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Section 2 Japan's Business Environment
in the Globalizing Economy
As noted in the preceding section,Japanese companies have been expanding
their business activities around the world,
particularly in Asia. In fact, the globaliza-
tion of business activities is a universaltrend. Companies are selecting business
locations in countries and areas that offer
attractive markets and favorable business
environments. At the same time, however,business globalization means that places
that are not internationally attractive could
lose economic vitality as a result of the
contraction of business activities. In thissense, it is urgently necessary for Japan to
make its business environment internation-
ally more attractive. In this section, we will
discuss the business environments in anumber of other countries, and that of
Japan, and will examine some of the chal-
lenges this nation faces.
1. Global Expansion of Direct Investment
and Japan's Investment Environment
The development of information andcommunications technologies and the global
trends toward deregulation and liberaliza-
tion are adding impetus to the global expan-
sion of markets and, through the intensifica-tion of international competition, to the
trans-national development of business
strategies. This situation is seen in the
worldwide expansion of direct investmentreflecting the globalization of business
activities. In these circumstances, Japan's
outward direct investment, including the
establishment of overseas production bases,has been expanding, as illustrated by a
rising overseas production ratio. In contrast,
direct investment from abroad has remained
at a low level, giving rise to concern thatJapan's business environment may be lack-
ing in international attractiveness. In the
following, we will review major trends in
world direct investment and then develop-
ments in host countries. Subsequently, wewill consider the investment environment in
Japan by reviewing developments in inward
direct investment which is said to be at an
extremely low level.
(1) Major Trends in World Direct Invest-
ment
A regional review of recent trends in
direct investment shows that developed
countries make up, in flow terms, about 80%
of total outward investment and about 60%of total inward investment (Fig. 4-2-1). In
particular, the U.S. and the UK maintain a
high level of both outward and inward
investment. Japan is playing a large role inoutward investment but holds an extremely
small share in inward investment.
Developing Countries Beckon OverseasInvestment
As described above, developed coun-
tries account for most of direct investment.
However, developing countries have beenexpanding their shares in inward direct
investment. This seems to reflect the fact
that production is increasingly shifting to
low-cost locations abroad, reflecting risingexpectations in these growth markets and
the growing exposure of business activities
to international competition. Also notable is
progress in the privatization of state-ownedenterprises in developing countries and
areas. These moves toward privatization,
which gained momentum in the 1990s, have
spread far and wide, involving countries notonly in Latin America and East Asia but
also in Central and Eastern Europe (Fig. 4-
2-2). Foreign funds have played a key role in
a privatization program in these regions,
mostly in the form of direct investment.
These moves have opened the way for the
expansion of foreign companies into domes-
tic markets. At the same time, the fact thatprivatization has progressed mainly in
infrastructure-related areas (Fig. 4-2-3) is
expected to make investment environments
in these areas more attractive.
Global Increase in M&A Deals
Next, we will review developments in
cross-border mergers and acquisitions,which hold a key to trends in direct invest-
ment.
With inter-company competition inten-
sifying worldwide with the progress ofglobalization, development of new markets
and operations or reinforcement of core
operational divisions is a major challenge
for companies. And M&A activity, which canquickly achieve these, represents a major
option in management strategy. For ex-
ample, in the chemicals industry where
production facilities and R&D costs areenormous, there have been large-scale M&A
deals designed to reap economies of scale. In
addition, acquisitions and sales of opera-
tional divisions, designed to concentratemanagerial resources in strategic divisions,
have increased. Reviewed by industry, M&A
transactions in tertiary industries have
expanded noticeably. On a sectoral basis,these deals have increased in business
service areas where more advanced and
international services are in demand
against a backdrop of globalizing businessactivities (Fig. 4-2-4).
Reviewed by region, two-way transac-
tions (acquisitions and sales) have increased
in the U.S. and European countries. InJapan, on the other hand, M&As deals
between Japanese and foreign companies
have been exceedingly limited in number
(Fig. 4-2-5).
(2) Comparison of Investment Environmentsin Selected Countries
Fig. 4-2-6 shows changes in inward
direct investment in major developed coun-tries. In the U.S. and the UK, which have
both enjoyed relatively good economic per-
formances in recent years, both outward
investment by domestic companies andinward investment by foreign companies
have increased markedly. In Germany and
Japan, by contrast, while overseas invest-
ment has followed a trend marked by expan-sion, investment from abroad has remained
at a low level. As a result, the gap between
outward and inward investment has wid-
ened in both countries (Fig. 4-2-7). Below,we will review developments in the inward
investment in these countries.
