Equity Outlook  |  Q1 2020

Is shareholder-friendly Japan taking a step backward?

Is shareholder-friendly Japan taking a step backward?

In 2007, Steel Partners, a New York hedge fund, attempted a hostile takeover of Japanese condiment maker Bull-Dog Sauce. Steel Partners sought to repeal Bull-Dog's poison pill scheme. It failed on legal grounds, but not on merits. In ruling against the takeover attempt, the Japanese lower court described Steel Partners as an "abusive acquirer" and a "vulture investor." Forbes magazine said the ruling reflected "the prevailing distaste in corporate Japan for foreign invaders that threaten the long-cherished coziness of its management ranks."

At the time, Japanese companies in aggregate suffered from poor returns on capital and low profit margins for a multitude of reasons. Among them was the fact that company managements were not held accountable for looking after shareholder interests.

Abenomics brings big changes

Fast forward to 2012, when Prime Minister Shinzo Abe came to power and made corporate governance reform a central part of his economic policy platform. Since then, Japanese stocks have outperformed most major non-U.S. markets. Improved profitability helped boost the stocks, and corporate governance took great strides forward. Managements became more accountable to shareholders, and share buybacks and dividends surged.

Among the key improvements were the creation of a Stewardship Code in February 2014, followed by a Corporate Governance Code later that year. Japanese investors today have significant powers. Beyond the codes, the government has announced additional measures to protect and promote minority shareholders' interests.

Are Japan's improvements sustainable?

Recently, however, doubts have emerged about the sustainability and direction of these shareholder-friendly measures. In late 2019, Japan's parliament passed the Foreign Exchange and Foreign Trade Act (FEFTA). The law requires foreign investors buying national-security-related stocks to seek prior permission to buy shares after they have reached 1% ownership. FEFTA seems to have fallen prey to some industry lobbies and false claims that certain companies are related to national security. Many investors are concerned that FEFTA will reduce investor activism, which could reverse the tide of improving shareholder friendliness.

However, there are still many reasons to believe Japan will continue to move forward in support of shareholders. For one, registered domestic and foreign institutional investors will likely be exempted from FEFTA, so they can continue their dialogue with managements to improve governance.

The most important reason for optimism is that Japanese managements and boards have finally internalized the change. As a result of the Stewardship Code, they have witnessed the positive effects of improving governance. Many measures have become part of Japanese corporate psyche and will likely remain there.

With regard to Bull-Dog, it is anyone's guess as to what would have happened if Steel Partners had been successful in its takeover. However, since then, Bull-Dog's profits have mostly gone sideways, and in March 2019, they were lower than they were in 2005.

Japan has outperformed mos major non-U.S. markets

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