Japan is loosening corporate governance constraints
Efforts to dismantle cross-held shares and improve board oversight are succeeding amid heightened interest from private equity and activist investors.
Something is stirring in corporate Japan.
For many years, the country’s biggest businesses have occasionally been in the spotlight, either because of their technical prowess or manufacturing success, or because of corporate scandal that has forced a storied company and its top executives into the uncomfortable glare of media scrutiny — with C-suite apologies and resignations following. But the latest spotlight is illuminating one of the most positive developments to have occurred in Japanese business in decades: the first signs of improvements in corporate governance.
The government of prime minister Shinzo Abe has been pushing an overhaul of corporate governance since 2014, when it introduced Japan’s first stewardship code, which — among other things — required transparency on voting records at fund managers. A year later, the government introduced a corporate governance code as part of a broader effort by the Abe administration to make Japanese companies more competitive.
The story of corporate Japan had hitherto been one of innovation, but also of sluggish growth, low return on investment, a hoarding of cash that could have been returned to shareholders, and weaknesses in board oversight of management (this last point was widely seen as a factor behind some of the corporate scandals that had generated headlines in recent years). The country’s governance ecosystem made it hard for shareholders to, among other things, press for changes at top Japanese companies. Further, critics said it fed a culture that was generally unresponsive to shareholder demands.
The biggest move to shake things up came in 2018 with a revision of the 2015 code. The revision aimed — in the words of the document that laid it out — to seek “sustainable corporate growth and increased corporate value over the mid- to long term.” It thus encouraged the unbundling of cross-shareholdings, which involved companies owning large chunks of each other’s shares. The phenomenon traces its roots as far back as the zaibatsu family business conglomerates that existed in 19th-century imperial Japan. Although these were to a significant extent disbanded after World War II, a different kind of business arrangement emerged over time known as keiretsu, relationships between companies, often involving cross-shareholdings as well as relationships with a core bank.
Although the Japanese banking crisis of the 1990s largely broke up ties between Japanese industry (and keiretsu) and the banks, cross-shareholdings have persisted. Often justified as a way of maintaining necessary business relationships, they nonetheless have been criticized by shareholder activists and others as locking up shareholder equity that could be more efficiently deployed elsewhere. The practice of cross-shareholding was also seen as protecting underperforming management from ouster, given that cross-shareholders could generally be relied upon to support incumbent management.
How far has Japan progressed on corporate governance today? The answer to this question is not only of interest from the perspective of a domestic audience; it is also highly relevant to foreign institutional and other investors. That is because the Abe administration’s push on corporate governance has come at a time of heightened foreign interest in Japanese corporates on the part of private equity and activist investors.
Early in 2019, corporate buyout firm KKR said Japan was now its top priority globally, citing the jettisoning of subsidiaries long held by Japanese conglomerates. A year earlier, ValueAct Holdings, a San Francisco–based hedge fund, took a large stake in Olympus, a Japanese camera and medical devices group, signaling its belief in opportunities that corporate governance reform might bring. Big foreign fund managers and corporate governance watchers generally also show significant interest in what is happening in Japan now.
Signs of progress
Taken together, these developments indicate that Japanese corporate governance is reforming and could signal a new era of greater C-suite accountability and responsiveness to shareholders — and thus a stretch of renewed business growth that could put Japan in an even more prominent position on the investor map.
Jamie Allen, secretary-general of the Hong Kong–based Asian Corporate Governance Association (ACGA), says Japanese companies — especially larger ones — have been busy reforming. “In general, you do see that companies are starting to realize that if they want to become global players, they need to start measuring themselves against global standards,” he said in an interview with s+b.
Companies are voluntarily following disclosure guidelines, gender equality is increasing, and there are more outside directors than before. All three factors are among criteria examined in the ACGA’s assessment of Asia’s corporate governance landscape in a biennial report. In particular, Japanese companies have made an effort to appoint more outside directors, in line with the governance code’s request that companies nominate a minimum of two outsiders to the board.
One of the companies that made it into the top 10 in the ACGA’s corporate governance rankings was Kao Corporation, a maker of chemicals and cosmetics. The company told s+b that it had benefited from having an outsider’s perspective on the board. This helped when it came to recalibrating executive pay in a country where the average salaries for executives are lower than for their counterparts elsewhere.
“Our new director advised us to raise executive remuneration, among other things,” a Kao spokesperson said. “It became easier to hire talented executives with higher pay to offer. I think these sorts of changes are happening in more Japanese companies.”
Electronics group Hitachi is perhaps the highest-profile example of change. It has in recent years developed a succession plan for its chief executive, who is an outsider — previously rare in corporate Japan. In addition, the company has determined that at least one-third of board directors need to be from outside. “Most of the independent outside directors are those who have extensive experience in the management of global enterprises,” a spokesperson told s+b. “Our goal is to receive objective criticisms or suggestions concerning what corporate management should be from different perspectives. If we try to construct our discussion on the board from that perspective, the information provided to the board will be very different, and I believe that it will contribute to better financial performance and [make the company] more sensitive to expectations from markets and customers.”
Such comments point to a significant change in mind-set, which experts say is as important as any government-led efforts to push for change through codes of conduct or even legislation. Some of the new tone has been set by the Government Pension Investment Fund (GPIF) — the Japanese pension fund and the world’s largest pension fund by assets. The GPIF has been pushing corporate governance reform behind the scenes for some time. The 2019 shareholder meetings season — which runs over the summer — featured a significant uptick in moves by Japanese companies to head off uncomfortable issues at annual general meetings (AGMs). The Financial Times reported that a record 46 Japanese corporations had pledged to drop their takeover defense strategies in anticipation of potential opposition from activist shareholders at their AGMs this year. That was more than twice the number that did so in 2018.
Looking at things from the shareholder perspective, the Financial Times, in the same report, cited Goldman Sachs estimates that the number of companies to have received shareholder proposals ahead of their AGMs had surged to a record 59, from 42 in 2018. Many proposals were related to dismissal of board directors. In particular, this change is allowing for more responsiveness to activist investors at Japanese corporations, although the number of examples in which this has been the case remains small. In June 2019, financial-services group Nomura bowed to shareholder demands by announcing a share buyback ahead of its AGM — sending its shares sharply higher. It also agreed to withdraw a proposal to nominate its chair to various board roles “to bolster governance.” The most striking recent example of activist investor influence came at Lixil, a building materials group, which in June 2019 acceded to shareholders’ demands to reinstate its former CEO — voting against the chair in so doing.
- Bobbie van der List is a correspondent for Dutch newspapers and magazines. Based in Tokyo, he specializes in business- and management-related topics.