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M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
Issue No. 34
Tuesday, July 1, 2003
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Viewpoint: Comply or Explain: Japan's Shareholders Speak Up
The Bottom Line:
o June is the rainy season in Japan, and in terms of shareholder
meetings, when it rains, it pours. This year, 82 percent of
Japan's listed companies had their shareholder meetings on the
26th and the 27th of June. In the past, these meetings were a
staged farce and were often over in 20 minutes or less.
o This year, however, noticeable change was afoot on several
fronts. For one, the shareholder meetings often lasted more
than an hour. For another, shareholders were asking some very
pointed questions to management, and even demanding that they
take responsibility for poor performance or deficits reported
during the year. One major institutional investor, the Pension
Fund Association, made a full-scale effort to vote its proxies
and to oppose management proposals based on predetermined
voting guidelines. Money Watch sees this move as potentially
marking a major turning point in Japan's corporate governance.
o Institutional investors around the world have expressed a
willingness to pay a premium for transparent accounting and
good corporate governance, a point that seems to be missed by
the majority of Japanese companies. On the other hand,
increasing pressure within and without Japan (from new
regulations and investors) for Japanese companies to adopt
US-style corporate governance could lead to another management
fad. Companies pressured to walk the walk and talk the talk
will be tempted to use simplistic quantitative measures (i.e.,
number of outside directors, et cetera) as indicators, but
this misses the whole point about good corporate governance.
Indeed, empirical studies trying to measure the economic
benefits of "good" corporate governance with quantitative
indicators find that there is little correlation.
o One of the most crucial factors is a company's corporate
culture -- i.e., how the firm is responsive to its shareholder
concerns and whether or not management intrinsically
understands the benefits to the company of good corporate
governance as well as accounting transparency, i.e., the
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Comply or Explain: Japan's Shareholders Speak Up
Surveys of institutional investors around the world indicate that
transparent accounting disclosure and good corporate governance
pay dividends for the companies that practice it. In other words,
institutional investors are willing to pay a premium for these
features. A 2002 McKinsey & Co. study of 201 professional investors
(fund management CEOs, CIOs and fund managers) of institutions with $9
trillion believe that the factors most important to their investment
decision are: a) accounting disclosure (71 percent), and b)
shareholder equality (47 percent). Moreover, these investors would be
willing to pay as much as a 40-percent premium in some equity markets
for good corporate governance, over 10 percent for good corporate
governance in developed markets like the US, the UK,
Germany and France, and over 20 percent for good corporate governance
"Comply or explain" corporate governance actually began in the UK.
The philosophy is that shareholder's basically respect their
investment target's management style as long as the company can fully
explain its reasoning for not complying with what are considered
"de-facto" or "best practice" corporate governance practices. In the
postwar period, however, the biggest shareholders in Japan, i.e., the
domestic financial institutions, business corporations and individual
shareholders, who still owned 81.2 percent of all outstanding stock
listed on Japan's stock exchanges as of March 31, 2003, were mute as
far as corporate governance was concerned.
However, the year 2003 could mark a major turning point in Japan's
corporate governance since the excess credit "bubble" burst in 1990.
It marks a year when Japan's large institutional investors finally
begin actively voting their proxies and exercising their rights as
shareholders and expecting their asset-management companies, which
make the day-to-day buy and sell decisions for these funds, to vote
their proxies in a systematic and responsible manner. They are also
beginning to confront management directly, demanding that management
comply or explain its actions.
At the June rush of shareholder meetings, the Pension Fund Association
voted on some 7,000 proposals from the approximately 1,500 companies
whose stock they own, or essentially all of the stock they hold in
Tokyo Stock Exchange first section companies. In 43 percent of these
cases, they voted against management. In particular, they voted
against changes in the company charters that would allow management to
achieve a shareholder's quorum with just 33 percent of shareholders
agreeing, as opposed to the previous requirement that majority
shareholder support was required. Ostensibly, the change in the
Commercial Code to allow a reduction in the proportion of supporting
shareholders was aimed at making it easier for companies to decide on
major reorganizations, such as a merger. But at companies where
management did not explain its reasoning for amending the corporate
charter, the institutions are voting "no."
