INTERNATIONAL FINANCIAL ECONOMICS UNIVERSITY OF AMSTERDAM

Koito Manufacturing, Ltd.

Jasper Dijkstra Jack Driessen Mark Jager Xin Wang Maarten Dalm

5876362 0516511 10192921

10216081

c) From the perspective of suppliers The major issue for suppliers is that they can be exploited by their Keiretsu leading company. not maximizing the market value of a single company: these cross holding arrangements also lead to ambiguity on whose interests are really being represented. unproductive cost management and top-down decision making based upon continuity and consensus all contributed to the decade-long recession. Also in our case. which is responsible for 53% of the sales. the negative features of the keiretsu form of governance maintained the economic slump. the absence of liberal market competition may preclude Japanese firms from implementing more cost-effective sourcing strategies at the global standard.Question 1 Many economists argue that the keiretsu system has been a formidable impediment to the entry of Western companies into the Japanese market. it is often argued that the keiretsu system has been partly responsible for the decade-long recession: while there was need for quick changes. a) From the perspective of financiers. 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. b) From the perspective of owners. However. They can work in different companies during the time. One of the key features of the keiretsu system is member cross-ownership. These owners are the control-oriented owners. The employees work in the same keiretsu during their career. The interdependence of suppliers. We will now discuss the corporate governance issues that may arise. health insurance and other benefits. Because of the tremendous dependence of the suppliers on their principals. when the leading company of the keiretsu needs money. Koito is more or less dependent on Toyota group. 2009). . Financiers are always looking for the best investment possibilities. they are basically forced to accept all terms and conditions. d) From the perspective of employees. seen from different perspectives. This is because of the fact that a keiretsu will not allow foreign or alien companies into their system. For that dedication to the keiretsu the employees are “rewarded” with job-security. On the other hand. The keiretsu system can make it difficult for (individual) financiers to invest in the best possible option. financiers can more or less be obliged to invest: the money is invested in a bad project and possible profits are lost (Kawai. Furthermore. So their objective is to maximize the relationship values and the economic performance of their keiretsu as a whole. Their primary concerns are the relationships with the businesses in which they have stocks. but will not work for another keiretsu.

but there are two reasons why he will never be on the board. the historic percentage dividend and retained earnings to the net income is looked at. Boone Pickens on the board. the upper limit of dividend that is regulated by Japanese law is considered. outside directors. Although he was the largest shareholder. Secondly. because the current board of directors accuses him of being a greenmailer. These employees do not have large shares in the company. As can be seen from the previous question. After that. suppliers. Both give different insights to the problem. . employees and also customers and local community into account. Boone Pickens bought shares in Koito Manufacturing to invest. but in Japan there are other different kind of stakeholders that boards in Japan think about. Mr Pickens could. First. In America the board consists of independent. As will be illustrated in the next question it is not surprising Mister T. After a six-month waiting period for exercising his shareholder rights. The employees of these companies with large shares are almost always put forward to represent the large shareholders on the board. owners. The problem here is that the company is allowed to reject this if they believe the shareholder wants to harm the company. Usually members of the board are elected with unanimous vote. but it was only as small part of what he asked for. Firstly. 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. This request by T. Japanese law also allows large shareholders to make a proposal to the board of directors. Question 3 Mister T. Mister T. but in Japan almost all directors are from inside of the keiretsu. he will not get enough votes in an annual meeting to be voted on the board. he was never in control of the company. if a shareholder holds more than 10% of the shares. In America it is custom to put shareholders interest first. Boone Pickens demanded that Koito Manufacturing should raise its dividends. This is not the case in Japan. First of all. the Japanese law probably allows T. In the end he got a raise in dividends. The board must at least give a reaction in writing according to Japanese law. Boone Pickens was denied twice probably for reasons above. ask to inspect the company‟s accounting records and to apply to a court to appoint a special auditor for this purpose. Boone Pickens asked for a larger dividend pay-out. By being the largest shareholder of the company he would have thought that he could have much to say about the company.Question 2 Mister T. there is a large culture difference between the Japanese corporate governance and the Anglo-American corporate governance. in Japan they also take financers. This does not mean that major shareholders have board representation. Boone Pickens demanded higher dividend pay outs. It is important to them that the big stakeholders within the keiretsu are represented on the board so everybody can ensure their own interest. There are two ways to approach this problem.

