From a Japanese perspective it was rather like a tsunami hitting its coast, threating to sweep away all the social groundwork that had made the country so proud and economically strong in the postwar period.
Foreign Activism And Corporate Japan: The Great Divide
Following the subsequent battles by activist funds and countermeasures by corporate Japan, many foreign investors became deeply frustrated with their experience of investing in the Japanese equity market. But not only investors did, there are also many strategic foreign companies that would have liked to acquire Japanese companies, but became disenchanted with the process and the difficulties involved.
Subsequently, the already existing perception gap between foreign investors and the Japanese elite was deepened. Many outside investors view Japanese management as a self-protecting, self-governing and inward looking group with no external accountability, and with the concomitant factor of disregard for shareholders’ interests. The Japanese establishment, on the other hand, sees activist-type investors as greedy and short-sighted, which only intent on taking quick profits by making opportunistic demands to the management of targeted companies. (EIU)
Such narrow perspectives are plain wrong and cloud the view on the huge opportunities a cooperation of the two antagonized protagonists could bring by, not only for individual shareholders and their companies but also for the Japanese society as a whole.
The corollary of the above observations are twofold:
The Reality That Corporate Japan Should Face
Managers in Japan have to understand that very little altruism in the world of finance exist. Activism against corporate managements takes time, energy and money. It is hardly to be expected that individuals expend all these merely to see the right thing done. It is indispensable for the Japanese elite to recognize that there is a role to be played by activist funds, might they be foreign or domestic. And that the activities of those funds could end up mutually beneficial to the shareholders, the company and management and the great country of Japan as a whole.
Japanese businesses are now more than ever being exposed to fierce global competition. The population is declining and with domestic demand and markets shrinking, Japanese companies are being forced to change the way they are managed and they have to engage in M&A activities in this environment.(Yano) Furthermore, with the trade account very likely to be in a structural deficit , the current account surplus under severe pressure and the saving rates of the Japanese population being depressed for the foreseeable future, Japanese corporations will have to attract foreign capital at a certain point of time. Aware of those facts, it should be clear to the Japanese establishment that to lump together all foreign investment funds, to call them vultures and trying to push them out of the country is short-sighted and plain wrong. There is no future to that kind of an approach for Japan.
The Reality That Activist Shareholders Should Face
Activist Investors, on the other hand, need to understand that investment activities in Japan are accompanied by a lot of difficulties, because of the unique Japanese culture and traditions. When venturing into the Japanese market it is indispensable to understand the mindset of managers and the society as a whole, which has developed over a long period of time. Changing the mindset, the customs and practices in this country is a difficult and delicate task. But, provided the right approach is taken, there is no reason to believe that it is impossible. But individuals and/ or institutions trying it have to understand that they need to have a long-term perspective, be extremely patient and tread warily.
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Activism in Japan: Characteristics of the Predators and their Prey
In general activist funds are investing in virtually all industrial sectors, thus the activity is not concentrated in any particular industry or group of industries, but rather it is across the board.
Relatively High Stock Market Liquidity
In Japan though, some common characteristics of targeted companies can be identified. Firstly, activist funds tended to target more liquid stocks. It makes position building easier and mitigates the free- raider problem of price and/or volume signaling. In addition, many of the targeted stocks were small companies not listed on the main stock indices and therefore underfollowed. (Hamao et al)
Fragmanted Ownership And Poor Operational Performance
Furthermore, activist funds targeted in great majority firms with high foreign- / institutional- / individual ownership and low insider ownership. (BOJ) Although targeted firms often lagged comparable firms in terms of Return on Assets (ROA) and Return on Equity (ROE), thus they were poorly performing firms with some potential for improvement (Hamao et al), the ownership structure was often more important for the activist fund.
Hence, there is evidence that activist funds selected their targets strategically in order to increase the probability of success- that is, they considered the composition of the firm's shareholder voting pool, and not simply performance, in choosing proposal targets. (Romano) The rationing might have been, that foreigners and individuals would act as a facilitator for a successful activist approach. Given their minority stakes, activist funds might had to rely on other, to the company's management, "unfriendly" shareholders in order to implement changes. (Hamao et al).
