Market Focus. Focus on the Japan Revitalisation Strategy - Strengthening Corporate Governance

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1 Market Focus 5 June 2015 Author: Soichiro Monji General Manager Economic Research Department Focus on the Japan Revitalisation Strategy - Strengthening Corporate Governance In this issue of Market Focus, we consider key elements of the 2015 version of the Japan Revitalisation Strategy, with a particular emphasis on the topic of strengthening corporate governance. The table below summarises primary initiatives included in the three action plans of the Japan Revitalisation Strategy. The Three Action Plans of the Japan Revitalisation Strategy Action Plan Elements of the Plan Specific Initiatives Industry Revitalisation Programme for accelerating structural Encourage more active private-sector Plan reform (vitalising industries) investment. Reforming the employment system, ensuring a sufficient labour force and enhancing its quality Promoting innovation in science and technology and becoming an intellectual property-based nation Strengthening Japan s location-specific competitive strengths Promote investment in business ventures and investment for revisiting business challenges. Strengthen corporate governance and promote mergers and acquisitions (M&A) deals overseas, as well as expansion abroad. Develop a business environment that is more conducive to wage hikes. Promote active participation of women in the workforce. Utilise highly skilled employees from overseas. Strengthen the control tower function of the Council for Science and Technology Policy. Strategic Innovation Creation Programme Establish National Strategic Special Zones and develop airports, seaports and other infrastructure. Restart nuclear power plants and cut liquefied natural gas (LNG) procurement costs. Reduce the effective corporate tax rate 1

2 Action Plan Elements of the Plan Specific Initiatives Strategic Market Extending healthy life expectancy Creation Plan - Developing commercial opportunities involving social systems to enable citizens to enjoy longer life expectancies in good health. Develop industries in areas such as health promotion, disease prevention and support for daily life. Create headquarters for research & development (R & D) in the medical field (a Japanese version of the National Institute of Health) Deregulation geared towards faster development of pharmaceuticals, medical devices and advanced medicine. Making clean and economical energy supply and demand a reality. - Developing commercial opportunities involving expertise of renewable energy and systems to enable recycling-oriented societies. Regional communities that generate income from local resources Regulatory reform for renewable energy development. Promote smart communities Bolster the competitive strengths of Japan s agriculture, forestry and fisheries industry, as well as transforming Japan into a tourist destination. Strategy of Global Outreach Promote free trade agreements (FTAs) and economic partnership agreements (EPAs), infrastructure exports and the Cool Japan campaign. Source: Prepared by Daiwa SB Investments on the basis of the Japan Revitalisation Strategy The 2014 version of the Japan Revitalisation Strategy starts off with a section entitled, past achievements. However, the achievements listed in the section are mainly limited to progress made with legislation such as Japan s enactment of the Industrial Competitiveness Enhancement Act and amendments to the Electricity Business Act. Given that such content falls short in terms of offering something that would appeal to market players, the Japan Revitalisation Strategy for 2014 failed to have a notable effect on the stock market. In contrast, this year s release is likely to showcase numerous initiatives due to the evident progress the growth strategy has achieved in various sectors. For instance, the 2015 version is likely to start off by highlighting initiatives for bolstering corporate governance. When it comes to market insiders, the issue of shareholder returns is first and foremost with respect to corporate governance. In that regard, the past year has seen expansion in shareholder returns from listed companies in the form of dividends and share buybacks, thereby helping to fuel the Nikkei s surge above 20,000. Without a doubt, initiatives to fortify governance have had a positive impact on the stock market, making the lack of awareness of the notion that the growth strategy has contributed to the positive outcome somewhat of a disappointment. However, the notion that enhancement of corporate governance is a leading factor in positive earnings results has an impact that goes beyond lifting share prices. More importantly, the move towards strengthening governance has helped bring about a rebound in confidence among company leaders. In the Japan Revitalisation Strategy for 2013, Prime Minister Shinzo Abe asserts that the two lost decades have resulted in waning confidence and subsequent inaction, which is worse than the tangible damage done, as was noted in the 29 August 2014 edition of Market focus, which covered the topic of the growth strategy waging war on the negative mindset in the Japanese economy. In light of that situation, the role of the growth strategy is to restore confidence of company managers and all people, and change their expectations into actions. Now that two years have transpired since then, Japan s people as well as its corporations appear to be regaining confidence, while moves to bolster governance have certainly been a contributing factor in that regard. Originally, the notion of strengthening governance was incorporated into the growth strategy with the aim of transforming attitudes among corporate management. The Japan Revitalisation 2

