How Japan’s stakeholder capitalism is changing

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SHIBUSAWA EIICHI is having a moment. A 19th-century industrialist known as the “father of Japanese capitalism’”, he helped found more than 500 firms, including Japan’s first modern bank. His life story has been turned into a hit new drama on NHK, Japan’s national broadcaster, and his likeness will grace a new ¥10,000 bill. “The change of the times is calling him back,” says Shibusawa’s great-great-grandson, Shibusawa Ken, who heads an asset manager in Tokyo. “There is a rethink about capitalism happening.”

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Shibusawa’s business philosophy, “the Analects and the abacus”, is in vogue. Echoing the 17th-century Edo-era precept of sanpo-yoshi, or “three-way good”—namely for buyers, sellers and society—Shibusawa fused Confucianism’s collectivist morality with market logic. Business should, Shibusawa believed, pursue private gain but in a way that benefits the public. If this sounds familiar, it is because “it is exactly stakeholder capitalism”, says Mimura Akio, head of the Japan Chamber of Commerce and Industry (JCCI), a business federation founded by Shibusawa.

The idea that companies should be guided by a social purpose and serve a broader range of interests beyond maximising shareholder returns is gaining adherents across the rich world. Japan is a rare big economy to have tried it at scale. It has become a rich country with low unemployment, comparatively little inequality and high social cohesion. But the system has also fostered corporate decadence and low growth. It is a case study of the trade-offs involved—and how they are changing. At Keidanren, Japan’s big business lobby, “no one denies” that corporations should create value beyond pure profit, says the group’s chairman, Nakanishi Hiroaki. Instead, the discussion is about “how to define” those broader, fuzzier values for today’s more complex society.

Japanese executives are no more culturally predisposed to be cuddly than American ones are to be prickly. Before the second world war the economy saw brutal merger-and-acquisition activity, brittle labour relations and dispersed ownership. It was only afterwards that corporate Japan started to rediscover its inner Shibusawa. Industrial policy supported businesses, while the private sector became part of the safety net, offering job security, often for life. A high-quality, stable labour force and strong ties with suppliers proved a successful mix in manufacturing, and enabled Japan’s economy to catch up with Western ones. “The workers wouldn’t strike and employers wouldn’t fire, and it worked out pretty well for everyone,” says Steven Vogel of the University of California, Berkeley.

Firms still maintain long-term relations with suppliers and customers even if this does not obviously benefit the bottom line. Boards and executive suites are dominated by long-time company insiders, who act less as representatives of shareholders than as heads of a family. Networks of cross-shareholdings, whereby friendly firms hold stakes in each other, help shield them from outside pressure.

This social contract can be a blessing when crisis strikes. During the pandemic Japan’s unemployment rate peaked at 3.1%, in part a function of a shrinking labour force, but also of employers’ loyalty to core workers. CEOs are paid far less than peers in the West. That may have helped Japan avoid the destructive populism that has arisen in America and other Western countries, thinks Hori Yoshito, founder of GLOBIS, a business school in Tokyo.

The old system’s drawbacks have also become more apparent. As Japan’s growth began to slow in the 1990s, the price was paid by a growing precariat. Firms reluctant to let full-time workers go have been hiring more people on short-term contracts with few of the protections afforded to salarymen. The share of “non-regular” workers has grown from 20% in 1990 to nearly 40% today. They are more likely to be young and female.

A lack of accountability has let executives grow complacent. Since the 1980s the influence of banks, which imposed discipline and oversight on management by controlling access to capital, has steadily waned. More capital now comes from foreign and institutional investors who have few ways of holding management to account. Instead of reinvesting profits or returning money to shareholders, managers hoard cash, ostensibly for a rainy day (see chart). If Shibusawa were alive he would be urging Japanese bosses “to take more risk”, says the younger Mr Shibusawa.

Japan needs a dynamic private sector to compensate for its shrinking and ageing workforce. Realising this, Abe Shinzo, prime minister from 2012 to 2020, made corporate governance central to his economic reforms. A stewardship code introduced in 2014 encouraged institutional investors to push executives to improve returns. A corporate-governance code implemented the following year pressed firms to bring in more outside directors to shake up boards. “In the US the issue is constraining the risk appetite of the CEOs,” explains a senior government official. “In Japan it’s poking the risk-averse CEOs”.