It can be seen from figure 2 that the maximum amount of dividends is not paid out. The difference between this is even rising through the years. article 293-5. In 1990 the total difference is almost 20. they have another reason to refuse him the demand of inspection of accounts based on article 293-7 of the commercial code of Japan. This has not happened in the years given in the case. Furthermore. because the difference in paid and maximum dividends is rising. He can make the directors liable for not distributing enough dividends. the amount of retained earnings is very high. In the commercial code of Japan there are two articles that provide a legal upper limit to the total amount of dividends. Thus. but it does not mean the Directors have to obey him if they are careful. As can be seen from the balance sheet in the case (Exhibit 4). . Article 290 (Profit dividends) and article 293-5 (Midterm dividends). the directors are liable if a shareholder submitted a proposal relating to profit dividends.000 million Yen and thus it is not surprising that Mister T. On the other hand. For midterm dividends. 45% and 44% respectively (figure 1). He can try to make the directors liable for distributing a smaller amount than the differential of the dividends based on article 293-5. see figure 2. In this article the directors can refuse the inspection of accounts if they think the inspector is a treat to the company. He does not want to get this reputation because this would mean the directors of Koito will not take him seriously. The average ratio is 40% and this is lower than the dividend ratio received in 1989 and 1990. the percentage is quite constant. Boone Pickens has done this. if the directors suspect him of greenmailing. Mister T. because this could be interpreted as „greenmailing‟. and in this way the directors can try to keep him in the dark. As can be seen these accounts are increasing every year. Boone Pickens did not do this. Only when the directors can prove that this is done because of care in his view. Boone Pickens would have a strong case looking at the figures.If we look at the figures of net income and the amount that is paid out as a dividend. Boone Pickens demands higher dividends. Mister T. than this is not considered as a liability for the directors. less legal earned surplus and less dividend and acquisition costs. voluntary earned surplus and unappropriated are the accounts where the earnings that have been retained are held. There is one way in which Mister T. looking at the history of the dividends it is not so surprising that Koito Manufacturing did not raise the dividends. this amount gets corrected with the reduction of past years legal earnings surplus and capital. the maximum dividends are much higher than the dividends actually paid by Koito Manufacturing. paragraph 5 of the commercial code of Japan. Boone Pickens can try to get more dividends. Taken into account these figures. 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. Here the total amount of dividends that can be paid out is the net assets less total capital and reserves. Mister T. This is the case at the moment. On the basis of article 266 (liability of directors of the corporation) of the commercial code of Japan.

Also there could be proof of overvaluation of the shares of Koito. Other things Pickens could investigate are explained in questions 3. which can indicate that the stock price is too high. because it dropped from 2. in 1989 (exhibit 5). the high stock price in 1989 is the cause of the high P/E ratio. 0. Question 5 The “Toyota Motor Group” consists of many companies built around the car building company Toyota Motor. This implies that these two corporations engage in a tight and long-term commercial relationship. First. This can be seen in exhibit 5 as well. A self-dealing transaction occurs when there is a company or a director on both sides of the transactions. Since Toyota Motor group is responsible for more than half of Koito‟s sales. Three members of the board of Koito were. Since Toyota has power over Koito.16%. If. it could be proven that Toyota limited the profits of Koito. So Toyota was on both sides of the transactions and thus it is a self-dealing transaction. This can be proof that Koito pays too little dividend. Pickens could look at the prices that are set for Toyota and for other companies. We would change the charter of the organization. the prices for Toyota differ from prices for other companies. the amount of dividends paid. there should be independent directors on the board of Koito.Question 4 Toyota and Koito are in a vertical Keiretsu (exhibit 6). As the P/E ratio is. If T Boone Pickens would take over the company. Thus the EPS are not growing as hard as the stock price. according to Pickens. So if Koito would increase their prices for Toyota it could be harmful for Koito and for Toyota. 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). In total these companies comprise a share in Koito Manufacturing Ltd of 53% of customer base (exhibit 2).34% in 1990. The P/E ratio is very high in 1989 compared with the years before. This is then also proves that there occurred a selfdealing transaction between Toyota and Koito. and it was even lower. representatives of Toyota. . Second. 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. it could keep the prices artificially low at the expense of shareholders. Toyota Group would cut all ties resulting in a tremendous loss in sales. for the same product. a retreat of the company would be devastating for the current stockholders of Koito Manufacturing. Therefore Toyota has a lot of influence on Koito and a negative effect on the profits of Toyota would affect Koito negatively as well. market value per share divided by the earnings per share.32% in 1982 to 0. If we were investment bankers we would tell Pickens to investigate the dividend yield. 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. Toyota is the main company of the Keiretsu. This can be explained by overvaluation of the shares. Other car manufacturers belonging to the group are Daihatsu Motor and Hino Motors (exhibit 6).

