By John Ho
Japan is no longer open for business to foreigners. That was the message the government sent last week when it blocked our fund, the Children's Investment Fund, from increasing our stake in Electric Power Development Co. to 20% from 9.9%. The reasoning behind that decision raises worrying questions about the future development and efficiency of Japan's capital markets.
Tokyo has the right to block foreign purchases of companies in certain industries. J-Power, as the utility is popularly known, is an electricity wholesaler and is planning to build a nuclear power plant. The Ministry of Finance and the Ministry of Economy, Trade and Industry claim our fund's purchase would endanger "public order" and "national security," but they didn't specify how.
They couldn't. Our fund agreed to sign a legal document protecting the government's right to seize J-Power's assets in the case of an emergency. We didn't ask for a majority stake. The Ministry of Finance also claimed that we were "shortterm" investors. But the realized holding period of an investor is irrelevant to the sound operations of a listed company.
What's really at threat isn't the safety of Japan's power supplies, but its system of cross-shareholdings, where companies hold stakes in one another to fend off takeovers. Also at risk: the practice of "amakudari," or literally, "descent from heaven," where senior bureaucrats retire from government and take high-ranking jobs in the private sector. Both practices had started to decline under former Prime Minister Junichiro Koizumi. Now they're back with a vengeance, and J-Power is a good example.
Out of J-Power's 13 board members, two are former employees of the Minister of Economy, Trade and Industry-the same ministry that rejected our application. Management spent approximately 68 billion yen ($652 million), or 10% of its current market capitalization, over the last three years purchasing shares in cross shareholders. Fully 35% of its shares are, in turn, held by its suppliers and other cross shareholders. Allowing a foreign investor to purchase additional shares would threaten this cozy arrangement.
Shareholders play an important role of providing supervision and monitoring of any board of directors, be it J-Power's or any other company. When management uses shareholders' capital to buy shares in another company, there is an implicit arrangement to support the decision of that other company. This arrangement isn't necessarily detrimental, but it can raise serious conflicts of interest.
In J-Power's case, two of its biggest shareholders are Nippon Life Insurance and Mizuho Group. Both do business with J-Power. We would have demanded higher standards of corporate governance in J-Power, including return on equity targets, independent directors and more appropriate returns to shareholder through higher dividends. Would cross shareholders vote for better governance in the face of management opposition?
Japanese retirees rely on investment income and improvement in corporate value to maintain their living standards. Yet the ministries involved in the J-Power deal seem to have a strong desire to preserve a status quo which insulates management from meaningful foreign involvement and the kind of investors who actively promote better corporate governance.
If the Japanese government continues to shield its economy from market discipline, Japan's asset values will continue to decline, as both foreign and domestic investors lose confidence in the capital markets. The biggest losers won't be the foreign investors, who will take their money elsewhere. The biggest losers will be the Japanese citizens who built their economy into a world power. Now that's a real threat to national security.
Mr. Ho is Director of the Children's Investment Fund (Asia) Ltd.
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