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‘Unprecedented’ Changes to Japan’s Corporate Governance

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Drew Edwards, portfolio manager at investment firm Advisory Research in Chicago and a Japan specialist, was surprised recently by a couple of phone calls from Japan. In all the years that he’s been investing in Japanese companies, Edwards has never received a call from company management, he said, but it’s quite likely that he may be called up again, because of the many changes that are taking root in Japan’s corporate sector.

Those changes are part of efforts underway in Japan to reform the corporate governance code and make companies more open and transparent to investors, the goal being to attract greater investment, local as well as foreign, and improve on a what is a relatively low return on equity (ROE) rate.

“There is tangible evidence that unprecedented things are happening in Japan,” Edwards said.

Investors such as Venk Lal, director of investment risk and strategy for Everkey Global, which manages the Wells Fargo Advantage International Equity Fund, believe that these and other changes are largely responsible for the stellar performance of Japan’s stock market. Last week, Tokyo stocks closed at a 15-year high Wednesday, on the back of strong economic data and GDP growth, but corporate profits are also at an all-time high, and that’s because of the changes taking place in corporate governance, Lal said.

“There are a number of things taking place that are positive and bode well for the long-term—the focus on shareholders through corporate governance and stewardship codes are helping, as well as the real focus on ROE improvement and on boosting dividend payoffs, which increased by approximately 60% last year,” Lal said.  

One of the management teams that called Edwards was keen to find out about his fund’s policy on voting proxies. A new rule in Japan states that any company management team that doesn’t generate a 5% ROE for five years should be voted out, he said, “and my guess is management was contacting us to say ‘don’t cut us out, listen to us.’ This is all new but for fundamental investors like us, it’s very important, because we’ve been pounding the table on these issues for decades.”

The Japanese market is now experiencing the benefits of solid macro and micro policy reform, both of which gained renewed firepower after the snap elections called last November by Prime Minister Shinzo Abe. His tenure has been marked by sound monetary policy and solid fiscal and structural reforms. These measures have all created a positive backdrop for change and the market is just starting to appreciate Japan’s potential, Lal said. However, many are still hesitant about the reforms and are wary of currency volatility, which reflects the underweight most non-Japanese investors still have in Japanese stocks, he said.

That bodes well for fundamental investors who are bullish on Japan in the long-term and for Lal, the Japanese market still offers good value and presents some great opportunities whose appeal will be further enhanced with the introduction of further corporate governance measures. He’s particularly interested in the stocks on the Nikkei Index 400, which debuted last year and comprises companies that have sound corporate governance and high and recurring profitability.

“These companies, which are ROE focused and are encouraged to create good returns, represent the New Japan,” Lal said.

Compared to other markets, Japan still trades very cheap both on a price-to-book basis and on a price-to-earnings basis, Edwards said. “Add to that you have much more material earnings momentum growth and with the corporate governance changes, that makes for a very interesting combination,” he said. “Corporate governance happens organically, seeing the needs of different constituents, and in Japan, those needs are changing dramatically. Once, the voice of the bank was important but that is becoming less loud and shareholders are becoming louder.”

Japan’s parliament has also approved a tax cut for corporations to boost economic growth by encouraging companies to increase investment, raise wages and make Japan more attractive both to Japanese as well as foreign companies. Abe’s administration is also focusing on reforming Japan’s labor markets, the hallmark being improving workforce diversity by encouraging more women to work and cementing trade partnerships around the world that would work to Japan’s advantage.