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Corporate Governance – portrayed in the individual cultural and legal framework, from the standpoint of equity capital.

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Welcome to VIPsight Asia - Japan

Author

Nicholas Benes

 

3 September 2012

Shareholder Spring” - Even in Japan!

2012 seems destined to go down in history as the year when “shareholder spring” not only took root in Europe and the U.S., but Japan as well. In the wake of risk oversight errors by TEPCO, a massive 10-year fraud by Olympus, and a series of scandals in Japan and around the world, in June of 2012 a significant number of Japanese individual shareholders joined foreign and domestic institutions in voicing their distrust of corporate governance at annual general meetings.

It was as if a dike broke. Suddenly, more individuals were taking action by submitting shareholder proposals, voting against proposals submitted by management, or voting in favor of proposals submitted by other shareholders.

A change in the wind could be felt not only at the shareholder meetings of the electric power companies beset by the “no nukes” movement, and not only at lesser-known companies mired in family politics. Some household name-companies like Nomura Holding and Mizuho Financial Group received numerous shareholder proposals, - fully 17 by Nomura, and 10 by Mizuho. Not all the proposals were “wacko” or about environmental issues unconnected to economics. A good number related to legitimate shareholder concerns about corporate sustainability, oversight, managerial incentives, and governance.

If it continues, over the next few years this trend could have a significant impact on governance practices, the competitiveness of Japanese firms, and the fortunes of the Japanese stock market, which is now mired down with a price-book ratio (PBR) of .8%, Since this PBR is roughly one-half that of the average for developed nations, Japan’s stock market has a lot of potential upside. Recent events also show that domestic proxy fights – which are essentially hostile acquisitions of control - may be increasing in frequency (albeit from a small base). And according to a Russell-Nomura poll of 304 companies, this year the average voting support rate for shareholder proposals increased to 11.5%, up from last year’s 9.1%.

Happily for stock market prospects, there are several reasons why Japan’s “shareholder spring” is likely to accelerate over the next few years.

First, as a general matter, Japan’s Company Law gives shareholders very strong rights. To be eligible to submit a shareholder proposal, one only needs to hold the lesser of 1% of the company’s issued shares or 300 “units” of stock. Especially at current stock prices, in most cases 300 units is a number well south of US$10,000. Furthermore, unlike the U.S., which allows management to exclude proposals to nominate or terminate directors from the proxy materials, Japan has very few rules clearly allowing the exclusion of shareholder proposals from proxy materials.

The result is a more powerful legal infrastructure to promote “shareholder democracy” than exists in most other countries. After decades of almost total neglect, this infrastructure is now coming to be used by individual shareholders on a more regular basis. (At its most basic level, this is reflected by the fact that more people attended AGMs this year than last year, as suggested by the July survey by the Japan Investor Relations Association (JIRA).)

A second factor is that individual shareholders have been growing in numbers for more than 10 years, and now comprise about 30% of all listed company shareholders, a figure that is even larger than the approximately 26% held by foreign shareholders. Proactive individual holders in Japan are now waking up to the fact that if they vote similarly to foreign institutional holders on governance and sustainability issues, together they will comprise a formidable force. And the advent of internet voting at more companies makes voting easier. According to surveys by Nomura, about 40%-50% of individual shareholders now vote their shares, and only about one-quarter of them respond that they “vote with management on every single proposal”.

Clearly, the days are gone when most Japanese companies could sit back and depend on individual holders and financial institutions to support them. Simply from looking at their own shareholder base, companies are well aware of this. Daiwa Institute of Research calculates that “stable shareholder” Japanese banks and insurance companies now hold only about 7% of TSE-listed shares, down from 39% in 1986.

Third, the trend of “more shareholder proposals” has actually been gathering steam for the past ten years. As of 1992 shareholder groups, or individuals only submitted proposals to about five or ten companies per year, most of them related to nuclear energy. Most of them were related to the anti-nuclear movement. But in 2010, more than 40 different firms received shareholder proposals, about a much broader range of topics.

Last but not least, the very low share prices of Japanese companies, which have not recovered as much as prices many other stock markets, is itself a factor. In any country, no one likes to sell stock he bought for 4,000 Yen for 400 Yen, especially if that current stock price is trading well below net book value per share (as is the case for 67% of TOPIX companies). When stock prices are this low, shareholders who rationally think the company must have much higher intrinsic value and can afford to be patient (e.g., retirees who bought many years ago), tend to voice their complaints rather then sell.

