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.