Policy Research Institute

Table of Contents

Vol. 136 : Exchange Market’s Influence over Companies and Response


Summary of Articles

Deciding Factor of the Return on Foreign Direct Investment
―Comparison between Japan and the United States―

Author
By Sanae Ono(Professor, Faculty of Economics, Musashi University)
By Yui Suzuki(Professor, Faculty of Economics, Musashi University)

(Abstract)

In Japan, where the aging of society with a low birth rate is ongoing, it is important to increase the return on net external assets as a way to offset a decline in the amount of such assets. As a result of an increase in the share of foreign direct investments in recent years, the return on net external assets is expected to rise. However, the return on foreign direct investments by Japan has continued to be lower than the return on investments by the United States. Some reports indicate that the return on foreign direct investments by the United States is being inflated as a result of tax avoidance practices, but it is essential to improve the return through appropriate risk-taking without relying on tax avoidance practices amid growing international criticism of such practices.

This research examines the deciding factor of the return on foreign direct investments by Japan and the United States and compares the characteristics unique to the two countries. The research results suggest that U.S. companies have a stronger tendency to choose investment destination countries in consideration of tax factors and that this tendency is likely to be reflected in the return on foreign direct investments. On the other hand, the results also suggest that while multinational companies face various risk factors in investment destination countries, U.S. companies are securing a higher excess return in exchange for risk-taking.


Keywords: foreign direct investment, return on net external assets, corporate tax, macro risks, structural risk factors
JEL Classification; F20, F21, F23, F30

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Japanese Companies’ Overseas Business Expansion and Impact of Exchange Rate Fluctuations

Author
By Eiji Ogawa(Professor, Graduate School of Business Administration, Hitotsubashi University)
By Naoki Shinada(Director, DBJ Securities Co., Ltd.)
By Masakazu Sato(Senior Economist, Research Institute of Capital Formation, Development Bank of Japan Inc.)

(Abstract)

Japanese companies continue to be active in expanding business operations abroad. Focusing on the expansion of business operations of listed Japanese companies’ overseas bases, this paper analyzed how differences in the asset size of overseas bases (the ratio of overseas bases’ assets) affect changes in the corporate value (PBR: price-book value ratio) due to exchange rate fluctuations. In addition, it analyzed the impact of changes in overseas bases’ balance sheets and profits/losses due to exchange rate fluctuations on related performance indicators (equity capital, capital adequacy ratio, and return on equity (ROE)). From the estimation results based on panel data, we found that before the Lehman Shock, there was a tendency that the larger the asset size of company’s overseas bases was, the larger the company’s volume of export was and the higher the company’s corporate value rose when the yen depreciated. We also found that after the Lehman Shock, the impact on the corporate value increased somewhat, but the increase was smaller compared to the situation where the yen depreciated. On the other hand, it became clear that the larger the asset size of company’s overseas bases was, the larger the impact of exchange rate fluctuations caused to the company’s equity capital amount and the capital adequacy ratio through changes in the foreign currency translation adjustment was. An analysis of the impact of exchange rate fluctuations on the ROE showed that depreciation of the yen tended to increase the ROE because net profits have a larger positive effect on ROE. However, as the equity capital amount increases in this case, the positive effect is partially offset. These results suggest that when studying the impact of exchange rate fluctuations on companies, it is necessary to conduct the study from the viewpoint of the impact not only on export and other trade activities but also on companies’ overseas bases.


Keywords: exchange rate, overseas business expansion, overseas base, corporate value, foreign currency translation adjustment, equity capital, ROE
JEL Classification; F20, F31, M20, M40

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Japanese firms' exchange rate exposure and risk management

Author
By Junko Shimizu(Professor, Graduate School of Economics, Gakushuin University)
By Kiyotaka Sato(Professor, Graduate School of International Social Sciences, Yokohama National University)

(Abstract)

Japanese companies, which have for many years experienced fluctuations of the yen’s exchange rate, have made various ingenious efforts to mitigate the impact of exchange rate fluctuations based on exchange risk management systems suited to their respective industries and the choice of suitable invoice currencies. This paper aims to verify the effects of exchange risk management using data on industry-by-industry exchange exposure estimated over a long period of time and data that substitute for exchange risk management methods.

It was confirmed that the estimated value of industry-by-industry exchange exposure has risen since the 2000s. In addition, a pooling estimate and a panel analysis using explanatory variables that substitute for exchange risk management methods were conducted, with exchange exposure as a dependent variable. As a result, it was found that the higher a company’s overseas production ratio is (the higher the number of a company’s local subsidiaries abroad is), the higher its exchange exposure is. This finding suggests that instead of benefiting from the operational hedging effect, which refers to the reduction of exchange transaction risk due to transfer of production from Japan to other countries, Japanese companies face increased foreign currency translation risk arising from an increase in assets denominated in foreign currencies and increased economic risk in the form of deterioration of profitability due to unexpected exchange rate fluctuations after the transfer.


