Why stock exchange reforms will turbocharge value in Japan

One question has gripped investors since the appointment of Kazuo Ueda as the new governor of the Bank of Japan: when will he abandon the ultra-loose monetary policy of his predecessor Haruhiko Kuroda?

Doubtless, this is an important consideration for investors in Japan. 

But it is far from the only major development in Japan to which investors should pay close attention, particularly those with a leaning towards value.

At the end of March, Japan Exchange Group (JPX), the operator of the Tokyo Stock Exchange (TSE), outlined the new JPX Prime 150 Index.

It will be made up of 150 stocks selected to represent "Japanese companies that are estimated to create value".

It will comprise the top 75 names in the TSE Prime Market by market capitalisation whose price-to-book ratio is greater than 1.0 times, and the top 75 names in terms of estimated equity spread (the difference between return on equity and cost of equity). 

Clearly, Japan has been a market in which companies have not sought to maximise shareholder value.

The creation of the index is significant for a number of reasons.

Most notably, it gives teeth to the TSE’s recent decision to demand capital improvement plans from companies languishing on sub-par valuations (partly a naming and shaming exercise).

If being outed as a laggard was not enough, the prospect of failing to make it into this exclusive index will provide a powerful incentive to management teams to improve their profitability and corporate value.

It is notable that some significant names will be under scrutiny – even Honda would not make it into the index on its current valuation. 

All told, these corporate reforms, as well as the others that accompany them – including those seeking to tackle traditional Japanese market bugbears like cross-shareholdings – represent the most important transformation in Japanese governance the investment team has ever witnessed.

Assessing the impact 

For investors like us, the drive towards better corporate governance provides additional leverage in terms of our influence over the companies in which we invest.

It is fast becoming untenable for management teams to brush off investor efforts to force companies to act in a more shareholder friendly manner.

Failure to directly address a low stock price is, as the government and the stock exchange implement major corporate governance reforms, not going to be a sustainable investor relations strategy.

There is nowhere else in the world where investors will find such a ‘self-help’ approach to improving returns.

At the same time, this will make management teams in Japan, who historically have played a backseat role compared their global peers, more important.