As Japanese cross-shareholdings unwind, IROs are forced to learn a new practice: targeting investors. Plus this month's depositary receipts round-up
In the heart of Tokyo's crowded, frantic Shibuya Station where millions of people pass every day, there is a statue of Hachico the loyal dog. The statue commemorates a real-life dog who allegedly met his master here each day after work, and continued to wait nobly for several years after the man had died. Today the statue stands as a national symbol for loyalty, fraternity and dedication - traits Japanese culture holds in highest esteem.
These traits have always solidified Japanese business relations and they continue to support the foundation of Japan Inc. However, that foundation is becoming less stable. Sustained economic pressures, widespread financial shakeouts, interest rates nearing zero percent and changes in reporting and accounting rules have forced business traditions to be revised. This is seen most visibly in the unwinding of corporate Japan's cross-shareholding structure.
For decades Japanese companies have reciprocally held shares of related companies, business partners and banks in order to strengthen their business ties and stabilize management. These holdings have always been both practical and symbolic. They have served to strengthen partnerships and demonstrate a sign of support. They have provided Japanese companies with a luxuriously loyal investor base, allowing them to maintain what outsiders view as inscrutably isolationist practices.
'Broadly speaking, you could say that there are two motivations for having cross-shareholdings,' explains Peter Morgan, chief economist of HSBC Securities (Japan). 'The first would be as a purely defensive measure to make sure that they are in friendly hands to ward off the possibility of a takeover.' Indeed, post-war Japan hasn't seen a single hostile takeover of a major business. 'And the second would be to strengthen business relationships.'
Global Investor Relations president Meg Taniuchi sees a fundamental difference between cross-holdings and other forms of investment. 'Banks who have cross-shareholdings are not seeking profit returns from investments. They are just holding those shares to maintain good relationships. So there's a huge difference between cross-shareholdings and, say, [shares held by] Merrill Lynch, which buys a company's shares because they are strictly seeking returns.'
In other words, cross-ownership is based on principle, not performance. This idealized structure has served Japan well over the decades, but this idealism is quickly eroding.
Japan unwinds
The Fiscal 1999 Cross-Shareholding Survey, conducted by NLI Financial Research Group, reports that by the end of Japanese fiscal 1999 (March 31, 2000 - the most recent data available), the cross-shareholding ratio stood at 10.53 percent in value (2.69 percent decline from the previous year), and 11.22 percent in share count (1.20 percent decline). 'These ratios mark new lows since the survey's inception and indicate that cross-shareholdings continue to unwind at a rapid pace,' explains NLI Research Group's senior research fellow, Hideaki Inoue.
The survey shows that in one year cross-holdings of five out of the six keiretsu (traditional business) groups fell 2-4 percent. This includes cross-shareholdings of the Mitsubishi, Sumitomo, Fuji, Dai-Ichi Kangyo and Sanwa groups.
To accelerate change, as of this year Japan's accounting rules require companies to report their holdings at market value - instead of book value. The decline of the country's equity market forced them to recognize the risk of holding their underperforming shares. If they hang on they run the risk that falling stock prices will erode their capital bases.
In anticipation of the rule change, banks began to unload their non-performing stocks en masse. Between March and October 2000, the combined stock portfolio book value of Japan's 14 major banks declined 4.45 percent, or ¥1.57 tn. And that movement continues in 2001.
Meg Taniuchi says the unwinding has hit small and mid-sized companies hardest. 'In order for [banks] to survive they have to start liquidating somewhere. So they are choosing weaker, smaller and medium-size companies which are not going to give them a huge benefit in the future.'
Many analysts believe there is much more to come and companies that already should have failed have been able to survive only because of cross-shareholdings. In a recent interview with Nikkei Weekly, Fujio Mitarai, president of Canon, predicted, 'The economy cannot recover as long as we allow companies that should have failed long ago to stay on. We must push structural reform even if it means many companies will go under. A soft landing is no longer an option.'
The sell-off is nudging Japanese companies closer to the American and European business model. According to the NLI survey, 'The expected trend toward shareholder value focused on share prices and corporate management will heighten the importance of return on equity, disclosure practices, and investor relations activities by companies.'
In other words, Japanese companies have to overcome their traditionally tight-lipped practices. Analysts say they have become more communicative recently, disclosing more information, disclosing higher quality of information and generally becoming more transparent.
Enlightened group
Curtis Schenck, representative and managing director of GA Kraut Company, says among Japanese companies there is a small, enlightened group - namely, Sony, Toyota, Orix, Bank of Tokyo-Mitsubishi, Tokyo Electron and others - that practices proactive investor relations. 'There are some companies out there that for some reason got the message. They realize that in order to interest investors they have to communicate their strategy; they have to communicate their vision. And I think many other companies want to resist that practice any way possible. They'll be dragged into proper disclosure kicking and screaming for a variety of reasons, including the fact that they may have a lot of skeletons in their closets.'
