Improving corporate governance was one of a flock of initiatives by the government of Japanese Prime Minister Shinzo Abe in its plans to reinvigorate the economy through what became known as Abenomics.
The argument went that profitable companies adopting the government’s new Corporate Governance Code would become more transparent in how they run their business, hence more attractive to investors, leading to a better performance in the stock market.
Moreover, beside beefing up corporate governance rules for companies, the government also introduced its so-called Stewardship Code for investors, effectively encouraging purchases of stocks of companies that showed enthusiasm for the new governance requirements.
As its main tool in promoting the new thinking, the authorities persuaded the Government Pension Investment Fund — the world’s largest pension fund with about US$1.3 trillion in assets — to switch more of its funds into stocks and less in bonds.
GPIF was among the first to adopt the government’s voluntary Stewardship Code, meaning it was now required to be more discerning about which stocks it buys — one criteria being companies adopting the Corporate Governance Code of Abenomics.
The flood of cash released into Japanese equities as a result of the GPIF move lifted the market and was supposedly aimed at progressive companies on board with the corporate governance initiatives of Abenomics.
But four years on and stock investments by the GPIF and the Bank of Japan (BoJ) — which unleashed its own waves of money in pursuit of the goals of Abenomics — are stifling corporate governance reform instead of promoting it.
Without heavyweight funds, such as GPIF, pushing for improvements it’s harder to persuade management governance changes are worth their while.
But with the market awash in money, the leverage is lost to put real governance pressure on companies that disregard investor interests, dodge disclosure or even announce internal financing irregularities.
A clear example is Toshiba’s stock. It had recovered by the end of last year almost all of the losses incurred after drawn out revelations of accounting fraud first announced by the company in 2015.
By the spring of last year, the GPIF and the BoJ controlled 8% of Japanese stocks, according to a Nikkei survey published in April last year. The fund and the bank were the biggest shareholders in one out of every four stocks listed on the first section of the Tokyo Stock Exchange.
Bloomberg data showed the BoJ alone was among the five main owners of stocks in more than one-third of the companies that make up the Nikkei 225 Stock Average.
Some investors say the investment strategy of the GPIF and the moves by the BoJ have simply led to outright distortion of share prices.
Most of their money went into passive funds; index-tracking funds that mirror the movement of a market benchmark in purchasing shares.
Buying into passive funds is cheaper than spending time on researching hundreds of companies with a view to picking winners. Plus, the theory says index funds are also more profitable over time, as few fund managers can consistently beat the average returns of the market.
About 70% of GPIF money is now managed passively, according to the Nikkei newspaper. This strategy is being followed by smaller Japanese pension funds, which also hold about 70% of their assets in index-tracking funds.
What is more, the GPIF, because it is a public entity, is said to be reluctant to criticize individual companies. The fund fears that in an economy where the means of production are mainly privately owned, being directly involved in companies would smack of state interference.
As GPIF and BoJ investments buoy the market on the way down and boost it on the way up, the mechanism for making corporate governance a valid investment criteria is lost.
Nicholas Benes at the Board Director Training Institute of Japan estimates that up to 70% of Japanese companies pay lip service to corporate governance rules, but seek to change as little as possible.
He says one of the most frequent responses by Japanese managers when asked to improve corporate governance is, “which investors, specifically, are asking?”
However, a couple of ways to harness passive investment to promote improvements in corporate governance have emerged. One is the JPX-Nikkei Index 400, set up by the Japan Exchange Group and Nikkei in 2013.
The component stocks are those of companies that meet certain criteria, including adoption of International Financial Reporting Standards, disclosures in English, and a three-year return on equity of 40% or more.
The Financial Times, citing Nomura data, reported in 2015 that the JPX-Nikkei 400 played a part in the reallocation of 1.7 trillion yen of GPIF cash by the middle that year – although the sum represents only a small fraction of all the fund’s assets.
And the Financial Services Agency in April proposed a revision to the Stewardship Code to ask funds to reveal how they vote at the annual general meetings of companies they invest in.
The hope is that revelations of support for companies that ignore the interests of shareholders will prod fund managers into changing the way they invest.
Research by brokerage CLSA suggests that stocks of companies with chief executives that face investor criticism at their AGMs tend to outperform the market benchmarks in the following year. The inference being the boss got the message.
The crux is opting into the Stewardship Code and Corporate Governance Code is voluntary and on the back of the deluge of GPIF money, most chief executives can rebuff questioning investors by pointing to healthy returns.
It would help if Japan’s corporate governance rules added some stick to the carrots.
(Yuriy Humber is a Tokyo-based researcher and award-winning journalist who has covered Japan’s Fukushima disaster, Vladimir Putin’s Russia, the rise of Mongolia, and the global commodity boom and bust. This is the second of a three-part series on corporate governance in Japan.)