The framework for supervising business in Japan is alarmingly flimsy. Politicians seem reluctant to change it
AP
WHO is a fan of Horiemon now? A hero of the internet age, who challenged fusty ways of doing business, Takafumi Horie now sits in a Tokyo jail. A couple of weeks after prosecutors raided the headquarters in Roppongi Hills of the upstart empire that Mr Horie assembled in a fit of acquisitions, livedoor lies in ruins, its stockmarket capitalisation now below the group's net asset value.
Nemesis takes just a year: last February, livedoor launched a shocking hostile bid, Japan's first ever, for an august broadcasting group, Fujisankei Communications, fought off only when a white knight was found. This week, by contrast, Fuji said that it might rescue livedoor by taking it over. When Mr Horie was riding high, the media—Fuji TV's reporters honourably excepted—delighted in building him up still further, conferring on him his nickname derived from a cartoon character with boundless optimism. The media are now having an equally high time of it pushing him back down. What has not changed is that Horiemon is still by far the biggest story in town.
Mr Horie was arrested on January 23rd, and has been held incommunicado since, while a new management team has taken over livedoor. Other former executives have also been arrested. Hideaki Noguchi, a friend and former livedoor executive, has been found dead in a hotel, an apparent suicide. No charges have yet been laid in the livedoor case, and it is still far from clear exactly what Mr Horie and other executives, notably Ryoji Miyauchi, the chief financial officer, are alleged to have done.
Certainly, without a hint of independent inquiry, the Japanese press recycles each day what it has been spoon-fed, off the record, by the Tokyo district prosecutor's office. Such leaks, seeking to build a case in public before charges are even filed, are a part of the problem, says Atsushi Nagano, a lawyer at Nishimura & Partners in Tokyo. They are, he says, why the public is still confused about what the livedoor scandal is all about.
Livedoor is said to have manipulated the market in 2004, when a subsidiary announced that it was pursuing a publishing company it already controlled. It is also said to have manipulated its accounts, moving money around the group when it saw fit, including into Swiss bank accounts under fictitious company names. Opaque investment partnerships—not unlike those used by Enron in America—were supposedly used to acquire stakes. Meanwhile, share splits artificially inflated the price of livedoor shares, which were invariably used as the currency for acquisitions.
The firm may well have been shot through with financial crookery. The trouble is that some of what the prosecutors allege through the press is vague, and much of the rest not necessarily illegal in Japan, even if it clearly is elsewhere. For instance, there are no accounting rules for Enron-style investment partnerships. At the least, questions ought to have been raised much earlier about livedoor's activities. After all, much of the freewheeling in which Mr Horie engaged—share splits, the building up of stakes in acquisition targets during off-market trading and the like—was there for all to see, yet regulators at the time applied little scrutiny and took little action.
That is why the prosecutors' actions now—more than $6 billion in stockmarket value has been destroyed before a single indictment has been made—come across as extremely harsh, with motivations that are still unclear. Some politicians and analysts wonder whether the prosecutors were put up to it by opposition politicians who were appalled by Mr Horie's decision to stand (unsuccessfully as it turned out) on a reformist ticket supporting the prime minister, Junichiro Koizumi, in last September's elections for the Diet (parliament). Whether or not there was direct encouragement, it is certainly true that many politicians are quietly happy with livedoor's fall from grace.
Though they have 30 days in which to file charges against Mr Horie, prosecutors in Japan rarely make arrests unless they are sure of their case—the verdict, it is said, comes first, and the trial later. So it may yet turn out that investigators have evidence of something more concrete and heinous. Rarely do they move like this in cases of pure securities fraud. It is conceivable that some of the companies livedoor acquired were in the pocket of yakuza crime syndicates, for instance, which used them for money-laundering. Conceivable, too, that livedoor was channelling funds to politicians, in which case the story will grow. Both possibilities are raised by informed observers, and both have historical precedents. In the meantime, the abruptness with which the authorities kicked down livedoor—Christopher Wells of White & Case, a law firm, calls them an “Old Testament god” (ie, vengeful)—adds to concerns about shortcomings both in the way business is conducted in Japan, and in the way it is supervised by the authorities.
He did it his way
The livedoor saga has brought these questions to the fore partly by unleashing an emotional debate about where the country is heading. This debate matters, because Japan's economy is now returning to something like normal, after 15 years of post-bubble slump. Companies have sloughed off their debts, and are making record profits (see chart 1). Some of the improvement in the corporate sector came about by cutting staff or wages which, while necessary, precluded the kind of recovery among households that ensures economic momentum. Since last year, however, wages have been rising, while jobs are also on the increase. This week it was announced that for the first time in 13 years Japan has a job again for everyone who wants one; in December alone, 30,000 jobs were added to the economy, while household spending was up by 3.2%, compared with a year earlier.
