Systemic Hypocrisies in the Japanese and US Views of Corporate Stakeholders

Two fundamental hypocrisies in the Japanese and the US views of corporate stakeholders must be addressed for the world’s largest economies to continue to prosper and lead in the 21^st century. The US must dedicate itself to protecting and empowering its workers, and Japan must do the same for its shareholders.

Japanese workers have traditionally been expected to remain at the same company from the time they are hired out of college until retirement, working long days and taking little vacation. For their hard work and loyalty to the firm, they receive comprehensive benefits, a generous pension upon retirement, and most importantly, job security. The tradeoff is that they receive on average less compensation than they might receive at a similar position at a US firm.

Compensation in Japan has traditionally been seniority-based, with pay raises given in tandem with age-based promotion, again promoting loyalty and retention. The employees are seen as the company’s most important stakeholders, dedicating their labor and most of their life to the company. They are seen more as members of a corporate family than as individual assets. The Japanese model in this sense is extremely transparent: employees generally understand how their commitment to the company will be rewarded.

In Japan, investing in general and stock investing in particular are widely considered akin to gambling, this aversion probably best exemplified by the fact that Japanese investors account for less than half of the market capitalization of the Japanese equity market, with foreign investors making up around 60%.

Shareholders are seen as short-term speculators, placing bets on the growth of companies and their stock prices and moving their money out the moment they have made a profit. As a result of this perception, little emphasis is placed on paying dividends, with Japanese firms tending to hold on to extra cash instead of redistributing it to shareholders. The average dividend yield, a relative measure of dividend earnings, for all companies making up the Japanese TOPIX was 1.98% in September 2008, compared to 2.62% for companies forming the US S&P 500 during the same month. 0.64% is by no means a nominal difference – compounded annually over ten years on an initial investment of it $1,000 it translates into added dividends of $65.88, or more than 6% of principal.

In the US, employees are also viewed as important assets, but much more as tradable, commoditized assets similar to inventory, physical assets and capital and not in the intimate familial sense of Japanese firms. Employees are only as valuable as their contributions to the company, and while compensation is often linked to these contributions in the form of “meritocratic” compensation schemes, employees may also lose their jobs more easily if they fail to perform or if their services can simply be acquired more cheaply through outsourcing arrangements resulting in downsizing. US employees are also more apt to change companies for better pay if they feel their contributions are not being properly rewarded, making retention in the US model more challenging.

The US shareholder is seen as the company’s most important stakeholder, providing the necessary capital to fuel corporate expansion and directly helping the company to grow. There is a high level of transparency in the way shareholders are compensated for their investment, in the form of publicized dividends and extensive disclosure including quarterly and annual reports, letters to shareholders and a wealth of other publicly available information. Shareholders receive compensation in the form of dividends that is directly proportional to their contribution to the company, namely, a dividend for every share they have purchased.

The US espouses “shareholders rights,” in the common-sense form of return on investment directly proportional to investment, dividends. Shareholders also have the right to vote on a certain level of corporate policy at shareholders meetings and are encouraged to offer their suggestions concerning this policy, another important manifestation of these rights. This is pitched in the US as the translation of the democratic principle of equal rights into corporate governance standards. This is at best only part of the truth.

The reason that “shareholders rights” are championed in the US by corporate executives is simply because corporate executives and other higher-ups profit when shareholders profit. In many cases, a large part of executive compensation at publicly-listed US firms is in the form up stock options. When stock prices and dividends go up, executives profit together with other shareholders. Plus, in many cases, executive bonuses are directly tied to the very rise in share price – not only are executives profiting from increased equity in the shares they hold, they are receiving a bonus for boosting the company’s share price. For them to be “properly” compensated, transparent disclosure is essential: they must demonstrate clearly how their efforts have led to increased share prices to reap the rewards.

But what is the problem with executives and shareholders, who have both made clear contributions to corporate profits and growth, being proportionally rewarded for their efforts? The first is that it is usually only a small percentage of employees aside from executives who are given stock options. While some companies do make SOPs, or “stock ownership programs,” available to employees, these require employees to use their own wages to purchase a stake in the value of the company that they themselves have created – a profoundly counterintuitive concept.

But the larger and more glaring hypocrisy is that the same logic is not applied to the compensation of employees of the company, and in fact often the very opposite logic applies.

While US firms pay lip-service to meritocratic compensation, pay scales are rarely if ever made known to employees, and instead of the comprehensive disclosure standards used in information regarding share prices, employee compensation is treated in most cases with ferocious secrecy. The very idea of making compensation standards public to employees would be considered laughable to most executives.

