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Japanese Research in Business History 2016 │ 33

The Policies and Depreciation Approaches of Japanese Companies in the 1930s

Takashi Kitaura Department of Business Administration, Faculty of Economics, Meiji Gakuin University

Introduction HIS PAPER SERVES to illuminate the factors motivating the dividend policies and depreciation approaches of Japanese T companies in the 1930s. A joint-stock company, by virtue of operating under the principle of limited shareholder liability, pays —portions of the profits of the company’s business activities—to its shareholders (the owners of the company). Dividends that exceed actual profits, including past undistributed earnings, are essentially returns on shareholder investments. In the joint-stock domain, where a shareholder’s investment value limits his or her liability, investment paybacks need to be subject to rigorous restrictions in order to protect creditors as company determine the amount of resources the company has to make paybacks on corporate liabilities. As a result, corporate profit calculations determine the maximum dividends that the company can pay to its shareholders. Fixed- depreciation is an method by which a company distributes the acquisition value of its fixed assets as while the assets are usable. Although fixed-asset depreciation is now a basic element of profit calculation practices, Japanese companies in the 1930s—the focus 34 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 of this paper—sometimes designated fixed-asset depreciation not as an but rather as part of profit appropriation (Saitō 2011, 144–146). Regardless of whether they are expense items or profit-appropriation items, however, depreciation expenses naturally reduces a company’s profits—its resources for dividends. Fixed assets, such as the plants and equipment in a company’s possession, usually remain in use for many years and contribute to corporate earnings throughout their time in service. Operating on the principle of - matching, which holds that a company should treat an asset’s contributions to corporate profits as , the practice of booking the acquisition cost of a as an expense upon acquisition reduces the company’s profits at the point of acquisition; this increases profits in the ensuing accounting periods. Companies thus used the fixed- asset-depreciation approach, which processes the depreciation of a fixed asset across its service life as an expense resulting from the asset’s contributions to corporate profits. The problem inherent in the fixed-asset-depreciation method is that a company has no way of determining exactly how much a given fixed asset depreciates from period to period.1 That uncertainty led corporate entities to adopt a variety of schema for distributing the acquisition costs of fixed assets across their respective years in service,2 with managers free to select their method of choice. Theoretically, a proprietor could even opt not to book fixed-asset depreciation as a depreciation expense if he or she were to conclude that the asset had not depreciated. A company operating from the more conservative standpoint of prioritizing expenses over profits, meanwhile, would benefit from booking as much as possible in depreciation expenses in the initial post-acquisition phase.3 Managers thus held considerable sway over calculation; with the ability to adjust

1. Therefore, calculations follow a regular process assuming certain conditions. The straight-line method, a common depreciation calculation technique, involves booking the same depreciation value in every period across a given asset’s service life. Under that framework, the company assumes that the fixed asset experiences the same amount of wear and tear every period. 2. Given the hypothetical nature of the calculations, there are several possible approaches. Companies have used the straight-line method, for instance, as well as other depreciation techniques like the declining-balance method of multiplying fixed-asset book values by a fixed ratio on a period-to-period basis. 3. According to Watts, one of the advantages of the conservative approach is that it safeguards against opportunistic managerial behavior (Watts 2003, 209). Kitaura: The Dividend Policies and Depreciation Approaches of ... 35 the booking value of depreciation expenses at their own discretion, they could adjust their firms’ profit totals. Any reduction in the booking value of depreciation expenses produces an equivalent increase in the company’s profits (without affecting any other losses), enabling higher dividends. Historically, then, depreciation and dividend policy have shared an intertwining relationship in shaping how companies determine their maximum dividend amounts through profit-calculation approaches. Littleton argued that, for American companies in the nineteenth century, depreciation played an essential role in meeting dividend policy objectives; firms often saw depreciation as a means of keeping distributable profit calculations from generating excessive dividends (Littleton 1988, 228). Researchers have devoted attention to the relationship between depreciation and dividend policy in prewar Japan, as well. Important studies of prewar corporate governance, for instance, have shown how corporate governance systems differed before and after the war: Under the prewar framework, major shareholders built their systems to monitor joint- stock company operations and served as substantial sources of company funding (Okazaki 1999, Hoshi and Kashap 2001, and Teranishi 2003 and 2011). Dividend rates were “higher than the rates after the war” (Aochi 2003, 51), with non-zaibatsu firms like power and spinning companies employing higher rates than Mitsui, Mitsubishi, Sumitomo, and other zaibatsu counterparts (Okazaki 1999, 108 and Miyajima 2004, 185) due in some part to shareholder demands for larger dividend sums (Morikawa 1996, 100–102 and Miyamoto 2010, 198). Past studies have also identified the effects of prewar high-divided policies on depreciation. According to the findings of Takadera Sadao, who investigated the depreciation practices of Meiji-period Japanese companies through the lens of accounting theory, the only depreciation that took place in the early Meiji period happened at companies that generated enough profits to pay the necessary dividends after accounting for depreciation—and the only firms falling into that category were recipients of profit subsidies from the government (Takadera 1974, 17). Several past studies have also addressed dividend policy and depreciation at Japanese companies in the 1920s and 1930s. Miyajima Hideaki, for example, showed that marginal dividend payout ratios relative to after-tax profits were higher in the 1930s (1933–1937) than they were in the 1920s (1921–1927) and attributed that difference to corporate efforts 36 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 to maintain high dividends during the 1920s recession (Miyajima 2004, 254). According to Miyajima and fellow scholar Saitō Nao, depreciation expense rates relative to both fixed assets and pre-depreciation profits were also higher in the 1930s than they were in the preceding decade (Miyajima 2004, 255 and Saitō 2011, 143).4 Aochi Masafumi also noted the upward trend in depreciation expense rates from the 1920s to the 1930s and took a closer look at the factors driving the increases, arguing that expanding business size affected managerial awareness and that wartime economic controls precipitated the creation and revision of various legal systems and accounting rules (Aochi 2014, 182 and 197). While Miyajima and Saitō elucidated the basic changes in dividend policy and depreciation from the 1920s to the 1930s, their works did not include any year-by-year, chronological analyses. A year-by-year investigation would be vital, however, considering the environmental shifts of the 1930s. The climate surrounding Japanese companies in the early 1930s, which saw the country experience an economic slowdown in the wake of the 1930 Shōwa depression, was considerably different from the situation in the late 1930s, when the country had emerged from the depression and begun to recover its economic vitality. Aochi, on the other hand, offered a year-by-year analysis of depreciation expense rates but no explanation of how depreciation expense rates related to dividend rates. This paper thus focuses on yearly changes in dividend rates and depreciation rates from 1928 to 1939. My analysis also examines two factors with an impact on shifts in dividend and depreciation values: how profits amounts fluctuated and how companies allocated their pre- depreciation profits among dividends and depreciation expenses. While the first factor lay largely out of managerial control, the second factor was squarely within a controllable scope. By thus dividing the causes of changing dividends and depreciation expenses along the line of managerial control, the paper aims to determine which factor had a stronger influence on the outcomes. My analysis then concludes with a discussion of the elements that informed managers’ decisions.