Firms With High Cash Balances And Low Financial Leverage
Most importantly, companies were predominantly targeted for high cash balances. Those findings are consistent with media reports that activist funds, in the majority of cases, demanded dividend increases and/ or share repurchases in order to optimize the balance sheet of the targeted companies and remedy the undervaluation. The liability side of the balance sheet mattered too, as targeted firms were significantly less levered than its peers. Consequently, it is highly likely that activist funds were also looking for the potential to add leverage to the targeted companies because of underutilized debt capacity. (Hamao et al)
Shareholder Activism In Japan: A Fertile Ground
It comes as no surprise that many activist funds concentrated their activities on Japan during that time. A research paper by Brandes from 2006 found that, although cash- rich firms existed worldwide, in Japan numerous companies could be identified with extraordinarily high cash balances. On aggregate average cash to total market cap in Japan was twice as high as in Europe and triple that of the U.S in a 16 year observation period. In addition, those companies, in contrast to Europe and the U.S., tended to cling to their cash holdings for an extended period of time. The year-to-year turnover of cash rich firms in Japan, i.e. the percentage of cash-rich companies in one year that were not cash rich the previous year, was significantly lower in Japan than in Europe and the U.S. (Brandes)
As the cash balance and little leverage was the most important driver for shareholder activism in Japan, many targeted companies were operating in mature markets. Capex requirement tends to be lower in those kind of businesses and retained profits turn into free cash, theoretically qualified for payout to the shareholders. (BOJ)
Warren Lichtenstein, co-founder of Steel Partners, notes in one of its letters to partners: "(...) After our launch on April 15, 2002, we began to purchase shares in seven small cap companies. Most of these companies trade at a discount to net cash, have stable businesses in niche markets. (...) The average cash to market cap ratio is 111%, with some companies having much more cash than market cap (highest at 167%) and some having less cash than market cap (lowest at 74%). In calculating our cash, we exclude real estate, plant and equipment, brand equity, etc. All of these have value above simple net cash holdings (...)." (SPJ; August 2002)
The combination of low leverage and high cash balances often made the targeted companies qualify for Graham and Dodd net-net investments. Moreover, the negative and significant coefficient on Tobin's Q of targeted firms implies that activist funds are value investors. (Hamao et al)
Steel Partners: The Most Transparent Activist in Japan
Most Activist Funds operating during that time in Japan were very secretive. Not so much about their holdings, as the "5% rule" in Japan requires any fund to disclose their holdings once this threshold is reached. But most are extremely arcane about their investment strategy.
A rare exception was Steel Partners Japan (SPJ). SPJ frequently briefed his partners on matters concerning individual holdings (when the 5% threshold was reached), its investment philosophy, intentions, thoughts on overall valuation of the Japanese equity markets and numerous other subjects. The Letters to the Partners are well worth reading for any deep value investor interested in Japan.
There is no doubt, that SPJ was a dedicated disciple of Graham and Dodd's approach to "deep" value investing. Concerning SPJ's strategy and philosophy when it comes to investing, Warren Lichtenstein noted: „ (...) Steel Partners Japan Strategic Fund LP (...) emphasizing a bottom-up "businessman's approach" to valuing companies. This process includes considerable effort in understanding the downside risks and upside potential inherent in a particular company (...)." (SPJ; August 2002) "(...) Our philosophy and strategy at SPJSF is to invest in well capitalized, profitable companies that are market leaders in their respective industries. We are keenly focused on the preservation of our capital and will only invest where we feel we have a significant margin of safety. In fact, SPJSF has never lost money over a complete fiscal year (...). We (...) focus on fundamentally sound companies that trade at a discount to intrinsic value (...)." (SPJ; August 2007)
Regards approaching the management Steel Partners had a twofold strategy in Japan: "(...) Shares of our portfolio companies remain significantly undervalued by the Japanese market and SPJSF seeks to work with the management of these companies to unlock that value for all stakeholders. In each portfolio company, we engage management in candid and formal discussions regarding its company’s operations and capital structure. Our relationship with management (often spanning many years) allows us to formulate an active value strategy focused not only on promoting operational and financial excellence, but equally important, assessing management mentality and responsiveness. (...) Steel Partners has always been and will continue to be a long-term investor, typically holding positions in companies from three to five years or longer. (...) A key ingredient in our success is the amount of time and focus we spend on each investment and our willingness to develop a professional relationship with the managements and boards of our portfolio companies.(...) We are constantly working with the management of these firms in order to further enhance their values. We continue to have private discussions and correspondence with our portfolio companies. (...) Our goal is to be an investor that managements welcome and associate with success, fairness, discipline, empowerment and accountability. (...)" (SPJ August; 2007)
I doubt that there was too much nervousness in Japanese boardrooms over the abovementioned strategy engaging the management of SPJ's holdings via dialogue, i.e. the "friendly" approach.
