In the weeks leading up to Japan’s AGM season, the country’s companies were reaching out to us. A lot. They contacted us through advisory firms, brokers, clients and members of their London offices, who appear to be functioning as makeshift investor relations.
Anxious messages were left, pages of supplementary information received, last minute conference calls arranged. Some companies arranged their first overseas investor roadshows, others made their executives available for calls at short notice, and again others decided to speak to foreign investors for the first time in their history.
Corporate Japan is experiencing a perfect storm. The country’s new Corporate Governance Code came into effect in June, and under its comply-or-explain principle, listed companies that fail to appoint at least two independent outside directors to their boards have to explain the reasons for their absence in their Corporate Governance Report, to be published within six months of their AGM date. The listing rules of the Tokyo Stock Exchange also require the appointment of two independent outsiders for certain companies.
In addition, Japanese companies have faced unprecedented pressure to improve their financial performance and capital efficiency, with proxy advisory firm Institutional Shareholder Services recommending that shareholders vote against the top management of companies whose five-year average for return on equity (ROE) is below 5% unless an improvement has been observed.
Some Japanese companies with low ROEs saw this coming and went on a multi-pronged offensive, making significant changes to their strategies, restructuring their businesses and frequently communicating these changes with shareholders in the months leading up to their AGMs. Others were caught unaware or failed to realise the full impact of the changes happening this year. They had to hurriedly prepare supplementary information for their AGMs to call for shareholder support for their beleaguered executives and made themselves available for difficult, sometimes awkward last minute conversations. Their message has always been the same: “Please support our directors.”
Apart from worries that poor ROE could lead to votes against top management, there is another reason why companies have been asking investors to support their directors – the issue of outsider independence. While Japanese companies have started to appoint outsiders to their boards, many of the nominees are not truly independent due to their affiliations with the company, either directly or by proxy through the companies they work for.
The ubiquity of affiliated outsiders on the boards of Japanese companies, which have traditionally suffered from poor levels of independence, in a market where cross-shareholding concerns prevail, has led us to take a strict stance on the appointment of such outsiders, particularly where the affiliated individual is nominated as a statutory auditor.
Japan’s keiretsu system, groups of affiliated companies whose presence has dominated corporate Japan for decades, has been challenging for large listed companies seeking to appoint suitably independent outsiders to their boards. And the sheer number of companies looking to appoint outside directors for this year’s AGM has increased pressure on an already limited candidate pool.
The independence of directors has been the most hotly contested issue for us this voting season, accounting for a significant proportion of our dialogue with companies. Many have complained that the criteria are too strict and some valid issues have been raised, such as the need for a cooling-off period for outsiders with links to companies before they can be called independent.
Companies have also argued that their affiliated directors are classified as independent under the Tokyo Stock Exchange listing rules and the different classifications of independence have been a cause of confusion.
Opportunity for board diversity
The opening up of Japanese boards to outsiders is also an opportunity to promote board diversity, and we have been engaging with companies to consider the appointment of independent women and international candidates. The proportion of women on the boards of listed companies stands at just over 1% and foreign executives have proved rare and at times controversial.
The changes taking place in Japan have attracted the attention of many overseas investors. It remains to be seen how significant these changes are and whether they really will bring the shifts in boardroom culture desired and have an impact on investors’ views of the attractiveness of Japanese stocks.