4. Miyajima sampled the years 1921 to 1927, and Saito focused on the year 1926. The scholars adopted similar time frames for the 1930s, as well: Miyajima looked at the years 1933 to 1937, while Saito used the year 1936 for his sample data. Kitaura: The Dividend Policies and Depreciation Approaches of ... 37

I. The legal systems governing profit dividends and depreciation in prewar Japan

The first part of my analysis outlines the legal systems governing profit dividends and depreciation accounting practices in the prewar context. Under the Commercial Code, joint-stock companies with deficits could not issue dividends (Article 219 of the 1890 Commercial Code and Article 195 of the 1899 Commercial Code). As this required joint- stock companies to calculate their profits in order to determine their profits available for dividends, the central question to address here is how joint- stock companies went about the process of profit calculation. For joint-stock companies in prewar Japan, generally accepted accounting principles (GAAP) were virtually non-existent. Not only did the Commercial Code make no mentions of the required accounting methods for calculating profits, but there were also no legally mandated accounting principles. Compliance with the rules for the preparation of financial statements, a set of accounting disclosure standards enacted in 1934, was optional. The only legal provisions in the Commercial Code with any bearing on accounting were the asset standards for accounting books (Article 32, Paragraph 2 of the 1890 Commercial Code, Article 26, Paragraph 2 of the 1899 Commercial Code, and Article 26, Paragraph 2 of the 1911 Revised Commercial Code). The 1899 Commercial Code required market-price asset valuation, which the 1911 Revised Commercial Code then amended to call for under-market-price asset valuation. In 1899, Japan adopted a corporate income tax system that prompted disagreements about whether firms should include depreciation expenses as losses when calculating their total income. Conflicts between companies that had implemented depreciation procedures and the tax authorities even developed into lawsuits in the early 1900s (Kitaura 2014, 61–64). Calculations of corporate income tax amounts depend on the given company’s income. The 1899 revisions to the income tax code defined “income” as total gross revenue minus total losses (Hamaoki 2005, 71–72). The question, however, was whether a company should include depreciation for accounting purposes in “total losses” when calculating its income. In 1899, the tax authorities treated any profit funds set aside for or profits—even amortization reserves, other types of 38 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 reserves, and any other funds taken from net profits and listed as losses— as income. If a company experienced a valuation loss after measuring its fixed assets at market value in accordance with the Commercial Code, the valuation loss counted as a loss under the contemporary tax system (Takemoto 1913, 96–97). However, three 1903 court rulings on accounting practices at steamship lines recognized the deductibility of depreciation expenses (Administrative Court 1889, 487). The tax authorities responded in 1918 by legitimizing the deductibility of depreciation expenses for all corporations and established a maximum depreciation loss by defining service life and amortization methods. The treatment of depreciation under the tax code up to 1918, in theory, likely had an important effect on how companies handled depreciation. If a company could include depreciation in its losses, depreciating company assets would reduce the company’s tax burden accordingly—a condition that would have surely motivated members of the corporate community to depreciate assets on their own volition. As there was no clear definition of depreciation deductibility or any rules determining maximum loss deductions up to 1918, however, the incentive for companies for depreciate their assets was not as strong as it could have been (Kitaura 2014, 64). The government recognized the deductibility of depreciation expenses under the tax code in 1918—but certain conditions applied. To deduct depreciation expenses under the tax code, a company had to depreciate its assets in its accounting. Naturally, that gave joint-stock companies an incentive to for depreciation expenses; however, the tax authorities had no incentive to force a company to account for depreciation expenses in its books. The reasons for that relatively weak impetus were both historical and practical: The tax authorities had always taken a generally negative view of depreciation expense deductions, first of all, and the government could collect more taxes from non-deducting companies (Kitaura 2014, 113). The depreciation expense practices at four power companies (Tokyo Dento [Tokyo Electric Light Company], Toho Denryoku [Toho Electric Power Company], Daido Denryoku [Great Consolidated Electric Power Company], and Ujigawa Denki [Ujigawa Electric Power Company]) from 1918 to 1924 shed light on how the 1918 changes in the treatment of depreciation expenses affected accounting. Relative to what they have Kitaura: The Dividend Policies and Depreciation Approaches of ... 39 booked under the 1918 provisions, the firms only accounted for 5–43% of their estimated maximum depreciation expenses (Kitaura 2014, 114).5 Despite having the legal ability to alleviate their tax burdens by booking more depreciation expenses, the companies instead chose to limit their depreciation expense values. The next section explores the reasons why these power companies refrained from maximizing their depreciation expenses within the limits of the existing tax code, looking specifically at the dual effects of increased depreciation expenses: tax-relief benefits on the one hand and lower dividend rates—a result of lower post-depreciation profit totals—on the other. If the power companies were to have increased their depreciation levels up to the maximum depreciation expenses allowable under the tax code (at a service life of 35 years and under the declining-balance method), they would have seen their reduced tax burden create a profit increase6 of roughly 1–6% (Kitaura 2014, 116). The drop in profits resulting from the increase in depreciation expenses would have been anywhere from 20% to 97% of the pre-increase profit total. If the companies were to have reduced their dividend totals to match the decreases in profits, the dividend amounts would have shrunk by 24% to 100% relative to the total before the depreciation expense increase (Kitaura 2014, 117). The tax benefits of depreciation were simply not enough to convince companies to maximize their depreciation expenses because the negative impact—reductions in profits and dividends—far outweighed the tax benefits. The power companies were subject to such low corporate tax rates, which ranged from just 4% to 7.5% between 1918 and 1924, that the cost-benefit imbalance always favored keeping depreciation expenses relatively low (Kitaura 2014, 117). The prewar legal framework thus had a sizable impact on dividend policy and depreciation. Joint-stock companies could only issue dividends within the scope of their past profits. Under the Commercial Code, however, managers had free rein over their companies’ profit totals— the lack of any accounting principles on profit calculations at joint-stock

