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TakashiNARUSAWA,MasafumiEMORIandSatoshiOHMORIApril1,2001RebirthofJapaneseCompaniesThroughGovernanceReforms1NRIPapersNo.25April1,2001Copyright2001byNomuraResearchInstitute,Ltd.RebirthofJapaneseCompaniesThroughGovernanceReformsTakashiNARUSAWA,MasafumiEMORIandSatoshiOHMORIIUrgentNeedforStructuralReformsinJapaneseFirms1CorporateEarningsBegantoRecover2InadequateRecoveryinEarnings3DelayedStructuralReformsinJapan4SignsofProgressinStructuralReformsinJapanIIBusinessEnvironmentsRequiringAdaptabilitytoChanges1Far-ReachingChangesinBusinessEnvironments2NeedtoQuicklyRespondtoChangesIIIMajorTraditionalFirmsRequireRevolutionaryReforms1USFirmsSufferSetbackAftertheBoomsofthe1960s2SuccessfulExamplesofManagementReformsintheUnitedStates3IncreasingInfluenceofInstitutionalInvestorsIVGovernancePromotesResponsestoChanges1ChangingGovernanceStructureinJapaneseCompanies2ReinforcedSupervisionOverCompanies3BoardroomReformsontheStartingLine4TowardstheCreationofaNewAdministrativeSystemSincethecollapseoftheso-calledbubbleeconomy,Japanesecompanieshavebeenworkingtoovercometheirsluggishperformancebymeansofreformsinbusinessmanagementstrate-gies.Whilecorporateearningshavebeguntorecovertosomeextent,returnsonassetsandotherindicatorsofprofitabilityarestillhoveringatverylowlevels,suggestingthatstructuralreformsinbusinessmanagementarefarfromsatisfactory.Recentslumpsinthestockmarketsalsosuggestthatinvestorsarestilldisappointedoverthedelaysincorporatestructuralreforms.Thediscus-sionsontheneedforsuchreformshavebeenfullyexhausted,andthetimehascometoactuallystartcarryingthemout.Itisdifficultforcompaniestoputreformsintopracticebythemselves,however,astheyinvari-ablyinvolveinternalpain.InmanycasesinEuropeandtheUnitedStates,forexample,suchreformswereachievedunderoutsidepressure,especiallyshareholdergovernance.InJapanaswell,recenttrendstowardssellingoffcross-heldsharesbybanksandaffiliates,theincreaseinoverseasshareholders,andtheintroductionofthecurrentvalueaccountingsystemareexpectedtoreinforcethepowerofshareholdergovernance.Andasshareholdersdemandimprovedinvestmentreturns,directorsarebeingforcedtoconcentrateontheirfundamentalfunctionssuchasstrategicplanningandoperationalsupervisionastherepresentativesoftheshareholders,acceleratingthemomentumforstructuralreform.Inshort,therebirthoftheJapaneseeconomyisconditionedontherecoveryofJapanesecompanies,whichinturnfullydependsonthefirmestablishmentofcorporategovernance.RebirthofJapaneseCompaniesThroughGovernanceReformsNRIPapersNo.25Copyright2001byNomuraResearchInstitute,Ltd.April1,20012IUrgentNeedforStructuralReformsinJapaneseFirms1CorporateEarningsBegantoRecoverItiscommonlyheldthateffectivebusinessmanagementrequiresaquickresponsetochanges.Duringthehighgrowthperiodfromthe1960sthroughthe1980s,Japa-nesefirmswereabletoenjoyprosperitythankstotheclearobjectivesofachievingstableandcontinuingeco-nomicgrowthandcatchingupwithandsurpassingtheircounterpartsinotheradvancednations—withoutworry-ingtoomuchabouthowtorespondtochanges.Withtheburstingoftheeconomicbubbleinthe1990sandthestartofaperiodofsustainedsluggishness,how-ever,companiessuddenlyfoundthemselvesfacingtheneedtoquicklyandproperlyrespondtoenvironmentalchanges.Duringthelast10years,Japanesefirmshavebeenworkingdesperatelytoimprovecorporateearnings.Inthefirsthalfofthe1990s,themajortargetwastoim-proveoperatingefficiency,includingreformsinsalesactivitiesandslimmingdowntheadministrativefunctionsofheadquartersdepartments.Followingsomesuccessesintheseareas,thesecondhalfofthe1990ssawfirmsconcentratingtheireffortsonreviewingandreformingcompanysystemsandorganizationsbyintroducingaperformance-basedpersonnelevaluationpolicy,reduc-ingthenumberofdirectorsandintroducingacorporateofficersystem,andreviewingstrategiesforindustrialgroupsasawhole.Afterachievingpartialsuccessintheseeffortsandsomeimprovementinearnings,manyfirmshavefinallystartedareexaminationoftheirfundamentalstrategies.Forex-ample,theyhavebeguntowithdrawfromunprofitablelines,toimplementrevolutionarymeasuresaimedatre-organizationandtocreatenewbusinesses.Asaresultoftheseresponses,companiesingeneralappeartohavemadeastarttowardsgettingoutoftheearningsdoldrums.Anumberofsecuritiesfirmsexpectthatthelevelofcur-rentprofitsforfiscal2000mayreturnclosetothepeakrecordedbeforethecollapseofthebubbleeconomy.2InadequateRecoveryinEarningsIncontrasttoasuperficialrecoveryinearnings,how-ever,webelievethatthestructuralreformsneededtosetanewstagefordevelopmentinJapaneseindustriesarestillinsufficient.Thisinadequacyseemsclearlyevidencedbythefactthatnorealturnaroundshaveyetemergedintheprolongeddeclineinthereturnonassets(ROA),amajorindicatorthatmonitorsbusinessprofitability.Ac-cordingtotheNRI400averagescompiledbyNomuraResearchInstitute,theROAforJapanesecompanies(ex-cludingfinancial,utility,transportationandtradesectors)standsat5percent,orroughlyone-thirdofthe15per-centreportedbytheS&P500averagesforUScompa-nies(excludingfinancial,utility,andtransportationsec-tors).(SeeFigure1.)Evenmeasuredonatime-seriesbasis,therehavebeennosignsofachangingdirectioninthesel