Corporate Governance in Japan: A Work in Progress

The work on Abenomics’ third arrow is promising so far, yet more needs to be done to ensure maximum value to shareholders.

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, Prime Minister Shinzo Abe’s plan to reinvigorate the country’s economy. For long-term investors, however, there has been one encouraging sign: Abenomics’ third and final arrow, improving corporate governance.

By now, the measures to impose higher governance standards on listed companies are well known. From the introduction of the Stewardship Code in 2014 to the adoption of the 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. Although payouts at some companies have risen — Amada Co. and Fanuc Corp. are oft-cited examples — weak oversight persists, as evidenced by the corporate woes at Toshiba Corp. and Mitsubishi Motors Corp. The recent upheaval within Seven & i Holdings Co.’s board, incited by U.S.-based activist hedge fund firm Third Point and in part by independent director and corporate governance advocate Kunio Ito, suggests that the path ahead will remain bumpy.

Our verdict at Aberdeen Asset Management: It’s still early days. Despite better payouts, Japanese companies still retain sizable cash balances for no good reason. Some companies embark on endless searches for dream candidates to serve as independent directors, whereas 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 issuance to third parties. This change can help instill 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 diminution 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 exercise full voting rights. As it stands, access is limited, and companies can — and do — arbitrarily reject the attendance of such shareholders.

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

Unmistakably, there have been real improvements to the corporate governance framework in Japan. Bedding down the new and improved codes will take time, however. It is unrealistic to expect a sea change in the near term. Nonetheless, the faults described 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.

Kwok Chern-Yeh is head of investment management, Japan equities, and David Smith is head of corporate governance, Asia equities; both at Aberdeen Asset Management’s Singapore office.

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