Howard D. Lowe Shortcomings of Japanese Consolidated Financial Statements

1
Howard D. Lowe Shortcomings of Japanese
Consolidated Financial Statements
2
Consolidated Statements in Japan

• In Japan, consolidated statements did not appear
  until 1976.
• It is traceable to the entry of Japanese
  corporations into foreign capital markets, which
  began in the 1960s, to the bankruptcy of Sanyo
  Special Steel Company in 1965, and to the entry
  of foreign corporations into Japanese capital
  markets.

3
Sony, Ltd.

• The pioneer corporation into foreign capital
  markets was Sony Ltd., which issued American
  Depository Receipts on the NYSE in 1961.
• Raising funds on an international market was an
  abrupt departure from the traditional custom of
  depending only on Japanese banks for financing.
• Following Sony's success many other large
  corporations (Mitsubishi, Honda, Matsushita)
  began to offer securities in foreign markets.

4
Consolidated Statements in Japan

• As bonds of Japanese companies began to appear on
  international capital markets it became clear
  that Japanese accounting practices were not
  acceptable oversees.
• By 1973, more than 60 Japanese corporation were
  voluntarily producing consolidated financial
  statements to meet the requirements for offering
  their securities abroad.

5
Sanyo Special Steel Company

• The other major stimuli for consolidated
  reporting was the publicity surrounding the
  fraudulent bankruptcy of Sanyo Special Steel
  Company in 1965.
• The company had created fictitious earnings over
  the previous 6 years of about 7 billion yen and
  paid dividends of 12 percent to 20 percent
  annually out of the overstated profits.
• The inflated earnings had been achieved largely
  through fabricated inter-company sales to
  subsidiaries and related companies not subject to
  the Securities Exchange Law these fictitious
  sales generally were undetected.

6
Ordinance Number 30

• In October, 1976, Ordinance No. 30 issued by the
  Ministry of Finance provided that all
  corporations subject to the Securities Law
  prepare consolidated financial statements for
  accounting periods beginning on or after 4-1-77.
• The method for consolidations was almost
  identical to that required in the US.

7
Consolidated Statements in Japan

• 13 years later, these consolidated statements
  still have not been fully accepted by the
  Ministry of Finance, the Japanese business
  community, and the Japanese accounting
  profession.
• Parent company only statements with the
  investment in affiliated companies carried at
  cost are always considered the primary
  statements consolidated statements serve as
  supplementary schedules only.
• Japanese believe that consolidation procedures
  often require them to prepare financial reports
  or unnatural corporate groups.
• Further, their commercial code is biased toward
  the protection of creditors in contrast to
  providing information for investors.

8
Consolidated Statements in Japan

• Entrenched ties of family and tradition
  influenced the transition to the corporate form
  when it was introduced to Japan in 1899.
• Ten large groups of companies (zaibatsu) were
  formed which dominated economic activity in Japan
  until the end of WWII.

9
Zaibatsu

• By the end of 1945, 15 zaibatsu existed and were
  ordered by directive of the military occupation
  to stop the sale, trade, transfer, or adjustment
  of their corporate shares, bonds, debentures,
  voting trusts, or other forms of securities.
• The ownership of the firms was distributed to a
  Holding Company Liquidation Commission for public
  distribution.
• Securities were issued to employees, then sold to
  local inhabitants, and finally to the public at
  large.
• An Antimonopoly Law prohibiting holding companies
  was enacted in 1947 to prevent the reappearance
  of these monopolies.

10

• Many small companies emerge immediately after the
  economic restructuring but the vast amounts of
  capital required for reconstruction put the banks
  in the center of the arena.
• Further, most Japanese citizens put their savings
  in bank deposits, and firms looked to banks for
  capital creation.
• With several large banks, each one serving as a
  focal point, postwar concentration of large
  corporate groupings emerged.
• These were not legal or institutional groupings
  but groupings based on dependence on a bank.
• This economic phenomenon is somewhat different
  from the pre-war zaibatsu but has the same
  characteristics in that it involves basically the
  same groups and a heavy concentration of power.

11
Keiretsu Groupings - Characteristics

• 1. Members are all independent major firms in
  their own oligopolistic industries.
• 2. The group is a confederation of firms
  excluding competition but aiming at representing
  all lines within the confederation
• 3. Service firms such as banking, trading,
  insurance, and shipping companies from within the
  group perform special functions for industrial
  member firms to the complete exclusion of
  outsiders.
• 4. Between the firms there are many cross ties.
  Examples are borrowing from the same bank, mutual
  shareholdings, interlocking directors, using the
  same trademark, or selling their products through
  the same trading company.

12
Keiretsu Groupings - Characteristics

• 5. The presidents of each member firm meet
  together once a month and discuss matters of
  mutual interest to the member corporations.
• 6. Inter-firm business within the group has a
  high priority.
• 7. Holding companies at the top are prohibited
  so the relationship between the firms is based on
  cooperation not control.

13
Six Major Groups

• 1. Mitsui
• 2. Mitsubishi
• 3. Sumitomo
• 4. Fuyo
• 5. Daiichi-Kangyo
• 6. Sanwa
• The first 3 are the Big 3

14
Keiretsu Groupings - Characteristics

• Each group is centered around a bank and includes
  a trading company, a real estate company, an
  insurance company, and numerous other companies
  each performing a special function useful to the
  group.
• Each of these major companies has from a few to
  hundreds of affiliated firms, many with small,
  and others with large, inter-company
  stockholdings.
• Each also holds a small fraction of the
  outstanding voting shares of the other major
  firms in the group.
• This is not done for control but to create good
  relationships and to stimulate the feeling of
  interdependence.

15

• It is difficult to determine the size of these
  corporate groups.
• They exist as a matter of fact by not as a matter
  of record.
• Sales, net income, or asset information is not
  published on a group basis.
• It appears as if each of these six is as large as
  a hypothetical group composed of one of the 10
  largest banks in the US and from 5 to 15 of the
  thirty largest manufacturing, construction,
  retail, insurance, transportation, or public
  utility companies in America.

16

• There are many groupings of firms other than the
  6 giant groups with members often as large as US
  Fortune 500 firms
• --Nissan, Sony Honda, Toyota, Hitachi

17
Keiretsu Groupings - Characteristics

• The success of these groupings seems to flow from
  cultural differences related to
  individualism/collectivism.
• Among corporations codes of conduct and standards
  of behavior associated with interdependent group
  relationships are based on mutual trust and
  loyalty.
• Internal settlement of disputes and the mutual
  help and protection of each other's interests is
  the norm.
• The corporation is perceived as emphasizing the
  people which it represents not as a legal
  organization.
• Rather, mutual shareholdings, loans, business
  transactions, and human relationships are the
  binding forces which hold the keiretsu together.

18
Keiretsu Groupings - Characteristics

• Another feature binding corporate groups is the
  Japanese practice adopted for protecting
  corporations from foreign intrusion through
  stable shareholdings.
• To prevent outside interests from obtaining legal
  control by obtaining majority share influence,
  systematic swapping of shares within the group
  with the tacit understanding that the shares
  traded were not be resold became the norm.
• The objective was to develop a relatively
  permanent cross-holding pattern of share
  ownership which would exceed 50 percent of the
  total shares O/S for each participating
  corporation.