Chapter 3.6 Corporations Plunge Into the Age of Activists

Join us in reading Chapter 3 of the book, The Only Way to Survive for Japan, subtitled "Corporate governance is sure to save our country." This book focuses on corporate governance. In Chapter 3, the author analyzes some well-known contests between activist shareholders and corporations with a focus on how management responds. The lessons also serve as a primer on the rules and cautions of corporate governance.

Find all published chapters at 'The Only Way to Survive for Japan'

Read Chapter 3.6, the 19th segment of the book:

Activists In the Family

Otsuka Kagu, Ltd, announced that the company's non-consolidated statement of income registered a loss of ¥3.4 billion JPY ($22.2 million USD) in the business year ending in December 2018. It is likely to end in the red for a third consecutive year, indicating no sign of a breakthrough for business recovery.

There was a conflict between then-Chairman Katsuhisa Otsuka, the founder, and then-President Kumiko Otsuka, his daughter, in 2014. However, at the general shareholders meeting the following year, President Kumiko won a complete victory. In support of the mid-term management plans manifested by President Kumiko, a proxy advisory firm had recommended voting for the proposed directors. Institutional investors thereafter moved in accordance with such a recommendation, which greatly contributed to her victory.

The case of Otsuka Kagu attests to how influential a proxy advisory firm is. At the same time, it clearly demonstrates that movements according to the recommendations of a proxy advisory firm will not necessarily lead to the enhancement of corporate value.

Sharing Information Matters

It has been a long time since it was pointed out that proxy advisory firms all too often just mechanically apply the numerical standards in the policy guidelines. Meanwhile, there are concerns of factual errors or misunderstandings when they collect information.

In the Stewardship Code, which contains the principles for the activities of institutional investors, it is stated that "advice should not be mechanically depended on." However, in reality, it is difficult for institutional investors to find reasons on their own not to follow the proxy advisory firms.

Investors are required to exercise the voting rights of a number of companies in a short period of time after the receipt of the notices of convocation of shareholders' meetings. However, it is difficult for them to independently gain information while passively investing. In order to exercise their voting rights, whereby they can contribute to the sustainable growth of investee companies, institutional investors may need to have the help of activists who conduct thorough analyses.

It is said that activists have become able to make reasonable proposals based on their elaborate and detailed analyses of the business operations and financial affairs of investee companies. This seems to indicate that a shift to the age of activists is desired.

(The Asahi Shimbun dated September 2018)

Fujifilm Logo

Corporate Value and Activists

In connection with the acquisition of Xerox Corporation by Fujifilm Holdings Corporation on October 16, 2018, the Appellate Division of the New York Supreme Court overturned the injunction against the acquisition issued by the lower court. Mr Darwin Deason, a majority shareholder of Xerox and "an activist," sued Xerox. He won an injunction in April, which was thereafter overturned.

Mr Carl Icahn, the largest shareholder and also an activist, was strongly against this acquisition, too. Unlike the time of the acquisition agreement, concurrently with the appeal, a majority of the Xerox management team was composed of directors recommended by Mr Icahn. The new management team had one-sidedly revoked the acquisition agreement. As a result, Fujifilm Holdings Corporation is likely to see other problems lying ahead.

How should a company respond to approaches made by "activists?"

Responding to Activist Shareholders

The company is required to consider sincerely and carefully whether proposals of activists will contribute to the enhancement of its corporate value. This is because such approaches could possibly help serve "the increase of corporate value over the mid- to long-term," which is an aim of corporate governance reform.

Furthermore, the company should make efforts to increase corporate value over the mid- to long-term and to obtain its shareholders' understanding of its plans and policies. They must communicate efforts to increase corporate value by disclosing proper information to shareholders and continuing to have sincere and constructive dialogue with them. These standard tactics would be a surefire way.

In addition, the use of outside directors can help, too. In the United States, there is an increasing recognition on the part of outside directors that it is outside directors themselves who should think and act in the same way as activists and that having activists make proposals to the company proves more than anything that its board of directors has not been functioning as it should be. I think this recognition will apply to Japan.

In any event, it would be safe to say that the time will soon come when companies cannot brush off decent activists. That is because institutional investors are watching from behind.

(The Asahi Shimbun dated November 2018)

Increasing Importance of Activists

Olympus Corporation announced in January 2019 that the company had decided to accept a director from ValueAct Capital Management, LP, its largest shareholder, known as a prominent American activist. Their choice was Mr Robert Hale, a partner of ValueAct Capital. Mr Yasuo Takeuchi, who was due to assume the roles of president and CEO as of April 1, 2019, said, "We have figured that Mr Hale's global knowledge, expertise, and experience are sure to help us reconstruct our company and increase our corporate value." It was said that Olympus proactively made the move to accept Mr Hale.

