BDTI/METRICAL CG Research Update: “Linkage between CG Practice and Value Creation”

BDTI and METRICAL collaborate on researching the linkage between CG practices sand value creation. We have recently released our updated analysis as of April 2018 for the roughly 1,800 publicly traded companies with market capitalization exceeding about JPY10 billion.

In this analysis, by examining board practices (CG guidelines, practices, and composition of the Board of Directors) and specific actions (real actions by a company) separately, we try to identify statistically significant correlations with financial performance measures (ROE, ROA, Tobin ‘s q) for each of these respectively – i.e, for, board practices and action respectively.

We have observed a certain degree of improvement in board practices since the introduction of the Corporate Governance Code.  However, assuming that one of the key goals of the corporation is value creation, in order to improve the effectiveness of engagement and stewardship it is very important to regularly analyze the way in which such improvement (and specifically, which improvements) appears to lead to value creation.

We can summarize the results of our recent analysis as follows:

Public Comment to the Proposed Revisions to Japan’s Governance Code – Nicholas Benes

by Nicholas Benes (as an individual)
April 30, 2018

1. Regarding the Overall Revision Process
2. Regarding Principle 2-6 (Activating the Function of Corporate Pension Funds as Asset Owners)
3. Regarding Principle 1-4 (“Policy Shareholdings”)
4. Regarding Principles 4-1③,4-3② and 4-3③ (Appointment and Termination of the CEO)
5. Regarding Principle 4-10① (The Use of Optional Structures)
6. Regarding Principle 4-14 (Training of Directors and Kansayaku)
7. Regarding Revision of the Machine-Readable Format of Corporate Governance Reports

(Note: This is a translation of a public comment which was originally written in Japanese and submitted in that form to the JPX/TSE.  The original version of the public comment is available here.)

1. Regarding the Overall Revision Process

I would like to express my thanks and appreciation for the hard work of the members of the Followup Committee with respect to this review of the Corporate Governance Code (the “CG Code”) . However,I would note that four years have elapsed since the initial drafting of the Code. As you know, in Germany there is a commission which monitors the effectiveness of the governance code on an ongoing basis, and proposes changes on a yearly basis if and as necessary.

Draft Revision of Japan’s Corporate Governance Code: Public Comment Period Begins

The Council of Experts Concerning the Follow-up of Japan’s Stewardship Code and Japan’s Corporate Governance Code (Chairman: Kazuhito Ikeo, Professor of Economics and Finance, Keio University) has  published its proposals for “Revision of the Corporate Governance Code” and  “Guidelines for Investor and Company Engagement”. Both are being put out for public comment until April 29, 2018.  Full information from the FSA is available here.   The documents themselves are available the links below.

Revision of the Coporate Governance Code and Establishment of Guidelines for Investor and Company Engagement(including Appendix1 and Appendix2)

(Appendix1)Japan’s Corporate Governance Code (Draft Revision)

(Appendix2)Guidelines for Investor and Company Engagement (Draft)

METRICALs CG Analysis Now Covers 1,808 Companies, Up From 511, Yielding More Robust Results

As of February 2018, METRICAL now covers more than 1,800 companies, having increased its scope from 500 companies. Our research now covers all TSE 1st section companies that have a market capitalization greater than Yen 10 Billion, which is to say almost all TSE1 companies. METRICAL has analyzed the corporate governance of Japanese companies for three years, using 10 criteria and more than 20 sub-criteria. The analysis focuses on both board practices as well as the corporate actions that should be closely affected by CG practice and should ultimately improve financial performance of companies.

