Corporate Governance

“Let’s be lovers first” is a high risk approach for Japanese overseas acquisitions

Most Japanese companies assume overseas acquisitions are high risk – and yet continue to acquire in pursuit of growth. But according to research from Daiki Tanaka (formerly of McKinsey and now running his own consultancy) Japanese overseas acquisitions of companies in the same industry from 1996 to 2018 had a lower failure rate (2.8%) than domestic Japanese acquisitions where the acquiring company is “jumping” into new sectors (3.4%).

The money at stake is are far bigger however for overseas takeovers. The average price tag of an overseas acquisition is Y24.5bn (over $200m), whereas the average domestic acquisition in Japan is around Y1bn (over $9m). This would be partly skewed by recent mega acquisitions such as Takeda acquiring Shire for $62bn and SoftBank acquiring ARM for $32bn.

Tanaka also concludes from his research that a “let’s be lovers first” approach is actually a higher risk strategy for overseas acquisitions. Taking a minority stake and then gradually raising it to full ownership/marriage can mean that due diligence is insufficient and the minority shareholder has not been able to participate fully in corporate governance.

Tanaka expects Japanese companies to continue to acquire overseas companies from the same industrial sector, because lower risk domestic acquisitions will not necessarily help to access higher growth overseas markets. If they want to escape the low growth, ageing Japanese market, acquiring overseas is the obvious quick route out. It would seem that a virgin marriage is recommended however.

Rudlin Consulting has assisted many European companies acquired by a Japanese parent. Please contact Pernille Rudlin for further details.

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Chipping away at the three treasures of Japanese HR

Several Japanese blue chip companies have announced some quite radical changes to their HR systems, just in time for the new Reiwa era. The so called three treasures of lifetime employment, seniority based pay and a company union have been looking a little tarnished for some years now. They seem a legacy not even of the Heisei era but of the post war Showa era of a booming economy and a need to retain a young workforce.

Hitachi had shown the way four years ago (as described in our blog post at the time), abolishing seniority based pay for its managers and replacing it with pay based on job roles. They have made further waves recently with the announcement of the first ever Hitachi subsidiary President to be in their forties. The newly formed Hitachi Global Life Solutions will be led by Jun Taniguchi, born in 1972.

Hitachi claim that this new system is needed for the company to be truly global and able to appoint and transfer managers around the world, regardless of where they were recruited. Beer and soft drink manufacturer Asahi Group Holdings has also been shifting to global standards. Around half their employees are non-Japanese, as a result of their acquisitions of European brands such as Peroni, Grolsch and Fullers. They have said their Presidents and CEOs will be evaluated on return on equity from now on, and given the boot if it is not maintained above 13%.

Japanese megabank MUFG says it will reduce new hires in Japan by 45% to 530 next spring, and will cut the 6000 employees in its Tokyo headquarters by half. Not all Japanese HR traditions are being thrown out of the window, however, as the surplus 3000 will not be made redundant, but rather redeployed to sales functions or sent overseas to areas where MUFG is expanding like the USA and Asia (but not it seems, Europe). MUFG is automating the functions that these staff performed, as well as cutting many of its retail branches in Japan. It will instead be beefing up its overseas compliance and digital payment systems divisions.

Some Japanese politicians and commentators have said that the “rei” of Reiwa sounds rather cold, as it can sometimes mean “order” or “command”. It also, when combined with the radical for water, becomes a character meaning chilly or freezing. It certainly feels like some icy winds will be blasting through Japanese cosy HR traditions in the new era.

Hitachi acquisition of ABB power grid business is a “Black Ship” to push globalization

It’s been 10 years since Hitachi made its record breaking loss and Takashi Kawamura became Chairman and President. Kawamura was chairman when Hitachi decided to buy Horizon Nuclear Power in the UK in 2012, and he now says he was one of the more cautious faction. “Costs pile up long before you’ve even produced one kilowatt of energy so I made it clear that we needed to set various points at which we will decide whether to proceed or not with the project”. Takashi Kawamura is now chairman of Tokyo Electric Power, so has not managed to escape the nuclear power industry despite his cautiousness.

Hiroaki Nakanishi lasted 4 years as President from 2010 to 2014, when Toshiaki Higashihara, also interviewed in the same Nikkei article, became President. Higashihara has not only frozen the Horizon project but acquired Swiss company ABB’s power grid business in 2018. “Globalization has not been achieved yet” for Hitachi he believes. He tells employees that the ABB acquisition is a Black Ship he has invited in, just like the foreign pressure to open up Japan in the Meiji Revolution, to change Hitachi and push globalization further.

