Governance Practices and Firm Performance in Japan – Preliminary Analysis of Causation

On December 11, 2019, Nicholas Benes gave a lecture on Corporate Governance Practices and Firm Performance in Japan at the Securities Analysts Association of Japan. It was generally well-received and covered the following topics:

  • An Introduction to BDTI
  • General Trends in Corporate Governance
  • Correlation Analysis on Relationships Between Corporate Governance and Firm Performance, and the Direction of Causation
  • Advice for Investors and Prospects for Future Research
  • Appendix: Preview of our internal corporate governance relational database

Of note were the three main themes that were discussed: (1) There are visible relationships between certain corporate governance practices and financial performance (2) the direction of causation is most important to confirm, and so far, BDTI’s analysis suggests that a number of specific governance practices actually do seem to “cause” improvement rather than simply serve as evidence that management wants to “look good”; and (3) this information is vitally useful for analysts and investors alike, in order to improve the effectiveness of investor engagement that enhances profitability, growth and stock performance in a win-win cycle.

“Japan’s Unfinished Corporate Governance Reforms”, by Nicholas Benes

My article on Japan’s unfinished reforms is online now. Lest the Abe administration and regulators “declare victory” when they are only half done, I describe seven specific measures that Japan needs to adopt in order to bring its market up to a global standard for a developed nation:

  1. Detailed rules for an independent committee
  2. A clear requirement for a majority of independent directors on the board
  3. Codifying the role and responsibilities of executive officers
  4. Consolidation of overlapping disclosure reports
  5. Protection of minority shareholder rights
  6. Enhancing transparency to reduce entrenchment and enhance inclusiveness
  7. Strengthening stewardship throughout the investment chain

I stress the reality that in all of these, strong political leadership from the Prime Minister and other senior parliamentarians will be needed. “Thus, is it essential that the Tokyo Stock Exchange (JPX/TSE) and the various regulatory agencies keep up reform momentum. However, one senses a desire from these groups to ‘declare victory’, and they have a tendency to not fully coordinate with each other. If Prime Minister Abe’s cabinet did more to make the key players coordinate their efforts in key areas, meaningful governance change (and protection of investors) would accelerate….

Correlations Between Governance Factors and Foreign Ownership

While overseas investors’ ownership decreased a year ago, activist investors are now likely to focus on Japanese companies. Corporate governance in Japan has improved since the Corporate Governance Code was introduced in June of 2015, but progress is much slower than foreign investors hoped. At this time, we analyze the relationship between % ownership held by overseas investors and key governance criteria. The following table shows the result of our regression analysis of the 13 governance factors that METRICAL uses as criteria and two performance measures, ROE and ROA. Of the 15 factors, 14 factors are significantly correlated with level of ownership by overseas investors.

What is the Difference Between Mr. Ghosn’s Deferred Compensation and Hiring Post-Retirement Directors as “Advisors?”

When you squint closely at the facts, not as much as you might think. Mostly, it is the difference between individual self-dealing and collective self-dealing.

As corporate policy, many Japanese companies re-hire their executive directors as “advisors (“sodanyaku” or “komon“) immediately after they retire from the board. The re-hiring occurs automatically, and the work expected from such “advisors” in their contracts (if any) is usually vague to the point of being non-existent.

Taking a Horse to Water – Prospects for the Japanese Corporate Governance Code

This paper was originally published by Zeitschrift für Japanisches Recht (Journal of Japanese Law) in its 2019 Spring edition (Vol.24). It is reproduced here by kind permission of the Executive Editors.

SUMMARY

“In 2014–2015 Japan implemented a series of reforms to its corporate governance regime. The principal measures adopted were the country’s first Corporate Governance Code, revisions to its Companies Law, and a Stewardship Code, together with a report (the Itō Review) on corporate competitiveness and incentives for growth. In this paper we analyse the objectives of these reforms and make an assessment of their likely success.

METRICAL/BDTI:Ratings of 1,800 companies (July 2019 Update)

In our July ratings, a more nuanced pictured emerged for Japanese companies. The significantly positive correlation of financial performance with the percentage of INEDs and the number of Female Directors disappeared this month, suggesting that an increasing number of non-superior performers are “copying” other companies in this respect, and/or have only only done so recently so no positive impact (should there be any) is discernible.

METRICAL: CG Top 20 stocks slightly underperformed in May… and a focus on board chairs

Chair of the Board of Directors
We would like to highlight the function of the chair of the board. Of about 1,800 companies, only 27 companies are chaired by an outside director. This indicates just how resistant inside directors are in entrusting the position of chair of the board to an outside director. The table below shows the 27 companies.

Corporate Governance in Japan: What Has Changed in the Past Three Years?

I recently gave a presentation in which I tried to answer this question. Here are the top-line conclusions:

  • Investors are finding their voting voices
  • Now they need to find to find their asking voices
  • There is a way to tear down the “allegiant shareholder ” wall
  • Factors that correlate with superior performance include: >= independent directors, low “allegiant” holdings, >15% female directors, and age of firm <45 years
  • Activism is becoming more effective

These conclusions are based on a huge amount of time-series data we have collected. We are now building a comprehensive time-series database that includes not only financial data, but all text and numerical data from financial reports and CG Reports, as well as tabulated AGM voting results for each resolution. The data will be organized so that one can zero in on exactly the data one needs. Here is a simple example showing board practices parameters, historical AGM participation and CEO approval rates, and the trend of ownership of “allegiant shareholdings”:

Japan’s Corporate Governance Conundrum, and How Investors Can Solve it

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.

How to Demolish Japan’s Wall of Yes-Man Allegiant Shareholders

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.



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.”