New Benchmarket to Link Japan Executive Pay to Market


The Japam Management Association plans to start a service next year that will provide companies with a benchmark for executive salaries in Japan. The organization plans to launch its director remuneration information service next spring. The goal is to accumulate information on all levels of executives, including monthly salaries, annual bonuses and stock options. Many Japanese companies want to introduce performance-based systems, but need an industry standard to benchmark against. A survey conducted this March implied that the current gap in annual salaries of senior executives was no more than 20%.

Japan's OTC Markets Move to Tighten Listing Restrictions


The Japan Securities Dealers' Association will move to tighten OTC listing resquirements from 2003 by introducing minimum market capitalization rules. Companies whose market capitalization falls under JPY500 million for nine consecutive months will be delisted. Minimum liquidity and net negative equity requirements will also be strenghtened. At the end of August, 2002, there were 14 of 900 OTC-listed companies that would not meet the new requirements. The Tokyo Stock Exchange has already introduced minimum market capitalization requirements. Currently under discussion is the introduction of stiffer requirements for average trading volumes. Companies that record net negative equity for two consecutive years will be subject to delisting, whereas the current cut-off is three years. The object of the exercise of course is to create market conditions to make it easier for individual investors to invest.


But while they are tightening the TSE and OTC market listing requirements, they have eased the "Green Sheet" listing requirements. The Green Sheet market is very similar to the "Pink Sheets" listing in the US, and it is becoming a popular alternative for emerging companies to tap the capital markets. These measures to tighten listing restrictions were included in the FSA (Financial Service Agency's) reform program for the brokerage industry. The Tokyo Stock Exchange already introduced a minimum market capitalization requirement of JPY500 million for their Mother's Market this May, while the minimum market capitalization cut-off for the TSE 1 and TSE 2 markets will be raised to JPY1 billion from April of next year.


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Changes in Japan's Securities Taxation


There will be significant changes in Japan's securities taxation from January 2003. Under the new tax structure, taxes due on securities transactions will differ significantly depending on how they are reported, and there are many time limit exceptions. The new system is confusing and difficult to understand. The largest change is that taxation at source will be discontinued and transactions will be treated as seperately reportable events. Under the old system, investors had the option of choosing taxation at source, which carried a tax rate of 1.05% of the total amount of the transaction. Some 70%~80% of individual shareholder transactions heretofore were treated in this manner. Under the reportable event method, investors will have to figure out what their capital gains were and the taxes due, and file a report to the tax authorities. The advantage is that capital losses can be offset against capital gains. Capital gains tax rates under the system are 20% income tax and 6% residence tax, for a total tax rate of 26%. From January, these rates will be lowered to 15% and 5% respectively, which is the same tax rate applied to interest income. Brokerage firms are preparing to offer individual investors services to satisfy the tax reporting requirement, but it requires that the individual investor keep good records concerning their purchase and sale costs.


Moreover, exceptions have been included. If you hold stocks for a year, the effective tax rate on the liquidation of these stocks will be 10% untial 2005. The domestic brokers are tasked with keeping proper records (for at least 10 years) of individual transactions, and these transaction reports are a record of purchase and sales prices. For stocks held over 10 years, bank transfer records or bank account records, or the date at which the shares were registered in the investors' name become the base for which historical cost is considered. However, there are many cases where a significant amount of time has elapsed between the actual purchase and when the shares were registered. If the original purchase cost cannot be determined by historical records, the effective purchase cost for stocks bought before September 31, 2001 and sold between 2003 and 2010 will become 80% of the value of the stock at the close on the first of Ocober, 2001.


However, as in the case of NTT's stock, where investors incurred substantial valuation losses on the company's IPO and subsequent public offerings, there may be cases where the effective cost would mean a tax liability. However, the special exception as described above can be chosen even in cases where a clear historical purchase cost can be established.


Another exception is the exemption on stock transaction taxes for purchases up to JPY10 million, where the purchases were made between November 30, 2001 and the end of December 2002, and sold between 2005 and 2007. In other words, no capital gain taxes will apply for capital gains made during this period. However, the total purchase value will not include broker commissions. In addition, the exception applies only to those stocks purchased from the market, not those stocks that were inherited during this period.