Hitachi is shifting more into services and believes it has the right product and solution mix to for the “Internet of Things”. Sales may not grow much – for services business the point is to improve profitability, rather than sales volume, Higashihara points out.

Kawamura also says the old ways, of life time employment and being a generalist have to come to an end. Hitachi offered retraining for people employed in the businesses he shut down or spun out, like the semi conductor business, but many of them had expected to stay at Hitachi all their life, and not to have to find work elsewhere.

Higashihara goes on to say the next leader needs to be able to manage globally, in particular, to be able to communicate, across generations, nationalities, sexuality and gender. “If they seem to have the right balance of qualities, it would not be a surprise if it was a foreigner” who succeeds him. That is likely to be soon, as Higashihara has been president for 5 years now, and 6 years is usually considered to be the maximum for Presidents in companies such as Hitachi. Maybe the Black Ship has brought some potential candidates with it, or Hitachi Rail’s former CEO Alistair Dormer, now Representative Executive Officer, Executive Vice President and Executive Officer of Hitachi Ltd is being lined up for the job.

Five elements of building trust between Japanese and European business cultures

If I were to capture what I try to do in my work in one phrase, it would be “build trust between Japanese and European business cultures.” This of course leads to questions of how trust is defined, and therefore how it is built.

The title of my new book, Shinrai, is the Japanese word for “trust”. It is composed of two characters, shin, meaning “believe”, and rai, which means “to request”. In other words, if you trust someone, you believe they will do what you request. The character for shin can be broken down further into components which mean “person” and “word” and the character for rai can be broken down into “bundle” and “leaves or pages”. It implies communication between people is a fundamental part of building trust, but also getting things done and pulling together.

Analysing the work I have done with clients over the past fifteen years, I would say there are five components of building trust in multinational companies. In sequential order they are communication, mutual interests, processes and regulations, reliability and accountability and vision and values – and then back to communication again in a virtuous circle.

1. Communication

Having a common language is critical – this is why any initiative to help immigrants integrate into a society usually starts with language lessons. The problem for Japan is that for native speakers of European languages, Japanese is one of the most difficult languages to learn and Japanese feel similarly about English. Japanese companies can do more to help Westerners learn Japanese – an intensive course in Japan is one of the most effective ways to do this. Japanese companies can also communicate better than they do in English – it’s not enough to make English the common language or force a minimum English level on employees, management needs to communicate vision, strategy and plans in English more effectively than it currently does.

2. Mutual interests

The Economic Partnership Agreement between Japan and the EU is a classic example of common interests helping to build trust. People have differing degrees of interests, but finding mutual interests means that there is a stable basis for negotiation. Japan wants to sell more cars in Europe, European consumers are happy to have cheaper, good quality Japanese cars. Europe wants to sell more food and drink to Japan, Japanese consumers are happy to have cheaper, good quality European wine and cheese. On a micro level, this is why I always encourage Japanese expatriates in Europe to engage in small talk with their European colleagues – it’s a way of discovering mutual interests, which means mutual understanding, compromises and agreements are more easily gained.

3. Processes and regulations

Once you have discovered your mutual interests, you can come to an agreement, but it needs mutually recognised standards to work well. What are the quality and safety standards expected of a car, or a cheese in your respective countries?

When there is a low level of trust, laws, regulations and processes are needed as a fall back. However, both Japanese companies and the European Union are sometimes guilty of becoming bogged down in bureaucracy and process. You have to show you are obeying regulations and following processes in order to be trusted, but ultimately, this is not sufficient. How you do something in terms of your intentions and behaviour towards others is as important as carrying out the process correctly and obeying the law.

4. Reliability & accountability

When you trust someone, it is not only because you believe they will obey the law, but also that they will do what they say they will do. For Japanese companies, this can be hard to define, as the culture is often a family style one, where everyone’s roles are vague, with no job descriptions and rely on a seniority-based hierarchy. It’s assumed everyone will do whatever necessary, in the best interests of the family. Rules can be bent for family members but this vagueness does not work well in more diverse organisations.

The current fight between Carlos Ghosn and Nissan is focused on processes and regulations. Nissan will try to prove Ghosn flouted Japanese law, but will have to answer questions about its own internal rules. Ghosn will try to prove that he followed both internal and external regulations. But what really seems to be at stake is a loss of mutual trust between Saikawa and other Japanese executives and Ghosn. If you are an insider in a Japanese company, you are trusted as a family member to act in the best interests of the family, and rules can be bent accordingly. But once you are seen as an outsider and acting in your own interests, possibly harming the company, then the rules are applied rigidly – just as the UK is finding out as it negotiates to leave the EU.

