Published in the Financial Times 24/6/2015
In many fields of human endeavour, change that is gradual, cumulative and consensual is more durable than dramatic reforms imposed from above. Such is likely to be the case with Japanese corporate governance which has been edging towards a new shareholder-centric approach since the collapse of the old banker-dominated model in the financial crises of the 1990s .
Helpful nudging from the administration of Prime Minister Shinzo Abe has expedited the process. Still, what emerges will not be a slavish copy of the British or American systems, but something that suits Japanese conditions. Who knows – there may even be features that western countries might consider borrowing.
A case in point is Toyota’s recently announced issue of “Model AA” shares, named after the company’s first passenger car, which was based on the Chrysler Airflow and launched by Kiichiro Toyoda in 1936. This new share class is aimed at Japanese retail investors – particularly those who own Toyota vehicles, according to the company – and designed to deter short-term traders.
The stock will not trade on the market and cannot be transferred to another person. In return for sacrificing liquidity investors will reap a dividend yield several multiples of the interest paid on a 10-year government bond. After 5 years they can sell it back to the company at issue price or convert to ordinary stock. Toyota chose the 5 year “lock-up” because that is the timeframe for the research and development projects it plans to finance with the proceeds.
A further benefit is that retail investors are likely to get closer than professional fund managers to Warren Buffett’s ideal holding period: “forever.” At the moment they own just 10% of the company, compared with the 31% owned by fickle foreign institutions.
All this is very much in line with Japan’s new corporate governance code, which extols long-term investors who “have the potential to become important partners for companies.” It must also be music to the ears of Mr Abe, who has made the revival of a Japanese equity culture a key part of his programme. According to “One Half- Billion Shareholders and Counting”, a study by Paul Grout, William Megginson and Anna Zalewska, 31 per cent of Japanese people own shares, against the UK’s estimated 15 per cent. The amounts held, though, are much smaller and have not increased in recent years
There has been pushback, especially from foreigners, who will find it difficult to invest unless they are Japanese residents. At Toyota’s recent shareholders’ meeting, the California State Teachers Retirement System complained that the special class violates the principle of shareholder equality. In the end the measure passed with 75 per cent of shareholders in favour, which is low by Toyota’s standards; no proposal by the board has been defeated since the company was founded.
Much of the criticism is unwarranted. The truly egregious violations of shareholder equality are the dual-class shareholding structures which give corporate insiders voting rights totally out of line with their financial exposure. Such schemes are illegal in Japan but not in the US, the UK and Canada, where they have allowed media moguls to turn public companies into dynasties and internet billionaires to cash out while retaining control of their empires.
The new issue may not conform with the tenets of corporate governance theory; as it carries no downside risk, it is effectively a bond and should not carry voting rights. Still as the baseball manager Yogi Berra is said to have said: “In theory there is no gap between practice and theory; in practice there is.”
Theoretically in the US and the UK financial institutions exercise competent governance over the companies whose shares they hold because it is in their own best interest. In practice they do not because each single position is too small to make a difference and, anyway, if things are going wrong they can simply sell.
Instead the governance gap is filled by activist investors and various codes of conduct that financial institutions are increasingly forced to observe. Even so there remains a natural tension between financial investors’ quest for short-term performance and the longer time-horizons that businesses require for healthy development.
The Model AA could do with a tune-up. There is no need to exclude foreigners though perhaps ownership of a Toyota vehicle should be a condition. The share should incorporate some equity risk too. All in all, though, this is a creative attempt to address a damaging dysfunction. If it works, its best features should be copied – just as Kiichiro Toyoda copied the best features of the Chrysler Airflow all those years ago.