GLOBALISATION AND THE ROLE OF FINANCIAL ACCOUNTING INFORMATION IN JAPAN ISBN978 90 5170 776 2 Cover design: Crasborn Graphic Designers bno, Valkenburg a.d. Geul This book is no. 399 of the Tinbergen Institute Research Series, established through cooperation between Thela Thesis and the Tinbergen Institute. A list of books which already appeared in the series can be found in the back. II Globalisation and the Role of Financial Accounting Information in Japan Globalisatie en de Rol van Financial Accounting Informatie in Japan Proefschrift ter verkrijging van de graad van doctor aan de Erasmus Universiteit Rotterdam op gezag van de rector magnificus Prof.dr. S.W.J. Lamberts en volgens besluit van het College voor Promoties . De openbare verdediging zal plaatsvinden op donderdag 1 maart 2007 om 13:30 uur door Catharina Maaike van Mourik geboren te Gouda III Promotiecommissie Promotoren : Prof.dr. M.A. van Hoepen RA Prof.dr. J.A. Stam Overige leden : Prof.dr. M.N. Hoogendoorn RA Prof.dr. E. Pauer Prof.dr. R.L. ter Hoeven RA IV Acknowledgements This project was initiated by Oscar Volder, who then chose a successful career in asset management. Professors Van Hoepen and Stam gave me the opportunity to start where Oscar left off, which was at the very beginning. They also introduced me to a world of knowledge, gave me wise counsel and support whenever I asked for it, and kept up the good faith even under the most adverse of circumstances. My deepest gratitude and respect go out to them. The four years of research in Japan would have been very hard to realise if it had not been for the guidance and benevolence of Professor Kunio Ito of the faculty of commerce at Hitotsubashi University in Tokyo. My research in Japan was made possible by funding from the Japanese Ministry of Education and the Canon Foundation in Europe. I am grateful for the friendship and support I received from the 3 rd and 4 th years, MA and PhD students of Professor Ito’s financial accounting seminar 1998 to 2000. I believe that Ito-zemi represents the very best that Japanese universities have to offer. I also gratefully acknowledge the support of my boss Philip and my colleagues at the Science and Technology Office and other departments of the Royal Netherlands Embassy in Tokyo, which helped me make the right choice. Atsuko, Mihoko, and Momoko taught me to always look at the bright side of life. I would like to thank my mother, grandmother, Irma and Bert for their unwavering support and encouragement. There is no way I can put into words what they mean to me so I won’t even try. My friends Denise, Elizabeth, Marian and Monique have provided critical, stimulating, supportive and very necessary comments on all parts of life, which helped me to put things into perspective. Arjan deserves special mention as my sempai who saved the day and also has a contagious sense of humour. Last but not least there is Debin, my hero. Thank you for everything. This book is dedicated to my father, because if he were still alive today he would probably read it from the first page to the last. Carien van Mourik London, January 2007 V CONTENTS CHAPTER 1: INTRODUCTION 1 1.0. GLOBALISATION