But Steel was very determined and did not content itself with such an approach: „ (...) Occasionally, Steel Partners will seek to acquire 100% ownership of a portfolio company if we decide it would be a great long-term opportunity for our partnership to own the entire business rather than just a piece of the business or if it continues trading at a discount to its intrinsic value (...) In certain instances, we may enter into negotiations with a company to acquire the shares that we don’t already own. Or we may commence a tender offer as the most efficient way to increase our holding by taking our offer directly to all shareholders in a fair and transparent manner. (...) Even though we are always prepared to exercise our rights and protect the interests of all shareholders, we prefer to act from outside the boardroom by engaging with management informally. We are also willing to serve as a company director where we believe we can add significant value and expertise since it is an extremely time consuming commitment. (...)" (SPJ; August 2007)
Those were very likely the wordings were corporate Japan switched into outright panic mode. Hostile take-over bids and proxy battles were just unheard of in Japan before and during that time.
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Collateral Damage: The Poison Pill and Cross Shareholdings
Superficially it appears that there is only one area in which shareholder activism in Japan had a major effect. Namely the widespread adoption of takeover defense measures by corporate Japan.
There is little doubt that the "hostile" activists had all the reasoning and facts on their side to demand higher operational- and financial efficiency from the management of targeted companies, as well as a significantly higher overall payout to the shareholders. Too long did corporate Japan ride roughshod over its shareholders to the detriment of individual shareholders, pensioners and the country of Japan as a whole.
But Steel Partners and Murakami's fell prey of several misjudgments and strategic errors.
Firstly, evidence for the U.S. shows that returns from activism are driven by the ability of "hostile" activists to force targets into a takeover. Activist investors perform poorly when there is little activity in the takeover market. In Japan M&A is not a clear exit strategy for the activist investor. Although M&A activity more than doubled in Japan in the first decade of the year 2000 (from 45 completed transactions in 2000 to 98 deals in 2008), it is still extremely limited for a market with roughly 4,000 listed companies. (Hamao et al).
The "hostile" activist funds severely underestimated the huge resistance in Japan when it comes to M&A activities along the lines familiar to the west. This point is extremely important to keep in mind, especially when intending to make an unsolicited tender- offer. From the Japanese point of view, when investors buy a company they are not seen as buying just financial assets, but rather investing in a strategic, long-term relationship. (EIU)
Secondly, and more importantly, the "hostile" activist funds didn't make allowances for the idiosyncrasies of the Japanese system in their strategies. They didn't take into account the relationship based corporate culture, the aspiration for harmony and how well entrenched the stakeholder approach to corporate governance is within the Japanese society. Companies in Japan are social institutions. They are expected to provide stable employment and consider the needs of customers, suppliers and the community at large, not just shareholders. Mr. Callon from Ichigo Asset Management puts it the following way: "(...) Japan has a long-standing tradition and practice, which is unique to this country. People in Japanese corporate management usually started as a freshman worker for the company, grew up and developed their skills within the company over the years, and finally climbed the ladder to an established position. To change their attitude is quite difficult." (Yano; 2007)
And, last but not least, in Japan one should not go around with a loudspeaker saying things like that you are going to “educate” and “enlighten” the Japanese management about American-style capitalism how Lichtenstein did in the Bull- Dog Sauce case. (Economist) That does not go down well with the management of targeted companies. Once you get into an ‘us-vs them’ type of struggle, there is no way out. One certainly does not end up in a situation where you can have a candid discussion with the management anymore. (EIU)
Rather it reinforces the impression of the management and the society as a whole that activist-type investors are greedy and short-sighted and that their only intention is to take quick profits by making opportunistic demands. Yano- san is with me on this observation: "(...) They gave the impression that they were just greedy, short-term oriented investors, only interested in the retained earnings that had been accumulated inside the company over the long term. They did not do a good job of communicating their intentions, and they did not handle the media very well. (...) foreign funds should make an effort to clarify that they are not after short-term profits. They should do a better job of communicating this to the people, and gain the understanding of the general shareholders of the company. (...) in Japan there are two perspectives; you are either seen as a good fund, or perceived as a bad one. Ichigo Asset Management is considered a good fund, while Steel Partners has a bad image. Steel Partners’ activities, particularly its shareholder proposals, were not necessarily wrong per se, but its approach in Japan was badly managed (...)." (Yano)
Summing it up, the facts and reasoning of the "hostile" activist funds were more than right, but their PR an utter disaster.
