Allocative Efficiency of Capital across Japanese Firms

Using the firm-level information of the Financial Statements Statistics of Corporations by Industry compiled annually by the Japanese Ministry of Finance, we gauge the allocative efficiency of capital across non-financial Japanese firms from 1983 to 2017. We correct carefully the biases stemming from changes in the sampling methodology over the years. We then estimate dispersion in the return on assets (EBIT/total assets) across firms in each year, controlling for differences in growth expectations and risks by regressions. Capital allocation rapidly became inefficient around the time when the economic bubbles burst. The degree of inefficiency seems to have stabilized at a high level afterwards, but recently, it appears deteriorating again. Moreover, we find that cash and deposit holding at firm level has nothing to do with the deteriorating trend of allocative efficiency of capital. Rather, it is estimated to increase the return.

Keywords: allocative efficiency of capital, cash and deposit holdings by firms
JEL Classification: E2, G3, O4

Top of the page

Japanese Asset Formation and Financial Literacy

(Abstract)

As the Japanese social security system is a pay-as-you-go system, it is an urgent challenge for Japan, a country experiencing an aging society with a low birthrate, to encourage asset accumulation by the people. This paper focuses on financial literacy, which is considered to be one of important factors for encouraging asset accumulation, analyzing its effects on asset accumulation, the paths of transmission of the effects, and its determinant factors. As a result of an empirical analysis conducted based on micro data from the Preference Parameters Study survey that was conducted in 2010, it was found that financial literacy has positive effects on asset accumulation and that its quantitative effects are substantial. The analysis results also indicated that financial literacy produces positive effects on asset accumulation by encouraging stockholding and developing savings plans. It was also found that people with low financial literacy typically have the following attributes: being young, being a woman, having poor academic achievement, having low grades in Japanese and mathematics, having low income, having many children, being over-confident, being risk-averse, having a high time discount rate, and being careless.

Keywords: financial literacy, asset accumulation, retirement planning, stockholding, financial education
JEL Classification: C26, D14, J26

Top of the page

Empirical Analysis Regarding Understanding of Financial Products

(Abstract)

The Principles for Customer-Oriented Business Conduct, which was published by the Financial Services Agency in 2017, requires financial institutions to provide important information in an easy-to-understand manner and provide services suited to customers. Under the Principles, financial institutions have to take two steps to provide services suited to customers. First, they have to distinguish the customers who purchase financial products without sufficient understanding of the financial products and/or who are unable to make an appropriate decision when purchasing financial products with a complex structure from the rest of the customers. Second, they have to provide these groups of customers with financial services that aid their understanding of the financial products and-well informed decision-making. However, how financial institutions should proceed to the first step remains an open question. To fill this gap, this paper conducts an empirical study on how financial institutions could proceed to the first step by distinguishing the abovementioned groups of customers from the rest of the customers by asking the following two questions.

First, what are the typical demographic characteristics of the customers who purchase stocks, investment trusts, foreign currency-denominated deposits and money market funds (MMF) without sufficient understanding of these products?

Second, what are the typical demographic characteristics of the customers who are unable to make an appropriate decision when purchasing financial products with a complex structure?

According to an empirical analysis based on household data from the Financial Literacy Survey (2016), to distinguish between customers, it is useful to examine information on customers' financial literacy that evaluates their capability to make informed decisions on savings and investment from three viewpoints—(1) understanding of compound interest rates, (2) understanding of changes in the real value of financial assets due to inflation, and (3) understanding of the effect of diversified investments—in addition to looking at traditional demographic variables such as the financial asset balance, annual income, age, and gender. That is because customers with high financial literacy from the three viewpoints are likely to engage in desirable investment behavior in the following sense: they have a certain degree of understanding of the nature of financial products with a complex structure, and they purchase such financial products only if they understand the investment risks related to the financial products.

Keywords: financial literacy, customer-oriented business conduct, provision of services suited to customers
JEL Classification: G11, E21

Top of the page

Design of an Institutional Framework for Asset formation by the Japanese People and the “Fiduciary Duty” of Financial Business Operators

(Abstract)

In order to promote asset formation through investment by the Japanese people, the Financial Services Agency (FSA) of Japan has been striving to strengthen confidence in the capital market by using terms such as "fiduciary duty" and "customer-oriented business conduct" for the purpose of encouraging financial business operators to behave in ways that suit customers' interests.

The first purpose of this paper is clarifying what meaning the term "fiduciary duty," when written in Japanese Katakana character, is used to convey in the field of financial administration in Japan. The term "fiduciary duty" as used by the FSA, unlike whose traditional meaning, does not mean a duty that strictly regulates relationships of conflicts of interest. Rather, it merely means an abstract concept like "respecting the interests of customers." It may be said that the term “fiduciary duty” is being used as a catchphrase for strengthening confidence in the capital market.

