Japan’s multi-year effort to improve corporate governance standards continues to be gaining momentum after the latest revisions to its Corporate Governance Code came into effect in June 2021. In this Q&A, Capital Group equity investment analyst Harry Gunji explains why recent cases of high-profile business misconduct have only served to highlight the importance of the country’s corporate governance push and that bottom-up research is key to unlocking the opportunities emerging from the ongoing reforms.

Several cases of high-profile business misconduct have led some sections of the investment community to question the progress of Japan’s corporate governance reforms. Are these incidents a broader reflection of Japan’s corporate culture?

Yes and no. Some organisations belong to a unique group of companies in Japan that often prioritise government policy objectives or public service ahead of shareholder interests. Historically, many Japanese companies such as banks, industrials and trading firms operated in a similar way. This concept of companies not prioritising shareholder interests can be difficult for international investors to understand as they are more accustomed to the Western model, where shareholders come first.

There is nothing wrong with companies pursuing certain interests that they believe will benefit a local community or the wider public. But these companies tend to make inefficient capital allocation decisions and generate low return on capital. We typically avoid these companies, although properly identifying them requires deep local research capabilities and a strong understanding of local culture. A common example would be when a company refuses to divest low return businesses to protect employment or the local economy. Good companies do not have to sacrifice the benefit of one stakeholder for another.

Low levels of corporate governance is quite a common issue among old economy companies in Japan. The good news is the government is aware of this problem. Japan’s population isn’t growing, so the only way left to improve the economy is to enhance capital efficiency. That was why it introduced the Corporate Governance Code in 2015 and efforts have been made to continuously upgrade it in order to elevate Japan’s corporate governance level to eventually meet global standards.

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“Japan’s population isn’t growing, so the only way left to improve the economy is to enhance capital efficiency.”

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How receptive are Japanese companies to introducing corporate governance reforms? Has there been a noticeable change in their attitudes?

It is no secret that international investors have been clamouring for corporate reforms in Japan for a long time – way before the introduction of the Corporate Governance Code. In the past, whenever we brought the topic up with company executives, most were fairly sceptical about the benefits of, for example, bringing in independent directors.

But many companies have now adopted the changes suggested by the Code, and most of those that I have spoken to in recent months have told me they have had positive experiences as a result. Regarding independent directors, the fresh perspective they have brought has expanded these companies’ horizons and allowed them to think about new risks and opportunities. This is especially true for profit-oriented companies, which tend to be more receptive to governance changes because they understand the value of them. For someone who has been covering Japan for many years, it is encouraging to me to listen to senior company officials now talking about majority independent boards, because such conversations were very uncommon in the past.

 

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