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Monday, Feb. 26, 2001


Japan in sore need of direct financing

The Tokyo stock market remains in a slump, with its key indicator threatening to fall below 13,000, as uncertainties linger over the future and selling pressures intensify with the unwinding of cross-shareholdings toward the end of the fiscal year.

There will be no quick fix to the situation, and all we can do is make full-scale efforts to structurally reform the economy. Of particular importance is a policy initiative to change the nation's financial system from one heavily dependent on indirect financing to one more focused on direct financing.

On Feb. 9, the ruling coalition compiled a set of draft measures to stimulate the stock market, featuring steps that can be immediately taken to prepare for the shift toward direct financing.

Above all, the proposed lifting of the ban on so-called treasury stocks should be implemented as quickly as possible. The Commercial Code basically bans companies from buying back and holding their own shares, on the grounds that the practice could damage their capital base and run counter to the principles of fairness in securities trading and equality among shareholders.

The firms are permitted buy back shares only when writing them off or using them as stock options for executives and employees. It has become increasingly necessary for Japanese firms to buy back and hold their own shares as a defensive measure at a time when the value of their stocks is being eroded. As more Japanese firms unwind cross-shareholdings and as their value continues to decline with the stock market, they will become increasingly vulnerable to hostile takeover attempts. Managers need some sort of defense against such risk.

In the United States, the state laws of New York and Delaware allow companies to buy back their own shares regardless of the purpose.

General Electric, for example, holds 11 percent of its outstanding shares as treasury stocks. These can be used not only as a tool to protect against hostile takeover bids, but also as stock options or for writing them off if necessary.

American firms own treasury stocks as "corporate currency" to be used for key management actions. Japan should follow suit in order to give companies better options for corporate management and to provide them with a means of self-defense after the unwinding of cross-shareholding relationships. Permitting treasury stocks would also stimulate the market.

One problem with the ruling coalition's proposal is that it lacks specifics about tax initiatives. In order to lure individual investors back to the stock market, Japan needs a taxation system that strikes a better balance between direct and indirect financing.

In light of the current situation, what is needed now are preferential tax measures on capital gains or losses.

For example, the state should consider allowing taxpayers to deduct losses on securities transactions from gains made in later years. They should also be allowed to deduct stock trading losses from salary or other income.

Shareholders should also be allowed the option of a 20 percent withholding tax on stock dividends, as is permitted for interest gains on deposits.

These steps should be taken quickly to demonstrate that the government will be promoting a shift toward direct financing. This is the key to increasing stock ownership among individual investors.

In addition to such efforts, the state needs to lay out a grand design for structural reforms that also covers social security programs, local government finances and tax measures so that it can regain confidence in the Japanese economy and its financial system. The private sector meanwhile must do its own part in this effort by pursuing greater management efficiency and accelerating the disposal of excessive debts and nonperforming loans.

Yoshio Nakamura is managing direc tor of the Japan Federation of Economic Organizations (Keidanren).

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