©Reuters. FILE PHOTO: A man walks past an electronic screen showing Japan’s Nikkei stock average as it hit an all-time closing high in Tokyo, Japan, February 26, 2024. REUTERS/Issei Kato/File Photo
By Makiko Yamazaki and Rae Wee
TOKYO/SINGAPORE (Reuters) – A revamp of corporate governance has helped fuel the revival of Japan’s once moribund stock market. Now investors want to see if the change will be real.
The index broke its all-time high last week, surpassing a level not seen since the asset bubble of December 1989, and continues to gain ground.
Foreign investors were responsible for much of the buying. This marks a big change for Japan, which has long been seen as indifferent to shareholders, particularly foreign ones, with governance problems related to cross-holdings between companies, a lack of independent directors and resistance to takeover bids.
While Japan has been strengthening governance for at least a decade, the effort got a big boost last year, when the Tokyo Stock Exchange called on companies to improve capital efficiency.
The exchange now publishes a monthly list of companies that have voluntarily disclosed plans to improve capital utilization, effectively naming and shaming those who don’t.
“Governance problems in Japan, the kind of things reported by foreign investors, are gradually improving,” said Kentaro Takayanagi, managing director of Nihonbashi Value Partners and a veteran asset manager.
“We want to see whether this trend will continue adequately or fade away as a short-lived hope. I think it will probably continue,” he said.
Positives include the growing presence of outside directors on boards and the sale of cross-holdings that typically shielded management from investors, Takayanagi said.
Over the past year, the Nikkei is up 46% including dividends. In dollar terms, that’s a 33% return, surpassing 29% and outperforming other major markets.
To be sure, the Nikkei has benefited from a number of positive factors: attractive valuations, earnings momentum from a weaker yen, and growing demand from funds that reduce exposure to China.
But it was the governance reform that made investors take note, even as South Korea’s regulators aim to roll out a similar program.
“Nobody used the word governance in 1989,” recalled Ken Shibusawa, president of Commons Asset Management and a member of Prime Minister Fumio Kishida’s advisory board.
The reform was part of the “three arrows” of former Prime Minister Shinzo Abe’s “Abenomics” project, which was launched ten years ago to revitalize the Japanese economy and was welcomed by investors who sent the Nikkei up more than 50% in 2013.
However, progress has been insufficient and lackluster returns have followed – so far, with the Nikkei rising 28% last year, the biggest annual gain since 2013. In some areas, reform remains a work in progress, such as the effort to increase female representation on boards of directors. .
LOW RATINGS
The Tokyo Stock Exchange’s guidelines are designed to boost valuations: About 44% of the 1,656 companies in the stock exchange’s top section were still trading below the value of their assets at the end of last year, an outlier for major developed markets.
A quick fix was to buy back more shares. The companies have announced plans to buy back shares worth a record 9.3 trillion yen ($62 billion) so far in the year ending in March, according to JPMorgan.
But companies are also facing what investors say are deeper, more structural problems.
Foreign investors believe Japan is going through a “major restructuring of corporate productivity,” said Naka Matsuzawa, chief Japan macro strategist at Nomura.
Analysts at Jefferies are so optimistic about the outlook that they believe the country is moving into a “golden age” from the “lost decades” of the past.
While cross-holdings traditionally used to solidify business ties and block potential acquisitions have been in decline for years, the pressure is greater now.
Companies are required to explain their reasons for maintaining cross-shareholdings, and some asset managers now vote against board directors of companies with large stakes.
OFFERS NOT SOLICITED
Japanese stock market veterans say the change isn’t just numerical.
Mike Allen, now director of research for Azabu Research in Tokyo, remembered a very different tone in the market when he began his career as a consumer sector analyst at Barclays in 1987 in Tokyo.
“Analyst meetings were quiet back then. Nobody asked questions after the company presentation. They asked questions and there weren’t any,” he said.
“And now the question-and-answer session makes up the majority of the meeting.”
Companies are also under pressure to sell or delist their subsidiaries, which has paved the way for some private equity spin-offs.
New government guidelines released last year on mergers and acquisitions have helped remove some of the stubborn reluctance towards unsolicited acquisitions.
Since then, both Nidec and Dai-ichi Life Holdings have made unsolicited offers, which was once unthinkable.
So far, most of the changes have affected larger companies. One example is Hitachi (OTC:), which has been aggressively selling off its subsidiaries in an effort to reorganize itself as a digital services company.
Over the past five years, its shares have returned about 317%, including dividends, compared to the Nikkei’s return of just over 100%.
What is less clear is how and when the change will take root in smaller companies. It is also unclear how much patience foreign investors have.
An ongoing dispute over NEC’s rejection of multiple takeover offers from private equity funds for its listed subsidiary Japan Aviation Electronics Industry suggests there is still resistance to governance changes.
The next stage of the rally will depend on whether companies can deliver higher earnings growth or implement reforms, said Ilan Furman, chief investment officer at Bridgewise.
If the latter, the impact of governance reforms will take “much longer to materialize than the headlines about the plans,” he said.
($1 = 150.1700 yen)