Inward Investment Developments in theU.S, and the UK
A regional breakdown of inward in-
vestment in the U.S. and the UK shows that
each country holds the largest share of suchinvestment in the other, indicating strong
business bonds between the two countries
(Fig. 4-2-8).
On an industry-by-industry basis,
compared with Japan, these two countries
hold a high share in non-manufacturingindustries, particularly in the financial
service industry (Fig. 4-2-9). In the UK,
foreign financial institutions have invested
vigorously, reflecting London's establishedposition as an international financial mar-
ket. Fig. 4-2-10 shows foreign exchange
volumes in major countries. The large vol-
ume in the UK, particularly of transactionsin foreign currencies, can be said to symbol-
ize the breadth of transactions in and the
great convenience of the London market. In
1986, the UK launched a host of financialsystem reforms, or the so-called Big Bang,
to correct inefficiencies and enhance its
international competitiveness. These re-
forms have invigorated financial transac-tions and increased their efficiency. At the
same time, they have led to the concentra-
tion of finance-related industries and hu-
man resources and of advanced information.These have further increased the attractive-
ness of London as an international financial
market.
Along with these financial marketreforms, the various systemic reforms car-
ried out in the 1980s under the administra-
tion of Prime Minister Margaret Thatcher
have dramatically changed the investmentenvironment in the UK (Note 1).
For companies with overseas opera-
tions, it is essential to map out internationalfinancial strategies and to deal properly
with different systems abroad, such as legal
and accounting systems. Since the provision
of such advanced services requires theaccumulation of a large volume of special-
ized information, it is necessary to concen-
trate related industries. Fig. 4-2-11 shows
changes in the share of work force in major
countries as a way to study how financial
and business services are concentrated in
these countries. In the U.S. and the UK, it is
noted that the share is large. In these coun-tries, financial institutions are highly con-
centrated, reflecting their status as an
international financial center. In addition, a
large body of professional people who arecapable of providing such advanced business
exists and are able to provide legal and
accounting services. It can be said from the
above that the U.S. and the UK offer strate-gic bases for global companies and that even
companies gaining market access for the
first time can readily gain business support.
Investment Environment in GermanyThe large size of the domestic market
and the high level of technology can be cited
as some of the advantages of the investment
environment in Germany. Fig. 4-2-12 showsregional activities of U.S. overseas affiliates
(manufacturing). In Germany and Japan,
high levels of personnel expenses and R&D-
related activities exist.
However, as already noted, inwardinvestment in Germany remains at a low
level in absolute terms. High costs, particu-
larly high labor costs, high tax rates and an
inflexible employment environment arecited as some of the reasons (Fig. 4-2-13). As
regards the environment surrounding em-
ployment in Germany, labor practices and
systems attach importance to employmentstability. As shown in Fig. 4-2-14, workers
with a long period of continuous service with
the same company hold a large share in
Germany, as they do in Japan and France.In recent years, however, rigidity in the
labor market in Germany have become more
evident, as shown by rising unemployment
rates, particularly large numbers of long-
term unemployed. (Fig. 4-2-15). With the
international economic environment under-going dynamic change, rigidity in the em-
ployment market are thought to weaken
companies' ability to respond to such change
and thus impose heavy constraints on busi-ness activities. At a time when economic
barriers between EU states are going down
as they move toward monetary union, these
problems regarding industrial location inGermany are raising much concern (Note 2).
(3) Inward Direct Investment and Invest-
ment Environment in Japan
Developments in Inward Direct Investment
The number of cases of inward direct
investment in Japan (based on reports andnotifications) continued to rise for three
successive years from fiscal 1994 to fiscal
1996. In fiscal 1996, the value of such in-
vestment reached an all-time record (\770.7billion), due partly to an increase in large-
scale investment (Fig. 4-2-16). In the first
half of fiscal 1997, manufacturing invest-
ment decreased in value a year earlier, butnon-manufacturing investment increased
40.1% from a year earlier. By region, most
investment was from the U.S. and Western
European countries. In fiscal 1996, however,investment from Asia also expanded mark-
edly, accounting for 17.8% of the total value
(Fig. 4-2-17).
Thus, inward direct investment inJapan has followed a trend marked by
expansion, particularly in the non-manufac-
turing industry. However, as already noted,
it remains at an internationally low level.In Japan, as a result of a series of
capital liberalization measures, foreign
investors making direct investment are
required, in principle, only to report ex post
facto (Note 2). In addition, foreign affiliates
in this country are entitled to various sup-port measures. In view of these facts, the
low level of inward direct investment sug-
gests that the business environment in
Japan is less attractive than those in someother countries.
