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Thursday, July 27, 2006
U.S. BUSINESS SCHOOL SYMPOSIUM
Is Japan about to ride an M&A wave, or flounder in just a ripple?
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Japan has witnessed an increasing number of corporate mergers and acquisitions in recent years, including some high-profile hostile takeover bids. But will they lead to the emergence of an active market for corporate control similar to those in the United States and Europe?
Professors from U.S. business schools who took part in the July 14 Keizai Koho Center symposium said M&A activities in Japan will certainly increase to a far greater extent than in the past -- though probably not to the same degree as in the U.S. -- given the change in business environment here since the 1990s.
Carl Kester, a professor of finance and deputy dean of academic affairs at the Harvard Business School, pointed to a worldwide M&A wave that has engulfed nearly every developed country, with the total value of the deals completed this year estimated to reach $3.5 trillion.
The recent pickup in M&A activity in Japan is noteworthy, given that the practice has historically been rather unpopular here, Kester said. Many of the past examples involved so-called forced marriages -- arranged by the former Ministry of International Trade and Industry, now the Ministry of Economy, Trade and Industry, for the purpose of rationalizing certain industries -- or the bailout of weaker companies by strong ones, he noted.
But even though the Japanese business community seems increasingly tolerant of M&As, Kester said there appears to be a deep-rooted skepticism in Japan whether the practice really does any good.
Even today, as Japan looks at thousands of deals completed in a year, the nation's market for corporate control is "pretty small" and except for a few major cases, most of the deals involve small private companies that are being sold either because they have run into financial difficulties or there's a succession problem in family management, he said.
The gap between the situations in Japan and the U.S., he said, raises the question whether M&As really do any good or who benefits from the deals. In fact, he added, even U.S. experts have a hard time agreeing on the matter.
"There are some who really think this activity is not all that productive. . . . Certainly there are examples of deals -- big and small -- that simply have not worked," Kester told the audience.
He cited the 2001 AOL Time Warner merger as a classic example of a deal that really has not yielded the kind of benefits that people had forecast. "Many people would say that as many as half -- or more than half -- of (corporate mergers) failed in the sense that they don't provide the benefits that were forecast," he said.
At the same time, there are lots of deals that resulted in improved performance, Kester noted. The Chevron-Texaco merger resulted in about $1.8 billion of expenses saved in the first year and another $400 million the next year while Hewlett Packard's acquisition of Compaq -- while it was controversial and in many respects fell short of expectations -- saved about $3 billion, he said.
Such anecdotal evidence gives a mixed picture, but empirical studies offer more unified -- although not entirely uniform -- results, Kester said.
He cited a Harvard Business School study of 50 large M&A deals, which showed that the return on investment for the combined firms improved by about 2.5 percent on average -- largely due to greater efficiency deriving from increased revenue on the same asset base or cost savings. Another study indicated that firms taken over in M&A deals, which earlier had lower productivity than competitors in their industries, closed the productivity gap by two-thirds within seven years after the marriage, he added.
While other research may dispute these findings, Kester said by and large studies are "consistent with the notion that there are indeed net positive gains in performance and value creation (from M&As)."
Opinions are more mixed about hostile takeovers, but they have indirect positive effects of imposing "discipline" on underperforming managers, Kester noted.
"Generally, the motive of a hostile deal is to take over a company that's underperforming in some significant respects, replace the board, change the top management and subsequently reform either operating practices or other kinds of financial policies such as cash distribution, debt policy and so forth
"The best defense against such a bid is to try to carry out these changes for yourself, and many companies in fact do just that," he said. "So whether or not hostile deals do indeed succeed and go through, an argument can be made that they in fact contribute to better performance overall" because they add pressures on corporate managers who feel that they may be the next target of a hostile bid, he added.
At the same time, hostile bids are indeed costly for both parties, he said. The targeted firms may get too preoccupied with their defense to pay sufficient attention to existing business opportunities while excessive defense against takeovers may put the companies in financial distress, he pointed out.
"Now does any of this matter to Japan, which has for so long had a quiescent market for corporate control that has been influenced by the former MITI or the Finance Ministry? I think it should," he said.
Kester said the past characteristics of Japanese deals were "partly due to business norms or cultural taboos against M&As" and to cross shareholding practices that made it difficult to execute a deal.
"Until roughly the (beginning of) the post-bubble period in the 1990s, Japan has not had an active market for corporate control -- in part because it did not need one," he said.