5. To determine the estimate maximum depreciation expenses, I assumed that the companies would have depreciated all depreciable fixed assets using the declining-balance method and a service life of 35 years. 6. (Estimated depreciation amount under the tax code − Depreciation amount for accounting purposes) × Tax rate / post-depreciation, after-tax profits × 100 40 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 companies meant that top-level management could choose the accounting methods that best served their aims. Without any clear, legal definitions of profit-calculation procedures, managers had full discretion over their respective approaches. The 1918 revisions to the tax code, which allowed companies to treat depreciation expenses as losses under the tax code, would normally have encouraged companies to book depreciation values up to the accepted limit. For the four companies in my analysis, however, the tax benefits of accounting for more depreciation expenses were too small to prompt maximum deductions.

II. Dividend policy and depreciation through 1930

As I have explained above, the managers of joint-stock companies in prewar Japan could freely decide the extent of their depreciation expense bookings due to the lack of any legal stipulations on depreciation expenses. The next point to address, then, is the relationship between dividend policy and depreciation at joint-stock companies in interwar Japan. An examination of the books and journals from around 1930 reveals that dividend policy-depreciation connection was a common theme for contemporary scholars. The economic tumult of the time was certainly one reason for the active discourse: When the Great Depression hit in 1929 and the Shōwa depression struck in 1930, joint-stock companies desperately needed to find ways of securing dividend resources as the recessions sapped their profitability. The section below takes a closer look at how scholars saw the relationship between dividend policy and depreciation through 1930. One scholar who addressed the theme was eminent economic analyst Takahashi Kamekichi. According to Takahashi, numerous joint-stock companies in Japan were on the verge of crumbling under the economic impact of the 1920 postwar collapse, 1923 Great Kanto Earthquake, 1927 financial crisis, and 1930 lifting of the gold embargo (Takahashi 1930, 147). Despite the dire straits, however, firms continued bowing to shareholder demands by issuing dividends at high rates—a situation that, the author argued, discouraged companies from performing proper depreciation (Takahashi 1930, 4–5). Takahashi also compared the 1928 data for eight major Japanese companies and three prominent American corporations, looking at their ratios of depreciation expenses to profits and Kitaura: The Dividend Policies and Depreciation Approaches of ... 41 their proportions of dividends and executive bonuses (Takahashi 1930, 15). Whereas depreciation expenses represented 0–32% of total profits at the Japanese companies, the same proportion at the American firms ranged from 18% to 41%. Dividends and executive bonuses accounted for 61–99% of profits at Japanese companies but only 20–49% of profits at the American firms. Takahashi’s study thus revealed that, compared to their US counterparts, Japanese companies not only had lower depreciation expense ratios but also demonstrated larger proportions of dividends and executive bonuses. Another feature of Takahashi’s study was a comparison of fixed-asset service lives (ideal depreciation periods) by industry (Takahashi 1930, 18). Looking at the number of years it would take for fixed assets to depreciate completely with depreciation expenses booked between 1926 and 1928, Takahashi showed that 11 of the 15 industries in his analysis specified ideal depreciation periods—and in 10 of those 11 industries, the expense- based depreciation deductions were longer than their ideal periods7 by 2 to 105 years. Using the actual depreciation expense figures in the company accounts, the author found depreciation durations of 26 to 694 years at the four industries with no specified ideal depreciation periods. That inconsistency, Takahashi concluded, was a sign that few companies were calculating depreciation expenses in line with the proper standards. In 1930, the then-leading economic journal Toyo Keizai Shinpō ran an article titled “Kansai nihyakusha no kaibō” [An analysis of two hundred Kansai companies] (Toyo Keizai Shinpō extra issue, November 30, 1930). The article examined 214 firms in the Kansai area to determine whether the companies were following the appropriate depreciation expense procedures. According to the authors’ findings, 32 of the 214companies (15%) had “insufficient” depreciation expense booking (Kitaura 2015, 35). The article attributed the shortcomings to the priority that companies assigned to dividends, citing Nihon Kenshoku as one example (Kitaura 2015, 32). These works shed valuable light on the connections between profit dividends and depreciation around 1930. Some companies apparently kept their depreciation expense bookings low so that they could keep issuing high profit dividends despite drooping profitability levels; the rationale

7. Full depreciation period (in years, calculated based on actual depreciation expenses) – Ideal depreciation period (in years) 42 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 was that, by decreasing the value of its depreciation expenses, a company could secure an equivalent increase in its distributable profits. Given the link between accounting and legal systems, the lack of any legal provisions governing depreciation expenses allowed joint-stock companies to book depreciation expenses in whatever way they saw fit. One reason to account for depreciation expenses was to accumulate fixed-asset reacquisition funding within the company’s holdings. Not booking the proper amounts of depreciation expenses hampered that fund-accumulation effect, making it harder for firms to afford new equipment when the need arose—and thereby hindering sustained corporate growth. Both the Takahashi study and the “Kansai nihyakusha no kaibō” article gave examples of companies experiencing that type of phenomenon. If a low-profit company minimized its depreciation expense bookings to maintain high dividend rates, dividends obviously took precedent over depreciation expense accounting. The relationship between dividend policy and depreciation at these types of companies operated on the following line of reasoning. If profitability were to recover from a low level, the initial increase in the ratio of dividends to paid-in capital (dividend rate) would be larger than the initial rise in the ratio of depreciation expenses to fixed assets. Once profitability reached a level that allowed the company to meet the shareholders’ dividend demands, the depreciation expense increase rate could overtake the growth in the dividend rate. There was also a connection between the ratios of dividends and depreciation expenses relative to pre-depreciation profits: In low-profit periods, companies prioritized dividends over depreciation booking more emphatically than they did in profitable periods; this focus on dividends reduced the ratio of depreciation expenses to pre-depreciation profits, giving dividends a larger share (dividend payout ratio) of the profit pool. The next section introduces statistical data in an effort to delineate how the companies balanced dividends and depreciation in the 1930s.

