Japanese corporate governance is changing
The 1987 film Wall Street and books such as The Predators’ Ball (1988) and Barbarians at the Gate (1989) portrayed corporate raiders as villains. Yet they also documented a profound shift in Western capitalism. Companies were increasingly judged not by their size, market share, or number of employees, but by their ability to generate returns for shareholders. That shift transformed corporate America and helped underpin the long-running US equity bull market that followed. Four decades later, Japan appears to be embarking on a comparable – if more measured – process of corporate reform.
Japan’s current reform process may lack the confrontational edge of its US counterpart, but its implications for shareholders could be just as significant. Change is being driven from the top: the Japanese government has introduced reforms to corporate law and strengthened governance codes, encouraging companies to improve efficiency, profitability and capital allocation across what has historically been an underperforming equity market.
This shift in emphasis has clear historical precedent. In the US, pressure on inefficient companies led to restructuring, improved capital discipline and ultimately higher profit margins. As illustrated in the chart below, S&P margins declined for decades after World War II, bottomed in the early 1990s, and then recovered sharply, helping to fuel a powerful and sustained equity market expansion.
Source: DQYDJ
Through the 1960s and 1970s, Western management emphasised conglomerate structures, where diversification was achieved by owning a wide array of unrelated businesses. Companies such as Gulf and Western controlled assets ranging from Paramount Pictures to sugar plantations and industrial manufacturing. While diversification was achieved, these sprawling organisations often became inefficient, bureaucratic, and ultimately less profitable.
The subsequent break-up of such conglomerates, combined with a sharper focus on return on equity (ROE) and capital discipline, was a key driver of improved corporate performance. This transformation required changes in regulation, mindset, and sustained pressure from shareholders.
Japan today is starting from a very different position. One of the clearest illustrations is its persistently low ROE. Since 1990, Japan’s ROE has typically been in the 6%-10% range, compared to 15-20% in the US, and it has also lagged Europe.
Source: Nikkei
ROE measures how effectively companies generate profit from shareholder capital. A firm earning 16% ROE produces twice as much distributable or reinvestable capital as one earning 8%. For investors, the transmission mechanism is straightforward: higher ROE drives stronger free cash flow, which in turn supports dividends, buybacks and, ultimately, valuation re-ratings.
At first glance, it is surprising that the stock market of a developed economy such as Japan – home to globally recognised companies like Toyota and Sony – has historically generated such modest returns. There are several explanations. Following the bursting of the asset price bubble in 1990, many companies focused on repairing balance sheets. This often resulted in the accumulation of low-yielding assets, such as excess cash or cross-shareholdings, which diluted returns on equity.
In addition, corporate strategy frequently prioritised market share over profitability, leading to investment in low-return expansion or diversification into lower-return sectors. While Japan’s export industries remained globally competitive, domestic sectors were often less efficient. Structural features such as lifetime employment contributed to overstaffing and reduced operational flexibility.
More broadly, corporate culture placed a premium on stability, consensus and stakeholder relationships (employees, customers and suppliers) rather than maximising shareholder returns. While this approach fostered resilience, it came at the expense of profitability and capital efficiency.
That mindset is now evolving. Policymakers increasingly recognise that an underperforming corporate sector represents a significant opportunity cost for the economy, for savers, and for long-term growth.
The scale of the opportunity is clear. Of Japan’s roughly 4,000 listed companies, around 40% still trade below book value, even after recent market strength. This suggests either undervaluation or, more fundamentally, insufficient profitability. Encouragingly, progress is already visible. Japanese companies are unwinding cross-shareholdings, increasing buybacks, and becoming more receptive to takeover activity – developments that were rare a decade ago.
Japanese Corporate Activity
With valuations still undemanding, even a modest improvement in ROE has the potential to drive a meaningful re-rating. In our view, this represents a structural opportunity rather than a cyclical one.
Through our partnership with Zennor Asset Management, we are particularly focused on identifying what they describe as “hidden treasure” – companies where underlying value is already evident but not yet recognised by the market. As the Keizan no gyoku parable reminds us, the value of a thing and the recognition of that value are often separated by time and patience. Ultimately, the opportunity in Japan lies in that process of recognition. It is now firmly underway.
Please be aware that the value of investments may go up or down and you may receive back less than you invested originally. Past performance is not a guide to the future.
This document contains general information only and does not provide any advice or guidance specific to your personal circumstances.
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