The changes in Japan may also fuel the interest of foreign investors seeking income, Simon Webber, lead portfolio manager for global and international equities, wrote in a research note.
The introduction of the stewardship code and the creation of the JPX-Nikkei Index 400 in 2014 have helped raise awareness of the benefits of proper governance.
The index is Japan’s first broad index that includes only profitable companies with value-creating returns and good governance.
The new index is composed of companies, which meet requirements of global investment standards, such as efficient use of capital and investor-focused management perspectives.
“This is certainly not the first time that Japan has attempted to tighten up its corporate governance,” Webber said.
“However, previous instances have largely stemmed from international pressure, whereas this time there is clearly a domestically-driven agenda with a much higher chance of real improvements as a result.”
Strong corporate governance is critical to boost confidence in the market and to achieve economic growth targets, he said.
“Reform of the country’s corporate governance structure is encouraging greater interaction between management and shareholders, which gives the latter more of an opportunity to draw attention to inefficient balance sheets and effect change in capital distribution policies.”
Progress being made
There are some clear signs of progress, he said.
He cited the example of Amada, a machine tool manufacturer, which has committed to return 100% of net profits to shareholders for the next two years.
“An improving global economy and the strong recovery in earnings that corporate Japan has experienced since Prime Minister Abe’s return to power at the end of 2012, means that companies are in a good position to let go of this cash conservatism and align their capital return policies more closely to those seen elsewhere in the developed world
“We expect this increasingly to be a feature of the Japanese stock market.”
Japanese companies traditionally have preferred to hold on to surplus cash rather than return it to shareholders, as corporate profits can be volatile due to high dependence on foreign demand.
Many companies hold more than 20% of their market capitalisation in cash, and some even hold more than 50%.
As a result, shareholders return-on-equity has significantly lagged that of other developed markets.