NTT and Japan’s corporate governance

By Ichiro Suzuki  Nippon Telephone & Telegram (NTT) has recently announced its intention to buy all the shares of NTT Mobile Communications Network (known as NTT DoCoMo) that NTT does not own. NTT DoCoMo is a 32% owned subsidiary of NTT. The size of this transaction is going to be 4.3 trillion yen or $42 billion, for by far the largest ever take-over bid on a Japanese company. With its equity market capitalization at 12.5 trillion yen ($118 billion), NTT DoCoMo is over 40% larger than the parent. NTT wants to take advantage of strong financials of DoCoMo at a time when the company is facing increasing capital investment requirements to deploy 5G systems and Prime Minister Suga’s pressure to lower rates on mobile communications. NTT also hopes to enhance its international competitiveness through the consolidation of the two companies. NTT is making a bid on its publicly traded subsidiary, and this is an important step toward healthier governance in the world of Corporate Japan. Japanese companies and business groups have been notorious about sprawling webs of group ownership structures, headed by a few companies that have leadership within the group. The complex structure was a response to dissolution of pre-war zaibatsu in a period that followed WWII. General MacArthur’s government headquarters (GHQ) banned a holding company structure altogether, through which Mitsubishi, Mitsui, etc. controlled myriads of subsidiaries in a variety of industries under an umbrella of one big headquarters company. In response to the ban, Corporate Japan evolved into holding a smaller number of subsidiary companies that had essential business relationships with the parent. Then, the parents took their subsidiaries to public, allowing a part of these companies to be traded in the stock exchange. Of course, bringing subsidiaries to the market brought cash to the parents’ coffer. DoCoMo was taken public as Japan’s largest ever IPO in October, 1998, at a time when the frenzied tech bubble was brewing. The IPO raised 2.1 trillion yen, or $18 billion. DoCoMo immediately became a wildly popular stock among retail investors at the height of the bubble. While listing subsidiaries in the stock exchange became a common practice, It has caused some serious problems. To begin with, this practice inflates the size of the stock market. These subsidiaries are still majority-owned by their parents, but the stake in the hands of the parents are double counted in the stock market. NTT’s 32% stake of DoCoMo must not be a part of the value that represents the stock exchange. However, in discussion of the size of the market, the doubly-counted value is often included. The size of the market on this basis, therefore, is overstated. Notorious mutual shareholding practices are further distorting the value of the Japanese market as a more complex version of subsidiary listing. As zaibatsu was dissolved after WWII and the main holding company at the pinnacle of the conglomerate was dismantled, the bank in the group became a pseudo holding company with only a 5% stake in a variety of companies in the group. Other major companies within the group also held minority stakes in their ’sister’ companies. This practice made it possible to place companies under control within the group such as Mitsubishi, Mitsui, Sumitomo etc. Again, this system of mutually-held shares overstated the value of the companies, due to double, triple or multiple counting of shares that are not free-float in the market. On top of double counting of shares, minority shareholders in those subsidiaries face a governance nightmare. These shareholders can be hardly sure about what kind of value their shares represent. In a land of weak protection of minority shareholders’ rights, minority interests in the publicly traded subsidiaries are most likely be disregarded. This is shameful. Having publicly-traded subsidiaries or mutually held shares, these practices add volatility to the market. The burst of the 1920s trusts in the U.S. was a case in point. Trusts became a multi-layer structure in the roaring 20s, to become a driver of a mega bull market. Many trusts had subsidiaries listed in the stock exchange and those subsidiary trusts had their own subsidiaries that were also publicly traded. Until the fall of 1929, inflated value of many of these trusts drove the market higher. Once the historic bull market had reached its peak, falling share prices of subsidiaries adversely affected the value of the parent companies. The structure magnified the depth and the severity of the downturn in the early 1930s. Corporate Japan suffered a similar ordeal once the stock market had reached the bubble’s peak at the end of 1989. Collapsing share prices of subsidiaries in a variety of group companies pushed down the value of core companies. Banks were hard it not only by ballooning of bad debts on real estate lending but also by shrinking value of the shares they carried on the balance sheets, intensifying a deep and persistent banking crisis in the 1990s. It took banks over a dozen years since the stock market reached peak before their balance sheet problems were sorted out. After the burst of the bubble, Corporate Japan moved, albeit very slowly, to the direction of better corporate governance. In 1997, holding company structures were legalized again, initially for the purpose of strengthening the struggling banks, to be in tune with a trend of financial industry consolidation in North America and Europe. After the 2008-09 global financial crisis, a shift to improved governance gathered pace. Electronics and engineering group Hitachi had bought out the stakes of about a half of the nearly two dozen publicly-traded subsidiaries, consolidating them into the balance sheets of the main company, Hitachi Ltd. Some other subsidiaries were spun out completely. Though Hitachi still have too many companies under its wing, the group structure has been much streamlined. And this process is still work in progress. Sony consolidated Sony Financials and Sony Music Entertainment on the balance sheet of the parent company, though these two publicly-traded subsidiaries were doing well and popular investments among retail investors. The direction NTT is going to pursue is commendable even if their management is doing this for a different reason. While NTT is making a right move, a large scale TOB by a company one-third owned by the government seems odd from a different perspective. It may look an anti-competitive action, against which the WTO might want to say something. In principle, governments, Japanese or else, should not be holding onto shares of the former monopoly businesses, be they communications, tobacco, railways or postal services. They should be fully spun out as independent, private businesses. The U.K. government has zero stake in British Telecom that was brought to public in October 1987, eight months after NTT. The French government owns only 13.4% of Orange, while almost a third of Deutsche Telecom is in the hands of the German government . About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.