Annual Report on
The Japanese Economy and Public Finance
- Japanese Economy Heading for New Growth Era
with Conditions for Growth Restored -
Government of Japan
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Section 3 Structural Reforms and Business Environment for Companies
As analyzed in Section 1, companies' restructuring efforts as well as the cyclical macroeconomic recovery have contributed much to the improvement of corporate earnings in the current recovery phase. Such restructuring efforts might have enhanced relevant companies' financial profiles and improved the efficiency of macroeconomic resources allocation, helping to sustain the current economic recovery(48).
The business sector's restructuring efforts are based on individual companies' business decisions. Legal, tax and other systems surrounding companies have been reformed to increase their freedom of business decisions. In addition, various institutions regarding companies have been modified to become more consistent with international standards as their activities have grown more global. These institutional changes might have worked to enhance investors' governance on companies. This section reviews major institutional reforms regarding companies since the second half of the 1990s and uses our questionnaire survey to analyze how companies have evaluated these institutional reforms.
1. Institutional Reforms Surrounding Companies
(Legal revisions regarding corporate governance and realignment)
Institutional developments regarding restructuring over the past years included the simplification of merger procedures in 1997, the introduction of the equity transfer and swap system in 1999 and the development of the corporate divestiture system in 2001. The equity transfer and swap system allowed a company to wholly acquire another firm by transferring the acquisition target's equity shares to itself or swapping the acquirer's new shares for the target's shares, instead of purchasing the target's shares. The corporate divestiture system eased such requirements as inspections by court-designated inspectors and approval by creditors for investment in kind. Both systems were designed to make it easier for companies to realign themselves. In a few years after the introduction of the equity swap and corporate divestiture systems, the number of companies utilizing these systems increased rapidly. Still, a steadily growing number of companies are utilizing them (Figure 2-3-1). Although tax had been imposed on asset transfers accompanying corporate reorganization, the reorganization tax system was developed in 2001 to defer such tax on certain conditions. In addition, the consolidated tax system was introduced in 2002.
Figure 2-3-1 Utilization of Equity Transfer and Swap, and Corporate Divestiture Systems
The number of corporate merger and acquisition deals increased 2.5-fold in five years from 1997 to 2002. The increase slowed in 2003 and accelerated in 2004 and 2005 (Figure 2-3-2).
Figure 2-3-2 Number of M&A Deals
Corporate governance-related institutions have also been developed over the recent years. They enhanced the role of auditors (by obliging auditors to attend and make opinions at board meetings and by requiring more than half of auditors to be outsiders) and had allowed a company's board of directors to selectively introduce a committee system (that separates business operations from management and supervision and requires a majority of members at each committee to be outside directors). The derivative lawsuit system for shareholders to sue board members over corporate management was revised (to reduce responsibilities of board members and auditors for payment of damages to their companies). These institutional reforms have apparently enhanced general shareholders' corporate governance, strengthened the management-supervising roles of the board and auditors and promoted external surveillances on companies.
(Business accounting system reforms)
Japan's business accounting systems have been reformed considerably since the late 1990s. Specifically, principal financial statements for disclosure shifted from unconsolidated ones to consolidated ones in 1999 as a rising number of firms were adopting the holding company system. In FY2000, the mark-to-market accounting system was introduced for financial products held by companies. The retirement benefit accounting system was also introduced, requiring companies to disclose pension assets in market value and make up for any shortfall within 15 years. In FY2001, cross shareholdings were subjected to mark-to-market accounting. The asset impairment accounting was implemented in FY2005 for mark-to-market valuation of land, building and equipment holdings.
These reforms have made Japan's business accounting more transparent and consistent with international standards and are expected to contribute to the improvement of companies' business efficiency by increasing shareholders' influences on corporate governance(49).
(Employment system reforms)
Employment system reforms have been made to respond to the diversification of employment. Specifically, the maximum fixed term for employment contracts has been lengthened from one year to three years. Jobs for temporary staffers were liberalized in principle with some exceptions in 1999. Later, manufacturing jobs were opened to temporary staffers. Guidelines for part-timers have been revised to improve working conditions for part-timers by giving considerations to the balance between part-timers and fulltime employees. A minimum annual income has been deleted from employment insurance eligibility requirements for part-timers.
(Corporate pension and tax system reforms)
Traditional defined-benefit corporate pension systems, including the employee pension and the qualified retirement pension, have been expected to face difficulties as investment returns deteriorate under prolonged low interest rates. In 2001, a corporate pension system reform was implemented for corporate pension funds to terminate their public employee pension management services with relevant assets returned to the government, to shift to new defined-benefit pension schemes, to transfer qualified retirement pension plans to other schemes by March 2012 and introduce new defined-contribution pension schemes.
Such new corporate pension schemes have been introduced rapidly. The number of new defined-benefit corporate pension schemes after the termination of employee pension fund management services increased to 1,103 in FY2004 (Figure 2-3-3). The number of new defined-contribution corporate pension schemes stood at 1,402 as of March 2005, covering 1.25 million people. Some 460,000 people have subscribed to personal defined-contribution pension plans.
Figure 2-3-3 Defined-benefit and Defined-contribution Pension Schemes
Recent corporate tax reforms, as described above, include tax measures for companies' reorganization (in FY2001), intensification and prioritization of research and development, and business investment tax credits (creation of special R&D tax deductions and information technology investment credits in FY2003) to enhance Japan's industrial competitiveness, and international tax reforms to promote international economic exchanges and rationalize taxation.