III. Dividend policy and depreciation in the 1930s

1. The Japanese business performance analysis To determine the characteristic features of dividend policy and depreciation—as well as the connections between the two—among Japanese joint-stock companies during the 1930s, I use the Honpō jigyō Kitaura: The Dividend Policies and Depreciation Approaches of ... 43 seiseki bunseki [Japanese business performance analysis], a collection of financial data and analysis reports on major Japanese firms published by the archives section at the Mitsubishi Limited Partnership and the Mitsubishi Research Institute (Nakamura 2006, 5). The first edition of the Japanese business performance analysis compiled the financial data for the six financial periods from the first half of 1928 to the second half of 1930 (under half-year accounting) into a “Japanese business performance analysis survey” and a “Japanese business performance analysis survey (appendix).” For the periods starting with the first half of 1931, the documents organize the financial data into a “Japanese business performance analysis” for each half-year period. Using the Japanese business performance analysis, this paper analyzes the dividend policies and depreciation approaches of Japanese companies from 1928 to 1939. The Japanese business performance analysis for the second half of 1931 and thereafter feature appendices including a “three-period comparison of business performance analyses by industry,” which lists financial data for the preceding three periods on an industry- by-industry basis. In building my financial database for this paper, I used the values in the “Total” column for general industry in the “three- period comparison of business performance analyses by industry.” The companies in the “general industry” category thus constitute the “Japanese companies” whose dividend policies and depreciation approaches form the scope of this paper. Although the “three-period comparison of business performance analyses by industry” also details financial data for sectors like ordinary banks, savings banks, trust businesses, and stock exchanges, I decided to exclude industries outside my focus due to their high- specificity characteristics.8 The “general industry” category that I chose for the scope of my analysis covers warehousing, rail, steam shipping, freight, trade, department-store retail, manufacturing (dyes, ceramics, chemicals, machinery, metalworking, and processed foods), mining, oil, gas, electricity, lumber, fishing, real estate, and printing. As the “three- period comparison of business performance analyses by industry” for the second half of 1931 includes the data for the second half of 1930 and both halves of 1931, the financial figures for these three periods come from the

8. The inherent differences between these sectors and the general industry sector are probably why they appear separately in the “three-period comparison of business performance analyses by industry.” 44 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 table for the second half of 1931. The financial data for the period from the first half of 1928 to the first half of 1930, however, presents some complications. Considering that there is not “three-period comparison of business performance analyses by industry” in the Japanese business performance analysis survey (appendix), Shōwa san-nen kamiki – Shōwa go-nen shimoki) [First half of 1928 to the second half of 1930] and the Japanese business performance analysis for the first half of 1931, extracting the financial data in a fashion consistent with the approach for the other period is impossible. That may create methodological discrepancies, but the Japanese business performance analysis survey (appendix), Shōwa san-nen kamiki – Shōwa go-nen shimoki) [First half of 1928 to the second half of 1930] does include industry-specific financial data for the time frame in question. I thus extracted the data from the first half of 1928 to the first half of 1930 for all the target “general industry” elements from the document and found the total category sum to enable comparisons with the data for the second half of 1930 and beyond.9

2. Dividend rates and depreciation rates relative to fixed assets The first portion of my analysis examines changes in dividend rates, ROA, and depreciation rates at Japanese companies from 1928 to 1939, using the Japanese business performance analysis for my source values (see Figure 1). A company’s dividend rate is its total dividend amount divided by its end-of-period paid-in capital volume. ROA is the quotient of profits after depreciation expense deductions and the mathematical average of the company’s total assets for the preceding half-year and current half- year. Depreciation rate refers to the company’s semiannual depreciation

9. The unit was thousand Yen. The sample counts for the years in my analysis were as follows. 1928 first half (1H)/second half (2H): 411/427 1929 1H/2H: 417/434 1930 1H/2H: 415/306 1931 1H/2H: 302/300 1932 1H/2H: 301/299 1933 1H/2H: 295/299 1934 1H: 297 1934 2H–1935 2H: 295 1936 1H–1939 2H: 296 Kitaura: The Dividend Policies and Depreciation Approaches of ... 45 expenses divided by its end-of-period fixed-asset volume, which I multiplied by two to produce annual values.

Figure 1: Dividend rates, ROA, and depreciation rates at Japanese companies from 1928 to 1939

Note: The left vertical axis corresponds to dividend rates, while the right vertical axis shows ROA and depreciation rates. Source: Created based on the Japanese business performance analysis

The first trend to note is the average dividend rate at Japanese companies, which sat between 8% and 9% from the fi rst half of 1928 to the second half of 1929 until beginning a steady drop in the fi rst half of 1930—and sinking as low as 5–6% from the second half of 1930 to the fi rst half of 1933. Dividend rates then began to recover in the second half of 1933, eventually surpassing the 9% mark in the fi rst half of 1938. ROA levels followed similar trends. After plummeting from 4.8% in the fi rst half of 1929 to just 1.8% in the fi rst half of 1930, the average ROA at Japanese companies made a steady ascent and remained above 6% after the fi rst half of 1936. The high correlation coeffi cient between dividend rate and ROA for 1928 to 1939 (0.82) suggests that Japanese companies aligned their dividend payments with their profi tability levels. The downward and upward swings in both dividend rates and ROA levels likely arose from the effects of the macroeconomic climate. The impact of the Great Depression, which stemmed from the crash of the New 46 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33

