Post on 21-Apr-2015
INTERNATIONAL FINANCIAL ECONOMICS
UNIVERSITY OF AMSTERDAM
Koito Manufacturing, Ltd.
Jasper Dijkstra 5876362
Jack Driessen 0516511
Mark Jager 10192921
Xin Wang
Maarten Dalm 10216081
Question 1
Many economists argue that the keiretsu system has been a formidable impediment to the
entry of Western companies into the Japanese market. However, the absence of liberal market
competition may preclude Japanese firms from implementing more cost-effective sourcing
strategies at the global standard.
Furthermore, it is often argued that the keiretsu system has been partly responsible for the
decade-long recession: while there was need for quick changes, the negative features of the
keiretsu form of governance maintained the economic slump. The interdependence of
suppliers, unproductive cost management and top-down decision making based upon
continuity and consensus all contributed to the decade-long recession.
We will now discuss the corporate governance issues that may arise, seen from different
perspectives.
a) From the perspective of financiers.
Financiers are always looking for the best investment possibilities. The keiretsu system
can make it difficult for (individual) financiers to invest in the best possible option. This
is because of the fact that a keiretsu will not allow foreign or alien companies into their
system. On the other hand, when the leading company of the keiretsu needs money,
financiers can more or less be obliged to invest: the money is invested in a bad project
and possible profits are lost (Kawai, 2009).
b) From the perspective of owners.
One of the key features of the keiretsu system is member cross-ownership. These owners
are the control-oriented owners. Their primary concerns are the relationships with the
businesses in which they have stocks. So their objective is to maximize the relationship
values and the economic performance of their keiretsu as a whole, not maximizing the
market value of a single company: these cross holding arrangements also lead to
ambiguity on whose interests are really being represented.
c) From the perspective of suppliers
The major issue for suppliers is that they can be exploited by their Keiretsu leading
company. Because of the tremendous dependence of the suppliers on their principals, they
are basically forced to accept all terms and conditions. Also in our case, Koito is more or
less dependent on Toyota group, which is responsible for 53% of the sales.
d) From the perspective of employees.
The employees work in the same keiretsu during their career. They can work in different
companies during the time, but will not work for another keiretsu. Employees of different
companies in one keiretsu will often engage in switches between companies for the long
term or for a short-term joint project. For that dedication to the keiretsu the employees are
“rewarded” with job-security, health insurance and other benefits.
Question 2
Mister T. Boone Pickens bought shares in Koito Manufacturing to invest. By being the
largest shareholder of the company he would have thought that he could have much to say
about the company. This is not the case in Japan. In America it is custom to put shareholders
interest first, but in Japan there are other different kind of stakeholders that boards in Japan
think about. As can be seen from the previous question, in Japan they also take financers,
owners, suppliers, employees and also customers and local community into account.
Although he was the largest shareholder, he was never in control of the company. The board
of directors accuses him of being a greenmailer mainly to convince the other shareholders not
to vote with him on the annual meetings and to resist giving him the company accounts.
First of all, the Japanese law probably allows T. Boone Pickens on the board, but there are
two reasons why he will never be on the board.
Firstly, he will not get enough votes in an annual meeting to be voted on the board, because
the current board of directors accuses him of being a greenmailer. Usually members of the
board are elected with unanimous vote.
Secondly, there is a large culture difference between the Japanese corporate governance and
the Anglo-American corporate governance. In America the board consists of independent,
outside directors, but in Japan almost all directors are from inside of the keiretsu. It is
important to them that the big stakeholders within the keiretsu are represented on the board so
everybody can ensure their own interest. This does not mean that major shareholders have
board representation. The employees of these companies with large shares are almost always
put forward to represent the large shareholders on the board. These employees do not have
large shares in the company.
Mr Pickens could, if a shareholder holds more than 10% of the shares, ask to inspect the
company‟s accounting records and to apply to a court to appoint a special auditor for this
purpose. The problem here is that the company is allowed to reject this if they believe the
shareholder wants to harm the company. This request by T. Boone Pickens was denied twice
probably for reasons above.
