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Corporate governance in Japan – a work in progress

Corporate governance in Japan – a work in progress

Amid a rising yen and weak economic growth, the swoon in Japan’s stock market this year has again raised doubts about the efficacy of Abenomics. But for longer-term investors, there has been one encouraging trend: the continuing momentum of improving corporate governance.

By now, the measures to impose higher governance standards on listed companies are well known: from the introduction of a Stewardship Code in 2014, to the adoption of a Corporate Governance Code last year. There are heartening signs: independent directors are in demand, awareness of capital efficiency is rising, and the number of companies engaging with investors has grown.

Despite the notable successes, there have also been some setbacks. While payouts at some companies have risen – Amada and Fanuc are the oft-cited examples – weak oversight persists, as evidenced by the corporate woes at Toshiba and Mitsubishi Motors. The recent upheaval within Seven & i Holdings’ board, incited by US-based activist hedge fund Third Point, and partly by independent director and corporate governance advocate Kunio Ito, suggests that the path ahead remains bumpy.

The change in corporate mind-sets will take time.

Our verdict: it’s still early days. Despite better payouts, companies still retain sizeable cash balances for no good reason. Some companies embark on endless searches for dream candidates to serve as independent directors, while others seem content just ticking the boxes. The change in corporate mind-sets will take time, although admittedly, these issues aren’t unique to Japan. What more can be done?

First, there should be stricter limits on share issuances to third parties. This can help to instil in companies the necessary discipline in the use of capital, while protecting minority shareholders from unnecessary dilution of their investments.

Next, there should be a clearer process for approving related-party transactions, an area susceptible to the abuse of minority shareholders’ rights. Several countries have adopted additional protection in recent years, including requiring approvals from minority shareholders and independent advice on the fairness of such transactions.

Third, institutional investors should be able to attend shareholder meetings and accorded with full voting rights. As it stands, access is limited, and companies can – and do – arbitrarily reject the attendance of such shareholders. A recent paper by a corporate- backed organisation that studies such issues sought to propose some solutions. But it did not go far enough in addressing the core problem: institutional investors still face significant hurdles in attending shareholder meetings.

Lastly, companies should also consider paying out surplus capital through special dividends, instead of via share buybacks. While buying shares back can provide a short-term boost to the share price, it can amount to a misallocation of capital if these shares are purchased at unfavourable valuations. With the push for better returns on equity, many companies appear misguided in pursuing this course of action, regardless of valuations.

If a multinational company wants an identifiably consistent culture it needs to ensure that it asserts its culture‎ throughout the organisation. The crystal of culture needs a seed to grow around – an individual or group at the top setting the style and standard for the new organisation.

Unmistakably, there have been real improvements to the corporate governance framework in Japan. Bedding down the new and improved codes will take time. It is unrealistic to expect a sea change in the near term. But these issues are very real and come with potentially damaging consequences for the minority shareholder. These should be addressed with urgency to further strengthen Japan’s corporate governance structures, which will ultimately benefit all investors.

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