Shareholder-friendly Japan Inc is a slow business

Shinzo Abe, the Japanese prime minister, has been credited widely with implementing the most radical overhaul of the country's corporate sector in decades as part of his economic reform programme known as "Abenomics".

Although Mr Abe's corporate governance reforms have been hailed as a significant step towards revitalising the economy, international investors agree that the transformation of Japan's business sector is far from complete.

David Smith, head of corporate governance at the Asia arm of Aberdeen Asset Management, Europe's largest listed fund house, says: "For a long time investors shook their heads with frustration when it came to Japan and corporate governance. We are encouraged by the [recent] changes, but I do not think anyone would say Japan Inc has changed overnight."

Corinna Arnold, who manages the Japan stewardship fund at RWC, the UK asset manager, adds: "Is governance change in Japan, where you had pretty sclerotic rules in place, happening fast enough? Yes, in terms of the rising number of [company] managers focusing on shareholder value, but not yet in terms of moving from lip service to real change on boards."

One of the most significant changes brought about by Mr Abe's government was the launch of an index, the JPX-Nikkei 400, in 2014. The index weights companies by operating profits and return on equity in addition to market capitalisation, which encourages groups to reduce their large cash piles and return more cash to shareholders.

The weightings are also affected by several "shareholder friendly" metrics, such as the number of external directors on a company's board and whether it publishes earnings information in English or not.

The government has encouraged the Government Pension Investment Fund (GPIF), the world's largest pension scheme, to invest in companies included in the JPX-400 index rather than the Nikkei or the Topix. Companies not included in the new index could therefore lose out.

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This is seen as a success story for the index. However, these promises also came after Daniel Loeb, the US activist investor, began pressuring the company to make better use of its $6.8bn cash pile.

Amada, the $3.5bn industrial company, also promised last year to return 100 per cent of net profits to shareholders for the next two years, after it discovered it had not made the JPX-400.

For Sarah Williams, portfolio manager at Columbia Threadneedle, the US fund house, the impact of this index may have been overstated. She says: "We are seeing strong dividend growth and a marked increase in share buybacks, but these are easy decisions for companies to make if their cash pile has become even larger. It does not yet mean they have revolutionised their thinking about putting cash to use or returning it to shareholders."

Andrew Rose, Japanese equities fund manager at Schroders, the UK fund house, is similarly cautious. "The bottom line is return on equity in Japan is lower than elsewhere, the degree of cross-shareholding is still high and [the proportion of] foreign and female independent directors is even worse [than in other developed markets]. There is substantial scope for improvement," he says.

<>"Shareholders believe [the corporate governance changes under way in Japan] will be sustained and that this time is different. If it turns out to be another false storm, that would be very disappointing."

In the hope of preventing a repeat of corporate scandals such as the multibillion-dollar Olympus fraud, which shook the Japanese business community in 2011, the government also introduced a stewardship code last year. The aim of the code, which 184 institutional investors have signed up to, was to encourage domestic institutions to take a more active approach to questioning governance at the companies they are invested in.

Simultaneously, companies are being pushed to add more outsiders to their boards, prompting the proportion of listed companies without an independent director to fall from more than half in 2013 to 39 per cent in 2014.

Only a fifth of the largest companies listed on the Tokyo Stock Exchange have more than one independent director.

In an attempt to accelerate the introduction of outsiders, the Tokyo Stock Exchange published a corporate governance code in March, stating that the biggest 1,888 companies in Japan should have at least two independent board directors.

The code, which enters into force in June, is not legally enforceable but companies that have not met the target must provide an explanation. Company law has also been amended to require listed entities to have at least one independent board director.

Ms Arnold says she is "extremely heartened" by such developments, but she is sceptical about the immediate impact of the changes. This is despite the fact that a number of groups, including Hitachi, the engineering and electronics company, Canon, the camera and printer maker, and Toyota, the carmaker, have added independent directors to their boards or promised to do so in the past 12 months.

She says: "Change is slow. Adding external directors to boards is all well and good but I pity the poor soul sitting on the board [as an independent director] as they will not have much of an opportunity to change the course of a company."

She references Toshiba, the technology conglomerate with four external directors, as an example. Last year Toshiba's managers bypassed its board altogether when drawing up a succession plan for its chairman.

Chris Rowley, professor of human resource management at London's Cass Business School, agrees that new independent directors in Japan might "not be listened too, especially on sensitive issues like succession of chief executives".

This is particularly problematic given "the sheer number of independent directors needed all at once", according to Mr Rowley. He points out that about 2,000 independent directors need to be hired by June for the companies that still do not have outsiders on their boards to meet the new requirements.

Ms Arnold says: "[Independent directors] cannot just be seen as a rubber stamp that can be ignored. When you take a position the rest of the board is not happy with, it is a tough place to be. In a Japanese context, it is even tougher."

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