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The Differences between the Tokyo
and New York Stock Exchanges
By Steve Amoia
Over two hundred years ago, so the legend says, the New York Stock Exchange
(NYSE) was created under a butterwood tree at the corner of what is now Wall and
Broad Streets in the lower east side of Manhattan. In 1949, in a less anecdotal
fashion, the American military occupational force organized the nascent Tokyo
Stock Exchange (TSE) in the rebuilding land of the rising sun. A stock exchange,
or market of stocks, is the most fundamental economic institution in a
capitalistic society. The prime economic function of a stock market is to raise
capital and spread risk. Both the NYSE and TSE fulfill their primary economic
function; however, the TSE differs from its American counterpart in five key
areas, each of which will be discussed in detail: 1) Role of the market
specialist, 2) Price/Earnings ratio, 3) System of ownership, 4) Philosophy of
publicly-traded corporations, and 5) Resilience to market collapses.
I. Role of the market specialist:
Each day on the NYSE, 1700 issues are traded between the hours of 9:30 a.m. and 4:00 p.m. The most widely followed barometer of market activity is the Dow Jones Industrial Average of 30 common stocks, which generates an average of 167 million shares of volume each trading day. These publicly-traded companies are controlled by 50 specialist firms, whose sole responsibility is to process an orderly market with the buy and sell orders for their stocks. If the stock of the specialist slips in price, which happens when there are more sellers than buyers, they must buy enough of the excess float to ease the stock's descent. Should the price begin to increase rapidly, the specialist will sell off inventory to maintain equilibrium.
In contrast, the Tokyo Stock Exchange is divided into two trading sessions. The largest companies trade during the hours of 9:00 a.m. to 11:00 a.m., and number 1,140 firms, which comprise the Topix value-weighted composite index. The most widely followed component of the Topix is the Nikkei 225 index. During the afternoon session, which takes place from 1:00 p.m. to 3:00 p.m., 440 smaller companies are traded.
As compared to the 50 specialists on the floor of the NYSE, only 4 specialists (Nomura, Daiwa, Nikko, and Yamaichi) handle the enormous daily volume of over 850,000,000 shares on the TSE. According to a financial writer of the investment publication Investor's Daily, Mr. Chuck Freadhoff, Japanese specialists must adhere to mandates that are not required of their American colleagues:
“Japanese specialists are prohibited
from buying and selling for their
own accounts. In Tokyo, if a stock
is slipping, the specialists run a
sort of blue-light special called
a `special asked quote,' in which
they can mark the price down every
five minutes until they attract
buyers... On the NYSE, the fortunes
of each specialist unit depends
on its correctly judging the market.
On the Tokyo Stock Exchange, the
four specialist firms pool their
revenues and divide them evenly.” (1)
II. The relationship of the Price/Earnings (PE) ratio:
The price to earnings ratio is a
measure of a stock's expensiveness and risk factor as compared to its quarterly
earnings. According to Investor's Daily, for the New York Stock Exchange
composite of over 1700 issues, as of August 30, 1989, the PE ratio was 14.01
times earnings. The Tokyo Stock Exchange has an average PE of 57 times earnings,
which is a substantial indice of Japanese investment tolerance to risk.
Reasons for the difference in PE ratios:
1) Accounting techniques: Japanese corporations differ significantly from their American contemporaries in their treatment of subsidiary unit accounting and depreciation of capital assets. Nikko International Capital Management, a branch of one of the "Big Four," provides the following reasons for higher Japanese PE ratios:
“The earnings of Japanese
corporations are
understated by about 15% because they
don't include the earnings of subsidiaries.
American companies report consolidated
earnings. The accelerated depreciation
method favored by Japanese corporations
greatly reduces reported earnings.The earnings
per share would increase by 78% if they (Japanese)
used the favored U.S.
method of straight-line
depreciation, which stretches out depreciation,
thus reducing earnings less each year.” (2)
2) Lack of investment choices: Japanese investors have fewer investment options,
and due to a current account surplus of $79.6 billion that is directed into
selected areas, stock prices rise in a classical supply-and-demand methodology.