York Stock Market on October 24, 1929, rattled the Japanese economy and eventually pushed the country into its own Shōwa depression—a devastating time for industries across the board. After the establishment of the Takahashi Korekiyo’s financial policy (the expansive financial policies created via the Bank of Japan’s underwriting of deficit bonds, the lowering of official discount rates, and a laissez-faire position on exchange rates), which began in December 1931, the Japanese economy finally started to get back on its feet in 1932 (Miwa 2012, 119–133). Japanese companies’ ROA and dividend rates may have followed similar trajectories, but the paths were not entirely identical. ROA fluctuated more wildly than dividend rates, for example; compared to the steep drop in ROA from 1929 to 1930, the corresponding decline in dividend rates was relatively gradual. The gentle downward slope of the dividend rate line is consistent with the observations of Takahashi, who explained how companies employed accounting processes to control falling dividend rates. Another divergence between ROA and dividend rates came in the second half of 1930: While ROA began to rebound from its nadir, dividend rates kept falling through the second half of 1931 and then recovered thereafter. ROA was thus trending upward while dividend rates continued to dwindle. The changes in depreciation rates, on the other hand, differed significantly from the other trends. The average depreciation rate relative to fixed assets hovered just under 2.1% from 1928 to 1930 (save for a blip up to 2.1% in the second half of 1930) and then proceeded to climb steadily starting in the first half of 1932 and eventually topping 5% in 1938. The divergent trends of depreciation rates relative to fixed assets from 1928 to 1939 and dividend rates across the same period are easy to see. While dividend rates fell from the second half of 1928 to the second half of 1931, depreciation rates remained essentially constant over the same span. Both indicators saw increases beginning in the second half of 1931, but their trajectories again split from the second half of 1931 to the first half of 1933: Depreciation rates surged upward at a clip of 129%, but dividend rates were basically flat with growth of just 22%. From the second half of 1933 to the second half of 1935, meanwhile, depreciation rates plateaued while dividend rates increased at a rate of 32%. The four- year period from the second half of 1935 to the second half of 1939 once again saw the indicators swap trajectories, with depreciation rates rising Kitaura: The Dividend Policies and Depreciation Approaches of ... 47

68% and dividend rates exhibiting an increase of only 12%. The dividend rate-depreciation connection at Japanese companies changed again between 1931 and 1939. In the second half of 1931, when Japan was just emerging from the Shōwa depression, to the second half of 1933, both depreciation rates shot upward faster than dividend rates. Then, from the second half of 1933 to the second half of 1935, the increases in dividend rates outpaced those in depreciation rates. These trends ran against the implications of Takahashi’s work and the “Kansai nihyakusha no kaibō.” If the pattern had held, dividend rate increases should have accelerated faster than depreciation rates in the initial stages of recovery from a low-profitability phase. According to the hypothesis, depreciation rate growth should have overtaken the dividend rate increase after profitability started to pick up and companies once again had the resources to meet their shareholders’ dividend rate demands. Contrary to the hypothesis, however, the period from the second half of 1931 to 1935 saw depreciation rates beginning their ascent before dividend rates. The hypothesis assumes the presence of a corporate governance structure under which shareholders would demand high dividend rates— but Japanese companies only ticked their dividend rates upward instead of quickly opting for high dividend rates. There are two possible explanations for why companies adopted that approach. First, shareholders’ dividend policy preferences in the 1930s were different from their preferences in the 1920s: Whereas shareholders tended to demand high dividends prior to 1930, they shifted their focus to corporate growth potential and began favoring increased depreciation rates over high dividend rates. The other viable interpretation is that shareholders maintained their existing preferences for high dividends but companies found it harder to reflect shareholder views in their dividend policies. If that were the case, there would have had to be some kind of different interest affecting corporate dividend policy. Section 5 addresses this point in more detail.

3. A factor analysis of dividend fluctuations In order to paint a clearer picture of the relationship between dividend policy and depreciation in the 1930s, I now turn my attention to a chronological analysis of how firms divided their pre-depreciation booking profits among dividends (their dividend payout ratios) and depreciation 48 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 expenses. Figure 2 shows the ratios of dividends and depreciation expenses relative to pre-depreciation-expense booking from 1928 to 1939.10

Figure 2: Dividend payout ratios and depreciation expense ratios at Japanese companies from 1928 to 1939

Note: Dividend payout ratio: Dividends divided by pre-depreciation profi ts Depreciation expense ratio: Depreciation expenses divided by pre-depreciation profi ts The left vertical axis corresponds to dividend payout ratios, while the right vertical axis shows depreciation expense ratios. Source: Created based on the Japanese business performance analysis

The first trend to examine is the dividend payout ratios, a percentage that climbed from 69.7% in the fi rst half of 1920 to over 80% in the fi rst and second halves of 1930. The ratio then transitioned into a sharp decline, falling to 42.1% in the second half of 1933. The value then ticked upward in the first half of 1934 and hovered under 50% until the second half of 1939. Compared to how dividend rates changed relative to paid-in capital, the drop in dividend rates from the fi rst half of 1930 to the second half of 1931 clearly stemmed in great part from the drop in dividend payout ratios. Considering that dividend payout ratios stayed consistently under 50% even though dividend rates began to recover in the fi rst half of 1939, however,

10. The sums of the dividend payout ratios and depreciation expense ratios relative to pre-depreciation profi ts for the second half of 1928 and the fi rst and second halves of 1930 exceed 100%. This suggests that the dividend amounts were larger than the actual profi ts for the corresponding accounting periods, which means that the companies used carry-forward resources from past profi ts. Kitaura: The Dividend Policies and Depreciation Approaches of ... 49 one could argue that the upswing in dividend rates during the period came from increases in overall profit amounts. A closer analysis of dividend fluctuations provides a clearer window on how changes in dividends, profits, and dividend payout ratios played off one another. Mathematically, dividends are equal to profits multiplied by the dividend payout ratio. When a company’s profits or dividend payout ratio rises, therefore, the company’s dividends go up. The converse is true, as well: A drop in either multiplier (or both multipliers) produces a drop in the dividend total. The next section investigates dividend fluctuations from the first half of 1928 to the second half of 1939, looking specifically at the degree to which changes in profits and dividend payout ratios affected changes in dividend volume.