The abovementioned scared to death many corporate leaders in Japan and they went into the defense. Following the "hostile" activist approaches and "unsolicited" tender- offers by Steel and Murakami many companies introduced poison pills. The scheme consists of the issuance of new stock warrants to all shareholders except the "raider".
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The Two Flavors of Poison Pills in Japan
Two main types of poison pills exist in Japan. The first one is the "prior warning" type, a takeover defense mechanism approved in advance. It defines a rule that must be followed by a party pursuing a takeover of a target firm. The breach of the rule by the acquirers leads to the issuance of new stock reservation rights. The second type is the "rights plan". It involves the issuance of new stock reservation rights in advance to a trust bank or special purpose corporation. If the takeover event occurs, these rights will be allocated to the shareholders. The "Type 1 – Prior Warning" measures are by far the most common form of "poison pills" used in Japan. (Hamao et al)
In addition to poison pills targeted companies reversed the encouraging trend of dismantling cross-shareholdings and began to refreshing “business alliances" in order to secure stable shareholders. Prominent companies such as Toyota, Nippon Steel, TBS and Oji Paper have significant investments in other publicly-held companies. On top of that, some companies even explored synthetic “ESOP” plans, whereby acquired shares are held by a special purpose vehicle and were not stripped of their voting privileges. (SPJ; August 2007)
The Renaissance of Cross Shareholding
Concerning the revitalization of cross shareholding in Japan; in 2007 a research institute found that corporates, life insurance companies and non-life insurance companies owned a combined 20% of all shares in the Japanese stock market. Thus, 2007 was the first time in 14 years that an increase in the level of cross-holdings amongst Japanese companies could be witnessed. It was the result of many companies feeling that anti-takeover measures would not be foolproof. Many managers in Japan consider cross-holding of shares the "protection of last resort". But cross-holdings come with severe side effects. Firstly, funds that should be channeled into capital expenditure, R&D and M&A are instead being used for dormant purposes. Furthermore, when share prices go down, the company could end up having severe business and market risk, as the Lehman-shoku showed rather plainly. Finally, when you have cross-held shares, especially in combination with poison pills, there is no market discipline at all in place. (Yano;2007)
The Evil of Poison Pills
Wit reference to the widespread introduction of poison pills, there is no doubt that the landmark ruling by the Japanese Supreme Court regarding the legitimacy of such devices following the Bull-Dog case was a huge mistake. Especially against the background that the Japanese law already provided a robust system of protection and due process for target companies and their shareholders to evaluate the merits of any take-over bid. (SPJ; March 2008) Yano-san notes: "(...) These judicial decisions lack any understanding of how a financial market functions, or how an investment should be made (...) such court decisions, once they take root in Japan, will be worrisome because investors would have no other option but to be silent, and there will be no market discipline functioning in Japan. That is my concern. (...)" (Yano; 2007)
Several implications of the court ruling and the widespread adoption of poison pills can be observed.
Firstly, the ruling further complicates matters in the sense that it mitigates/ eliminates the incentive for market participants to monitor individual Japanese companies, i.e. extremely limited market discipline. That, in combination with a significant reduction of monitoring activities by banks that had followed the unwinding of their cross-shareholdings and the reduction of staff (analysts) in investment banking, is the single most important reason for the Japanese stock market being extremely inefficient.
