SEPTEMBER 2016
Japanese Corporate Governance:
The Sun Starts to Shine
Todd Wax, cfa | Portfolio Specialist
Abenomics employs a “three-arrow” approach. Taken together, the three tenets
aim to kick-start the economy and put it on a sustainable, higher growth track. One
component of the third arrow—corporate governance reform—reflects a monumental change in Japan.
The “Three Arrows” Explained
Since his reelection in 2012, Japanese
Prime Minister Shinzo Abe has brought
significant change to a country in desperate need of it. He is moving to fulfill
the promise of his first run as the nation’s
leader in 2006/2007, when he resigned
before the end of his term for health reasons.
In an effort to put an end to two decades of
economic stagnation, Abe invoked what is
now widely known as “Abenomics” with
a goal of lifting economic activity by
creating inflation. A core tenant of economic theory is that if prices slowly and
steadily rise (sustainable inflation), there
is an incentive to consume now, while
prices are lower. Such consumption can
lead to healthy economic activity and prolonged prosperity. Japan had been facing
the o­ pposite problem, the daunting challenge of deflation, for two decades. Falling prices lead to the opposite incentive:
delayed consumption amid expectations
for lower prices down the road, and thus
prolonged economic stagnation.
Abenomics employs a “three-arrow”
approach. The first is aggressive monetary policy designed to make the yen
more cost-competitive. The second arrow
involves expansionary fiscal policy. The
third, called the “Japan Revitalization
Strategy,” comprises structural reforms.
Taken together, all three aim to kick-start
the economy and put it on a sustainable,
higher-growth track. Here we will discuss
one component of the third arrow: corporate governance reform.
Addressing Principal–Agent
Conflict
For years, the Japanese market has
lacked many of the corporate governance
strengths present in most developed world
markets, contributing to paltry Japanese
equity market returns. Strong corporate
governance protects shareholders and so
encourages investment.
In response to Abe’s reform agenda, the
Japanese Exchange Group in August
2013 created the JPX Nikkei 400 Index
“composed of companies with high appeal
for investors, which meet requirements of
global investment standards, such as efficient use of capital and investor-focused
management perspectives. The new index
will promote the appeal of Japanese corporations domestically and abroad, while
encouraging continued improvement of
corporate value, thereby aiming to revitalize the Japanese stock market.”1
In June 2015, the Tokyo Stock Exchange,
which is owned by Japan Exchange Group,
adopted a code to improve corporate governance practices among Japanese companies. One new requirement in the code
mandates that listed companies have at
least two independent external directors:
boards at many Japanese firms have traditionally been captive to company management. The purpose of corporate boards
is to oversee company management in the
interest of the company owner. Often, the
interests of company owners and those
of company executives can differ, a problem known as “principal–agent conflict.”
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As Japanese companies are ever more focused on
shareholder value, capital returns to shareholders
have increased in record numbers, already reflecting
improved corporate governance.
Company management acts as an agent
representing the principal (or owner), but
many conflicts are inherent, and can be
difficult for company owners to oversee.
It is the job of corporate boards to oversee management and limit this conflict,
highlighting the importance of external
directors who are truly independent of
company management.
This corporate governance code reflects a
monumental change in Japan, reflecting
a desire to focus on shareholder wealth
and to open its markets more to the global
investment community. Listed companies
are now increasing the external director
count, with over 90% of listed companies
holding more than one external director.
Admittedly, this is notably lower than in
other developed world markets, but it is
certainly progress.
Some companies are actively focusing
on increasing profitability and returns
on equity, as well as on diminishing
inter-corporate investments to increase
value to shareholders. Many Japanese
companies have long been seen as inefficient users of capital, culminating in large
conglomerates of multiple inter-corporate
entities. Such large and inefficient structures are generally less valuable as a single
entity—a “sum of the parts”—than they
would be as separate units. That is, they
could have a higher breakup value.