Figure 3: A factor analysis of dividend fluctuations from the first half to the second half of 1928 (Unit: Thousand Yen)

78.6% Increase in dividend value resulting from the increase in dividend payout ratios: 65.1 =732.0×(78.6%-69.7%) 69.7% Dividend volume for Increase in dividend value the first half of 1928: resulting from the increase 561.6=805.9×69.7% in profits: -51.5 Dividend payout ratio =(732.0-805.9)×69.7% Profits 805.9 732.0

Source: Created based on the Japanese business performance analysis

Figure 3 provides an overview of my methodology, which I apply to per-company average dividends from the first half and second half of 1928. I decided to focus on per-company average dividends because each year had a different sample count, which made averages the optimal approach. The per-company average dividends for the first half and second half of 1928 came to 561.6 and 575.1, respectively, representing an increase of 14.1 over the year. The next step is to determine how much of that growth came from increasing dividend payout ratios and how much came from increasing profits. Dividend payout ratios rose from 69.7% in the first half of 1928 to 78.6% in the second half of the year for a total increase of 8.9%. Looking at the figure is for total profits, on the other hand, one can see that per-company average profits dropped from 805.9 in the first half to 732.0 50 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 star in the second half—a yearly decline of 73.9 points. If a company were to have applied a dividend payout ratio of 69.7% (the dividend payout ratio in the fi rst half of 1928) to profi ts of 732.0 (the per- company average profi ts for the second half of 1928), it would have paid 510.2 (732.0 x 69.7%) in dividends. However, the actual average dividends for the second half of 1928 totaled 575.7. The actual values came in 65.1 points higher than the mathematical projections due to the increase in the average dividend payout ratio, which grew from 69.7% to 70.6% over the course of the year. Assume that the company applied a dividend payout ratio of 69.7% (the dividend payout ratio in the fi rst half of 1928) to profits of 732.0 (the per-company average profits for the second half of 1928). That dividend total is 51.4 points lower than the actual per- company dividends in the fi rst half of 1928, which came to 561.6.11 The two calculations both use the same dividend payout ratio (69.7%), which means that the 51.4-point drop was the result of a decrease in profi ts from the fi rst half to the second half of 1928. Given that the average Japanese company saw its profi ts fall from the fi rst half to the second half of 1928, the increase can per-company average dividends during 1928 could thus have occurred due to the effects of the other factor: dividend payout ratio. The impact of increased dividend payout ratios was thus more infl uential than the drop in profi t totals, bringing about a net increase in dividends.

Figure 4: A factor analysis of dividend fl uctuations from 1928 to 1939 (Unit : thousand Yen)

Source: Created based on the Japanese business performance analysis

Figure 4, which I created via the same analytical methodology, provides the basis for defining the fluctuations in per-company average

11. The value in Figure 3 is -51.5; fraction rounding explains the difference. Kitaura: The Dividend Policies and Depreciation Approaches of ... 51 dividends from the first half of 1928 to the second half of 1939 and illustrates how the changes arose from the dividend payout ratio factor and per-company average profit factor. As the figure shows, the two factors move in opposite directions. In the first half of 1930, for example, the profit factor is negative, while the dividend payout ratio factor is positive— a set of offsetting conditions that minimizes the corresponding fluctuation in dividends. The correlation coefficient between the profit factor and the dividend payout ratio factor from 1928 to 1939 is -0.726, indicating a strong negative correlation between the two. The standard deviation of the dividend fluctuation from 1928 to 1939 (49.799) is also smaller than those of both the profit factor (72.412) and the dividend payout ratio factor (50.830). Companies had no control over profits, but they did have to the ability to adjust dividend payout ratios. The standard deviation data suggests that companies’ strategic manipulation of dividend payout ratios prevented dividend totals from swinging as wildly as the profits did. As Figure 4 shows, dividends remained on a relatively steady upward course after the first half of 1931. This trend came about because of the relationship between profits and dividends. As companies avoided slashing their dividend payout ratios amidst increases in profits, the dividend payout ratio factor—even if it dipped into negative territory— always had a smaller absolute value than the profit factor.

4. A factor analysis of depreciation expenses For my next section, I take another look at Figure 2 to investigate the ratio of depreciation expenses to pre-depreciation profits from 1928 to 1939. Figure 2 shows that the ratio rose across the period from the first half of 1928 to the first half of 1933 (except for a drop to 41.8% in the second half of 1930) and then proceeded to trickle downward from the second half of 1933 to the second half of 1939. In statistical terms, the dividend payout ratio and the ratios of depreciation expenses to pre-depreciation profits from 1928 to 1939 had a negative correlation coefficient of -0.202. The period between the first half of 1931 and the second half of 1933 saw a pronounced negative correlation, with a coefficient of -0.973. That negative correlation in Figure 2 echoes my analysis of Figure 1, illustrating that Japanese companies reduced their dividend payout ratios and implemented depreciation practices from 1931 to 1933. Next, I apply the approach that I used for my analyses of Figure 2 and 52 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33

Figure 4 to separate the roots of fluctuations in depreciation expenses into the factor of profits and the factor of changes in depreciation expenses relative to pre-depreciation profits. Considering that dividends generally stay within a company’s profits (including past profits), the methodology is obviously valid. The only complication lies in the implications of accounting theory. The depreciation of fixed assets should take place on a regular basis across the usable life of the assets in question. Theoretically, then, fixed-asset depreciation should have a certain correlation with fixed assets and no relationship whatsoever with profits. As I explained above, however, the lack of any legal standards governing depreciation expense booking in prewar Japan gave firms considerable freedom in determining their accounting practices. There were no regulations requiring companies to link their depreciation expense figures to their fixed asset values. Companies thus took advantage of that liberty and decreased their depreciation expenses in order to secure the profits necessary for paying dividends, as Takahashi noted. In my previous work, as well, I found that Tokyo Dento—Japan’s largest power company around the beginning of the twentieth century—switched periodically between booking 10%, 15%, or 20% of pre-depreciation profits as depreciation expenses between 1894 and 1917 (Kitaura 2014, 66–67). From these historical trends, one can surmise that profit values had a palpable impact on how prewar Japanese companies accounted for their depreciation expenses.