According to voting guidelines established in February, they are
demanding that Japan's bloated insider boards be limited to 20 or
less and that one-third or more of the members of these boards be
outside directors. In addition, for those companies reporting three
consecutive years of net income losses and who do not pay a dividend,
the association is demanding that director compensation and retirement
payouts get cut or even eliminated.
A Nikkei survey of other financial institutions on June 26 revealed
that 60 percent of those surveyed voted against management, demanding
that management of companies in deficit take responsibility and
opposing specific proposals for election of directors and proposed
retirement bonuses. Indeed, 33 percent of the opposing votes was
against proposed director remuneration and retirement allowances, 22
percent was against proposed election of individual directors, 20
percent was against how the company planned to distribute profits,
and 12 percent was against a lowering of the minimum percentage of
consenting shareholders required to achieve a quorum.
At the same time, 80 percent of those surveyed believed that quarterly
reporting was needed. The big fish in the public pensions pond is the
Government Pension Investment Fund, which manages the nation's welfare
pension funds. Nippon Life, which holds shares in 2,000 listed
companies, apparently was focusing in share buybacks, asking 40 to
explain their reluctance to follow up on promises to buy back shares.
Nomura Asset Management's approach is a softer touch. It has begun
informing clients about companies that have been trading at notably
low prices in their respective industries. Dai-ichi Kangyo Asset
Management is doing likewise. Even individual investors are also
becoming organized, through vehicles such as the Japan Association of
As usual, the annual shareholder meetings of Japanese companies were
all concentrated in essentially two days in June, on the 26th and the
27th. Some 1,174 companies all held their annual shareholder meetings
on June 26, which represents 68 percent of all listed companies.
Another 14 percent held their meetings on June 27, meaning that no
less than 82 percent of all listed Japanese companies held their
shareholder meetings on either of these two days.
This year, however, shareholders had some very pointed questions for
management, which undoubtedly is secretly wishing for the old days of
"shanshan" shareholder meetings that lasted all of 20 minutes. At the
Hitachi shareholder meeting, Hitachi management was accused of being
too optimistic about its "V-shaped recovery," while Isuzu management,
which has nothing but a net loss of 140 billion yen and five
consecutive years of no dividends to show for its efforts, was
asked just when it thought it could produce a dividend. At NTT's
meeting, investors wanted a full explanation of why the company had
recorded its first revenue decrease in its history.
Not surprisingly, investors at the shareholder meetings of the major
banks were demanding that management take responsibility for the mess
it created. The question to Resona Bank's management was point-blank:
"Do you really intend to revive the bank?" At the Mitsui Sumitomo
Financial Group, investors demanded to know why the bank had lowered
dividends on its common shares while paying a fat dividend to a
foreign capital firm. At Tokyo Electric Power, investors demanded that
director bonuses be cut to zero for the feared electricity shortage
this summer. At All Nippon Airlines, investors demanded to know why it
was necessary to pay fat retirement bonuses to directors that were
responsible for substantial losses. In response, the ANA president
reportedly replied that seven directors would receive no retirement
payments. At NTT Docomo, investors demanded that the company cut about
half of its 27 directors from the board.
Japanese institutions are now looking to outside service providers
such as ISS (Institutional Shareholder Services), which examined the
proxy materials of more than 2,300 Japanese companies this year, and
made recommendations, including one that the largest 300 companies
should disclose their director retirement benefits.
In addition, Japan's Commercial Code has been amended to allow for
online proxy voting, removing the physical barriers of "snail mail"
and multi-tiered custodians. A total of 163 firms have now implemented
online proxy voting, which is done through special Web pages run by
trust banks and securities agents. However, actual voting online by
shareholders is still tiny, representing only 5 percent of the proxy
votes of the companies who have implemented online voting.