What Made This Year Different

A confluence of scandals and value-destroying events during the past 18 months raised Japan’s fledgling investor renaissance to a “next level” of shareholder involvement and activism. In a nutshell, here is what was different in 2012:

1. Fukushima made people angry. In the Fukushima crisis, Japan had its own glaring, scary example of the huge destructive potential that arises when a company’s governance and risk management oversight does not independently consider issues that impact “sustainability” enough, and assumes that anything it can get approved by the regulators is acceptable. Said another way, the Japanese public had its own domestic case of massive “risk externalization” to ponder over, similar to BP in the Gulf of Mexico or the bankruptcies of Lehman and AIG.

2. The very topic of “Corporate governance” events was constantly in the news. Whether it was Olympus, Daio, Kyushu Electric’s political tampering, the third amendment of the Company Law in 10 years (still ongoing), or movements abroad such as “Occupy Wall Street” and “say on pay”, - the public was constantly reminded that there seems to be something wrong with the state of corporate governance. And with Japan’s price-book ratio (.9) at a level that is half the average for developed nations, many investors did not need much of a reminder.

3. For the first time, not all of the people putting forth shareholder proposals were unknown individuals who could be dismissed as “fringe elements”. Led by the popular Governor Hashimoto, the city of Osaka (as an 8.9% stockholder) submitted proposals to Kansai Electric, and made critical statements at the latter’s AGM, and Vice-Governor Naoki Inose of the Tokyo Metropolitan government led the charge for the Tokyo metropolitan government (a 2.7% holder) to submit four proposals to TEPCO’s shareholder meeting. These gentlemen repeatedly appeared on television to explain their opinions. For the first time in memory, making shareholder proposals was treated by the media as a legitimate procedure worthy of coverage, - whereas when anti-nuclear groups made proposals in earlier years, they were completely ignored.

Because of a new FSA rule requiring disclosure of per-item vote counts, this higher level of voting support was immediately disclosed and therefore publicly visible. Japan’s shareholder spring will now tend to accelerate because proposing shareholders have received clear feedback, for the first time, that reasonable proposals can attract enough voting support that they might actually have an impact on the stance that managers take in response, for example by provoking a change from “flat no” to “let’s compromise where we can”. (The best example of this prospect is the case of Mizuho Financial Group, described later in this article.)

This new rule was implemented by the FSA as of the June 2010 AGM season, as a result of requests for greater transparency about voting results by both foreign and domestic investors going back a number of years. It has generated a sea change in the market. Its full impact will take a few more years to sink in, but because of it we already know (for instance) that the highest approval percentage for a shareholder proposal was 38% this year and 48.5% last year. It seems quite possible that in the next few years, a shareholder proposal opposed by management may be approved…which will show that “it can happen”.

Not surprisingly, nearly half (48%, up from 42% a year ago) of those firms responding to the JIRA survey said they intend to look carefully at the shareholder proposals that got significant support, and analyze the reasons why.

4. Most importantly, a number of proposals were of the “generally reasonable” type rather than the “personal grudge” or “political” type, and often it was these proposals that received more support from other shareholders. They suggested changes that many investors could agree with in terms of corporate sustainability, improved governance, or enhanced investment efficiency, rather than unrealistic things like the immediate stoppage of all nuclear power generation. The result was higher levels of voting support for the “eminently reasonable” proposals.

Overview of Shareholder Proposals

There are generally three situations in which shareholder proposals have put forth in recent years:

1. Cases where control of the company is in dispute, and there is a effectively proxy fight under way. This year, this group included companies such as Accordia Golf (vs. PGM and an investor group); Aeon (vs. Parco); Eikoh Holdings (vs. Shingaku-kai); Yakult (vs. Danone, a 20% owner); and Yamada Corporation (internal). Sometimes, some sort of scandalous behavior or misuse of corporate funds is alleged as the pretext for the dispute, but the reality is that it is really control of the company that is at stake, not just improving governance practices or remediating the alleged offense. In such cases, unsurprisingly, the most frequent proposals made are those to appoint a different slate of directors and statutory auditors, and perhaps also to terminate certain members of the board.

