Japan: What The Toshiba Story Tells Us About The Country’s Corporations, Keiretsu Model Of Cartelisation And Capitalism

Japanese behemoth Toshiba has announced plans to split into three different companies. The 145-year-old company decided to split in order to pacify investors, who have been at loggerheads with the conglomerate’s management over several questionable corporate governance practices.

The investors include activist funds like Effissimo Capital Management, Elliott Capital Management and several others.

Since the last seven-odd years, the company has been embroiled in various major problems that almost derailed the sprawling empire.

The problems came out in the public domain in 2015 when it came to light that multiple divisions across the company had been overstating their earnings since 2008, cumulatively increasing their profits by $2 billion over the previous seven years.

In the same year, Toshiba acquired the United States-based Westinghouse. But by 2016, Toshiba realised that the acquisition had not worked out the way it was supposed to, resulting in a write-down worth billions of dollars.

By 2017, Westinghouse filed for a bankruptcy due to cost overruns in power projects, notably its nuclear power projects. Consequently, in a bid to save itself from being delisted due to a negative net worth, Toshiba put its chip business on the block.

However, the deal didn’t go through and Toshiba was forced to raise money from Paul Singer’s Elliott Management, Third Point Capital, and Farallon. The move allowed it to raise cash of $5.4 billion.

By 2018, Toshiba had managed to sell off its chip business, bringing in more funds into the business. However, its investors demanded a more diversified board of directors with more outsiders — a demand that resulted in Toshiba bringing in four non-Japanese directors. But, another accounting scandal was unearthed in 2020 at its subsidiary, causing the major shareholders to ask for board seats — a move that Toshiba’s board was strongly opposed to.

In the July shareholders’ meeting, the candidates nominated by activist investors were rejected according to the voting results. However, as investors began investigations, Toshiba later revealed that a number votes had not been counted.

In 2021, shareholders opened an investigation into the allegations about Toshiba enlisting the help of the Japanese trade ministry.

An independent investigation found that Japanese government officials colluded with Toshiba executes to prevent shareholders from exercising their voting rights during the 2020 annual general meeting.

The report concluded that Toshiba, together with officials from the Ministry of Economy, Trade and Industry (METI), colluded to prevent Effissimo Capital Management, which holds 9.9 per cent of Toshiba shares, from exercising its shareholder proposal.

Effissimo, a fund based out of Singapore and managed by two long-time Japanese activist investors, has been a bugbear for the conglomerate.

The report cast serious aspersions on the quality of corporate governance in Japanese companies and raised concerns on the role played by the Japanese government to secure the interests of Japanese shareholders over foreign investors.

What Explains Japan’s Strong Opposition to Foreign Investors?

The reservations around allowing foreign investors to have board seats can be explained with Toshiba’s exposure to nationally critical sectors such as nuclear energy and defence.

However, a part of the opposition has to do with Japanese dislike of foreign investment. According to the United Nations Conference on Trade and Development ranking, Japan had the lowest ratio of inward foreign direct investment to the gross domestic product among all 196 countries.

Further, the Japanese dislike of foreign capital is evident in the fact that in financially-strong countries, merger and acquisition-related FDI usually forms more than 80 per cent of the total FDI. According to a report, the same figure for Japan stood at less than 15 per cent.

Japanese corporations are known for following a form of cartelisation, known as Keiretsu. Under the system, various industrial groups often form unofficial alliances with unwritten rules as a means to help each other in hours of need.

The same system had spawned the large number of inter-corporate crossholdings across multiple Japanese companies. Managements were not concerned about minority shareholders or about maximising shareholder returns.

The cross holdings make the company structure extremely messy, resulting in the “conglomerate discount”. The messy corporate structures further make corporate governance questionable.

Is the Scenario Changing?

The Japanese government had introduced a taxation system that lowers the tax liabilities on restructurings and spin-offs in 2017. However, until 2021, the benefits were hardly used, with most companies preferring to continue with their large structures.

Toshiba would be among the first few companies to use the tax benefits to break up its empire. The Japanese government has been looking to improve growth, and the perception of improving governance could help attract foreign investors to the country.

In addition, the historic event of foreign shareholders defeating the management of one of Japan’s largest corporations could point to a decline in the Keiretsu system.

According to analysts, a potential reason could be that major Japanese corporations do not want to draw the ire of activist shareholders, especially at a time when inexplicable financial manoeuvres are facing increasing investor scrutiny.

Splitting-Up versus Going Private

The Strategic Review Committee consisting of the four outsider directors has recommended splitting up the company, while declining the private sale-route.

However, several shareholders have questioned the move as they aren’t convinced about it being the best way to create value. After the announcement, the company’s shares traded in Frankfurt fell over four per cent.

In April 2021, CVC Capital had proposed a $21 billion bid for Toshiba, whose current value is under $20 billion currently. The proposal was rebuffed by Toshiba back then.

The shareholder readiness to accept a split instead of sale of Toshiba would depend on the investor perception of the Strategic Review Committee and its independence.

The company might find it difficult to get investors to believe in the company’s split with blind faith, rather than opting for a outright sale.

Given Toshiba’s exposure to critical sectors, the Japanese government might be reluctant to let foreign private investors in. Some investors like Elliott Management hiked their stakes after the CVC bid for Toshiba, indicating that these shareholder activists might prefer a sale.

It remains to be seen whether the split will be supported by investors, especially activists who would prefer a more concrete path to value creation.

Nevertheless, the recent events did shake up Japanese managements that have so far relied on Keiretsu, government alliances, and the lack of shareholder activism to run companies like their personal fiefdoms.

Also Read: Explained: Why The Troubled Japanese Conglomerate Toshiba Is Splitting Into 3 Separate Companies