AND FINANCIAL ACCOUNTING IN JAPAN 1 1.1. HYPOTHESIS DEVELOPMENT 3 1.2. ANALYTICAL FRAMEWORK 4 1.3. PURPOSE , PERSPECTIVE AND IMPORTANCE OF THIS STUDY 6 1.4. METHODOLOGY AND ORGANISATION 7 CHAPTER 2: ENVIRONMENTAL FACTORS AND PARADIGMS 11 2.0. INTRODUCTION 11 2.1. INTERNATIONAL RELATIONS 15 2.2. ECONOMIC GROWTH AND DEVELOPMENT 23 2.3. THE FINANCIAL SYSTEM 27 2.4. TAXATION 38 2.5. CORPORATE GOVERNANCE 45 2.6. FUNCTIONS OF FINANCIAL ACCOUNTING STANDARDS UNDER DIFFERENT PARADIGMS 55 2.7. CONCLUSIONS 58 CHAPTER 3: JAPAN’S FINANCIAL ACCOUNTING SYSTEM 61 3.0. INTRODUCTION 61 3.1. CHARACTERISTICS OF THE JAPANESE ACCOUNTING SYSTEM 65 3.1.1. REGULATORY AUTHORITIES 66 3.1.2. LAWS , STANDARDS , RULES AND REGULATIONS 70 3.1.3. CREDITOR AND SHAREHOLDER PROTECTION 77 3.1.4. STATUS OF CONSOLIDATED FINANCIAL STATEMENTS 88 3.2. ACCOUNTING CONCEPTS AND APPROACHES 93 3.2.1. DETERMINING PROFITS 93 3.2.2. CAPITAL MAINTENANCE 96 3.2.3. DEFINITIONS OF LIABILITIES AND EQUITY , AND DISTRIBUTION OF INCOME CONCEPTS 99 3.2.4. CLEAN AND DIRTY SURPLUS CONCEPTS 102 3.3. ACCOUNTING STANDARDS AND REGULATIONS IN RESPONSE TO INTERNATIONALISATION 104 3.4. CONCLUSIONS FOR PART 1 108 CHAPTER 4: THE US AND JAPAN’S FINANCIAL ACCOUNTING SYSTEMS 111 4.0. INTRODUCTION 111 4.1. COMPARISON OF THE ACCOUNTING CONCEPTS AND APPROACHES , AND THE FUNCTIONS OF ACCOUNTING STANDARDS IN JAPAN AND THE US 112 4.1.1. BRIEF OUTLINE OF THE US ACCOUNTING SYSTEM 112 4.1.2. SOURCES OF JAPANESE CONSOLIDATED FINANCIAL ACCOUNTING STANDARDS 116 4.1.3. FUNCTIONS OF ACCOUNTING STANDARDS IN THE US AND JAPAN 118 4.1.4. CHARACTERISTICS OF THE ACCOUNTING SYSTEMS IN THE US AND JAPAN 119 4.1.5. ACCOUNTING CONCEPTS AND APPROACHES IN THE US AND JAPAN 121 VI 4.2. COMPARING RECOGNITION AND MEASUREMENT 123 4.2.1. RECOGNITION OF REVENUE AND EXPENSES 123 4.2.2. RECOGNITION OF ASSETS AND LIABILITIES 123 4.2.3. MEASUREMENT OF ASSETS 124 4.2.4. MEASUREMENT OF LIABILITIES 126 4.3. SUMMARY 126 CHAPTER 5: THE US AND JAPAN’S FINANCIAL DISCLOSURE SYSTEMS 129 5.0. COMPARISON OF DISCLOSURE STANDARDS BETWEEN US-GAAP AND JP-GAAP 129 5.1. FINANCIAL STATEMENTS REQUIRED 131 5.2. DISCLOSURE OF ACCOUNTING POLICIES , ACCOUNTING CHANGES , DISCLOSURE CHANGES , AND THE SCOPE OF CONSOLIDATION 132 5.3. NOTES AND SUPPORTING SCHEDULES 134 5.3.1. SUBSEQUENT EVENTS , CONTINGENT LIABILITIES , BILLS DISCOUNTED AND NOTES ENDORSED , AND PROVISIONS RELATED TO CONTRACTS 134 5.3.2. SEGMENTAL DISCLOSURE 135 5.3.3. LEASES 135 5.3.4. RELATED PARTY DISCLOSURES , CLAIMS TO UNCONSOLIDATED SUBSIDIARIES , OBLIGATIONS TO UNCONSOLIDATED SUBSIDIARIES 136 5.3.5. MARKETABLE SECURITIES AND INVESTMENTS 137 5.3.6. DERIVATIVES AND HEDGING 138 5.3.7. RETIREMENT BENEFITS AND PENSIONS 139 5.3.8. EARNINGS PER SHARE AND NET WORTH PER SHARE 140 5.3.9. DEFERRED TAXES 140 5.3.10. R&D EXPENDITURES 142 5.3.12. IMPAIRMENT OF LONG -LIVED ASSETS AND LOANS 144 5.3.13. BUSINESS COMBINATIONS 145 5.4. AUDITING 146 5.5. SUMMARY OF DIFFERENCES BETWEEN US-GAAP AND JP-GAAP FOR CONSOLIDATED FINANCIAL STATEMENTS 147 5.6. EXPLANATION OF THE DISCLOSURE SCORE SHEET 148 5.7. CONCLUSIONS OF PART 2 149 CHAPTER 6: EMPIRICAL STUDY 151 6.0. INTRODUCTION 151 6.1. RELATED