Efforts by Japanese shareholders to demand more accountability from
management are beginning to have some effect. Mizuho Financial Group
disclosed to investors its average wage for the year, and the fact
that they had not received any bonuses. Tokyo Electric Power
grudgingly reduced director's bonuses by half. While sparring with Mr.
Murakami of M&A Consulting, Tokyo Style is yielding.
However, at other zombie companies, such as Ando Construction and
Tobishima Construction, there were no questions, ostensibly because
anyone with an ounce of sense has already sold the stock, leaving only
"relationship holders" such as the financial institutions and related
companies. Indeed, Mr. Yano, head of the Pension Fund Association,
admits that the association hasn't yet had any notable successes and
isn't likely to win any major battles with management in the near
future. While the association does hold some 2 trillion yen of
Japanese equities, it and other activist shareholders are outnumbered
by the 50.8 trillion yen of equities (as of the end of March 2003)
held by business corporations and the 34 trillion yen in equities
still held by the major banks and insurance companies. Thus, as
"passive" shareholders still own the majority of most listed
companies' outstanding shares, the balance of power between management
and shareholders has yet to shift in favor of shareholders.
The Sarbanes-Oxley Act ushered in a new era of corporate governance
reforms for US companies and foreign companies listing their stock on
US exchanges. These reforms include certification of the numbers by
the CEO and CFO, prohibiting company loans to directors and executive
officers, having audit committees that consist of outside directors
and giving GAAP comparisons of "pro forma" numbers.
The previous wave was in the early 1990s, as exemplified by the
boardroom coup by outside directors at General Motors that forced out
CEO Robert Stemple. Led by Calpers, whose consultants, Wilshire
Associates, had concluded that Calpers' highly publicized activism in
the early 1990s added value to the portfolio of US stocks they owned,
US institutions frustrated with poorly performing companies began to
actively vote their proxies and to aid and abet corporate raiders,
leading to an M&A boom.
Yet the empirical evidence from the prior corporate governance wave in
the US "indicates that such activism had little or no effect on the
targeted firm's performance. Economists have not been able to
identify a positive performance effect of shareholder activism because
much of that activism was, in fact, misdirected." (Roberta Romano,
"Less is More: Making Shareholder Activism a Valuable Mechanism of
Corporate Governance," Center for Research on Pensions and Welfare
Policies, NBER Working Paper, December 2001).
Take for example a study by Sanjai Bhagat, a finance professor at the
University of Colorado, and Bernard Black, a professor at Stanford,
who found that in examining 1,000 US companies from the end of 1990
to 1993, the companies that performed the worst had the greatest
proportion of outside directors!
According to a recent New York Times article, researchers have found
little evidence that companies improve their performance by raising
the number of independent directors on their boards. In fact, some
studies (such as the one quoted) have found that they perform worse.
But one of the most crucial factors, according to Paul Gompers, a
professor at Harvard University, is a company's corporate culture,
i.e., how the firm is responsive to its shareholder concerns.
His point is that "until and unless boards become more active, board
independence will continue to be a poor proxy for good corporate
As Mr. Mitarai of Canon insists, merely importing the trappings of
US-style corporate governance without also incorporating the corporate
culture with it will not significantly improve Japanese corporate
Japanese companies (especially Canon) that have given the issue a lot
of thought have realized that introducing US-style corporate
governance without integrating the principals behind such actions
(such as active boards) or without changing the corporate culture is
like importing a left-hand drive 1960s Cadillac to drive on Tokyo's
In this regard, the increasing pressure within Japan (from
Sarbanes-Oxley and investors) for Japanese companies to adopt US-style
corporate governance is leading to another fad among companies.
Previous fads include ROE and EVA (economic value-added). Because they
were often asked, companies would offer, for example, ROE targets, but
then would have trouble explaining just how they would achieve the ROE
target. The temptation is to use simplistic quantitative measures
(i.e., number of outside directors, et cetera) as indicators, but this
misses the whole point about good corporate governance.
