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Monday, July 16, 2007

JAPANESE PERSPECTIVES

Companies must fight for balance between greenmailers, growth


The biggest feature of this year's crop of annual shareholders' meetings — which came on the heels of May's removal of the ban on triangular mergers — was the move to install defensive measures against so-called greenmailers, the corporate interlopers who chase after short-term profits.

The measures were generally introduced by management teams that had the support of a majority of shareholders, with the number of firms estimatedto have gone that route reaching about 200.

One of those companies was Japanese sauce maker Bull-Dog Sauce Co. On July 9, the Tokyo High Court rejected an appeal by U.S. investment fund Steel Partners, which was seeking an injunction to stop Bull-Dog from adopting a poison pill defense that would dilute its growing stake in the takeover target.

Steel Partners criticized the defense as discriminatory and said it represented the backwardness of Japan's stock market. But Steel, which was described by the court as an "abusive bidder," had apparently erred in predicting how Bull-Dog's shareholders would react.

Despite the setback, the influence of investment funds like Steel Partners will no doubt continue to rise. It is estimated there are more than 9,500 hedge funds around the world in control of a combined $1.4 trillion in assets.

Contributing to this trend is the fact that financial institutions are increasingly using a type of lending called Covenant-Lite to supply funds needed for corporate takeovers. Normally, banks draw up a set of obligations and restrictions called a covenant when making loans. Typical covenants include the coverage covenant, under which the borrower is required to keep the cash flow-to-interest payment ratio above a certain level, and the leverage covenant, which obliges the borrower to maintain a debt-to-capital ratio below a certain threshold. However, the glut in global liquidity and intensifying competition among banks in recent years have cleared the way for easing these conditions.

Addressing these circumstances, the declaration adopted at the Group of Eight summit in Heiligendamm, Germany, on June 7 contained the following reference to the hedge fund industry, which is where many greenmailers originate.

1) The global hedge fund industry should review and enhance existing sound practices benchmarks for hedge fund managers; in particular in the areas of risk management, valuations and disclosure to investors and counterparties in the light of expectations for improved practices set out by the official and private sectors.

2) Counterparties and investors should act to strengthen the effectiveness of market discipline, including, by obtaining accurate and timely portfolio valuation and risk information.

3) Supervisors should act so that core intermediaries continue to strengthen their counterparty risk management practices.

Another development requiring attention is the increasing growth of "sovereign wealth funds." Such funds aim to separate some of the foreign currency reserves of a nation and manage them in different ways and for different purposes.

The funds come in two types. The first invests the proceeds from a country's natural resources exports or fiscal surplus outside the country to prepare for a future rise in expenditures. The second type aims to cover valuation losses on assets denominated in foreign currencies when the nation's own currency is appreciating, as well as the negative spread between domestic interest rates charged for raising funds to buy foreign currencies, and overseas interest rates.

It has been reported that Japan is considering the establishment of a sovereign wealth fund based on income from its foreign-currency reserves. These sovereign wealth funds may, depending on future developments, trigger an upheaval in the global financial, stock and currency exchange markets.

The power of each small-lot shareholder, such as an individual investor, remains limited, like a small ball of lead. But a fund can become much more powerful than that — just as a lead ball can if it is turned into a shotgun pellet.

The number of blackmailers, including the "sokaiya" (corporate racketeers) who disrupt Japan's shareholders' meetings, is said to be falling because the law has been tightened to crack down on their activities.

In this rapidly globalizing business environment, corporate managers will face the urgent task of striking an appropriate balance between warding off greenmailers and ensuring their companies stay on track for medium- to long-term growth.

Teruhiko Mano is a professor at Seigakuin University Graduate School.


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