3) Individual investors are less concerned with dividends than American investors: In the opinion of Mr. Hajime Takahashi, who is the capital market manager of Nikko Research Center Ltd. of Tokyo, "Most investors are thinking of capital gains because Japan's stock prices are skyrocketing." (3)
4) Government intervention: Mr. Akyoshi Horiuchi, Professor of Economics at the University of Tokyo, believes that the current high PE ratio can be traced to the government's attempt to reduce the trade surplus with the United States. According to Professor Horiuchi, "The Japanese government wants to expand domestic expenditures because of trade friction with the U.S.... To help increase spending, the nation's monetary authorities have followed an easy money policy." (4)
III. System of Ownership: Keiretsu.
In the short span of forty years, the TSE has captured over 42% of the total world stock market capitalization. (Chart 1) One of the prime reasons for this success can be attributed to the Japanese economic and cultural system of interlocking companies, or keiretsu.
The keiretsu system was a direct result of the U.S. occupation of Japan after World War II, for the Americans decided to revamp the old family-owned companies, or zaibatsu. These zaibatsu were ofttimes in the structure of trading companies that revolved around a single bank. In an attempt to reorganize Japanese business structure, the American financial authorities imposed laws that prohibited banks from owning 5% of a single company's stock, with the intent of enjoining monopoly control.
The Japanese responded to the new arrangements with the innovation of the keiretsu, which like the former zaibatsu, are centered around a bank, who promotes strong relationships among the members of their industrial groups, along with the key feature of cross-holding of each others' common stock. Companies that comprise a keiretsu group often share directors and maintain large equity positions in each others' corporations, which act as an imposing barrier to foreign or undesired entry.
Many American business leaders, along with the government, claim that the keiretsu system effectively locks out foreign competition to Japanese financial and capital markets. In recent months, the famous American corporate raider, Mr. T. Boone Pickens, received an expensive lesson in keiretsu. Mr. Pickens had amassed over 20% of the outstanding common shares of Koito Manufacturing Company, which is a member in the Toyota group, who happen to own 19% of the same firm, and also maintain three members on the Koito board of directors. Mr. Pickens plea for a seat on the Koito board, in spite of a personal appearance at the annual shareholders meeting, was denied unequivocally by the board. Mr. Pickens made a terse statement after his ordeal with Koito, where he compared Japanese corporate structure to "... a club and a cartel, that are much like the trusts that controlled America's corporations 100 years ago." (5)
With the keiretsu system in mind, foreign securities firms must face a special barrier to entry on the TSE. According to the February issue of Business Tokyo:
“The world's largest and busiest
stock exchange has an exorbitant
new entry fee. Foreign securities
firms now have to shell out $9.65
million to purchase and maintain a
seat on the Tokyo Stock Exchange,
20 times the cost of a New York
Stock Exchange seat.“ (6)
IV. Corporate philosophy of publicly-traded firms:
The fourth element of my analysis is perhaps the most fundamental difference between both stock markets. In the United States, the function of corporate financial management is to maximize shareholder value. Quarterly earnings, which drive the price of a public firm up or down in the marketplace, force the American CEO to focus upon a short-term agenda for economic survival.
In Japan, the role of corporate financial management does not rest upon appeasing the individual shareholder. Current Japanese management practices, which have been coined Theory Z by Dr. William Ouchi of UCLA, foster a corporate culture that is familial and strongly employee-oriented. According to Mr. Fumihiro Tokumasu, who is the director of Nikko Research Center Ltd. in Tokyo:
“In Japan, if you ask who owns the
company, probably the last one
(listed) is the shareholder. First
on the list would be the employees.
