Toshiba and the Japanese business establishment

First there was the Fukushima Dai-ichi nuclear disaster, where nuclear power plants were installed incorrectly and both the utility and government regulators falsified inspection reports to cover this up.

Then there was Olympus Optical, whose tip management lost billions in stock market speculation because it was unwilling to restructure loss-making operations and covered up the fact for over a decade by fabricating its financial statements.

Now there’s Toshiba, which falsified results for years, under pressure from unrealistic profit goals set by a series of CEOs  (shades of Jack Welsh at GE).


Not that surprising, in my view, given the Japanese corporate world’s widespread adherence to a samurai-like code of absolute, unquestioning obedience to instructions given by older/more senior managers in one’s company.  After all, many of these enterprises have their origin in samurai cast adrift as regional warlords were marginalized during the early shogun days.

This mindset is also a reason why a lot of Japanese business is still stuck in the 1980s–that the world is changing at a fast clip, but you pretty much have to have white hair before anyone will listen to what you have to say.  To be clear, I don’t think this samurai-ness is a universal attitude in Japan as a whole.  Unfortunately,it thrives in the Tokyo/Osaka-based, export-oriented industrial sector which is the primarily beneficiary of the deep depreciation of the yen engineered by PM Abe.

Why don’t out-of-date sixty- and seventy-somethings just retire and let a younger generation take the reins?

For one thing, speaking as a sixty-something myself, it’s hard to go from being king of the world to being just another nameless retiree.

I think, however,that there may also be a deeper, more damaging reason than the ego problems of the people in charge:

One of the first companies I followed as an analyst was a small copier manufacturer/distributor.  The firm was in enough financial trouble that it bought breathing room by selling a large chunk of its plant and equipment and leasing it back from a bank.  That netted $50 million or so in cash.

Soon afterward, Carl Icahn bought  5%-10% of the company’s stock and threatened to make a hostile bid for the rest.  The firm quickly bought back Icahn’s shares for, as I recall, about a 30% premium.  I was shocked.  I didn’t get it at all.

Only when the firm subsequently went into Chapter 11 did I learn the CEO, a former accountant, had been fiddling with the books for years.  That fact was the real leverage Icahn had over his target, whether he knew it or not.  The CEO couldn’t let an outsider in, because the accounting shenanigans would be discovered and he would be disgraced.

I don’t know, but I suspect–because I’ve seen the same pattern in numerous smaller firms in Japan that Olympus and Toshiba are only the tip of the iceberg in Tokyo.  If I’m correct, Abenomics is even more problematic than I’ve been writing.







Abenomics and outside corporate directors

The original plan—and, in my opinion, fatal flaw—of Abenomics regarding reform of industry in Japan to make it more profitable was to depreciate the yen in a significant way that would supposedly compel now-more-profitable corporation to invest in expansion.  That would increase the number of employed and boost wages for all.  This would, in turn, generate a positive, self-reinforcing spiral of economic activity.

The depreciation has happened.  The hoped-for wage increases, employment gains and new investment haven’t.  This has been devastating for ordinary Japanese citizens, for whom a sharp decline in the currency has only meant an increase in the cost of living and a tremendous loss of wealth.

Tokyo has recently decided to try to force recalcitrant firms to use the increasing piles of cash that depreciation has brought them.  The vehicle is new legislation that mandates that publicly traded concerns install board members who are not insiders—that is, who have no connection with the firm.

The idea is that these fresh eyes and new voices will somehow compel companies to change their ways.  The initiative has received lots of praise from brokerage firms and the financial press.  For Japan’s sake, I hope they’re right.  Unfortunately for the country, my guess is that this enthusiasm is misplaced.

My son-in-law and I were talking about this the other day.  He immediately said what I have been thinking from the start—“What about Olympus?”

The Olympus in question if Olympus Optical (8831).

Several years ago, the head of that company’s European operations was made CEO of the entire company.  An outsider but an accomplished businessman, the new CEO found that he was not given the full access to corporate information he (justifiably) expected.  His requests for certain data were routinely deflected by the rest of the board.  Through a combination of whistleblower information and forensic accounting he conducted in secret, the CEO discovered a massive accounting fraud Olympus had been perpetrating since the early 1990s.  (The company hit hard times in the late 1980s.  Embarrassed, and unwilling to restructure, Olympus decided to supplement profits with stock market speculation.  The company, of course, experienced massive losses and covered the whole mess up.)  After confronting key board members, he ended up resigning and fleeing the country, saying that he feared for his life.

I’m not contending that the introduction of outside board members it going to create a whole raft of new Olympus-like incidents (although if there were a way to wager a small amount that there would be at least one, I’d be willing to bet).

am saying that I think the culture of protecting the status quo and of regarding any sort of restructuring as meaning creating/enduring life-shattering shame is still pervasive in Japan–and that simply adding a few outside directors won’t be enough to change that.

To my mind, the obvious thing to do is to dismantle the legislation enacted in the 1990s to protect Japanese companies from potential foreign acquirers–and therefore from activists.  But I don;t see that as on the cards any time soon.

inheritance tax changes as a lever for structural change in Japan

value investing and corporate change…

One of the basic tenets of value investing in the US is that when a company is performing badly, one of two favorable events will occur:  either the board of directors will make changes to improve results; or if the board is unwilling or incapable of doing so, a third party will seize control and force improvements to be made.

…hasn’t worked in Japan

Not so in Japan, as many Westerners have learned to their sorrow over the thirty years I have been watching the Japanese economy/market.

