Increasing Japanese Overseas M&A Has Significant Management Implications

The last few years have seen increasingly strong overseas merger and acquisition activity by Japanese companies. This is being driven by factors such as: a Japanese domestic market which is shrinking in many sectors as a result of Japan’s declining population; a cashed up Japanese corporate sector which is finally emerging from 20 years of balance sheet deleveraging, following the bubble of the late 1980s; a continued strong Japanese yen, making new overseas investment especially attractive; and the state of the economic cycle in the US and Europe, which is seeing companies in specific sectors as ripe targets for takeover.

In the ‘80s, a good deal of Japanese overseas M&A was fuelled by the Japanese banks providing their customers access to huge leverage. With plenty of funds to splash around, due diligence around the investment decision was often relegated to a lesser role in the determination of whether or not to proceed with such investment. A number of disastrous investments, most notably in the acquisition of foreign real estate, saw huge destruction of investment value as these overseas owned assets, following the bubble, were progressively liquidated over the decade of the ‘90s and funds were repatriated to the lenders in Japan. This over exuberance by the Japanese corporate sector has many historical precedents. It can be characterised as a management/investment style which, whilst expensive, has provided the “learning by mistake” mode that many Japanese corporates have adopted. After a hiatus (often measured in years), follow up overseas investments in the same area have been more studied as the lessons from the past have been digested.

Although past behaviour would suggest that this current overseas M&A boom will see a more measured investment stance, the current surge in overseas Japanese M&A is throwing up a new challenge. This is the shortage of Japanese executive talent having global experience. Why has this occurred?

There are many factors which have resulted in this outcome. On Japan’s domestic front, years of deflation in Japan and a sluggish domestic economy have seen the unravelling of Japan’s excessively layered distribution channel. A conspicuous change also saw the excessively inflated Japanese domestic prices of luxury brand goods tumble. This occurred as those overseas brand companies took stronger footholds in the Japan market and a larger slice of profits from a slimmed down distribution channel. So, whereas previously, the Japanese traveller would go overseas and purchase luxury brand goods at much more reasonable prices than Tokyo, now there was less incentive to do so. Above all, Japan’s record of safety (although recently challenged by Fukushima) and the legendary operational efficiency of Japan have reinforced in young Japanese the attitude that they do not require the interruption of an overseas adventure as a necessary part of their career development – why is it necessary when everything is so accessible and available in Japan – and furthermore where you do not experience any language communication challenges.

The result of this is an erosion of the numbers of Japanese studying abroad (and interestingly, a strong decline in the number of young Japanese participating in volunteer projects abroad.) This has resulted in a smaller potential pool of management having extended exposure to foreign cultures as well as their developing foreign language skills or competency.

So many male management aspirants have pursued less risky career paths, opting for the certainty of working with a known quantity of a Japanese corporation in Japan.

Bearing in mind the lead times necessary to develop the managerial talent, the current status suggests that this is only going to exacerbate the shortage of globally qualified and experienced executives.

A further pressure point in this story is the increasing requirement for these executives to have board experience consistent with the “Anglo-US” model. As the Japanese overseas M&A proceeds, Japanese executives are likely to find themselves in executive director and non-executive director roles. Drawing only on their Japanese board experience, they have little exposure to the role and operation of Anglo-US boards, a key difference being the strong acknowledgment of governance issues and the board being composed in balanced fashion of both executive and non-executive directors to add another layer of control. (In Japan, amongst listed companies for example, the average number of non-executive directors on a board is very small and insignificant compared to the number of executive directors.) The reason why Japanese boards have developed along their path as they are today, is well documented. But failures of governance (the current Olympus issue is a case in point) and demands for greater transparency are increasingly becoming a subject for debate and additional regulation in Japan.

So a key challenge will be how Japanese executives, with board positions on their overseas acquisitions, use their board position and authority to nurture, protect and preserve their company’s overseas investment.

In Japan meanwhile, there is an awareness that globally minded and experienced managerial talent has to be developed. There are a number of interesting policies (both of a short and long term nature) which are being implemented including: recruitment of more foreign nationals to work in Japan alongside Japanese managers; experiments in mandating English as a main communication language in Japanese companies; mandatory assignment of new employees to serve for one or two years in the company’s offices abroad; and seeking to tap into the female managerial segment which is grossly under represented in Japan, compared to overseas. Further recognition of the importance of the globalisation issue is the recent announcement by Tokyo University of consideration of changing the annual enrolment timing which is currently at odds with the timing of the intake into institutions in the major overseas markets. This acts as a deterrent to foreign students studying in Japan – one method of building future global human network linkages. The proposed timing move by Tokyo University would see first year students have a “gap term” of 6 months between their high school graduation and university entry – at which time they would be encouraged to gain valuable early experience by going abroad.

Japanese M&A activity this time around is certainly going to offer up a new set of management challenges and it is not to difficult to see that the required responses both in the short and medium term will generate a number of new business opportunities, both in overseas markets as well as inside Japan.

 David H Jacobs