2. What were T. Boone Pickens’ motives when he bought the share? As the largest shareholder of Koito Manufacturing, is he entitled to representation on the board, does Japanese law allow for that? If not what in the law could he use to get an equivalent result?
T. Boone Pickens was known in America as an aggressive hostile bidder for corporations that he targeted as good investment opportunities. Mr. Boone complaineid that the Japanese market was essentially closed to American investors wanting to invest (with full rights) in Japan. The biggest problem were the silent barriers caused by business customs. Boone stated that the U.S. sentiment toward Japan would become hostile if Japan did not open its market more to American investors. In 1989, Boone announced that he had bought 32.4 million outstanding shares (20.2%) of Koito. He saw this purchase as a “test case” to determine the accessibility of the Tokyo market. In september Boone extended this amount to 42.2 million (26%). With this amount Boone would be the largest shareholder of Koito (Exhibit 1).
Because the holding of Boone exceeded the 10% he was allowed to inspect the Koitos’ accounting records and to demand for confidental financial documents. Analysts considered a takeover unlikely, since the remaining 60 to 65% was still in “friendly” hands. Mr. Pickens did a request for board representation, but Mr. Matsuura told the press,: “ We gave no specific answer but explained generally that it is not a custom in Japan to just say, I’ve become a major shareholder so I should become a director.“ Other directors said they don’t like Mr. Pickens to participate, because he works in the oil business and has no experience in a manufacturing industry, so we don’t want to recognize him as a manager.
In Japan the common shareholders as a whole elect the board of directors and have the ultimate legal control. Corporate Governance in Japan is strongly influenced by relationships: relationships between the company and its employees who expect a lifetime employment, and the relationship between the company and its customers and suppliers (keiretsu). These relationships influence board composition and company policy. Most of the time long-term employees are the primary source for the board of directors. This also explains why the policy is more employee oriented than shareholder oriented (Loewenstein, 2001).
You can see this clearly in the Toyota group as well. They were estimated to have at least 26% of their shares held within the group. Corporations and financial institutions with which Toyota had business dealings owned 87.7% of its shares and individual shareholders only held 9.3% of Toyota’s common stock. When Mr. Pickens requested for board representation he was overwhelmingly dienied by 60% of shareholders of the ‘management’s pocket’.
These cross-shareholding agreements are very common in Japan. The ownership is higly concentrated and the divergence between cash-flow rights and control rights is large (Claessens, Djankov, Fan & Lang, 2002). This makes it very difficult to get in the board of a Japanese corporation, especially as an American outsider.
What to use to get an equivalent result? He may expropriate minority shareholders by tunneling resources from firms where has have low cash flow rights to firms where he has high cash flow rights. Mr. Pickens can do this by buying shares in another company in which the controlling shreholder has some shares (Bertrand, Mehta & Mullainathan, 2002).
3. Besides board representation, T. Boone Pickens demanded higher dividend payouts. Were his demands justified? Provide quantitative evidence to back your answer. Is there anything in the Japanese commercial code that would allow Pickens to try to get more dividends? If yes, why doesn’t he use this? If not, based on your experience as an international investment banker, what changes would you recommend him to propose?
Mr. Pickens asked Koito to increase its September 30 semi-annual dividend to ¥7 from ¥4 per share. As a response Koito announced not to raise the dividend. If Mr. Pickens’s shares had been purchased on margin, the annual interest burden of carrying them would have been between $50 million and $100 million, well above stock’s roughly $2.5 million dividend. He bought the shares using leverage to maximize his wealth when prices rise. Any increase in Koito’s dividend would make it easier for whoever held the Koito stock to cover margin interest. Mr. Pickens criticized the board’s move for neglecting individual shareholder interest. A full seven months after Mr. Pickens challenged Koito to raise its dividend, Koito did so, from ¥8 to ¥10 per share (5 semi-annually).
To see whether Mr. Pickens demand is justified we have analyzed the history of Koito. If we look to the payout ratio, it is quite constant over the years around 40%. The ratio increased to 44/45% in In 1989 and 1990 the ratio increased to 44% and 45% respectively. Based on this number it is not suprising that Koito did not raise the dividends. On the other hand, the current ratio has risen from 1,47 in 1982 to 2,02 in 1989. So Koito is at least able to decrease their current ratio again to 1,5. Since the cash balance increased from ¥ 3295 in 1982 to ¥19146 in 1989 (Exhibit 5). Therefore Koito should be able to increase their dividend payments by using cash.
Looking at the dividend yield. 10/2,950=0.34. Average dividend yield of the S&P 500 is 2.11%, and the average dividend yield of the Tokyo Stock Exchange in 1990 was 0,81%. The dividend yield of Koito 0.16 in 1989 and 0.34 in 1990 are quite low in comparison with the average dividend yield. So if the dividends will rise to 7 (14 annually) the dividend yield will be: 14/29,50=0,47. Based on the information of the total industry, Koito’s dividend is low and the demand may be justified.
In the Japanese commercial code there are some articles, which sets an upper limit to the payout of dividends. The results are in the excel sheet.
Article 290. Profit Dividends states:
1. Profit dividends shall have as their limit the net assets of the balance sheet less the amounts hereunder: (1) Amount of Stated Capital (2) The total amount of legal earned surplus and legal capital surplus (3) The amount reserved for the said accounting period for legal earned surplus (4) Such other amounts as provided by Ministry of Justice Ordinance 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. T Boone should improve confidence of the board, this could be another way.
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. Article 293 Standards for Profit Dividends and Interest Dividends Interest or profit dividends shall be in proportion to the number of shares held by each shareholder. Provided, however, that this shall not prevent the application of the provisions of Article 222 [Classes of Shares], paragraph 1. In addition, there shall be no interest or profit dividends for shares held by the corporation itself.
Article 538. Dividing of Obligations – Profit Dividends
When the investment has been reduced to losses, the undisclosed association member cannot demand distribution of profits unless he makes up such decrease. Article 290.
1. Profit dividends shall have as their limit the net assets of the balance sheet less the amounts hereunder: (1) Amount of Stated Capital
(2) The total amount of legal earned surplus and legal capital surplus (3) The amount reserved for the said accounting period for legal earned surplus (4) Such other amounts as provided by Ministry of Justice Ordinance 2. When there has been a dividend made in violation of the provisions of previous paragraph, the creditors of the corporation can require a refund.
Shareholders without direct or close indirect representation on corporate boards had little voice in the control of Japanese corporations. Shareholders with 1% ownership or more could add items to the agenda at shareholders’s meetings. With 3% of the stock, they could call a special shareholders meeting (at their own expense) and could apply to a court to remove a director.
[ 1 ]. Only if the holding is for more than six months.
[ 2 ]. http://www.learnbonds.com/the-chart-that-should-scare-every-bond-investor/ [ 3 ]. Negishi, Ramachandran & Mino, 2001, Economic Theory, Dynamics and Markets.
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