Figure 5: A factor analysis of depreciation expenses from 1928 to 1939 (Unit : thousand Yen)

Note: Depreciation expense ratio: The factor of depreciation expenses relative to pre-depreciation profits Profits: The factor of fluctuations in pre-depreciation profits Source: Created based on the Japanese business performance analysis Kitaura: The Dividend Policies and Depreciation Approaches of ... 53

Figure 5 breaks the fluctuations in per-company average depreciation expenses for the period from the first half of 1928 to the second half of 1939 into two factors: fluctuations in per-company average pre- depreciation profits and the ratio of depreciation expenses to pre- depreciation profits. Per-company average pre-depreciation profits were on a negative trajectory during the second half of 1928 and from the second half of 1929 to the second half of 1930. As the Figure shows, companies responded by increasing their depreciation expense ratios— a move that either increased their depreciation expenses or kept the drop in depreciation to a minimum. The Japanese companies’ depreciation totals rose significantly from the second half of 1931 to the first half of 1933, which occurred because of increases in both per-company average pre-depreciation profits and the average depreciation expense ratio. The data also shows that the growth in per-company average pre-depreciation profits had a bigger impact on the increase in total depreciation expenses than the rise in the average depreciation expense ratio did. The increases in depreciation expenses then proceeded to decelerate after the second half of 1933, owing to the fall in depreciation expense ratios in every period over that span except for the second half of 1936, second half of 1937, first half of 1938, and second half of 1939. Despite the downward trend, however, the actual volume of depreciation expenses continued to move upward because the per-company pre-depreciation profits kept rising—and the absolute value of the resulting increase in per-company average pre- depreciation profits was consistently larger than the absolute value of the drop in depreciation expenses stemming from changes in the depreciation expense ratio. According to my analysis of the connections between dividend policy and depreciation during the 1930s, then, the primary driver of the increasing dividends and depreciation totals was the growth in per-company average pre-depreciation profits. A comparison of the depreciation rates and dividend rates reveals an interesting divergence: from the second half of 1931 to the second half of 1933, though, as depreciation rates rose while dividend rates fell. The reason for that temporary divergence lay in the relationship between depreciation, dividends, and profits, with the increasing ratio of depreciation expenses to profits contrasting the falling dividend payout ratios. 54 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33

IV. Changes in corporate governance during the 1930s

1. Demands from financial institutions for lower dividends and higher depreciation expenses As I have noted several times above, Japanese companies reduced their dividend payout ratios and allocated higher proportions of their profits to depreciation expenses in the first half of the 1930s. That approach reflected a unique period in Japan’s business history. It grew out of a departure from the conditions of the preceding decades, as Takahashi noted. It also struck a contrast with the second half of the 1930s—a period when recovering profits stabilized dividend payout ratios and ratios of depreciation expenses to overall profits, thereby fueling a steady increase in dividends and depreciation amounts. Drawing on the findings of past scholars, I next explore several factors that made the early 1930s different from the conditions both prior to and after the period in question. First, financial institutions like Mitsui bank and the Industrial Bank of Japan demanded that the companies that they funded or underwrote bonds for to lower their dividend rates and boost their depreciation rates. Companies often complied with the requests. One example was Tokyo Dento, Japan’s largest power company, which issued bonds among the United States, the United Kingdom, and Japan in 1928. When the company fell into an operational crisis in 1930, however, Guarantee Co. (the US bond-underwriter) sent its vice-president to Japan to meet with Tokyo Dento executives (Kitaura 2014, 101). The two sides then reached an agreement to reduce Tokyo Dento’s dividend rates to under 5% for 1930, a deal that Tokyo Dento honored by cutting its dividend rate for the first half of 1930 from 8% to 5% (Ikeda 1949, 231 and Kitaura 2014, 162). In 1930, Mitsui Bank, Mitsubishi Bank, Dai-ichi Ginko, Sumitomo Bank, Mitsui Trust, and Mitsubishi Trust, which had invested 14 million yen in Keihan Railway, called for the company to cut its dividends. Acquiescing to the demand, Keihan Railway dropped its dividend rate from 11% to 5% in the second half of 1930 and implemented accounting procedures that would depreciate 15 million yen in fixed assets over 40 years (“Dentetsu gyōseki: Keihan Tetsudō no maki (chū)” [Railway business performance (2): Keihan Railway], in Osaka Jiji Shinpō, October 16, 1930 and Kitaura 2014, 233–234). The company also formed an agreement with its funders in December 1933, consenting to suspend Kitaura: The Dividend Policies and Depreciation Approaches of ... 55 dividends during low-interest periods instead of cutting its interest rates (Keihan Railway 2011, 147–148). The company’s dividend rates thus fell to zero for around three years. Daido Denryoku also encountered similar demands. When the Industrial Bank of Japan and several financial institutions invested in the company in 1930, the funders requested the company to bring its dividend rates from 8% to 6% in October 1930. Daido Denryoku obliged, making the 2% reduction in the second half of 1931 (“Yūshi renmei tōshi kaisha kantoku” [Supervision of borrowers by the Lender Union ], in Tōkyō Asahi Shinbun, October 31, 1930 and Kitaura 2014, 208). Upon obtaining a loan of 10 million yen from the Industrial Bank of Japan, Mitsui Bank, Mitsui Trust, Sumitomo Bank, and Sanjushi Bank in 1931, Nihon Denryoku (Nihon Electric Power Company) also agreed to a dividend-related demand from its funders: cut the dividend rate for the second half of 1931 from 7% to 5% (Watari 1996, 64–65 and Kitaura 2014, 208–209). Daido Denryoku, Nihon Denryoku, and Ujigawa Denki formulated plans in 1933 under the supervision of their financial institutions. At Daido Denryoku and Ujigawa Denki, the plans involved slashing the dividend rate to zero, while Nihon Denryoku’s directive not only included implementing common depreciation but also required the company to implement special depreciation over a five-year period. As a result, Daido Denryoku and Ujigawa Denki eliminated their dividend rates for around two years from 1933 to 1935 (Kitaura 2014, 210). The dividend reductions in depreciation expense increases that companies implemented on the demands of financial institutions also occurred at companies (be they power companies or other firms) in management crises, as was the case for NKK Corporation and Karafuto Kōgyō (Nagashima 1987, 479–480, Shinomiya 1997, 128–129, and Miyajima 2004, 224–225). The reasons why financial institutions adopted these rather aggressive policies are many, but one of the primary motivators was that the institutions first started to recognize their responsibilities as corporate bond-underwriting institutions in the early 1930s. The Shōwa depression in 1930 wreaked havoc on the markets, resulting in deficits totaling around 40 million yen in value by the end of the year (Shimura 1969, 24). In addition to shrinking the primary bond market, the crisis following the Shōwa depression also brought bond- 56 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 underwriting institutions under heavy criticism. The Industrial Bank of Japan, one of the leading bond underwriters of the time, resolved at a board meeting in January 1931 to involve itself heavily in the management of companies that it funded or underwrote bonds for and, in some cases, demand reduced dividends (“Nihon Kōgyō Ginkō no jigyō kin’yū hōshin” [The Industrial Bank of Japan’s business-financing policy], in Ginkō Tsūshin-roku, January 20, 1931 and Kitaura 2014, 119–200). The shifting policies at financial institutions in the first half of the 1930s thus played a pivotal role in prompting debtors and bond issuers to reduce their dividends and increase their depreciation expenses.

