive “wave” of hostile takeovers coming to Japan’s shores, inciting a flurry of distorted reports that threatens to derail Mr. Koizumi’s worthy plan.

The hysteria over this perceived tide of hostile activity has little to do with what was actually proposed. The most important FDI policy promoted by the Cabinet Office was to enable cross-border stock swaps and the tax-deferral treatment that makes them feasible. Cross-border stock swaps are transactions in which a foreign company exchanges its stock with shares held by investors in a Japanese company, in order to acquire it. No measures to facilitate “hostile” M&A via stock swaps were proposed, and the only thing recommended was legal treatment equal with that of domestic acquirers, to address current discrimination in the law.

Regardless of these facts, earlier this year articles suddenly started appearing in the press and business magazines about the imminent “crisis” of hostile-takeover activity. According to various sources, even after being notified of their misreporting, the media were not particularly interested in correcting their mistakes. They were not very interested to learn, for example, that exchange offers, the only kind of swap that can ever be “hostile” in practice (i.e., offered directly to shareholders), are not scheduled to receive any tax deferral. They also chose not to report that the vast majority of strategic investors tend to shy away from transactions with the taint of a “hostile” reputation in Japan.

Next, the Cabinet Office’s think tank, the Economic and Social Research Institute, published a report by its “M&A Study Group” containing more than 50 detailed (and very constructive) recommendations on how to improve the M&A market in Japan. One of the recommendations was to consider the pros and cons for adopting takeover defenses such as “poison pills.”

As if waiting for its cue, the Ministry of Economy, Trade and Industry immediately announced that it was forming its own study group to follow up on the topic and possibly suggest legal changes. The ministry says that its group will also be studying a variety of other methods for “increasing shareholder value,” but none of these have been specified. Only takeover defenses have been proposed, even though there have been no hostile M&A deals in Japan. It was essentially the same refrain as in the press: a maelstrom of hostile M&A is about to hit Japan. Frustratingly, METI made no announcements about how (if at all) it intends to follow up on any of the other 49 recommendations in the M&A Study Group’s report.

Recently Nippon Keidanren entered the circus in full public view, issuing a policy recommendation in favor of — guess what? — takeover defenses. It referred at length to the upcoming legislation to allow cross-border stock swaps and raised the specter of all the horrible and hostile things that may ensue.

Once again, we saw the same false hostile threat (the one which cannot legally occur) being used to press emotional buttons. The refrain was that companies with a “completely different corporate culture” might soon be able, without using any cash, to buy up Japanese companies on the cheap and do things that are “damaging” to the interests of shareholders, employees, and regional economies, like sell off non-core divisions or affiliates. Ironically, much of the intended alarmist litany sounds exactly like what Renault did at Nissan, Japan’s greatest turnaround success story of the past 15 years. Dangerous and hostile to whom, one is tempted to ask. Complacent management, perhaps, but that’s about all.

Keidanren claims to need takeover defenses so as to be on an “equal footing” with foreign companies that can use these defenses. But since hostile tax-deferred swaps still will not be possible, what Keidanren’s member companies are really worried about is the prospect of having to seriously analyze friendly offers that increase corporate value, because there are bound to be more inquiries under the new laws. An investment banker would say that this is nothing but the self-serving reaction of executives at weak companies who find it inconvenient to even consider how to maximize shareholder value with such transactions.

“Equal footing” with domestic companies, indeed, is exactly what the foreign community wants on the swaps issue. But there, it appears that the Keidanren has actively sought to limit the stock-swap alternatives that may be permitted to foreign acquirers.

Initially there were three key proposals, all of which are necessary in different circumstances. The first and simplest to adopt, merely a logical change to the tax law, was proposed by the American Chamber of Commerce in Japan. So far, this has been summarily rejected by the Ministry of Finance, seemingly because it makes getting near-equal treatment too easy. The second proposal was to modify the current stock swap provisions of the Commercial Code (Section 352), which is very simple and convenient, so that foreign firms can use it. Thanks partly to comments reportedly made by the Keidanren representative in the Legal System Advisory Council, it appears that that simple proposal will be struck down as well.

That leaves only one alternative on the table: the exceedingly complex “triangular merger” structure, namely transactions in which a foreign company acquires a Japanese company by exchanging its own shares with shares of the Japanese company, and merging all into a vehicle company in Japan. This type of transaction is likely to be enabled, but with criteria for obtaining tax deferral that are restrictive and burdensome for foreign investors. Because they are so complicated, the rules needed for the mechanics and tax and accounting treatment have not yet been designed. Barring a complete about-face from the Ministry of Finance, experts are not hopeful that the resulting structure will be convenient to use. And triangular mergers can’t possibly provide treatment that is equal to that enjoyed by domestic acquirers. As one Japanese banker noted, “that structure itself is a takeover defense.”

Hence, disinformation about hostile swaps (which are not being proposed!) is being used to restrict FDI alternatives while lobbying for other changes. With respect to takeover defenses, management at Keidanren member companies stand to benefit more than elsewhere. These are almost all listed companies, many large and weak. Thet often trade at low multiples, and hence they feel exposed to a takeover threat, even though there is nothing in the recent stock-swap proposals that would actually threaten them.

As a result of all this scaremongering, the foreign community will ask: Is this foreign direct investment promotion, or is it Keidanren promotion? — and will look at other markets.