Japanese law also allows large shareholders to make a proposal to the board of directors.
After a six-month waiting period for exercising his shareholder rights, Mister T. Boone
Pickens demanded that Koito Manufacturing should raise its dividends. The board must at
least give a reaction in writing according to Japanese law. In the end he got a raise in
dividends, but it was only as small part of what he asked for. As will be illustrated in the next
question it is not surprising Mister T. Boone Pickens asked for a larger dividend pay-out.
Question 3
Mister T. Boone Pickens demanded higher dividend pay outs. There are two ways to
approach this problem. First, the historic percentage dividend and retained earnings to the net
income is looked at. After that, the upper limit of dividend that is regulated by Japanese law
is considered. Both give different insights to the problem.
If we look at the figures of net income and the amount that is paid out as a dividend, the
percentage is quite constant. The average ratio is 40% and this is lower than the dividend
ratio received in 1989 and 1990, 45% and 44% respectively (figure 1).
Thus, looking at the history of the dividends it is not so surprising that Koito Manufacturing
did not raise the dividends. On the other hand, the amount of retained earnings is very high.
On average 58% of the net income is reserved as retained earnings and therefore not paid out
as dividends. This is a vast amount of earnings that is not distributed to shareholders.
In the commercial code of Japan there are two articles that provide a legal upper limit to the
total amount of dividends. Article 290 (Profit dividends) and article 293-5 (Midterm
dividends). Here the total amount of dividends that can be paid out is the net assets less total
capital and reserves, less legal earned surplus and less dividend and acquisition costs. For
midterm dividends, article 293-5, this amount gets corrected with the reduction of past years
legal earnings surplus and capital. This has not happened in the years given in the case. It can
be seen from figure 2 that the maximum amount of dividends is not paid out.
Taken into account these figures, the maximum dividends are much higher than the dividends
actually paid by Koito Manufacturing. The difference between this is even rising through the
years, see figure 2. In 1990 the total difference is almost 20.000 million Yen and thus it is not
surprising that Mister T. Boone Pickens demands higher dividends.
As can be seen from the balance sheet in the case (Exhibit 4), voluntary earned surplus and
unappropriated are the accounts where the earnings that have been retained are held. As can
be seen these accounts are increasing every year.
There is one way in which Mister T. Boone Pickens can try to get more dividends. He can try
to make the directors liable for distributing a smaller amount than the differential of the
dividends based on article 293-5, paragraph 5 of the commercial code of Japan. Only when
the directors can prove that this is done because of care in his view, than this is not
considered as a liability for the directors. On the basis of article 266 (liability of directors of
the corporation) of the commercial code of Japan, the directors are liable if a shareholder
submitted a proposal relating to profit dividends. Mister T. Boone Pickens has done this, but
it does not mean the Directors have to obey him if they are careful. Mister T. Boone Pickens
would have a strong case looking at the figures, because the difference in paid and maximum
dividends is rising. He can make the directors liable for not distributing enough dividends.
Mister T. Boone Pickens did not do this, because this could be interpreted as „greenmailing‟.
He does not want to get this reputation because this would mean the directors of Koito will
not take him seriously. Furthermore, if the directors suspect him of greenmailing, they have
another reason to refuse him the demand of inspection of accounts based on article 293-7 of
the commercial code of Japan. In this article the directors can refuse the inspection of
accounts if they think the inspector is a treat to the company. This is the case at the moment,
and in this way the directors can try to keep him in the dark.
Question 4
Toyota and Koito are in a vertical Keiretsu (exhibit 6). This implies that these two
corporations engage in a tight and long-term commercial relationship. Toyota is the main
company of the Keiretsu, it is the most important customer of Koito with 48% of the sales
(exhibit 2) and it is the second largest shareholder of Koito with 19% (exhibit 1). Therefore
Toyota has a lot of influence on Koito and a negative effect on the profits of Toyota would
affect Koito negatively as well. So if Koito would increase their prices for Toyota it could be
harmful for Koito and for Toyota. Since Toyota has power over Koito, it could keep the
prices artificially low at the expense of shareholders. A self-dealing transaction occurs when
there is a company or a director on both sides of the transactions. Three members of the board
of Koito were, according to Pickens, representatives of Toyota. So Toyota was on both sides
of the transactions and thus it is a self-dealing transaction.