5. Vision & Values

This is why you need a clear vision of where the company is going and how you want it to be seen. The vision and values have to be discussed with and shared with employees so they feel they belong. The values will guide them as to how they should behave in order to achieve that vision. If the vision is simply to hit various targets, within the boundaries of rigid rules and processes, without employees engaged with the company values, then the kinds of corporate scandals we have seen in both Japanese and European companies will continue, with catastrophic consequences for trust across societies and cultures.

This article is in the introduction of “Shinrai: Japanese Corporate Integrity in a Disintegrating Europe” by Pernille Rudlin, available on Amazon as a paperback and ebook.

What role did Carlos Ghosn’s status as a foreigner have in terms of his downfall?

And what does this mean for any other foreigner leading or looking to reach the top of a Japanese company? Obviously the Nissan story is evolving hour by hour, so what follows is based on my current understanding as of 20th November 2018.

The specific accusations are that Carlos Ghosn received share price-related compensation and the Dutch holding company of which he was a director along with Greg Kelly, as part of the Nissan-Renault alliance, used its funds to acquire and refurbish houses which were his residences. These were not declared, not as an income tax issue, but as a fiduciary/governance issue, in terms of declarations to the Japanese securities and exchange commission.

Is the way this possible misuse of funds was exposed specifically because Ghosn was not Japanese? Actually a lot of Japanese Presidents and Chairmen are allowed to use company funds for personal reasons, and because of the blurring of personal/private and employer in Japanese companies, it is quite common for companies to provide housing and other benefits far beyond the norm in the West, particularly to senior executives, who are not, on paper, paid that well. This is particularly true of companies where the President is also the founder or has a high degree of autonomy.

Terrie Lloyd, a long term resident and entrepreneur in Japan wrote an interesting piece on this recently – https://www.terrielloyd.com/terries-take/tt-970-imploding-one-man-shacho-listed-companies-e-biz-news-from-japan/

You also can’t help wondering what had been going on over the years in terms of internal checks and corporate governance at Nissan if they did not know and challenge what kind of “benefits” and compensation Ghosn was getting – as illustrated by this blog post from a Japanese corporate insider https://bdti.or.jp/en/blog/en/nissanltr/?77

So the next question is, as it often is with Japanese corporate scandals, why is this particular accusation being exposed and why now? The official story is that it was made by a whistleblower, which necessitated an internal investigation, and then this led to a plea bargain which would reduce the penalties to Nissan.* There is only one other instance of this happening – with Mitsubishi Hitachi Power Systems and a Thai bribery case – and it was a Japanese manager who was involved.

But I suspect, as do other analysts, that Nissan chose to pursue this and publicly expose it because they didn’t like the direction Ghosn was taking the company in and couldn’t work out another way to get rid of him. There was undoubtedly a long running worry about the degree of control/interference by Renault and the French government and Ghosn’s intention to make the alliance irreversible by the time he finally stepped down in 2022. I also just read a story in the Nikkei Business magazine that Ghosn was very keen for the alliance to partner with Google, Microsoft and Daimler and Chinese companies to create a CASE (Connected, Autonomous, Shared, Electric) strategy. That degree of “foreignness” and with the US, and China, and Daimler with whom Mitsubishi Motors already had a failed alliance might have elicited an allergic reaction from Japanese executives at Nissan and Mitsubishi Motors.

But also, which accounts for the strong words from current President Saikawa, indulgence of senior executives is tolerated so long as they still seem to be working for the good of the company, and Ghosn not turning up for the public apology after the inspection scandal, and the sense that it was his corporate culture of imposing aggressive targets on employees that might have caused that scandal – and yet he blamed Saikawa, might have tipped Nissan executives further into exposing the issue publicly rather than dealing with it in the usual way.

The usual way (see Fujitsu/President Nozoe resignation in 2009), when other executives decide that a President has to go sooner than the usual carousel of 6 years as President and another 6 years as Chairman because they think he’s gone beyond what is morally acceptable and/or they don’t like his strategy, is that they try to let the executive exit honourably, by getting him to resign due to illness or some similar blamefree excuse.

Maybe this option was offered to Ghosn – who had after all been leading Nissan as President and Chairman for nearly 20 years, so way beyond the norm for Japan. But I can imagine that he refused it – and this could be attributed to him being “foreign” – instead of understanding Japan’s “shame” culture, he would have gone down the Judaeo-Christian and legalistic route of saying he had a contract until 2022 and as far as he was concerned he had done nothing wrong, innocent until proven guilty, so bring it on.