Furthermore, it impedes the effective execution of individual shareholder rights and significantly aggravates the fundamental disconnect between the "steward" (management) and the shareholder, i.e. it worsens the principle- agent problem. They intensify the fundamental issue of the lack of separation between management and ownership. They give the managers an incentive to make corporate decisions that place their interests before shareholders (empire building/ high risk- low profit investments), as it makes it easier to the management to ignore to whom their actions are accountable and with what responsibilities they have been entrusted by the shareholders.
Finally, poison pills strip the owner of a company of his right to dispose their shares at a fair price. Marketability is a chief advantage of publicly traded companies. But this advantage can be only utilized if all the potential market places are working efficiently in order to establish fair valuations in a company's stock. The widespread introduction of poison pills and other anti-takeover devices leads to the drying-out of such a potential market place, namely the market of corporate control and thus seriously harms the efficiency of the stock market in general.
There is every reason for concern about the proliferation of defensive measures. In the majority of cases (but not all of them!!!) these measures are not being used to protect shareholder interests, but instead are being used to protect and entrench management at the expense of the ordinary shareholders. (SPJ; September 2008)
It might come as a surprise to many, but there is a growing recognition by the Ministry of Economy, Trade and Industry (METI), as well as corporations in Japan and Japanese institutional investors, that shareholders, not stakeholders or management, are the true owners of a publicly-listed company. METI has supported that view by revising its takeover defense guidelines in June 2008 and warning that managers should earnestly negotiate with an acquirer and view the concept of corporate value purely in the context of cash flow. (SP; September 2008)
Also public remarks by Atsushi Saito, president of the TSE cover the same topic. He commented on June 20, 2008 that: “(...) Strict oversight by shareholders will keep companies' governance straight. Companies should appreciate shareholders more (...).” On August 26, 2008, Mr. Saito reiterated his disapproval for takeover defense strategies that protect management at the expense of shareholders, saying: “(...) Decisive steps against takeover defenses that harm investor returns are needed (...).”(SP; September 2008) In another interview Saito notes:"(...) Make no mistake. I do think that there needs to be pressure from shareholders. Human beings have a tendency to be lazy, so there needs to be pressure from the market, but I don’t see room for a no-holds-barred type of investor violence. There needs to be a proper balance there. (...)" (EIU)
Those are savvy words. But deeds speak more than a thousand words, especially in Japan! Concerning the abolition of AWS and poison pills very little has been accomplished up to now. Especially the lack of action taken by the TSE, mainly attributable due to severe lobbying by the Japanese business organization Keidanren, is a severe drop of bitterness and disappointment.
Let’s close this paragraph with some words of wisdom by the astute Yano-san: "(...) from the standpoint of an investor, I would like to say that the introduction of anti-takeover measures cannot be welcomed. Before a company introduces such measures, there are things that it should do. For example, efforts should be made to enhance long-term shareholder value. Such anti-takeover measures, when they are introduced, are introduced with the intention of preventing any takeover approach at all costs. This is very inward-looking and I have concerns as to whether a company would be able to survive global competition with that kind of mindset. (...)" (Yano; 2007)
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Shareholder Activism in Japan: Accomplishments
But not all is going awry in Japan. Focusing on the bad aspects of corporate Japan does cloud the mind for the huge opportunities Japan holds for the patient and long-term value investor, who is genuinely interested in Japan and for the Japanese country as a whole.
There are very encouraging signs that a productive relationship can be built between investors and management, assuming the right approach is taken.
