Investment Research
Are Japan’s Corporate Governance Reforms Working?
Scott R. Anderson, CFA, Director, Portfolio Manager/Analyst
Japan, home to some of the world’s most renowned companies in terms of operational excellence, has lagged its global peers in the areas of profitability and capital efficiency over the past three decades. This gap, which can be largely explained by the country’s approach to corporate governance, is showing signs of narrowing. While there have been setbacks and disappointments in the past, policy reforms ushered in by Prime Minister Shinzo Abe are driving corporate change and we are starting to see a difference in our interactions with management teams. Better corporate governance has driven improved profitability and, we believe, could lead to a rerating of the Japanese markets. 2
A Brief History of Japanese Corporate Exhibit 1 Tradition Nearly 60% of Japanese Companies Are Cash Rich In the aftermath of World War II, the pre-war “Zaibatsu1” e ent e m n es e e s e ee Inte est e n e t industrial and financial business conglomerates re-emerged as informal alliances known as “Keiretsu”. Companies in these groups invested in each other as a means of solidifying their business relationships—a practice known as cross shareholding. Over time, high levels of cross shareholdings encouraged company manage- ment to focus on business relationships, and not profitability. In the Keiretsu system, a “main” bank—not the capital markets— provided not only financing, but also comprehensive financial and business advice. Faced with the turmoil of labor disputes in the 1950s, Japan’s bureaucrats and politicians worked with the main e n banks to direct corporate capital allocation to achieve national As of 7 August 2018 growth and unity, in a system that came to be termed “Japan, Inc.” Source: Goldman Sachs, FactSet This bank-led governance system persisted through the period of rapid economic growth through the stock and real estate market Exhibit 2 bubble in the late 1980s. It led to a corporate culture that empha- Japanese ROE Lags Global Peers sized overinvestment and risk aversion which has resulted in low profitability. Things began to change after the bursting of Japan’s massive stock and real estate bubble in 1990. The subsequent decline in asset prices caused a solvency crisis for the overly leveraged banks, which led to a credit crunch and period of economic contraction in the mid- to late-1990s. As a result, banks increasingly abandoned their roles of lender and advisor. Corporations viewed this withdrawal as a “betrayal” and responded by reducing debt and accumulating cash in order to distance themselves from the banks.2 e n
This history led to the current situation in corporate Japan where As of 7 August 2018 stable shareholders and insider-dominated board structures have Source: Goldman Sachs, FactSet shielded underperforming management teams from external disci- pline. There are a number of unfortunate results that remain in effect today. First, the amount of cash on corporate balance sheets Exhibit 3 is excessive. Nearly 60% of Japanese companies outside the finan- Japanese Valuations Are Also Lower than Their Global Peers cial sector hold more cash than interest-bearing debt, compared to just 15% and 20% for US and European companies, respectively e t (Exhibit 1).