Ichiro Suzuki From time to time in recent years, Japan’s opposition politicians have called for a new tax. It is one on retained earnings that sits on balance sheets. Since cleaning up the balance sheets in the aftermath of the late 1980s bubble, Corporate Japan relentlessly built their capital base in order to cope with unexpected shocks. Their robust base of retained earnings often made headlines, as a proof of their fortress balance sheets. Hefty retained earnings base drew attention of some politicians, perhaps not surprisingly. Calling for a new tax on retained earnings, however, these politicians have exposed their ignorance to the public. Retained earnings is a part of shareholders’ equity on the right hand side of the balance sheet. It is a difference of a combined figure of liabilities and paid-in capital, subtracted from total assets. Since it is a residual figure, what it exactly represents can’t be pinpointed. For most corporations, this residual number is closely related to the sum of cash and marketable (short-term) securities, long-term equity stakes in other companies and fixed assets. Corporate Japan’s notorious mutual shareholdings system stands for a distinct example of long-term equity holdings shown on the asset side of the balance sheets. What politicians want to tax appears to be cash and its equivalents. Over the last three decades, Corporate Japan has built a hefty cash base. Banks became unwilling and sometimes unable to extend loans in the 1990s upon the burst of the bubble that damaged their capital base. Corporations played defense in this emergency to build a stack of cash, by aggressively disposing under-performing assets and discontinuing businesses that were no longer considered as their core. Mutual shareholding practices took a decisive hit. Holding other companies’ shares made sense in an environment of rising share prices. Then, relentless correction of the equity markets weighed on their balance sheets, even if cost of those shares, acquired decades ago, were still a fraction of their market prices. By the end of the 20th century, Corporate Japan’s balance sheets carried abundant cash and continue to do so so in the 21st century. It was said at that time that banks wanted to lend only to Toyota that did not have to borrow from them. So everyone tried to become like Toyota. The post-bubble banking crisis made Corporate Japan better at generating cash than before. Significant slowdown of the Japanese economy’s growth rates did not give management investment opportunities. This allowed cash to be pile up on balance sheets. This excess cash, or excess savings, was deposited with banks which in turn bought Japanese government bonds due to lack of lending opportunities. This is how JGB’s yields were brought down to utterly insane low levels though yield levels in the last ten years were much to do with the Bank of Japan’s hyper-aggressive quantitative easing. This is also how public spending was financed in recent decades, with government expenditure running persistently and distinctly above revenue. While ridiculous levels of Japan’s debt to GDP ratio, 250% at present and rising, alarmed many economists and hedge fund managers around the world, betting against JGBs has been a losing bet for well over a quarter century. In the mid-1990s already, its 10-year yield was as low as utterly unthinkable 0.50%, and still managed to fall to zero in the next 20 years. Excess savings in the private sector allowed the government to spend in an attempt to create some demand that was otherwise nonexistent in the economy. (But no one blames Japan’s private sector for savings too much, thus allowing the government’s spending spree.) Accumulation of long-term securities investments has been outpacing cash for decades. This took place in spite of unwinding of mutual cross share holdings. Rise of long-term investments probably displays Corporate Japan’s expansion into the overseas market with the domestic Japanese market hitting the wall. Japanese companies have been acquiring large stakes in foreign corporations in an attempt to expand their global presence. Many of these investments disappointed shareholders, as showcased in Japan Post’s Toll Holdings fiasco. In 2015, Japan Post acquired Australia’s transportation and distribution company for ¥620 billion (USD 5.2billion) in the hope of building a global distribution network. By 2021, JP wrote off two-thirds of the investment as it was revealed that the JP management grossly overpaid for Toll. While this case stands out as management’s inability to correctly assess the value of a company they buy, Japanese corporations’ naïveté is generally known among M&A players around the world. Goodwill as a consequence of paying too much, therefore, can explain some of retained earnings. Retained earnings can’t be taxed on. If politicians want to harass and punish big bad corporations, they might advocate a tax on cash. It may be rational for management to hold a large stash of cash for fear of unforeseen events. Such an event has erupted at last in 2020 with the novel coronavirus. That said, they should be still pressed harder for greater efficiency of assets, in a country where shareholders are less vocal and a threat of being taken over is not as strong as it is in the U.S. They wouldn’t act without some external pressure. A 10% ROE is a popular management goal among Japanese corporations for years, and this remains unfulfilled for two-thirds of them. In sharp contrast, Corporate America on average delivers ROEs in the north of 20% through management of balance sheets on top of higher profit margins. For Corporate America, pursuit of higher ROEs has gone too far with leveraged balance sheets that shrinks their equity base. Unlike Japanese counterparts, Corporate America is not excessively concerned about rainy days. Despite this, few episodes of extreme financial difficulties have been heard in getting through the economic downturn caused by the pandemic. If Corporate Japan finds it hard to boost profitability dramatically, management has to learn at least to keep their operations and hence balance sheets lean. A new tax on cash could be a good first step to drive them to this direction.
About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.