TSE has released the material “Status of Companies’ Responses and Follow-up on “Responses to Achieve Management Conscious of Cost of Capital and Stock Prices” at the 11th Follow-up Meeting on Revision of Market Classification held on August 29, 2023. I would like to provide a summary of this document below and consider the issues discussed.
Status of display regarding “Measures to realize management conscious of cost of capital and stock price”
Based on the corporate governance reports* of listed companies in light of the recent request for “measures to realize management with awareness of cost of capital and stock price” (compiled as of mid-July, when the CG reports of companies whose fiscal year ended in March were available).
※ The current request does not specify the documents to be disclosed, but requires that a statement be made in the CG report to the effect that disclosure has been made and the method of access to such disclosure.
Because the request requires sufficient analysis and study of the current situation as a precondition for formulating and disclosing a plan, no specific deadline has been set for the timing of disclosure, but 31% (379 companies) of the prime market and 14% (120 companies) of the standard market have already disclosed their plans (based on companies whose fiscal year ends in March).
Of these, a certain number of companies stated that they are currently considering specific measures (to be announced in the future). (Of the companies that disclosed information, about one-third in the prime market and two-thirds in the standard market.)
P/B, Market capitalization level (Prime market)
Disclosure status by P/B and market capitalization: Companies with lower P/B ratios and larger market capitalizations are more likely to disclose.
45% of prime market listed companies with P/B of less than 1x and market capitalization of 100 billion yen or more are on display.
On the other hand, for companies with high P/B and small market capitalization, relatively little progress has been made in the display
(Reference) Examples of comments and questions received to date
Most of the documents on display were mid-term management plans and financial results presentation materials (approx. 30% each).
Efforts to improve return on capital and market valuation often include investment for growth, strengthening shareholder returns, addressing sustainability, investing in human capital, and reviewing business portfolios, etc. Many companies with relatively high ROE but P/B of less than 1x also strengthen investor relations (almost no companies simply provide shareholder returns). (Almost no companies simply focus on shareholder returns.)
However, even in cases where initiatives, etc. are disclosed, there appear to be a certain number of cases where the descriptions are not sufficient from the viewpoint of promoting constructive dialogue with investors, such as where there is only reference to existing displays and no mention is made of current analysis and evaluation based on cost of capital.
Challenges perceived by companies in promoting initiatives
According to a questionnaire survey of listed companies conducted by the Japan Investor Relations Association from May to June 2023, the challenges that companies face in promoting efforts to “realize management with an awareness of cost of capital and stock price” include the risk of not achieving the plan due to external factors and the lack of resources and systems in place to implement the efforts, many companies cited an increase in the ratio of passive management and a decrease in the number of analysts who analyze and judge corporate value from a medium- to long-term perspective as challenges faced by investors.
(Reference) Disclosure status by industry (prime market)
The display is more advanced in industries with lower average P/B. In the banking industry, about 70% of the companies are disclosing their P/Bs *Including companies that are disclosing their P/Bs as “under consideration.”
On the other hand, the information/communications, service, and retail industries, which have high average P/Bs, are relatively less advanced.
(Reference) Disclosure by ROE level and stock ownership (prime market)
For companies with a P/B of less than 1x, the display is progressing regardless of whether the ROE level is high or low.
Even for companies with P/B less than 1x, companies with uneven shareholdings, especially those with controlling shareholders, are relatively less open.
Feedback from investors and others (1)
After the announcement, many investors, including overseas investors, have expressed high expectations for the company’s changes based on the request, as the request has the effect of aligning the investors’ and management’s perspectives.
In fact, many domestic and foreign investors have said that they sense positive changes in companies after the request, such as companies becoming more proactive in dialogue, increased discussion of capital profitability and business portfolios in dialogue, and increased requests for advice from companies.