Two reasons for this:

culturally it’s abhorrent for any person of low status (e.g., a younger person, a woman or a foreigner) to interfere in any way with–or even to comment less than 100% favorably on–a person of high status.  So change from within isn’t a real possibility.

–in the early 1990s, as the sun was setting on Japanese industry, the Diet passed laws that make it impossible for a foreign firm to buy a large Japanese company without the latter’s consent–which is rarely, if ever, given.

The resulting enshrinement of the status quo circa 1980 has resulted in a quarter century of economic stagnation.

Abenomics to the rescue?

Abenomics, which intends to raise Japan from its torpor, consists of three “arrows”–massive currency devaluation, substantial deficit government spending and radical reform of business practices.

Now more than two years in, the devaluation and spending arrows have been fired, at great cost to Japan’s national wealth–and great benefit to old-style Japanese export companies.  But there’s been no progress on reform.  The laws preventing change of control remain in place.  And there’s zero sign that corporations–many of whose pockets have been filled to the brim by arrows 1 and 2, are voluntarily modernizing their businesses.  Mr. Abe’s failure to make any more than the most cosmetic changes in corporate governance in Japan is behind my belief that Abenomics will end in tears.

One ray of sunshine, though.

Japan raised its inheritance tax laws at the end of last year, as the Financial Times reported yesterday.  The change affects three million small and medium-sized companies.

The top rate for inheritance tax is 55%, with payment due by the heir ten months after the death of the former holder.   This development is prompting small business owners to consider how to improve their operations to make their firms salable in the event the owner dies.  More important, it’s making them open to overtures from Western private equity firms for the first time.  Increasing competition from small firms may well force their larger brethren to reform as well.

For Japan’s sake, let’s hope this is the thin edge of the wedge.



slowdown in Japan

People who like black and white answers and numerical precision–whether the situation calls for them or not–define a recession as being two consecutive quarters of decline in real GDP (“real” here meaning after factoring out the effects of price changes–in Japan’s case, deflation).

On this way of looking at things, Japan entered its fourth recession since the global financial crisis when the government announced early this week that the economy had shrunk by 1.3% on an annualized basis during the September quarter.  This comes after a fall of 7.3% during the June quarter, when Tokyo implemented the first of two planned increases in the national value added tax.

Today’s situation seems to me eerily similar to that in 1997, when Tokyo stopped a nascent recovery in its tracks with a similar value added tax rise.

Prime Minister Abe reacted to the new GDP data by postponing the second value added tax increase, which had been penciled in for 2015, and calling for a general election that he intends to serve as a referendum on his policies.

Almost two years in, the fundamental sticking point for Abenomics remains unaddressed.  The idea has been to induce a large depreciation of the currency–a loss of a third of its value, so far–to lower production costs for export-oriented industry.  This makes export goods more competitive in world markets and buys time for industry to streamline and expand.  Industrial renaissance gradually repairs the damage done to national wealth through the currency depreciation.  Prosperity also induces a gradual currency rebound, restoring at least some of the wealth lost through its decline.

In many ways, Abenomics is the successful template Japan used to recover after WWII.  This time, however, Japanese industry has shown no inclination to restructure itself that I can see.  And until now Tokyo has done virtually nothing to dismantle the barriers to change of corporate control which it put in place as its economic malaise began in the 1990s and that ensure ossified managements remain in place.

For the sake of Japan, one can only hope that the point of the upcoming election will be a mandate to force industrial reform.  Without this, Abenomics will wind up merely as creating a massive loss of national wealth and a similar drop in living standards.

overnight: sharp drop in the yen, global stock market rally

what’s going on

A month or so ago–I don’t remember the exact timing–the Japanese central bank expressed concern that its weak yen policy was great for export-oriented companies but was hurting ordinary citizens, since food, fuel and other daily necessities are generally priced in dollars.  So these items cost a quarter or a third more today than they did before Abenomics kicked in.  The Bank of Japan intimated strongly that, because of the deterioration in citizens’ living standards, it was no longer interested in further yen weakness.

This morning in Tokyo the Bank reversed course and voted 5 – 4 to increase the amount of extra money it’s pumping into the economy, in what is now an all-out effort to create 2% inflation.

The yen has dropped by about 2.5% against the dollar, as I’m writing this just at the NY open.  The Japanese stock market rose by about 5% on the announcement.  Europe and US stock index futures are up as well.

my take

As I’ve written, probably too many times, I think Abenomics will end in tears.  Continuing currency weakness will just make the ultimate bad outcome worse.  That’s because I believe the root cause of Japan’s quarter-century economic malaise is that the country has chosen to defend its traditional way of life at the expense of economic progress.  One result has been to perpetuate a culture of covering up industrial/manufacturing mistakes.  Fukushima Daiichi is a terrible example; Takata airbags are the latest.  Impossible legal and cultural bars, many erected in the 1990s, still exist to removing from power people at the top of the pagoda, so to speak.

Continuing currency weakness will, in theory, buy more time for change to occur.  Admittedly, I’m no longer in close contact with the Japanese economy, but I don’t see any signs that effective change is happening.  Without it, the depreciation of the yen will mostly mean a massive loss of national wealth–and more time in power for incompetent industrialists.

(In my view, France and Italy have almost exactly the same issues.)

So, while the new tide of central bank money into the world will likely make markets move higher for a while, its main effect will probably be to smooth over economic bumps in the road for the US and China.  We should enjoy the ride.  But we’ve also got to think about how to defend ourselves from the ultimate negative consequences for Japan–and anyone who does business with/in the Land of Wa.