Proposals were also submitted to a range of other firms including Toshiba, Japan Tobacco, Charle, Hoya, and family-controlled Suntec, to name a few examples.

Like Mizuho Financial and Suntec, Toshiba received a proposal to change its Articles to alter the present “pro-management” way that proxy cards are counted when they contain blanks, - that is, always in favor of management’s proposals, but against any shareholder proposals. This obtained 21% voting support, which is generally considered to be some degree of “success” for an activist shareholder.

Suntec received seven detailed proposals from the same investor (Mr. Nakayama) who made proposals at Mizuho Financial Group. Many of these focused on the governance practices and eliminating the company’s nepotistic board composition and management structure. Proposals to use capital surplus redeem treasury stock, and appoint an independent outside director, received respectively 22% and 23% support from shareholders. Other proposals, such as to require disclosure of director training policy, terminate the family board members, reform proxy card counting practice, generally received a bit less than 20% support, still respectable showings.

Japan Tobacco’s shareholders voted on several proposals from The Children’s Fund (TCI) related to increasing the dividend or buying back or cancelling treasury stock. These were defeated, but received support at the 16-17% support level. Charle’s shareholders wanted cooperation with a shareholder lawsuit, changes to the Articles restricting activities to core businesses, and disclosure of each director’s compensation. The proposals to were rejected, but received support at the 9-10% level.

2. Cases in which shareholders are seeking improvements in corporate governance structure and practice. In 2012, this included many serious and rational proposals, such as many of those sent by individual investors to Mizuho Financial Group. There, seven garnered more than 23% support and demonstrated the power of the “eminently reasonable” proposal. (See below.)

3. Cases where specific management policy issues are a principal driving force. This year, this group comprised most of the major electric power companies (including TEPCO, Kansai Electric, Tohoku Electric, Shikoku Electric, and Kyushu Electric); and Nomura Holdings.

At the power companies, while there were a number (both realistic and unrealistic) proposals to exit from the nuclear power generation business, or spin off the power distribution business, there were also a number of proposals more suitable for consideration at an AGM. Most notable among them were Tokyo Metropolitan Government’s (Vice-Governor Inose’s) proposals: a) to add language to the Articles clarifying that the mission of the company is the stable provision of electricity, focusing on good customer service (21% approval); b) to require TEPCO to disclose enough details of its cost-plus-based electricity pricing calculations to allow third-party confirmation of their appropriateness (arguably, a compliance or “sustainability” issue; 16% approval); or c) to further reduce costs and consider use of standard “smart-meters” to prepare for the competition-based electricity industry that will no doubt soon arise in Japan (14% approval).

Kansai Electric topped TEPCO’s 14 proposals, with 30 in total. In this group some of the more reasonable ones proposed: a) reducing the size if the board from 19 to 12; b) creating a CSR policy founded in the Articles; c) requiring the disclosure of compensation to individual directors (32.6% approval), as well as their ties to foundations or quasi-governmental bodies; d) requiring disclosure of information about electricity price increases; or more disclosure in general (30.8% approval); e) requiring deployment of smart meters and energy-saving policies (26.3%); f) permitting indemnification of outside directors, so as to facilitate their appointment (38% approval); g) appointing a certain independent director (the former CEO of Google Japan; 25.9% approval), or g) firing the current President. In total, eight out of the 27 shareholder proposals received more than 20% voting support.

At Nomura, there were 17 shareholder proposals, many of which can only be categorized as “troublemaking” (iyagarase) or even “absurd” – e.g. , change the short name of the company, abolish the “three banzai” cheer, change all company toilets to Japanese-style toilets, restrict executive compensation to minimum wage in case of low profits. To its credit, Nomura included them all in the proxy materials, even though it probably had legal grounds to exclude a number of them. In the author’s opinion such proposals do damage to the entire market by potentially tainting the image of all “activist” investors, including those who are constructive and conciliatory of mind.

Most meaningful was the fact that the current Chairman of the company, Nobuyuki Koga, only received approval from 70.3% of shareholders, and one of the independent director candidates, Tsuguoki Fujinuma (a Governor of the Tokyo Stock Exchange and outside board member at several major companies), only received approval from 65.9% of shareholders. In the world of shareholder meetings, these are very low approval ratios. A large number of “normal” shareholders were effectively saying, “don’t come back” or “we do not trust that you are sufficiently ‘independent’”.