Pickens could look at the prices that are set for Toyota and for other companies. If, for the
same product, the prices for Toyota differ from prices for other companies, it could be proven
that Toyota limited the profits of Koito. This is then also proves that there occurred a self-
dealing transaction between Toyota and Koito.
If we were investment bankers we would tell Pickens to investigate the dividend yield,
because it dropped from 2.32% in 1982 to 0.34% in 1990, and it was even lower, 0.16%, in
1989 (exhibit 5). This can be proof that Koito pays too little dividend. Also there could be
proof of overvaluation of the shares of Koito. This can be seen in exhibit 5 as well. The P/E
ratio is very high in 1989 compared with the years before. This can be explained by
overvaluation of the shares. As the P/E ratio is, market value per share divided by the
earnings per share, the high stock price in 1989 is the cause of the high P/E ratio. Thus the
EPS are not growing as hard as the stock price, which can indicate that the stock price is too
high. Other things Pickens could investigate are explained in questions 3, the amount of
dividends paid.
We would change the charter of the organization. First, the representatives of Toyota should
be removed from the board and there should not be other retirees from Toyota on the board of
Koito to prevent self-dealing transactions. Second, there should be independent directors on
the board of Koito. They can have an unbiased look at the profits of the company and they
could look after the interest of minority shareholders who are not on the board.
Question 5
The “Toyota Motor Group” consists of many companies built around the car building
company Toyota Motor. Other car manufacturers belonging to the group are Daihatsu Motor
and Hino Motors (exhibit 6). In total these companies comprise a share in Koito
Manufacturing Ltd of 53% of customer base (exhibit 2). If T Boone Pickens would take over
the company, Toyota Group would cut all ties resulting in a tremendous loss in sales. Since
Toyota Motor group is responsible for more than half of Koito‟s sales, a retreat of the
company would be devastating for the current stockholders of Koito Manufacturing.
Being a minority shareholder, and having to choose between Koito Ltd and T. Boone
Pickens, we would definitely choose the side of Koito Ltd. Our main argument is that when
T. Boone Pickens would take control of the company, Toyota Motor Group would cut all ties
with Koito Ltd, resulting in a huge loss in sales and consequently shareholder value.
As mentioned before, 53% of the total sales of Koito Manufacturing Ltd. are to companies
belonging to the Toyota Motor Group. In a situation where T. Boone Pickens takes full
control of the company and the Toyota Motor Group decides to cut all ties, it is reasonable to
assume that the companies of the Toyota Motor Group will no longer buy auto parts from
Koito Manufacturing. This is because the Japanese keiretsu system exists of first and second-
degree suppliers, where Koito Manufacturing can be appointed to the first-degree suppliers
being in direct contact with the car assemblers. Koito in its turn buys its intermediate goods
from the second-degree suppliers also belonging to the Toyota Motor Group. They will
probably also need to search for new suppliers for these intermediate goods as these ties will
probably be cut as well.
A very important note is that we assume that the share price at 1990 fully reflects the beliefs
of the stockholders of Koito Manufacturing which means that Toyota Motor remains a client
of Koito Manufacturing.
Although the latter case is hard to quantify we can, however, take the loss in customer base
into account. If T Boone Pickens takes control of the company in 1990, we argue that 53% of
the revenue will be gone. The annual growth rate of the sales of the company is about 7.2%
per year (see table 1). We have further assumed that the large accounts in the income
statement will remain the same as a percentage of sales (e.g. costs of goods sold were around
85% of sales in the last 8 years; see table).
