Nikkei Veritas – Market Eye column, 13th July 2008
Japanese and American attitudes to shareholders differ. In both countries shareholders are, in theory, the owners of their companies and they appoint management to run the businesses in the interest of shareholders. But in neither country do things work that way in practice. The primary concerns of management everywhere are their own interests. The key difference between Japan and America is the perception of how management can best look after its own interests.
In America, the main aim of management is to get rich quickly. Companies’ results are highly variable and, if you believe that these variations are the result of management’s decisions rather than chance, then it is sensible to pay highly for good managers. This belief is almost universal in America, with the result that managements have become increasingly highly paid with large bonuses and huge profits from stock options being received when companies do well, but not being paid back when the results are poor.
Attitudes in Japan are different. Managers don’t move from company to company and tend not to receive such high or such highly variable remuneration. Americans tend to esteem themselves and others in terms of their wealth; Japanese put more emphasis on position. Japanese managers wish therefore to stay with their company and are thus much more interested in how the company will prosper over the next decade or more than Americans.
These differences are reflected in both the economies and the stock markets of the two countries. In America, companies devote their cash to share buy-backs, which drive up the share prices on which management’s remuneration largely depends. In Japan, companies devote their cash to fixed investment, on which the long-term future largely depends.
A comparison between the two countries shows that the difference is startling. Japanese corporations invest 16% of the country’s GDP in plant and equipment, while the US invests only 10.5%. If Japanese investment was as productive as the US, then Japan would grow about 50% faster than the US, simply because it invests that much more of its GDP. In recent years, however, America has grown much faster than Japan. As the profitability of new investment largely depends on its productivity, the result has been that US investment has produced much better returns than Japanese investment.
It is therefore widely believed that Japanese shareholders would benefit if attitudes changed. It is argued that, if Japanese companies spent more money on buying shares and less on equipment investment, the profitability of Japanese companies would rise. In practice, however, profits would almost certainly fall. This is because a fall in investment must be matched by a rise in some other form of demand or the economy will fall back into recession. If shareholders who sell their shares back to the company would immediately go out and spend the money, then demand should hold up. But this is unlikely. The most probable result from a fall in investment would be a weak economy with falling profits. Indeed, we may already be seeing signs of this. Investment by Japanese companies already seems to be slowing and profits in the first quarter of 2008 have been decidedly weak. Demand might hold up a bit better if companies increased their dividends rather than bought back shares, but not much better. Japanese individuals only own 18% of the shares of listed companies.
The present situation seems therefore both unsatisfactory and unstable. Japanese companies have very poor returns on their investment, when compared with US companies, and foreigners, who own 28% of the shares of listed companies, are pressing for less money to be invested in equipment and more returned to shareholders. But, if they were to succeed, they would be likely to damage both the economy and the interests of shareholders in general, as profits in aggregate would be likely to fall.
A rapid change in attitudes to shareholders is thus undesirable, but some small shift in behaviour seems under way. Japanese corporations, which had been reducing their cross-holdings slowly in recent years, changed from being net sellers in the first quarter of 2007 to being net buyers in the first quarter of 2008. If this continues, it should provide some support to the stock market, which is likely to be much needed in the face of falling profits.