Part 1 Introduction
Introductory Statement

This book is a sequel to Shareholder Engagement of Corporate Japan (Shojihomu), published in early 2013 (hereinafter, “the previous work”) (Note 1).

The previous work carried the slogan: “Transforming companies that avoid engagement into those that earn trust through it.” Since then, almost all Japanese listed companies have entered an “era of engagement” with shareholders/investors. During this period, the average stock price of Japanese companies has increased more than fourfold in roughly 12 years. This book aims to help Japanese listed companies enhance their value by leveraging engagement with capital markets and shareholders/investors. To what extent has Japan been able to gain trust in its companies and its domestic market?

The themes addressed in this book are even more multifaceted and diverse than in the previous work.

Following a pandemic that lasted over two years, a rare event in modern history, the world appears increasingly fragmented, with wars erupting in multiple regions and climate change moving in an unfavorable direction. In the United States, president who espouses “America First” has returned to power, and the era of big data and artificial intelligence (AI) has become a reality. All these factors are deeply intertwined with industry and capital markets.

In Japan, efforts to break away from the so-called “lost 20 to 30 years” following the collapse of the bubble economy have led to the launch of corporate governance reforms by the government under the “Abenomics” strategy for Japan's revitalization. This agenda, which includes reforms of the investment chain, continues today amid the global mainstreaming of responsible investment that takes ESG into account. These reforms appear to be intended to bring about the creative destruction of the post-war Japanese corporate model, which had effectively come to an end during the “lost” period.

Readers are probably familiar with the sinking ship joke. When a ship carrying passengers from various countries is sinking and there aren't enough lifeboats for everyone, what should you say to get people from different countries to jump into the sea? The joke is that the most effective thing to say to Japanese people is, “Everyone else is jumping in, too!” (Note 2). Japan is currently in a phase where everyone must make a collective decision to take risks and jump into the open sea. And the Japanese tendency to follow the government's lead has remained largely unchanged to this day.

1. Where is policy headed?

Governmental policy is expected to shift toward greater integration of national and corporate wealth with the stock market. The Policy Plan for Promoting Japan as a Leading Asset Management Center outlined by the Kishida Cabinet (Note 3) is likely part of this effort. Let us imagine a world where rising stock prices and dividends bring a sense of well-being to the people (hopefully nearly everyone) (though this does not imply a “bubble”). In such a world, both growing and mature companies maintain a constant focus on enhancing shareholder value through corporate governance, and the returns generated by stock investments provide a sense of security for asset formation and future pensions.

What is the significance of listing shares for a company? Among mature Japanese companies, many have accumulated substantial internal reserves and do not need to raise funds from the stock market. Even during temporary performance declines or stagnant stock prices, such companies deserve recognition for enabling wealth creation for the public and employees through the stock market. However, in today's environment, the increasing demands for information disclosure and investor relations (IR) activities, engagement with shareholders established as shareholder relations (SR) activities, as well as the growing burden of shareholder activism and responses to shareholder meetings, make it difficult for companies to justify the costs associated with being listed without such respect. The current global capital market is urging companies that have failed to realize the significance of listing over the long term to exit the market, restructure their businesses, or undergo corporate restructuring, thereby promoting market renewal. Market winners are praised while they are winning, but their success may be short-lived. The creation of sustainable market value is crucial, and the key lies in building long-term trust through engagement with the market, shareholders and investors.

As pointed out in the previous work, shareholder rights under the Japanese Companies Act are strong, and the barriers to acquiring effective control of a company are relatively low. Furthermore, the Financial Instruments and Exchange Act, the Corporate Governance Code (hereinafter, “CG Code”), and other laws and regulations contain provisions that could be exploited by astute investors for activist strategies. Therefore, Japan could be considered a treasure island where companies and businesses with intrinsic value can be bought cheaply and sold at a higher price.

Over three decades have passed since the era when Japanese companies were driven by “animal spirits” (animalistic, ambitious drive) (Note 4) and achieved high economic growth, earning the label “economic animals.” It seems unlikely that an era of “animal spirits for all” will arrive easily for a mature population. From a defensive perspective, relatively weak organisms form groups to protect their species as a standard survival strategy. The backdrop to the establishment of the European Union (EU) in 1993 was likely similar. Japanese companies, whose collective structure was once destroyed after the Second World War, rebuilt it through bank governance and temporary shareholding arrangements to protect their species. However, this defensive structure, which is now considered inappropriate under standard corporate governance theory, is nearing its end. European and Asian companies have unique protective mechanisms, and multiple-class shares (Note 5) are widely used not only in Europe but also in US IT companies. As groups of Japanese companies approach the state of disintegration of the old system over the next few years, the importance of building long-term trust relationships through engagement between companies and shareholders will grow even more, beyond mere alignment of legal systems.

2. The importance of engagement with institutional investors

This chapter provides an overview of institutional investors for corporate stakeholders, with a more in-depth examination to follow in subsequent chapters. Today, institutional investors are the driving force behind capital markets and stock prices in most parts of the world, and they hold significant influence over the fate of listed companies. Institutional investors are also central to the reforms of the investment chain and the vision of becoming a leading asset management center, as well as being the most important counterparties in shareholder engagement. By understanding the structure of the investment chain, the asset management industry as a business, and the theories that stock investors rely on, we aim to establish the prerequisites for engagement to take place and function effectively.