Overall, Nomura’s proposals reflected the high degree of distrust with which certain members of the public – including its own unhappy shareholders! - view the company, a suspicion that the recent insider trading scandal may have simply confirmed. Together with Hoya, which last year was beset with a long list of detailed proposals, Nomura’s case serves as a reminder to companies that corporate image and the way they engage with their disgruntled shareholders can directly affect the quality of their AGMs as a constructive forum for beneficial communication, and vice versa.

But there were also a few arguably reasonable proposals, such as abolishing director indemnification (but not D&O insurance), requiring new share offerings take place via rights offerings, or abolishing upside-only stock acquisition rights. The first two of these proposals garnered 8.0% and 8.9 support, despite their flippant tone.

The Power of “Reasonable Proposals”: Mizuho Financial Group

As noted, this year not all of the people putting forth shareholder proposals were unknown individuals who could be dismissed as “fringe elements”. But more importantly, a number of proposals were of the “generally reasonable” type rather than the “personal grudge” type. It was these proposals that received relatively more support from other shareholders. They suggested changes that many investors could agree with in terms of corporate sustainability, improved governance, or enhanced investment efficiency.

The best example of the potential for a positive and constructive feedback loop arising from “eminently reasonable” shareholder proposals in Japan was set by Mizuho Financial Group’s AGM. Out of ten shareholder proposals were submitted by various individuals, eight were supported by more than 10% of all voting shareholders, and an impressive even received 23% or more voting support. Fully seven were supported buy ISS, the proxy voting advisor which influences the voting of many foreign institutional investors.

Not surprisingly, the proposal that received the most support was the most clearly “reasonable” one. This was a proposal that would have required Mizuho to simply disclose whether it had a policy for training directors about governance and the law, and if so, to disclose what that policy entailed, and the actual training undertaken during the prior year. Given that shareholders are asked to approve director candidates based on their qualifications and most Japanese believe that education and training are good things, it is not surprising that this proposal (#7) garnered the highest level of support of all, an impressive 28%.

Why are these numbers significant? First of all, they reflect a level of distrust about large corporations and their governance practices which has not been seen before.

Secondly, in most countries, even if it is not approved at the AGM, if a shareholder proposal is supported by more than about 20% of voting shareholders, it is considered a sharp rebuke of current management, which then is put under intense pressure to take some sort of concrete action on that item over the next year. Only by doing so can management hope to prevent the same proposal from being submitted again, whereupon it is almost certain to obtain more support simply because shareholders are irritated that, say, an opinion held by 25% of voting shareholders was completely and totally ignored. (Note also that since not all shareholders vote, it could easily be the case that a larger number of investors than 25% actually agree with the proposal, and may vote in favor of it next year.)

Below, I have set forth the substance of seven shareholder proposals made to Mizuho Financial Group by Mr. Yasushi Nakayama (a private investor and active trader who once worked at a bank) and others, all of which received voting support in excess of 23%. All of these were proposals to amend the Articles of Incorporation in ways that are hard to dismiss as silly or “fringe”. The translated sentences are those given by Mizuho Financial Group, except where word usage was incorrect:

“Proposal #6: (27% support) The Company shall instruct its subsidiaries that the Company administers, such as bank subsidiaries and securities companies subsidiaries, in exercising voting rights of shares held for strategic reasons, to exercise their voting rights appropriately by means such as seeking opinions from independent proxy advisers. [intended to prevent “blindly” supporting cross-held companies’ managers]

Proposal #7: (28% support) The policy, contents and results of the training provided by the Company and its consolidated subsidiaries for their board members shall be disclosed on the Company’s website.

Proposal #8: (27% support) The amount of compensation and/or bonus to be paid to Directors and Corporate Auditors during each fiscal year shall be described and disclosed — on an individual basis for such Directors and Corporate Auditors,…

Proposal #10: (26% support) The restriction on the number of characters in a description of reasons for a shareholder’s proposal shall be relaxed from 400 to 4,000.