Various problems involved in the
business activities of foreign affiliates in
Japan have been identified by surveys andother studies. For example, Fig. 4-2-18,
based on a survey conducted by the Japan
External Trade Organization (JETRO),
shows high response rates for such items as
"high business cost," high level of user
demand" and "difficulty of securing person-
nel," although the overall business environ-ment has improved since the survey of 1995.
(Note 1) The Thatcher administration,
which took office in 1979, carried out vari-ous regulatory reforms with emphasis
placed on the competitive principles of the
free market. From this point of view, the
administration also expanded the tax basethrough the abolition of special taxation
measures, reduced the corporate tax rate
and privatized state-owned enterprises. As a
result of these and other reforms, inwardindirect investment in the UK has remained
at a high level since the second half of the
1980s.
(Note 2) Reflecting such concern, activedebates on revising the tax system have
been conducted in Germany. For instance, in
1997 a revision of tax system bill was intro-
duced with the aim of reducing the effectivecorporate income tax rate from 49.79% to
the 42% level by lowering the tax rate on
retained earnings to 40% in fiscal 1998 and
35% in fiscal 1995. However, the bill wasrejected by the legislature in September
1997.
(Note 3) As an exception to the rule, inward
direct investment requires advance report-ing with respect to the following: (1)
investment related to "sectors that could
impair national safety," which is generally
subject to regulation under the OECD Codeof Liberalization of Capital Movements; (2)
investment related to sectors where Japan
holds reservations about liberalization
(agriculture, forestry, fisheries, petroleumindustry) under the above code; and (3)
investment by individuals or companies
from countries for which review is recog-
nized as being necessary from the stand-
point of reciprocity.
High-Cost Structure in Japan
"High business cost" in Japan has longbeen cited in comparative surveys of domes-
tic and overseas prices. It is generally be-
lieved that foreign affiliates planning to
enter the Japanese market base their in-vestment decisions on return forecasts and
cost estimates. It can be said that high
business-related costs in Japan make for-
eign affiliates reluctant to invest in Japanas these deteriorate investment efficiency.
Fig. 4-2-19, which compares land
prices in major cities, shows that prices in
Japan remain much higher than those inmajor Western countries, although the gap
has narrowed in recent years, partly due to
land price falls in this country. In addition,
business-related costs in Japan, such aselectricity and telephone rates (Fig. 4-2-20),
remain relatively high. Meanwhile, a
sectoral breakdown of survey results con-
cerning intermediate input costs shows thatsuch costs in Japan remain relatively high,
particularly in non-manufacuring sectors
(Fig. 4-2-21). This is attributed to the fact
that internationally wide disparities in therate of productivity gains have existed
between manufacturing and non-manufac-
turing industries, reflecting different com-
petitive environments in these two areas.This situation is also reflected, as shown in
Fig. 4-2-22, in an upward departure from
the effective purchasing power parity using
the consumer price index, which includesmany non-trade goods.
In addition, the high effective corpo-
rate tax rate in Japan, as seen in Fig. 4-2-
13, can be regarded as representing a highbusiness-related cost (Note 1).
The high-cost structure in Japan such
as described above is assuming greater
significance than ever before. The globaliza-
tion of corporate activities and the resultant
intensification of international competition
between companies are increasing the
awareness of international cost disparities.In addition, the further development of
service sectors in the economy (the growing
weight of non-trade goods industries) and
the increasing complementary relationshipbetween manufacturing and non-manufac-
turing sectors are providing a background
against which the domestic-overseas price
differential, particularly in non-manufactur-ing sectors, are having major negative
effects on the competitiveness of companies
operating in Japan.
Developments in M&As in Japan
As already noted, M&A activity is
playing a large role in cross-border invest-
ment activities. Japan's M&A market is lessdeveloped than those of major Western
countries. This is often cited as a reason for
the low level of in ward direct investment in
Japan.Recent developments in M&A activity
in Japan indicates that M&As of domestic
companies by foreign companies, though
still at a low level, have been increasing andthat M&As between domestic companies
have been expanding markedly (Fig. 4-2-23).