STUDIES 152 6.2. RESEARCH QUESTIONS 154 6.3. HYPOTHESIS FORMULATION 154 6.3.1. THEORETICAL FRAMEWORK 154 6.3.2. FORMULATION OF THE HYPOTHESES 156 6.4. PERIOD AND SAMPLE SELECTION 157 6.4.1. PERIOD OF ANALYSIS 157 6.4.2. SAMPLE SELECTION 158 6.5. MODEL AND VARIABLE DESCRIPTION 158 6.5.1. MODEL 1 158 6.5.2. MODEL 2 161 6.5.4. CORRELATIONS 164 6.6. EMPIRICAL RESULTS 165 VII 6.6.1. EMPIRICAL RESULTS FOR MODEL 1 165 6.6.2. EMPIRICAL RESULTS FOR MODEL 2 170 6.7. SUMMARY AND CONCLUSIONS 172 CHAPTER 7: CONCLUSION 177 7.0. SUMMARY 177 7.1. THE ROLE OF INTERNATIONALISATION IN JAPAN ’S FINANCIAL ACCOUNTING SYSTEM DEVELOPMENT 177 7.2. CONVERGENCE BETWEEN US-GAAP AND JP-GAAP 180 7.3. ECONOMIC RATIONALES FOR VOLUNTARY ACCOUNTING DISCLOSURE 181 7.4. INSTITUTIONS , INFORMATION ASYMMETRY AND MORAL HAZARD 182 REFERENCE LIST 185 APPENDICES 200 VIII LIST OF FIGURES Figure 1: GNE and Gross Domestic Fixed Capital Formation (1875-1940) 24 Figure 2: Military capital formation percentage of Gross Domestic Fixed Capital Formation 24 Figure 3: GNE and Gross Domestic Fixed Capital Formation (1949-2003) 26 Figure 4: Cost of capital 162 Figure 5: Financial leverage (at book-values) 163 Figure 6: Partial coefficients of disclosure regressed on cost of capital variables 169 Figure 7: Partial coefficients of size regressed on cost of capital variables 169 Figure 8: Partial coefficients of leverage regressed on cost of capital variables 169 Figure 9: Partial coefficients of the book-to-market ratio regressed on cost of capital variables 169 Figure 10: Coefficients of corporate governance variables regressed on disclosure scores 171 LIST OF TABLES Table 1. : Sources of national tax revenues 44 Table 2: Tax revenues including social security contributions as a percentage of GDP 45 Table 3: Independent variables of Model (1) 160 Table 4: Regression variables of Model (2) 162 Table 5: Correlations Model (1) 165 Table 6: Correlations Model (2) 165 Table 7: Estimation Results for Model (1): Pooled Data Regressions, dependent variable WACC 166 Table 8: Estimation results for Model (1), dependent variable: WACC 168 Table 9: Estimation results for Model (2): Pooled Regressions, dependent variable: disc 170 Table 10: Estimation results for Model (2): Cross-sectional Regressions, dependent variable: disc 172 IX X Chapter 1: Introduction 1.0. Globalisation and financial accounting in Japan 1.1. Hypothesis development 1.2. Analytical framework 1.3. Purpose, perspective and importance of this study 1.4. Methodology and organisation 1.0. Globalisation and financial accounting in Japan Globalisation has been made possible by ongoing development in transportation, communication and information technologies, and relies partly on the acceptance of global standards. Internationalisation is premised on the existence of nation states, and depends on effective national and international institutional infrastructure. Although trade over long distances is as old as the Silk Road, international trade took off between 1870 and 1920. After World War II international institutions such as the UN and the IMF were established and international direct investment increased substantially.