Keywords: exchange risk, exchange exposure, operational hedging, financial hedging, invoice currency, pass-through
JEL Classification: F31, G15, G32

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Determinants of Japanese Companies’ Choice of the Invoice Currency

Author
By Kiyotaka Sato(Professor, Graduate School of International Social Sciences, Yokohama National University)
By Uraku Yoshimoto(Doctoral course student, Graduate School of International Social Sciences, Yokohama National University)

(Abstract)

This paper examines how Japanese companies choose the invoice currency on a product-by-product basis through a new estimation method using the Bank of Japan’s Export Price Index. In addition, we developed explanatory variables based on corporate data and analyzed the determinants of the choice of the invoice currency. As a result of the estimation based on a dynamic panel data using the yen-denominated export ratio as the explained variable, it was found that the determinants of the choice of the invoice currency regarding exports from Japan in the strong-yen phase between 2007 and 2012 is different from the determinants in the weak-yen phase since the end of 2012. First, exporting companies with a higher research and development (R&D) intensity tend to conduct yen-denominated export transactions in the strong-yen phase and foreign currency-denominated export transactions in the weak-yen phase. It was found that companies with higher export competitiveness are better able to choose an invoice currency suited to a high exchange volatility phase. Second, the coefficient of the rate of change in the nominal effective exchange rate took a statistically significant level of positive value in the strong-yen phase, which may be interpreted to mean that exporting companies raised the yen-denominated export ratio in that phase for the purpose of avoiding exchange losses. In addition, while the overseas sales ratio did not have a significant impact on the choice of the invoice currency in the strong-yen phase, Japanese companies raised the yen-denominated export ratio significantly in the weak-yen phase, thereby lowering export prices in local currency terms. Japanese companies will continue to face the strategic challenge of how to deal with exchange rate fluctuations, but the important thing for them to do, as a way to deal with exchange rate fluctuations, is to strengthen export competitiveness by increasing R&D investment.


Keywords: invoice currency, pass-through effect, export competitiveness, R&D intensity, overseas sales ratio, yen-strong and yen-weak phases
JEL Classification: F30, F31

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Pass-Through Effect: Exchange Market Impact on Prices
―Is the Pass-Through Effect on Japanese Imports Declining?―

Author
By Yuri Sasaki(Professor, Department of Economics, Meiji Gakuin University)

(Abstract)

In many cases, the exchange market’s current account balance-adjusting function is said to be weak. After the Plaza Agreement, Japanese companies’ pricing-to-market (PTM) behavior was pointed out as the cause of the weakness of that function. On the other hand, export-related stocks rise steeply when the yen depreciates, so at the time of the yen’s depreciation after the launch of the Abenomics policy, expectations grew for the trade balance to return to a surplus and for a rise in import prices to exert inflationary pressure in Japan at the same time. Therefore, it is still unclear whether or not the exchange market is actually adjusting Japan’s current account balance, so we may say that this is an important point of debate.

At a time when the pass-through effect, which affects the exchange market’s current account balance-adjusting function, is declining worldwide, this paper examines whether or not this effect is declining in Japan as well. Until now, several studies have shown that the pass-through effect in the exchange market was declining in Japan. There are three key points for this paper. First, the paper updates previous studies by measuring the pass-through effect using the Corporate Goods Price Index, which is prepared by the Bank of Japan, and examines changes in the pass-through effect in Japan in the period until recently while comparing the measurement results with the results of the previous analyses. Second, focusing on past changes in the pass-through effect, this paper conducts a rolling estimate of the pass-through elasticity through the method used by Campa and Goldberg, as was the case in many previous studies. Third, in order to ensure the robustness of the estimation results, this paper conducts an analysis based on TVP-VAR (Time Varying Parameter Variance Auto Regression) and measures the pass-through effect using import prices under the HS code two-digit classification that was developed by Sasaki and Yoshida (2018), thereby identifying the recent pass-through effect.

The main conclusion is that although the pass-through effect on Japanese imports was declining, it has been increasing since the financial crisis. The global trend of the declining pass-through effect was expected to take hold in Japan as well, but in reality, that did not happen. The finding of the TVP-VAR-based analysis was similar, and the HS-code two-digit classification-based analysis also showed that the pass-through effect increased after the crisis. However, as the increase is attributable in part to rises in prices of crude oil, coal and natural gas, a further analysis needs to be conducted with respect to a more detailed impact.


Keywords: foreign exchange market, pass-through effect, Japanese imports
JEL Classification: E31, F14, F32, F40

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