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June 17, 2024 | Global Equity
Evolving Corporate Governance in Japan

Director of Sustainable Investing

Blake Pontius, CFA, is director of sustainable investing. In this role, he coordinates the firm’s integration of environmental, social and governance (ESG) factors in its investment processes and provides ESG research support to the global equity team. Blake also leads the firm's ESG leadership team. Previously at William Blair, he was a global portfolio specialist and institutional client relationship manager. Before joining William Blair in 2005, Blake worked at UBS Asset Management and Mercer. He is a board member of Easterseals DuPage & Fox Valley, and a member of CFA Institute and CFA Society Chicago. In addition, Blake holds the SASB Fundamentals of Sustainability Accounting (FSA) credential and the CFA Certificate in ESG Investing. He received a B.A. in economics, with honors, from Michigan State University and an M.B.A. in finance, with distinction, from DePaul University.

Global Research Analyst

Rita Spitz, CFA, partner, is a global equity research analyst focusing on ESG integration. She is on William Blair’s Global Inclusion Council and the ESG/Impact Investing Working Group. Previously, she was a research analyst covering U.S. and global consumer stocks across the range of market capitalizations. She served as director of research from 2001 to 2008. Rita joined William Blair in 1986 as a sell-side research analyst covering advertising and marketing firms, a role she held for 13 years. She is a member of the CFA Society Chicago, the CFA Institute, and The Economic Club of Chicago. She has also served on the advisory groups of the Financial Accounting Standards Board. She is a trustee of The Joffrey Ballet. Rita received a B.B.A. in finance and Spanish from the University of Wisconsin–Madison and an M.B.A. from the University of Chicago’s Booth School of Business.

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Japanese economic reform efforts began in earnest during the Abenomics era, when Prime Minister Shinzo Abe spearheaded a comprehensive agenda to address the prolonged period of deflation and corporate inefficiency that had plagued Japan for decades. But today, Japan is undergoing a remarkable transformation in its corporate governance landscape, which we believe makes it an increasingly attractive destination for global investors.

GPIF’s Influence in Improving Standards

A pivotal player in Japan’s corporate reform story is the Government Pension Investment Fund (GPIF), which is Japan’s largest public pension fund. Established in 2001, it is one of the largest pension funds in the world.

To support Japan’s aging population, the country’s Government Pension Investment Fund has significantly shifted its investment strategy from bonds to equities.

Over the past decade, to drive the growth needed to support Japan’s aging population, the GPIF has significantly shifted its investment strategy from low-yielding Japanese government bonds to equities, increasing its equity target allocation fivefold, with a significant portion dedicated to Japanese equities.

The GPIF is also driven by a “universal owner” mentality, which acknowledges that it owns a substantial portion of the entire market, with significant stakes in numerous companies across various sectors. Given this extensive influence, GPIF promotes long-term market sustainability and stability by pushing for higher governance standards. For example, the GPIF has adopted ESG-focused indices for passive allocations, encouraging companies to improve their practices to be included in these indices.

Corporate Governance Reforms

At the same time, Japan’s corporate governance reforms have been substantial, focusing on enhancing board independence and diversity.

Over the past decade, there has been a significant increase in the number of companies with independent directors, a critical component of effective governance.

Additionally, there has been a cultural shift toward greater gender diversity on boards, with a noticeable rise in the participation of women. Revisions to Japan’s corporate governance code, effective April 2022, set a target of one female director by 2025 and 30% female directors by 2030.

Japan is the only country we are aware of where the percentage of men taking paternity leave is required corporate disclosure.

This shift reflects broader societal changes in Japan, including efforts to destigmatize paternity leave, promoting shared responsibility in child-rearing. In fact, Japan is the only country we are aware of where the percentage of men taking paternity leave is required corporate disclosure.

Despite these advancements, challenges remain. As our college Kyle Concannon wrote in another post, in terms of board independence, separation of CEO and chair, and female directors, Japanese companies rank well behind their developed market peers and even behind most emerging markets. Japanese companies also have the highest number of directors over age 70 (which isn’t surprising, given its demographics).

Tokyo Stock Exchange Reforms

The Tokyo Stock Exchange (TSE) has also played a crucial role in Japan’s corporate governance evolution. In April 2022, the TSE restructured its market into three segments: prime, standard, and growth, each with specific governance requirements.

For example, companies listed on the prime segment must have at least one-third independent directors, one female director by 2025, and a skills matrix disclosure to provide transparency about board members’ roles.

The TSE has also mandated electronic voting and simultaneous disclosure of information in English and Japanese to enhance investor engagement and transparency

The Tokyo Stock Exchange is urging all companies with a P/B ratio of less than one or ROE of less than 8% to improve capital efficiency … or be delisted.

