Japan's corporate governance overhaul

This analysis is by Bloomberg Intelligence analyst Gregory Elders. It appeared first on the Bloomberg Terminal. 

Governance gains show Japan competitiveness reforms taking hold

Japan’s corporate governance reforms are slowly taking hold, showing signs of success in the government’s efforts to boost business competitiveness. Boards at most Topix companies now have at least two outside directors. Investors pledge to prod management to boost returns and trim protectionist cross-shareholdings. Companies that embrace the spirit — and not just the letter — of good governance may be able to realize better growth.

Photographer: Pau Barrena/Bloomberg

Governance reforms mobilize investors, companies to lift returns

Japan’s governance reforms take a two-pronged approach, pushing both investors and companies to help promote higher economic growth. The third arrow of Prime Minister Shinzo Abe’s “Abenomics” policies for boosting the economy, Japan published a stewardship code in 2014 encouraging investors to sign up to be more forceful in prodding companies to increase returns. A corporate governance code that took effect in 2015 seeks to make companies more transparent and responsive to shareholders.

Japanese boards slowly evolve on governance reforms; long way to go

Japan’s governance reforms have made some progress in diversifying corporate boardrooms, but much more may need to change to make companies globally competitive. Nikkei 225 companies have the lowest median proportion of independent directors (26%) and female directors (0%) and the oldest average age (63.2 years) among developed-market peers. A homogeneous board may be less effective at steering management to realize opportunities in new and changing markets.

Few Japan companies exceed governance minimum for global mark

Japanese companies, particularly those focused internationally, may be best served targeting global board governance standards. Only eight Topix 500 companies have majority independent boards and at least two female directors, which is typical in other developed markets. Japan’s corporate governance code that took effect in 2015 requires a minimum of two independent directors, and encourages companies to consider at least one-third independent boards and to boost the number of female directors.

Japan’s corporate openness is yet to address meetings clash

One aspect of Japan’s corporate governance reforms that companies have resisted addressing is spreading annual meetings out to allow investors more time to consider agenda items and to attend. This year, nearly 400 Topix index companies held their annual meeting on the same day, June 29, and 900 in that last week, similar to past years. Japan’s corporate governance code held back on specific recommendations, saying simply that companies choose a date that facilitates “sufficient constructive dialogue.”

Investors wielding votes bodes well for Japan governance reforms

Asset managers are following through on the call of Japan’s stewardship code to be more aggressive with companies. This may bode well for the success of Abenomics’ corporate-governance reforms and for manager returns. The 75 largest Japan asset managers that disclose data voted against directors at a median 22% of holdings in the year to June 2016, the latest available, which is double the 2014 rate, and voted at 50% more companies. Greater investor engagement is supposed to prod companies to boost performance.

Japan asset managers using vote power may be key to own success

The success of Japan’s governance reforms, as well as the performance of asset managers, may rest on how forcefully investors demand better returns on their holdings. Sumitomo Mitsui Trust is leading large asset managers in increasing both the voting rate and number of votes against company directors, which rose to 43% in 2016 from 11% in 2014, when Japan’s stewardship code was published. Daiwa SB and Amundi also sharply increased their voting, while other asset managers had more moderate increases.

Asset managers responding to code’s new voting – transparency call

Japan’s investor stewardship code, updated in May, calls on institutional investors to disclose their item-specific voting, a move that would bring greater transparency and shine a light on potential conflicts of interest. The update strengthens the code’s efforts to prod asset owners and managers to exercise their voting power to push management at holdings to improve performance. Mitsubishi UFJ has started reporting detailed data and Sumitomo Mitsui Trust, Dai-ichi Life and Mizuho Trust have stated they will.

Japanese investors need vote transparency in governance reforms

Few Japanese institutional investors disclose their proxy voting decisions at the company and resolution level, potentially masking conflicts of interest and limiting stewardship effectiveness. Only 9% of 152 asset managers disclose such detail, something that is mandatory in the U.S. and common practice among many large European investors. Japan’s governance reforms Council of Experts recommends requiring detailed company and resolution disclosure, at the very least on a “comply or explain” basis.

Japan stewardship efforts gain import on GPIF new manager call

Japanese asset manager governance efforts, and indirectly corporate Japan performance, will gain greater importance on the Government Pension Investment Fund’s March 13 call for new external passive asset managers. The application includes questions on stewardship and proxy voting processes and policies, indicating more effort by the $1.3 trillion fund to support the government’s governance reform goals. Asset manager voting records may help demonstrate the vigorousness of stewardship.

Investors must address conflicts on business, holdings ties

Japanese banks and insurance companies’ web of cross-shareholding and business ties means asset-management arms must address potential conflicts of interest to achieve effective shareholder stewardship. Institutional investors should establish clear proxy policies and governance structures, such as independent boards and third-party committees, for making voting decisions, according to recommendations by the Council of Experts advising on Japan’s governance reforms.

Domestic managers’ deference challenges Japan governance reforms

Japanese asset managers’ higher approval rates for retirement bonuses to executives at their investment holdings may point to a challenge in achieving Japan’s corporate-governance reforms. While all asset managers are less likely to favor bonuses since the launch of Japan’s investor stewardship code, domestic managers show greater deference, voting against bonuses a median 31% of the time vs. 50% for foreign-based investors. About 70% of Japanese shares are domestically owned.

Active investor interest retreats, but remains elevated in Japan

Activist investors may be the biggest beneficiaries of Japan’s corporate governance reforms, with companies encouraged to be more responsive to investor calls to boost returns. Activists launched 22 new campaigns in fiscal year 2016 (ending in March 2017), down from 49 the previous year, but up from the previous few years’ average of 14, among 15 activist investors tracked by Bloomberg. Japan’s investor stewardship code in 2014 and governance code in 2015 may be spurring the activist space.

Industrials, technology sectors lead Japan activist interest

Industrials and technology sector companies remained the top targets for Japan’s activist investors tracked by Bloomberg, but consumer discretionary dropped down the list as financials moved up. Typical activist investor targets are companies that fall behind changing tastes and technologies, and have rich balance sheets. Japan’s corporate governance reforms may both embolden activists and encourage corporate targets to acquiesce to demands, encouraging activist campaign levels to remain elevated.

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