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Zombie firms pressured to act

FSA pens Japanese version of Stewardship Code to hike growth

by Atsushi Kodera

Staff Writer

The government is targeting stagnant companies that lack the will to grow and has drafted a plan to help institutional investors pressure them into pursuing growth more aggressively.

The Financial Services Agency’s Principles for Responsible Investors, better known as the Japanese version of Britain’s Stewardship Code, were established in February as part of the growth strategy unveiled last June as part of the prime minister’s deflation-busting “Abenomics” program.

Modeled after the Stewardship Code compiled in July 2010 by Britain’s Financial Reporting Council, the code lays out a set of principles for institutional investors to follow.

Part of the code, for example, states, “Institutional investors should have a clear policy on how they fulfill their stewardship responsibilities, and publicly disclose it,” calling on these investors to explicitly commit to their responsibilities as an agent managing their clients’ funds.

Also, to commit institutional investors to focus on investee companies’ growth, another principle says that “Institutional investors should monitor investee companies so that they can appropriately fulfill their stewardship responsibilities with an orientation toward the sustainable growth of the companies.”

The FSA hopes these principles will make powerful investors communicate more closely with investee firms and improve the clarity of their investment policies — part of what the FSA calls “stewardship responsibility.”

Institutional investors own the bulk of the shares issued by listed firms. In the most recent statistics from the Tokyo Stock Exchange, 73 percent of all first section issues were held by such investors in fiscal 2012, in terms of number of shares.

The FSA plans to announce the names of institutional investors who are publicly pushing for adoption of the code and those who have disclosed how they plan to meet the goals expressed by the principles every three months.

The first announcement is due this month.

“Our hope is that it will encourage constructive dialogue between institutional investors and investee companies, with a goal of medium- to long-term growth,” said an FSA official.

So far, Resona Bank, MU Investments Co., Dai-ichi Life Insurance Co. and Mitsubishi UFJ Trust and Banking Corp., among others, have expressed plans to adopt the FSA’s new code.

Yutaka Suzuki, an analyst at Daiwa Institute of Research, sees the code as part of an effort to make company executives more conscious of earnings.

“The problem for corporate management in Japan is that executive compensation is not tied to the performance of a company’s stock price,” which has much to do with its earnings and growth potential, Suzuki said. “If companies become more growth-oriented, they will become more aggressive in making investments and hiring people,” thereby contributing to economic growth, Suzuki said.

Under the “comply or explain” principle of the code, institutional investors are only “invited” to express their acceptance of it and their policy for achieving its aims. But if they decide not to adopt any of the principles, they are asked to explain why.

Although the code is free for institutional investors to adopt, rather than legally binding, the FSA believes it will force them to behave in the way intended, said Yasushi Ando, chief executive officer of New Horizon Capital Co.

“Institutional investors essentially are forced to express at least if they take it seriously” by expressing whether they adopt it, said Ando, who has helped manage and rehabilitate more than 80 ailing companies with his private equity fund.

“The FSA says it ‘expects’ them to express adoption of the code, but when the FSA expects something, you interpret it to mean you have to do it, because if you don’t, your clients will take a dim view of you.”

A senior asset manager at Resona Bank said the code bears a distinct message.

“We see it as the government’s first-ever message to asset managers like us to put some elbow grease into our work (as institutional investors) for the sake of (Abe’s) growth strategy,” the banker said on condition of anonymity.

Resona was one of the first lenders to announce its acceptance and to draft policies to achieve the code’s goals.

“In that sense, I think there’s probably no choice but to accept it, considering our responsibility in society,” the banker said.

Ando said the Japanese Stewardship Code complements a stock exchange rule introduced in February that calls on listed firms to “make efforts” to add at least one token independent outside director to their boards to bolster corporate governance.

The rule, of course, is not legally binding and was almost scrapped.

“When we have both the Japanese Stewardship Code and more independent directors, Japanese firms will be able to achieve the level of credibility more common in global capital markets,” said Ando, who said he thinks Japanese firms lack effective oversight of management, as recently exemplified by the debacle at Olympus Corp.

“That will prompt foreign investors to buy more Japanese stocks, because companies that have solid corporate governance (mechanisms) are attractive.”

Ando points out that a dual monitoring system will also help boost Japanese competitiveness abroad.

“Business executives who aren’t under pressure from shareholders, which is the case for bosses who have climbed up the corporate ladder in the traditional governance structure in this country, are not alert enough for the job,” Ando said, criticizing what he describes as a corporate culture in which obedient individuals tend to be promoted over innovative or outspoken individuals.

The added bonus of the internal and external monitoring afforded by the stewardship code and outside director rule is potentially stronger promotion of national, gender and ethnic diversity in the workplace. This is because correct corporate decisions will ignore such differences, he said.

“We hope that a broad range of institutional investors will express acceptance of the code so that it will eventually be firmly established,” said the FSA official. “That would lift the reputation of the Japanese stock market among investors overseas, and lure more medium- to long-term investment in Japan.”