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Matthews Asia Weekly

Japanese Prime Minister Shinzo Abe gets another chance at driving reforms.

Rebuilding Earnings Power at Japan Inc.

Week of January 30, 2015

Last month, Prime Minister Shinzo Abe and his Liberal Democratic Party (LDP) won a landslide victory in a key Lower House election, securing four more years with which to push forward their reform agenda. I happened to be in Tokyo on the day of the election to watch the news unfold. It was a somewhat uneventful election given that the win was widely expected. Still, it was reassuring to see the LDP clinch a firm mandate to drive reforms. Following the elections, the government has swiftly ushered through a number of key initiatives that I believe will benefit Japan investors over the long term. 

Corporate Governance Code

First, let’s look at the Corporate Governance Code. The Financial Services Agency announced the final draft of the code just two days after the election, with the aim of implementing it by June 2015—to coincide with the time most listed Japanese firms hold their annual general meetings. The code will effectively require listed companies to appoint at least two independent directors to their boards, disclose an economic rationale and proxy voting procedure for cross shareholdings, and announce financial targets, such as return on equity (ROE). When I ask company management about ROE, the most common response I get is “we don’t really look at ROE.” Honesty is one thing, but it’s still really not something you want to hear. The aim of this code is to prod such management teams toward making better capital allocation decisions in-line with shareholder interests. There is additional pressure from Institutional Shareholder Services, a global provider of corporate governance solutions, which will introduce a 5% ROE threshold into its Japan voting guidelines starting February.  

Corporate Tax Cut

The LDP announced its proposal to cut the corporate tax rate from 34.62% to 32.11%, starting April 2015, and further reduce it to 31.33% in the following year. The measure also includes a tax break for companies that raise wages by over 3% in 2015 and over 4% in 2016. Given tight labor market conditions, many companies are already contemplating wage increases and some of them may be obliged to raise such wages to reach the threshold needed for the tax break. An increase in dividend taxation on non-controlling shareholdings was also included to discourage cross-shareholdings by corporations, in-line with the principles in the above-mentioned corporate governance code. 

White Collar Exemption

Last, but not least, is the proposal to deregulate a portion of the labor laws through so-called “white collar exemption.” Under Japanese labor laws, a work week is limited to 40 hours, and companies must pay overtime to non-management level white collar employees for any hours beyond that limit. The aim of this exemption is to better align achievements and pay as the existing system can result in less efficient workers being paid more. The exemption will apply only to workers making more than US$90,000 annual pay—a small, but necessary step to deregulate Japan’s rigid labor market and foster a culture of more meritocratic pay. However, unlike the first two proposals that face little opposition, this measure may face stiff resistance from within the LDP and labor groups.  

These measures cut straight to the heart of many Japan Inc. issues, namely inefficient capital allocation, cash hoarding and a low labor distribution ratio. It also shows Prime Minister Abe’s strong commitment to concentrate his efforts on Abenomics. However, the market seems to be overlooking the progress being made on these key issues in the wake of stumbling GDP figures that have followed the consumption tax hike. I believe such views are short-sighted and that these measures, in combination, may bode well for Japan investors over the long term. 

Kenichi Amaki 
Portfolio Manager 
Matthews Asia

The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.