the free cash flows have to be calculated before we can calculate the share price. The fair value of the share then becomes ¥341. The other accounts have been calculated as a percentage of sales (the percentages are calculated in table 2). resulting in a huge loss in sales and consequently shareholder value. 53% of the total sales of Koito Manufacturing Ltd. In table 3 our prognosis for the coming 10 years is stated. Koito in its turn buys its intermediate goods from the second-degree suppliers also belonging to the Toyota Motor Group. As mentioned before. In 1991 the company will lose 53% of its existing customer base. Free cash flow = EBIT – taxes+ depreciation – change in net working capital – capital expenditures. which was also the case in period before the take-over. Boone Pickens would take control of the company. The discounted free cash flows are also stated in table 5. we would definitely choose the side of Koito Ltd. Boone Pickens takes full control of the company and the Toyota Motor Group decides to cut all ties.g.Being a minority shareholder. Boone Pickens. The annual growth rate of the sales of the company is about 7. This is because the Japanese keiretsu system exists of first and seconddegree suppliers. If T Boone Pickens takes control of the company in 1990. see table). In a situation where T. We have further assumed that the large accounts in the income statement will remain the same as a percentage of sales (e. The same goes for the balance sheet items (see table 4). costs of goods sold were around 85% of sales in the last 8 years. we argue that 53% of the revenue will be gone. take the loss in customer base into account. are to companies belonging to the Toyota Motor Group. it is reasonable to assume that the companies of the Toyota Motor Group will no longer buy auto parts from Koito Manufacturing. where Koito Manufacturing can be appointed to the first-degree suppliers being in direct contact with the car assemblers.2% per year (see table 1). This results in total sales of ¥62. Boone Pickens. Although the latter case is hard to quantify we can. which is only a fraction of the share price at 1990 of ¥2. and having to choose between Koito Ltd and T. For the following nine years the autonomous growth rate of 7.256 million over 1991.950 (exhibit 5).2% is furthermore assumed for sales. We have however assumed an autonomous growth rate of 7. however. 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. They will probably also need to search for new suppliers for these intermediate goods as these ties will probably be cut as well. Our main argument is that when T. . Now that we have calculated all the financial statement items for the period after a possible takeover of T. 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. This is done in table 5. Toyota Motor Group would cut all ties with Koito Ltd.2%.

Appendix Figure 1 Figure 2 .

611 ¥261 ¥36. DCF ¥341 160.html DCF Valuation Cumulative discounted FcF (millions) Interest bearing debt (millions) Cash at bank (millions) Value of equity.valuatum.36 ¥18. DCF (millions) Number of shares total (millions) Fair value of share.332 .540 ¥54.Figure 3: DCF Valuation Source: http://www.com/supportportal/support/help-files-by-topic/wacc-&-valuation/112-dcfvaluation.

2% 44.9% average 7.5% 0.9% 47.9% 1985-1986 10.5% 42.8% 32.2% 1989 85.0% 24.Table 1: annual growth per year 1982-1983 sales 2.4% 49.0% 27.5% 28.1% 38.5% 0.6% 2.5% 10.7% 81.4% 1983 85.3% 9.7% 26.3% 0.5% 27.4% 1988-1989 5.3% 76.7% 0.8% 2.7% 10.2% 2.9% 2.1% 10.2% 1985 83.5% 29.9% 2.5% 2.3% 0.6% 0.5% 71.0% 73.8% 49.3% 1984-1985 7.6% 2.2% Table 2: as a % of sales 1982 COGS SG&A expenses Operating income Non-operating income Non-operating expenses Current Assets Fixed Assets Total assets Current liabilities Total Liabilities Stockholder's equity 41.7% 0.9% 29.8% 39.9% 30.4% 71.1% 1987-1988 9.6% 2.1% 1990 86.8% 28.5% 32.7% 28.8% 24.8% 71.6% 45.5% 29.8% 45.3% 0.0% 77.2% 41.6% 48.8% 43.1% 28.7% 81.4% 0.2% 33.2% 1986 84.3% 85.3% 0.5% 0.7% 2.4% 25.7% 42.4% 1984 83.8% 78.2% 9.3% .5% 0.9% 53.7% 0.5% 0.4% 44.0% 38.5% 78.3% 26.1% 27.5% 0.0% 49.1% 57.3% 28.2% 29.4% 0.6% 0.4% 2.3% 28.5% 32.2% 1987 85.7% 33.1% 26.2% 10.1% 1989-1990 10.6% 39.4% 24.2% 31.6% 10.2% 1986-1987 4.1% 1988 83.9% 11.7% 48.5% 0.2% 10.9% 32.6% 10.9% 1983-1984 7.2% 0.1% average 84.7% 0.5% 27.

