In this article, we take a brief look at the history of Japanese corporate governance and how the tide is slowing turning against oppressive age-old practices.
Japanese Corporate Governance
Japan’s Corporate Governance Code entered into force on 1 Jun 15 and established fundamental principles for effective corporate governance in listed companies. Its general principles include:
1. Securing the rights and equal treatment of shareholders;
2. Appropriate cooperation with stakeholders other than shareholders;
3. Appropriate information disclosure and transparency.
For those familiar with archery, corporate governance reforms are the 3rd arrow in Shinzo Abe’s quiver. Japan has long been regarded as a global corporate governance pariah for its treatment of corporate shareholders; its corporate history is replete with anecdotal accounts of governance issues.
Skin Deep Corporate Governance
The Olympus scandal involved the concealment of U$1.7bn in losses, while Toshiba’s US1.2bn inflation in profits involved complicit management. Takata falsified data to cover up a deadly airbag defect for 15 years and the latest, Mitsubishi Motors’ mileage cheating scandal that spanned 25 years.
This has led to concerns that improvement in corporate governance may only be skin deep as it is not legally binding.
Japan’s poor corporate governance stems from the club-like manner in which they are run, wherein board members are frequently friends, former bureaucrats and politicians.
This is also exacerbated by the Japanese practice of cross-shareholdings, where shares of the company are held by suppliers and customers as well as friendly local banks.
While previously useful in a time when Japanese companies were growing and good business relationships were vital for the protection of mutual interests, it can lead to problems. For example, shares may be voted to support managers instead of holding them to account as in the case of undervalue takeover offers. It also creates shared fates among companies.
The practice started in 1952 when the now Mitsubishi Estate was subject to a takeover. 11 Mitsubishi-linked companies subsequently bought enough shares to block the takeover. Post liberalization of the Japanese financial markets in the 60s, cross-shareholdings became widely adopted as a shark repellent.
A Reuters poll has shown that 80% of Japanese firms with such holdings are reluctant to unwind their cross-shareholdings as they are viewed to be important for business ties. The reluctance to part with friendly shareholders is not a surprise given their concern over shareholder activism.
Confucianism, one of 3 traditional Chinese religions besides Taoism and Buddhism is widespread in Japanese culture. One important Confucian principle is respect for authority and a structure in which the lower level obeys the higher. Japanese corporate culture is polarized with employees never questioning their superiors or the status quo.
The Tide is Turning
Toshifumi Suzuki on 7 Apr 16, lost a board fight to Daniel Loeb’s Third Point and resigned from his position as chief executive, handing Japanese activist investors a victory, suggesting that the tide may have turned.
SMC Corporation on 13 Dec 16 fell as much as 10% following a 63 page short sell report by Well Investments Research which questioned the company’s books and how it overstated its cash position.
Nidec was SMC’s bedfellow that morning — Carson Block’s Muddy Waters Capital issued a 53 page report questioning the company’s “highly aggressive accounting”. It fell 5.9% before recovering to close 0.1% lower.
The issues raised are not endemic to these companies but rather the result of poor corporate practices in Japan.
GPIF to Draw the Line?
On 2 Apr 15, in their mid term plan, the GPIF said that it would consider corporate governance issues in addition to returns when assessing investments. There were however, no specifics. There is also no mention of the code in GPIF’s policy documents.
The GPIF owned 3.82% in Daihatsu, whose buyout by Toyota was widely criticized by proxy advisers ISS and Glass Lewis for being cheap. Toyota offered a ratio of 0.26 while activist investors cited a ratio of 0.45 as being fair.
As with Daihatsu, the complaints against Panasonic are price related. An activist hedge fund has publicly stated that PanaHome shares could command ¥1,500 per share. It cited the Panasonic offer as being worth only worth ¥399 after accounting for net cash.
There was no known opposition by the GPIF in Daihatsu. It owns 3.55% in PanaHome making this a potentially pivotal “put your money where your mouth is” situation.
Director of Special Situations
Religare Capital Markets