Dividend Payouts,
Buybacks Rise
As Japanese companies are ever more
focused on shareholder value, capital
returns to shareholders have increased
in record numbers, already reflecting
improved corporate governance. Indeed,
dividend payouts have increased and share
buybacks are up an estimated 60% since
the creation of the corporate governance
2
code. These are all signs that Japanese
companies plan to treat shareholders in a
friendlier manner, potentially creating a
tailwind for Japanese equity i­nvestors.
Jefferies’ Head of Research Japan, Zuhair
Khan, has performed extensive research
on the make-up of corporate boards in
Japan. He concluded that investing in
companies with the strongest board practices should generate superior returns to
those in the overall Japanese market, as
represented by the TOPIX 500.2
Investing in Japan, Thornburg Investment
Management has targeted companies
with stronger board practices and focus on
returns to shareholders. Over the last year,
our Japanese stocks have also fared better
than the TOPIX 500.3
Still Room for Improvement
Japanese companies, however, still have
to work to improve corporate governance,
especially compared with much of the
rest of the developed world. While 90%
of listed companies now have one independent director, some may not actually
be independent, either because they come
from parent companies or other parties
that could be aligned with the interests
of company management. Also, as mentioned, the rest of the developed world has
a far greater number of independent board
members. Japan’s TOPIX 500 companies’
boards consist, on average, of 25% outside
members. Compare that to Germany’s
DAX 30, at 76%; France’s CAC 40, at
90%; and the U.S’s Dow Jones Industrial
Average, at 84%.4 Significant intercorporate investment and a focus on low returnon-equity businesses owned by large Japanese conglomerates still exists, and that
is where active management is important
to specifically select the companies undertaking shareholder-friendly reform.
A Meaningful Start
We are certainly seeing positive developments at the company level as a result
of Abe’s reform push. We see management and board shake-ups and increasing
shareholder-friendly activity. It’s a meaningful start to long-term reform. While
these changes take time, we believe they
are real.
From an investment standpoint, we at
Thornburg Investment Management benefit from a broad mandate with a focus
on bottom-up fundamental analysis. We
have flexibility to look for good relative
values between many different types of
companies in an effort to identify those
that we judge to be making progress
toward improved corporate governance
and thus raising return prospects for our
clients and shareholders. We have been
finding interesting investment opportunities where management has acted in
shareholders’ best interests and divested
less profitable business lines to focus on
higher-return activities. This is an exciting
time to seek good companies trading at a
discount to our assessments of their longterm i­ntrinsic value. n
1. J PX-Nikkei Index 400–Japan Exchange Group, http://
www.jpx.co.jp/english/markets/indices/jpx-nikkei400/
2. Z uhair Khan, Head of Research, Japan, “Japanese Corporate Governance: Boiling the Frog,” Jefferies, Japan
Equity Research, July 2016.
3. T hornburg Investment Management.
4. K han, “Japanese Corporate Governance.”
Unless otherwise noted, the source of all data is Thornburg Investment Management, Inc., as of September 2016.
The views expressed by Mr. Wax reflect his professional opinions and are subject to change. Under no circumstances does the information contained within represent a recommendation to buy or sell any security.
International investing involves special risks including currency fluctuations, illiquidity, volatility, and political and economic risks. These risks may be heightened in emerging
markets.
CAC 40 Index – The benchmark index for the French stock markets composed of 40 of the largest and most liquid stocks trading on the Paris Bourse exchange.
DAX Index – Represents 30 of the largest and most liquid German companies that trade on the Frankfurt Exchange.
Dow Jones Industrial Average (DJIA) – A price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented
companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.
JPX-Nikkei 400 Index – A capitalization-weighted index of 400 companies listed on the Tokyo Stock Exchange and selected based on ROE etc. from the First Section, Second
Section, JASDAQ, and Mothers.
TOPIX 500 Index – A capitalization-weighted index designed to measure the performance of the 500 most liquid stocks with the largest market capitalization that are members
of the Tokyo Stock Price Index (TOPIX).
The performance of any index is not indicative of the performance of any particular investment. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index.
Return On Equity – A measure of a corporation’s profitability. The ROE is useful in comparing the profitability of a company to other firms in the same industry.
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