Interim Report of The Committee on New Business of Keidanren

Recommendations for Creating New Businesses:
Building an Economy and Society that Nurtures the Entrepreneurial Spirit

Chapter II : Building The Environment Necessary For New Industries and Businesses.

A free and open market is necessary in order to develop new industries and businesses, as is the creation of an appropriate economic environment that promotes the equitable sharing of risks and rewards, the free movement of personnel and adequate support for research and development.

  1. Realization of A Free And Vigorous Market Economy.
    1. Creation of distribution channels that are open to both domestic and foreign participants:
    2. In order to firmly establish and then develop new industries and businesses, their products and services must be fairly evaluated by the market, which must not be distorted by special interests and must welcome the participation of newcomers. A free, transparent and fair market that is wide open to domestic and foreign participants is, above all else, the essential foundation for creation of new industries and businesses.
      In Japan today, however, government regulations coupled with corporate behavior based on business affiliations or keiretsu for production and distribution, along with certain uniquely Japanese commercial practices, make the market structure closed and difficult to understand. It has been noted that these conditions obstruct new business entries by both domestic and foreign firms. Even if one assumes that these practices have an economic rationality for Japanese Economic System, it is still just as important to adopt transparent commercial practices that can readily be understood by domestic and foreign business people, thereby making it easier for all new participants to enter the Japanese market.

    3. Creation of new business opportunities through deregulation:
    4. Government regulations constitute the biggest impediment to realization of a free and vigorous market. As pointed out by the Advisory Group for Economic Structural Reform, "Deregulation opens up new business opportunities to companies, expands employment and widens the choice of diverse products and services available to consumers," On Deregulation, November '93. The prerequisites for generating and developing new industries and businesses are an absence of economic regulations, as a rule, a minimum of social regulations, with individual responsibility as the foundation of society, and the promotion of innovative corporate activities.
      On two occasions last year, in April and November, Keidanren made specific proposals calling for the repeal and/or easing of various regulations that are obstructing corporate activities and requesting that the government draw up a program for promoting deregulation that is truly effective. However, the plan announced by the government in March of this year did not respond sufficiently to the kind of deregulation that is needed immediately. Thus, reforming the government's regulation-oriented character must remain a key priority in the future.
      It is a given that in order to promote the development of new industries and businesses, the policy recommendations noted in the deregulation promotion plan must be implemented without fail. In addition, more far reaching and thorough deregulation must be implemented and must be aggressively pursued in every regulatory arena. For instance:
      1. It is necessary to accelerate the networking of information technologies of the administrative, judicial and educational fields to accomplish this.
      2. In the field of medical care and welfare, appropriate for the coming era of the aging society, delivery of care can be greatly improved by private-sector involvement. The vitality of the private sector should be drawn upon in hospital and clinic management, which now excludes all but licensed doctors. Private sector service firms must be permitted to provide expanded home care for the elderly by increasing the scope of designated home-visit nursing service firms. Furthermore, in order to improve the efficiency and convenience of medical care, medical examination services which use multimedia technology must be established.
      3. In the distribution field, there is urgent need for revision of laws and ordinances that obstruct free entry into the Japanese market. Above all else Large-Scale Retail Store Law must be targeted for early repeal.
      4. In the financial and securities fields, the building of markets predicated on individual responsibility and thorough disclosure must be pursued by comprehensive reform of protective and restrictive administrative regulations. This will also ensure a smooth supply of funds to new industries and businesses.
      5. Outline for Factory Location Law, which obstructs the development of manufacturing enterprises in urban areas, should be revised to exempt industries which have a minimum environmental impact from the Law.
      In promoting the development of new industries and businesses, it is essential that development policies be appropriate to the unique characteristics of each region. Decision-making authority and fiscal resources must be transferred to local governments and a partnership must be forged between the region's public and private sectors entities in order to create a supportive economic climate for start-up businesses.

