Enigmatic as ever

Japanese companies are rightly praised for their stance on many responsible investment issues. But there remain some deep-seated structural problems. Richard Newell reports

The use of so-called poison pills to ward off activist foreign shareholders has some commentators suggesting Japan is, if anything, regressing. As a recent paper from CLSA©ˆ noted: “2007 witnessed a surge in the number of shareholder proposals from foreign investors, but they have continued to fail.”

Corporate Japan’s apparent reluctance to accept proposals that would seem to be well-intentioned is a real problem for foreigners. Although the landscape of market ownership has changed in Japan of late, with nearly 30% of the market now owned by foreigners and significant reduction in the level of cross-shareholdings, Japanese firms refuse to play the game.

Stephen Givens, a corporate lawyer in Japan who authored the paper for CLSA, says: “The foreigners who submitted shareholder proposals in 2007 were wrong-footed by the monolithic opposition of all Japanese constituencies - individual shareholders, institutional investors and corporate shareholders alike. They casually assumed that meritorious proposals would spontaneously attract at least some Japanese support that would make the vote competitive. Those assumptions were wrong, but what remains true is that the margin between defeat and victory is a relatively small Japanese swing vote. Identifying and winning over that swing vote is the key to the future of shareholder activism in Japan.”

The Tokyo High Court’s ruling in July 2007 endorsing the poison pill adopted by Bulldog Sauce in its attempt to ward off the US hedge fund Steel Partners, reflects the establishment view of shareholder activism by foreign shareholders. The ruling asserts that Steel was an ‘abusive player’, characterised by ‘financial motivation’. As Givens notes, this effectively means that other hedge funds and private equity investors can now be put on the blacklist. “The opinion explicitly endorses the view that maximising shareholder return is not the be-all and end-all of the policies served by corporate law. It vividly captures the current Japanese consensus, that squeezing the last nickel out of a company is not the point.”

The Asian Corporate Governance Association (ACGA) held its annual conference in Tokyo last November. Yoshihiko Miyauchi, chairman and CEO of Orix Corporation said: “Japanese management needs to feel the pressure for change. Unfortunately the assertive shareholder is still a rarity. The typical behaviour is to sell the stock, not to engage. Institutional shareholders need to put more pressure on, and through that, corporate governance will improve. But the fact is that Japanese management prefers not to be pressured.”

The mood of the discussion at the ACGA conference darkened noticeably with the comments from Kathy Matsui, chief Japan strategist at Goldman Sachs. She is one of the most vocal critics of corporate Japan’s insularity. She was also disparaging of government officials’ lack of business knowledge (she claims that when she was called in by the LDP to explain why foreigners were dumping Japanese shares, she had to explain to them what the letters ROE (return on equity) stood for. She is equally dismissive of the idea you can bring pressure to bear on companies that employ “make-believe accounting”.

Matsui lamented how the second largest economy in the world has only 3% of global M&A, and a pathetically low level of IPO activity: “Sure, dividends have doubled in three years and buy-backs have also increased. But it’s still difficult for me to explain the low rates of return in Japan, and to me that’s unacceptable. People come to Japan and see a lack of concern for stakeholders. But Japanese CIOs are not paid to care.”

Matsui illustrated this point with a slide showing how the 1,300 companies who have moved to introduce stock options have performed much better compared to the rest of the Topix index companies.

Chris Ailman of CalSTRS asked whether the activities of Steel Partners had set back the cause of foreign investors in Japan. Matsui responded: “Well, obviously we wouldn’t have had the poison pill, but it has been beneficial in corporate governance terms. It has brought to the public eye the level of bad management.”

The focus, she said, needs to be on Japanese companies recognising why better governance matters, and why ROE targets are necessary. “We are on the right track with regard to corporate governance, but with the events of the recent past, we see that levels of cross shareholding are creeping back up. Japan has announced to the world that it wants to become an Asian finance hub. But if you want to have that, it needs to be an attractive place for investment. Unfortunately the Japanese authorities have left governance behind in the public policy arena. The shortage of independent directors is used as a convenient excuse.”

Her concern is really that Japan must break out of its low growth malaise. “Japan cannot go at this pace forever,” she says. “The demographic situation is going to force the issue. I’m really surprised at the lack of attention paid to this issue. Are your children going to have the same standard of living that you enjoy? We need to address how we can improve the returns on capital in this country. Why are Japanese savings leaving Japan and investing in New Zealand and other countries? Because Japanese investors are smart.”

Public pension funds, says Matsui, have a role to play in highlighting the structural and cultural problems. She praised the stance taken by the Pension Fund Association in its corporate governance funds, under the guidance of Daisuke Hamaguchi. “We have to give them credit for standing up to Japanese companies, for having the guts. It’s not about greedy investors, it’s about improving the returns on Japanese capital.”

1CLSA report, ‘Indecent Proposals - Shareholder democracy’
CLSA report, ‘Indecent Proposals - Shareholder democracy’