I came across these articles and they may be relevant for some readers. Both are highly readable.
Japanese Corporate Governance and Macroeconomic Problems
By: Randall Morch and Masao Nakamura
Outlines structural problems that keep the Japanese economy in recession.
post.economics.harvard.edu
economics.harvard.edu
Abstract
Japan's prolonged economic problems are due to more than faulty macro-economic
policies. We do not deny the importance of bungled macro-economic policy, but argue
that deeper maladies in Japanese corporate governance made that country increasingly
vulnerable to such problems. We argue that Japan's main bank and financial keiretsu
systems left corporate governance largely in the hands of creditors rather than
shareholders. Thus, Japanese governance practices did not assign effective control
rights to residual claimants. This, we argue, led to a widespread misallocation of capital
that mired Japan in excess capacity and liquidity problems.
........
How creditors’ and shareholders’ interests diverge
The essential difference between creditors’ interests and shareholders’ interests in
corporate governance can best be illustrated with a simple example. Let V= D + E be the
value of the firm, with E the value of its equity, and D the value of its debt. Shareholders
want to maximize E[V – D], whereas creditors want to minimize Prob[V < D]. Suppose
the firm has an investment opportunity that costs C and returns P with probability p and
zero with probability 1- p, and let pP > C. Clearly, risk-neutral shareholders want the
project to go ahead. In contrast, the creditors are indifferent about the project if C < V – D, and are opposed to it if C > V – D. Myers (1977) argues that shareholders, given sole control rights, can exploit creditors by launching projects for which C > V – D, and that this raises the cost of debt financing.
If creditors have control rights and shareholders are merely along for the ride, such a project would clearly not be approved if C > V – D. The problem with giving creditors control is that it might not be approved if C < V – D either. Indeed, new constellation of criteria might come into play. Creditors might exploit shareholders by
charging the firm artificially high interest rates. They might distort the firm’s investment decisions towards projects with low risk, especially if this keeps cash flows stable and thereby lets the firm use more debt financing. They might also skew the firm’s investment decisions towards projects that provide lots of collateral. These possibilities
should increase the cost of equity finance and depress share prices in proportion to their
probabilities of occurring.
These predictions are consistent with the observed behavior of Japanese banks and their client firms in which they exercise corporate control. Hoshi et al. (1993) show that firms in bank-centered keiretsu pay higher interest costs than other similar firms.
They also use more bank debt, and show worse financial performance. There is also some empirical evidence that Japanese firms affiliated with keiretsu groups and/or main banks pay higher interest rates on their loans from their main banks than unaffiliatesd firms (Nakatani (1984), Weinstein and Yafeh (1998)).
5. Conclusions
Japan's prolonged economic problems are due to more than faulty macro-economic
policies. We do not deny the importance of bungled macro-economic policy,
but argue that deeper maladies in Japanese corporate governance made that country
increasingly vulnerable to such problems. We argue that Japan's main bank and
financial keiretsu systems left corporate governance largely in the hands of creditors
rather than shareholders. Thus, Japanese governance practices did not assign effective
control rights to residual claimants. This, we argue, led to a widespread misallocation of
capital that mired Japan in excess capacity and liquidity problems.
There is a significant amount of interest in Japan in identifying the aspects of the
Anglo-American corporate governance system that can be implemented within the
Japanese system. Some measures have been either taken or proposed for serious
consideration. Holding companies are now legal for large industrial firms. Toshiba, for
example, has already announced its intention to become a holding company with all
present production divisions to be reorganized into separate companies. Hitachi and
Toyota will follow suit. It is now legal for firms to purchase their own shares to prop up
their stock prices. Tax and other legal conditions are being revised for firms to be able to
offer certain types of stock options to their executives. These measures have been taken
to a large extent to tighten the connection between firms' performance and their stock
prices. These measures were also taken because of the policy maker's belief that
implementing these measures might improve firm performance and bring Japan out of its
recession.
'It' Happened, but Not Again: A Minskian Analysis of Japan's Lost Decade.
