Excess Capacity and Difficulty of Exit

In this book, we argue that excess capacity and difficulty of exit are responsible for the two lost decades. Non-performing loans and zombie lending are the consequences of overcapacity in the banking industry due to financial deregulation in the 1980s. The large-scale bubble burst is a result and a trigger of the first lost decade. In parallel with the bursting of the bubble economy, regulatory, technological, and economic changes have been the main causes of excess capacity in the electronics industry after 1990. However, Japan’s employment practices make it difficult for prompt downsizing and exit to take place. We demonstrate that two major electronics companies generated waste of cash flow for investment in declining core electronics businesses after 1990. Ultimately, it took 20 years or more for major Japanese electronics companies to exit from their slumped PC business. Analysis of segment investment shows that Japanese electronics conglomerates allocated more credit to segments with more employment even if they were making losses. Naturally, segment profitability is negatively related to unnatural segment investment. This evidence is in support of the employment consideration hypothesis. At the same time, the stand-alone electronics companies also continued to invest regardless of poor investment opportunities. The sluggish post-mergers and acquisitions (M&A) employment adjustment in stand-alone Japanese electronics firms suggests that employment considerations also hinder the success of M&A to restructure electronics component businesses. The two lost decades are a result of the slow response to the rise of cheap and high-quality electronics products of Apple, Samsung, and Lenovo. Many well-known Japanese electronics companies globally enjoyed rapid growth, dominant market positions, and high profits till the 1980s; however, we expect to see fast-growing startups that can take their place.

In this section, we focus on the misallocation of credit to loss-making electronics business segments in major Japanese electronics companies. We show that Sony wasted its internal funds from profitable finance and entertainment businesses to subsidize its primary loss-making electronics business. Similarly, NEC spent most free cash flow on its main loss-making electronic devices sector. In contrast, Mitsubishi has been promptly cutting off investment in small underperforming business segments and improving its profitability. It is not surprising that the perverse investment in loss-making segments prolongs poor performance. The direct reason is that free cash flow is in excess of investment opportunities in the electronics industry. However, the outside-dominated board does not prevent Sony from deficit segment investment. In addition, foreign institutional investors neither voice nor vote with their feet against inefficient segment investment in Sony and NEC. Exceptionally, Third Point, a U.S. based activist investor fund, exerted pressure, and then Sony spun off its loss-making PC business.

Linking segment employment to segment investment in Japanese electronics firms, we find that segment investment increases with segment employment irrespective of segment operating profitability. We show that the internal capital market equalizes the impacts of cash flow across segments. However, the internal capital market does not cut back on investments in loss-making segments. Moreover, investments in all segments increase even when the whole firm is in deficit. Nevertheless, segments with better investment opportunities do not invest more. Not surprisingly, investment in a deficit segment exacerbates subsequent segment profitability and segment asset turnover. Likewise, single-segment firms also have excess capacity, whereas they prolong unnatural investment.

In this section, we focus on the consequences of M&A of disintegrated in-house parts and components businesses. Renesas Electronics, a hodgepodge of semiconductor divisions, suffered prolonged losses after M&A. Drastic downsizing in employment after Innovation Network Corporation of Japan (INCJ), a government investment fund, taking control of distressed Renesas, successfully restructured its business. On the other hand, the inopportune and easy collection of loss-making LCD divisions, that is, the birth of JDI led by INCJ, did not result in a new sustainable display company. Irrespective of post-M&A losses, JDI expanded production capacity rather than downsizing. Moreover, the company failed to drastically downsize employment promptly even when the new plant turned out impaired assets. At last, foreign investors withdrew the bailout plan due to debt overhang. Despite this, Japan has been supporting loss-making JDI. The slowdown in the smartphone market due to a prolonged smartphone life cycle, overcapacity in the smartphone industry, the new entry of the display manufacturers of China, and the widespread adoption of OLED by smartphone makers are responsible for JDI’s declining sales and consecutive losses. Renesas is specialized in semiconductor manufacturing, and JDI has a single segment of small-medium LCD. Their slow employment adjustment in response to poor post-M&A profitability is in support of the employment consideration hypothesis for stand-alone Japanese firms.

In this chapter, we will summarize the lessons learned from the two lost decades. Successful Japanese electronics companies were experiencing steady decline in the early 1990s, but they continued to invest in declining segments to maintain employment. Ultimately, employment adjustments were frequently made till the first half of the 2010s, to resolve overcapacity problems that were abandoned in the first lost decade. Japan has been constantly facing new entrants and technological changes. As fruitful outcomes of the massive downsizing in the electronic products unit, some companies have achieved concentration in core competence and their performance has improved. However, most declining electronics companies are still struggling. Worldwide new entries and technological changes are taking place in many industries after the two lost decades, and it is still a major issue to prevent profitable companies that are beginning to fade from easy investment and outdated R&D. Instead, labor market reform, capital market reform advocating investment activism, spinoffs, M&A, buyouts, open innovation, and corporate venture investment are necessary to regain technological advantages and to acquire the seeds of growth.