It gets worse. Over the past several weeks, a series of court rulings and shareholder votes have gone against foreign activist investors who had been pressing managements to improve. And Japan certainly needs activists. Currently, less than one fifth of profits are paid out to shareholders. One recent request for an electric power utility to hike its dividend for the first time this century was rejected on the ground that a “stable dividend” is preferable to a growing dividend.
Things weren’t supposed to turn out this way. Two years ago, Japan was the darling of global investors. Prime Minister Junichiro Koizumi had just won a landslide election, the Nikkei soared 40 percent in just five months, and foreigners, excited by Koizumi’s promises of liberalizing Japan’s vast pool of post-office savings, poured capital into Japanese shares.
But Japan is not China or India. It is a mature economy with a large, liquid stock market, still the second largest in the world. No amount of reform was ever going to be sufficient to sustain the kind of steep rise it enjoyed in late 2005.
That said, things today aren’t as bad as they seem. For starters, Japanese corporate profitability has increased, especially for world-beating auto and machinery companies riding a yen that is at its most competitive level since the early 1980s. Japan’s private sector generates a vast amount of savings, far more than enough to fund booming capital investment and the budget deficit, with plenty left over to pump overseas.
Meanwhile, there’s plenty of value to be released at the corporate level. Shareholder activists have been disappointed by recent events, but the story is by no means over. The requests for higher dividends may have been voted down, but in several cases the motions did achieve respectable levels of support, offering hope for next time. A Tokyo district court did, for example, greenlight the controversial poison-pill tactic proposed by the food company Bulldog Sauce, allowing the firm to dilute activists’ holdings. But the ruling was carefully worded to avoid setting a precedent that would give management absolute protection in the future. The case now goes to the Supreme Court.
Whatever the ruling is, activists will fight back with new tactics. After all, foreign investors now own 28 percent of the Japanese stock market, up from 12 percent in 1990. With the increasing number of M&A deals that have been taking place, minority shareholders are being empowered in a way that was unthinkable a few years ago, when standard operating practice was to hash out terms in smoke-filled back rooms and announce them to investors as a fait accompli. The average premium offered by acquirers is now 25 percent, roughly the same as in the United States and Europe.
What’s more, the discontent isn’t limited to foreign institutions. Japanese individuals, mutual funds and pension funds now own some 26 percent of the market. Like outsiders, they are tired of complacent management and low returns. Recently the head of the Japanese pension-fund association was vocal in his support of a bid by a foreign activist fund.
Japanese investors’ influence—inside and outside the country—will only grow. Until now, Japanese investors looking for an alternative to the rock-bottom bond yield or equity returns they could get at home poured their money into overseas markets. This trend will likely continue, as millions of Japanese boomers begin taking their pension payments as lump-sum cash payouts and start looking for places to put that money.
But this is potentially a very bullish indicator for the Japanese market. Stock peaks are achieved in conditions of euphoria and excess, where everyone buys in. The Japanese haven’t even started to buy into their own market yet—but they will.
When that happens, change will, too. Big shifts in institutions and behavior can rarely be imposed top-down, even by leaders as charismatic as Koizumi. Instead, the process is organic, and driven from the ground up by investors themselves. Though headlines might make it seem otherwise, in Japan that grass-roots momentum is growing.