"The traditional system of ownership and control in Japan, combined with things like main bank monitoring and intervention when needed, and a generally high-growth environment, worked very well . . . and strategic aims could be achieved without necessarily having to extend hierarchical control over other companies" because it was somewhat easier to establish long-term business relationships, he noted.
"But a lot has changed since those old days. . . . Companies have largely been emancipated from main banks, the banks have grown weaker, the demands for loans are fewer, cross shareholdings are unwinding, new investors have begun to feel the void here, and many of them are active in terms of their demands for (stock price) performance, and of course foreign investors have increased their ownership and brought their Western standards and expectations to this market," Kester said, noting that these developments have contributed to an environment in which there is a greater and more legitimate role for M&As than in the past.
Overall, Kester said M&As are not an inherently bad economic activity -- although they carry risk -- and can be an "effective means of implementing a growth strategy or restructuring of companies."
An important point, he noted, is that an M&A needs to be executed successfully. "It's always easier to come up with plans and expectations for how a combination might improve performance or create value, but there are probably a thousand ways to screw up a deal -- no matter how attractive it appears ahead of time," he said.
Richard Roll, a professor of finance at the UCLA Anderson Business School, also predicted that Japan will have a merger wave in coming years -- unless government regulations are tightened to impede the trend.
Roll said a wave of M&As tends to coincide with an uptrend in stock markets. "So if the Japanese market is recovering, it's likely that there will be more M&A activity in Japan -- maybe never to the same degree as in Europe and the U.S. but certainly to a far greater extent than you've seen in the past," he said.
But Roll warned that Japanese firms should be aware of two things if they are to engage in M&A activities -- the frequent risk of overvaluing target companies and the presence of increasingly vigilant overseas regulators who might try to block even mergers between Japanese companies, if they could have international competitive impacts.
Studies show that companies trying to acquire others tend to offer shareholders of the target firms a hefty premium on market prices -- frequently 20 percent to 30 percent higher than the prevailing market value, he said.
However, it is less clear whether shareholders of the acquiring firms will gain from the deal because their returns are either zero or even negative if their target is a publicly traded company, he added.
The larger the premium that the acquiring firm offers to the target, the less positive or even negative impact the deal will have on the share prices of the acquiring firm, Roll said.
"Why does that happen? Because you pay too much," he said.
Managers of the acquiring firms are often overconfident in their assessment of the value of the firms they target, Roll said. "Evidence strongly shows that the more you pay for a public target, the worse off your stock owners are going to be."
Roll also said that M&A regulations are becoming more international, citing the example of a few years ago of European Union regulators blocking a merger between General Electric and Honeywell -- two American firms whose deal had been approved by U.S. regulators.
Since 1990, EU regulators have examined about 1,000 proposed combinations and they challenged a lot of them, including those involving no European firms. "I suspect that if you have a merger between two large Japanese firms that did a lot of business in Europe, they would very likely attempt to examine that merger and to block it," he told the audience.
Hiroyuki Itami, a professor of management with the Graduate School of Commerce and Management at Hitotsubashi University, said he was more cautious over the prospect of sharp increases in M&As in Japan.
Itami, who served as moderator in the discussions, said he could not imagine M&A activities in Japan reaching a level where a market for corporate control like the ones in the U.S. will emerge.
The gap will remain between Japan and the U.S. in public attitudes toward M&As, he suggested, due partly to their different views on the basic question: to whom a corporation belongs -- the shareholders or the people who comprise the company?
Another speaker on the panel, Charles Wolf, a senior economic adviser and corporate fellow in international economics at RAND Corp., discussed some aspects of corporate governance on which Japan and the U.S. differ.
In trying to strike a balance between the interests of shareholders and stakeholders such as employees, the community to which the companies belong, and business partners, etc., Japanese firms tend to emphasize the latter more than their American counterparts, Wolf pointed out.
And while some Japanese firms have adopted the practice -- mandated in the U.S. -- of having a majority of corporate board members comprised by independent directors, others, including some successful firms, have not and rely instead on inside directors, he said.
At the same time, Wolf suggested that the criteria used in the U.S. and referred to by some Japanese firms with regard to the "independence" of outside directors may be questionable.
While the criteria focuses on the directors' prior employment, affiliation with and compensation from the company, a more important but elusive criteria should be the directors' "contrarian disposition," he said. Unless the ostensibly independent directors are willing to ask corporate management embarrassing questions, their "independence" may simply be superficial, he added.