Dismantling of Take Over Defense Plans
For example, some companies (but way too little) abolished their takeover defense plans. Cosmetics maker Shiseido (4911), internet provider eAccess (9427), contact lenses company Nihon Optical (2680), mail order retailer Nissen Holdings (8248), and food chain operator Osho Food (9936) are among the companies who scrapped their anti-take-over defense measures. According to Shinzo Maeda, former president of Shiseido, “The best way to raise a company's value is to grow its value by improving growth outlooks." (SP; Sept.2008)
Bingo! Apparently, some corporate leaders starting to recognize that a reasonable valuation of a company is the single best defense device to unsolicited take-over bids. But still there is a lot to wish for in the future, as roughly 600 companies (approx. 1/6 of companies listed at the Japanese stock exchange) cling to its anti-takeover measure (numbers from 2008). (Hamato et al)
Corporate Japan Starting to Embrace M&A And Improve IR
Japanese firms are also changing their attitudes towards M&A. The pace is picking up and the nature of the deals is changing. In the past M&A deals involved mainly domestic firms as they restructured and spun off non-core subsidiaries. But lately the merger activity spreads to core businesses, with consolidation in a number of industries including oil, steel, banking, insurance, pharmaceuticals and retailing. Japanese firms have also made more acquisitions abroad. Most importantly, those deals are not about snapping up trophy assets like in the late 1980s. They are strategic purchases by Japanese firms to make themselves more competitive globally. (Economist)
Another encouraging development is the fact that more Japanese companies have stepped up their investor relations efforts. NTT might be a good example. The IR page is just superb. They even broadcast the analyst meetings live and with English translation.
A More Pro- Active Japanese Pension Fund
Excited one should be with the changing mindset coming from the institutional sphere within Japan. The spearhead is the pension fund (PFA), run by the already mentioned Tomomi Yano.In 2007 he announced that the fund would not reelect corporate directors if the company’s ROE was 8% or lower for three consecutive years. (SPJ; March 2008) Tomomi Yano's remarks are extremely encouraging: "(...) we purchased ¥1 trillion worth of Japanese equities and decided to be vocal with Japanese management. Not that we enjoyed this, we did it rather reluctantly. It would be better if Japanese companies could increase their profits and return it to their shareholders without us being this active. (...)" (Yano; 2007)
AGM's Finally Becoming Relevant
Moreover, Annual general meetings of shareholders (AGMs) in Japan have undergone a significant transformation too. It was common for many companies in Japan to hold their AGMs on the last Thursday in June. But meeting schedules have gradually become less concentrated. In 1997 93.8% of all listed companies (1,807 of 1,927 companies) held their AGM on the same day. This number declined to below 50% for the first time in 2008.
Consequently, it is now easier for shareholders to participate at the AGM's of their companies. In addition, most of these meetings are not mere rubber-stamp affairs anymore when it comes to voting by institutional investors. (Iwatani et al) An increasing number of them are scrutinizing the proposals diligently. In 2002, asset managers only rejected 3% of proposals, but that number rose to 10-15% in 2008. In 2001, GPIF (Government Pension Investment Fund), the largest pension fund with ¥114 trillion worth of assets under management in 2008 (US$1 trillion approximately), voted against a mere 0.5% of proposals, but that rejection ratio was up to 10-20%. The mutual fund societies for local civil servants are also starting to exercise their voting rights. However, a great number of asset managers continue to remain silent, out of deference to their clients. (Yano)
As for the time allotted to these meetings, in the past management and institutional investors thought the shorter the shareholder meeting the better. In 2003, 40% of companies had shareholder meetings which lasted less than 30 minutes, while in 2008 that percentage came down to 20%. Meanwhile (in 2007), companies that have shareholder meetings lasting more than one hour rose from 15% to 24%. (Yano)
At AGM's in Japan there used to be almost no opportunity for attendees to ask questions. General shareholders did not give the AGM much thought. But meetings now are more open to the shareholders themselves and thus, have stoked greater interest to the owners in shareholder voting.
Furthermore, annual meetings have essentially become a platform for investor relations. Executives have become more receptive to receiving and answering questions. A growing number of companies are now actively encouraging individual investors to attend the shareholder meetings. They provide samples of their products, holding concerts (in the case of entertainment companies) or other events in conjunction with the meeting. They are holding roundtable discussions with shareholders following the annual meeting as a forum for shareholders to share their opinions.
Most importantly for foreign shareholders, many AGMs are now designed so as to make it easier for nonresident shareholders to vote. Nonresident investors have long claimed that, in addition to most AGMs being scheduled simultaneously, the short period between the time the notices are sent out and the day of the meeting did not leave them enough time to attentively review the proposals. A growing number of companies have responded to this complaint by sending meeting notices out earlier. There is also an increasing number (albeit gradual) of companies sending out notices and conducting shareholder votes electronically, making it easier for nonresident shareholders to vote. (Iwatani et al) In short, many AGMs in Japan finally have begun to function as an effective decision-making body.
