As recently as a decade ago, the Japanese system was universally admired on the belief that it allowed managers to focus on building long-term value, rather than on the pressures of quarterly earnings expectations of shareholders and market analysts. Today, however, there is a growing realization that more dynamic mechanisms are required to provide Japanese firms with the competitiveness, labor mobility, access to venture and equity capital and other efficiencies and technological advances needed to compete more effectively in today’s highly aggressive global economy.

One of the primary reasons for this change of priorities is that the Japanese economy has matured. Living and educational standards have risen, and, with these, so have the expectations of the Japanese people. As other nations developed lower-cost production capacity, Japanese firms have been required to adopt higher value-added business models. The system that served Japan so well during its period of rapid export-oriented growth has now begun to constrain its ability to expand the domestic economy and to nurture and finance world-class enterprises and technologies of the future.

In spite of the collapse of the overheated Japanese "bubble" economy of the early 1990s, Japanese firms have been slow to develop new business and economic paradigms. It is increasingly recognized that such changes are essential if Japan is to successfully restore the dynamic growth and capacity for innovation it has exhibited in the past. Part of the reason for this slow acceptance is that Japanese firms, lacking a corporate governance system driven by shareholder interests, have not had the same exposure to external influences as their U.S. counterparts.

This structural difference has constrained the ability of Japanese firms to adopt the corporate structures, strategies, practices and responses needed to competitively access global capital markets. Organizational rigidities have also constrained the mobility of human resources. Together, these factors have prevented Japanese firms from entering into the flexible alliances and staffing configurations needed to develop and profit from the new and emerging technologies that are driving economic growth in the United States and many European countries.

Over the past year, however, there is growing evidence that a consensus has been developing -- with both government and the private sector moving to initiate the often painful changes needed to "re-tool" the Japanese economy for the next level of expansion and growth.

Through targeted initiatives promoting deregulation and reform, the Japanese government hopes to introduce more market-oriented mechanisms to raise efficiency and lower the cost of doing business in Japan.

Some of the many reforms now being enacted include the following measures:

Changes in Anti-Monopoly Regulations

Japan’s anti-monopoly law has been revised to facilitate mergers and acquisitions and to update the country’s competition policy. This includes a relaxation of registration and reporting requirements. Where companies had formerly been required to report all mergers and acquisitions, currently only those transactions where the assets of the acquiring company exceeds 10 billion yen, and the value of the acquired company exceeds one billion yen, need to be registered with Japan’s Fair Trade Commission.

The Japanese Fair Trade Commission also announced new guidelines on January 1, 1999 to administrate corporate consolidations. This includes measures to promote transparency and disclosure in cases where a corporation’s stockholdings exceed 50% of total equity in another company or where an officer holds a similar position in an unaffiliated firm.


Changes in Commercial Law

The procedural mechanisms to enable corporate acquisitions by stock transfer rather than cash purchases are now in the final stages of approval. Other changes in Japan’s stock transfer system include allowing smaller companies to transfer stock to their parent and holding companies.

Regulations concerning the legal structure of Japanese companies are now being reviewed and altered. This includes rules governing corporate spin-offs and divestitures.


Changes in Corporate Taxation

A permanent tax cut was implemented at the start of the current fiscal year, reducing Japan’s corporate tax rate from 46% to 40%. This is competitive to tax rates in the U.S. and Germany.

Efforts are also underway to introduce a consolidated tax payment system by 2001.


Changes in Corporate Pension Systems

In FY2000, a defined pension contribution system will be introduced.

Employer-sponsored, 401K, self employment retirement plans and other innovations to improve funds mobility and the flexibility of Japanese pension fund practices are now being considered, with a targeted introduction date of FY2000.


Changes in Accounting Regulations

To improve transparency and disclosure, Japanese companies will be required in FY2000 to use market-based accounting to report cross-shareholdings and pension liabilities.

Recently enacted changes to Japanese accounting standards include the introduction of tax credits and liabilities onto corporate balance sheets.

Japanese corporations have traditionally enjoyed a higher degree of autonomy than their U.S. counterparts. This is due to the evolution of the Japanese system, which can be traced back to the Meiji era (1868-1912), when Japan selected Germany as the model for its Commercial Code. In contrast to the U.S., where corporate governance emphasizes a separation of ownership and control, Japan has been governed by a system in which management and labor work together in cooperation with main banks. These banks hold an equity stake in, and assume responsibility for, watching over the operations and performance of their customers.

While these close relationships have helped Japanese firms to expand during periods of high growth, they have tended to discourage interactions with "outsiders". This can decrease economic efficiency by discouraging firms from transacting business with the most suitable partner, who may or may not be Japanese. Cross-sharholding often produces interlocking directorates. This can insulate boards from the interests of shareholders. Additionally, the lack of external governance mechanisms discourages an active takeover market and constrains the influence of outside investors and other external constituencies, who encourage efficiency and provide a system of "checks and balances" in the U.S. and other countries.

Several factors are now forcing Japanese firms to reevaluate this system. One is the relatively poor corporate performance since the implosion of Japan’s bubble economy in the early 1990s. One recent survey estimated that the average return on equity of Japanese firms is approximately 4% -- only a fraction of the 20%+ returns delivered by U.S. companies. Japanese firms are also no longer able to rely exclusively on one banking relationship. Today, Japanese financial institutions are struggling to dispose of non-performing loans, and are themselves looking to attract capital from outside investors. This is requiring Japanese firms to expose themselves to outsiders in the same manner as Western companies.