630 ¥3.177 ¥4.148 ¥5.520 ¥2.385 ¥2.389 ¥2.478 ¥2.803 ¥6.802 ¥4.160 ¥1.567 ¥60.633 ¥1.345 ¥3.922 ¥15.749 ¥56.535 ¥305 1992 ¥66.028 ¥403 1996 ¥88.663 ¥3.274 ¥5.294 ¥3.478 ¥4.176 ¥2.500 ¥497 1999 ¥108.177 ¥2.294 ¥7.520 ¥5.712 ¥8.947 ¥1.892 ¥3.503 ¥6.Table 3: prognoses when T Boone Pickens takes over the company – income statement 1991 sales COGS Gross profit SG&A expenses Operating income Non-operating income Non-operating expenses ¥127 Recurring profit income before taxes Taxes net income ¥4.558 ¥8.477 ¥2.761 ¥193 ¥6.803 ¥3.643 ¥10.157 ¥2.924 ¥7.079 ¥3.447 ¥5.240 ¥157 ¥5.464 ¥9.895 ¥2.958 ¥4.677 ¥4.124 ¥16.345 ¥6.208 ¥74.821 ¥7.801 ¥2.747 ¥2.574 ¥80.403 ¥238 ¥7.288 ¥4.400 ¥85.945 ¥2.175 ¥433 1997 ¥94.028 ¥3.089 ¥146 ¥4.555 ¥2.148 ¥2.138 ¥14.646 ¥327 1993 ¥71.918 ¥3.174 ¥222 ¥7.229 ¥1.744 ¥13.561 ¥10.772 ¥17.764 ¥351 1994 ¥76.562 ¥2.188 ¥7.595 ¥11.802 ¥2.575 ¥180 ¥5.718 ¥92.270 ¥69.256 ¥52.821 ¥4.388 ¥1.680 ¥533 2000 ¥116.519 ¥2.732 ¥65.792 ¥12.020 ¥11.712 ¥12.948 ¥62.960 ¥207 ¥6.536 ¥3.753 ¥9.918 ¥5.332 ¥464 1998 ¥101.892 ¥376 1995 ¥82.436 ¥9.173 ¥3.401 ¥168 ¥5.648 .147 ¥2.477 ¥10.565 ¥98.874 ¥572 ¥136 ¥4.

867 ¥50.528 ¥20.773078757 3.12 1999 -¥1.933 ¥67.454 1999 ¥52.952 ¥13.12 2000 -¥1.892 ¥2.890 ¥2.12 1.202 ¥24.400 ¥20.12 1998 -¥949 8 0.137 ¥12.959 ¥1.091 10 0.175 ¥26.248 ¥26.820 ¥2.711 ¥21.134 ¥23.945 ¥38.266 ¥3.229 ¥54.513 ¥28.120 1992 -¥625 2 0.Table 4: prognoses when T Boone Pickens takes over the company .12 1.12 1996 -¥826 6 0.983 ¥15.919 ¥33.105848208 -¥456 -¥437 -¥418 -¥400 -¥383 -¥367 -¥351 .401 ¥1.717 ¥30.018 9 0.762341683 1.240 ¥20.823 ¥2.210681407 2.721 ¥21.760 ¥1.024 ¥2.172 ¥1.999 ¥23.689 ¥58.841 ¥26.361 ¥23.037 ¥2.661 ¥77.769 ¥32.469 ¥18.980 ¥25.395 ¥10.948 ¥957 1993 ¥34.597 ¥47.417 ¥28.187 ¥19.935 ¥18.015 ¥30.786 ¥17.616 ¥18.239 ¥1.215 ¥1.12 1.585 ¥3.356 1998 ¥48.254 ¥62.897 ¥14.12 Discount FcF ¥40.balance sheet 1991 Current Assets Fixed Assets Total assets Current liabilities Total Liabilities Stockholder's equity Capital expenditures change in net working capital Table 5: Free cash flows 1992 ¥31.026 1994 ¥36.264 1997 ¥45.2544 -¥498 1993 -¥670 3 0.404928 -¥477 1994 -¥718 4 0.383 ¥16.12 1997 -¥885 7 0.57351936 1.574 ¥1.100 1995 ¥39.371 ¥25.935 1 0.615 ¥21.107 ¥30.12 1.475963176 2.088 ¥1.802 ¥17.745 ¥28.036 1991 Free cash flows t Discount factor ¥44.445 ¥12.730 ¥82.772 -¥13.867 ¥11.671 ¥29.973822685 2.12 1995 -¥770 5 0.559 2000 ¥55.219 ¥17.401 ¥1.862 ¥35.460 -¥29.732 ¥71.179 1996 ¥42.948 ¥88.

References Kawai N. 2009. but could this System finally be changing?” Japan inc. “Keiretsu Corporate Networks are Innate to the Japanese auto-sector. .

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