The writing team of this book has extensive experience in capital market-related operations, asset management, and stock trading, and currently provides advice and practical support to Japanese companies. Many members of the team have also worked on the institutional investor/shareholder side, and we believe we can offer diverse perspectives and practical ideas by incorporating interviews with external experts in each specialized chapter. Please note that we have not sought to achieve uniformity in content, position, or perspective beyond the theme of the importance of engagement.

3. Mismatch phenomenon in engagement

Engagement between parties with fundamentally different values rarely succeeds. However, sustained dialogue can narrow these gaps and foster shared values. This underscores the importance of mutual understanding, even among groups with deeply divergent beliefs. The following are some points where Japanese companies often feel a mismatch in their engagement with institutional investors.

<General>

Mismatch in definitions: Differences arise due to the linguistic characteristic of the Japanese language, where a single term can carry multiple interpretations and sometimes become “spiritualized” (Note 6) (Examples: corporate value, pure investment, cross-shareholdings, stable shareholders, etc.) or discussions that proceed without defining terms.

Mismatch between corporate management and investment theory/strategy: Institutional investors tend to engage based on industry-standard theories and strategies shaped by their training and experiences. Investment theory is often expressed through mathematical models, which can seem at odds with management’s practical focus on people and business specific resource allocation.

Mismatch in time horizons: Although engagement aims to counter short-termism, investors and companies often differ in their interpretation of short-, medium-, and long-term timeframes.

<Engagement with overseas investors>

The “Lost in Translation” (Note 7) phenomenon occurs when ambiguous Japanese terms are further translated. This can even be seen in the official English translation of the CG Code.

As management and investment practices become more globalized, corporate governance models – including their institutional designs　– are evolving, creating a growing demand for frameworks that are easy to understand. However, the corporate laws that legally govern corporate governance are local in nature and vary significantly across countries. (Example: Lack of understanding of Japan's audit and supervisory board system or engaging in dialogue based on one's own country’s legal system and practices.)

<Engagement with domestic investors>

Domestic investors familiar with domestic laws and regulations and communicate in Japanese generally have a deep understanding of Japanese companies. However, some investors who previously overlooked engagement have rushed to adopt the “stewardship system,” resulting in uneven quality of dialogue. While this situation has improved rapidly through the efforts of all parties, the mainstreaming of “responsible investment” has led to sustainability-related issues being incorporated into engagement activities. This, combined with increased disclosure obligations for companies and expanded reporting requirements for investors to their clients such as pension funds (asset owners), has increased the burden on both sides. Consequently, factors contributing to this mismatch are likely to persist for some time.

4. Shareholders' meetings as engagement/events with retail investors

Non-institutional shareholders come from highly diverse backgrounds, making it challenging to discuss the nature of engagement with them. However, from the perspective of the trend toward the integration of national wealth with the stock market, it can be argued that the disclosure of information and engagement with retail investors are not fundamentally different from those with institutional investors. In the current context, where a significant number of listed companies are holding “hybrid virtual shareholder meetings” or shareholder meetings that are also public events on their websites in the form of post-event broadcasts, we encourage readers to review Sections 5 through 7 of this book, which highlight the importance of such meetings as critical communication opportunities.

5. Finally, diversity

“Diversity” is an important keyword for Japanese companies and the Japanese economy as they move forward into the future. Although the global ESG boom has shown signs of slowing, it remains essential that Japan – often regarded as lagging behind – does not back away from its commitment to diversity, including the active participation of women. Innovation for the future is unlikely to arise from corporate or investment strategies built on homogeneous human capital and uniform organizational approaches – a view shared by many experts. This book aims to serve as a guide for fostering diverse value recognition, promoting governance, and driving strategic corporate actions, based on a fundamental understanding of capital markets and shareholders/investors.
From this point forward, each section of the JSS-written parts will provide guidance on how to read the chapter. Please refer to these sections as needed.

(Note 1) Mitsubishi UFJ Trust and Banking and Japan Shareholder Services. Shareholder Engagement of Corporate Japan, Shojihomu, 2013,
https://www.shojihomu.co.jp/publishing/details?publish_id=2372&cd=2043&state=new_and_already2372
(in Japanese only)

(Note 2) This seems similar to the “other-directed” sensibility that American sociologist Riesman analyzed in his 1950 book The Lonely Crowd as a characteristic of American mass society.
(Note 3) Financial Services Agency. “Policy Plan for Promoting Japan as a Leading Asset Management Center.”
https://www.fsa.go.jp/en/policy/pjlamc/20231214.html.

(Note 4) This term became widely used in economics after it was used by economist John Maynard Keynes in his book The General Theory of Employment, Interest, and Money (1936). It is one of the keywords in Japan's Revitalization Strategy. The unique element of Japan's CG Code, which encourages companies to take risks, is thought to have originated from the awareness that this spirit was lacking.

(Note 5) Shares that differ from common shares, such as those with different voting rights. Institutional investors dislike this mechanic.

(Note 6) In The Demystification of the ‘Land of Spirit Words,’ Shogakukan, 1998, Motohiko Izawa argues that “under the belief in ‘spirit words’ that govern the Japanese people, logical predictions and hopeful observations are confused, and it is believed that changing the words used will change reality.” Pressure to conform to spirit words is also used to shape public opinion for the promotion of policies.

(Note 7) Lost in Translation is a romantic drama film directed by Sofia Coppola, set in Tokyo, 2003.