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Turn in the sun

1 December 2016 By Quentin Webb

Japan is the new darling of regional reform champions after a big push under Prime Minister Shinzo Abe to make companies better run and more profitable. But the country is still a long way from getting its black-belt in governance.

The Asian Corporate Governance Association descended on Tokyo in mid-November for its annual shindig. The location and high attendance were both telling. Since rolling out a stewardship code for investors in 2014, and a counterpart for companies a year later, Japan has made real advances.

Firms are shifting away from a system where the interests of lifetime employees – bosses and the “salary men” who work for them – eclipse those of shareholders and other stakeholders.

A conference poll found 76 percent of attendees thought governance reforms under Abe had thus far been good or very good. The country soared from sixth to second place after Australia in a recent biannual survey of regional governance by CLSA analysts.

Boards once stuffed with yes-men are toughening up. Exhibit A is this year’s boardroom rebellion at retailer Seven & i . More broadly, over three-quarters of large Tokyo stocks now have at least two outside directors, trebling in two years, Zuhair Khan of Jefferies reckons.

Companies have rushed to adopt return-on-equity targets and showered shareholders with cash. Nomura estimates dividends and buybacks could hit 16.8 trillion yen ($149 billion) in a third record-breaking year.

A clubby system of cross-shareholdings is also gradually eroding: firms sold 1.6 trillion yen of shares in subsidiaries and affiliates last year, Goldman Sachs analysts say.

No grandmaster

For all that though, many shareholders remain wary. Polling by governance guru Ryohei Yanagi shows a clear majority of investors, both foreign and domestic, think both returns and governance are still unsatisfactory.

Their concerns are understandable. One danger is that compliance is just skin-deep, as executives seek a quiet life. Shinichiro Hyogo of Mitsubishi UFJ Trust and Banking, one of Japan’s largest asset managers, warns there is a “bipolarisation” between genuine believers in reform and laggard companies that resist real change.

As for oversight, former presidents still too often stick around in advisory roles, restricting their successors’ freedom to act. And diversity is laughable. Too many boardrooms lack women, foreigners, or even experienced leaders from other businesses, heightening the risk of groupthink. An MSCI survey last year found only 3.4 percent of directors were women, versus 19 percent across all of the companies in the MSCI World index.

Management is timid, too. Many bosses are lifers who have risen up the ranks internally. They are generally paid modestly, at least by the standards of the global elite, and largely in cash, further reducing their incentive to take risks.

It is also hard to get firms to focus on what they do best. Some standouts, like Sony , are willing to be ruthless. But corporate sprawl is endemic and often only a crisis, as with Toshiba , can force change.

Upping their game

That caution shows up in the financial statements. Across the whole economy, companies are hoarding a record 242 trillion yen of cash, according to Bank of Japan data. An amazing 56 percent of listed groups ended last year with no net debt, Nikkei figures show.

In turn, those flabby balance sheets can depress returns. For all the praise showered on Japan, return on equity this financial year is likely to average 8.2 percent across the Russell/Nomura index of larger stocks, Nomura analysts forecast. That is an improvement on last year, but still barely above the 8 percent threshold widely seen as the cost of capital in Japan.

Overall, Japan offers encouraging evidence that corporate cultures can adapt, albeit slowly. If this prods companies, investors and regulators elsewhere in Asia into upping their game, so much the better.

South Korea and Taiwan are already introducing stewardship codes similar to the one that has helped Japan make progress. They too will use a British-style “comply-or-explain” system. Japan may be Asia’s new corporate governance darling but it started on a low grade.

 

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