Proposal #11: (28% support) With respect to voting forms for general meetings of shareholders of the Company, blank voting forms without indications of shareholders’ approval or disapproval should not be treated differently for the Company’s proposals and the shareholders’ proposals. [intended to prevent Mizuho FG from effectively voting blank proxy cards in favor of its own proposals but against shareholder proposals]

Proposal #12: (24% support) In principle, a Director is prohibited from acting concurrently as chairman of the meeting of the board of directors and CEO, and any of Outside Directors shall act as chairman of a meeting of the board of directors….[intended to split the roles of Chairman and CEO, with the former served by an outside director]

Proposal #13: (23% support) A liaison for whistle-blowing within and from outside the Company with respect to misconduct of in-house members of the Board of Directors shall be established at the Board of Corporate Auditors…..”

The Proposal Requiring Disclosure About Director Training (#7)

This proposal is not only fascinating to me on a personal basis, but also exemplifies why I believe we will see more “reasonable” proposals like it. In short, Mr. Nakayama made a cogent argument, and Mizuho responded in what other shareholders could easily see as an evasive, even lackadaisical response. From the proxy materials:

Reasons for Proposal

The brief personal records of candidates for Directors and Corporate Auditors presently described in convocation notices for general meetings of shareholders are not sufficient to determine whether or not each candidate is an appropriate person for Director or Corporate Auditor when voting for such Directors and Corporate Auditors. Monitoring and supervising the Company as a whole is different from executing business in each department, and for the performance of board members’ duties, it is necessary for that person to be well-acquainted with his or her obligations as a board member as well as the general business, including areas he or she has not yet experienced. The level of such knowledge and the attitude held by not only candidates for outside board member positions, but also candidates from inside the Company who constitute the majority of the candidates, is not clear. Therefore, disclosure about board member training on the Company’s website as to its policy (the persons to receive training, the time when training is to be given and the type of training), contents (training details, training period and training provider) and results (persons who received and did not receive the training) can enable shareholders to approve candidates with confidence.

In addition, the Company’s responsibility is limited only to the duty of disclosure, thereby putting fewer burdens on the Company.

Opinion of the Board of Directors of the Company

The Board of Directors of the Company opposes this proposal.

The Board of Directors also recognizes that Directors and Corporate Auditors of the Company are required to have broad knowledge and attitudes as board members in order to perform their duties, and believes that such broad knowledge and attitudes as board members should be gained through experiencing various kinds of duties, etc.

When selecting candidates for Directors and Corporate Auditors, the Board of Directors determines as the candidates, persons whom it concludes to be appropriate as Directors and Corporate Auditors of the Company, based upon due consideration of the knowledge and experience, etc., required for board members, including knowledge of general business, as well as wide-ranging insight and a high degree of expertise gained through duties experienced inside and outside the Company.

After this, the information necessary for shareholders in their selection is appropriately provided in reference materials for ordinary general meetings of shareholders in accordance with laws and regulations.

Accordingly, the Board of Directors is of the opinion that it is unnecessary to add the proposed provision to the Articles of Incorporation.”

Mizuho was basically saying: “just trust us, we select good guys…no special training about governance and the law is needed…and despite what you may think, whatever information we give you (or do not give you) about them is sufficient”.

But the reality is that Mizuho Financial Group’s board is composed of 12 persons, nine of whom have worked at Mizuho for their entire careers. Most of them do not have any experience serving as impartial directors of outside companies, let alone publicly listed ones – but precisely because they have been internally promoted, it would be easy for Mizuho Financial to give them standardized training and update their knowledge before nominating them as director candidates. Moreover, outside perspectives they might gain from third-party training could offset the inevitable insularity that arises from their single-company career paths. As recent events during the financial crisis and at banks as venerated at Barclays and JP Morgan show, in today’s world the banking business is an increasingly risky one fraught with complex compliance, governance, and regulatory issues. Boards need all the fresh insights they can get.

Under these circumstances, one can hardly blame shareholders for wanting to confirm the preparedness, dedication and corporate governance knowledge base of the director candidates they are being asked to vote for.

In conclusion, Japan’s capital markets seem to be entering a new phase, one that will be characterized by improvement of corporate governance practices and more company-shareholder engagement. These changes will be driven by: (a) corporate concerns about low voting approval for certain director appointments and other company proposals, and (b) a growing number of “reasonable” shareholder proposals that gain significant support (even if there are also more odd ones that get little support). The full impact of these changes will take time to occur at the majority of firms, but many Japanese managers are aware that they now inevitable.

"by Nicholas Benes Representative Director of The Board Director Training Institute of Japan"

 

 


 

VIPsight Archives Asia - Japan