Next would be the customers. The
shareholders would come later, perhaps
after banks.” (7)
Due to the keiretsu system of ownership that was explained in section III,
officers of publicly-traded Japanese firms operate with much longer-term
earnings and growth projections than their American counterparts. The apparent
rigid corporate structure that is common in Japan can contribute to stock market
volatility, for according to the most recent estimate, "Only 20% of shares
listed on the TSE are held by individuals, most of whom move quickly in and out
of the market." (8)
V. Resilience to market collapses:
In the anxious days that followed Black Monday of October 19, 1987, when the DOW 30 suffered a historic 508 point loss (22.6%) of its value in one trading session, the TSE and other leading global exchanges would experience the fallout from Wall Street. With the threat of financial market collapse heard from Wall Street to Main Street, the Federal Reserve Board immediately injected abundant liquid reserves into the financial system to ensure that loan obligations could be honored. On Tuesday, the DOW 30 advanced by 102 points, temporarily quelling the fears of imminent collapse of American financial markets not evidenced since 1929.
Although the DOW 30 recovered the entire 508 points (and subsequently advanced to a new, all-time high during the first week of January, 1990) in 22 months, the TSE Topix index only required 5 months to recoup its 1987 losses. The Topix lost 21% in the month following Black Monday; the DOW lost 22.6% during one day. The disparity can be explained by three reasons.
1) Monetary policy: The Bank of Japan was not required to inject mass quantities of liquidity into the Japanese market on October 20, 1987 to mirror the Federal Reserve actions. A mere suggestion by the Finance Ministry advised institutions not to create a panic by dumping their shares. The Topix did decline; however, such a descent took over one month, and only resulted in a 21% overall decrease from pre-Crash levels.
2) Financial market strength: Japan is one of the richest nations in the world, with a current account surplus of $79.6 billion (1988) and an individual savings rate of 16% (Investor's Daily: 10/27/89). As was noted earlier in section III of this paper, the TSE accounts for over 42% of global market capitalization. Excess cash reserves always bode well in times of financial crisis. Eventually, these surpluses will end up in the capital market. Japan's current tax laws, which encourage investment spending due to favorable treatment of capital gains, along with the fact that over 80% of the available stock float does not change hands, provide the foundation for a strong, confident, and efficient liquid market.
In the short span of 40 years, the Tokyo Stock Exchange has vaulted into the bellwether position of the global market. Although created by American financial officials after World War II, the TSE's phenomenal growth can be traced to Japanese innovative techniques with regards to the role of market specialists, P/E ratio, ownership system, corporate philosophy, and market resilience to crises.
References
(1) Chuck Freadhoff, “In Tokyo, Shareholders Tend to Finish Last,” Investor’s Daily, 26 October 1989, page 34, column 1.
(2) Chuck Freadhoff, “P-E Ratios Undermine Differences Between Japanese, U. S. Markets,” Investor’s Daily, 27 October 1989, page 34, column 1.
(3) Freadhoff, page 34.
(4) Idem.
(5) Chuck Freadhoff, “Japan’s Ownership System Wards Off Rivals,” Investors Daily, 28, June 1989, page 30, column 2.
(6) CEO Briefing, “There’s a Special Barrier…” Investor’s Daily, 06 February 1990, page 6, column 1.
(7) Chuck Freadhoff, “In Tokyo, Shareholders Tend to Finish Last,” Investor’s Daily, 26 October 1989, page 34, column 1.
(8) Idem.
Bibliography
CEO Briefing. "There's A Special
Barrier." Investors Daily, (06 February 1990): p. 6.
Freadhoff, Chuck. "In Tokyo, Shareholders Tend to Finish Last." Investor's Daily, (26 October 1989): 1,34.
Freadhoff, Chuck. "Japan's
Ownership System Wards Off Rivals." Investor's Daily, (28 June 1989): 1,30.
Freadhoff, Chuck. "P-E Ratios Undermine Difference Between Japanese, U.S.
Markets." Investors Daily, (26 October 1989): 1,34.
Freadhoff, Chuck. "U.S.-Style Buyouts Are Anathema In Japan." Investor's Daily,
(25 October 1989): 1,34.
"Guide to International Investing." Fidelity Investments, (03 March 1989): p. 4.
Metz, Tim. Black Monday. New York:
William Morrow, 1988.
Welles, Edward. "The Tokyo Connection." Inc., (February 1990): 52-65.
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