Corporate Governance and Value Creation in Japan (eBook)

Ryohei Yanagi is Chief Financial Officer of Eisai Co., Ltd., one of the largest pharmaceutical companies in Japan. He is also Visiting Professor at Toyo University and Visiting Lecturer at Waseda University Graduate School of Accountancy, where he teaches corporate governance, corporate finance and investor relations. He earned his Ph.D. from Kyoto University. During the last 15 years, Dr. Yanagi has conducted approximately 3,000 meetings in the aggregate with global investors (about 200 meetings per annum) throughout his career with UBS as Executive Director and at Eisai as CFO. He was selected as the Best CFO in Japan’s healthcare sector in 2016 and 2017 by the Institutional Investor magazine. He was also ranked in the Top 10 CFOs by Forbes Japan for the second consecutive year. In addition, Dr. Yanagi has served as advisor to the Tokyo Stock Exchange and the Ministry of Economy, Trade and Industry (METI), including the Ito Review. He is Secretary of the Institute of Management Accountants (IMA) Tokyo Chapter as a certified management accountant, and has written and published many books and theses on his research agenda. 

Preface 5
Contents 7
About the Author 12
1 Dawn of Corporate Governance: Japan Must Change 14
1.1 Japan’s Stewardship Code, Corporate Governance Code, and the Ito Review (Three Pillars of Japan’s Corporate Governance Reforms) 14
1.1.1 Japan’s Stewardship Code: Principles for Responsible Institutional Investors to Promote Sustainable Growth of Companies Through Investment and Dialogue 15
1.1.2 Japan’s Corporate Governance Code: Seeking Sustainable Corporate Growth and Increased Corporate Value Over the Mid- to Long-Term 16
1.1.3 The Ito Review: Competitiveness and Incentives for Sustainable Growth Building Favorable Relationships Between Companies and Investors (Final Report) 17
1.2 The Perspective of Global Investors and Japan’s Corporate Value 18
References 24
2 Cash Valuation Assessment of Japanese Corporations: When 100 Yen Is Valued at 50 Yen 25
2.1 Why Is 100 Yen Valued as 50 Yen?: Discounting the Value of Cash Held by Japanese Companies 25
2.2 Background of Cash Discount Previous Academic Research Results: 100 Yen of Japanese Company Is Worth Only 55 Yen 30
2.3 Latest Empirical Research on the Marginal Value of Japanese Companies’ Cash—Evidence and Reconfirmation of the 50% Discount 33
2.3.1 Research Design and Sample 34
2.3.2 Empirical Results and Analysis 44
2.4 85% of Overseas Investors Discount the Value of Cash Held by Japanese Companies 48
2.4.1 Global Investor Survey Results 49
2.4.2 Major Comments by Overseas Investors Concerning the Value of Cash Held by Japanese Companies 52
2.5 How Can Japanese Companies Obtain the Market Valuation of 100 Yen as 100 Yen? 57
References 59
3 Abenomics Requires Enhancement of Corporate Value via ROE 61
3.1 What Is ROE? 61
3.2 Inconvenient Truth: Japan as a Low ROE Nation Primary Cause of International ROE Inferiority Is not Leverage but Margin 64
3.2.1 Decomposition of ROE by DuPont Analysis Method, in Which the Primary Cause of the Problem Was not Leverage but Margin 64
3.3 Leverage Matters (Life-Cycle Consideration and Optimal Capital Structure Needed for Value Maximization) 67
3.4 Global Investor Perceptions of ROE and Governance: Investors Expect to Improve ROE Through Governance Reforms 70
3.4.1 Japanese Companies and Investors, and the Gap in ROE Recognition 70
3.5 Global Investor Survey of Japan’s Version of Its Stewardship Code 71
3.5.1 Global Investor Survey About the Corporate Governance Code 77
3.6 Why Is ROE a Priority for Global Investors? ROE Is a Proxy of Shareholder Value 83
