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Top>Opinion>Income Approach Management as a Means of Communication with Shareholders


Makoto Ichimura

Makoto Ichimura [Profile]

Income Approach Management as a Means of Communication with Shareholders

Makoto Ichimura
Associate Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Financial Management, Business Administration, Corporate Governance, and Business Analysis and Valuation

Recommendation of income approach management

June is a season of shareholder meetings. This is because almost all companies that close the books in March hold their meeting of shareholders in June. Currently, many Japanese corporations are suffering from falling stock prices or undervalued stocks. The average PER (price-earnings ratio) in the previous term for companies listed on the Tokyo Stock Exchange First Section was 17.1, and the PBR (price-book value ratio) was 1.01. Though many people once wondered why Japanese companies enjoyed a high PER, they are now groaning under low valuation. These companies are undergoing numerous factors: low PER and PBR; being undervalued because both parent and subsidiary companies are listed at the same time; conglomerate discount (undervaluation resulting from business diversification); sluggish stock prices in spite of cash-richness, and so forth. To overcome this situation, I would recommend introducing business management based on the income approach.

Change in Japanese shareholder structure

According to the Shareownership Survey released by the Tokyo Stock Exchange and other organizations on June 20th, financial institutions accounted for 29.7% of the total shareholders who held interests in Japanese companies in FY2010 (including 4.1% represented by commercial and regional banks). This figure dipped from 30% for the first time. Adding 21.2%-the ratio of corporate shareholders other than financial institutions (so called general private companies including manufacturers and service corporations)-barely raises the figure to a majority, or 50.9%. Given the highest-ever corporate holdings ratio of 73.1% in FY1988 (44.1% by financial institutions including 15.7% by commercial and regional banks, and 29.0% by other business entities), this is a great change in the shareholder structure from corporate-centric holdings.
Cross-shareholding also dropped from 27.8% in FY1991 to 6.5% in FY2009 in terms of money amounts, according to the Daiwa Institute of Research. This apparently means the dissolution of a substantial portion of cross-shareholding for non-core parts. This is, in turn, likely to have caused a loss of functions that are regarded as the benefits of cross-shareholding.
On the other hand, overseas shareholders considerably increased from 4.3% to 26.7% in the same period. The total number of individual shareholders also rapidly expanded by 1.12 million year on year to 45.91 million, though the percentage increased only slightly from 19.9% to 20.3%. While it is currently obscure whether this transition will continue in the future, neither businesses nor shareholders would be able to ignore this impact.

Results from cross-shareholding and its dissolution

Cross-shareholding is said to have (1) functioned as a measure for building stable shareholder relations and preventing hostile buyouts or takeovers; (2) underpinned stock prices by absorbing floating stocks oversupplied in the market; (3) ensured stable income through business transactions between cross-shareholding companies; and (4) enabled tightening of ties among group companies. These helped facilitate relations between the company and stakeholders including cross-holding shareholders, and build low-risk and low-cost business relations free from unnecessary friction. On the other hand, cross-shareholding has also caused problems such as (5) in-group business transactions potentially hindering fair competition; (6) failure in corporate governance due to shareholders' checking functions being impaired by the maneuvering of stable shareholders who have voting rights reciprocally; and (7) hollowing out of capital caused by capital increase for the purpose of cross-shareholding. These problems, which have frequently been criticized by governments or shareholders overseas, are also likely to have disappeared by the dissolution of cross-shareholding.

The income approach for building new relations

IR (Investor Relations) activities are also demanded more than ever for building stable shareholder relations with newly increasing individual shareholders and overseas shareholders based in Asia or the Middle East as well as in Europe. This is because IR activities are expected to mitigate declining stock prices or low valuation attributable to costs or risks increased by deteriorating asymmetry of information. Business management based on the income approach should contribute to IR activities considerably.
The income approach, whose only goal is to maximize corporate value, is a method of valuing corporations or businesses based on the size of future cash flow (in some cases, profits or dividends). In other words, this approach assumes that the source of valuation is how much cash flow the corporation has ability to generate from now on, when such cash flow will be generated, and how certain it will be, instead of how much costs they paid or what will be the prices of their products (techniques for this approach include the discounted cash flow (DCF) method and the economic value added (EVA)).
Aside from data granularity, many investors and stakeholders can also use this approach. In this approach, they exchange and discuss data and valuation with each other to find possibilities for reducing information disparity among them, which is called asymmetry of information in the fields of economics and finance. Because the common platform of the income approach makes it easier to discuss differences in opinions, companies would have more opportunities to receive more appropriate valuation and feedback. This approach also enables the whole company, the entire business, and all personnel inside the company to push on toward their clear and unique goals.


I understand that the income approach is associated with negative aspects pointed out by some critics, such as inaccurate cash flow information, ambiguous risk adjustment, and unclear or arbitrary estimation of capital costs (discount rates). Any stakeholders, nevertheless, should have no objection to the fact that the goal of companies is defined as maximizing corporate value. The income approach confronts shareholders with this as the only goal. Introduction of the income approach represents the declaration that the company is ready to exchange communications about their business with stakeholders in a common language. Its implementation is expected to alleviate the asymmetry of information and improve the undervaluation of the corporation, whereas it would also lead to disclosing undesirable sorts of information. What is necessary is courageous decisions.

Makoto Ichimura
Associate Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Financial Management, Business Administration, Corporate Governance, and Business Analysis and Valuation
Professor Ichimura was born in Fukuoka Prefecture in 1961. He graduated with a degree in Management Science and Engineering, College of Policy and Planning Science, Third Cluster of Colleges, University of Tsukuba in 1986; and Graduate School of Business Administration and Public Policy, University of Tsukuba in 1988. He withdrew from the Ph.D. Program, Graduate School of Economics, Kyushu University in 1992 after completing the course work. He became a full-time lecturer on the Faculty of Commerce at Chuo University in 1992, and is currently an Associate Professor at the same institution. He was a Visiting Scholar at the University of Michigan Ross School of Business from 2001 to March 2003. He is also a councilor of the Japan Finance Association and a board member of the International Academy of Strategic Management. Professor Ichimura's major publications include "Corporate Capital Structure and Corporate Valuation [Kigyo no Shihon Kozo to Kigyo Hyoka]," in Ikegami and Muta, eds., The Structure and Change of Corporate Financial System [Kigyo Zaimu Seido no Kozo to Hen'yo] (Kyushu University Press); and "Free Cash Flow and Economic Value Added [Furi Kyasshufuro to Keizaiteki Fukakachi]," in Rin'ya Hayashi, ed., Management Finance and Corporate Valuation [Keiei Zaimu to Kigyo Hyoka] (Yachiyo Shuppan).