Views from Investors in the U.S. on Corporate Governance Reform in Japan | Print |
Session II: Perspectives on Corporate Governance and M&A in Japan
  • Mr. David Makman, Counsel, Howrey LLP

From his background serving as Chair of the Japan Society of Northern California Forum on Corporate Governance, Mr. Makman gave an overview of how investors in the U.S. perceive the corporate governance reforms taking place in Japan.

Perceptions in the U.S.
He began with a graph from a Morgan Stanley analysis of the Japanese stock market, written shortly before the recent crisis in the U.S. financial markets. The analysis shows that Morgan Stanley believes corporate governance reform is a main factor for growth of GDP in Japan. Mr. Makman pointed out that the graph may have had a sales-related agenda and may not be directly accurate, but it represents a perception in the U.S.—one that is held not only by Morgan Stanley—that corporate governance reform is important for economic growth in Japan.

There is also a perception that corporate governance reforms are not as applicable to publicly listed companies rated in the top quintile for return on equity than companies in the lower quintiles. Investors will see more benefits from corporate governance reform of companies that are not among the top global companies but from ones with lower stock liquidity.

Sources of pressure for corporate governance in Japan
Much of the pressures driving Japan to make changes to their corporate governance laws seem to be coming from the upcoming ‘pension crunch,’ a growing need for more workers in Japan, and rising health costs. In particular, the ‘pension crunch,’ where much of the Japanese population will be retired by 2025, could cause great strain on the Japanese economy. It could lower the savings rates and greatly increase health costs.

Solutions
From the perspective of U.S. investors, Mr. Makman posed a few solutions to this pressure. One solution is to get better returns from capital. Changing corporate governance laws, Mr. Makman believes, is a way to do that. Another option is to not reform and hope that through pressure and consensus of Japanese companies that better returns can be achieved, which may work as well. A third solution could be to get better returns from intellectual property, using intellectual property in international settings and getting the respective royalty streams. The Japanese government also seems to plan to import foreigners into the country. Mr. Makman mentioned plans to bring into Japan 10 million foreigners to provide managerial talent as well as low-cost labor. Another route the government is looking to take is cutting health costs. It is from a backdrop of these issues, said Mr. Makman, that Japan is getting pressure to reform its corporate governance.

The U.S. system
Mr. Makman then discussed how the U.S. corporate governance system tries to guarantee shareholder returns. One method is tying employee pay to share price. This creates an incentive for management to improve share value. U.S. investors feel that this method aligns managements’ interests with those of shareholders and creates an incentive for a rise in share price. Another tool of the U.S. system is replacing management. If shareholders do not feel that management is running the company efficiently enough, shareholders can sanction managers by removal or by voting against specific managers. This creates a concern for keeping in line with shareholders’ interests. Mr. Makman said a level of discipline comes out of shareholder voting. Such a system is in place legally in Japan, and although there has not been traditionally much pressure from shareholders, it is certainly increasing. The U.S. also has the ERISA obligation that requires institutional shareholders to vote shares to the benefit of their depositors or accounts, which is very different from Japan.

Another aspect of the U.S. system is a relatively efficient market for corporate control. By this, Mr. Makman meant that an investor with capital can purchase control of a publicly listed company, and it is very difficult for the management of that publicly listed company to prevent the investor from buying control of it. Also in the U.S. system, the courts play a large role in trying to balance the multiple rights of stakeholders in the company, i.e. the shareholders, the management, the employees, and even the community. The U.S. Federal Court System creates a platform for negotiating these issues in a “speedy, just, transparent, and impartial forum for dispute resolution,” said Mr. Makman.

While these aspects of the U.S. system may be seen as beneficial in the U.S., Mr. Makman noted the U.S. pays significant social costs for its system and that it is not suggested that Japan adopt the U.S. system as a whole.

Takeovers in Japan
In the past, it had been very difficult for a foreign investor to buy a company in Japan. The investor can be stopped in many ways. Some of the more recent cases are Steel Partners’ attempt to takeover Sapporo Beer, as well as shareholders voting against the takeover of Bulldog Sauce. To improve the ability of foreign investors to purchase a company in Japan, a group of ‘soft investors’ called the Asian Corporate Governance Association published a white paper containing recommendations for changing the Japanese corporate governance system. The proposals of the paper regard the following six areas:
  1. Strengthening shareholders’ rights as owners
  2. Strengthening the efficient use of capital
  3. Independent supervision of management
  4. Preemptive rights
  5. Poison pills and takeover defenses
  6. Shareholder meeting and voting

While the paper does not propose a full reproduction of the U.S. system, it sets the agenda for an international discussion on how Japan should reform its corporate governance system.

Factors in Japan working in favor of corporate governance reform
Mr. Makman then went through some factors in Japan that are working in favor of corporate governance reform. The Pension Fund Association (PFA), because they are responsible for managing the potentially underfunded pensions in Japan, were pushing Japanese management to deliver an 8% average return on equity over a three-year period. While this is an aggressive agenda, the PFA is using an approach of setting a target and persuading companies to meet this target, an approach that has worked fairly well for CalPERS in the U.S.

METI has also proposed corporate governance reform by writing a corporate value study group report. The report is something that can be used in court, said Mr. Makman, and used in negotiations between shareholders and management. It clearly and decisively makes management much more liable to shareholders. It states that shareholder returns is the goal of management. And it discusses that takeover defenses are meant to slow down negotiations and not to entrench management. If the report is used in court, for example, to show that management is to work for a good share price for shareholders, a target company would have to have a very good reason to avoid a takeover offering a good share price, said Mr. Makman. However the report is used, he views it as “a real positive advance from the point of view of corporate governance reform.”

Mr. Makman commented on the impressiveness of the TSE surveys mentioned earlier by Mr. Tomita, and that the Japan Society of Northern California put together a model response to the survey and circulated it among pension funds in the Bay Area and elsewhere, encouraging them to respond. “The Tokyo Stock Exchange really identified the right issues, the key issues, and they are moving forward in good faith to try and figure out how to modify things,” said Mr. Makman.

Overall, the reforms so far seem to be having an effect, Mr. Makman said. The Nikkei reported that dividends are at record highs in Japan and that stock buybacks are also at record highs. The past few years have seen several interesting cases in corporate governance and takeovers. And some in the investment community posit that next year is going to be the year of the independent director, that the American Chamber of Commerce and foreign pension funds are pushing Japanese companies and trying to persuade them to hire independent, outside directors. Mr. Makman expects this to be a major issue in shareholder meetings next summer.

As for the Japan Society of Northern California, it continues its efforts to bring speakers from Japan to communicate with investors and fund managers in the U.S. to align expectations, understand the corporate governance agenda in Japan, and distill what investors in the U.S. want from the agenda in Japan. The Society will be holding a number of such programs over the next year.


Want more information about opportunities for your business in Japan?
Contact us


Note: The above summary is an adaptation of the speaker’s presentation. Contents and quotes may not be entirely accurate.