There may also be a political aspect – again nothing specifically to do with Ghosn being foreign – but Nissan may have got the hint from Japanese government agencies that they would be supported in taking Ghosn down because they were not politically in favour of the direction he was taking the alliance in – see what happened to Horiemon/Livedoor.

So in summary, I doubt Ghosn was treated differently because he was foreign per se, but because he was foreign he probably reacted differently, just as Michael Woodford did when asked to resign after uncovering scandals at Olympus, believing his own innocence and not fearing public exposure.

But underlying this there could be a resistance in Nissan and beyond, to any further globalizing, whether it results in French or Chinese or American or German control or influence. If I was a foreign executive, particularly if I was Christophe Weber at Takeda, I would be watching further developments in this case like a hawk and making sure I built as many strong, trusting relationships with my Japanese executives as possible.

*The story has indeed evolved – it now turns out that Nissan itself was not part of the plea bargaining deal, it was the two officials, one non-Japanese SVP who managed the Dutch subsidiary and one Japanese who was Ghosn’s chief of staff, who agreed to cooperate with the investigation under a plea bargain.

I was also quoted in the New York Times on this subject.

Nissan and Ghosn – the cycle of coups d’état reaches back to the 1960s

I always prefer coincidence or cock-up to conspiracy, and former journalist and PR consultant Masaki Kubota clearly feels the same way, judging by the first few paragraphs of his article on Carlos Ghosn and Nissan in Diamond magazine.

As he says, in his years as a journalist, it was the standard defence of any Japanese executive caught up in a scandal that it was a conspiracy of people out to get him.

With Ghosn, you could easily claim, as many have, that this was a conspiracy, born of some kind of alliance between insiders at Nissan who wanted to get rid of Ghosn, his ex-wife and the Japanese government, and this kind of accusation is handy both for Ghosn and the French government or Renault who might have wanted Ghosn to continue to be influential.

But then Kubota does a classic kishotenketsu twist, pointing out the history of Nissan, going back to Ghosn’s installation and even before, is one of a cycle of coup d’etats.

Starting with the most recent history, of the inspection scandals – the exposure of the problem was a way of resisting the inspection system that Ghosn’s management team had introduced, shortly after Saikawa (identified as one of Ghosn’s team) became the new President of Nissan. It was in effect an abortive coup d’état.

Going further back to 1999 the then President Yoshikazu Hanawa was in negotiations with Daimler Chrysler and Ford but instead installed three Renault executives, without even consulting the previous Presidents who were advisors to the company at the time. “It was a kind of a coup d’état” the Nikkei said at the time.

Purging the Don

Even further back, to the 1980s, when the Chairman and former President for 16 years from 1957 was Katsuji Kawamata, there was a coup which led to the purge of union power at Nissan in Japan. It was well known that Kawamata gained his power through cooperating with the Nissan group labour union leader Ichiro Shioji. But then in 1984, Shioji, who was seen as the main obstacle to Nissan opening its factory in Sunderland UK and before that in the US, was hit by a scandal – photos appeared in the weekly magazine Focus, of Shioji on a yacht with a beautiful young woman. Criticism of Shioji, as “the Don”, mounted and he resigned on 22^nd February 1986. The Nikkei reported on this as “the 2.22 coup d’état” a reference to the 26^th February Incident, a failed coup attempt in Japan in 1936. It was said that the power behind the 2.22 coup was Takashi Ishihara who was in favour of global expansion, and was the President at the time.

Ishihara had been involved in an earlier coup, when he was still at managing director level in 1969. Documents were leaked to the media about an incident involving a Nissan microbus. It became clear that this was done in order to purge the upper ranks of the company.

As Kubota says, when there is a fraud in a company, this is often results in a clear out of those in the upper levels of management who are to blame. In fact, this kind of incident has been quite rare at Nissan, so when it happens, it is likely that it is part of a major change in strategic direction. So, Kubota asserts, it is definitely a coup d’état. In Kubota’s experience, it is hard to change a corporate culture that easily, so if Nissan is used to changing strategies by coup d’état, then it will continue to use this mechanism.

Corporate culture will not change just because foreign executives are put in place

Corporate culture will not change just because foreign executives are put in place. Kubota reminds us that for Saikawa to criticize Ghosn so strongly, when Ghosn has not yet been put on trial, is certainly a change from the usual crisis management of Japanese companies.

Kubota sees this singling out of Ghosn by Saikawa, who worked so closely with Ghosn for many years, as a kind of personal insurance.