The deterioration of the main banks' supervisory and auditing function is helping to promote economic efficiency. This is driving a general trend toward restructuring and a different model of corporate governance in Japan. As a result, the main bank system is in decline. According to one recent survey released by a Japanese Ministry of International Trade and Industry (MITI) study group in March 1998, 86% of Japanese companies believe the main-bank system must change in the years to come. Cross-shareholding rates have also been falling in recent years. Banks and affiliated shareholders are now being forced by economic conditions to redirect their funds toward more productive investments. In addition, foreign investors have become a more significant factor.

Developing a New Corporate Governance Model

In the U.S., institutional investors play an active role in corporate governance. They closely monitor and critique the activities of management to insure the success of their investments. Japanese companies have largely been resistant to these pressures. As recently as 1996 over 2,000 Japanese corporations carried out their annual shareholder meetings on the same day, with the majority completing these meetings within 30 minutes.

Japanese companies and policy-makers are, however, coming to realize the real costs that this system exacts on their growth and development. They are moving to adopt new business practices, including a new corporate governance model. In June 1998, approvals were granted to allow the distribution of stock options, strengthening linkages between outside investors and insiders. Companies granting options need to pay greater attention to the interests of all shareholders -- which can now include employees as well as outside investors.

Companies are also embarking on internal reforms. The Tokyo Stock Exchange reports that 129 companies announced corporate restructurings in March 1999. On April 1st alone, several major corporations, including Marubeni, Sogo and Hitachi, announced significant changes in their business practices, mirroring similar pledges made earlier this year by Sony, NEC and Toshiba. The average size of Japanese corporate boards has declined. Companies such as Sony, Toshiba, Hitachi and Fuji-Xerox have begun to make significant boardroom cuts. Sony's board has been reduced from 38 to 10 directors -- and now includes three outsiders. Furthermore, Sony is now planning to adopt additional innovations, including remuneration and nomination committees. Toshiba has introduced a U.S.-style system of officers that specialize in specific business operations.

Smaller companies are also participating in this phenomenon. One company, Teijin Ltd., a polyester manufacturer, set up a committee last June to advise on their president’s compensation and employment contract. This is highly unusual In a seniority-based system such as Japan’s and indicative of the changes that will likely be seen in the future. Teijin also plans to include outsiders on this committee from Japan, the U.S. and Europe. Other companies are also taking steps to disclose the compensation packages of their key executives.


Moving to Restructure and Rationalize Business Operations

Corporations have also begun to restructure and rationalize their business operations. Toshiba implemented far-reaching organizational reforms last year and initiated a comprehensive reorganization of its business operations. Hitachi also restructured five semiconductor-related subsidiaries into three, with additional moves now being contemplated in the area of electric appliances. Toyota plans to introduce a global executive exchange program, signaling the company’s belief it must globalize corporate management to remain competitive.

Corporations are also moving to develop a more competitive cost structure by trimming staff, selling off subsidiaries and closing offices. Some companies such as Nippon Oil and Mitsubishi Oil have decided to merge to improve efficiency through the consolidation of their 14,600 domestic service stations. Others such as Sumitomo have entered into joint ventures with foreign firms like Goodyear to maintain and expand their global presence.

In the financial sector, there has been substantial activity as well. Many foreign financial institutions, including Merrill Lynch, Citigroup and GE Capital, have been purchasing assets in Japan and upgrading their presence in the Japanese market.

An unfortunate and disruptive byproduct of this extensive reorganizational activity -- whether cyclical or permanent-- is that Japan has now surpassed the United States in unemployment, rising to 4.6% last February -- the highest level since the Japanese Management and Coordination Agency began recording this data in 1953.

Despite the social dislocation -- and attendant "pain"-- inherent in these numbers, these and similar moves in the future will serve to enhance the overall competitiveness of Japan’s corporate sector. Business sentiment is also beginning to improve. Nearly 90% of 112 Japanese company presidents surveyed by the Nihon Keizai newspaper expressed their belief that the indications of a turnaround should begin to be felt before the end of 1999.

Japanese policy-makers are moving to accelerate and facilitate these trends, taking concrete steps to encourage corporations to reduce their excess capacity. At the end of March 1999, Prime Minister Keizo Obuchi launched a panel of prominent business and government leaders to help Japanese companies restructure their operations, as a tangible complement to the stimulus measures introduced by the government over the past year. This commission is modeled after the "Competitiveness Council" set up by U.S. President Ronald Reagan in the 1980s. Among the items under discussion are measures to help Japanese companies reduce their excess plant and equipment.

To assess longer-term trends, a Study Group was convened by MITI in September 1997. This group was composed of 15 leading academics and business executives, including representatives from Tokyo University, Nippon Steel, Sony Precision Technology, Nippon Life and Fuji-Xerox. The resulting MITI study highlighted corporate systems for the 21st century. It emphasized the need for greater reliance on equity and appropriate capital structures composed of bonds, equity and commercial loans. In addition, it stressed that Japanese managers need to understand the real capital costs of their business practices and that Japan’s capital markets and corporate governance standards must be changed to introduce greater flexibility, accountability, reliance on market practices and strict self-responsibility.

The strength of the Japanese stock market in the early months of 1999 indicates that international investors, who have tended to undervalue Japanese assets in recent years, are beginning to recognize and endorse these important changes. Many U.S. analysts have become increasingly bullish, expressing their belief that the Japanese economy has "hit bottom", and offers investors an extremely attractive opportunity to earn superior returns for many years to come.