The reforms have had some effect. Over 95% of firms listed in the first section of the Tokyo Stock Exchange, a grouping of mostly large firms, now have two or more independent directors, up from 22% in 2014. The share with nomination and compensation committees, which advise on selecting and paying directors and executives, has gone from less than one in five in 2015 to three in five today. As a result, bosses pay more attention to financial performance and shareholder demands. Returns and cost of equity are “very much on their minds”, says Arthur Mitchell, a long-standing outside director. Although they remain stingier than their American counterparts when it comes to shareholder payouts, they are less so than before.

Return on equity for the MSCI Japan index reached over 10% in 2018 for the first time since before the global financial crisis. But other measures of profitability, such as return on assets, have not budged. Mostly, the disparity between top performers and stragglers has grown wider, says Nicholas Benes, who helped draft the governance code: “It’s a stock picker’s market”.

Merger and acquisition activity has ramped up, too. Legal poison pills against takeovers have become rarer: just 10% of listed firms had them in 2020, down from nearly 25% a decade earlier. Unsolicited offers for rivals are no longer taboo, notes Niinami Takeshi, boss of Suntory, a drinks behemoth, and government adviser. Japan saw five hostile bids in 2019—few by American standards, but the most in Japan since 2006. Some have succeeded, such as the purchase last year by Nitori, a home-goods chain, of Shimachu, a smaller rival.

Steps in the right direction

This month Japan’s Financial Services Agency is expected to toughen the governance code further, such as by demanding that firms bring in more and better outside directors. The Tokyo Stock Exchange is finalising plans to streamline its listings with membership of the top tier perhaps contingent on better governance. Shareholders have become more vocal. ISS, a firm which advises investors on shareholder votes, now suggests voting against directors of companies with 20% or more of their net assets in cross-shareholdings. At an extraordinary general meeting this week, shareholders of Toshiba, a conglomerate, gave the go-ahead for an independent investigation called for by an activist fund. It suspects the firm’s management pressured investors to protect the CEO at last year’s annual shareholders meeting.

Yet shareholders remain one voice among many—and still not a terribly loud one. Independent directors are in the majority on the board of only 6% of large listed firms. Before covid-19 hit, more than half of companies in the Topix index still had a net cash position, compared with just 14% of the firms in America’s S&P 500 index. Lifers still dominate. More than 90% of top managers at big listed firms are internal promotions, reckons Miyajima Hideaki of Waseda University. Cross-shareholdings still account for 32% of Japan’s market capitalisation, according to Morgan Stanley, an investment bank. That means that in many cases, “management is not really worried about the voice of the shareholders,” laments Murakami Aya, the CEO of C&I Holdings, an activist investor.

“In Japan, the traditional influence of workers and suppliers is not going anywhere,” says Mr Mimura of the JCCI. Japan has long been evolving a “hybrid form of governance” that seeks to balance shareholders’ focus on performance and management’s concern for stakeholders, argues Mr Miyajima. Meanwhile, the list of stakeholders that companies must consider is lengthening. Many investors, particularly foreign ones, are pushing firms to pay more attention to things like the environment and diversity, which Japan Inc has traditionally ignored. Gender equality is preached increasingly often, but still rarely practised. Women occupy just 15% of managerial positions and 11% of board seats.

Expectations about career paths are in flux. For some young Japanese, being treated well no longer means eternal job stability. They want better pay, flexible work conditions and less monotonous jobs. Keidanren, Japan’s business lobby, has recommended that its members move away from lifetime employment and towards merit-based promotion and compensation. Workers’ contributions should no longer be measured by the hours they put in, but by the value they add, says Mr Nakanishi, who has pushed the practice at Hitachi, the electronics conglomerate he heads.

In many ways, says Mr Mimura, Japanese and American capitalism appear to be moving toward each other. “America needs more stakeholderism. Japan needs more shareholderism,” observes Takenaka Heizo, a former government minister. As Mr Shibusawa points out, his forefather’s idea was “the analects and the abacus, not the Analects or the abacus”.

This article appeared in the Business section of the print edition under the headline “Analects and abacus”

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