Executive Summary Evidence from this case suggests that the traditional Japanese corporate governance stance has started to shift in order to include some elements of the Anglo-American way of corporate governance.
It appears that a final decision has been made to build Disney Sea Park (despite unattractive ARR, but attractive NPV/IRR and ACFR) not only for the potential profits reaped for the company but also due to their responsibility to keep uphold the interests of its stakeholders (which would include its parent company, stockholders, landowners, suppliers, creditors, the local communities and government), whose livelihoods would be directly affected by this critical decision. However, we also believe that the Japanese corporation Oriental Land (OL) was justified in exercising caution before investing the Disney Sea Park project.
We base our reasons primarily due to the culture and norms of Japanese Corporate Governance practices. The value of the investment is calculated using figures calculated in the period during 2000-2005 (note the project starts in 2000). Numbers used in the Appendix A and B are drawn directly from Case Exhibits 3-7. AAR will be calculated as indicated in Case Exhibit 2, and NPV and IRR calculations will be based on Discounted Cash Flows including Interest Payments (because in Exhibit 7, OL seems to include Interest in their calculations). Case Background
The case describes how the OL management team was eager to expand the business beyond its Disneyland enterprise in Japan, and thus considers the investment in a new project – the Disneyland Sea Park. Upon negotiating with Walt Disney (who are notoriously tough in their negotiation, demanding 10% royalty on entrance fees, 5% fee on food and novelty goods), OL management were initially skeptical in the project as it involved a huge risk for them – since they will not only solely invest in the land, but shoulder 100% of the construction cost as well.
In addition, unlike Anglo American companies who focus solely on maximizing shareholders wealth (especially in the short term), Japanese corporations such as OL would focus on maximizing corporate wealth for the long term (financial, technical, market and human resources), putting stakeholders on par with shareholders in their investment decision making process. Average Accounting Return In Japan, the most common method is to utilize the AAR method, as it most reflects the culture in which Japanese companies are run (e. g. they do not value opportunity cost of its assets, and rarely deal with foreign companies).
When referring to Appendix A (attached), we will see that the calculated AAR = -1% which would lead the management team to conclude that the investment is unattractive and nonsensical to pursue. However, using the AAR alone as an assessment tool may prove to be too simplistic as such a method does not take into account the time value of money, and the timing of cash flows. In addition, cash flows after the operating period are completely ignored and the calculations do not take into account the discount rate of the market.
Thus, we conclude that AAR may be useful as a rough measure of investment risk; however we feel it to be inadequate in assessing potential projects in the modern day of business. Net Present Value and Investment Rate of Return The Walt Disney team, however, are using the conventional ‘western’ methodologies: NPV and IRR; which addresses the shortcomings of the AAR method. Referring to Appendix B1 and B2 (attached), the Discounted Cash Flow was calculated both from figures pieced together as given in the case (please refer to Assumptions column) and cross checked this with the cash flow numbers given in Exhibit 7 (in the case).
The results are within close range of each other, and thus we are reasonably confident in the accuracy of the numbers. Referring to numbers in Appendix B. 2, at the end of the five year period, NPV works out to be positive at $466. 5 million, and IRR is at 8. 3%. As mentioned in the case, these numbers are in stark contrast vs. Japanese AAR figures. Although NPV and IRR methods directly maximizes shareholders wealth, in understanding Japanese corporate governance, we understand that the NPV and IRR method may not fit with the Japanese management decision making culture.
Accordingly, the case mentions that Japanese managers are often less “numbers driven” than their “western” counterparts and would need to balance serving the interests of stakeholders (rather than shareholders only) as well looking after the company’s long term wealth. Average Cash Flow Return As cited in the case, The Bank of Japan (IBJ – the main bank financing OL) proved to be instrumental in mediating between WD and OL in order for a successful outcome.
Due to their international business exposure and experience in brokering between Japanese and overseas clients, IBJ proposed an alternative method in which compromises between AAR and NPV/IRR in calculating the financial projections. As shown on Appendix A, the ACFR is positive at +79. 1%, considerably much better than the original AAR of -1%. While this method utilizes the concept of cash flow and uses the initial investment as the denominator, discounted cash flow is still not used, and we suspect this method is geared more towards the comfort level of OL managers, while WD managers would continue to utilize the NPV and IRR figures.
Conclusion The case happily concludes that the OL management finally decided to go ahead with the Disney Sea Park Project. However, while this may be in part due to the positive numbers generated by IBJ’s ACFR methodology, we feel that part of the decision was also forcibly made in the interests of OL’s stakeholders, such as •OL’s Disney business (and ultimately profit margins for parent company): To override the potential downturn of Disneyland by generating new attraction and innovations for the consumer to keep the visitors coming •The landowner: maximize use of land, reap profits Suppliers: new contracts generate revenues for the suppliers and related businesses •Stockholders: potential profits would drive up price of shares •The Local Community: getting this project going would generate jobs, and therefore wealth for the community Taking into account the traditional Japanese corporate culture, we fully sympathize with management’s sense of caution and conservatism before making this critical decision, since they bear 100% risk in in financing and constructing the park while also having to pay WD for phenomenal licensing fees – a lot is at stake.
On the other hand, WD’s management team is understandably keen to utilize the positive NPV and IRR numbers to assess the new investment project as we believe such a project would bring them additional revenue from bearing practically zero investment risk. However, moving on to the future, there is an increasing need to internationalize Japanese corporations (as IBJ has led and pioneered). Based on this, it seems that the future of capital budgeting decision making would move towards the Anglo-American method of NPV and IRR calculations.
NPV and IRR methods encapsulate the cash flow generating capability based on the lifecycle of the invested assets by taking WACC as the appropriate discount rate on the time value of the future cash flow. Since Disney Sea Park is a highly capital intense infrastructure project, such methods would reflect more accurately on the risk and return in comparing to AAR method; as AAR doesn’t normalize the future value of the cash flow thus would yield an unfair ground of cash flow evaluation when the real revenue comes in at a later stage.
Although ACFR uses the adjusted cash flow based on the terminal value of the initial investment, such method still doesn’t take into account of the discount cash flow position thus could not reflect on the actual risk and ongoing concern basis of the project. If this takes place, Japanese corporations will inevitably move towards being increasingly shareholder (not stakeholder) orientated. There may be an upside here, as moving towards such a system would also address the complex principle-agency relationship which may arise from the current system.
At present, agents (managers) of the Japanese companies are likely to have goals that are not completely aligned with those of the principals (stakeholders in this case), since there are so many different parties interests at hand, and it’s not possible to answer to everyone’s interests, thus diluting the agent’s productivity. Whereas in Western companies, shareholders are theoretically the only principals, and it is substantially more transparent for agents (managers) to answer to the goals of the principles – especially through incentivized schemes.
