InvestmentsNov 30 2015

Reforms are key to increasing dividends

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Ongoing corporate governance reform is the catalyst to unlock Japan’s substantial ability to become a key source of dividends for global income investors.

Indeed, the country has the potential to generate the strongest dividend growth among developed markets in the next decade.

In a now infamous comment made during a lecture in 2008, the then vice-minister of Japan’s powerful Ministry of Economy, Trade and Industry (Meti) Takao Kitabata said: “To be blunt, shareholders in general do not have the ability to run a company; they are fickle and irresponsible. They only take on a limited responsibility, but they greedily demand high dividend payments.”

For many, this sums up how corporate Japan tends to think, or indeed not think, about its minority shareholders. It goes a long way in explaining why the country has not always been a friendly place for dividend investors. Japanese companies were quick to cut payouts during the recent financial crisis, for instance.

Listed firms in the nation have not historically been managed with the same corporate mindset that is taken for granted in the majority of developed equity markets.

Management decisions have instead been largely guided by stakeholders rather than shareholders, particularly the companies that made up the ‘keiretsu’ network – a group of businesses often with interlocking relationships and shareholdings – and the main bank that provided financing.

As a result, rewarding shareholders with a healthy and progressive dividend was often low on the list of priorities.

This standpoint is encapsulated by a 1995 survey of senior executives at large firms. They were asked two questions: whether they saw the company as the property of shareholders or stakeholders, and whether they prioritised job security or dividends.

Japanese executives responded emphatically that stakeholders and job security were the primary concern, to the detriment of shareholders and dividends.

Attitudes towards shareholders and their returns are undergoing significant change in Japan. We are witnessing fresh impetus for corporate governance reform, which is a key tenet of Abenomics – the name given to prime minister Shinzo Abe’s efforts to boost the economy – and Japan’s Revitalisation Strategy.

The latest wave of Japanese corporate governance reform was kicked off by the launch of the JPX-Nikkei 400 index in January 2014.

The important point about this index is that it has an explicit 5 per cent return on equity threshold, which is incentivising companies to both invest more into their businesses and crucially – from an income investor’s standpoint – to increase the level of shareholder returns.

Since then further reforms have included the adoption of a stewardship code, which encourages investors to act and vote as owners of businesses, and the corporate governance code, which came into force at the beginning of June this year.

Indeed, Meti has been at the forefront of corporate governance reform. It was responsible for the August 2014 Ito Review, which called for companies to commit to achieving a minimum return on equity of 8 per cent, well in excess of the Nikkei 400 index’s threshold. This change of heart is a clear indication of the shift in attitude towards shareholders.

The job is far from done, of course. Corporate scandals – such as Toshiba’s falsified accounts, which came to light earlier this year – serve as a reminder that there is a long way to go. However, the fact that there is such significant room for improvement is where the opportunity for income investors lies.

Japan has long had the ability to pay higher dividends and this has only been enhanced by the surge in profits brought about by Abenomics. Cash levels on Japanese balance sheets are extreme; the 1,880 companies that make up the Topix index are sitting on nearly ¥80trn (£432bn) of cash. That is equivalent to an economy the size of Switzerland.

The catalyst to unlocking this ability to pay higher shareholder returns has been missing until now. There’s no doubt that the corporate governance reforms are driving a new-found willingness to align Japanese firms’ interests with their shareholders. This means that, in Mr Kitabata’s words, investors can now greedily expect higher dividend payments in Japan.

George Boyd-Bowman is manager of the Neptune Global Income fund