Greater transparency vital for raising capital

Kazuhiko Toyama, The Asahi Shimbun, Tokyo

There are still people in Japan who argue that stricter audits and financial inspections would hurt the corporate bottom line.

As the Industrial Revitalization Corp. of Japan tries to help troubled companies turn around, one tough challenge it faces constantly is how to raise money needed to reverse their fortunes.

Companies struggling to return to profitability must continue developing new technology despite their financial straits if they are to hold their own with rivals in the global market.

That often requires new investment in plants and facilities. If they shy away from these costly efforts, they will eventually find themselves beaten by rivals who keep churning out new products through continued spending on research and development.

Money is also needed for human resources management. If design becomes very important for the competitiveness of products, for instance, manufacturers need to hire more talented designers. If, on the other hand, a company decides to withdraw from a certain business and shed the related positions, offering good retirement deals is usually the best way for smooth job cuts. Attractive early retirement packages can reduce the anguish caused by streamlining.

Banks used to be the main supplier of capital for corporate rehabilitation. Are they still fit for the role?

What depositors demand more than anything else is the guarantee that they will not lose their savings no matter what happens. They expect banks to place top priority on safe fund management. While the scope of the limitation in deposit protection is scheduled to be expanded to cover most types of bank deposits in April next year, depositors still expect banks to protect their money.

Corporate turnaround ventures inevitably entail the risk of failure. There is no sure-fire recipe for success.

When banks supply funds for corporate rehabilitation, they put the money of depositors-who assume their savings are invested safely-into risky projects, turning the money into risk capital. Banks used to be able to make such bets because they could secure them with real estate put up as collateral.

Rising real estate prices had a close correlation with growth of gross domestic product. Steady increases in land values easily absorbed investment risks. This allowed banks to provide funds to these kinds of risky projects while maintaining their responsibility to guarantee the safety of deposits. Now that land prices have stopped rising steadily, banks can no longer make such investments without exposing depositors' money to unacceptable risks.

In the Japanese financial markets, supplies of capital come overwhelmingly from deposits, including those in government- managed accounts. This results in an extreme scarcity of risk capital. There is considerable room for improvements in the systems for reducing risks for capital suppliers, as well as the risk-management capability of banks. With risk management technology insufficiently developed in Japan, however, it is enormously difficult to raise capital for corporate turnaround ventures.

From a macroeconomic point of view, the ultimate supplier of capital is the household. If households are to be encouraged to provide more risk capital, by investing in stocks and bonds, fuller financial disclosure by companies is absolutely vital.

Clean and reliable corporate financial figures, underpinned by the sanctity of audit reports, are essential for increasing supplies of risk capital.

But in Japan, the true financial picture of a company is often not very visible to outsiders. Individuals will feel more reassured about investing in a business when they can count on accurate and rigorous disclosure of its assets and financial conditions. A business cannot attract money from any investor, individuals or institutions, when its financial figures seem to be unreliable or somehow manipulated.

There are still people in Japan who argue that stricter audits and financial inspections would hurt the corporate bottom line, thereby putting a drag on the emerging economic recovery. This is absolutely wrong.

Corporate earnings performances cannot be improved through cosmetic bookkeeping. Investors and markets want to see the financial results-without window dressing. Both money and information flow into the countries and markets that guarantee transparency of information, not into those that don't.

Securing honest and sincere disclosure of vital information boosts the competitiveness of the financial markets and capitalist systems of a country. That's why China is making serious efforts to inject greater transparency into its financial markets and corporate accounting.

The U.S. made a remarkably quick and determined response to the accounting scandal involving Enron Corp., which erupted in the autumn of 2001, because it cast serious doubt on the credibility of corporate financial reports. The U.S. financial regulators, Congress and the business community all took the scandal very seriously as a potentially fatal threat to the foundation of America's competitiveness.

It is important to have very clear ideas about what capitalism and corporations are all about. There seems to be a serious gap in the depth of understanding about the essence of capitalism between Japan, where there are many wrong-headed arguments concerning accounting and disclosure, and the U.S., which responded quickly to the accounting scandal.

Why has capitalism won over socialism? Because the capitalist system, which allows free and open markets to control flows of money, is more efficient in moving savings to the most productive ideas than the socialist system, which leaves the task to a small number of bureaucrats who believe they are smart.

The beauty of a joint-stock company is that with its limited liability owners can lose only what they invest. This makes it a much less risky investment than plans such as proprietorships where the owner has unlimited liability. The essence of joint- stock companies is limited liability. This is a universal feature of this system.

The basic tenets of capitalism are the same anywhere in the world, and there is no such thing as an "Anglo-Saxon" model of capitalism. Adopting a free-market economy means embracing these tenets.

The success of the government-led effort for industrial revitalization depends greatly on whether Japan can make full and effective use of two marvelous systems that mankind has created: capitalism and the corporation. Embracing the soul of capitalist philosophy is crucial for Japan's economic rejuvenation in the 21st century.

The writer worked for a consulting firm before joining the Industrial Revitalization Corp. as a director.