On the other hand, it was also pointed out that there were cases where management did not fully understand the significance and necessity of the initiatives, and there were cases where there was a sense of crisis but not enough knowledge and resources to promote the measures. Many respondents requested support to promote the initiatives of listed companies, such as continuous dissemination of the content and purpose of requests, creation of more detailed guidelines, sharing of good practices and educational content.
Listed companies that are considering taking action have also said that it is easier to take action when there are examples of good approaches.
Current Assessments and Issues
The request has been taken seriously, especially by companies with low P/B ratios, and although no specific deadline has been set because sufficient analysis and consideration of the current situation is required as a precondition for formulating and disclosing plans, a certain number of companies are already taking action, and domestic and overseas investors have generally given positive feedback about the company’s changes.
However, even in cases where initiatives, etc. are already disclosed, there are cases where they are not considered sufficient from the investor’s perspective.
On the other hand, given the relative delays in response among companies with high P/B ratios and small market capitalizations, as well as feedback from listed companies/investors, the following cases can be identified as challenges for companies that have not seen progress in response
– There is a misunderstanding that if P/B ratios exceed 1x, the current request is irrelevant.
– Management does not feel the significance and necessity of the response is sufficient
– Resources are not in place to promote the response.
Based on the above issues, we would like to first promote the following measures from the perspective of further promoting the examination and disclosure of initiatives to improve capital profitability and market valuation in the corporate sector.
– We will continue to follow up on the status of corporate disclosures, details of initiatives, issues faced by companies, and evaluation of initiatives by investors, etc., at this follow-up meeting, and disseminate information to companies, investors, and other market participants.
– For companies that already have high P/B ratios, we would like to reiterate that this request is a measure to promote constructive dialogue aimed at improving corporate value over the medium to long term, and that all companies listed on the Prime and Standard Markets are requested to respond regardless of their P/B ratios.
– Compilation and dissemination of key points of response from the investor’s perspective (including cases under consideration) and examples of desirable approaches (taking care not to induce companies to take formal measures).
Discussion Point 1: 31% (379 companies) of the prime market and 14% (14%) of the standard market companies included in their corporate governance reports based on the requirement to “take action to achieve cost of capital and stock price conscious management (120 companies).”
Regardless of “TSE’s request,” only 31% of prime market listed companies (including those under consideration) disclosed “measures to realize management conscious of cost of capital and stock price” in their Corporate Governance Report (one of the documents required to be disclosed under TSE’s listing rules). If about half of the companies had P/Bs below 1x, then at least 50% of the companies should have “complied with the request” and disclosed it in their corporate governance reports. This may be due to the fact that (a) listed companies are not yet fully aware of the importance of disclosure, (b) they have not yet prepared measures to respond to the request, and (c) they are considering how to respond to the request after observing the trend of disclosure by other companies. The fact that the “TSE request” is not mandatory this time may have at least some influence: only 45% of prime market listed companies with a P/B of less than 1x disclosed, indicating that disclosure has been delayed for one of the above reasons (a), (b), or (c).
Discussion Point 2: “Even in cases where initiatives, etc. are disclosed, there appear to be a certain number of cases where the descriptions are not sufficient from the viewpoint of promoting constructive dialogue with investors, such as cases where only references are made to existing disclosures and no mention is made of current analysis and evaluation based on the cost of capital.”
When we actually look at the disclosure documents, we can only say that it is unfortunate that many of the disclosures seem to be lacking in content. Ultimately, shareholders are interested in management’s plans for cash flow and asset utilization in response to the management goal of maximizing shareholder returns. The key point is whether these plans are satisfactory. The challenge is that these are not adequately described in the disclosed materials.
Discussion Point 3: “The challenges faced by listed companies in promoting efforts to “realize management with awareness of cost of capital and stock price” include the risk of not achieving the plan due to external factors, the lack of resources and systems to implement the efforts, and the difficulty of incorporating the plan into management targets.”
As for “the future remains uncertain and there is a significant risk of not achieving the plan due to external factors,” this is just another excuse. It is imaginable that investors would take into account significant external factors that could affect the plan. For example, ISS has changed its 2020 Voting Advisory Policy to state that “the policy of recommending a vote against the election of top management of companies whose five-year average ROE has not reached 5% will temporarily cease to apply in the Corona Disaster.