Yet another exception is that capital gains of up to JPY1 million per year will not be subject to capital gains taxes. If the entire capital gains tax exemption is not used in a particular year, the remainder cannot be carried over into the next year. Moreover, this measure became effective from October 1 of last year, whereas the other measures become effective from April of next year.

Japanese Companies Increase Shareholder Perks


In a misguided effort to increase the attractiveness of their company to individual investors, the number of Japanese companies that have implemented shareholder perk programs is increasing, and now account for around 20% of all listed firms, according to Daiwa Securities. In addition, they are lowering the minimum amount of shares that need to be held to be eligible for these perks.


Misguided Effort Rather than offering perks to individual shareholders, Japanese companies should be pushing the government to change the Commercial Code to allow for dividend reinvestment programs, and aim to either; a) revitalize their profit growth, and/or b) begin to offer attractive dividend yields if their is no prospect of achieving stable, attractive profit growth. At present, individual Japanese investors have almost no hope of creating a porfolio of high yielding fixed income and dividend paying companies. Dividend yields in Japan remain below 2%, even though many healthier companies are extremely cash rich. Moreover, the Commercial Code prevents the establishment of dividend reinvestment programs, where investors can over time accumulate significant amounts of high dividend yield stocks without paying broker fees.

Japanese Companies Move to Beef Up Compliance


After a string of corporate scandals supposedly involving wayward employees have embarrased senior management and forced their resignations, Japanese companies are belatedly moving to beefen up their corporate compliance infrastructure. Mitsubishi Corp. plans to expand their corporate compliance staff by 30% over the next two years, while Eizai has set up teams to receive and act on infractions of corporate compliance rules. Mitsui & Co. only recently embarrased by foreign country bribery scandals, will expand their internal audit team two fold, to 40 people. After becoming embroiled in a recall scandal two years ago, Mitsubishi Auto set up an "employee consulting center", hopefully to detect such problems earlier.


Basically, corporate compliance involves;


1) Prevention: Rules of engagement, and employee education on these ruels


2) Early detection: establishing an internal audit function, defining the role of the auditor, audits by external auditors, establishing an internal reporting line for infractions


3) Remediation: establishing a task force to research the problem and recommend remedial measures.


Toyota has set up a direct internet-based communication line which employees can use to communicate directly with the legal department, and the legal department is tasked with responding to such inquiries in 24 hours. There is also a move to clearly establish the rules of engagement. Ito Ham has created a corporate ethics handbook that they are distributing to their employees as well as the employees of there 56 group companies. The key of course is how to make such countermeasures function properly.


Loss of confidence by both investors and the public. In many of the cases of recent scandals, the CEO was simply out of touch, to the point of being crminally negligent in their duties as senior executive officers of the company. In Tokyo Electric Power's case, the previous president of the firm first heard of possible problems in their nuclear power division in July 2000, when a subordinate reported that METI had pointed out problems with the firms internal nuclear plant checks. IThe reports were not followed up on. In Nippon Ham's case, the two corporate officers that took responsibility for the false labelling of meat scam new of the problem in February of this year, after Snow Brand's scandal broke. The president (son of the founder) of Nippon Ham however got the real story only hours before the press conference. This is because his father, then chairman of the firm, had completely entrusted the meat operations to one of the accused. While Nippon Ham's meat division was a major cash cow accounting for some 60% consolidated revenues, it was a completely independent operation ran by Heihachiro Higashi, the vice president. It was an operation which apparently the younger president was adverse to poking his nose into.


Unlike the tales of personal greed that have emerged from the Enron and Worldcom scandals, internal power and intense internal pressure on division managers to produce results for "the company" are more likely culprits in Japan. In the extremely inward-focused corporate culture in Japan, little consideration is given for the social implications of their actions. However, this is not true for the best managed companies in Japan. For example, at Japan IBM and Canon, internal auditors check the receipts and expenditures of even the company president and senior management. Teijin even polls its business partners to check the activities of its employees.