3.6.1 Total Return of Shareholders Is Attributable to ROE 83
3.7 Companies’ Valuation of PBR Depends on ROE 86
3.8 High ROE Is Partly Determined by Corporate Governance 89
3.9 Japanese Companies Will Benefit from Enhancing ROE: Win-Win Situation on a Long-Term Basis 91
References 92
4 Equity Spread and Value Creation 93
4.1 “Ito Review” and Equity Spread 8% Is Magic Number 94
4.2 What Is Equity Spread? The Black-Ink on Accounting Is Actually Red-Ink in Some Cases 95
4.2.1 What Is Equity Spread (ES)? Residual Income Model (RIM) Verifies It 95
4.2.2 Equity Spread and Value Creation Indicated by Empirical Data 98
4.3 The Perception Gap Between Japanese Companies and Investors: Dialogue on Equity Spread Could Bridge the Gulf 102
4.4 Value Proposition of Disclosure of Equity Spread and Engagement: We Have to Feel the Pain as Pain for Change 105
4.5 Overseas Investors Views on Shareholders’ Capital Cost: Evidence of 8% Backed by Empirical Research 107
4.5.1 Estimated Calculation of Shareholders’ Equity Cost and Empirical Research 107
4.5.2 Estimation of Shareholders’ Equity Cost by Global Investor Survey 112
4.6 Quantitative Analysis of Equity Spread and Performance Investment Strategy Adopting Equity Spread Wins 114
4.7 Perspective of the Company and Long-Term Investor Could Be Synchronized: Equity Spread and Non-financial Capital Are Connected Through MVA 122
References 124
5 Value Creative Investment Criteria 126
5.1 Investment Criteria for Capital Expenditure of Japanese Companies: Too Obsessed with Simple Payback Period (SPP) Without Considering Capital Cost 127
5.2 What Investment Criteria Are Required by Investors? It Is Mandatory to Be Conscious of the Cost of Capital 129
5.3 Utilizing Two Hundred Kinds of Hurdle Rates: Importance of the Risk Adjusted Hurdle Rate 135
5.4 Investment Criteria for Cross-Shareholdings that Correspond to Investor Criticism 140
5.4.1 Griping of Foreign Investor: Cross-Shareholdings Is “the Root of All Evil” 140
5.4.2 Accountability for Investment Criteria of Cross-Shareholdings 143
5.5 Focal Point for Japanese Companies: Is Value Creation Secured by M& A?
References 151
6 Optimal Dividend Policy Based on Optimal Capital Structure 152
6.1 Dividend Puzzle 153
6.2 Dividend Payout Ratio of Japanese Companies Has Caught up with the U.S.: All Problems Are Solved? 154
6.3 Fallacy of Boilerplate Dividend Policy by Japanese Companies 158
6.4 Dichotomy Between Japanese Companies Groupism and Investor Perspectives 160
6.5 Global Investors Demand Dividend Policy Based on Optimal Capital Structure 163
6.5.1 The Result of Global Investor Survey: Most Overseas Investors Answer that Companies Have to Focus on Capital Efficiency and ROE 163
6.5.2 Global Investors’ Perspectives About the Dividend Policy of Japanese Companies 163
6.6 Optimal Dividend Policy Based on Optimal Capital Structure: Fulfill Their Own Accountability 169
6.6.1 What Is the Optimal Dividend Policy Based on Optimal Capital Structure? 169
6.6.2 Japanese Companies Have to Fulfill the Accountability for Dividend Policy 174
References 176
7 Synchronization of Non-financial Capital and Value Creation: Japan Should Show ROE of ESG 178
7.1 The Purposeful Dialogue Between Companies and Investors Recommended by the Japanese Stewardship Code and the Corporate Governance Code 179
7.2 ESG (Environment, Social, Governance) Impact on Corporate Value Global Investor Survey Pertaining to ESG as Qualitative Evidence 181
7.3 Engagement Agenda Between Japanese Companies and Overseas Investors: Achieving a Good Balance Between Social Value and Economic Value 185
7.4 The Integrated Report as a Tool of “Purposeful Dialogue”: Case Study of Integrated Report by Eisai Co., Ltd. 188