That is all good news. But Japan has a demographic predicament: a rapidly declining workforce in relation to a population which itself is set to shrink. This can be addressed, in the long run, only by a permanently higher level of productivity growth. And here lies the significance of the livedoor debate. If what happened at livedoor is somehow symptomatic of a broader misallocation of economic and financial resources—for example, due to regulatory incentives that skew company behaviour—then Japan will lack the economic strength to address its demographic predicament. Still worse would be if the wrong lessons were drawn from livedoor, skewing incentives even further.
At the moment, it is Japan's old corporate establishment that is most likely to draw the wrong conclusions. To the members of the corporate old guard whom Mr Horie so delighted in taunting, the case is clear-cut. Among the members of the Keidanren, Japan's big-business association, are plenty of die-hards for whom livedoor represents the excesses of what in Japan is called “market fundamentalism”, for which read the liberalisation of markets and raw-blooded capitalism imported, as opponents see it, under American pressure. Their criticism has a political dimension, too, for this is the style championed in Mr Koizumi's rhetoric. At least until the livedoor scandal, it was the approach he wanted his potential successor to adopt after he steps down in September.
Certainly, livedoor and its fast-moving acquisitive style—an internet portal, it came to own, among many things, a second-hand car dealer and an online share brokerage—could not have come about without the recent liberalisation of Japan's markets. For instance, the “big bang” financial reforms of 1998—actually a rolling programme of deregulation—rendered acquisitions among Japanese firms easier. In the early 1990s nearly half of all listed equities were held by companies in a cosy web of cross-shareholdings. Reforms required such holdings to be valued in company accounts at their market price, encouraging their disposal. Today, cross-shareholdings account for less than a quarter of the market. The changes also encouraged share splits, which, by increasing stockmarket liquidity, make shares relatively easier to buy. And changes to tax rules have since made it easier for domestic companies to pay for acquisitions with shares rather than with cash. (Foreign companies, meeting local political resistance, are still waiting for new rules that will allow them the same treatment.)
In with the new
Such changes have spawned new breeds of companies, of which the prelapsarian livedoor was neither the first nor the most impressive, even if it was perhaps the most conspicuous. Rakuten and Softbank, which owns a 41.8% controlling stake in Yahoo! Japan, are examples of internet and information-technology ventures for which acquisitions have been important. With hindsight, all now have business models that are markedly more coherent than livedoor's improvisatory approach, which appeared to consist mainly of inflating its share price ever higher. Other outfits, such as the high-profile M&A Consulting Fund, have put their money to work challenging company managers, turning around stricken businesses or helping to merge or dispose of assets. These firms are all part of a trend encouraging a transformation of corporate Japan. The outcome is greater management focus and attention to shareholder returns. For the past four or so years, mergers and acquisitions in Japan have been growing fast. Last year, according to Thomson Financial, deals more than doubled in value, to $170 billion, easily outpacing the rest of the world. Restructuring has contributed to companies' record profitability, and underpinned a stockmarket that rose by 40% in 2005.
While the old guard plays down the benefits of such “market fundamentalism”, it loudly bewails the risks: the implication is that somehow the old system enshrined higher ethical norms. Really? Old corporate Japan is rife with scandal. Only last year, Seibu, a railway firm and longtime paragon of the elite, was charged with accounting fraud, and its shares were delisted from the Tokyo Stock Exchange (TSE). The difference, says Peter Tasker, a consultant in Tokyo, is that where “Old Japan” used to be concerned about covering up losses, “New Japan” rogues appear set on fabricating gains.
The TSE has now moved quickly to quarantine livedoor, which is listed on the exchange's start-up board called the Mothers Market; trading is limited to just an hour a day, presaging that it may soon be delisted entirely, as Seibu was. But, like the livedoor arrests, this seems to have come too late. The livedoor story underscores the woeful state of corporate governance and market supervision in Japan, and shows that the system is incapable of regulating behaviour at an earlier stage. The establishment has thought for too long that it is enough for Japan to be hidebound, while paying insufficient attention to ensuring that it was rulebound. Livedoor tested the defences, and found them to be weak.
Governance in Japan is marked by a lack of clear disclosure rules. The absence of accounting rules for investment partnerships is one example. When it comes to takeover bids, no clear rules are in place about how and in what ways parties may act in concert to acquire stakes in target companies. Thus, Mr Horie was able to gather a 35% stake in Fuji's radio subsidiary in after-hours trading—and even got a court to bless the action—though an investor is meant to declare once his stake reaches 5%. There is no threshold, as there is in Europe and some of the rest of Asia, above which an acquirer of shares must make a full bid for a target. Nor need a bidder offer the same price to all shareholders. In the case of Fuji, Mr Horie saw the gaps in all these areas, and drove a coach right through them.
