On the Growing Interest in the Japanese Stock Market

On February 22, 2024, the Nikkei Stock Average reached a new market high for the first time in 34 years. This is a sign that expectations for the Japanese stock market are recovering, and at the same time, we can expect further interest from more investors as the news makes headlines.

The rise in stock prices can be attributed to several factors, including the end of deflation and the shift of funds from China, but the most important factor for us is the improvement in corporate governance.

Brief Overview of the Japanese Corporate Governance

Weak corporate governance has long been a problem in Japan. During Japan's postwar economic recovery, an economic system based on indirect financing was established, in which banks also held shares in the companies they lent to and played a supervisory role over the companies. In 1985, banks and insurance companies owned 39.5% of Japanese stocks (Source: TSE).  However, in the 1990s, due to a combination of factors including the financial crisis, investment diversification, and capital controls, financial institutions began to sell their holdings of Japanese stocks, and their holdings have declined to less than 10% since 2004 and to 5.9% in 2022. With the decline in financial institutions' shareholdings, some companies have been left without supervision. This situation began to change when Shinzo Abe became prime minister in 2012, and the following year he began implementing corporate governance reform measures as part of his growth strategy. The Japanese Stewardship Code and Corporate Governance Code were enacted successively in 2014 and 2015, respectively, leading to a change in awareness among both institutional investors and listed companies.

Over time, these measures have become more widespread, and awareness among Japanese companies has begun to change. For example, in 2015, only 10.5% of companies listed in the First Section of the Tokyo Stock Exchange had a nomination committee, but by 2022, 83.6% of those listed in the Prime Market had a nomination committee (Source: TSE). This has brought transparency to top management appointments that were previously made behind closed doors, allowing people to be selected based on their abilities and establishing a system that allows management decisions to be made free from the ties of predecessors. Furthermore, in March 2023, the Tokyo Stock Exchange required listed companies to manage their businesses with an eye on the stock price, which further raised management's awareness of corporate value.

These positive changes were powerful enough to raise investor expectations, which we believe has helped lead the market to its highest level in 34 years.

Next Step

However, Japanese companies still have a long way to go in improving corporate governance. The establishment of an effective system must be reflected in corporate performance and other tangible results.

From a shareholder perspective, the focus will be on whether ROE improves. In 2012, just before the start of corporate governance reform, the average ROE of Japanese companies was 4.4% (Source: TSE). Although it rose to 9.1% in 2023, it is still low by global standards. For companies with a low ROE due to their large holdings of low-profit assets such as cross-shareholdings and cash & cash equivalents, profitability can be greatly improved simply by management making rational decisions. Once profitability improves, management will be able to assess a wider range of actions and make decisions with a long-term perspective, which is expected to lead to a virtuous cycle of further improvement in profitability.