Japan’s Hidden Corporate Debt Beginning to Surface
Foreign investors have spent years playing a fiscal version of “Where’s Waldo?” searching for bad real estate deals and other debt bombs buried deep inside Japanese companies.
Now they are finally getting help in their bid to expose this often dark, fetid area of Japan’s economy. And if the early disclosures are any indication, Japan’s day of corporate reckoning will be ugly.
This spring, Japan begins to overhaul its accounting system and is forcing companies to divulge many of their dirty little secrets. “It’s been like the shell game with three cups and a pea,” says Mark Grinis, accountant with the E&Y; Kenneth Leventhal Real Estate Group. “This change is extremely significant.”
The same companies and banks that a decade ago seemed destined to rule the world are being forced to reveal just how bad their business decisions were at the height of their power. Squandered pension money, festering stock market losses, near-worthless golf course projects and failed resort developments dating to Japan’s speculative bubble period are finally starting to get written off.
Already, Japanese companies have reported at least $19 billion in pension shortfalls--money never properly set aside for their workers. This amount, which includes a $7.6-billion write-off at NTT Corp. and $3.12 billion at Nissan Motor Co., is only a fraction of the pension problems brewing, accountants say.
Meanwhile, Mitsui Real Estate Co. expects to write down $866 million, and construction engineering firm Taisei Corp., $266 million on bad land deals. Kawasaki Heavy Industries Ltd. has owned up to a $38-million securities-related loss.
The changes probably will hit corporate earnings hard, just as many companies are starting to recover from Japan’s long economic downturn. That said, analysts believe firms strong enough to survive the blow to earnings should benefit relatively quickly as the books are cleared. Ailing companies, by contrast, could be left further behind.
The accounting reforms are driven in part by a growing recognition of just how many problems and abuses lay hidden under the old system.
After it took control of auto maker Mazda, Ford Motor Co. found more than 100 golf club memberships tucked away in various Mazda subsidiaries, some still valued on the books at up to $400,000. They’ve since been sold off at about one-fourth that price.
“Golf is a big part of Japan’s corporate culture,” says Gary Hexter, chief financial officer of Mazda. “But we thought that was a bit excessive.”
And last year department store owner Mitsukoshi Ltd. suddenly reported a huge loss on not just a golf membership but an entire golf course, a failed project no one knew existed.
“It was a real surprise,” says Toshiko Binder, analyst with HSBC Securities.
In a particularly egregious case, another department store operator, troubled Sogo Co.--which traditionally has reported on just one subsidiary--will have 127 under the new rules.
Late last month, a day after Sogo reported a $1.3-billion consolidated loss and $6.1 billion in bad debts, the company’s vice president of finance hanged himself in his living room, using 17 neckties to do so.
Finally, accounting experts cite All Nippon Airways, where the company’s own pilots started questioning how the airline could be profitable since they were flying so many empty planes. It turned out that the company has lost money almost every year since 1993.
Years of trying to find Waldo in the crowd have often required all the ingenuity, intelligence-gathering and guesswork that foreign investors could muster.
They hired corporate spies to track down obscure documents, befriend loose-lipped bankers and go drinking with company employees in a bid to ferret out problem subsidiaries and other corporate troubles. But more often than not, secrets remained hidden.
“Basically, it’s often been almost impossible to find out what’s really going on,” says Merrill Lynch analyst William Gallagher.
Japan’s decision to start counting the same way most other developed countries do promises several secondary benefits, analysts say. The country’s long-moribund market for mergers and acquisitions should be goosed as more companies shed their mangy affiliates, for example.
And traditionally lax Japanese business practices should continue to fade as executives are pressured to act on, not simply pay lip service to, principles such as efficiency, cash flow and shareholder returns.
The divestiture of weak subsidiaries could also accelerate labor reform, eventually putting more people into productive “new-economy” jobs, as companies come under more pressure to streamline.
Finally, the changes could help narrow Japan’s worldwide credibility gap. A survey last year by Davis Global Advisors ranked Japan’s accounting standards last among the world’s rich countries, with the U.S. on top and France in the middle.
“This will help foreign investors believe Japanese financial statements,” says Yoshio Tokizawa, managing director at Moody’s Investors Service Japan. “I don’t know how much they’ve been trusted.”
To be sure, few expect Japan to come clean overnight, or to abruptly change its insider business practices, many of which have evolved over centuries. Furthermore, auditors say, the new rules still leave enough wiggle room for companies to continue hiding big problems.
Still, most analysts say the reforms are welcome, meaningful and long overdue.
“What you see happening in Japan is a win-win for everybody--the companies, the financial institutions and investors,” Mazda’s Hexter says. “They’re all much better informed. It’s just very healthy.”
Japan headed down the wrong road in the wake of World War II. Ostensibly, Japan’s postwar system was based on U.S. rules. But Japan chipped away at the penalties, independent oversight bodies and internal discipline needed to ensure that people followed the rules.
“The rules were clear enough,” says Fujio Yamaguchi, accounting and management professor at Aoyama Gakuin University. “But they weren’t enforced.”
Japan’s rules also differed from Western ones in crucial ways. Companies didn’t have to disclose when pensions were underfunded. They weren’t required to disclose the market value of stocks or land they owned, but could instead use the price they paid--even if that was decades ago and they subsequently became worthless.
And because managers were required to disclose only details of the parent company, not most subsidiaries, they had a license to transfer bad land deals, inefficient workers, old equipment, unfavorable leases and other burdens to their ugly corporate stepchildren--out of sight and often out of mind.
The analogy for an individual might be of someone who applies for a mortgage and must disclose only his $40,000 salary, not the $70,000 in credit card debts or the $25,000 owed to loan sharks.
Behind the rules was a broader agenda, says Yasuhide Fujii, a partner with Asahi & Co. Arthur Andersen: To make sure Japanese companies had every possible advantage in their bid to conquer global export markets.
The result was an increasingly blurry line between the regulators and the regulated. Isao Tomita, founder of Deloitte Touche Tohmatsu, recalls issuing a qualified opinion on one of his clients and being told by the finance ministry to rewrite his report and omit the warning flags.
“Traditionally, CPAs in Japan are not independent,” he says. “They would rather [go down] with their clients.”
The system worked well enough during Japan’s high-growth period. As growth stalled in the 1990s, however, foreign investors stepped up pressure for more disclosure.
And several spectacular collapses at Long-Term Credit Bank of Japan Ltd., Nippon Credit Bank Ltd. and Yamaichi Securities--many of which had been issued clean bills of health by Japanese accountants--laid bare just how rotten the system had become.
Japan’s move to a consolidated reporting system takes place this year. Requirements that land and securities be valued at market rates will be phased in over the next two years; pension liability reporting will be transformed over 15 years.
