Japan’s normally uneventful annual shareholder meetings—which take place in late June and often on the same day to prevent shareholders from attending multiple meetings—are getting a shot of adrenaline this year. The country’s new corporate governance code (JCGC) went into effect last month and has enhanced shareholders’ and other stakeholders’ oversight of director actions at Japanese corporations, hitherto famous for their opacity.
The JCGC, together with Japan’s new stock index (Nikkei 400, also known as the “shame index” because of its exclusion of many famous but poorly performing companies) focuses for the first time on corporate return on equity (ROE), which has long lagged ROE levels in other major international markets. The JCGC also requires Japanese companies’ boards of directors to maintain an active dialogue with shareholders beyond mere reporting at annual shareholder meetings. Cumulatively, these changes have reportedly sparked a further rise (up almost 40% since June 2014 when the JCGC was announced by the TSE and Abe Government) in the Nikkei stock average as an unprecedented number of companies have increased share buybacks or dividends to raise ROE.
These changes are part of the overall reforms under Abenomics, and their effect on the Japanese economy is expected to not be limited to just the Japanese stock market. Japanese institutions that have traditionally held on to large pools of cash and retained earnings are more likely to increase investment in global markets where better returns will help raise ROE, including mergers and acquisitions (M&A) and real estate investment activity. This is particularly true in the United States and Europe, which are viewed as less volatile. At the same time, many Japanese corporations are gradually more open to streamlining their operations through sales of business divisions and assets, including intellectual property.
Our Japanese Practice anticipates that these changes will provide major new business opportunities, regardless of the nature of your connection to Japan. The Japanese practice has more than 50 years of experience advising global clients on inbound and outbound work relating to Japan, as well as representing Japanese corporations throughout the world in major M&A and disputes. We understand the unique aspects and complexities of transactions and disputes relating to Japan.
Partners Satoru Murase (New York) and Chris Wells (Tokyo) spoke with us about the forces shaping the new era of Japanese corporate governance, the implications for clients that do business with Japanese corporations, and the challenges ahead.
Why does this shareholder season merit special attention?
The stakes are high, not only for non-Japanese shareholders, but also for Japan-based stakeholders. Large foreign investors and hedge funds as well as the huge Japanese government fund GPIF are scrutinizing these meetings for signs of change, and the Japanese government is encouraging shareholders to exert more influence on management to increase corporate performance and entrepreneurship. Unwinding traditional Japanese share cross-ownership is also being implemented. This is a unique opportunity for the Japanese political and business leadership to show its commitment to improving the Japanese investment environment and corporate governance standards to spark Japanese economic growth and encourage foreign investors to maintain and increase their investments in Japan.
This is a radical Japanese government overhaul of shareholder and company relations. What in particular makes these corporate governance changes revolutionary?
We’re seeing coordinated government action to deliver on visible change in corporate Japan. Prime Minister Shinzō Abe, the architect of Abenomics, is relentless in his push for economic recovery paired with massive quantitative easing by the Bank of Japan. The focus on governance and targeting substantial ROE increases is key. The real possibility of an uptick in wages, M&A, and restructuring to increase Japanese corporate competitiveness in light of demographic challenges will have implications for foreign and domestic investors for years to come. Some hope to soon see strategic corporate takeovers and industry realignments that unleash corporate value because Japanese corporations have traditionally held on to unproductive real estate and large pools of cash rather than optimize their use. The objective of the overhaul is to form a foundation of sustained corporate economic growth, and the signs look good that this is achievable.
Although the changes in corporate governance will not have an immediate impact, what are the main challenges that investors and businesses with Japanese exposure need to be vigilant about?
Radical change is not easy in any country, especially in a tradition-bound one like Japan. Although Japanese corporations feel increased pressure to undertake more profitable investments and strategic deals, the new risks and globalization will not be easy. However, Abenomics and the JCGC provide a “socially acceptable” framework to hold Japanese management accountable for under-performance and to encourage meeting “global standards” of excellence. Many believe that Japanese companies will rise to this challenge and drive the Japanese economy forward. If ROE levels in Japan were to rise to those now existing in the United States, the Nikkei stock index could easily double.
In addition, it will take time for corporate boards of Japanese companies to become more independent and objective. Finally, a major risk is that the sharp rise in the Nikkei stock average will also make corporate management complacent. However, overall, the scale of these reforms is unprecedented and is resulting in broad changes to Japanese business globally and the investment environment in Japan, which should lead to many new business opportunities.