Lastly, the TSE is urging all companies with a price-to-book (P/B) ratio of less than one (meaning the market values the company below its book value, which could indicate undervaluation or potential problems with the company’s fundamentals) or return on equity (ROE) of less than 8% to devise a plan to improve capital efficiency and promote investment. Companies that do not develop such a plan could be delisted.

In January 2024, the TSE began publicly naming the listed companies that have complied with its request. Hiromi Yamaji, chief executive of the Japan Exchange Group, which controls the TSE, was quoted in The Financial Times as follows: “We will renew the list every month. In Japan … peer pressure or nudge is a very important method to push people to go forward.”[1]

The Push for Better Capital Efficiency

Speaking of ROE, improving capital management is another key focus of Japan’s ongoing reforms, as many Japanese companies have poor ROE, which indicates how well a company uses its equity to generate profit. Higher ROE suggests that the company is using its capital effectively to produce earnings.

But currently, many Japanese companies have low ROE. About 40% of Japanese stocks listed on the TOPIX 500 have a ROE of less than 8%. In the United States, that number is 14%, and in Europe 19%.

Aligning Japan’s cross-shareholding ratios with those of the United States and Europe could potentially increase market ROE by up to 300 basis points.

To address this, Japan has introduced the Plan-Do-Check-Act (PDCA) method, which is an improvement cycle based on the scientific method of proposing a change in a process, implementing the change, measuring the results, and taking appropriate action.

This, Japan believes, should encourage companies to articulate and improve their investment strategies, including research and development, capital expenditures, and shareholder returns through buybacks and dividends.

Additionally, there is a significant push to reduce cross-shareholdings, which could have a substantial impact on overall market returns. For example, aligning Japan’s cross-shareholding ratios with those of the United States and Europe could potentially increase market ROE by up to 300 basis points.

Engaging the Global Investor Community

The TSE is actively working to foster transparent and effective dialogues between companies and investors. This effort includes global investor meetings, where Japanese companies are encouraged to engage with international investors, enhancing their visibility and investment appeal.

Conclusion

Japan’s corporate governance journey over the past decade has been transformative, laying the foundation for a promising future.

While there is still much work to be done, the progress made so far is encouraging. The ongoing reforms, combined with Japan’s strategic focus on improving capital efficiency and investor engagement, should create better alignment between executive decision-makers and investors, which we believe will lead to enhanced risk management, better decision-making that focuses on value creation, and ultimately, better shareholder returns.

As Japan continues to evolve and modernize, we believe it stands poised to become a more relevant and attractive market for global investors, offering compelling growth and profit improvement prospects. We also see a compelling bottom-up story based on multiple on-the-ground research trips.

Blake Pontius, CFA, is the director of sustainable investing at William Blair.
Rita Spitz, CFA, partner, is a research analyst on William Blair’s Global Equity team.

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[1] https://www.ft.com/content/94dfe7fb-d244-4c26-809b-3d1ec213815d

Director of Sustainable Investing

Blake Pontius, CFA, is director of sustainable investing. In this role, he coordinates the firm’s integration of environmental, social and governance (ESG) factors in its investment processes and provides ESG research support to the global equity team. Blake also leads the firm's ESG leadership team. Previously at William Blair, he was a global portfolio specialist and institutional client relationship manager. Before joining William Blair in 2005, Blake worked at UBS Asset Management and Mercer. He is a board member of Easterseals DuPage & Fox Valley, and a member of CFA Institute and CFA Society Chicago. In addition, Blake holds the SASB Fundamentals of Sustainability Accounting (FSA) credential and the CFA Certificate in ESG Investing. He received a B.A. in economics, with honors, from Michigan State University and an M.B.A. in finance, with distinction, from DePaul University.

Global Research Analyst

Rita Spitz, CFA, partner, is a global equity research analyst focusing on ESG integration. She is on William Blair’s Global Inclusion Council and the ESG/Impact Investing Working Group. Previously, she was a research analyst covering U.S. and global consumer stocks across the range of market capitalizations. She served as director of research from 2001 to 2008. Rita joined William Blair in 1986 as a sell-side research analyst covering advertising and marketing firms, a role she held for 13 years. She is a member of the CFA Society Chicago, the CFA Institute, and The Economic Club of Chicago. She has also served on the advisory groups of the Financial Accounting Standards Board. She is a trustee of The Joffrey Ballet. Rita received a B.B.A. in finance and Spanish from the University of Wisconsin–Madison and an M.B.A. from the University of Chicago’s Booth School of Business.

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