In table 3 our prognosis for the coming 10 years is stated. In 1991 the company will lose 53%
of its existing customer base. We have however assumed an autonomous growth rate of
7.2%, which was also the case in period before the take-over. This results in total sales of
¥62,256 million over 1991. The other accounts have been calculated as a percentage of sales
(the percentages are calculated in table 2). For the following nine years the autonomous
growth rate of 7.2% is furthermore assumed for sales. The same goes for the balance sheet
items (see table 4).
Now that we have calculated all the financial statement items for the period after a possible
takeover of T. Boone Pickens, the free cash flows have to be calculated before we can
calculate the share price. This is done in table 5. Free cash flow = EBIT – taxes+ depreciation
– change in net working capital – capital expenditures.
The discounted free cash flows are also stated in table 5. The valuation of the share price is
according to figure 3 where we also take into account the cash reserves and interest bearing
debt of the company. The fair value of the share then becomes ¥341, which is only a fraction
of the share price at 1990 of ¥2,950 (exhibit 5).
Appendix
Figure 1
Figure 2
Figure 3: DCF Valuation
Source: http://www.valuatum.com/supportportal/support/help-files-by-topic/wacc-&-valuation/112-dcf-
valuation.html
DCF Valuation
Cumulative discounted
FcF (millions)
¥36,332
Interest bearing debt
(millions)
¥261
Cash at bank (millions) ¥18,540
Value of equity, DCF
(millions)
¥54,611
Number of shares total
(millions)
160.36
Fair value of share, DCF ¥341
Table 1: annual growth per year
1982-1983 1983-1984 1984-1985 1985-1986 1986-1987 1987-1988 1988-1989 1989-1990 average
sales 2.9% 7.3% 7.9% 10.2% 4.1% 9.4% 5.1% 10.9% 7.2%
Table 2: as a % of sales
1982 1983 1984 1985 1986 1987 1988 1989 1990 average
COGS 85.2% 85.3% 83.5% 83.6% 84.1% 85.6% 83.9% 85.2% 86.2% 84.7%
SG&A expenses 9.4% 9.8% 10.9% 10.6% 10.6% 10.7% 11.2% 10.9% 10.6% 10.5%
Operating income 2.2% 2.4% 2.3% 2.7% 2.7% 2.7% 2.3% 2.5% 2.5% 2.5%
Non-operating income 0.6% 0.5% 0.5% 0.6% 0.4% 0.7% 0.3% 0.3% 0.5% 0.5%
Non-operating
expenses
0.4% 0.4% 0.2% 0.2% 0.2% 0.1% 0.2% 0.1% 0.1% 0.2%
Current Assets 41.5% 41.5% 44.1% 49.3% 45.5% 53.1% 57.0% 48.9% 49.7% 47.8%
Fixed Assets 29.8% 29.5% 27.4% 28.0% 28.0% 28.7% 24.7% 29.5% 28.8% 28.3%
Total assets 71.3% 71.0% 71.5% 77.3% 73.4% 81.8% 81.7% 78.4% 78.5% 76.1%
Current liabilities 28.2% 27.2% 27.7% 26.9% 25.9% 24.6% 26.8% 24.2% 27.5% 26.5%
Total Liabilities 33.0% 31.8% 33.1% 32.4% 30.5% 39.7% 32.0% 29.6% 32.6% 32.8%
