Hark, the call of the shareholder

Masahiko ISHIZUKA (Counselor, Foreign Press Center/Japan)

Investors' voices getting a hearing as companies cast off old practices

In Japan, the 1990s are commonly known as the "lost decade." It was also a period of desperate efforts for survival by the corporate sector. Japanese companies have undergone surprising changes, some hardly anticipated 10 years ago, in corporate governance and employment practices, among other things. These changes mirror a broader transformation of Japanese society at large.

In corporate governance, one new trend is that companies are coming to recognize, presumably as a result of the globalization of corporate management, that shareholders deserve respect. The idea is that for a company to be profitable and grow, it must maximize return on equity, which in the past tended to be sidelined in Japan.

Stealth bureaucracy
As Prof. Michio Morishima of the University of London argues, the Japanese corporation was in essence a bureaucratic system in disguise of a private business entity. For quasi-bureaucrats who ran big firms, the voices of shareholders needed to be minimized as a disturbance from the outside. This was nothing but the alienation of shareholders - a sheer contradiction of the capitalist system.

Shareholders in big companies should be neither seen nor heard, as far as corporate management was concerned. That was achieved in two ways. One was the practice of crossholding, under which businesses hold a substantial chunk of each other's stock as "stable" shareholders - stable in the sense that they stay silent, without criticizing management, and actually protecting it from interfering shareholders. In this way, Japanese corporations helped each other defend their bureaucracies.

The unwinding of crossholding, which is still in progress, is another major change in the past decade. The once closely-knit corporate community is disintegrating simply because companies can no longer afford to keep blindly holding each others' stocks irrespective of what happens to it.

They can no longer sacrifice their precious capital in such unjustifiable inefficiency. The prolonged slump squeezed profit positions so hard that they cannot continue to keep sleeping shareholdings in other companies.

Shareholders, or investors, were also responsible for their second-class citizen status. Japanese investors, especially during the high growth period, were more interested in short-term capital gains as share prices skyrocketed. They took little interest in the long term, and therefore did not bother about corporate governance that affected the company's long-term health.

Corporate management used to be a serene world thanks to crossholding and silent shareholders, except for sokaiya, who extort money by threatening to harass management at shareholders' meetings. But it is much noisier now. Replacing stable corporate shareholders are a new breed of investors, individual and institutional, who are more sensitive and assertive about the way the company is managed and the level of profits. The notoriously perfunctory way shareholders' meetings are conducted is fast becoming a thing of the past.

One recent sign of increasing assertiveness of shareholders vis-à-vis management is their demands for disclosure of executive compensation. Under pressure, some major companies have started disclosing the exact amount of salaries and other compensation each executive on its board receives.

Although such disclosure is not required by law and most companies are still reluctant to provide full disclosure, the direction is for greater transparency in corporate management. In the U.S., disclosure is legally obligatory, presumably because of executives' exorbitant compensation, which has come under fire, while for their Japanese counterparts, the amount is far more modest. Some even speculate that Japanese companies are reluctant to give the numbers because they are shamefully low. In any event, Japanese shareholders now keep a close watch on executive compensation to make sure they are worth the money.

At Japanese companies, there is traditionally only a weak notion that the board members represent shareholders' interests. They are invariably chosen from within the company, and naturally identify with management rather than with shareholders. The Japanese corporate world is leaning toward more clear-cut division of interests and responsibility between the management and shareholders.

Low ROE
The traditionally low ROES of Japanese companies testify to the fact that shareholders' interests have been sidelined. As Katsuhito Iwai, a University of Tokyo economics professor, noted, Japanese companies have traditionally prioritized survival and growth over returns. Corporate managers have generally not been held responsible or ousted for low returns, as in America, and therefore have hardly paid much attention to returns.

This environment prevailed because of the so-called "main bank" system, in which a bank acts as a lender of last resort. Crossholders also tolerated low returns in favor of stability and continuation.

Battered by globalization and the financial revolution, this system is crumbling. In the place of the "main bank," the ultimate protector and guarantor, companies must depend more than ever on the equity market, so they are attaching greater importance to shareholders' interests, though the shareholder may not reign supreme in Japan because corporations still attach importance to other constituencies as well, particularly employees. But for the time being, shareholders are coming into the limelight, presumably in reaction to their past neglect.

(Originally appeared in the July 5, 2004 issue of The Nikkei Weekly, reproduced here with permission.)