https://www.wsj.com/articles/SB1003269995492120880

Oct. 17, 2001 12:01 am ET

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

More than 10 years after the bursting of “the bubble,” why is the Japanese stock market still in the doldrums? One major reason is that policy makers in Japan have not demonstrated that they have a viable plan to reform the private sector. Japan is not clearing its logjam of misallocated assets and underutilized resources at a pace that exceeds value erosion.

To change this devastating trend, Prime Minister Junichiro Koizumi and his cabinet will have to extend their policies for “structural reform” of the government to the private sector. Private enterprises comprise the other three-fourths of Japan’s economy. Those businesses need additional reforms to promote transparency, accountability and monitoring among dedicated owners, just as public bodies do.

At the same time, Mr. Koizumi needs to avoid mistakes that take the entire reform process backwards, such as the shady “stock-buying company” that the government plans to set up in January. Pressuring banks, such as Shinsei Bank, to extend or rollover loans against their better judgment is another example.

With the world economy deteriorating, the backlog of urgencies is reaching crisis proportions. Several of Japan’s banks need to be nationalized and sold — the sooner the better. Major insurance companies need to be sold to better-funded acquirers in order to halt policy cancellations. Some of the nation’s largest retailers have gone bankrupt and others are teetering on the brink with debt that cannot possibly be repaid.

These trends show that transformation of Japan’s economy needs to be accelerated, not delayed. Only this can bring resources under the wing of better owners and strategies, or hasten the liquidation of excess capacity. If this process had been running in high gear for several years, the magnitude of the bloat that now faces Japan would be far less.

But anyone who has seen how Japanese banks operate behind the scenes knows that at this point simply exhorting them to write off bad loans faster will accomplish very little. That is like encouraging bank executives to bring the bank to failure and then fire themselves to take responsibility. From the managers’ point of view, there are a host of larger, offsetting pressures: not only job and mortgage, but also reputation and “face;” promises to support large borrowers; commitments based on cross-shareholdings or to unions; and the “shame” of reporting large losses, etc.

To overcome these forces, it is time for bank “owners” to rise up and act like owners by injecting a real sense of legal rights, liabilities and enforcement into the game. This means that the government itself must take up the mantle of leadership in the following ways:

• Aggressively move to convert its preferred stock holdings in banks into common stock if the banks cannot or ought not pay dividends after accounting properly for loan losses. Do not waive or defer the exercise of such conversion rights. Working with financial advisors, use this voting stock to assign independent outside directors and consultants to the boards of these banks, if needed, and force the banks to seek repayment or write off distressed loan assets at a faster pace.
• Coordinate with other major shareholders to submit recommendations to management and to pursue governance and audit/accounting reform. For the banks, this would present a useful “halfway house” that might rejuvenate shareholder monitoring and transparent control processes in time to do some good. The government would be getting on the side of the market, and mobilizing it. In contrast, full nationalization usually occurs too late and overloads the regulatory infrastructure while feeding fears of favoritism by the government.
• Require additional capital-raising to fund the resulting losses, and raise capital for all banks that need more. Invest government money as preferred or common stock, as necessary. Properly structured as a recoverable investment, this money will be much better “spent” than if used to support government guarantees for a murky “stock-buying company” that distorts corporate governance, market pricing and liquidity.
• At the nearest opportunity, auction off bank stock positions to investor groups or strategic partners who commit to hands-on management or monitoring and augment the capital base. Hopefully this will be possible withoutgoing through a stage involving full nationalization, thus preserving value for both existing shareholders and the government.

The Koizumi cabinet should complement this approach by taking more effective steps to address the corporate government vacuum that presently plagues the Japanese corporate scene. This can be done by expanding the scope of Commercial Code reform. One of the most needed reforms is modernizing Japan’s shareholder voting rules, which restrict the number of shareholder proposals submitted each year to about 20, less than half of which are substantive in nature. How can corporate democracy and accountability possibly thrive if there is so little to vote on? Japan needs to:

• Increase a hundred-fold the number of shareholders who are entitled to submit proposals at shareholder meetings, and hence the number of proposals. This can be done by lowering the bar for “entitled shareholder” from the (absurdly restrictive) present level of 1% of issued and voting stock, to a rule such as “at least 300,000 yen in market value of stock.” (In the U.S., for listed companies this level is generally $2,000 — about 240,000 yen).
• Broaden the scope of matters which are automatically deemed acceptable as the focus of shareholder proposals, such that management cannot decline to include them in proxy materials. (At present, for practical purposes, management can easily reject all but a narrow list of mechanical decision items.) Specify that proposals to nominate statutory auditors (kansayaku, monitors of management) fall in the automatically allowed scope by definition. Specify the same thing for the case when a 5% shareholder or shareholder group proposes candidates for board directors.
• Reduce to 3% from 10% the level of voting support that a shareholder proposal must have obtained in order to be resubmitted the following year. (At present, proposals that did not obtain 10% support are excluded for a full three years.)
• Reject the bill now being considered in the Diet that would require existing statutory auditors themselves to approve new candidates for kansayaku submitted by boards of directors. This is tantamount to the “extreme honor system” of corporate governance: letting students simultaneously be the test crafters, proctors and graders of their own tests.

Without these changes, the present regulatory push for “proxy voting” by pension funds will merely result in ritualistic paper-shuffling. With no increase in the paltry 20 shareholder proposals per year that are presently submitted, there will be nothing to vote on except items required by the Commercial Code.

“Structural reform” in the private sector will not be popular with certain elderly business executives. However, transparency and corporate democracy are essential to the timely recovery of Japan’s economy, stock market, pension funding crisis and banking industry.

As executives make moves in the reverse direction, regrettably they expose that their true agenda comes with some self-serving priorities. They are not alone in this regard, as shown by the creative use of takeover defenses and golden parachutes in the U.S. But as long as this tendency is not countered with policy leadership, value will continue to be lost by both Japanese shareholders and taxpayers.

Japan’s various crises will take years to overcome. But the process will take much longer without the assistance of healthy capital markets and active owners.

— From The Asian Wall Street Journal