Among the factors contributing to the ex-
pansion of M&A activity are active sales ofnon-core business divisions -- moves that
reflect a review of the upbeat business
strategy that followed during the period of
the bubble economy -- and stepped-up reor-ganizations in sectors where deregulation
has been making headway, such as finance,
distribution and communications (Fig. 4-2-
24).The low level of M&A activity has been
ascribed in part to the strongly negative
perception of corporate sales and to the
various impediments to acquisition, such as
cross-shareholdings among companies and
the difficulty of obtaining the necessarycorporate information. However, the need
for M&As is expected to increase in the
years head, partly because importance has
been attached in recent years to the sale ofstrategic divisions and partly because com-
panies planning to enter new business areas
have come to regard acquisition as an effec-
tive means of doing so (Note 2).
Developments in Activities of Foreign Affili-
ates
Next, we will review developments in
the activities of foreign affiliates in Japan,
particularly trends in their profits. First, the
ratio of current profits to sales has exceededthat of domestic companies by a wide mar-
gin. The gap has widened in recent years
(Fig. 4-2-25). This is due partly to the fact
that foreign affiliates usually withdraw frompoorly performing operations. However, the
more important reason seems to be that
they maintain a high level of competitive-
ness in Japan that is supported by theirexcellent managerial resources.
The ratio of current profits to total
assets, or return on capital investment, is
also much higher than that of domesticcompanies. This shows that foreign affiliates
have been using their capital more effi-
ciently. The return on equity (ROE) was
12.1%, or about four times that of domesticcompanies, in fiscal 1995 (Fig. 4-2-26).
These indicate that foreign affiliates are
more strongly inclined than domestic com-
panies to increase capital efficiency withemphasis on shareholder interest (Note 3).
Reviewed by the scale of company,
large foreign affiliates that are believed to
have accumulated extensive managerialresources in their own organizations hold a
large share (Fig. 4-2-27). By contrast, a
large percentage of companies that entered
the Japanese market relatively recentlyhave been running deficits, indicating that
they face considerable difficulties in the
initial period of operations (Note 4). This
suggests that it is not easy for foreign affili-ates to do business in Japan. In fact, a
regional comparison of profit margins based
on U.S. statistics shows that profit margins
in Japan are the lowest (Fig. 4-2-28).
Growing Presence of Foreign Affiliates in
Japan
Japan, which has the second largest
market after the U.S. and a high level of
purchasing power, can be said to be an
attractive market for countries around theworld. For example, as shown in Fig. 4-2-29
on local sales ratio of U.S. overseas affili-
ates, most production in Japan is destined
for the domestic market. This shows thatU.S. affiliates in Japan position Japan as
their marketing bases in their global strate-
gies. However, the number of foreign compa-
nies entering the Japanese market has been
relatively limited (Note 5). This seems to
suggest that it has been difficult for foreign
companies to open up new business pros-pects in Japan as existing markets reach
the saturation point as a result of the matu-
ration of Japan's economy (Note 6).
Meanwhile, as described above, in-ward direct investment in Japan has been
increasing in recent years. As a result, the
presence of foreign affiliates in this country
has been gradually expanding. This is duepartly to the fact that the correction of the
yen's overvaluation beginning in 1995 and
the recent fall in asset prices have improved
the Japanese investment environment forforeign companies. It also should be noted
that the series of deregulation measures
taken by Japan in recent years has encour-
aged foreign companies to enter the Japa-nese market.
For example, an increasing number of
foreign companies have expanded into the
distribution area as a result of deregulation,including the abolition of the large-Scale
Retail Store Law (Note 7). The retail indus-
try in particular has seen a spate of new
entries in such sectors as toys, records andfashion apparel. What is notable about
these newcomers is that they are trying to
differentiate themselves from established
companies on the strength of their own
concepts or brand power (Note 8). Further-more, these newly expanding companies
include those which are having a great
impact on Japan's existing distribution
systems by introducing new marketingmethods, trading systems, etc.
In addition, a series of financial liber-
alization measures in Japan, starting with
the revision of the Foreign Exchange Lawthat took effect in April 1998, are arousing
great interest in Japan among foreign-
affiliated financial institutions. It is said
that in the background of such interest is ahuge potential market symbolized by more
than \1,200 trillion in personal financial
assets.
Foreign-affiliated financial institutionsare expanding aggressively into the Japa-
nese market by seizing these business
opportunities, in addition to promoting their
existing operations. Thus, their presence inJapan has been increasing. For example,
foreign banks have been markedly expand-
ing their share in domestic deposits out-
standing, as shown in Fig. 4-2-30.In addition, the expanding business
activities of foreign-affiliated financial
institutions are creating new demand in the
Japanese market by providing new servicesand more advanced financial services here-
tofore unavailable in Japan, in ways that
make better use of the techniques and
know-how they have cultivated in existingmarkets.