    5. The role of competition policy:
    6. In a free and vigorous market economy, the role that Japan's Anti-monopoly Law should play becomes all the more important. In our country, exceptions to the application of the law exist across a broad range of businesses which, coupled with government restrictions, have impeded free economic activities. Given this situation, regardless of how much the law is strengthened and enforced, it would not be possible to build a free, transparent and fair market which would foster the growth of new industries and businesses. Exceptions to the law should be reduced and competition should be the ultimate regulator of business in every industry.
      On the other hand, because of the fact that the Anti-Monopoly Law is the basic rule of the market economy, its practical system and operation must not disregard the realities of the Japanese economy and society. Every provision of the law must be reviewed to ensure its relevance.
      Regulations such as the prohibition on pure holding companies and the restriction on total volume of stock holdings constitute major obstacles to the formation of venture capital, development of new business by established firms and diversification within firms. In August of 1994, the Fair Trade Commission (FTC) disclosed its "thinking regarding the application of the provisions of Article 9 of the Anti-Monopoly law with respect to venture capital." The FTC indicated the limits it plans to impose on business holding companies that fulfill the function of a holding company while functioning as a primary business at the same time. Unfortunately, the FTC reaffirmed its total ban on pure holding companies.
      This is a case of across the board regulation that does not consider whether competition is actually hindered, but overemphasizes the potential "evils" of monopoly. This restriction, which is unique to Japan, which is not used in Europe or the US. If for example, a corporation coping with changes in the industrial structure, plans to create a new business or to create an alliance with independent venture businesses, it must create an administrative arrangement which permits the corporate structure to practice flexible management. Each operating company within the group must be dispositioned under a head office that specializes in management strategy and there must be a constant flow of management resources, including personnel, among all relevant companies. To accomplish this the pure holding company is the most efficient form of organization. Therefore, the formula for restricting the use of pure holding companies should be changed from that of total prohibition to that of restricted use, only in circumstances of potential harm to competition.

  2. Adoption of The Stock Option System:
    1. Stock options as a system of rewards:
    2. The stock option system is a mechanism used by firms under which management and employees are given the right to purchase a firm's stock at a prescribed price. If the firm performs well and its stock price rises, those with stock options may purchase the firm's stock at a below market price and then resell it at a profit.
      Many US firms use the stock option system and in the case of venture businesses, in particular, it is an indispensable system for providing an incentive to start-up a new business and secure outstanding personnel to develop the company. The stock option system should be adopted by Japanese business as an effective method of distributing rewards commensurate with the risks assumed by individuals who are willing to establish venture businesses and by existing firms willing to enter into new fields of business.

    3. New stock option proposal:
    4. Ever since 1977, Keidanren has been calling for the institution of a stock option system as part of its agenda for easing restrictions against the buyback of a firm's own shares. However, even in the most recent revision of the Commercial Law, firms did not receive authority to purchase their own shares for the purpose of transferring them to their directors. In the case of acquisition of shares for transfer to employees, a time limit of six months was placed on their holding of their firm's own shares. Restrictions on the corporate buyback of a firm's own shares must be relaxed and a US-style stock option system must be adopted within Japan -- and the business community must continue to work towards realization of this goal.
      Along with these suggestions, we propose the following two new items:
      1. Stock options for new shares acquired at favorable terms:
        Regarding the issuing of shares for acquisition by directors/employees at favorable terms as provided for in Paragraph 2, Article 280 of the Commercial Law, we propose that the 6 month valid period for the special resolution of the general meeting of shareholders be extended. We further propose that an exception to the rule be established to allow the issue price to be set at a higher level than the stock price prevailing an the time the resolution was adopted.
        Article 164 of the Securities and Exchange Law should be revised to establish an exception to the rule that directors and others must return to the company any profit realized from the sale of their own firm's shares which have been held for only a short period of time. Furthermore, the Income Tax Law should exempt from taxation the differential between the issue price and market price at the time of issue, for stocks which are eventually sold.

      2. System of linking directors' compensation to stock price and corporate performance:
        As an alternative to the stock option system, the compensation of directors could be linked to the company's stock price or corporate performance. It would probably be necessary to stipulate a firm formula for this computation in the articles of association, or in a resolution of the general meeting of shareholders.
        Article 269 of the Commercial Law stipulates that the compensation for directors shall either be prescribed in the company's articles of association or be determined by a resolution of the general meeting of shareholders. All companies that determine the compensation for directors by a shareholders resolution fix a concrete sum. However, the law can be interpreted to mean that shareholders can prescribe a specific formula for computing director's compensation in ways that leaves no discretionary leeway for the directors themselves. Or it can be interpreted to mean that the shareholders can set a framework for the total sum of compensation for directors and that individual amounts can be determined within this framework. Therefore, the method of establishing director's compensation by means of a resolution of a general meeting of shareholders, has the advantage of not requiring a revision of the law.

