Cleaning Up Japan Inc. Three recent scandals show Tokyo's financial reforms are working.

Byline: Edward Lincoln (Lincoln is the director of the Center for Japan-U.S. Business and Economic Studies at NYU's Stern School of Business.)

Early this month, the scandal at Nikko Cordial, a Japanese brokerage firm accused of misstating earnings, finally claimed its first victims when several top executives resigned in disgrace. So far, however, the firm has gotten off relatively lightly, paying a fine of just 500 million yen--a pittance by U.S. standards. The contrast between this and the criminal indictments brought last year for securities fraud against the Web entrepreneur Takafumi Horie and the investor Yoshiaki Murakami have led critics to accuse Tokyo of hypocrisy. Japan's government has stated repeatedly over the last decade that it's serious about cracking down on all forms of financial irregularities. But the very different punishments meted out in these cases suggest to some that Tokyo is really only interested in going after boisterous entrepreneurs while coddling old-line companies.

Cynics can be forgiven for taking such a view. In years past, Japan has often announced regulatory changes but not done much to implement them. Moreover, much of the business establishment was angry with Horie and Murakami for challenging traditional practices. Nikko Cordial, by contrast, behaved the way most Japanese firms do; when its misdeeds came to light it promptly admitted fault and a number of its top executives resigned. Horie and Murakami denied all wrongdoing, and it would be easy to see their prosecutions as acts of revenge by the establishment.

But it would also be a mistake. All three cases proved that Japan's financial system now works the way it's supposed to, and should reinforce recent reforms.

Those reforms aimed to open up new opportunities for Japanese investors and impose stiffer reporting responsibilities on corporations. The idea was to move the economy away from its reliance on bank financing, which got it into so much trouble in the 1990s, and toward the use of bond and equity markets to raise corporate funds. For this system to work, Japan needed innovative entrepreneurs and financiers to test the limits of the new rules. The markets also needed to be able to punish poorly managed companies--by raising interest rates on their bonds, by allowing hostile-takeover bids and by letting shareholders pressure them into changing bad policies and dumping bad managers. It ...