Significance of Inward Direct Investment
It is expected that inward direct in-vestment will lead to the introduction of
excellent managerial resources held by
foreign companies and to the invigoration of
the domestic market through competition
induced by the entry of foreign companies.These effects will be studied with
respect to the U.S. where foreign affiliates
maintain a relatively large presence. Fig. 4-
2-31 shows relationships between salesshare of foreign affiliates and producer
prices in the U.S.. It is noted that producer
prices tend to be held at lower levels in
sectors where foreign affiliates are moreactively engaged.
The revival of the U.S. automotive
industry is often cited as an successful
example of the introduction of excellentmanagerial resources. Fig. 4-2-32 shows
changes in rates of productivity gains in the
Japanese and U.S. automotive industries,
with all domestic manufacturing industriestaken as the standard. In the U.S. the car
industry stagnated from the 1970s to the
1980s, but its productivity improved mark-
edly in the 1990s. The revival of the U.S. carindustry is ascribed in large part to the fact
that the Japanese-style production control
system was adopted by U.S. makers through
U.S. investment by Japanese automakers.In Japan as well, it is expected that
market activation through the entry of
foreign companies will contribute to improv-
ing the productivity of domestic companies.
It can be said that introduction of a competi-tive environment through inward direct
investment has great significance particu-
larly to non-trade goods industries, which
are hardly exposed to competition throughthe international market.
Business customs have often been
cited as impediments to the entry of foreign
companies into the Japanese market. Whilethese practices are losing economic rational-
ity as a result of changes in the economic
environment and other liberalizing forces,
there are still quite a few practices that are
blocking efforts to increase efficiency. It is
likely that foreign affiliates not bound bytradition will also play a large role in
prompting a review of these customs and
practices.
The more important point, however, isthat many impediments to the business
activities of foreign affiliates in Japan are
also standing in the way of domestic compa-
nies, particularly newly investing compa-nies. As already noted, foreign affiliates
have been actively investing in deregulated
sectors. But at the same time many domes-
tic companies have also expanded into thesesectors. It can be said, therefore, that devel-
opment of conditions that create new busi-
ness opportunities will greatly contribute to
the revitalization of the Japanese economythrough stepped-up investment by both
foreign and domestic companies.
It may be said, moreover, that develop-
ment of conditions conducive to the invigo-ration of the M&A market, which plays a
large role in inward direct investment, will
also promote the entry of foreign companies
into the Japanese market. On the otherhand, M&As are expected to make possible
the more efficient utilization of managerial
resources through the combination of exist-
ing and new managerial resources. In addi-tion to introducing managerial resources
from foreign companies, these M&As, even
where they involve deals between domestic
companies, will contribute to the revitaliza-tion of the Japanese economy through
restucturing of managerial resources that
have been accumulated over the years.
(Note 1) The effective tax rate in Japan has
dropped by 3.6% to 46.36% as a result of tax
system revisions for fiscal 1998.
(Note 2) In recent years, needs for M&As
have increased particularly among small
and medium enterprises beset by the suc-
cession problem.
(Note 3) Returns on equity by nationalityare as follows: 13.1% for U.S. affiliates,
11.0% for European affiliates; and 6.3% for
Asian affiliates.
(Note 4) According to the "Survey of Trendsin Business of Foreign Affiliates in Japan,"
MITI, about 60% of the companies that
entered the Japanese market in and after
fiscal 1993 are in the red. A questionnaire-based poll taken during the survey shows
that 30% of companies replied it took them
more than five years to put their operations
on course.(Note 5) According to a JETRO poll of for-
eign affiliates, the status of Japanese bases
in their global strategies is as follows: (1)
marketing base, 83.2%; (2) informationbase, 29.4%; (3) production base, 22.3%; (4)
headquarters for Asian operations, 18.7%;
and (5) R&D base, 18.7%.
(Note 6) According to a survey of Japanesecompanies doing business abroad (Survey on
Japanese Business Activities Abroad, MITI),
the percentages of replies that described
market potential as "great" were as follows:the U.S.--41.5%; the EU--14.9%; and Japan--
12.3%.
(Note 7) The law governing the coordination
of activities of large-scale retail stores.During the last regular Diet session the law
was abolished, and a bill for the "Large-
Scale Retail Store Site Law" was introduced.
(Note 8) For example, so-called categorykillers, most of them affiliated with foreign
retail companies, are conducting business by
limiting the products they handle, with wide
product variety in selected areas and lowprices their main sales points.
