The Chuo Aoyama Incident and its Implications
May 19 (Friday) 2006
ChuoAoyama PricewaterhouseCoopers has been ordered by the Ministry of finance to suspend operations for two months, beginning on July 1, 2006. Chuo Aoyama is one of Japan's four largest accountancy organizations, carrying roughly 2,300 clients. Chuo Aoyama's corporate clients fear that the two month suspension may open up a vacuum in auditing operations.
The corporate auditing process is transforming into one in which one year's worth of monthly auditing operations are compiled and a business' corporate activities over the past year are audited. A two-month vacuum in corporate auditing means that auditing operations will not be conducted as usual. From an investor's point of view, it is difficult to place trust in auditing results that include such a blank period. Therefore, the measure handed down by the Ministry of Finance stands to upset the credibility of many of the companies who are clients of Chuo Aoyama, and will trigger major repercussions across Japan's capital markets.
When the Ministry of Finance announced Chuo Aoyama's suspension of operations, stock prices for many companies on the TYSE fell into a decline that lasted for one week. Even though the announcement was not the sole cause of this decline, it seems undeniable that the Chuo Aoyama incident had a negative psychological effect on many individual investors.
The enhancement of Japan's capital markets marks an extremely important turning point for the Japanese economy of today. With this in mind, the Chuo Aoyama incident has major implications. The current transition facing the Japanese economy is in keeping with its historical development, and it represents a shift in the nature of corporate financing from indirect financing to direct financing.
In the era of indirect financing, where banks acted as intermediaries, all companies had to do was provide banks with sufficient information; there was no need to provide general investors with detailed information disclosure. As the Japanese economy matures into an advanced economy, however, the financial base is shifting to direct financing of companies by investors. In this new format, it is necessary for companies to provide ample disclosure to investors, to raise transparency and to improve accountability. The fundamental points in the new framework for corporate law enacted on May 1, 2006 include the guarantee of transparency and obligatory accountability.
As part of this general trend, corporate auditing is playing an increasingly important role in ensuring transparency and accountability. The erosion of trust spawned by the fraudulent auditing in the Chuo Aoyama incident is proof of how grave a situation such problems can trigger.
Adding to this, it must be noted that the rapid progression of Japan's aging demographics have resulted in a stark decline in household savings rates. Abundant household savings was the single greatest source of support for the development of Japan's economy up until now, and was the most important resource for supporting Japan's budget deficit. Now that this is shrinking, Japan will be forced to look to foreign sources for the large-scale capital necessary to compensate for decreased household savings.
The capital that Japan requires is long-term direct investment, rather than short-term speculative capital. It is common for such long-term direct-investment capital to be introduced in the form of M&A. The merits of M&A include superior management that allows the effective use of the Japanese economy's resources via the acquisition of companies' resources. Whether the managers are Japanese or foreign, if the management is sound it should be welcomed, as it will stimulate the effective use of resources. In order to promote the effective use of resources in this way as well, the capital market must cultivate transparency and trust, and carry out quick and efficient management.
It seems to me that the Chuo Aoyama scandal is teaching us a crucial lesson. As Japanese society continues to age, the country must strive toward using its limited resources in the most effective way possible. To achieve these ends, we are currently in the midst of a vital learning process in how to construct a capital market that is efficient and trustworthy, and how to secure a management environment that possesses transparency and accountability.