3 Strategy for 2013 stated to ensure that shareholders and other stakeholders proactively support forward-looking initiatives by company managers, corporate governance will be reviewed so that Japanese companies will excel in international competition. From last year onwards, progress has been made towards developing an environment conducive to dialogue between companies and shareholders, through initiatives involving Japan s Stewardship Code, Japan s Corporate Governance Code and independent outside directors. Meanwhile, corporations have presented return on equity (ROE) targets that are favourable to shareholders, with such entities effectively obligated to explain how they will make such returns possible. The notion of companies unnecessarily holding onto cash is no longer acceptable, thereby forcing them to decide whether to channel surplus funds towards growth or shareholder returns. Amid this transformation has been a prevailing change in attitudes among managers primarily of large corporations, involving a shift from a defensive approach to one geared towards offence. For one thing, this change in attitudes is particularly evident with respect to recent M&A activity. On 14 March, the Nikkei reported that M&As by Japanese companies involving foreign businesses are climbing to an all-time high in the January-to-March period, already reaching roughly JPY4 trillion. These deals are primarily twofold in terms of strategic aims. First of all, M&As over Q involved deals pursued by Japanese companies that traditionally rely on domestic demand. They are forging such deals with the aim of gaining human resources, know-how, networks and other resources, such that will help these companies make inroads into foreign markets, as was the case with Japan Post s USD6.3 billion acquisition of Australian logistics company, Toll Holdings. Secondly, M&As over Q also involved Japanese companies acquiring firms with leading technology and products with potential to act as seeds of growth for the Japanese entity, such as in Canon s USD2.7 billion acquisition of Swedish network video surveillance firm, Axis. Either way, such activity seems to suggest that management teams of Japanese companies are shifting more towards an offensive strategy. Nippon Life plans to invest somewhere around JPY1 trillion in acquisitions of domestic and overseas insurance companies and asset management firms over the next three years, while Nidec President and Chairman, Shigenobu Nagamori announced that it would seek out acquisitions at home and abroad, thereby boosting its current group sales of JPY1 trillion by another JPY500 billion by FY2020. There appears to be little doubt that Japanese companies are about to pick up the pace another notch in terms of overseas business acquisitions. Firms in Japan also appear to be channelling more funds into capital investment. In FY2014, spending on plants and equipment fell, partially because of the consumption tax rate hike. However, Japanese companies are poised to increase capital investment by +10.5% in FY2015, with manufacturers in particular expecting to increase domestic capital investment by +17.9%, according to a survey of large corporations compiled by the Nikkei. It is likely that this investment is being driven by recovery of domestic manufacturing centres, in addition to their need to update facilities. On the other hand, telecommunications companies and other non-manufacturers whose capital spending has run its course aim to increase such outlays by no more than +2.0% domestically, yet intend to channel +19.5% more into capital spending overseas. Meanwhile, yet another prime example of the shift to offence among management is reflected in moves into overseas markets by Japanese companies that traditionally rely on domestic demand, such as in the case of Mitsui Fudosan s development of a high-rise building in Manhattan. The shift towards more robust corporate governance has also had a positive impact in terms of wage hikes. Japan s shunto spring wage negotiations this year resulted in substantial hikes for the second year in a row. As such, companies previously reluctant to offer raises eventually came around, thereby electing to spend more on employee pay given that personnel expense has come to be seen as an investment in future growth, rather than as a cost as had previously been the case. While managers who are not looking to expand operations tend to view personnel expense as nothing more than a cost of doing business, executives who aim for growth tend to regard such outlays as an essential element to achieving such goals. As such, it has been essential that 3

4 managers come to view personnel expense as an investment essential to achieving growth, rather than as a cost. Indeed, the change in attitudes along those lines underpinned substantial wage gains of Japanese workers over the last two years running. Stronger governance has acted not only to increase shareholder returns, thereby lifting share prices, but has also played a large role in transforming the attitudes of management. Moreover, this change is likely to have a favourable effect in other areas as well, encouraging more active private sector investment, promoting M&A deals overseas and expansion abroad, as well as improving the environment for wage hikes. This is why initiatives for enhancing governance practices are quite likely to find a place in the 2015 Japan Revitalisation Strategy as a means of boosting corporate performance. The growth strategy is likely to have more of an influence on the market once investors become aware of its potential for driving economic development, particularly once they hear more about the 2015 Japan Revitalisation Strategy details such as those outlined in this report. We expect this to act as a significant catalyst for further investment in Japanese equities, particularly among overseas investors who tend to focus on whether or not structural changes are being implemented in Japan. In conclusion, the analysis above suggests that the primary point of focus with respect to the 2015 release is likely to be on where the government stands in terms of initiatives for strengthening corporate governance in Japan. 4

5 2-1 Soichiro Monji General Manager, Economic Research Department Mr Monji joined Daiwa Securities in 1985 and transferred to DICAM in At DICAM, he accrued investment experience as an economist between 1988 and 1990, and as an Asian Equities portfolio manager between 1990 and He rose to the position of strategist 1997 and then chief strategist in He became the General Manager of the Economic Research Department in 2009, which is the position he holds today. Tokyo University, BA/Law, 1985 Contact Details Yuhki King Head of Business Development & Client Relations Phone: +44 (0) Benjamin Ellis Business Development Manager Phone: +44 (0) This document may not be copied, redistributed or reproduced in whole or in part without prior written approval from Daiwa SB Investments (UK) Ltd. The content of this document should not be interpreted as a solicitation for business and is intended as background information for professional institutional investors only. Please contact us should you require further information. Daiwa SB Investments (UK) Ltd. is authorised and regulated by the Financial Conduct Authority.