Japan does a lot of things right. I love the enthusiasm and focus that, to generalize massively, its citizens bring to their passions. A Japanese friend of mine teaches her nation's cuisine. Her dream is to focus so intently that she offers instruction on just one dish.
When it comes to shareholders, it does a lot of things wrong. The system of cross-holdings between companies, the lack of outside representation on boards and a total absence of diversity are all blights on the corporate landscape.
In a continent that prizes connections over shareholder returns, management has often run companies with themselves, then corporate partners, then employees and finally shareholders, in mind. Many companies have designed poison pills that deter hostile mergers, which of course would likely drive share prices up. They horde cash that could be put to better use.
It's an understatement to say that the culture doesn't exactly shift overnight in Japan. But with Abenomics reforms propelling Prime Minister Shinzo Abe to such heights of popularity that he may become its longest-serving post-war leader, it's clear that the country is ready for change.
Activist hedge funds have flexed more muscle -- and have had a handful of successes. Latest to add his voice to a rising chorus is Daisuke Hamaguchi, the chief investment officer at the Pension Fund Association, one of Japan's biggest pension funds. He is fed up with the system of cross-holdings that many Japanese companies have constructed. Banks hold shares in their clients, meaning they won't call in bad loans. Customers own shares in their suppliers, meaning they won't push for the best deal on parts. Parent companies spin off assets to subsidiaries at sweetheart prices.
Hamaguchi says that "stable" shareholders -- translation: vested interests -- outweigh even major institutional investors such as the PFA, which has ¥11.8 trillion ($105 billion) in assets under management.
"Even if we try to have a dialogue with management, it is not effective in the current environment -- so we need action by the government," he said in an interview with Asian Investor magazine.
He would like to see companies get a tax break on capital gains if they unwind their cross-holdings. The idea might gain some traction since there's a broad push to improve corporate governance. Abe's administration has already managed to cajole an improvement in return on shareholder's equity -- previously an afterthought -- out of "Japan Inc."
Institutional investors have hardly been blameless. All too often, they have developed overly friendly relationships with the management of their investees that have discouraged them from pushing executives too hard. In many cases, they may have blithely followed management's bidding in shareholder votes, or even at times voted against the interests of the people they represent.
There are voluntary efforts to redress the situation. Japan introduced a Stewardship Code in early 2014 that spells out what institutional shareholders should do in terms of responsible investing. The Tokyo Stock Exchange brought in a Corporate Governance Code in June 2015 to improve the way companies are run -- particularly with regard to how they treat shareholders.
The government plans to review that oversight next year. Hamaguchi believes the administration should introduce an incentive similar to that in Germany, which cut capital gains on share sales by companies from a rate of 40% to zero, if they were successfully removing cross-holdings.
That's the kind of "strong incentive" required, according to Hamaguchi, and there should be a stick to go with that carrot. "There should be a requirement for issuers to disclose a plan to reduce cross-holdings," he said at Asian Investor's Japan Institutional Investment Forum on March 15.
Even with an increase in outside directors on Japanese boards, around two-thirds of those appointed come from those "stable shareholders," rendering them impotent.
"In the current business context, outside directors do not work," Hamaguchi said. The "stable" investors inevitably vote down attempts, for instance, to remove poison pill defense measures.
There are signs of change. Japanese Recruit Holdings T:6098, Fujitsu (FJTSY) and Fuji Electric (FELTY) have all recently unwound cross-holdings.
However, Japan's biggest banks -- Mitsubishi UFJ Financial Group (MTU) , Sumitomo Mitsui Financial Group (SMFG) and Mizuho Financial Group (MFG) -- own shares in nearly all the companies listed on the Japanese exchanges, in Tokyo and Osaka. The banks use the holdings to make sure they win business.
In defense of such structures, Asian managers say they provide stability and allow companies to focus on long-term strategies rather than the short-termism introduced by Western capitalism and stock markets. But Hamaguchi says the system has broken down, to the disadvantage of shareholders.
"The power of the issuer has become so great that in exchange for maintaining the relationship, they can demand that suppliers hold their shares," he said. "The Japanese market is not an exchange between investors, it is an exchange between companies."
International investors own an outsize portion of shares in Japan, accounting for around one-third of holdings and, at times, two-thirds of trading. While the momentum inside Japan is certainly building towards change, it could do with a shove from outside.