One of the strategies of American activists is to send directors from outside the company. In the United States, activists sent 167 directors to listed companies during the first half of 2018. That represented an increase of 60 from the corresponding period of a year earlier and the highest number recorded for the past four years. Nevertheless, it was quite uncommon for Japan's big corporations to accept activists as directors in their own right.

In the United States, General Electric Company had once accepted a director from an outside activist. Apparently, the company concluded that it should not conflict with activists who have institutional investors working behind them.

Expectations For Improved Governance

Upon Olympus's announcement, its stock price surged in expectation of improved governance. Cases can be seen in Japan in recent years where activists have made their proposals happen with the approval and support of institutional investors. In the United States, it is said that there is an increasing recognition shared by outside directors that outside directors themselves should think the way activists do. Olympus's case may be appreciated as an epoch-making precedent.

In any event, activists, as long as they are backed by institutional investors, will arguably play the most important role in the enhancement of corporate governance.

(The Asahi Shimbun dated February 2019)

Itochu's TOB Acquisition of Descente Ltd

A recent case showed that there was a person of wisdom in Itochu Corporation. I am talking about the takeover bid (TOB) of Descente, Ltd by Itochu. It was an unprecedented hostile takeover involving Japan's leading companies. Behind the conflict was a difference between the two companies' attitudes toward their overseas strategies.

Itochu suggested that it should acquire not more than a 40% stake, that Descente and Itochu should each occupy one third of the board of directors equally, without aiming to acquire a majority, and that independent directors should also comprise a third. This was a clever maneuver by a person of wisdom.

Because Itochu placed about a 50% premium on the market price, far above the average premium of around 30%, most institutional investors would find it too good a chance to pass up. But Itochu only intended to acquire an additional 10% stake.

Protecting Minority Shareholders in a Takeover

The problem was that if there were more sellers, they were most likely to tender their shares for a price calculated on a pro-rata basis. Furthermore, if Descente erred in its business operations after this, the value of its remaining stock would be liable to decline. Then, it would make sense to question whether it was prudent to apply for the TOB.

What was noteworthy was that if Descente's board of directors became uncontrollable by its management or largest shareholder, it would have appeared to benefit the protection of its minority shareholders. This example could suggest an exemplary model of board reform to realize governance-controlled management.

Descente also recommended a system of revolving independent outside directors. However, it was already known how things would be with Descente. Nevertheless, the practical scheme suggested by Itochu, that any side which failed to obtain support from independent directors in the board meeting could not manage the company, could be a governance-controlled management reform.

The TOB by Itochu could help change the capital markets of Japan.

(The Asahi Shimbun dated March 2019)

A Hostile TOB by HIS

HIS Co, Ltd (HIS), failed in its TOB of Unizo Holdings Company, Ltd. There were no tendering shareholders. An American investment management firm was offering a higher price to hobble the TOB behind the scenes.

The TOB by HIS set the limit of ownership at 45%. Also, HIS seemed to employ the same method of a hostile TOB that was used by Itochu against Descente.

I wonder if there is no problem with such a hostile TOB as this?

Practically speaking, this method makes it possible for a company to give considerable clout to the management of the target company, even if the company does not have a majority stake. Itochu actually gained significant influence over the management of Descente by sending a representative director when, in fact, it only held a 40% stake. It would be quite an effective method for acquirers.

Outside Directors as the Solution

But it is worthy of note that Itochu clearly stands for a board composed of two directors from Itochu, two from Descente, and two independent outside directors, respectively. As was clear from the case of ASKUL Corporation, it is essential to have practically independent outside directors for a company with minority shareholders because there is a conflict of interest between the minority shareholders and the majority shareholder. It looks like Itochu has manifested a practical solution.

ASKUL failed in demonstrating such a solution. This is why it looked like Yahoo abused its control. There is a decisive difference between the two companies.

It also looks like HIS lacked consideration for its minority shareholders. However, such hostile TOBs would augment in the future. Especially those companies that suffer declining stock prices should be most careful. Unizo Holdings' price-to-book ratio was actually lower than one at that time.

In the future, how to protect minority shareholders will constitute a matter of concern. The existence of independent outside directors is increasingly important. But what matters above all is the practicality and proper functioning of such independent outside directors.

(The Asahi Shimbun dated September 2019)

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