So where does Saikawa fit in? Kubota has dug out the fact that Saikawa was executive assistant to the President from 1992, Yoshifumi Tsuji. Tsuji had taken over from Yutaka Kume, who had succeeded Ishihara, the instigator of the coup against union Don Shioji. Saikawa was therefore part of the team that survived the Renault coup.

So it goes round. As Kubota puts it, even in the midst of this coup d’état, there will be people wondering whether they will be the next to be stabbed.

How Japanese risk aversion explains reactions to Brexit and whether UK should join the CPTPP

I was a panellist for the UK Trade Forum on 25th September 2018, on Japanese business and government viewpoints in response to the UK’s request to join the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (CPTPP, TPP as was, often known in Japan as the TP11)

The Chatham House rule was invoked, but I believe that I am allowed to report what I said, so long as I don’t attribute any comments to the other speakers.

As I only had 10 minutes, I decided to focus on risk aversion to explain Japanese reactions to Brexit and the UK joining the CPTPP. Even so, I had to drop the final part of my speech, so I will add this back in at the end:

“I have spent more than 45 years now living in or visiting Japan and working with or for more than 200 Japanese companies, and one generalisation I feel I can make, even though I am well aware of the dangers of stereotyping, is that Japan as a nation – as well as Japanese companies – are highly risk averse.

The geopolitical angle

I was reminded of this when I attended a lecture by Koji Tsuruoka last week, the current Japanese Ambassador to the UK, who was also the chief negotiator for Japan for the TPP. He gave a very powerful, thought-provoking speech, tackling head-on controversial subjects like Japan’s behaviour in WWII, whaling, defending Big Pharma IP interests in trade negotiations and so on, in a way that didn’t seem strictly necessary given it was an audience of Japanophiles, but I think his message, on reflection, was very clear. Japan feels very vulnerable, with neighbours such as China and North Korea and Russia, and supposed allies and defenders such as the USA now behaving unpredictably, and it needs a rules based international order because it is energy and resource poor and relies on other countries for imports of these things. WIthout a rules based international order being adhered to, countries behave unpredictably, and this can lead to war.

So this is why Tsuruoka and other Japanese government representatives and ministers have been very positive and welcoming of the UK wanting to join the CPTPP or roll over the EU-Japan EPA, even if the practicalities of this are not clear. They worry that the UK leaving the EU means the UK is also leaving that rules based international order, so needs to be roped back in somehow.

Why are Japanese companies so risk averse?

So that’s the geopolitical side to this – for the rest of my ten minutes I want to look at the Japanese business side, and three sectors in particular, what kind of trends we are seeing and how they are reacting to Brexit and what TPP might contribute in terms of mitigation or otherwise.

So why are Japanese companies so risk averse? I think it’s because they operate on a very different model to the Anglo Saxon, short term, shareholder value model. It could be called a stakeholder model, but primarily the motivation is not to make a quick profit, but long term survival. So they don’t want to do anything so risky as to jeopardise that, and they are very hot on ESG – Environmental, Social and Governance – issues. It’s one of the really good things about Japanese companies, why I am still a fan.

So when the Japan bashing started happening in the 1980s, and many Japanese remember Americans taking hammers to Japanese cars, Japanese companies decided that foreign direct investment was the way forward, and started up factories in the USA and of course also in the UK, with Nissan, and then Honda and Toyota.

They chose the UK – and the UK is the recipient of 40% of Japan’s cumulative FDI into the EU, and has the largest Japanese population in the EU, including intra-company transferees – (but both those numbers are declining these past couple of years – I leave that to you to conclude why, but a hostile environment certainly isn’t helping) – because the UK was seen as a stable, rules based system, low risk place to invest, and of course because we were then members of the EU and a gateway into the EU.

So what is happening now with Brexit in terms of Japanese risk aversion, is that it is tipping them into making decisions and directions they were going in anyway. Looking at the three main sectors of Japanese investment in the UK – automotive and supply chains, IT and electronics and “pure” services – these sectors make up the bulk of the around 1000 Japanese companies in the UK, employing around 140,000 people. Actually many of the 1000 don’t really count because they are paper companies, brass plates, or several versions of the same company, but there are 30 or so really big employers who make up more than half of those 140,000 employees.

Automotive supply chains – a pivot to a new chain of right hand driving nations?

So for Japanese companies, trade negotiations aren’t really about trade in products so much any more, more about protecting their foreign investments. Even then, to be realistic, the EU only makes up around 10% of Japanese companies’ turnover. Asia is still the really big market outside of Japan, and within that, China, and then secondly the US. And the UK is probably only around 10% of the EU total. But the UK is also host to a lot of regional HQs and of course the three car plants.