2. Improving the Business Environment
Toward A Vigorous Japanese Economy
In light of globalizing business activi-
ties, it is necessary to create an internation-
ally attractive business environment in
Japan so as to reactivate business activities,which are the main source of economic
vitality.
It is no longer impossible, particularly
in Japan, to achieve sustainable growththrough catching up with industrialized
Western countries, a process the nation has
pursued in the past. It is increasingly impor-
tant that Japan create new sources ofgrowth on its own. In other words, it is more
important than ever before to create a
business environment that gives full plash
to creativity. This is also necessary to createnew business seeds and new growth indus-
tries in Japan. Furthermore, since globaliza-
tion makes it easier for companies to move
managerial resources to regions where thesecan be most effectively and efficiently uti-
lized, it can be said that creating an envi-
ronment that makes it possible to introduce
a wide variety of excellent managerialresources is essential in order to increase
economic vitality.
In the following, we will review, while
keeping these points of view in mind, someof the changes that have taken place in
recent years in the environment surround-
ing Japanese companies. We will then dis-
cuss the kind of business environmentwhich Japan needs to create in the future.
(1) Developments Concerning Industrial
Financing
It can be said that the financing that
forms the basis of industrial activities
greatly affects corporate performance,
depending on whether its functions are
effectively performed. In particular, finan-
cial "intermediation," whereby funds are
redistributed through financial institutions,improves overall economic efficiency
through the supply of funds to entities
capable of effectively performing these
functions. Furthermore, financing is onearea in which the progress of globalization is
most evident. It is therefore increasingly
important that corporate management also
take global points of view in raising fundsthrough financial markets. In the following,
we will review some of the recent develop-
ments in industrial financing.
Changes in Corporate Fund Procurement
Structure
The large share of bank borrowings in
the composition of corporate liabilities (Fig.4-2-33) and the high ratio of deposits to
personal financial assets, a pool of perma-
nent fund surpluses in the economy (Fig. 4-
2-34), both indicate that banks have beenplaying the central role in performing finan-
cial intermediary functions in Japan. It is
said that this financial intermediary struc-
ture has played a vital role in supplyingfunds on a stable basis to the chronically
fund-short corporate sector during the
period of Japan's high-rate economic
growth. However, changes in the domesticand international business environment
have markedly changed this structure.
As shown in Fig. 4-2-35, corporate
dependence on bank borrowings has contin-ued to decline in recent years. One back-
ground factor is the fact that, with capital
markets developing as a result of financial
liberalization, creditworthy companies,particularly large ones, have diversified
their means of fund procurement -- by
shifting from indirect to direct financing, for
example -- in order to reduce funding costs.
In addition to using more efficient means offund procurement, companies also face a
growing need to pursue more sophisticated
financial strategies, including fund manage-
ment and settlement, that reflect the global-ization of corporate activities and the accu-
mulation of internal reserves. In particular,
the globalization of financial markets and
the global development of financial tech-niques make it increasingly likely that the
degree of corporate competitiveness will
depend largely on the sophistication of
financial strategy and the availability of
advanced financial services. In these cir-cumstances, companies are expected to shift
the emphasis in their dealings with finan-
cial institutions from maintaining stable
relations, such as they have held in thepast, to selecting financial institutions
primarily on the basis of their financial
needs. At the same time, this means that
the ability of Japan's financial institutionsto develop financial instruments, which is
said to fall behind that of Western financial
institutions, will be tested more severely in
the midst of mounting international compe-
tition.
Corporate Management Open to the MarketThe shift from indirect to direct financ-
ing, such as is seen in the fund procurement
structure, makes it increasingly necessary
for companies to pay greater attention thanever before to how they are evaluated by
investors. Furthermore, the growing pres-
ence of foreign investors in Japan is having
a great impact on corporate management inthis country. Fig. 4-2-36, which illustrates
stockholding shares by group of owners,
shows that the share of foreign investors
has been rapidly increasing; it reached11.9% at the end of fiscal 1996. In addition,
Fig. 4-2-37, which gives a sectoral break-
down of stock turnovers, shows that turn-
over has been relatively low for industrialcorporations and financial institutions, both
of which have been central shareholders,
and that turnover for foreign investors, with
their growing ownership share, has been thehighest.
Foreign investors have increased their
presence in major Western countries as well.