  3. Reform of The Taxation System:
    1. Tax reform that places importance on economic vitality:
    2. Launching a new enterprise involves major risk-taking. Therefore, a tax code must provide incentives for those who are willing to take risks, which allows them to enjoy the rewards of success. And to ensure that smooth flow of capital that is essential for start-up businesses, the tax system which currently focuses on taxing corporate and individual incomes, must be drastically reformed.

    3. Change to a taxation system that promotes capital accumulation:
    4. Venture capital is indispensable for starting up any new business. The amount of venture capital available within an economy determines in part whether a new enterprise will succeed. In this respect it must be said that Japan's taxation system does not encourage the accumulation of capital because of its excessive emphasis on equality.
      The high progressive tax rate on income must be revised to make the taxation rate structure, including the inhabitant's tax, as flat as possible. The securities transaction tax should be abolished immediately and the capital gains tax further reduced.
      The deemed dividend tax should be abolished as soon as possible and the imputation system should be adopted in order to eliminate the dual taxation on dividends (resulting from corporate and individual income taxes). Under this system, taxation at the level of corporate tax will be regarded as advance payment of income tax, and at the level of income tax, the tax levied on dividend income will be deducted from corporate tax.
      The heavy tax imposed on corporations as well needs to be reformed as soon as possible. Even in terms of the effective tax rate, Japan's corporate rate of 49.98% is much higher than that of the US or the European nations. In terms of the policy taxation system, the excessively heavy tax burden shouldered by Japanese corporations cannot be disguised. We believe that the corporate tax rate should be lowered to at least the level of western nations. Furthermore, if corporations are to aggressively pursue diversification and new business creation, it is critical that Japan adopt a consolidated tax system under which a corporate group pays tax as a single entity by consolidating the profits and losses of the parent company and its subsidiaries.

    5. Taxation measures for promoting the "start-up of new enterprises":
    6. Increasing research and development is the key to developing new industries and businesses. In view of the fact that in Japan, the greater percentage of R&D expenses is shouldered by private sector firms, it is essential that the tax code address their contribution. As well, to encourage investment at the launching of new enterprises, the privileged tax treatment relating to investment in plant and equipment should be extended and firms should be allowed to carry-over losses for 10 years from incorporation.
      High real estate prices and rental costs greatly inflate the initial start-up costs of any new enterprise, and constitute a major impediment to new business creation. New businesses should be exempt from land tax and fixed asset tax for a certain period following establishment.

  4. The Free Flow of Human Resources:
    1. Reform of employment practices:
    2. Human resources are a vital factor in sustaining new industries and businesses. People of outstanding ability, foresight and vitality are needed to challenge the new frontiers of industry. To promote new industry and business creation, it is critical to improve the mobility of human resources within Japanese society so that it is possible to assemble a staff characterized by determination, zeal and ability.
      Signs of increasing mobility of human resources are already evident but to accelerate this trend, established firms must adopt an open employment system and change their employment practices, including no longer limiting recruiting mainly to new graduates, no longer basing personnel and salary systems on life- time or continuous long-term employment, no longer providing company-based welfare. As a start, revision of the pension system could be initiated, with retirement payments, now linked to length of service, decreased in favor of increased salaries during the working life of employees.

    3. Reform of the pension system:
    4. To facilitate employee mobility among companies, pension systems should be made portable so that when employees move from one company to another, they automatically take their pension benefits with them. In keeping with the increased mobility of the work force, it will be necessary to reform the current tax on retirement income, which is structured to favor long term employment, and to review current taxation of income and fringe benefits.

