Olympus and the ‘Japanese Solution”

[ Article by Stephen Givens,the Japanese version of which is available at: http://bit.ly/NkdDDi] –>

The story of Olympus continues to unfold in fascinating ways, an uncontrolled experiment revealing what happens when Japanese corporate culture collides against the forces of globalization.

The first act began as a morality play unwittingly set in motion when Olympus’ pagan management invited a Christian missionary into the village. Olympus management, having spent decades elaborately sweeping investment losses under the rug, appointed an Anglo-Saxon Christian completely unschooled in the ways of Japan as a figurehead president. With Aeschylean hubris Olympus management believed that Michael Woodford, blind as Mr. McGoo in the Japanese village, would never uncover the accounting fraud and would serve as a docile symbol of the company’s international aspirations. But, upsetting the best laid plans, a Japanese investigative reporter tipped off Woodford, who proceeded to act like Jesus throwing the moneylenders out of the temple. Instead of handling the problem behind the scenes in the expected Japanese way, Woodford blabbed to the Financial Times and flew back to England to ask the British Special Fraud Office to investigate. Annoyed at the moralistic fingerpointing by Woodford and his foreign allies, the Japanese establishment closed ranks and resolved to handle matters in the Japanese way.

Following ancient precedent, the task of righting Olympus fell to Olympus’ “main bank”. It was decreed that, if nothing else, Olympus would not be allowed to fall into foreign hands. Olympus management was selectively purged. Carefully rallying the Japanese corporate shareholders of Olympus, the establishment fought off an attempt by Woodford and Olympus’ foreign shareholders to restore him to office. “Independent” committees were established to nominate a new slate of “independent” directors; this resulted in the nomination of veteran of the “main bank” as chairman and two members of the nominating committee nominating themselves. The foreign shareholders called foul, but did not have the votes to reinstate Woodford or elect their own slate of candidates.

Having dealt with Woodford and the foreign shareholders, the Olympus’ minders were now free to implement a classic longer-term Japanese solution, brilliantly designed to appease and lock in all of Olympus’ principal constituencies—all constituencies, that is, other than the general shareholders. The proposed solution is to appoint a Japanese “sponsor” to help restore Olympus back to health, in a package deal that combines three elements.

First, the sponsor would inject equity to beef up the debt-burdened balance sheet. The two leading sponsor candidates, Sony and Terumo, have both offered an equity injection of ¥50 billion. At the current share price this would translate into an 11% shareholding. Second, Olympus and the sponsor would enter into some form of “cooperation agreement” to exploit synergies between the two companies, primarily in the field of medical devices, where Olympus is still viable. Third, the door would be left open for a full merger between Olympus and the sponsor at some point in the future, on undetermined terms.

It is easy to understand why the “sponsor” scenario appeals to Olympus management: It preserves Olympus as an independent entity and therefore enables incumbent management to maintain their positions and autonomy. Talk of a full merger and loss of independence is deferred to the future. Discussions have been limited to potential sponsors incumbent management feels comfortable with, which apparently disqualifies foreign sponsors. Olympus management is indebted to the banks for not selling them down the river, a favor they will surely return in due course in the years to come: a classic Japan bond of mutual obligation.

It is easy to understand why it appeals to the bank lenders, who have ¥390 billion in loans outstanding and a very thin equity cushion at this point. Every bit of additional equity pumped into Olympus will make it more certain that their loans are repaid. As Olympus’ foreign shareholders have pointed out, the banks do not care how much Olympus shareholders are diluted by a third party allotment of shares. The value of the banks’ share ownership in Olympus is trivial compared to the huge amounts they stand to lose if their loans are not repaid. Unlike general shareholders, the banks care about how much equity is injected, but not so much about the number of shares the sponsor gets in return. When you wear two hats as shareholder and lender you look at the big picture.

It is also easy to understand why this approach appeals to the potential sponsors. For a modest equity injection up front, the successful candidate will get bargain access to “cooperation” and technology that would normally be available only if the entire company were acquired. As Olympus’ largest shareholder, the sponsor would be in a position to influence the terms and content of the “cooperation” in the sponsor’s favor, just as Renault has been able to negotiate favorable “cooperation” from Nissan. It hedges the risk that after paying to acquire the entire company, the value of the investment would be impaired by a large judgment in favor of Olympus’ former shareholders who have brought securities fraud litigation against the company. Perhaps best of all, the sponsor would enjoy an 11% shareholding that would effectively (with the cooperation of the bank shareholders) prevent Olympus from falling into the hands of a third party. Therefore, when the time for a full merger arrives, the sponsor can negotiate the merger on favorable terms and effectively block any competing bids.

Finally, one can infer why Olympus’ board of directors also likes the plan. It lets the board avoid taking a position on Olympus’ corporate valuation. This would be a highly visible and controversial issue if the proposed transaction were a straight equity participation or buyout. The sponsor plan fudges the issue of valuation by structuring the equity injection and “cooperation agreement” as a package deal and deferring the terms of a complete merger down the road. The sponsor plan, in short, lets the board avoid making decisions about anything so vulgar as money, and lets it instead act as a beauty contest judge evaluating in softer focus the appropriateness of the sponsor candidates as long term partners for Olympus. Frustrated that it was being ignored as a sponsor candidate and conscious that simply offering more money would not improve its chances, Terumo took the risky and un-Japanese tactic of filing a lawsuit against Olympus to gather attention.

As we are often told, business in Japan is not about money, it is about relationships, complex webs of relationships. The Japanese solution to the problem of Olympus is to weave yet more interdependent relationships and obligations, more blurred roles and dual functions, between and among Olympus’ constituencies, with the result that no decision can ever be made cleanly on the merits. The FSA, the shareholder/lender banks, the shareholder/sponsor/business partner/presumptive merger counterparty, incumbent Olympus management, the new “independent” board are all woven into a prototypically Japanese symbiotic ecology. Nobody can move without consulting everyone else. It is an organic ecology of interests, relationships and obligations ubiquitous in Japanese society.

According to Western norms of corporate governance, of course, this is heretical nonsense. If Warren Buffett were on the board of Olympus, the first question he would ask would be, “Why aren’t we putting the company up for sale?” Viewed from the standpoint of Olympus’ general shareholders, it is hard to understand the benefits of the “sponsor” scenario compared to the much more straight-forward alternative of putting the company up for sale to the highest bidder. Giving the sponsor a significant block of shares up front means that there will almost certainly never be a contest for control that would yield a significant control premium for shareholders.

To be sure, there is nothing in law or in theory to prevent General Electric or any other company that finds Olympus’ assets attractive from going over the heads of Olympus management and making a tender offer bid directly to Olympus’ shareholders. But the company is protected by a nasty poison pill. Dismantling the poison pill would require taking a shareholders vote. And as Michael Woodford’s failed bid for reinstatement showed, Olympus’ domestic corporate shareholders will almost certainly turn their backs on a hostile bid, no matter how much of a premium they are offered. A Japanese company that tried a hostile bid would be treated as a pariah. As of 2012, Japan still has yet to witness a successful hostile bid. It is not the Japanese way.

Olympus was an opportunity for Japan to bring its corporate governance in line with that of the other advanced economies. Instead the establishment chose a Japanese solution that exposes how quaintly out of synch Japan’s corporate culture is with that of the rest of the world.

- Stephen Givens, Principal at Givens Gaikokuho Jimu Bengoshi Jimusho

The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.

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