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JH Explorer in Japan: A corporate governance awakening

Portfolio Manager Aaron Scully shares first-hand perspective gained on his recent trip to Japan on the evolving Japanese equities landscape.

Aaron Scully, CFA

Aaron Scully, CFA

Portfolio Manager

May 1, 2024
6 minute read

Key takeaways:

  • Japanese companies are embracing shareholder-friendly governance to improve value creation through greater transparency, balance sheet accountability, and incentive alignment.
  • Labor shortages and escalating trade tensions represent challenges for Japanese companies. In response, companies are hiring foreign workers and looking to diversify production beyond China to Southeast Asia and India.
  • Japan has innovative specialist companies in industries like semiconductors and water treatment that represent under-the-radar investment opportunities.
The JH Explorer series follows our investment teams across the globe and shares their on-the-ground research at a country and company level.


My recent trip to Japan offered insights into the evolving Japanese equities landscape and a firsthand look at some of the underappreciated, innovative companies in the country. Many of these companies operate in niche markets, so in-person visits provide the best opportunities to engage directly with management and others in the ecosystem to better gauge business models. Following are some of the key findings I uncovered during my visit.

Japanese firms are embracing shareholder-friendly governance

After 14 years of visits, this trip highlighted a significant shift in corporate governance. One reason for the shift is the Tokyo Stock Exchange’s (TSE) more stringent listing requirements and its approach to “naming and shaming” firms that are not enhancing capital efficiency.1 Not coincidentally, companies are now “seeing the light,” with management and employees embracing practices that enhance shareholder value.

Meetings during my visit were noticeably more productive this time and many were conducted in English. There were also some notable firsts: for example, one company’s management team openly discussed the possibility of hostile takeovers, something historically considered practically a mortal sin by Japanese executives. While not every company will adopt this approach, the mere willingness I witnessed signifies a significant shift in corporate culture.

In another first, an investor relations representative expressed interest in buying his own company’s stock. Traditionally, stock ownership is low in risk-averse Japan, where the public prefers the stability of postal savings. Management openly discussing personal share purchases highlights growing comfort with equity ownership. As my colleague Junichi Inoue, Head of Japanese Equities, noted in a recent article on the revival of investor interest in the Japanese market, “In contrast to past decades, the majority of Japanese companies are now owned by shareholders rather than keiretsu banks2 or employees and management acting as if they own the companies.”

Management compensation structures are also evolving and now incorporate equity awards for hitting medium-term financial targets, aligning employee interests with long-term shareholder value creation. Furthermore, the TSE’s practice of “naming and shaming” for subpar balance sheet efficiency has encouraged better asset management to avoid public scrutiny.

Early in cherry blossom season, these trees are showing signs of life. Similarly, shareholder capitalism in Japan is budding as more companies adopt shareholder-friendly policies.

Companies are grappling with labor shortages, trade tensions

As with past visits, labor shortages emerged as a recurring theme. Japan still faces an aging population and increasingly relies on foreign workers across sectors.

One company stated that it struggles hiring overseas workers to fill healthcare positions due to inadequate compensation. Technopro, an IT outsourcing firm, also highlighted the labor challenge in the technology sector. The company hires mainly IT-related engineers and outsources them to projects but can only meet 30% of customer demand.

Japan’s ongoing focus on digitization provides some labor offset and is a positive theme for companies offering automation and business solution services. Rakus, a software company allowing users to digitize expense management processes, has benefitted from Japan’s new digital invoicing system. But overall, labor constraints remain a structural headwind.

Management teams also expressed concerns about escalating U.S.-China trade tensions and the threat of high tariffs on Chinese goods. Many companies are contingency planning and considering a “dual manufacturing capacity” strategy to diversify production beyond China into Southeast Asia and India. However, despite this hedge, potential trade conflicts could create a significant headwind for Japanese companies exporting goods out of China in a more draconian trade war scenario.

Kyoto was once the capital of Japan and is known for its 1,000-year-old companies and craftsmanship. The central part of the city is crowded with small workshops.

From semiconductor to water-tech industries, Japanese innovation endures

Visiting the ancient city of Kyoto was particularly insightful. This city, known for its rich history of craftsmanship, is now home to a number of fascinating companies, a few of which have carved out niche roles in the semiconductor industry. Horiba and Nichicon, for example, specialize in high-precision components critical to chip production and electric vehicle technology, respectively. Their expertise underscores Kyoto’s innovation and continued relevance in the global economy.

Two of my more intriguing meetings happened to occur back to back and involved water treatment companies Organo and Kurita. These firms operate a water-as-a-service model with a focus on the semiconductor industry, which is becoming increasingly relevant as these customers face pressure to enhance water utilization. The service installs on-site purification and recycling systems that help promote a circular economy. This innovative service has gone largely unnoticed by investors, and I believe it offers a compelling sustainability solution.

The value of firsthand experience

We are firm believers that active management demands grass roots research to gain an edge. This particular trip reinforced the importance of firsthand experience in gauging the quality of new business models and in verifying the Japanese market’s corporate governance transformation. In my view, positive developments in the country hold the potential for exciting long-term investment opportunities.

Kyoto is also known for its traditional Japanese culture, including temples, shrines, palaces, gardens, and tea houses.

1 In 2023 the TSE announced a voluntary request for listed companies to create business plans to improve capital efficiency. In 2024, TSE began publishing a monthly list of companies that are disclosing action toward meeting those goals, thereby placing pressure on those that have not disclosed plans.

2 Keiretsu banks are financiers that are part of a keiretsu, which is a network of Japanese companies that have strong relationships with each other.

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