For a true meritocracy to exist, objectivity and transparency are essential, just as they are regarding the compensation of shareholders. In other words: If I make this level of contribution to the company, I can expect this level of compensation; I expect those making similar contributions to receive similar compensation, those contributing less to receive less, and those contributing more to receive more. This is the exact logic employed for shareholders, so why not for the company’s other equally important stakeholders, the employees? The answer is again the same, greed. While the rights of shareholders are aligned with the interests of the executives, they are at odds with the rights of the employees.

US executives rely on their ability to take advantage of employees’ ignorance of fellow employees’ compensation, and where present, the existence of systematized compensation standards, to ensure higher compensation for themselves. Reduced personnel costs translate into increased earnings, which translate into higher dividends and share prices, both of which the executives stand to profit from. But, as individual compensation, pay raise milestones, bonus potential and the like are often made clear to employees in their individual contract agreements, what is the problem?

The problem is that they are not made publicly available to all employees, as equity disclosures are made available to all shareholders. Executives take advantage of certain employees ignorance of their own value and lack of negotiating skills to tamp down costs. This culture of secrecy is exactly what fuels “personnel arbitrage” in the US job market – other companies may be prepared to pay a higher price, in some cases simply the fair market value, for the same commodity, the employee, resulting in higher levels of turnover in the US.

If employees were made aware of company-wide compensation structures and the individual compensation of fellow employees, those employees receiving unfairly low compensation would rightly seek redress. This would mean increased payroll costs, decreased earnings, and difficulty for executives to meet financial targets, leading to reduced compensation for themselves in the short-term. In the long-term, it would lead to increased retention and more motivated employees who took greater pride and passion in their work.

While global cost competition can not be denied as a large factor in the decline of certain US industries, particularly manufacturing, the systematic disenfranchisement of workers also plays a role. Were these same workers provided with equitable, truly meritocratic compensation, perhaps the US could again become a society that takes pride in its work and produces good things. One need look no further than the Japanese and American automobile industries as evidence of the validity of this argument.

There is also a stark double standard in the Japanese view of stakeholders that stands almost in diametric opposition to the US model. While the pay raises accompanying corresponding levels of seniority are often common knowledge among employees at many Japanese firms, disclosure standards and the protection of shareholders rights rank well behind other developed markets. In the World Economic Forum’s Global Competitiveness Report 2008-2009, out of 134 countries surveyed, Japan ranked 44^th in terms of “strength of auditing and reporting standards” and 45^th in terms of “protection of minority shareholders rights,” despite being the world’s second-largest economy with the world’s second-largest stock market.

Traditionally, Japanese firms have sought to marginalize instead of empowering shareholders, particularly so-called activist shareholders who seek to influence or dominate corporate policy by controlling majority blocks of shares and the proxy voting rights accompanying them. This tendency is best evidenced by the 2007 Bull Dog Sauce case, in which the Supreme Court of Japan blocked the attempted takeover of Bull-Dog Sauce Co. by the US hedge fund Steel Partners.

In 2007, Steel Partners tried to acquire a 100% stake in the sauce maker Bull-Dog Sauce. It should be stated here that Steel Partners’ intentions at the time were not considered to be benevolent: many thought it would threaten to sell off Bull-Dog’s individual assets upon acquisition, forcing Bull-Dog to buy back any shares Steel Partners might acquire at a premium to the bid price before the deal was completed, or wait for a “white knight,” a bidder friendly to Bull-Dog who would do the same. Neither of these outcomes would result in any added value for Bull-Dog, while only resulting in profits for Steel Partners.

When Steel Partners initiated its tender offer on May 18, 2007 for all of Bull-Dog’s shares, Bull-Dog responded with a “poison-pill” defense, the legality of which in terms of shareholders rights would form the basis of the Supreme Court case. In a poison-pill defense, the takeover target, in this case Bull-Dog, issues rights to a large number of shares to shareholders other than the bidder, which may be converted into shares should any one bidder, i.e. the initiator of the takeover (Steel Partners), acquire a given percentage of outstanding shares, typically slightly less than a majority. The result is that it becomes more difficult for the initiator of the takeover bid to acquire enough shares to control a majority stake in the target company and in doing so influence or control its corporate policy. The term poison pill, a reference the suicide pills taken by spies at the time of enemy capture to prevent interrogation, refers to the point at which the bidder has acquired enough shares to force the issuance of share rights to other shareholders to block the takeover, in effect “killing” the deal and the bidder.

The issue that would be decided by the Supreme Court was whether the poison-pill defense constituted shareholder discrimination by offering rights to certain shareholders and not others, specifically Steel Partners. Following is an excerpt from the ruling (translated from the Japanese by the author):

Despite having no true intentions of participating in the management of the target company, as so-called abusive acquirers (emphasis added) seek only to inflate share prices of the target company and force members of the target company to then reacquire them at the inflated price etc., in the interest of abusive corporate management or control and without sound management motives, causing a loss in corporate value and negatively affecting the interests of the shareholders of the target company, these abusive acquirers may face shareholder discrimination.