2. Changes in ownership structures and the emergence of professional managers While financial institutions had a direct impact on corporate operations through their demands for lower dividend rates and higher depreciation expenses in the early 1930s, changes in shareholder makeup and management organizations may have also affected how contemporary Japanese firms handled their dividends and depreciation expenses. Corporate ownership structures, for one, underwent changes in the 1930s. At companies in the heavy chemical industry, where criticism of the zaibatsu led zaibatsu-type companies to make public stock offerings and emerging zaibatsu affiliates to increase capital through public stock offerings, stock ownership diffusion was the new trend—and a change that gave professional managers more authority over corporate operations (Miyajima 2004, 220). The incorporation of the stock-ownership structure also gained traction in the 1930s (Shimura 1969, 408–409). Five power companies—Tokyo Dento, Toho Denryoku, Daido Denryoku, Nihon Denryoku, and Ujigawa Denki—saw their respective subsidiaries become their largest shareholders by 1938 (Kitaura 2014, 190). As there were no provisions in the Commercial Code on freezing the voting rights for subsidiary-held stock in parent companies during the period in question, one can assume that subsidiaries had voting rights for their parent companies. Parent company managers thus used the subsidiary-held voting rights to expand their influence over dividend policy decisions and other matters. In contrast to the growing sway of the professional manager stratum, the percentage of the individual shareholders among the top 10 shareholders at the five companies dwindled from 3.6% in 1930 to 1.9% in Kitaura: The Dividend Policies and Depreciation Approaches of ... 57

1938 (simple averages; Kitaura 2014, 191). In the 1930s, then, many managers saw their authority grow—and some, such as Toho Denryoku executive Matsunaga Yasuzaemon, take an active interest in depreciation rates (Kikkawa 1995, 325). By 1930, over 90% of all major companies (with paid-in capital of at least 10 million yen or banks/power companies with paid-in capital of at least 20 million yen) had at least one professional manager (a manager with no company ownership) on their boards. At 27% of these major corporations, professional managers occupied a majority of their respective boards (Morikawa 1996, 75). Alfred Chandler, Jr. tackled the issue of professional managers in his 1977 work The Visible Hand. In his “seventh proposition on modern corporations,” Chandler argued that a professional manager, knowing that his or her company’s survival is vital to his or her personal career, would prefer policies that favor long-term stability and corporate growth when it came to making managerial decisions. In doing so, Chandler said, managers would take the initiative to reduce dividends or even suspend dividends altogether—measures that shareholders would rarely consider implementing (Chandler 1977, 10). Although there is no definitive way to know whether Chandler’s proposition applied to Japanese companies of the 1930s, one could certainly assert that the shifting ownership structure and emerging managerial class many have helped trigger the dividend reductions and depreciation expense increases at Japanese companies in the first half of the decade.

Conclusion This paper explored the factors behind the changing dividend policies and depreciation approaches at Japanese companies in the 1930s. In the prewar era, the Commercial Code prohibited joint-stock companies with deficits from paying out dividends—but firm managers basically had free rein in deciding which method they would use we calculate profits, which determined dividend volume. Under that legal framework, as Takahashi argued, many Japanese companies put maintaining dividends ahead of booking depreciation amidst the numerous recessions of the 1920s. Operating from that vantage point, I sought to delineate the connections between dividend policies and depreciation at Japanese companies in the 1930s. One of my findings was how the two shared a changing relationship 58 JAPANESE RESEARCH IN BUSINESS HISTORY 2016 │ 33 over the decade, with dividend rates and depreciation relative to fixed assets moving in different directions from 1931 to 1933—depreciation rates going up and dividend rates falling—and then both maintaining an upward trend after 1933. I also classified the factors affecting fluctuations in dividends and depreciation expenses into two factor categories: the factor of profits and the factor of fluctuating dividend payout and depreciation expenses relative to pre-depreciation profits. The profit factor had a substantial impact on both dividends and depreciation expenses; as corporate profits began to rally in 1930, those growing earnings drove increases in dividends and depreciation expenses. The general pattern was consistent with the analysis of Miyajima, who found that marginal dividend payout ratios and marginal depreciation rates were higher in the 1930s than they were the 1920s (Miyajima 2004, 254). However, one stretch—1931 to 1933—defied the general assumptions. During that three- year period, dividends actually fell as dividend payout ratio clots of wade profit increases. Depreciation expenses, meanwhile, increased due to both increasing profit levels and companies’ decisions to devote more of their pre-depreciation profits to depreciation expenses. Adjustments in dividend payout ratios and depreciation expenses relative to pre-depreciation profits are squarely within the scope of executive control. I thus adopted the perspective of corporate governance to examine the falling dividend payout ratios and rising depreciation expense rates from 1931 to 1933. Analyzing the factors behind these trends, I came to two conclusions: that financial institutions may have triggered fluctuations through demands for lower dividends and higher depreciation expenses, first of all, and that the changes in ownership structures and the developing “professional manager” class in the 1930s was another possible influence.

This paper is part of a research projects supported by a 2016 Grant-in- Aid for Young Scientists (B) (16K17156) from the Japan Society for the Promotion of Science.

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