7.4.1 The Character of the Integrated Report 188
7.4.2 Case Study of the Integrated Report of Eisai Co., Ltd. 189
7.5 All Japan Case from the Viewpoint of IIRC-PBR Model 194
7.5.1 Inconvenient Truth 194
7.6 IIRC-PBR Model and Synchronization of Non-financials and Equity Spread 195
7.7 Case Study of Non-financial Capitals and Equity Spread Synchronization Model 198
7.7.1 Eisai Case: Supplying DEC Tablets Free of Charge 198
7.7.2 SAP Case: Employee Satisfaction Translated into Profit 200
7.8 Correlation Between Five Non-financial Capitals and PBR: Empirical Research as Quantitative Evidence 201
7.8.1 Existing Empirical Research Implying Correlation Between Non-financial Capitals and Shareholder Value as Quantitative Evidence 201
7.8.2 Latest Empirical Research Regarding the Relationship Between Non-financial Capitals and PBR in the Case of Japanese Healthcare Companies to Support the IIRC-PBR Model 215
7.8.3 Latest Empirical Research on the Relationship Between Intellectual Capital/Human Capital Versus MVA in Japan to Prove the Synchronization Model of Non-financial and Equity Spread 217
7.9 Conclusion: Synchronization Model of Non-financial Capital and Shareholders Return 219
References 220
Appendix: Latest Investor Survey 2016 and 2017 222
Introduction 222
Questionnaire Survey of Investor Perspectives on Corporate Governance Reform 2016 223
What Do You Most Expect from the CGC (Corporate Governance Code)? 223
Are You Satisfied with Overall CG at Japanese Companies? 224
Are You Satisfied with ROE at Japanese Companies? 225
Is There Any Relationship Between CG and ROE? 226
How Much Do You Estimate Shareholders’ Equity Cost to Be (Although Different for Individual Companies, Given in Average Japanese Stock Based on 1-Beta Premise)? 227
Are You in Favor of an 8% Minimum ROE as Recommended in the Ito Review? 228
Do You Agree with ISS’ Voting Guidelines About Voting Against the CEO in Cases Where the Five-Year ROE Average Is Less Than 5%? 229
Equity Spread (ROE Minus Shareholders’ Equity Cost, ES) Was also Introduced in the Ito Review as a Proxy Variable for Value Creation. Do You Support the Proposal that ES Should Be Disclosed in Tokyo Stock Exchange Financial Statements and Discussed in Order to “Educate on Achieving ROE Above Cost of Capital”? 230
What Is the Overall Most Important Issue Regarding Dividend Policies of Japanese Companies? 231
Do You Agree that Good-Quality CG Reduces Cost of Capital? 232
What Do You Think About ESG (and Integrated Report Disclosures) by Japanese Companies? 233
Lastly, How Do You View the Outcomes to Date in Recent Years in the Japanese Market, Such as the Abenomics CG Reforms? (Total of Japanese Investor and Foreign Investor) 235
2017 Survey Results 239
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Are You Satisfied with Japan’s Corporate Governance in General? 239
Are You Satisfied with Japan’s ROE in General? 241
How About “Financial Literacy” of Japanese Corporate Executives? 242
In General, What Is Cost of Equity (CoE) for Corporate Japan? (COE Depends on Each Company but Let Assume All Japan Average Generally, that Is Beta = 1 TOPIX Condition) 243
Do You Agree with the Statement “Japanese Companies Should Seek at Least 8% ROE” as Stated in “The Ito Review”? 244
Do You Agree with the Proposal “Equity Spread (= ROE Minus Cost of Equity) Should Be Discussed to Enhance the Literacy of ROE Above COE”? 245
What Do You Think About Japanese Companies’ ESG (Environment, Social, Governance) and Its Disclosure (by Integrated Reports)? 246
How Do You Factor ESG of Japanese Companies in Your Valuation/Investment Decisions? 247
Implications 247
Index 248