Stockholder's equity 38.3% 39.2% 38.4% 44.8% 42.9% 42.1% 49.7% 48.8% 45.9% 43.3%
Table 3: prognoses when T Boone Pickens takes over the company – income statement
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
sales ¥62,256 ¥66,749 ¥71,567 ¥76,732 ¥82,270 ¥88,208 ¥94,574 ¥101,400 ¥108,718 ¥116,565
COGS ¥52,753 ¥56,561 ¥60,643 ¥65,020 ¥69,712 ¥74,744 ¥80,138 ¥85,922 ¥92,124 ¥98,772
Gross profit ¥9,503 ¥10,188 ¥10,924 ¥11,712 ¥12,558 ¥13,464 ¥14,436 ¥15,477 ¥16,595 ¥17,792
SG&A expenses ¥6,555 ¥7,028 ¥7,536 ¥8,079 ¥8,663 ¥9,288 ¥9,958 ¥10,677 ¥11,447 ¥12,274
Operating income ¥2,947 ¥3,160 ¥3,388 ¥3,633 ¥3,895 ¥4,176 ¥4,477 ¥4,801 ¥5,147 ¥5,519
Non-operating income ¥1,535 ¥1,646 ¥1,764 ¥1,892 ¥2,028 ¥2,175 ¥2,332 ¥2,500 ¥2,680 ¥2,874
Non-operating
expenses
¥305 ¥327 ¥351 ¥376 ¥403 ¥433 ¥464 ¥497 ¥533 ¥572
¥127 ¥136 ¥146 ¥157 ¥168 ¥180 ¥193 ¥207 ¥222 ¥238
Recurring profit ¥4,177 ¥4,478 ¥4,802 ¥5,148 ¥5,520 ¥5,918 ¥6,345 ¥6,803 ¥7,294 ¥7,821
income before taxes ¥4,177 ¥4,478 ¥4,802 ¥5,148 ¥5,520 ¥5,918 ¥6,345 ¥6,803 ¥7,294 ¥7,821
Taxes ¥2,229 ¥2,389 ¥2,562 ¥2,747 ¥2,945 ¥3,157 ¥3,385 ¥3,630 ¥3,892 ¥4,173
net income ¥1,948 ¥2,089 ¥2,240 ¥2,401 ¥2,575 ¥2,761 ¥2,960 ¥3,174 ¥3,403 ¥3,648
Table 4: prognoses when T Boone Pickens takes over the company - balance sheet
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Current Assets ¥29,786 ¥31,935 ¥34,240 ¥36,711 ¥39,361 ¥42,202 ¥45,248 ¥48,513 ¥52,015 ¥55,769
Fixed Assets ¥17,597 ¥18,867 ¥20,229 ¥21,689 ¥23,254 ¥24,933 ¥26,732 ¥28,661 ¥30,730 ¥32,948
Total assets ¥47,383 ¥50,802 ¥54,469 ¥58,400 ¥62,615 ¥67,134 ¥71,980 ¥77,175 ¥82,745 ¥88,717
Current liabilities ¥16,528 ¥17,721 ¥18,999 ¥20,371 ¥21,841 ¥23,417 ¥25,107 ¥26,919 ¥28,862 ¥30,945
Total Liabilities ¥20,395 ¥21,867 ¥23,445 ¥25,137 ¥26,952 ¥28,897 ¥30,983 ¥33,219 ¥35,616 ¥38,187
Stockholder's equity ¥10,460 ¥11,215 ¥12,024 ¥12,892 ¥13,823 ¥14,820 ¥15,890 ¥17,037 ¥18,266 ¥19,585
Capital expenditures -¥29,772 ¥1,948 ¥2,088 ¥2,239 ¥2,401 ¥2,574 ¥2,760 ¥2,959 ¥3,172 ¥3,401
change in net working
capital
-¥13,036 ¥957 ¥1,026 ¥1,100 ¥1,179 ¥1,264 ¥1,356 ¥1,454 ¥1,559 ¥1,671
Table 5: Free cash flows
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Free cash flows ¥44,935 -¥625 -¥670 -¥718 -¥770 -¥826 -¥885 -¥949 -¥1,018 -¥1,091
t 1 2 3 4 5 6 7 8 9 10
Discount factor 0.12 0.12 0.12 0.12 0.12 0.12 0.12 0.12 0.12 0.12
1.12 1.2544 1.404928 1.57351936 1.762341683 1.973822685 2.210681407 2.475963176 2.773078757 3.105848208
Discount FcF ¥40,120 -¥498 -¥477 -¥456 -¥437 -¥418 -¥400 -¥383 -¥367 -¥351
References
Kawai N. “Keiretsu Corporate Networks are Innate to the Japanese auto-sector, but could this System finally be changing?” Japan inc, 2009.