Ministry of the Environment: January2017 ESG Working Group Report

” With the recent developments in ESG (Environment, Social and Governance) in our country, the Ministry of the Environment established a “Working Group on Incorporating Issues Regarding Sustainability into Investment” (ESG Working Group) in October 2015. Following discussion and debate over two fiscal years, the Ministry is pleased to announce that it has produced the […]

The Economist: “Environmental, societal, and…what? The craze for ethical investment has reached Japan”

The Economist has published two articles on ESG, one focusing on its expansion in Japan led by the GPIF and the other focusing on the impact of passive funds on the effectiveness of ESG investment overall. I was [accurately] quoted in the former – ” Nick Benes, who heads the Board Director Training Institute of Japan, an educational body, says he is “all for” the enthusiasm for ESG in Japan. But he frets that Japanese companies are focusing on environmental and social aspects at the expense of governance. “That is the real driver of sustainability,” says Mr Benes. “But here it’s a big, bold E and S, and a small, plain G.”

Progress: GPIF Refers to “Corporate Governance Codes” for the First Time

The GPIF should be highly commended for including reference to “the corporate governance codes of each country” to its recent statements regarding its stewardship policy and its proxy voting policy. This is a major step forward, considering the politics that it faces and the long-standing and unfounded claim by leaders in the industrial community who claim that if the GPIF had its own “principles and guidance for governance and proxy voting”, that would be “intervening in managerial decision making.  Even though the reference in the recently-released principles bends over backwards to encourage “giving a full hearing to explanations of non-compliance”, if you know the full background, this is significant progress.  (For the first time, the GPIF has uttered the words “corporate governance code” in writing!)

FT: “Companies fail to buy into Japan’s stewardship code”

“Minuscule adoption of code a hit to Abe corporate governance efforts”

“…..Nicholas Benes, one of the architects of Japan’s corporate governance code and head of the Board Director Training Institute of Japan said: “In order for the stewardship code to function as it was intended and be effective as hoped for, the most important part of the ‘investment chain’ that needs to be signed up are the end asset owners — a large proportion of which are corporate pension funds … they are the ones that dictate policy to the fund managers that have signed the code”.

Unless the corporate pension funds — as the biggest customers of the asset managers — are actively demanding better stewardship, fund managers would inevitably cut corners on engagement and proxy voting, Mr Benes added…. ”

Attribution Analysis of Change in CG Scores 09/2015-09/2016

Titlis has updated corporate its governance ratings for 500 major public companies in Japan as of September 2016. The CG scores improved 3/100 pts from a year ago,  steadily but at a slower pace than expectations at the inception of Corporate Governance Code. According to the attribution analysis of the changes in CG scores for a year, the category (factor) of the Board of Directors was the largest contributor and the categories of Incentive of Remuneration, Takeover Defense, and Share Cancellation also inched up scores.

Cross-shareholdings should be considered the effect of share price plunges. The resolution of cross-share holding is extremely slow. We should keep eyes on enhancement of CG.
http://www.titlisgroup.com/mwbhpwp/wp-content/uploads/CGR-attribution20161008.pdf

Report: Investor Obligations and Duties in Asian Markets

By Peter Knight, President, Generation Investment Management, Fiona Reynolds, Managing Director, PRI,  Nick Robins, Co-Director, UNEP Inquiry into a Sustainable Financial System and Eric Usher, Head, UNEP Finance Initiative

Executive Summary:

In China, Hong Kong, India, Malaysia, Singapore and South Korea there are compelling national interest reasons for policy makers to promote the incorporation of environmental, social and governance factors into investment practice. Issues include addressing air quality, improving citizens’ long-term health, reducing inequality, providing for an ageing population and attracting the international capital necessary to meet economic growth targets. Investing prudently requires ESG factors to be considered in investment decision-making and to be part of the dialogue between investors and companies. This is consistent with the legal framework in all the markets studied in this report.

However, despite growing awareness of responsible investment, many investors have yet to fully integrate ESG factors into their investment decision-making processes. Public policy and regulation are a key influence. Currently, these markets have few formal requirements to integrate ESG factors, but investor obligations and duties are dynamic concepts that continuously evolve as society changes.

By working together, policy makers and investors can shape investment frameworks to clarify the obligations and duties investors owe to beneficiaries – obligations to embed ESG factors into investment decision-making, ownership practices, and ultimately, the way in which companies are managed.