After a decade of sluggish economic performance in Japan, it is now widely recognized that its economy will not improve and crisis vulnerability will not be reduced without major restructuring of the corporate sector. Corporate leverage is quite high in Japan, reflecting investment and governance problems. The low profitability of the corporate sector is linked to the weak balance sheets and operating income of the banks. While important progress has been made in reducing corporate leverage in recent years, this has been attained not only by an increase in equity but also by a relatively sharp decline in corporate borrowing, which may limit the scope for economic expansion.
The authorities in 2002 began accelerating the introduction of measures aimed at jump-starting corporate restructuring. Banks and firms are being encouraged to agree to out-of-court restructuring in exchange for debt forgiveness or debt-equity conversion, subject to guidelines to be established by relevant ministries and the business and bankers’ associations.
As the case of Japan illustrates, large-scale corporate restructuring made necessary by increased financial vulnerability or, as in other countries, by a fullblown financial crisis, is one of the more daunting policy challenges a country can face. The government is forced to take a leading role, even if indirectly, because of the need to prioritize policy goals, address market failures, reform legal and tax systems, and deal with the resistance of powerful interest groups.
Stone, the author of papers and articles on the corporate sector, financial crises, and monetary policy, says that successful government-led corporate restructuring policies usually follow a sequence. First, the government should formulate macroeconomic and legal policies that lay the basis for successful restructuring. After that, financial restructuring must start to establish the proper incentives to get banks involved and get credit flowing again. Only then can corporate restructuring begin in earnest with the separating out of the viable from nonviable corporations, with the former being restructured and the latter liquidated.
Laying the foundation
Corporate restructuring on a large scale is usually made necessary by a systemic financial crisis—defined as a severe disruption of financial markets that, by impairing their ability to function, has large and adverse effects on the economy. The intertwining of the corporate and financial sectors that defines a systemic crisis requires that the restructuring address both sectors together. Stone argues that successful restructuring must have a strong foundation established by government action across the spectrum of economic policies:
• Overall economic stability must be entrenched to provide the confidence needed for debt restructuring. Stable prices, interest rates, and exchange rates are needed for debtors, creditors, and potential investors to have enough certainty to do business.
• The scale and nature of corporate distress must be quickly assessed to determine if the problems are systemic and thus whether the government should take a leading role.
• A comprehensive strategy for restructuring, encompassing both the corporate and financial sectors, should be drawn up as soon as the crisis is judged to be systemic and should involve all interested parties.
• A supportive legal, regulatory, and accounting environment needs to be in place. Important legal aspects of restructuring include foreclosure standards, foreign investment rules, and merger and acquisition policies.
• Corporate governance must be brought up to international standards to provide incentives for viable firms to restructure their balance sheets and maximize their value.
• Closing nonviable corporations will incur social costs that may require offsetting government actions to help the poor and to maintain political support for restructuring. Social measures should be formulated with the cooperation of corporations and unions.
Financialsector. Even after the foundation has been laid, corporate restructuring cannot begin to make headway without substantial progress in restructuring the financial sector. The draining of bank capital as part of the crisis will usually lead to a sharp cutback in lending to viable and nonviable corporations alike, worsening the overall contraction. Moreover, banks must have the capital and incentives to play a role in restructuring.
The first task of financial restructuring is to separate out the viable from the nonviable financial institutions to the extent possible. To do this work, financing and technical assistance from international financial institutions can be helpful. Nonviable banks should be taken over and their assets eventually sold or shifted to an asset management corporation, while viable banks should be recapitalized.
Corporatesector. Corporate restructuring can begin only when banks and market players are willing and able to participate. As with the financial sector, the first task is distinguishing viable from nonviable corporations. Nonviable corporations are those whose liquidation value is greater than their value as a going concern, taking into account potential restructuring costs, the “equilibrium” exchange rate, and interest rates. The closure of nonviable firms ensures that they do not absorb credit or worsen bank losses. However, the identification of nonviable corporations is complicated by the poor overall performance of the corporate sector during and just after the crisis. Liquidation can be speeded up by special courts or new bankruptcy laws.
What are the government’s choices?
Stone finds that the government’s role in corporate restructuring is highly country-specific because of the complexity, social consequences, and involvement of different elements of society. Thus, there are relatively few overarching operational principles or obvious ways to organize the policy choices, especially in comparison to other structural policy areas, such as capital account liberalization and labor market reform.
Stone identifies five government-led corporate restructuring methods, and includes case studies from Chile, Hungary, Mexico, Poland, and Thailand to illustrate his points. The five approaches, in ascending order of government involvement, are government mediation, government-financed incentive schemes, bank recapitalization, the creation of a government-financed asset management corporation, and the appointment of a restructuring director to accelerate the pace of reform.
Financial incentives through a preset government-financed scheme can help if corporate distress is systemic, market or regulatory failures inhibit restructuring, and the government has adequate fiscal resources at hand. A government-financed asset management corporation can buy bad loans, provide equity to banks and corporations, negotiate with debtors, and take an active financial and operational role in restructuring. Stone argues that this type of approach is called for if the number of troubled corporations is large and there are microeconomic elements that severely inhibit restructuring.
Lessons from country experiences
What general lessons can be drawn from these countries’ experiences? Stone suggests the following:
• Governments should be prepared to take on a large role as soon as a crisis is judged to be systemic.
• A sound supporting macroeconomic and legal environment is essential.
• Measures should be taken quickly to offset the social costs of crisis and restructuring.
• Restructuring should be based on a holistic and transparent strategy encompassing the corporate and financial sectors.
• Restructuring goals should be stated at the outset, and sunset provisions embedded within the enabling legislation for new restructuring institutions based on these goals.
• A determined effort to establish effective bankruptcy procedures in the face of pressures from vested interest groups is essential.
• The government should pare back its role in the economy after achieving its restructuring goals to set the stage for higher growth in the long run.
• Large-scale postcrisis corporate restructuring takes five years to complete, on average.
• Finally, crisis can ultimately boost long-term growth prospects both by weakening special interests that had previously blocked change and by encouraging the successful completion of corporate restructuring.
Copies of the Economic Issues pamphlet, Corporate Sector Restructuring: The Role of Government in Times of Crisis, by Mark R. Stone, will be available free from IMF Publication Services in July. See page 204 for ordering information.
Julio R. Prego
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