As for “the company does not have the resources and systems in place to improve return on capital based on the cost of capital,” this means that the company does not have the necessary human resources to manage the company. It means that the company has not been able to recruit the necessary people on both the internal and external board of directors on a skills basis.
As for “it is difficult to incorporate the improvement of return on capital based on the cost of capital into management objectives,” this is an indication that the company is unable to come up with a business plan that can generate a return that is sufficient to exceed the cost of capital. The above indicates that the company is not prepared to disclose the information.
Discussion Point 4: “Even for companies with a P/B of less than 1x, companies with uneven shareholdings, especially those with controlling shareholders, have made relatively little progress in displaying their shares.”
For companies with large shareholders, especially those with parent companies, the profit margin is often higher than that of the subsidiary or affiliate than that of the parent company (possibly due to concentration in a particular business, access to the parent company’s brand, etc.). Companies under the umbrella of these listed parent companies with depressed share prices, such as a P/B of less than 1x, may have share prices that do not reach their intrinsic value because of the risk of not securing minority interests, low liquidity, or limited ability to implement share repurchase programs. Only 34% of companies with shareholders owning more than 20% but less than 50% disclose P/B less than 1x, and only 21% of companies with shareholders owning more than 50% disclose P/B less than 1x. On the other hand, 40% of companies with no shareholders owning 20% or more of the company disclose their P/B. It would seem that the best solution for companies with large shareholders that have P/B less than 1x and higher profit margins than the parent company would be to make the company a wholly owned subsidiary. However, the fact that this conclusion has not yet been reached seems to be holding back disclosure.
Discussion Point 5: “We will further promote the examination and disclosure of initiatives to improve corporate return on capital and market valuation.”
The TSE commented, “There is a misunderstanding that if the P/B exceeds 1x, the current request is irrelevant. Management does not feel the significance and necessity of the measures to be taken to the fullest extent. TSE plans to further encourage listed companies to consider and disclose their initiatives based on the recognition that “resources are not in place to promote the measures”. The TSE plans to provide a “reference book (examples of desirable approaches)” to listed companies whose stock prices have been stagnant and who have yet to submit the required information, to encourage them to submit the required information. It can be imagined that creating answers by copying and pasting from a reference book without making an effort to find a solution on one’s own will end up with an empty plan with no substance. We hope that as many companies as possible will disclose their business and management strategies by searching for solutions on their own.
In summary, I have considered the outline of “Status of Companies’ Responses and Follow-up on Responses to Achieve Management Conscious of Cost of Capital and Stock Prices” at the 11th Follow-up Meeting on Revision of Market Classification held on August 29 and its discussion points.
Regardless of the “TSE request,” only 31% of prime market listed companies (including those in the process of considering it) disclosed “measures to realize management with awareness of cost of capital and stock price” in their corporate governance reports. In addition to the fact that “TSE’s request” is not mandatory, it is believed to be due to the fact that listed companies are not ready to prepare measures for disclosure.
The challenge is that few companies have been able to present a compelling plan for management to fully exceed the cost of capital in cash flow and asset utilization for the management goal of maximizing shareholder returns for shareholders and investors, even in the documents they have actually disclosed.
Companies with a large shareholder and a P/B of less than 1x are not as likely to disclose this information as those with a large shareholder and a P/B of less than 1x. For companies with a large shareholder and a P/B of less than 1x, a possible solution would be to make the company a wholly owned subsidiary or sell it to another company, but the fact that this conclusion has not yet been reached may be holding back disclosure. These companies should continue to be watched closely as a conclusion will be reached in due course.
TSE plans to further encourage listed companies to consider and disclose their approaches. If a company does not seek solutions and disclose its business and management strategies on its own, the disclosure may be empty and lacking in feasibility.
Aki Matsumoto, CFA
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