Schenck admits that the IR role is changing, though until recently IROs have been so far out of the loop as to be ineffectual. 'There's a term in Japan for someone who reaches a point in his career where he's no longer useful and his company gives him a desk by the window so he'll have plenty of light to read the newspaper. It's called madogi wazoku. It literally means the idiot who sits by the window. And there was one industry analyst here who covered the Japanese retail sector, which includes big department stores and chain stores. He said, All the IR people I meet are madogi, meaning: They offer me no quality information.'
Schenck admits any significant change in IR practices must come from upper management. And most Japanese IROs feel the same way. In a recent survey of 1,500 listed companies conducted by the Japan Investor Relations Association (Jira), roughly 80 percent of respondents said it was important to have top management participate in investor relations activities to explain earnings reports and speak with analysts.
This all may seem obvious to non-Japanese audiences, but until very recently IR activities had been relegated to very low levels of importance, certainly far below the level to which any senior executive would usually stoop.
HSBC's Morgan says this kind of widespread change in corporate mentality is something that happens slowly, though companies cannot afford to take too much time. The unwinding process makes managements vulnerable to the pressures of new, independent investors. 'If hostile takeovers became a considerable threat then they would have profound implications for Japanese management practices.'
In the past, the cross-holding system dampened momentum for corporate reform because it effectively shielded management from outside pressures. The shares that traditional business partners sell are now being scooped up by profit-oriented shareholders - many of them foreign institutions and Japanese individuals - who want to see returns. They make investment decisions based purely on market performance and they reward or punish companies accordingly. So managements are waking up to the importance of voluntary disclosure.
Companies know they have to find new, stable shareholders due to the increasing liquidation of cross-shareholdings. They are beginning to target employees, management, major corporate clients, creditors and, to a lesser degree, pension funds and investment trusts.
Jira's senior research fellow, Yoshiko Sato, says financial reports are the key to successfully accessing new shareholder groups, and Japanese companies are bringing their reports in line with international standards. 'The contents of the reports are becoming easier to compare with foreign companies. Japanese corporations have come to care about the contents of their financial reports and to care about meeting with analysts and institutional investors.'
Morgan agrees: 'My sense is that foreign investors who are visiting companies are finding them more forthcoming with information than in the past.'
The state of IR
So where does that leave the average Japanese IRO? Well, that depends on who you ask. Many say the recent changes are encouraging. Certainly the recent explosion of Jira's membership is encouraging, as is the increasing number of companies that print their financial reports in English and other languages. These indicate a willingness to move beyond traditionally insular business relations. On the other hand, many say the change is not happening quickly enough.
History has shown that Japan tends to change in response to outside influences. The Japanese themselves have a term for it: gaiatsu, which literally means foreign pressure. Currently the strongest pressure is coming from foreign investment firms, most of which believe Japanese companies are arelatively opaque compared with their US and European counterparts.
We may be about to witness a re-enactment of the 1853 incident when Commodore Perry fired his cannons in Edo Bay and demanded that the Japanese open up their previously closed markets. As the Japanese know all too well, once cultural change takes place, the effect is irreversible.
Depositary Receipts
Brought to book
Global depositary receipt programs do not have a reputation for excellent liquidity, but that could be about to change for some European-based GDR issuers after the London Stock Exchange launched a new electronic trading service aimed at the most popular London-listed GDRs. The Seaq International order book has been introduced for what the exchange describes as 'a number of the more liquid stocks currently trading on Seaq International.'
The order book should lend a hand to investors and issuers involved in London-listed GDRs, taking the most liquid stocks out of the standard Seaq International service and onto the order book, which has been modeled on the LSE's main SETS order book.
The LSE's move is being seen as part of its strategy to focus on the European market in the wake of the collapse of last year's merger talks between the London exchange and Germany's Deutsche Borse.
Stop press There was a time when few people could claim to know about the DR business. But such has been the growth in DRs in recent years that depositary receipts are now a popular tool with both retail and institutional investors. Evidence of this can be seen in the decision by the Financial Times to publish the Bank of New York's ADR indices on a daily basis.
BoNY's indices represent over 500 ADR programs from 42 separate countries and are the only ADR indices to track all US-listed depositary receipts on a real-time basis. The tables published in the Financial Times will also include information on trading volumes and data on price highs, lows and year-to-date changes.
The news comes as BoNY takes control of around 40 sponsored and unsponsored ADR programs previously administered by HSBC Bank USA, including HSBC's own ADR program.