A fresh commission
These gaps can be plugged, and some no doubt now will be. There is also the keen expectation among those pushing for change that regulatory bodies will now be beefed up, in particular, the Securities and Exchange Surveillance Commission (SESC), an arm of the Financial Services Agency, the cabinet-level body responsible for financial regulation. The SESC is pitifully staffed, with fewer than 320, compared with 3,800 at America's equivalent, the Securities and Exchange Commission. With Mr Koizumi's commitment to cut the government bureaucracy by 5%, it has been hard for politicians to argue that more staff should be sent to the SESC to identify and stop securities shenanigans. Now, the economy minister, Kaoru Yosano, says that more staff should be a top priority. Though calls to split off the SESC and give it independent clout are likely to face strong opposition from politicians, a debate needs to start on what powers a reformed SESC should have, and how it should be financed. For instance, in America civil fines levied for financial misdemeanours are ploughed back into enforcement. The Japanese system caters neither for civil fines nor for class-action suits.
More changes will be needed. Regulators must also be ready to act sooner on signs of unsavoury activity. A case in point is livedoor's frequent use of stock splits (it split its shares 30,000-fold). In theory, splitting shares should not lead to a change in a company's valuation. In Japan, however, a paperbound system means that investors must send off for new certificates, and in the several weeks that this takes they have no means to trade. It is not hard, therefore, to take advantage of a temporary artificial shortage of shares after a stock split to ramp up a company's shares, increase the company's stockmarket valuation, and use that to acquire more assets, or borrow more money, or whatever.
Nishimura's Mr Nagano, who as a former senior official at the finance ministry was a key participant in the big-bang reforms, says this was an unintended consequence of them. When the flaw became apparent, he says, the authorities should have stepped straight up and admitted it; for instance, they should have banned any announcements of mergers or acquisitions during the period of artificial scarcity following a stock split. That they did not, Mr Nagano thinks, was perhaps because of Mr Horie's popularity at the time.
Livedoor lessons point not just to a need for thorough overhaul of surveillance and corporate governance. The hardware at the heart of Japan's market capitalism, at the TSE, has also been tried and found to be sorely lacking. On news of the livedoor raid by prosecutors last month, investors, many of them housewives who had taken up day trading during the bull market, dumped shares in a panic. Orders swamped the exchange, forcing it to close early for the first time in its history. The exchange, says a bank head in Tokyo, is a “sclerotic, bureaucratised institution without a strategy, unable to think ahead.” Though the TSE is rushing to upgrade capacity, doubts will remain about its readiness in the face of the more vibrant markets that an economic recovery might be expected to bring.
AFP
Horrified by Horie Whether the livedoor mess leads to swifter improvements in disclosure, surveillance and corporate governance, or whether the opposite conclusion is drawn—that liberalisation should be rolled back—hangs to an extent on the political contest among those keen to take over from Mr Koizumi as prime minister and leader of the ruling Liberal Democratic Party (LDP).
For the first time since the LDP's landslide win last September, the opposition Democratic Party of Japan has found its voice, attacking Mr Koizumi and his reformist allies for allowing unbridled corporate greed. But the strongest criticism comes from within his own party. In particular, the reputation of the chief architect of the prime minister's reforms, Heizo Takenaka, a former economics professor who has many detractors, is badly dented within the LDP, says Takao Toshikawa, editor of Insideline, a political newsletter. Mr Takenaka vigorously championed Mr Horie's bid for parliament, going down to Hiroshima to campaign for him. Until recently, he had been increasingly mentioned as a contender for the premiership, but if he had such hopes, they have now been dashed. What is more, Mr Takenaka now becomes a liability for the presumed front-runner, Shinzo Abe, the chief cabinet secretary, who had been counting on him to provide the domestic-policy expertise that Mr Abe obviously lacks.
There are other areas where reform, broadly defined, is on the defensive in Japan. One has to do with a growing construction scandal, where architects were discovered to have faked earthquake-resistance data for condominiums after the inspection system was deregulated in the late 1990s. Conceivably, this, together with the political effects of the livedoor scandal, could move Japanese policymaking back towards the cosy, more consensual form of politicking from which Mr Koizumi did so much to separate himself.
On the other hand, whatever wrongs Mr Horie is found to have committed at livedoor, some radical changes in public perceptions that he helped bring about are unlikely to revert. The biggest is the concept, recent to Japan, that companies belong to shareholders, not managers. That is not to say a spate of hostile takeovers is imminent. Still, shareholders will increasingly ask managers to listen to them. Even a children's television programme, “Weekly Children News”, describes, in the simplest terms, such things as investments and the benefits of mergers. Given the present harrumphing about livedoor from the old guard, perhaps the programme airs in the wrong slot.