Companies Starting To Concentrate on ROE And Capital Efficiency
Also worth mentioning is the increasing number of companies formulating mid-term business plans, long-term capital policies and policies for shareholders. As for directors’ remuneration, retirement allowances have been abolished and some companies have adopted a system of linking share prices to the remuneration of directors. (Yano)
But most importantly, corporate Japan advanced significantly when it comes to the return of excess cash and free cash- flow to the owners. Although many of the demands for higher dividend payouts and share repurchases were defeated at the AGM's between 2003 and 2009, it was also observable that in many cases companies subsequently introduced their own resolutions and policies to increase dividends and share repurchases by a smaller amount, in effect meeting the activists halfway. (Economist)
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Did Hostile Activists Do Fellow Investors A Disfavor?
Following the "hostile" approaches in Japan there was a controversy going on. A lot of people in the business and financial community were basically mad at the "activist" funds. They reasoned that their activities made it more difficult for other investors to convince corporate Japan to do what they had to do for the good of the shareholders and the country as a whole. (Economist)
But not everyone sympathized with that view. A handful of investors stated that the controversy engulfing the "hostile" activist funds made executives at Japanese companies more, not less, sensitive to shareholder demands. After the action of Steel and Murakami went viral corporations like Toyota Motor (TM), Matsushita Electric Industrial (MC) and other big companies aggressively steeped up their stock repurchase programs. Many investors were reassured by those developments and stayed put. Others even added to positions in a market that was deemed undervalued. (Businessweek)
Be that as it may. The trend of increased shareholder return has not abated. Dividend payments in Japan have been increasing steadily, in some instances significantly (although the pay-out ratio in aggregate has to be considered too low when taking into account extraordinary items, i.e. when using the adjusted earnings).
Even more encouraging is the trend in share repurchases. 2013 was very likely close to the record years of the mid 2000's. What the increased awareness regarding the return to shareholders might be; if it was independent judgment by the management or guidance by activist funds behind the curtains. It does not matter! What is important is that corporate Japan does the right thing. Namely to return an increased amount of funds, resulting from the unwinding of cross shareholdings, free cash- flow and/or excess cash holdings, to the shareholders. Either through dividends or share repurchases. Whatever management deems as appropriate. Sound financial practices require that excess earnings not being efficiently utilized by a company should be returned to its shareholders.
Most importantly, retained earnings should not be used to disenfranchise ordinary shareholders by entering into cross shareholding arrangements intended to serve as takeover defense mechanisms. Shareholders are the true owners of the company and, by extension, its retained earnings. (SPJ; May 2009)
Concluding Remarks
In this post, among other things, I tried to shed some light on the actors and their strategies, characteristics of the targeted companies and their countermeasures and, last but not least, on the outcome of the actions by activist funds in the first decade of the year 2000 in Japan. Apparently a lot of things went into the wrong direction. Not seldom the actions, mainly those of "hostile" activists, ended in an outright mud- throwing contest by the participants, with insubstantial accusations on both sides.
Granted, Steel Partners was strategy wise ill-advised when it came to communicating, or better the lack of communicating , his intentions to management and the Japanese public in a comprehensive manner. But calling someone a "villain", "locust", "vulture", or even worse, calling into question someone’s integrity, as it happened to Warren Lichtenstein in Japan, went way too far.
There is no doubt, that Lichtenstein is a true value investor in the spirit of Graham and Dodd. Short- termism and undue demands are not components of the Graham and Dodd philosophy. The enhancing of long-term shareholder value and an efficient and sustainable corporate structure is. Most importantly, integrity is the most precious resource of a value investor, especially when he is vocal and active.
The accusations of Lichtenstein being a greenmailer might serve as a good example for unduly calling into question his integrity. Lichtenstein, in his letter from August 2007, explicitly clarified that: "(...) Neither Steel Partners Japan nor any other affiliates of the Steel Partners group has or ever will engage in “greenmail.” Greenmail means that a shareholder buys shares and ultimately forces the company to repurchase its shares, but not the shares of other shareholders, at a higher price. We would never accept an offer that wasn’t made to all shareholders. (...)." (SP; August 2007)
During my research of SPJ's activities in Japan I didn't come across one instance that could have arousen any suspicion of breaching this strict code of conduct. This cannot be said about all of the active players, might they be "hostile" or "friendly; foreign or domestic. Some of them did engage in greenmailing.
