Corporate governance reforms in Japan: Investor dialogue

Holding companies to account

In 2023, The Tokyo Stock Exchange (TSE) made updates to its listing requirements, tightening its listing criteria, encouraging companies to disclose plans to increase their capital efficiency, and announcing stricter rules around diversity, disclosure and sustainability. We discussed what these updates mean for investors in our blog Japan: Investment implications of corporate governance reforms.

A key implication of the reform is the additional impetus for investors to hold companies to account, both for their disclosures and the quality of their plans. We expect that for the initiatives to be most effective, investors will have to act as enforcers by providing additional incentive to meet the spirit of the requirements. Without such incentives, there is the possibility that companies respond with low-quality disclosures which are merely ‘box-ticking’ in nature, or with a plan lacking in credibility, with no repercussions.

Understanding the full picture

Improved access to information about a company’s capital management is helpful for active investors when analysing opportunities. An ambitious plan with poor credibility, for which there is little faith that the management will be able to execute, could present an opportunity if investors were instead to believe in it. Dialogue with management can add valuable qualitative data points concerning the management’s actual priorities, thereby adding to investors’ confidence in the plan or otherwise. Ultimately, we see great value in combining disclosures with direct interaction with companies to understand the full picture.

We see great value in combining disclosures with direct interaction with companies to understand the full picture.

Engagement opportunities

Insights gained from company dialogue may also present opportunities to invest in companies in which investor confidence does not yet fully exist, or where its potential is not priced in by the market but we believe there to be a reasonable prospect of increasing conviction. A number of elements could improve investors’ confidence in a company: proposed changes to the company’s plan, enhancing its credibility; successful execution of the plan; or even improved transparency of the plan to the market, enabling the plan and potential investment implications to be fully recognised.

In cases where investors believe changes need to go further, they may turn to engagement.  Engagement at Newton centres on the purposeful dialogue that we can have with issuers to reduce risk and potentially add value to an investment. We set clear outcome-focused objectives for each engagement, tailored to the specific action the issuer can take to address the matter of concern, which can be evaluated over a suitable time horizon and can be linked back to a relevant investment thesis.[1] For this reason, capital allocation, as part of corporate governance and business strategy, is a topic that we tend to focus on when engaging with companies in Japan.

Engagement in action

We engaged with a small-cap Japanese company which provides labour dispatching services such as outsourcing of permanent employees in manufacturing, design and development, construction, and other sectors across Japan. After analysing its reporting, we considered disclosures to be insufficient, and consequently, there was an opportunity for the company to improve them and receive market recognition. This is frequently the case for smaller companies, which often have fewer resources to dedicate to reporting and market transparency, whether that be in relation to financial measures and/or sustainability. Specifically, we considered the following areas to be light on information: its required investments to achieve the mid-term plan, its expected cash flows, its target balance sheet, and its capital distribution plan. Having met the company, including external directors, we shared our view that improving these disclosures on the financial/capital allocation plan is important.

Positively, in the updated mid-term plan, the company had enhanced the disclosure of its financial and capital allocation plan. In addition, it amended the policy for the payout to shareholders, increasing the payout ratio. The market value of this company rose by more than 30%, which we consider to be in part owing to the increase in payout to shareholders. We expect to continue this dialogue with the company, and will monitor it to ensure that the capital allocation plan is both communicated and carried out successfully.

Meaningful dialogue

This is another interesting period for the Japanese market, and many stakeholders appear to be keeping a keen eye on the impacts of the TSE’s latest initiatives and company responses. Even though there is considerable support and strong drivers behind the reforms, there is a risk that this does not move past a box-ticking exercise and does not deliver the intended effects. We believe that to achieve the desired aims, a cultural change across corporate Japan is needed, which will be slow and require persistent efforts over the longer term. However, the achievement of this could present mutual benefits for numerous stakeholders, including investors, their clients, companies and management. Meaningful dialogue between investors and investee companies, focused on financially material enhancements, within the context of the business model and culture, could begin to unlock such benefits.

We believe that to achieve the desired aims, a cultural change across corporate Japan is needed

However, even assuming a rising tide, we do not believe that the reforms will lift all boats. We believe that investors that can conduct meaningful analysis and dialogue with companies will be better able to identify investment opportunities. It will be imperative to understand businesses, the credibility and relevance of the capital allocation and financial plan, management’s ability to execute its plans, and their capacity to communicate effectively with the market. Investors can combine this understanding with targeted engagement to encourage improvements, where such improvements are likely to unlock value for all stakeholders. A local-market understanding of culture, language and context may support investors in doing so most effectively.

[1] View Our approach to engagement to learn more: https://newtonim.com/responsibleinvestment

Authors

Rebecca White

Global ESG integration lead

Anchit Sharma

Responsible investment stewardship analyst*

Nagaya Hiroyuki

Responsible investment stewardship analyst