What is most important here is not the specific motives of Steel Partners in its acquisition, be they abusive or otherwise. Rather, it is the fact that, in its definition of “abusive acquirers,” the Supreme Court of Japan has created a subjective standard for the legal institutionalization of shareholder discrimination.

The fact that Steel Partners was also a foreign firm caused the foreign media to view the Bull-Dog case as one of the largest set-backs for foreign investment in Japan’s history and as having the potential to scare off more well-intentioned foreign investors. The Financial Times offered the following on this perceived set-back in a October 2007 article entitled, Poison pills cause upset among foreign investors:

The million-dollar question everyone is asking is whether Japan will ever change.

Many foreign investors, who cannot afford to wait for an answer, have reduced their presence in Japan, if they have not abandoned the Japanese market altogether.

But if shareholders are nothing but fly-by-night vultures seeking quick profits by destroying otherwise good companies, why should they be given an equal voice?

The inherent hypocrisy in this point of view is that, if you have no interest in paying fair dividends, are unconcerned about your share price and take no issue with discriminating against your shareholders, than you have no business being a public company. As a private company you would be free to reinvest earnings instead of disbursing them as dividends, make decisions irrelevant of their effect on your share price, and be much more insulated against takeovers. So why do firms such as these list? The answer is again greed. While not interested in their shareholders interests or opinions, many Japanese firms are still more than happy to take their money.

Japan, together with other highly developed countries such as Italy and South Korea, is facing an unprecedented natural population decline – the secular challenge for both its society and economy. For Japan to have any chance of future economic growth, even more foreign investment is essential. Japan has paid lip-service to enforcing shareholders rights, but we have seen that this is far from the reality.

While foreign investors indeed account for the majority of investment in the Japanese equity market, according to benchmark data from the United Nations Conference on Trade and Development, foreign direct investment into Japan still stands at an amazingly low 3% of GDP. This compares to an average of 27.9% for the world, 27.2% for all developed countries, 15.1% for the US, and is higher than only Iraq, Iran, Nepal, Kuwait and Cuba.

The reality is that personnel and capital are the two most important assets of any company, and an equitable approach to the two most important stakeholders, employees and investors, is key to the success of any company.

The United State’s false homage to shareholders rights in the true interest of boosting executive profits and to the detriment of sound financial decisions and the fair treatment of employees has contributed to producing disastrous consequences for the US market and the entire world economy. Firms that bet big chunks of their balance sheets on non-transparent and at times deceptive loans re-packaged ad infinitum in the form of securitized debt instruments to unsuspecting investors the world over are now at best bankrupt, and at worst under criminal investigation by the FBI. The US investment-banking industry, once the global pinnacle of high finance, no longer exists. 401Ks and retirement funds of hard-working people are being depleted by the second, and entire countries are now facing insolvency. The lessons couldn’t be more clear.

US companies can continue to respect the rights of their shareholders, but when profits become the only factor in decision making, employees and companies as a whole will suffer. The US must make sure that the factory and office workers, those who add true value to companies and form the foundation of the US’s ability to compete globally, are rewarded and venerated together with investors.

By 2050 Japan’s population is expected to decrease from the current 127 million to around 90 million, and a full one third of its population will be made up of people 65 years or older. With only an expected 50 million workers in 2050 and the world’s third highest average life expectancy, its social security system will not be able to care for the countries retirees. While Japan has succeeded so far in talking about history’s largest demographic time bomb, no real action has been taken.

The solution will be multi-faceted: it must include a fundamental change in the way Japan views immigrants; it must provide a legal structure that allows workers, most importantly women, to balance work with the ability to raise a family; and it must facilitate a faster shift from a manufacturing-driven economy to one fueled by true innovation.

It must also encourage investment, both by Japanese individuals who can no longer rely solely on the government and corporate pensions to fund their retirement, and by foreign countries and companies seeking the opportunity to invest in Japan. To do so, it must race to catch up with other developed markets in terms of disclosure and shareholder protection and quickly level the playing field for foreign investors. If it fails to, help will more likely come in the form of ODA than FDI.

The United States and Japan have perhaps more differences than similarities, and here I have addressed some very large differences. But what is encouraging to me as someone who was born in the United States and has lived, been educated and worked in Japan is what I consider their singular similarity: resiliency.

Best exemplified by the Meiji Restoration and post-war reconstruction, Japan has time and again transcended the confines of a small island nation and established itself through determination and hard work. After overcoming an economic crisis dwarfing its current problems in the Great Depression, the US emerged as the world’s preeminent economy and innovator and to many a as global symbol of opportunity. I have no doubt that both countries will rise to meet their individual challenges, but to conquer them, they must both fundamentally rethink the way they do business, and they must do so now.

— James Gregory