(Other corporate reforms)
The analysis here focuses on institutional reforms regarding many companies and fails to deal with some important reforms. For example, the government has implemented reforms to promote banks' disposal of non-performing loans, revitalize companies and stimulate new business launchings. It has also developed legal systems for corporate reconstruction, rehabilitation and other business turnarounds. These reforms should have contributed to improving the allocation of resources. In-depth analysis has been done in the Cabinet Office (2003) and the Cabinet Office (2005)(50).
A new corporation law has been implemented since May 2006 to thoroughly reform corporate systems. With a view to making it easier for people to utilize corporate systems, the new law unified stock and limited companies into a single category (stock company) and eliminated the minimum capital requirement. In order to improve the mobility and flexibility of corporate management, the law reformed corporate reorganization regulations. Specifically, the new law made merger costs more flexible and created a simple corporate reorganization system where a company may take control of another without approval at the other's shareholders. In order to secure sound corporate management, the law also rationalized the derivative lawsuit system and obliged large companies to adopt basic policies for building internal control systems
2. Institutional Reforms Regarding Corporate Activities and Their Ratings
(Ratings of institutional reforms as seen in questionnaire survey)
How have companies rated the above institutional reforms regarding corporate activities? The Cabinet Office's questionnaire survey, as cited in the previous section, included questions about companies' ratings of major institutional reforms. Specifically, respondents were asked to describe real effects and ratings of institutional reforms in the six areas as cited above - corporate governance, business realignment and reorganization, corporate taxation, accounting, corporate pension, and employment and wages.
Companies' responses on each area are summarized below (Figure 2-3-4).
Figure 2-3-4 Corporate Questionnaire Survey Findings
A) Corporate governance
Some 40% of companies view the institutional reforms as having positive effects. About 50% see these reforms as generally appropriate. Specifically, some 60% of companies viewing these reforms as having positive effects say, "Improvement of corporate governance has increased the confidence of customers, business partners and financial institutions in our company."
B) Business realignment and reorganization
Some 30% of companies see positive effects of the institutional reforms, while 70% find no effect. This may be because there are many companies that have not experienced business realignment. But nearly 70% view these reforms as appropriate.
C) Corporate taxation
Some 30% view the institutional reforms as having positive effects. More than 50% describe these reforms as generally appropriate. As for specific positive effects, many say, "Research and development, and business investment has been promoted."
More than 50% of companies see positive effects of the institutional reforms and nearly 70% view these reforms as generally appropriate. But more than 20% see negative effects of these reforms. As for positive effects, companies say these reforms have made it easier for companies to make business decisions and have worked to increase investors' ratings of companies. Negative effects include large temporary losses and administrative costs.
E) Corporate pension
Some 40% see the institutional reforms as having positive effects and more than 50% view these reforms as generally appropriate. But about 10% see these reforms having negative effects. As a positive effect, many companies cited a decline in companies' future contributions. A large temporary increase in companies' contributions is cited by many as a negative effect.
F) Employment and wages
Some 30% of companies see positive effects of the institutional reforms and more than 50% view these reforms as generally appropriate. Of companies seeing positive effects, 40% say, "These reforms have allowed companies to flexibly develop businesses." Another 40% say, "These reforms have contributed to securing human resources." But 20% say, "These reforms have contributed to curbing personnel costs." More 30% described these reforms as going in a favorable direction while being insufficient.
Overall, the questionnaire survey findings say that more than 50% of the respondent companies view institutional reforms in all the six areas as "generally appropriate." This apparently indicates companies have given high ratings to these reforms.
(Attributes of companies supporting structural reforms)
Companies' ratings of structural reforms in the survey have been counted as scores. These scores have been used as explained variables along with explaining variables including the ROA and other financial indicators and other responses in the survey to analyze the attributes of companies giving high ratings to structural reforms (Table 2-3-5).
Table 2-3-5 Companies' Ratings of Structural Reforms and Their Attributes
There are some remarkable correlations between companies' ratings of structural reforms and their attributes. First, reforms have been given high ratings by companies that have met these reforms' objectives. Specifically, holding companies have given high ratings to reorganization-related reforms. Companies that have conducted M&A operations under their business strategies have provided high ratings to relevant corporate tax reforms. These correlations indicate that companies that have promoted integrations have rated relevant institutional and tax reforms high. Companies planning to expand R&D expenditures give high ratings to corporate tax reforms, indicating their appreciation of R&D investment credits. Second, Tobin's q includes some items that have positive correlations with ratings of structural reforms while ROA figures have little correlation with structural reform ratings. This apparently indicates that growing companies have given high ratings to reforms.
(Companies' requests regarding future institutional reforms)
As for companies' requests for future institutional reforms, around 50% of the respondent companies hope to see improvements in convenience and transparency of administrative procedures, corporate tax reforms, and deregulation and opening of public sector services to the private sector. Voluntarily given requests have centered on the following three areas: Coming first are improvements in administrative services. Specific requests call for simplification and increased efficiency of administrative procedures, the consistency between the commercial code, tax laws and accounting systems, and further improvements in bidding systems. The second is related to social security and tax systems. Companies are concerned that the falling birthrate and aging population could force them to increase their contributions. They call for improving the convenience of corporate pension schemes and simplifying the tax system. Third, companies request the government to promote deregulation and open more public sector services to the private sector. In various industries, companies request further deregulation.
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