Japanese pension fund managers have a reputation for bowing down to the country’s powerful business lobby. Not so Daisuke Hamaguchi, who has launched a scathing attack on a key aspect of the country's corporate culture: cross-shareholdings.
Japanese companies often buy shares in each other to cement alliances. These relationships tend to focus on mutual protection rather than maximising shareholder returns.
“Management are standing within the fortress of a shareholder alliance,” said Hamaguchi, chief investment officer at one of Japan’s biggest retirement funds, the Pension Fund Association (PFA), in an interview with AsianInvestor.
Despite PFA’s considerable ¥11.8 trillion ($104.66 billion) of assets under management as of March 31, 2016, Hamaguchi feels his organisation – and other institutional investors – are being ignored.
“Stable shareholders outweigh us,” he said. “Even if we try to have a dialogue with management, it is not effective in the current environment – so we need action by the government.”
He called on the Japanese government to offer a tax break for companies that dissolve these cross-shareholdings. His timing is impeccable as Japan’s corporate governance rules are up for review next year.
"Impotent" current code
Prime Minister Shinzo Abe’s administration is doing battle with Japan’s corporate culture of secrecy and hierarchy in the hope of boosting the stock market and with it, consumer confidence. His team presented a new corporate governance code in 2015, laying down rules on disclosure, shareholders’ rights and independent directors.
Yet Hamaguchi said the code in its current form is impotent and urged the government to go further. At present it merely requires companies to disclose their reasons for having cross-shareholdings – which they generally say are in place to maintain transactional relationships.
“There should be a requirement for issuers to disclose a plan to reduce cross shareholdings,” said Hamaguchi, speaking at AsianInvestor’s Japan Institutional Investment Forum on March 15.
His proposal of a tax break on capital gains, which are usually calculated based on the difference between the value of the shareholders’ books and the market value, has a precedent. Germany made the sale of cross-holdings tax-free from the start of 2002. Previously they had been subject to a capital gains levy of 40%.
“A strong incentive has to be offered, as happened in Germany, and maybe the idea is worthy of consideration in Japan,” said Hamaguchi.
Without this tax break, he noted, the code’s focus on outside directors is toothless, as around two-thirds of external directors are from stable shareholders. “In the current business context, outside directors do not work,” he added.
Hamaguchi feels the web of cross-shareholdings protects underperforming managers, shielding them from hostile takeovers and pressure from activist shareholders at AGMs, and ultimately resulting in poor stock market performance.
“Usually AGMs are stormless; a mere formality,” said Hamaguchi. “If there is a proposal that institutional directors want to reject, such as an anti-takeover pill, it ends up being approved by stable shareholders.”
Japan’s Topix benchmark was trading at just 1.91 price to book value as of March 20, with about one-third of constituents trading below book value.
To be sure, there have been signs of change. Japanese Recruit Holdings unwound its cross shareholdings with key supporters in August, as did Fujitsu and Fuji Electric in February.
Some commentators argue that cross-shareholdings go to the crux of the difference between longer-term, Asian-style finance and short-term western capitalism – as cross shareholdings give management more breathing space to push through reform.
Slow process of reform
However, very little has changed in Japanese business culture for a long time. Cross-shareholdings have reduced the sense of crisis among Japanese managers and slowed the restructuring needed to stay profitable in a shrinking domestic market.
Japan’s three largest banks, also known as megabanks – MUFG, SMFG and Mizuho –are the most prolific collectors of cross-shareholdings. They usually each hold stock in around 3,000 companies, according to PFA’s analysis; nearly all of the names listed on Japanese stock exchanges.
Japanese banks hold these shares as a kind of guarantee that they will retain their status as most favoured banks for lending. Partly as a result, the Topix Bank Index trades at 0.92 price to book value.
The situation has become so dire that Hamaguchi thinks the entire Japanese stock market is malfunctioning.
“The power of the issuer has become so great that in exchange for maintaining the relationship they can demand that suppliers hold their shares,” he said. “The Japanese market is not an exchange between investors, it is an exchange between companies.”
Hamaguchi’s comments come amid a rising focus on corporate governance domestically as well as elsewhere in Asia. Japan’s huge Government Pension Investment Fund is leading the home charge in this area.
Moreover, Singapore is moving to update its corporate governance code. And Hong Kong’s head regulator has raised concerns in the past week that the growth in passive investment could harm corporate governance, because active managers tend to hold more sway than index funds as shareholders.