Kobe University Repository : Kernel タイトル Relationship Between Corporate Groups and Auditors in Japan Title 著者 Suzuki, Kazumi Author(s) 掲載誌・巻号・ページ The Annals of the School of Business Administration, Kobe Citation University,40:75-101 刊行日 1996 Issue date 資源タイプ Departmental Bulletin Paper / 紀要論文 Resource Type 版区分 publisher Resource Version 権利 Rights DOI JaLCDOI 10.24546/81003679 URL http://www.lib.kobe-u.ac.jp/handle_kernel/81003679 PDF issue: 2021-10-05 Relationship between Corporate Groups and Auditors in Japan Kazumi Suzuki* I . Introduction It is said that financial statements reflect a combination of recorded facts, accounting conventions and personal judgements. This suggests that the choice of the accounting methods and accounting judgments made by managers have a major effect on the disclosure level, quality and contents of the accounting information in the financial statements. They are expected properly to choose and judge under the conditions in which accounting information is prepared. So, the extent of the discretion which the managers of publicly-held firms can use in choosing accounting methods and in making accounting judgments is limited, because the appropriateness of their choices and judgements is subject to the examination by audit corporations or certified public accountants (hereafter, " auditors"). The relationship between a firm and its auditor has a major effect on the accounting information in the financial statements. This relationship determines whether the auditor, acting on behalf of outside interests, presses the firm to narrow the range of its options, or consents to accept broad discretion by the executives of the client firm. The relationship between a firm and its auditor in Japan may be influenced by the tendency of firms to form corporate groups. Auditing one member firm of a corporate group may lead to auditing the other members too. Thus an audit transaction with a firm can be a foot-in- the-door of the group as a whole. In this paper, we ask why corporate groups are so prominent in Japan, and then, discuss the possibility and the process of an auditor being taken into a corporate group. Thirdly, we look for evidence to support this possibility, and finally, we consider the problems that arise from this arrangement. " Associate Professor , School of Business Administration, Kobe University. 76 K. Suzuki II. Why do companies form groups? A corporate group is an intermediate entity positioned between the market and a firm. Why do companies form such corporate groups? Generally, a transaction is likely to be incorporated into a business organization when a market failure occurs, or if the costs of executing the transaction inside an organization is lower than the costs of the market transaction. But, once a transaction is incorporated into an organization, it is no longer subject to the discipline of the market place. Consequently, its costs may increase, and it may also become uneconomical (Coase [1937]). A corporate group is an intermediate form of business organization between a firm and the market that serves the function of minimizing such inefficiencies of the market as well as a firm. These circumstances give rise to corporate groups (Imai, Itami and Koike [1982] pp.126-12'7; Goto [1978]). How can transaction costs be saved by forming a group? Costs are incurred in all aspects of operations of a firm: in collecting information, in negotiations, and in both concluding and enforcing contracts. Two sets of factors are the primary determinants of these costs. The first set of factors is the characteristics of the goods and services involved, and the circumstances of the transactions. Transaction costs are higher for complex goods and services which have many relevant attributes. Drinking water, for example, is a simple good, a house is more complex. Of course, the costs of trading a house which consist of search expense, commissions, taxes and so on are higher than the costs of trading water. Transaction costs also increase, when a transaction is carried out in a tactical environment which permits complex strategies, and therefore requires the costs of collecting information, confirming the execution of contracts and the division of risk among the transacting parties. The second set of factors concerns the nature of people who conduct the transaction. People make decisions with bounded rationality and limited information. Bargaining for a transaction often includes a search for alternatives, recognition of opportunities, understanding the tactics of the counterparty, and devising one's own tactics. They give rise to personal effort and transaction costs. Relationship between Corporate Groups and Auditors in Japan 77 A corporate group could be expected to form when these transaction costs with the existence of a group are less than the costs of performing these transactions without one, that is, either through the market or through individual firms. Now we need to show how the groups reduce transaction costs in ways that individual firms cannot. Let us consider each aspect of transactions from this point of view. Information becomes a public good if free-riders cannot be excluded from its benefits once it is collected. Those who collect the information end up paying the costs. If a corporate group functions as an information club , it can remove the obstacles arising from public goods through exclusively communicating information within the group (Odagiri[1975]pp.145-146). Once a group has been formed, its members can save the costs of repeating within-group transactions through the market mechanism in the group. The risk of opportunistic behavior by members of the group, and the transaction uncertainties they face are also reduced. Once organized within the group, transactions take a standardized form, and the costs of enforcing them are reduced. On the other hand, firms can avoid the costs and inefficiency of organizational conflicts and bureaucracy by not making these transactions inside the individual firms themselves. In this manner, moving the transaction from the market to the group structure, without taking it into the individual firm, cuts the costs of doing the transaction through the market mechanism in the group. Thus group formation may increase profits for member firms by saving their transaction costs. However, Caves and. Uekusa [1976] point out that such a group profit maximization hypothesis may apply to the pre-World War II financial combines (ZAIBATSU), not to the recent corporate groups in Japan. The financial combines before the War increased their profits through saving transaction costs and exercising monopoly power. But, according to their analysis of Japanese firms data for 1961-70, profits before interest on assets were negatively related to the group 1. Information club is a party organized on the following three promises. a) Each member firm voluntarily communicates information which it has to other firms within the club. b) Member firms must not communicate wrong information intentionally. c) Member firms must not leak information collected within the group to the outside. 78 K. Suzuki affiliation. They also found a weak tendency for the group affiliation to reduce the variability of profit and a significant positive relation between the group affiliation and the height of interest payments on borrowed capital. These results suggest that the profits are re- distributed by the groups' main banks in complex ways (Caves and Uekusa [1976] Chapter 4). Similarly, Nakatani[1984], by analyzing Japanese firms data for 1971-82, shows that group formation does not always increase the rates of profit and growth of firms but that the time series variance of these ratios of firms that belong to groups are lower than those of the independent firms. These results lead to the conclusion that the purpose of forming groups is to stabilize, not maximize, profits. A corporate group functions as an insurance pool for its member firms, including the main bank of course, through the sharing of profits and risks over a long period of time. This conclusion is also consistent with the empirical results reported by Caves and Uekusa. In addition, Nakatani finds that the firms that belong to groups pay higher salaries and wages than independent firms. Wages and salaries are tax deductible while the distribution of income is subject to corporate income tax. Corporate groups influence the distribution of income among the suppliers of various factors of production and help to isolate the individual firm from market pressures. Imai[1989] explains group formation on the basis of the process in which a firm adjusts itself to changes in its environment. According to Imai, the fundamentally important activities of managers in a modern firm are creating information, seeking a new context for doing business, and developing the accumulating process of continuous innovation through the interaction of personnel. The choice of market or organization is determined by such interactions. An interaction is, of course, easily conducted within a firm. But, even in the market, an interaction can be conducted through forming continual transaction relations. Which is better, internal organization or the market, depends on the contents of the interaction. Generally an internal organization is oriented in terms of speed of research and development, production, and marketing. But an internal organization, especially an intra-firm organization, has a defect that the information created within the firm is likely