The main trends you see in the automotive supply chains is that they are shifting eastwards in Europe, to the Czech Republic, Slovakia, and Japanese car manufacturers also have factories in Russia and Turkey, and the suppliers – of wire harnesses for example – have factories in Africa. So Brexit is accelerating that shift.

Can the CPTPP help with this? Well I suppose there are a large number of CPTPP members who are right hand driving like the UK, but when you look at what sells in Australasia for Toyota, it’s pick up trucks like the Hilux, whereas Toyota in the UK is manufacturing the Auris/Corolla. I suppose that shift could happen – at least then there is access to a market of over 100 million, which is supposed to be the minimum to sustain an automotive supply chain. Honda is already trying to sell half of its Civic production from Swindon to the US, so it could happen, despite the distance.

Information technology and electronics – integrated disintegration

You’re also seeing a shift in the power balance in those supply chains, towards the components suppliers, and IT, because of Big Data, the Internet of Things and so on. Which brings me to the second major sector – information & communication technology, electronics etc. Here you’re seeing what I call an integrated disintegration. Japanese companies are becoming more B2B, solutions based, and trying to integrate back office functions, but also customer support, technical support into low cost locations with multilingual educated workforces – so in Europe this would be Portugal, or Poland.

But at the same time, the regional management and sales are becoming more dispersed. Anyone who has worked in a multinational as I did working at Fujitsu will know what this means – endless fights about who gets what in terms of money or actually doing the work, and whereas the UK often won those fights, I am beginning to see signs that Japanese companies are reverting back to the country model, are finding the matrix system just too tough. If you’ve ever run a global or regional virtual team, as I did, you can understand why. So there is a drift away from the UK and to Germany or the Netherlands, as we’ve seen with Panasonic, and it would seem also Sony now, accelerated by Brexit. And that’s bad news for UK suppliers of services to those Japanese companies.

Pure services also need a rule based international order

But Panasonic did not just cite Brexit as a reason for moving its headquarters to the Netherlands. It was also to do with the tightening of Japan’s tax haven rules from April of this year. Dividends and other “passive income” in Japan’s overseas subsidiaries will be the subject of attention of Japanese tax authorities, regardless of how much real business activity they are undertaking, if the corporate tax rate is below 20%. And of course the UK’s is 19% and due to decrease further – reiterated by the Chancellor after the referendum to show that the UK is still open for business.

But actually this is not appealing to Japanese companies. Nor is the “chlorinated chicken” approach about deregulating or having looser environmental or other regulations of much interest to Japanese companies. They want to maintain high standards, and like robust, thorough rules – again, because of the risk aversion.

But there are cultural issues beyond the need for a rules based international order

Although Japanese companies really like being in the UK and I think a lot of the commercial and financial sector companies, like Japanese banks, or trading companies like Mitsubishi Corporation that I used to work for, have no intention of entirely shifting their regional headquarters out of the the UK despite Brexit, if they can help it, one thing that keeps me in business is the cultural gap between Japan’s very process and rule oriented way of managing and the more principles based, some might say “winging it” approach of British management.

I believe Japan is still very reluctant to open up its public procurement and professional services sector, even to the UK, and I can see why. There is not really a developed set of professional specialists the way we have in the UK. Most Japanese employees follow a generalist track. So in trade negotiations, such as the CPTTP or the EPA, it must be very difficult to find common terminology in order to agree any rules for recognition of qualifications, or mutual understanding of governance principles for services, much more difficult than defining standards for products. “Risk” in Japanese is the same word that is used for “crisis”. So it has a very negative meaning, and the neutral concept of risk management is not translatable into Japanese as a result.

Who’s looking grumpy in Japan’s summer bonus season?

If you’ve noticed your Japanese colleagues looking grumpier than usual and making pointed remarks about the amount of money overseas offices soak up, you may need to be aware that it’s not just the heat and the typhoons getting to them, but the fact that despite Prime Minister Abe’s push, some companies are still cutting salaries – and employee numbers are shrinking. The summer bonus season, which will have been added to their monthly pay cheque in June or July, may have reminded them that their salaries have not increased much in real terms over all for some years, but they are supposed to be grateful they have a secure job, with bonuses, benefits and a pension.

