How Japan improved corporate governance and overcame deflation

Deflation and slow economic growth had long plagued Japan

Now that deflation has been overcome, Japanese companies are at last paying attention to their investors.

Japan has a long history of deflation. It has hampered the nation's economy for the past 20 years or so. However, the tide has now finally turned.

According to Masaki Taketsume, manager of the Schroder Japan Trust, on the BFIA Talks podcast, the first trigger was the rise in import expenses in 2022, which forced Japanese companies to raise prices.

This created a positive feedback loop whereby higher earnings growth fueled higher wage growth. Increased consumption was fueled by higher wages, which further increased earnings.

Although this cycle may have contributed to the deflation crisis' resolution, a large portion of the foundation was established years earlier during the tenure of Prime Minister Shinzo Abe, who returned to office in 2012 following a term in 2006-2007.

Abe used the "three arrows" tactic to help Japan break out of its rut. According to Taketsume, the tactic was employed to address the economy's lack of demand, which was leading to deflation and high unemployment.

"A wide range of accommodative monetary policy and physical stimulus were the three arrows. As a result of the combination, the gap between supply and demand shrank and the Japanese economy improved.

"Deregulation, which included corporate governance reform, was the final arrow. The Japanese government, regulatory bodies like the Tokyo Stock Exchange, and investors like us all worked together to lead this effort.

"To sustainably increase their return on equity, all interested parties were helping the Japanese corporation rebuild their business portfolio and review their balance sheet. That endeavor has been progressing quite nicely.

How Japan Inc. received Abenomics.

A startle. Shinzo Abe, the prime minister of Japan, at Kilo Pier at Joint Base Pearl Harbor Hickamand.

Abes corporate governance reforms have assisted Japanese companies in overcoming their well-earned reputation as being indifferent to the opinions of their shareholders in recent years.

According to Taketsume, in order to be more responsive to shareholders, the reforms forced Japanese businesses to remove extra cash from their balance sheets, start buying back shares, or raise dividends.

In order to achieve a sustainable improvement in return on equity, a crucial measure of profitability, businesses are now under pressure to conduct a thorough review of their business portfolio or make growth investments.

Therefore, the Japanese equity market benefits structurally from corporate governance reform."

According to Taketsume, another feature of the Abenomics reforms was the crackdown on cross-shareholding, which had been common among Japanese companies but is currently declining.

"The Toyota Group was once known for having a close relationship with its suppliers, but the majority of the Toyota Group has since disbanded their cross-shareholding. One solid anecdotal indication that cross-shareholding is no longer practiced is that."

The reforms are producing higher returns on equity.

"If we go back to before the Abenomics era, the average return on equity for the Japanese corporation was something like 4 percent or 5 percent, but now, thanks to the corporate governance reform, the Japanese company is getting closer to 9 percent or 10 percent," stated Taketsume.

Even though this change is significantit has doubled in less than ten yearsit still lags behind the US or European markets.

"We may see further upside in the return on equity for the Japanese company and move closer to that of the US or Europe because corporate governance reform is an ongoing effort," Taketsume stated.

Watch the entire episode of BFIA Talks with Masaki Taketsume on YouTube or listen to it wherever you get your podcasts to learn more about the Japanese stock market, the political background of Japan's reforms, and more.

Regarding the podcast.

You can discover the keys to financial success with the help of the podcast BFIA Talks. Influential guests, including CEOs, entrepreneurs, economists, and fund managers, join editors James Mackreides, James Mackreides, and James Mackreides to share their best advice on money management, prudent investing, and accumulating wealth.

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