How Japanese companies are wiping out shareholder value?

Just how many times have we heard that Japanese equity markets have been stagnant for last two decades? Analysts and economists around the world have elucidated various reasons behind it and occasionally suggested solutions on how Japanese companies and its respective management can improve the situation. Many upbeat economists have highlighted that Japanese equities are one of the cheapest in the world and trading below their net asset values, citing fundamental ratios such as Price-to-earning, price-to-book value etc.  Recently Financial Times wrote a big piece on how investors are relinquishing Japanese equities due to equity dilution and lack of focus on shareholders’ value. Shareholders, especially foreign shareholders, have often castigated Japanese companies for not caring about its shareholders and treating them like a third cousin.

We may look at the structural and fundamental problems, but the issue is more chronic. It is like layers of onions and as one peels a layer only to discover yet another layer and then some more. The problem is cultural than structural. The problem is behavioral than benightedness. The problem is about rigidity than ineptness. The problem is about challenging the status quo than lack of creativity. And finally the problem is more about complacency than objectivity.

Any amount of data crunching, reading balance sheets and meeting company management would not explain why the Japanese companies continue to falter. Failure to adapt to the changing world is like a sharp razor blade that is killing profitability and share holders’ value. One would think the problem persists in smaller or newer companies, but surprisingly it is predominant in established, larger firms that are not only unable to create shareholders value but even destroy the century old brand value that was once created on the same principles of strong leadership, efficient operation and maximizing shareholders value.

In next few series, I’ll try to peel some layers of issues within the Japanese financial & services industry. Let’s start with the very top layer - the management layer. I think everyone would agree that having the right leadership and management is a key to success for any company.

Japanese companies work within a very rigid framework, so human resource management, consensus-based-decision making, ineffective communication style etc is impossible to change, irrespective of how grave the company situation is. Naturally only a Japanese manager can adapt to such rigid structural framework, and so Japanese companies do not want to put a foreigner at its helm. Japanese corporations have an inherent distrust for foreign employees and executives. Not surprising that Foreign-to-Japanese executive ratio is very low, and even when a firm occasionally decides to hire foreign executive, it is often viewed as a transient role. The result - only a handful of foreign executives in Japanese corporations compared to companies in any other developed country.

Without any prejudice, Japanese executives are equally competent to their foreign counterpart, so Japanese executives should be evaluated at par with foreign executives equally during the selection process, especially when a company decides to expand its operations beyond its traditional realms, or has been reeling under losses for years.  In such cases it should appoint executives with the deepest experience to turn around. Take for instance, the board of all listed companies in Japan and compare their background with their global counterparts. The result is shocking – almost 95% of the management has no experience of working with any other company outside that specific employer.

Japanese companies strongly believe that employees who have worked in only one company for their life and done his rounds within various departments of the organization have the best knowledge on the company and its problems. Yes, that is true in certain industries such as assembly, manufacturing, industrial design etc but not in a dynamic services industry. Undoubtedly, it is always useful to have an insider who is groomed to take the helm of the company, but if the company does not have an eligible candidate, companies should certainly seek the right candidate externally rather than picking someone just because he belongs to the fraternity.

Companies, especially larger corporations have a profound impact on any economy, so it is critical for the top management to have a deep understanding of the culture, language, political and regulations which a foreigner might not have. In such cases, companies can adopt a Co-CEO policy, clearly defining the responsibilities and boundaries within which each CEO would operate in.

An interesting point to note is that Japanese companies believe that it is crucial for Japanese executives to understand the culture and business style in Japan but that doesn’t hold true for its overseas operations. Almost all Japanese companies put Japanese executives to run its overseas affiliates and subsidiaries irrespective of the country or product. With an exception of extremely few managers, can someone explain on how a person who has never worked outside Japan nor has a track record of building successful businesses can suddenly go and contribute to run its Chinese or Brazilian or Nigerian operations?

Japanese management have diluted its equity on many occasions in its quest for expansion and acquisitions, only to pay extremely high premium for targets and wiping off the value of the target company and its own shareholders; just by one simple act - replacing the management of the target company with its own employees.

Life-time employment and low compensation is another double-edged sword that Japanese companies dangle on its management. When one knows that one will not be penalized for under-performance or mistakes, nor will be rewarded for its achievement then there is no real motivation to grow shareholder value. The only motivation remains is self-preservation and getting the right role within the right department and office that provides highest perquisites. One reason for such behavior is Japanese executives are paid in cash rather than stocks, and therefore worry less about stock prices and shareholder value.

Surprisingly this is the same country where we had visionary leaders such as Konosuke Matsushita, Akio Morita, Sakichi Toyoda and Soichiro Honda, who not only laid a strong foundation and transformed their respective companies but the whole industry and nation.

It’s about time for Japanese companies to realize that it takes a lot more than knowing its company and Japanese culture to bring true value to a company, shareholders and the nation as a whole. The world has changed and Japanese domestic business is shrinking, so it is better to change than to be forced out. The statement may sound radical and extreme, but if you give it a time horizon of 15-20 years, the reality will slap your face harder than you know.