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 examines corporate responses to outside investors, activists, and their influence on shareholders. How has that furthered dialogue with management and implementation of ESG practices? The author abundantly peppers the lessons with real-life examples that 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 3.5, the 18th segment of the book:
Exercise of Voting Rights by Institutional Investors
In 2017, four leading trust banks saw an increase in the ratio of voting against their agenda at their general shareholders' meetings. That emerging phenomenon was a by-product of the tightened criteria for the exercise of voting rights, including the following: "The selection of directors should be opposed in case the number of outside directors does not meet the required number." For all four of the banks, the opposition ratio reached 14% to 17% for all the items on the agenda.
Institutional investors showed no mercy to their client companies or even to member companies in the same corporate group. For example, Mitsubishi UFJ Trust and Banking Corporation voted against the selection of some directors at the general shareholders meeting of Mitsubishi UFJ Lease & Finance, a member company of the same corporate group. Moreover, "The results of exercising voting rights shall be disclosed with respect to each investee company and each agenda," as stipulated in the revised Stewardship Code.
Strategies for Managing Short-termism
But the results of active exercise of voting rights by institutional investors do not necessarily reflect the real circumstances of their investee companies. There is an argument that institutional investors are generally short-term-oriented, which concerns me, too. If institutional investors who are not experts on management mechanically exercise their voting rights without having sufficient dialogue with the directors of their investee companies, it would work against the sustainable growth of those companies. It could even impede their good business operations.
What should be done to encourage institutional investors to exercise their voting rights, whereby they can help enhance the sustainable growth of their investee companies? Toyota Motor Corporation's issuance of class shares in 2015 is sure to help.
Those class shares were mainly geared toward individual investors, and the shareholders were expected to hold the shares for the long term. The same shareholders are restricted from transferring their shares for five years. However, after that period ends, they are entitled to choose either to convert them into common shares or to get the company to buy them at the issue price.
Now is the time to consider making legislation to give more voting rights to investors who are inclined to hold shares for the mid- and long-term. It is important to build such a large-framed scheme for institutional investors to benefit from supporting and contributing to the sustainable growth of their investee companies.
(The Asahi Shimbun dated October 2017)
Dialogue Between a Company and Its Shareholders
Oasis Management Company Ltd, a Hong Kong-based investment fund, submitted its shareholder proposals to GMO Internet Group, Inc, a leading Internet company. Oasis alleged that GMO's management had failed to respond to Oasis's request to have a dialogue and to provide sufficient responses to its proposals. Therefore, Oasis suggested that GMO take steps to enhance its government. They included abolishing its anti-takeover measures, transitioning to a company with a nominating committee, etc, and reconsidering its system to determine directors' compensation. That was for the March 2018 GMO's general shareholders' meeting.
It was not clear how management responded to Oasis, but the board of directors was apparently against items included in the shareholder proposals. Still, when the shareholder proposals were publicized, the stock price of the company temporarily rose by about 5%.
In recent years, there has been an increasing number of cases where "activists" offer their investee companies concrete proposals to increase their long-term corporate value based on elaborate and in-depth analyses of their business operations and financial affairs. Among them, there are also some successful cases.
When Institutional Investors Follow Activists
What is noteworthy, more than anything else, is that institutional investors are beginning to support "activists" in consideration of the nature of their proposals. And it makes sense from the perspective of fiduciary duty, which advocates business management oriented to benefit shareholders. It is important for the top executive of a company to seriously consider whether or not "activists'" proposals help to enhance its mid- to long-term corporate value and to provide his/her views on them.
The Japan Stewardship Code, which articulates the principles for "Responsible Institutional Investors," as well as the Corporate Governance Code, which provides the principles for listed companies, emphasize constructive dialogue between shareholders and companies as a means to improve and foster their corporate value and sustainable growth.
There is no imposition of a legal obligation. However, the time has come when any company that has failed to engage in purposeful and constructive dialogue with its shareholders is branded by the market as a failure. Those who read and get ahead of the times will be winners in the end.
(The Asahi Shimbun dated March 2018)
A Step Forward Toward the Age of ESG
I heard that the stock prices of gunmakers have been declining in the United States since a shooting incident at a high school. The other day, the bankruptcy of a gun manufacturer was reported. It is said to have been caused by a reduction in demand for guns, triggered by the presumption that, unlike the previous regimes, the Trump regime seems to be reluctant to promote gun control.
What is noticeable is a rapid increase in the number of users of a website, "Goodbye Gun Stocks," which helps you check how much gun-related stock is contained in your investment fund.
This change also seems to be in line with a growing trend of environment, social, and governance (ESG) investing. These are cases in which investment decisions are made after due evaluation of a company in terms of environmental, social, and governance factors.
Institutional investors dominate the stock market because they manage vast amounts of pension resources. When they make investments, they assign importance to the intentions of beneficiaries, who are behind the pensions, namely, pension recipients. In developed countries, which have achieved a certain level of wealth, people are increasingly beginning to feel reluctant to use the money earned through the production and sales of guns for their livelihood after retirement.
Corporate Value in ESGs
"The age of valuing ESG because it helps bring profit" is moving forward in one leap toward "the age of earning money in a decent manner." In the background may lie the idea that they should not put their money into investments that many people consider dodgy and objectionable.
If this tendency develops further into the future, the hitherto held conception that a company's business is to make money will lose its foundation. If renewable energy-related business is prioritized over oil-related business, the present-day economic structure is likely to fall apart.
Well-to-do retirees in wealthy developed countries will not be much affected, but people who live otherwise and companies in developing countries, which are greatly in need of foreign capital, are expected to face quandaries that they have never experienced before.
(The Asahi Shimbun dated April 2018)
'Dialogue' Over Cross-shareholding
The Corporate Governance Code was revised on the first of June, 2018. As revised, the Code requires that listed companies holding shares of other listed companies for cross-shareholding should disclose their policies and views regarding the reduction of cross-shareholdings.
In addition, "the guidelines on dialogue between investors and companies" were newly established. Under these, the main focus of such discussion is expected to be whether the policies and views regarding the reduction of cross-shareholdings are clarified, and whether actions taken to reduce cross-shareholdings are appropriately performed in accordance with such policies and views.
Cross-shareholding is likely to constitute a limiting factor of dialogue between the issuing companies and ordinary shareholders. There are cases where listed companies hold the shares of other listed companies for reasonable reasons. However, it is deemed desirable to discuss the benefits and risks of cross-shareholding and resolve disagreements, if any, through dialogue with shareholders. The revision of the Code this time was made in line with such a view.
Driven by Institutional Investors
In May, Asset Value Investors Limited, a British investment manager for activists, sent a written shareholder proposal to Tokyo Broadcasting System Television, Inc (TBS). It demanded the distribution of a dividend in kind of its cross-held shares. ISS, an American proxy advisory firm, recommended voting for it. However, TBS disclosed the purpose of the holding to its shareholders, thereby expressing a dissenting opinion. Votes for the proposal reached about 11%.
Reportedly, activists have made proactive movements in other fields. Moreover, they are likely to launch a full-scale attack on cross-shareholding down the road. Activists are also going to work on institutional investors whose responsibilities involve monitoring investee companies for their business management in accordance with the Stewardship Code.
In the United States, the winning percentage is said to be about 70%, including partial successes. It is said that through the movements and involvement of activists, something happens with a probability of 100%, including the cases where companies responded voluntarily.
Japan would follow suit. This drive is not generated from activists, but from institutional investors, especially those who engage in passive management.
(The Asahi Shimbun dated July 2018)
Follow the book from Chapter 1, as it is published.
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Author: Shin Ushijima