It’s surprising to see who tops the list in Toyo Keizai’s ranking of companies who have had the biggest reductions in pay and number of employees over the past five years – trading company Mitsui Bussan is at #1. Toyo Keizai reckons this is because their business was badly hit by falling resource prices over the past few years. Although average annual income at Mitsui is high – around Y12.3m (US$111,000), it has dropped by Y1.48m compared to five years’ ago. The number of employees has also fallen by 201 to 5,971. Sumitomo Corporation, another major trading company is at #9 – average income falling Y1.255m but personnel numbers only falling by 23. Mitsubishi Corporation is at #78 – total average income has fallen by around Y260,000, and numbers of staff have dropped by 579 to 5,217.

As you might expect, given its recent problems and selling off of businesses, Toshiba is in the top rankings, at #15, having reduced the number of employees by 4,401, to 32,353, with average income falling by Y880,000. Similarly Sharp has also reduced total average income by around Y600,000 and cut staff at almost double the rate of Toshiba, by 8,175, to 13,363. Sony has reduced staff even more, by 10,391 to 6,185, and total average income has fallen by Y410,000.

Eisai, the pharmaceuticals company, is at #23, having cut its staff by 938, to 3,246 and average income falling Y710,000. There has been no obvious negative issues for Eisai over the past five years, so maybe this is the work of the CFO, Ryohei Yanagi, trying to keep ROE above 8%, as we previously blogged.

What is a Japanese company? An investment perspective

Ryohei Yanagi is a self-styled untypical Japanese business person – not only is he holding down several jobs – as CFO of Eisai pharmaceutical company and also a Visiting Professor at Toyo University and a Visiting Lecturer at Waseda University, but he has changed employers in his career, even more unusually switching from a foreign company (UBS) to a Japanese company, rather than the other way round.

ROE of 8% was not plucked from nowhere

He is also a very dynamic speaker, and not low on ego. In his talk to the Daiwa Anglo-Japanese Foundation earlier this month he claimed credit for setting the ROE target of 8% in the Ito Review instigated by Prime Minister Abe as part of his Abenomics structural and governance reforms. Yanagi was criticised for plucking this figure out of nowhere, which was seen as unrealistic given that ROE in Japan had been averaging at just over 5% over the past 30 years.

He took us through his research, to point out that the Price Book Ratio only moves into positive territory (in other words the company is valued on the stock market at a higher rate than the cash and assets it has) when ROE is 8% in Japan. Apparently investors are discounting cash held by Japanese companies by 50%, because they fear that the company might make a stupid investment, and overpay, or just sleep on the cash instead of using it productively. By contrast, US companies’ average ROE over the past 28 years has been around 14%.

Shareholder value destruction rooted in Japan’s main bank governance system

Yanagi sees the root cause of this shareholder value destruction as being the main-bank governance system that used to dominate Japanese blue chip companies – whereby each major company had a “main bank” from one of the keiretsu, who provided most of their funding, governance and cross shareholding along with other keiretsu members. This main bank system was crumbling even before the Ito Review set the ROE target and other corporate governance reforms. Foreign shareholders now represent the largest shareholder group on average – owning around 30.8% of listed Japanese companies’ shares, up from less than 10% 30 years’ ago. Since the governance reforms of 2012-2015, Japanese companies’ ROE has increased to 9% and the Price Book Ratio has become positive.

Of course this analysis provoked quite a lot of questioning from the audience – many of whom were investing in Japanese companies, and had qualms about any notion that Japan should adopt wholesale the Anglo Saxon short term shareholder value maximization model. Yanagi was not saying that Japanese companies should drop their commitment to the environmental and social elements of ESG, but should look at the return on equity of such initiatives too.

An investment in a Japanese company is not just an investment in the Japanese economy

He gave the example of Eisai’s commitment to manufacturing – for free – medicine to eliminate the neglected tropical disease lymphatic filariasis. He believes Eisai will see a return to the cost of this, as it will increase the capacity utilization of Eisai’s factory in India, and improve their skills, and this factory then has the capability to produce other profit making drugs which can be exported to Europe.

There are quite a few investment funds in the West focused on Japan, and also several funds that exclude Japan because of its historically low returns. Most emphasise that they are aiming for long term capital growth, rather than quick returns. Usually they define a “Japanese company” as listed in Japan, or if listed elsewhere, having the majority of their business in Japan. As mentioned in another post, looking at companies like Takeda or SoftBank, or at this increase in foreign shareholdings, and more emphasis on return on equity – I do wonder whether the definition needs to be refined further.

An investment in a Japanese company is not just an investment in the Japanese economy. Many Japanese companies have the majority of their revenues from outside Japan. Takeda has more non-Japanese than Japanese executives. Whilst no shareholder should tolerate value destruction, the Japanese company’s traditional long term perspective, with emphasis on positive environmental and social contribution, rooted in specifics of the Japanese market and society, and now with added improved corporate governance, is surely an attractive one.

