Shareholders in Japan no longer accept below-par corporate governance standards. Changes are taking place, but there are still areas for improvement, says Tetsuro Takase at SuMi Trust. International investors sometimes say corporate governance is Japan’s Achilles heel. There’s a view that companies lack external oversight and shareholders lack the ability to influence change. For some, this is one of the key reasons why Japanese companies currently face a valuation discount. However, we believe this view is largely unfair and that a cultural shift has been occurring in Japan that has created greater levels of board accountability and sowed the seeds of shareholder activism. This shift should only become more pronounced in the coming years. This change in the nation’s mindset is visible in a number of areas, for example, through the Corporate Governance Code, which resembles the UK’s own corporate governance code. This was originally introduced by the Tokyo Stock Exchange (TSE) in 2015, and it was revised in 2018 and 2021 to include much stricter requirements for companies. Even though the Code enforces no legal requirements on the listed companies on the Exchange it has already had a significant impact, particularly with regard to the number of external directors on the boards of Japanese companies.

Shareholder accountability

In 2014, before the Code existed, only 6.4% of Prime Market listed companies on the TSE had an independent director ratio of least a third. However, according to TSE figures, by 2021, this had risen to 72%, and it has grown to over 92% as of August 2022 as a result of the 2021 revision, with the number still rising. While this is still lower than the EU and the US, it shows that Japanese companies are heading in the right direction and that company executives and boards are committed to becoming more accountable to their shareholders. Public sentiment is also increasingly moving in favour of ending the phenomenon of cross-shareholding. This is a business practice that is largely unique to Japan, where companies hold certain amounts of each other’s stocks in an attempt to foster mutual cooperation and support the recovery of the Japanese economy after the Second World War. While it helped to spark Japan’s post-war economic miracle in the 20th century, its continuation has led to numerous problems when it comes to corporate governance. Not only does the practice serve as a burden on return-on-equity (ROE), given that it ties up a significant proportion of shareholder equity, but it also limits the opportunity for external shareholders to influence a company’s operations. This is because cross-holders have historically been in lockstep with incumbent management, regardless of their performance. It is no coincidence, therefore, that investors are increasingly looking to invest in companies that are dismantling their cross-shareholding arrangements, including Warren Buffett, who recently told Nikkei Asia during a visit to Japan that he saw companies who were initiating share buyback programmes as a “plus”. There have already been a number of positive developments on this front. First, the Japanese government has taken steps to increase the transparency of these arrangements, such as the Financial Services Agency that introduced requirements for companies to disclose more information about cross-shareholding schemes. This has created more pressure on companies to divest these arrangements and has helped to facilitate the decline of this practice from 11,661 issues in 2013 to 9,302 in 2020. One example is that of Obayashi Corporation, one of Japan’s largest construction companies that announced last year it would sell 150 billion yen worth of shares to bring the ratio of cross-shareholdings to net assets to less than 20% by March 2027. Its share price has already risen from 949 JPY (as of Jan 10) to 1,172 JPY (as of May 10), showing the market has reacted favourably to its strategy of allocating the proceeds from this programme into strategic investments for sustainable long-term growth. This is just one of many companies undertaking such endeavours.

Areas of improvement needed

However, while the shift towards more effective corporate governance is well underway, there are still areas where Japanese companies could improve. While the percentage of JPX-Nikkei 400 companies with a majority of independent directors has risen to 17% as of 2022, this ratio is still a long way off other indexes, such as – according to Spencer Stuart research - 86% of S&P 500 companies and 93% of FTSE 150 companies. Japanese companies also lag behind when it comes to the gender diversity of their boards, with only 8% of boards consisting of at least 30% women, compared to 100% in France, 88% in the UK and 58% in the US, according to MSCI. Given that companies with a higher percentage of women on the board consistently post better corporate governance scores, this is an area that Japanese companies will need to work on in the coming years if they want to complete their transformation. However, what is readily apparent is that shareholders in Japan are no longer content to accept below-par corporate governance standards and that corporate Japan is starting to change as a result. There may be a long way to go before Japan catches up to Europe and the US, but it is clear that the wheels are in motion. *Tetsuro Takase is senior stewardship officer at SuMi Trust. © 2023 funds europe