Value proposition of integrated reporting and the price-book ratio model: Evidence from Japan

by Dr. Ryohei Yanagi, CFO, Eisai and Visiting Professor, Waseda University

How can we connect non-financial capitals and corporate value? A new book, ‘Corporate Governance and Value Creation in Japan‘, which was launched in May 2018 as my first English book, provides a conceptual framework for integrating intangibles with ROE as well as empirical evidence and case studies supporting this model.  (Here is the Japanese version of this book.)

Inconvenient truth: No meaningful value creation although Japanese companies tout ESG

In Japan, ESG and non-financial reporting are booming with 341 listed companies, according to KPMG, having adopted integrated reporting in 2017. Japanese corporate managers are traditionally inclined to tout their companies’ intangibles such as human resources and social contribution rather than financial metrics like ROE.

In recent years, however, Japan’s PBR (price-book value ratio: market capitalization to equity book value) has been stagnant and hovering around one without meaningful “market value added” (MVA, market cap above equity book value). If we assume that current financial capital is related to equity book value (BV, PBR up to 1x) while non-financial capitals are connected with MVA (PBR above 1x), Japan’s emphasis on intangibles should have resulted in MVA well above 1x. Why is there an apparent lack of value creation by Japanese companies despite its allegedly affluent intangibles?

Lack of corporate governance in the wake of so-called “bank-led governance” in Japan exemplified by infamous “cross-shareholdings” may have incurred the significant “ESG discount” with persistent effects on valuation at least in the past. With that, according to a global investor survey which I conducted this spring, 73% of global investors said that Japanese companies should show value-relevance between ESG and ROE.

Value proposition: Synchronization of ESG and ROE (IIRC-PBR Model)

Allegedly corporate value can be represented by PBR whereby MVA indicates PBR above 1x as value creation over nominal book value. I assume MVA is related to non-financial capitals or intangibles.

On the other hand, in accordance with Residual Income Model (RIM), MVA is theoretically the function of future flow of ROE. Therefore, my assertion as IIRC-PBR model is that non-financials can be synchronized with ROE via MVA on a long-term basis (note: we must avoid short-termism), enabling the win-win situation for both investors and companies.


Corporate value = BV + MVA

BV = PBR 1x = current ‘financial capital’

MVA = PBR above 1x = related to non-financial capitals

= ‘intellectual capital’ + ‘human capital’ + ‘manufactured capital’ + ‘social and relationship capital’ and ‘natural capital’ as the IIRC defines = potentially future ‘financial capital’

(via RIM)

= the sum of the present values of future stream of “BV x ROE over cost of equity (Residual Income)”

Compelling evidence: Positive correlation shown between non-financials and value

To support the IIRC-PBR model, the book introduces empirical studies showing a statistical correlation. For example, a study conducted by my team with Chuo University found a significant positive correlation (+0.733 with p-value less than 1%) between the IIRC’s five non-financial capitals and PBR in Japan’s healthcare sector.

Furthermore, another empirical study which I conducted with a quants analyst sampled Japanese companies across-the-board and showed that the more a company’s intangibles were formed from personnel expenses (human capital) and R&D expenses (intellectual capital), the higher its MVA accordingly. Given more than 0.10 of the R2 value respectively with p-value less than 1%, the study concluded that more than 10% of MVA is explainable by intellectual capital whereas another 10% or more is attributable to human capital. This can be interpreted as significant and direct evidence supporting the IIRC-PBR model.

Case Study: Eisai offers its drugs for a neglected tropical disease free of charge

Eisai is the 5th largest pharma company in Japan and considered to be an early adopter of ESG and integrated reporting. Building on its Corporate Philosophy which places the first priority on patients’ satisfaction; Eisai pursues value relevance between ‘financial capital’ and ‘non-financial capitals’.

For example, Eisai has been with WHO distributing 2.2 billion tablets for the treatment of lymphatic filariasis, a neglected tropical disease, free of charge to patients in emerging countries until 2020. This social contribution to access to medicines is not a donation and does not merely stop at CSR, but acts as an aspect of ‘ultra–long-term investment’ that can be accepted by investors. It was a negative factor on short-term profits and ROE, but in the ultra-long term, NPV can become positive through factors such as brand value in the company’s operations in emerging countries, increased productivity and improved skills of employees through higher production rates at the India plant.

Based on such evidence from Japan, the book concludes that we can synchronize five non-financial capitals as defined by the IIRC with PBR representing corporate value, thereby creating the win-win situation for both global investors and Japanese companies on a long-term basis.

Dr. Ryohei Yanagi, CFO, Eisai and Visiting Professor, Waseda University


Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.