What is a Japanese company?

I had anticipated the “do you have any questions for us?” at a recent final interview for a non-executive directorship for an investment trust focused on Japan. I was advised by another experienced non-executive director to think of a thought provoking question, to show the board I was capable of bringing a different perspective, something they had not thought of before.

On reflection, I probably erred too far on the “thought provoking”. It was a genuine question, however, and I was genuinely interested in their answer. As the fund’s strategy was to invest only in Japanese companies, how do you define a Japanese company?

Listed in Japan or majority of business in Japan?

The fund defined it as being listed on a Japanese stock exchange. This may seem a clear enough definition, but does this mean Sharp, now owned by a Taiwanese company, Hon Hai, is a still a Japanese company? How about Hitachi Power Tools and Calsonic Kansei, now both owned by American buyout firm KKR?

Other Japan focused funds also invest in companies that are listed outside Japan, so long as a significant majority of their business is in Japan. But if percentage of sales in Japan is the criterion, then there are plenty of Japanese companies who are listed in Japan, for whom a majority of their business is outside Japan – Takeuchi for example exports 95% of its diggers to overseas markets and 68% of Sony’s business is outside Japan.

Avoiding ‘country risk’

Why does it matter? It matters to the boards of such funds, because if they define “Japanese” as Japan listed or majority of business in Japan, then clearly they need to consider the “country risk” of Japan and ensure the strategy is adjusted, or mitigation is put in place accordingly.

They need an expert in Japanese economics or politics to read the entrails on whether Prime Minister Abe will be re-elected as leader of the LDP in September, and if so whether he will be in a strong enough position to carry on with his “Three Arrows” of reform. They need to be able to judge whether the recent dip in Japan’s GDP growth is temporary, or likely to be revised upwards in June, as often happens. They might need some inside track on trade friction around the world and how this might affect the Yen.

But if the strategy is to invest in specific Japanese companies with long term growth potential, then this is not the same as investing in the Japanese economy or a Japanese index tracker. The aim should be to look for companies that will succeed no matter what happens to the Yen or Abe.

Managed by Japanese executives?

Specifying that those companies should be Japanese indicates to me that there is thought to be something unique to Japanese companies that makes them worthy of special attention. So should it be that the management of the company is Japanese? In which case, how should Takeda be classified – likely to become even more dominated by non-Japanese executives after the acquisition of Shire?

What about other companies who, like Takeda, have substantial overseas business acquired through acquisition, but manage it mostly through an international HQ based outside Japan, such as Japan Tobacco (Swiss HQ) or Dentsu (Dentsu Aegis Network in the UK)?

Or how about SoftBank, founded and run by Masayoshi Son, ethnically Korean and educated in the USA? The original telecoms business is clearly Japanese, but what about ARM in the UK and Sprint in the US – not to mention Softbank’s massive Vision Fund which notably is not investing much into Japanese companies at all?

Where Japanese companies have the edge…

I propose some further, admittedly fuzzier definitions of “Japanese”. Firstly, the business should reflect an aspect where Japan has an “edge” – a comparative advantage. For example, any business that is focused on the elderly, as Japan has the most rapidly ageing population in the world, with over 25% over the age of 65. Or a business which has evolved from Japan’s traditional manufacturing and craftsmanship strengths, what is known as monozukuri in Japanese – highly sophisticated machine tools, robotics and components.

But I think there is something more than that to being “Japanese”. It’s about the corporate culture and governance – a different model to the Anglo-Saxon shareholder value maximization model. Investing in a Japanese company should be for long term capital growth rather than a quick dividend, as well as some satisfaction that the investment is going into a company which does not engage in creative destruction type capitalism.

…is also where the risks lie

And this is where the risks also lie. Japan’s stakeholder capitalist model means job security, but also hidden underemployment and low productivity. Jealous guarding of corporate reputation can mean cover ups when something goes wrong. Strong loyalty to other members of the corporate family can mean deference to seniors without questioning or challenging orders given. Extreme risk aversion can mean opportunities missed.

Understanding and mitigating these risks is not something that can be resolved by an informal chat with a contact in a ministry, nor by looking at exchange rate forecasts and putting some hedges in place.

This was the conversation I wanted to have, and where I thought I could add value, but that’s the trouble with the “any questions for us” coming at the end of the interview. As the board chair said – fascinating question, but you’d need a whole afternoon or a seminar to thrash it out. And no, I did not get the job.

Category: Corporate Governance