    5. Liberalization of the labor market:
    6. To achieve human resource mobility, Japan must establish a labor market that is capable of matching the diverse demands of business with highly trained employees. The existing Public Employment Security Office may be of value in guaranteeing "marginal employment", but its standardized method of introducing jobs is not capable of handling the requirements of firms that need the level of skilled employees essential in new industries and businesses. Therefore, regulations should be liberalized in order to stimulate the growth of private sector, profit- making employment services.
      In addition, the regulations governing temporary employment services should be liberalized in order to accommodate the diversification of modes of employment, and the range of businesses which they are permitted to serve should be expanded greatly.

  5. Promotion of R&D That Creates Business:
    1. R&D is the wellspring of new industries and businesses:
    2. Innovative thinking coupled with R & D is what turns new ideas into new products and services -- which in turn inspire the creation of new industries and businesses -- in high tech as well as other sectors. If Japan is to maintain its international competitiveness, the entire nation must get behind the push for increased research for advanced scientific discoveries and R&D that leads in the creation of new enterprises.

    3. The role of the university and public research institutes:
    4. Universities, the state and public research institutes are expected to play exceedingly important roles in generating new industries and businesses. These institutions are, as well, expected to play major roles in conducting the necessary R&D as starting new enterprises in rural areas require sophisticated R&D activities, and private sector vitality is indispensable.
      1. Role of providing support to corporations:
        By providing leading-edge technology, cooperating with corporate R&D and exchanging personnel, these research institutes should become major incubators of new enterprises. However it is first necessary to relax the restrictions prohibiting researchers who are staff members of research institutions from concurrently holding other positions.
        Additionally, in order to promote personnel exchanges, a system should be established to assist researchers who have completed their doctoral degree, to conduct research while working simultaneously in their institutes as well as private corporations. Creation of a joint research facilities with private sector partners should be considered as should operation of research parks by university or public research institutes in order to promote cooperative relationships with private corporations. Corporations should aggressively seek to build new cooperative relationships with the academic community.
        Furthermore, research institutes can play in promoting new business growth, while other non-research related departments within academic institutions can as well make a significant contribution by providing management training to newly created firms.

      2. The role of public universities:
        Public universities and professional schools located in the rural areas should become the driving force behind regional industrial development. To generate new industries and businesses within each region of the country, it is vital that support be provided that is in keeping with the special strengths and needs of the region. These educational institutions are the most appropriate vehicles for this kind of industrial development.

      3. Division of roles and cooperation with industry:
        The research conducted by these institutions must not be isolated from society. Research results must continually be shared with the general public so that they may contribute to an improved quality of life for all. The prime use of research findings should be to generate new industries and businesses. We must seek a careful balance within the roles played by the research institutes on one hand, and those played by industry on the other, regarding the use of basic and applied research.
        It is necessary to build a close cooperative relationship between all parties. However, a key factor preventing such cooperation are the restrictions imposed on national universities and research institutes regarding the acceptance of fees from the private sector for commissioned research. These restrictions should be repealed at once, so that universities can undertake research for the private sector and thereby improve the climate under which they operate.

      4. Research in advanced science and technology:
        All research institutes must strive to become world leaders in advanced science, a field in which the capability of the private sector is limited. In Japan, however, the research/education environment has deteriorated to such a degree that if nothing is done, there are fears that Japan will fall below the world's leaders. Leading edge science and technology should be positioned as an important pillar of the new social infrastructure and the government must sharply increase appropriations related to science, technology and advanced education to address this impending crisis.

    5. Intellectual Property:
    6. The revitalization of R&D will be effected greatly by the way in which intellectual property rights resulting from R&D are addressed. It must be admitted that in Japan little attention is paid to the issue of such rights and other intangible property rights. In the perception of the general public, they are not given sufficient respect and consequently there have been cases in which entrepreneurs, who based a new business on new knowledge or an invention, faced great difficulties because they could not receive the necessary protection.
      We must seek to foster a climate that respects intellectual property rights and at the same time develop a system that guarantees such rights. We must establish clear-cut rules governing inventions developed within a private sector firm that define ownership and compensation. With regard to inventions resulting from research institute/private sector cooperation, a system should be established that allows shared ownership of the rights themselves and the earnings they generate, as opposed to simply granting corporations the right of operation.

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