Out of more than 700 defined-benefit corporate pension plans in Japan, only five non-financial corporate pension plans have signed the SC. Second, a major portion of Japan’s asset owners are the companies themselves, in the form of direct “policy holdings” of the shares issued by other companies. Japan’s dual walls of “conflicted pension governance” and “allegiant shareholders” need to be torn down. Here is how it can be done.
By Nicholas Benes
The short story: it will not be so hard if institutional shareholders really want to topple it, and use the technique suggested here. But first, the background.
This is still the biggest defect of Japan’s equity market, and recent reforms have only made a small dent in it. At the average listed company, between 35% and 50% of the stock is owned by such holders if one includes not only firms in “cross-shareholding” relationships but also firms that unilaterally hold stock in order to win business; most holdings by
banks and insurance companies; and parent companies, subsidiaries, and affiliates. Consistent with this estimate, when Japanese listed companies were asked, “what percent of your shareholders can you count to support management?” in late 2017, fully more than two-thirds of companies responded with numbers in the 30-60% range.
These “policy holdings” by “stable shareholders” represent a massive misallocation of capital that is being put at risk largely for the purpose of protecting executive teams at other companies. In 1967, Japan’s one of Japan’s most venerated managers and the founder of Panasonic, Konosuke Matsushita, minced no words in noting his concern about the then-recent rise of “stable” cross-shareholdings in these words: “If this situation continues, I think it is in no way desirable, because of the risk that once again a maldistribution of capital in our country will occur. I believe that this is not a sign of progress in capitalism; rather, it should be considered as a sign that we are moving backwards.”
Frequent visitors to our blog are likely aware of Japan’s major corporate governance reforms, but not everyone is familiar with the story behind how these reforms were crafted. The eminent Steven K. Vogel (Professor of Political Science at the University of California, Berkeley), recently wrote a concise and easy-to-follow history of the major reforms to Japanese corporate governance practices since the 1990s, describing how and why they came to pass.
As the person who initially proposed the Corporate Governance Code to the LDP in 2013 and 2014, I am well aware of its limitations in various areas. For this reason, I am very pleased that Fair M&A Study Group have decided that its discussions should cover not only MBOs, but also ”cases which are likewise significantly affected by the issues of conflict of interest and information asymmetry”, including “cases of acquisition of a controlled company by its controlling shareholder.”
This indeed an important mission, because these topics include virtually all types of M&A transactions and the public statements of executives and boards with regard to them. For many years in the post-war era, the failure of the government and the JPX/TSE to set forth clear bright-line rules that facilitate a fair, robust M&A market in Japan has stunted productivity, dynamism and growth in the Japanese economy.
Our joint research – “Linkage Between Corporate Governance and Value Creation” – between BDTI and METRICAL has been updated as of January 31. The most important inferences are summarized below.
(1) Correlations: Board Practices
Significant correlation between board practices and performance continues.
(a) ROE: Nominations Committee existence, the number of female directors and percentage of INEDs show a significant positive correlation.
(b) Tobins Q: Nominations Committee, retired top management “advisors” (ex-CEO “advisors”), and percentage of INEDs show
(c) ROA (actual): Compensation Committee existence (negative correlation), Incentive Compensation Plan disclosure, and retired top management (ex-CEO) serving as advisors show significant correlation.
NOTE: This public comment supersedes and replaces the one that I, Nicholas Benes, submitted on January 12, 2019)
As the person who initially proposed the Corporate Governance Code to the LDP in 2013 and 2014, and suggested a number of principles in it, I am well aware of its limitations in various areas and the fact that Japan has not yet attained the quality level for an equity market that is expected by global investors. In this sense I am very pleased that the JPX has decided to review its equity market structure and related standards.
Challenges and Realities
This indeed an important mission, for which is it essential to recognize and discuss the impact of a number of challenges that Japan faces in improving governance, efficiency, and trustworthiness of its equity capital markets. These challenges include:
Executive training is badly needed in order for independent directors to perform their expected role
When I proposed to the LDP and the government in 2013 that Japan promulgate a corporate governance code, one of the most important principles that I advised should be included in it was a requirement for director and pre-director training. To anyone who has ever sat on an average Japanese board, the need for this is obvious. Without more training of both executives and external directors in Japan, it will continue to be very difficult for independent directors to perform the roles that are now expected of them. From personal experience, I know that it is simply not possible to convince engineers who do not understand finance that their company could very easily go bankrupt in two years.
We are pleased to note that against the backdrop of the recent events at Nissan, the Institutional Corporate Governance Network (ICGN) has submitted a letter to Japan’s Council of Experts for the Follow-up of Japan’s Stewardship Code and Corporate Governance Code, stressing the importance of independent directors, independent board committees, director training, use of a “skills matrix”, capital allocation, disclosures, and a number of other issues that BDTI has been stressing for many years, – ever since its establishment in 2009, in fact. On the topic of director training, Kerrie Waring of the ICGN wrote:
” ICGN encourages the introduction of high quality training for independent directors in Japan to help build an understanding of what their role entails, particularly in relation to monitoring management and public disclosures. This would help ensure objective decision-making in response to business issues and in alignment with the company’s vision, mission and strategy. We also stress the importance of financial literacy to ensure that independent directors are able to challenge management on issues such as capital efficiency, the use of cross shareholdings and CEO remuneration.” (emphasis added)
By Ken Hokugo
Director, Head of Corporate Governance, Pension Fund Association
Director, The Board Director Training Institute of Japan
There has always been confusion surrounding this topic. From the point of view of those who want to help foreign investors understand the realities of the Japanese market, the most troubling number that is thrown about is the seemingly magic number of “10% or less”. This number is frequently referred to by the media, with the source given as being the reports by a certain analyst at a research institute that is affiliated with a prominent securities firm.
Quite often, we encounter foreign investors who casually believe this widely-touted number of “10% or less” and therefore are not concerned very much (if at all) with the issue of “cross-shareholdings” in Japan, in light of recent improvements in Japan’s corporate governance. Needless to say, it takes a lot of energy to convince such investors that the reality of the Japanese market is different. In this post, I am not trying to scare foreign investors away from Japan’s stock markets, but rather trying to encourage them to invest based on an accurate understanding of the situation in the context of history, culture, and the overall current environment.
CG Top 20 stocks continued solid performance in August
August stock prices have continued low trading volume. Topix and JPX400 indices tumbled in the middle of the month, but recovered toward the month end. Meanwhile, CG Top 20 prices also recovered their losses toward the end of the month. The gap between CG quality stocks and the market indices is widening. The stock price charts for in the indices and the composite of CG top 20 companies are shown in the following link.