As to the argument that these funds are vultures, I think the following can be said. Instead of mud- throwing the establishment in Japan should ask themselves: Why did those companies became targeted by foreign activist funds. As far as I can see it, first and foremost, because those companies were underleveraged and had a lot of assets on their balance sheets, like cash deposits, securities and land, which were not being utilized efficiently. Furthermore, they kept on (and still doing so) accumulating vast amounts of retained earnings. Profitability was low, and while they had good management resources, management performance was poor, which was why the share price suffered to such an extent that in many instances they traded below liquidation value. (Yano)
The management, not being bothered at all with the absurd situation of the existing shareholders being poor and their companies rich, kept on playing golf and enjoyed the social prestige and the animities of being an executive or director. They not even bothered giving any satisfactory explanation of this obscene situation to their shareholders. This was observed by activist funds, most of them foreign, which not only have the means to remedy such a ludicrous situation, but as much important (or more so) the expertise. Before criticizing the funds, the Japanese establishment should have looked at the targeted companies, trying to figure out whether there were any problems in their corporate governance. They should have forced the management to explain to the shareholders of the company the status- quo and remedied those problems. (Yano)
Unfortunately, most "vocal" investors in Japan are foreign funds. Only a limited number of Japanese institutional investors are vocal, due to the fact that the Japanese seldom confront apparent nuisance actively and openly. But they in Japan should do more, because it is in the interest of Japan and its people. Instead they are leaving it to the foreign funds, which is quite regrettable. It appears that without foreign pressure Japanese people do not budge. While this may be one of their characteristics, they should shed that kind of image and change. It is time for the Japanese people to understand that the great majority of stock listed on the Japanese stock market is their money. Market developments are going to make a difference to how much they will receive in pension money. (Yano)
So this is Japan's matter and it is in their interest to study proposals made by fellow shareholders carefully. More often than not those proposals are savvy and productive. Not only for the individual shareholder, but also for the employees, the Japanese economy, and the people of Japan as a whole.
On the other hand foreign funds should make an effort to clarify that they are not after short-term profits. They should do a better job of communicating this to the people, and gain the understanding of the general shareholders of the company and the Japanese society. (Yano)
The Little Post about Shareholder Activism in Japan - (Part One)
The Little Post about Shareholder Activism in Japan - (Part Three)
Source:
Masanobu Iwatani; Toshio Taki; Evolution of General Shareholders' Meetings in Japan; Nomura Institute of Capital Market Research
Yasushi Hamao, University of Southern California; Kenji Kutsuna, Kobe University Pedro Matos, University of Southern California U.S.-Style Investor Activism in Japan: The First Ten Years This Version: October 21, 2010
Message in a bottle of sauce (Economist)
Firms Look to Buy Back Interest in Their Shares (Wall Street Journal)
Brandes; Balance Sheet Cash: Unlocking Value in Japan; October 2006
Tomomi Yano; Closing Keynote Speech; Asian Business Dialogue on Corporate Governance 2007
Miki Tanikawa; Mixing it up? Shareholder activism, corporate governance and the outlook for M&A in Japan; An Economist Intelligence Unit White paper 2008
Robert Romano; LESS IS MORE: MAKING SHAREHOLDER ACTIVISM A VALUABLE MECHANISM OF CORPORATE GOVERNANCE; Working Paper 12/01 CERP
Konari Uchida; Peng Xu; US Barbarians at the Japan Gate: Cross Border Hedge Fund Activism; Bank of Japan Working Paper Series February 2008
Steel Partners Japan; Letters to Shareholders; August 2002
Steel Partners Japan; Letters to Shareholders; August 2007
Steel Partners Japan; Letters to Shareholders; February 2005
Steel Partners Japan; Letters to Shareholders; March 2008
Steel Partners Japan; Letters to Shareholders; September 2008
Steel Partners Japan; Letters to Shareholders; May 2009
Steel Partners Japan; Letters to Shareholders; September 2008
Steel Partners off the Sauce in Japan (by Kenji Hall; Businessweek)
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Great read, thanks.
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