A total of 36 listed companies will adopt US-style corporate
governance by the end of June, following amendments to the Commercial
Code that took effect in April, according to the Nihon Keizai.
Companies that adopt the system will set up three committees -- one to
conduct audits, one to nominate board members and one to set executive
pay. Many of the companies adopting the new format have done so
apparently to improve their corporate image in the eyes of overseas
investors. Some Japanese firms are also embracing US-style corporate
governance because they have come under the wing of foreign companies.
Among the firms that are embracing the US style, five companies,
including Hoya, Seiyu and Resona Holdings, have more outside directors
than insiders, and five other firms have the same number of inside and
outside directors. Hoya is unique among these three because it has
consistently demonstrated a proactive attitude toward good corporate
governance, and its management actually understands concepts like EVA.
At 26 companies, insiders outnumber outsiders. Japan Telecom boasts
the highest number of outside directors at nine, followed by Sony at
eight and Seiyu at seven.
While such numbers would indicate progress, astute investors know that
they must dig deeper to identify good corporate governance. A report
by the Policy Research Institute of the Ministry of Finance (Ken-ichi
Inagaki, "Report of the Research Committee on the Diversification of
Japanese Companies and Corporate Governance") came up with conclusions
similar to the empirical studies in the US. This report found that
there was no clear correlation between the introduction of "in-house"
companies (divisional profit centers) so popular among Japanese
companies today and corporate performance.
Moreover, the effect of the "executive officer" system, which has also
become popular in Japan as a reform of the board of directors' system,
is limited; it is not contributing to the enhancement of internal
governance or to the strengthening of decision-making in Japanese
companies. The same goes for holding companies. To date, pure holding
companies are mostly used as an alternative to mergers.
Thus such quantitative measures in the main have made no significant
contribution to solving the gap between the interests of shareholders
and business managers.
In addition, surveys such as one conducted by the Finance Ministry's
Policy Research Institute indicate that old corporate attitudes die
very hard in Japan. These surveys show that companies still attach
more importance to: a) their main banks; b) keiretsu group companies;
c) clients; and d) employees, in that order, than they do to
institutional investors and, most certainly, individual investors.
And as long as such attitudes persist, while the activities of Mr.
Murakami at M&A Consulting will continue to draw a lot of attention
and are being cheered by foreign investors, these efforts in isolation
will have minimal impact on overall corporate management attitudes.
Rather, the most likely candidates to become the new standard bearers
for Japanese corporate governance will be the public pension funds,
just as they were in the US. As corporate pension funds return the
portion of the welfare pensions managed for the government back to the
Government Pension Investment Fund and more employee pensions from
discontinued corporate plans are passed to the Pension Fund
Association, the influence of these public pension funds will continue
to increase. Asset-management companies that compete for these public
pension funds' business will be obliged to comply with their proxy
While the news from this year's tsunami of shareholder meetings is
encouraging, we may be some time away from the point where
shareholders are influential enough to succeed in forcing out the
management of a large and influential but poorly performing company
and effectively putting all senior managers on notice, such as was
exemplified by the removal of Bob Stemple at GM in the early 1990s.
For example, having their shareholders give them the boot would be a
much more powerful signal to management of the major banks than would
having the government come in and bail them out and then weakly demand
The only clear benefit from the recent capital infusion for Resona
Bank was that it resuscitated the stocks of the zombie companies that
had been hanging from the bank's coattails. Money Watch would be very
interested in seeing an honest appraisal by the major banks of who
they consider their most important stakeholders. One thing for certain
is that it would most certainly not be the domestic pension funds or
foreign institutional investors.
-- Darrel Whitten
THE ABW MARKET LETTER
"What You Should Read After Irrational Exuberance"
A weekly strategic analysis of Japan's economy and
financial markets with views you use.
Subscribers: 552 as of June 30, 2003
Written by Darrel Whitten email@example.com
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