Trading Volumes on Japan's Venture Capital Markets Dries Up


Trading on Japan's newer exchanges has dropped off sharply in August. On the JASDAQ, trading values have dropped to less than half June levels, with many days of less than JPY10 billion/day trading value. The depressed level of trading reflects the aftermath of the bursting of the TMT bubble. Since NASDAQ Japan has decided to close its doors to trading, trading value on the TSE's Mothers market has dried up as well. The poor market activity is discouraging venture firms from listing. Last year some 32 companies were newly listed on the three venture capital markets (JASDAQ, NASDAQ Japan, and the Mothers markets) during the July~August period. This year, there have been only seven new listings. For the January~September period, some 65 companies will be newly listed this year, versus 99 last year.


Depressed major markets, fear of negative earnings surprises and economic uncertainty keep investors away. The new markets were once billed as the authorities' best hope of attracting new individual shareholders. But the government has discouraged already waning interest by new tax rules which take effect next fiscal year. From the new fiscal year, investors will not be able to choose between taxation at source (taxed on the total value of the transaction) or at 20% of the capital gain.


Investor Distrust of Markets Is Deep. Japanese investor distrust of the stock market and brokers in particular runs deep. This is because historically they have always had to pay for misguided broker advice. Analyst opinions are also suspect. Being associated with investment banks, their opinions were already considered biased, but now, with the problems in the US, the firewalls that seperate brokers, analysts and investment bankers in a firm are also suspect. Institutional investors are also seen as having problems. In many cases, their investment philosophy is not clear--are they long-term or short-term investors? Merely going with the flow of recommendations from the brokers is not fund management.


The Accounting System is Improving, but much of the real balance sheet problems are understated. Investors have to be able to determine a companies earnings power seperate from the impact of market valuations on the balance sheet. Often they have insufficient information to do so.


There is a corporate governance crisis in Japan. The 1970s and 1980s were the era of the "Omikoshi Shacho" where the president and senior management of the firm rode "fat, dumb and happy" on the shoulders of the companies workers. There were few little internal checks and balances, and all of the board members were corporate outsiders. Unhappy shareholders were effectively prevented from venting their opposition to management policies at the annual shareholder meetings. While signficant changes have been made in the Commercial Code, mangement of Japanese companies have yet to wake up to the fact that the balance of power has shifted from strategic stakeholders to shareholders who expect a decent return for their investment.

Japanese Companies Dropping Out of Corporate Pension System on the Rise


The structure of Japan's welfare pension system is dependent on the participation of Japanese companies, who bear a large portion of the total burden (the rest being born by the employee) for the national pension fund system. However, since the Welfare Ministry gave companies the option to opt out of the welfare pension system last spring, the number of companies dropping out of the system has risen to 7,000 firms. This is because the performance of the corporate pension funds has been unable to match the required returns, while disclosure requirements now dictate that firms disclose the underfunded portion of their pension funds.


Since the onset of FY2002, 10 pension funds have already liquidated their corporate pension systems, which is a lot faster pace than at this time last year, when a total of 59 funds were discontinued. For small and medium-sized firms, many firms in the same industry often band together to create a pension fund, but given the steady increase in the financial burden of these funds, some 5,000 of these companies are dropping out of the system per year. In total there were 170,000 welfare pension funds as of the end of 2001, or 13% less than FY1996. The number of funds returning management of the welfare pension portion of their corporate pension funds back to the government is rising sharply as well. Usually, larger firms assume administration of the national welfare pension fund portion, and add additional company-specific benefits to it. The reasons for this include; a) depressed earnings by the companies sponsoring the welfare pension funds, b) abysmal returns on the funds with a depressed stock market, and c) the fact that it is now possible to return administration of the required welfare pension fund portion back to the government.


Progress in Diffusion of New 401K-Type Defined Contribution Plans has been SlowJapan is currently in the process of converting from a defined benefit (the welfare pension fund) pension system to a defined contribution (Japan's version of a 401K), but progress in the conversion has been slow. The new pension plans are a) voluntary, and b) require the approval of workers. Were they able to, corporations would undoubtedly make a full scale switch to the defined contribution model, as it would put the onus of achieving sufficient investment returns on the individual employee himself, and at the same time save the company a lot of money in pension fund related expenses. Once the defined contribution plans begin to gain momentum, there will undoubtedly be many more corporations dropping out of the current defined benefit system. For the time being, however, it appears that the real driver for firms is not to convert to the new defined contribution system, but simply that they can no longer afford to maintain the old pension system.