In the background are the expansion ofinternational money flows resulting from
financial globalization and the rising pres-
ence of institutional investors who are
increasingly concerned for investmentreturns (Fig. 4-2-38). Among these investors
are U.S. pension funds and others whose
basic stance is to hold shares on a long-term
basis and who are working actively oncorporate management to increase the value
of their stock holdings (Note 1) (Note 2)
The increasing weight of direct financ-
ing and the growing voice of shareholdersmean that financial intermediary functions
and the disciplining of corporate manage-
ment for greater efficiency are being per-
formed in a more open market. It is there-
fore important to create conditions condu-
cive to the full performance of market func-
tions. To that end, it is essential not only to
develop a system for adequate disclosure ofcorporate information but also to increase
the number and improve the quality of
information intermediaries, such as finan-
cial analysts and credit rating agencies, whosecure financial information needed for
proper corporate evaluation and at the same
time improve the utility of such information.
Smooth Fund Supply to New Growth Indus-
tries
It is increasingly important in the
Japanese economy to create conditions thatencourage creativity. Consequently, it is
desirable to ease the constraints on the
activities of innovative companies trying to
demonstrate creativity and open up newmarkets on their own.
Companies exploring opportunities in
new business areas often face constraints in
fund procurement because, generally, theirfuture prospects are considerably uncertain
and therefore high risks are involved in
their operations. These are believed to be
major problems particularly for youngcompanies, such as venture-capitalized
businesses, which, having been established
not long ago, do not enjoy ordinary credit
standing or have an absolute shortage ofinternal reserves. To supply so-called risk
money to these companies is also important
from the standpoints of creating new indus-
tries and reactivating the Japaneseeconomy.
In the following, we will study develop-
ments in venture capital, the main source of
funds to venture businesses.Fig. 4-2-39 shows shares in venture
capital investment by number of years after
establishment. Investment in companies
with a history of 10 years or more accounts
for more than half the total. Investment in
companies within five years of establish-
ment also has been expanding. However,
compared with the U.S. where investmentin start-up companies immediately or a
short while after establishment holds the
lion's share, the level in Japan remains low
(Fig. 4-2-40). One reason given for the highlevel of investment in young companies in
the U.S. is that investment is recovered
through public stock offering in a relatively
short period. NASDAQ, the U.S. over-the-counter stock market, is playing a vital role
as the place where stocks are sold and
where funds are raised through public stock
offerings. Because of its great convenience,this market has grown almost as large as
the domestic stock exchanges (Fig. 4-2-41).
In addition to playing a key role in fund
supply to start-up companies, it is pointedout that venture capital in the U.S. is also
taking a large part in developing these
companies through management support,
such as coordinating needed specialists suchas lawyers, accountants and investment
bankers (Note 3).
Next, regarding sources of venture
capital, in Japan corporations and financial
institutions are the main suppliers (Fig. 4-2-42). In the U.S., by contrast, such capital is
supplied by a broad range of investors,
notably pension funds (Fig. 4-2-43). Pension
funds and other institutional investors whohave large reserves of funds are capable of
maximizing profits and dispersing risks by
holding diverse portfolios, including risk
assets. In Japan, too, these investors can beexpected to play an important role as suppli-
ers of risk money.
In Japan it can be said that fund
supply routes to companies with an uncer-tain future are narrow, as shown by the fact
that personal financial assets, the final
supplier of funds, are concentrated in risk-
free assets. In order to ensure smooth fundsupplies to diverse businesses, it is hoped
that diverse investors with different risk
preferences will enter the market. To that
end, it is considered important to develop anenvironment conductive to free fund man-
agement (Note 4).
(Note 1) For example, CALERS (CaliforniaPublic Employee's Retirement System) is
noted for its positive approaches to manage-
ment, such as moves to improve information
disclosure to shareholders and the board of
directors.
(Note 2) A number of background factors are
cited, including the autonomy of theseinvestors in fund management, the require-
ment for prudent fund management under
the so-called prudent man rule, and the
difficulty of withdrawing from the marketbecause of the enormous size of investment.
(Note 3) See Section 2, Chapter ‡W, White
Paper on International Trade and Industry,
1997.(Note 4) In this sense, the abolition of regu-
lations governing asset management, such
as the "5-3-3-2 regulation" on the private-
sector employee pension funds, is to bewelcomed.
(2) Changes in the Environment Surround-
ing Employment
With business activities going global,
it is important that the employment envi-
ronment, a key element of the businessenvironment, be made internationally more
attractive.
In Japan, too, there are moves under-
way to explore various modes of employ-ment in a globalizing competitive environ-
ment. For example, as shown in Fig. 4-2-44,
the share of non-regular employees has been
expanding at a level exceeding 20% of the
total work force. In addition, a growing
number of companies have adopted a sys-
tem of variable working hours, such as theflextime system (Note 1). Thus, the modes of
employment and work have been diversify-
ing. Furthermore, the modes of remunera-
tion also have undergone marked change, asshown by an increasing number of compa-
nies adopting an annual pay system reflect-
ing individual ability, achievement, etc. (Fig.