The second purpose of the paper is to emphasize the following point by clarifying the traditional meaning of the term "fiduciary duty": that (1) the need to protect investors because of the fiduciary relationship between financial business operators and investors, and (2) the need to protect investors who are at a significant disadvantage compared with financial business operators in terms of access to information and capabilities are two different matters each of which must be accurately distinguished and understood. As institutional and legal changes continue to be made frequently in the field of financial regulations, it is essential to make clear which need forms the basis of the imposition of regulation and justifies it.

Finally, this paper discusses one specific matter for consideration based on the understanding of the traditional meaning of the term "fiduciary duty." Can it be justified to impose restrictions on financial product providers' practice of making monetary or other payment to sales companies in proportion to the amount of sales recorded by the sales companies? Companies providing non-financial products and services are not necessarily subject to restrictions on payment of rebates to sales companies. Therefore, if restrictions are to be imposed in the case of financial products in particular, it is necessary to make clear what justifies the imposition of the restrictions. Here, as reference materials, we look at “Principles for Customer-Oriented Business Conduct” in Japan, "Regulation Best Interest," which was adopted by the U.S. Securities and Exchange Commission in June 2019, and the rules of the healthcare industry, which has introduced strict restrictions.

Keywords: fiduciary duty, customer-oriented business conduct, conflict of interest, investor protection, rebate

Top of the page

Enforcement of the "Comply or Explain" Rule
—Study Focusing on the Principles for Customer-Oriented Business Conduct”—

(Abstract)

This paper aims to study how the “Principles for Customer-Oriented Business Conduct” should be enforced. To that end, we identified factors essential for considering the enforcement of the "comply or explain" rule that is applied to financial institutions' approach to the principles. In doing that, we referred to the discussions related to Article 327-2 of the Companies Act, the Stewardship Code, and the Corporate Governance Code. As a result, it was found that the codes for which the "comply or explain" rule has been adopted include rules, for which compliance is specific, and plinciples, for which compliance can be achieved in several ways.. Thus, violations of the rule can be divided into the following categories: (i) cases in which a financial institution has disclosed the policy of complying with the principle but does not actually comply; (ii) cases in which the compliance is insufficient; (iii) cases in which the explanation given is insufficient; and (iv) cases in which a financial institution neither complies nor explains. It is necessary to study how legal and non-legal enforcement should be used with respect to each of those four categories of violation. In the study, the intent of adoptingthe "comply or explain" rule is an important judgment factor. The conclusion reached is that legal enforcement is desirable with respect to violations that fall into Categories (i) and (iv), while non-legal enforcement is desirable with respect to violations that fall into Categories (ii) and (iii).

Keywords: "comply or explain," enforcement, corporate governance, stewardship, Principles for Customer-Oriented Business Conduct, rules-based, principles-based

Top of the page

U.S. Legal System for Protection of Elderly Customers
――Recent Initiatives by the Federal Government――

(Abstract)

Because of the arrival of a super-aging society, various activities to protect elderly investors are ongoing in Japan. This paper explores how best to protect elderly people in reference to cases in the United States, a country that has addressed this challenge since early on. In the United States, the challenge has been considered in the context of activities to provide "wide" and "effective" protection to elderly people against practices that deprive (or attempt to deprive) them of financial assets (known in the United States as "financial abuse"). In other words, the United States has strived to comprehensively protect elderly people against various practices that cause (or may cause) economic damage to them ("wide" protection) and has sought to ensure that such practices are actually identified so that the legal system for protection can be implemented ("effective" protection). The U.S. legal system has developed based on these initiatives. Of those initiatives, this paper discusses the use of a system of "mandatory reporting" (which obligates financial institutions, which are in a position to identify acts of financial abuse at an early stage, to report such acts), which could become a powerful tool for "effective" protection. While Manzawa (2018) examined the system of mandatory reporting in the U.S. state of California and reached a provisional conclusion that it is doubtful whether this system is highly effective, this paper focuses on the system of mandatory reporting that has recently been adopted by the U.S. federal government, investigating the specifics and actual enforcement of the system and considering the significance of the system. Through the comparison of the systems of mandatory reporting adopted by the state of California and the federal government, the paper seeks to grasp a comprehensive picture of mandatory reporting in the United States.

Keywords: super-aging society, elderly investors, elderly customers, United States, financial abuse, financial fraud, mandatory reporting, banks, securities companies, financial institutions

Top of the page