Corporate governance reform and addressing an aging society are the keys to a lasting recovery
The Japanese stock market enjoyed an impressive rally this year, with the Nikkei 225 Index gaining well over 20% and achieving its highest level in three decades. This unexpected vote of confidence in the Japanese economy and future corporate performance prompted numerous analysts to ponder the question: “Is Japan finally back?”
We’ve seen such rallies before, including one in 2013 after then-Prime Minister Shinzo Abe announced a set of pro-growth policies known as “Abenomics,” including the promise of structural reform in areas such as corporate governance and the role of women. That rally petered out. Is this time different?
The “this time it’s for real” group can point to a resilient economy, recent success against deflation, rising wages, and, most importantly, ongoing corporate governance reforms that have created new hope for long-term investors, including Warren Buffett.
But the “we’ve heard this all before” group can marshal solid arguments for why this recent boom is merely temporary. They can cite the Bank of Japan moving towards “normalizing” low interest rate policies that help support stock valuations, the persistence of hidebound Japanese management at many companies, the dominance of foreign investors in the current rally, and the likelihood that China will pull out of its slump and reemerge as an attractive investment alternative.
It is too soon to tell whether the recent market rally is a short-term phenomenon or the start of a period of sustained growth. But here are two key areas to watch, as they will be necessary for any lasting recovery.
1. Corporate Governance. Are Japanese managers being held accountable for their companies’ performance? If foreign investors try to buy control of under-performing Japanese companies, are they welcomed or blocked? These two questions are closely related because foreign activists have been leaders in shaking up complacent management that fails to deliver growth to shareholders. There have been many corporate governance reforms since the beginning of Abenomics, including a requirement for independent directors at listed companies, a decline in cross-shareholding (that is, friendly corporate shareholders supporting management), and greater acceptance of shareholder activism and a more positive role by Japanese institutional investors. It is still unclear whether these reforms have finally resulted in substantive changes in practice.
Is it now accepted in Japan that … allowing weak companies to be bought (even by traditionally disfavored foreign investors) may be beneficial to the economy and society?
Perhaps the most significant change, although difficult to measure, would be a change of attitudes. Is it now accepted in Japan that sustained economic growth requires strong productivity, that poorly performing Japanese companies with overly conservative management should be pressured rather than supported, and that allowing these weak companies to be bought (even by traditionally disfavored foreign investors) may be beneficial to the economy and society? There is some evidence that Japanese increasingly accept the general proposition of “letting the market work.” For example, in the employment area, one could point to the continued weakening of “lifetime employment,” a new emphasis on labor mobility, and the reported interest of young university graduates in start-up ventures. If such changes take root, management at Japanese companies may focus more on improving performance to attract both employees and foreign investors.
Better corporate governance implies that Japanese companies will be more accountable to shareholders and will take the necessary risks to achieve profitability and shareholder returns, rather than focus on workplace stability. In the short run, shareholders can easily be satisfied by increasing payouts through dividends and share buybacks. However, in the long run, profitability requires increased corporate investment in a number of areas such as R&D and human capital. Abenomics did not just rely on corporate governance and other structural reforms—it also stimulated the economy and took other measures, such as cutting corporate taxes, in an effort to aid companies in making investments. As many Japanese companies then simply increased their cash cushion rather than investing, this led to further involvement by activist investors and could also cause the government to re-evaluate its own approach.
Is Japan taking meaningful steps to overcome the negative effects of an aging society? This is the most fundamental challenge and has no easy solution.
Accordingly, the clearest indication of change will be the policies and actions of the Japanese government. For a decade the government has talked about how it welcomes foreign investment and wants Japanese companies to take greater risks and improve their performance. The Kishida administration has proclaimed its intention to deepen the corporate governance reforms promoted by Abe. In March, the Tokyo Stock Exchange called for listed Japanese companies to formulate and disclose plans to increase their capital efficiency, especially if their shares trade below book value. In May, the Ministry of Economy, Trade and Industry (METI) drafted new M&A guidelines, and the Financial Services Agency is studying liberalization of tender offer rules to encourage “value-creating” acquisitions. A number of domestic hostile takeovers have occurred over the past few years; investors are waiting to see if foreign buyers will also be successful, and whether METI, traditionally seen as a protector of Japanese companies, will fully support foreign buyers.
2. Aging Society. Is Japan taking meaningful steps to overcome the negative effects of an aging society? This is the most fundamental challenge and has no easy solution. A positive result would require two elements: (1) further government-led reforms in a range of areas such as raising the retirement age, expanding the role of women in the workforce, and increasing immigration – all to boost the number of workers – as well as encouraging households to invest in stocks and other financial assets that could help grow the economy (instead of simply hoarding cash), and (2) on the private sector side, the successful expansion of Japanese companies into overseas markets ( including through acquisitions) and effective management and oversight of increasingly global operations in order to keep growing despite a shrinking market at home.
In judging whether “Japan is back,” we should not look for dramatic policy reform, but rather for signs of ongoing incremental change which, over time, may lead to a tipping point and significant improvements. That means the practical effects of continuing corporate governance reform, genuine acceptance of foreign investors, and effective measures for increasing productivity and growth in an aging society.
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Bruce Aronson is an adjunct professor at NYU School of Law and senior advisor at the Japan Center at the U.S.-Asia Law Institute. He has been a tenured law professor at universities in the United States and Japan and an outside director at a listed Japanese pharmaceutical company.
Suggested citation:
Bruce Aronson, “Is Japan (Finally) Back?,” in USALI Perspectives, 4, No. 6, December 3, 2023, https://usali.org/usali-perspectives-blog/is-japan-finally-back.
The views expressed in USALI Perspectives essays are those of the authors, and do not represent those of USALI or NYU.
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