By Marc-Andre Pigeoon Jerome Levey Economics Institute
Pigeoon reveiws the recession in Japan concentrating on debt and its excesses.
levy.org
CONCLUSION AND REFLECTIONS
We have suggested that Japan's crisis followed what might be best labeled a "Minskian" pattern, which can be found in Minsky's discussions of financial deregulation (see, for example, the chapter on banking in his 1986 tome) as well as the important and stabilizing role of government deficits and central bank lender-of-last resort policy. We can group the causal factors into two broadly defined groups. First, we have the contextual facts. They are as follows:
The real estate sector was highly leveraged relative to other sectors. Even though DE ratios moved lower in the period leading up to the crash, the subsequent worsening of DE ratios--especially in light of the continued improvement in other sectors--suggests these improvements were insufficient or illusory. When the speculation ended, so did the improvements. The importance of the real estate sector cannot be underestimated because of its impact on the banking sector, which we revisit next. In other words, the real estate sector constituted a "critical mass" of firms needed to trigger a crisis.
The banking sector grew ever more exposed to the real estate sector and stock market because of a broad
decline in demand for financing from its traditional clients, the large Japanese corporations. The collapse of stock and then real estate prices, interacting with Basle accord provisions and other institutional changes, induced a "liquidity preference" on the part of banks.
The U.S., seeking to redress trade imbalances, put pressure on Japan to stimulate domestic and deregulate its financial markets.
The catalysts to the crisis were:
A sharp spike in interest rates by the BoJ, which abandoned its earlier commitment to high growth. The increase collapsed first the stock market and then the real estate sector by reducing the demand price and increasing the supply price. The collapse of the former and its impact on the banking industry and overall
sentiment contributed to the collapse of the latter.
A government budget surplus, which impinged on corporate profits and a consumption tax that slowed
consumption, thereby further eroding corporate profits.
The broad over-riding theme in Minsky's work and in most non-mainstream work for that matter is that of a capitalist economy that naturally moves in and out of crises. The only constant is constant change. There certainly is no staticequilibrium, as the most simple textbook presentations (and even many of the more sophisticated mathematical models) seem to suggest. If anything, the absence of large scale non-market institutions (big governments, central banks) make crises worse, not better. The best institutions adapt quickly to these constant changes. And still the transition from one set of institutions to another imparts inherent fragility precisely because the adjustment process ventures into the unknown. The pallet of "uncertain" events grows with the adjustment process. And yet that does not imply hopelessness and defeatism, as many latter day laissez-faire preachers seem to suggest. Rather, it demands a more vigorous and creative attempt to design better economic institutions. This is where economists should direct the
brunt of their intellectual energy, as Paul Davidson and a whole tradition of American and Canadian Institutionalists and Keynesians have repeatedly suggested.
This paper has kept Japan's institutional and economic history front and center. Minsky thought this was essential for a clear understanding of financial processes. Our brief analysis of the parallels between Japan, the U.S. and Canada explicitly abstracts from this kind of analysis. To the extent that there is a growing "homogenization" of institutional practices and customs in the developed countries, this may be justified. In any case, a vulgarized version of our Japan story would say that institutional and historical realities meant the country could not easily escape its relatively rigid past. This was a great weakness in a fast-changing world. This was Minsky's main message and it is one of the few things we can say with certainty about economies and, for that matter, people.
Internet-Based Reading and References:
Bank of Japan : boj.or.jp
Ministry of Finance : mof.go.jp
Other government departments : epa.go.jp
Tokyo Stock Exchange : tse.or.jp
Japanese Macro-Economic Data : econom10.cc.sophia.ac.jp
Penn-World data on Japan : arcadia.chass.utoronto.ca
Other Japanese Internet Sites: darkwing.uoregon.edu
Asian Crisis Homepage : stern.nyu.edu
Rowley, Anthony, Whither Japan? US is (partly) to blame. Available at the following Internet address:
http:///www.gwjapan.org/ftp/pub/nrca/ctv3n08e.html
Central Intelligence Agency : odci.gov
The New York Times, Internet edition : nytimes.com
Bloomberg L.P. : bloomberg.com |