4-2-45). In the background of these movesare not only attempts by companies to meet
their needs in response to changes in the
economic environment but also changes in
work ethics on the part of workers. Whereworkers are given opportunities to choose
freely from these diverse employment
modes, companies are likely to be able to
make more effective use of their humanresources, while workers themselves are
likely to be induced to give full play to their
abilities and creativity.
Furthermore, with the economic envi-ronment changing rapidly, an environment
conducive to the hiring of the necessary
personnel can be said to be a key componentof an attractive business environment. In
this sense, it is vital to create conditions
that help to increase flexibility in and se-
cure workers through the labor market. Forthat, it is necessary to enhance labor force
supply-demand adjustment functions
through such measures as revision of the
temporary service system and to re-examinesystems concerning separation allowances,
pensions, etc. so that workers who change
jobs will not be placed at a heavy disadvan-
tage. And realizing smooth labor movementthrough the external labor market, in addi-
tion to putting the right man in the right
place in each company, may be said to be
also highly significant from the standpointof ensuring more effective utilization of
human resources, a key element of manage-
rial resources, in the economy as a whole.
(Note 1) According to the "General Survey
on Wage and Working Hour Systems," Labor
Ministry, the percentage of companies on
the variable working hour system increasedmarkedly from 13.2% in 1990 to 40.5% in
1996.
(3) Flexibility in Corporate Organization
Required
In order to efficiently use managerial
resources such as personnel and capital it is
desirable that corporate organizationsthemselves exist in ways that ensure most
effective utilization of these resources. In
fact, Japanese companies, too, are making
efforts toward business restructuring, suchas developing new business areas in re-
sponse to new needs and technological
innovations, and rationalizing existing
operations. In doing so these companies aremoving toward re-examining their organiza-
tions so as to ensure more efficient distribu-
tion of managerial resources.
In addition, sales of inefficient orunprofitable operations, or corporate acqui-
sitions and mergers designed to secure
managerial resources needed to improve
business efficiency are likely to contributematerially to the more effective utilization
of existing managerial resources. For ex-
ample, in the U.S. where business reorgani-
zation is gaining momentum, active M&Adeals involving high-tech companies, par-
ticularly in the software area, have been
concluded (Fig. 4-2-46). As a factor contrib-
uting to this, it has been pointed out thatacquisitions aimed at securing technologies
and personnel and sales designed to raise
investment funds needed for new operations
have been conducted from a strategic pointof view. Generally, the activation of the
M&A market, which will ease these con-
straints, may be of great significance to
rapidly growing companies, given theirabsolute shortage of internal managerial
resources.
With market needs diversifying and
rapidly changing along with rapid techno-
logical innovations, companies are increas-ingly required to make quick decisions. If
companies are managed as in the past by
holding all managerial resources in their
own organizations, they could not only loseflexibility but also end up holding consider-
able managerial resources they cannot
effectively use. Furthermore, the develop-
ment of means of communication throughprogress in information technology has
made it easier to access external resources.
In these circumstances, utilization of exter-
nal managerial resources, such asoutsourcing, where they are required will
make it possible to enjoy the merits of
information and increase managerial flex-
ibility (Note 1). In other words, a businessenvironment in which managerial resources
can be flexibly redistributed and organiza-
tion promptly changed in response to exter-
nal changes can be said to be a major factorin corporate efforts to improve performance
on a sustainable basis.
As the world economy undergoes
dynamic change, it is essential that, in orderto achieve sustainable growth, Japan make
its business environment internationally
more attractive and induce more active
business activities at home. To that end, it is
important to develop a domestic environ-
ment that allows diversity and freedom of
choice. Such an environment will enableindividuals and corporations to exhibit
creativity and thereby help to create new
growth industries essential to the Japanese
economy.In addition, since the globalization of
business activities inevitably confront com-
panies with systemic differences abroad,
any extreme departure of Japanese systemsfrom the international standards would not
only hamper the overall efficiency of Japa-
nese companies with global operations but
also seriously impede the entry of foreigncompanies into Japan. In other words, in
efforts to improve the business environment
in Japan it is essential to harmonize domes-
tic systems with the global standards. Thatis also of vital importance in order to fully
enjoy the merits of globalization.
(Note 1) For details of information:s rela-tionship with outsourcing, see Section 3,
Chapter‡U.