"Kee" Points with Jim Kee, Ph.D.


  • Japan
  • Corporate GovernanceUS
  • Corporate GovernanceJapan
  • A Long-Awaited Change?
  • Why is This Important?

There were several articles in the press last week that I thought deserved more emphasis than they got because of their broader applicability. This week I am going to focus on Japan.


Japan

When Japanese Prime Minister Shinzo Abe was (re)-elected in 2012, he proposed three areas of reform or stimulus to get the Japanese economy growing. Known as Abeconomics, these three “arrows,” as they continue to be called, are, (1) monetary stimulus, (2) fiscal or government spending stimulus, and (3) structural reform including corporate governance reform. Most of the policy emphasis since 2012 has been upon the first two, fiscal and monetary reform. At the time (2012), I wrote in Kee Points that these were unlikely to move the needle much on Japanese growth because, fundamentally, Japan’s problems weren’t monetary or fiscal. And indeed since then the Japanese economy has averaged just under 1.3% average annual real GDP growth (Japanese stocks did turn upward after a 15-year decline). That’s a little above its longer-term average growth rate of just under 1% growth, but not much. From an investment perspective, Japan’s problem is corporate governance.


Corporate GovernanceUS

Does a company use its resources efficiently and profitably? That depends upon the system of rules or processes by which a firm is managed and controlled, which is known as corporate governance. For example, in the US the emphasis – since the late 1980s – has been on profitability or Return-on-Investment (ROI). This is made manifest through management buyouts (MBOs), M&A activity (mergers and acquisitions), and private equity actions (formerly LBO’s or “leveraged buy outs”). These corporate governance actions fall under the rubric of “the market for corporate control.” They are aimed at replacing underperforming managements and selling off underperforming assets in an attempt to unlock hidden or potential value. In fact, in his Nobel Lecture, economist Merton Miller argued that the legacy of the 1980’s corporate buyout movement was that it forced all managements to behave as though they had been “LBO’d.” The result is that US companies have the highest ROIs in the world, averaging about 9.5% real or inflation-adjusted (Credit-Suisse HOLT). They also have the highest shareholder (investor) returns.

 

Corporate GovernanceJapan

Japan, on the other hand, has had a corporate governance problem for decades, which has resulted in companies there misallocating capital (i.e. not using it profitably) for decades. In fact, the whole ‘managing for shareholder value’ revolution described above that occurred in the US from the late 1980s to present has been absent in Japan over the same period. Japanese managements have not been compensated with stock, and Japanese people have not been encouraged to own stock. Company takeovers and buyouts have been discouraged or barred. As a result, Japanese companies have the lowest ROIs in the world, or about 4.5%. Thatis why US shareholders have gained tremendously over this period, while Japanese shareholders have not. It is one reason why the US is not the next Japan.


Long-Awaited Change?

But it appears that corporate governance reform in Japan may be at hand, a key aspect of Abe’s Third Arrow. Last week, the Wall Street Journal had an article titled, “Japan Inc. Is Decluttering – and Foreign Investors Love the Look.” The article pointed to the growing pressure to improve returns (ROIs) and corporate governance, citing the Abe Government’s push for a “greater focus on shareholder returns – not traditionally a high priority for Japanese executives.” My intention here is not to make a case for or against investing in Japanese companies. It is to draw a broader insight.


Why is This Important?

Looking at the world broadly, US corporate governance rules favor shareholders the most, while in other regions like Europe, shareholders share the focus with workers (and/or environmental concerns), and in Japan shareholders have been pretty much neglected until recently. That explains a lot of the shareholder (i.e. stock market) returns in these countries, and it is important. Most discussions about international investing focus on two things, country growth rates and market valuation levels. Those are important, but incomplete. What is missing is corporate governance, which varies substantially from country to country. Accounting for differences in corporate governance, and the consequent differences in ROIs, does a much better job at explaining long-term investor returns in different countries.