I have discussed several times in my previous articles the widening gap between companies with large and small market capitalizations in terms of profitability and corporate governance initiatives. In this article, I would like to examine this issue. In my previous articles, “Increasing Profitability to Gain Support from Overseas Investors Is a Condition for Higher Valuation” and “Why Are Companies with High Corporate Governance Practices Ratings More Profitable?”, I stated that companies with high foreign ownership tend to have larger market capitalization and higher profitability. In addition, these companies also tend to have superior corporate governance practices. This is due to the fact that the companies have improved their profitability and corporate governance practices through years of engagement with overseas investors. Overseas investors have been calling for the need to improve the board of directors and the effective use of cash flow and cash on hand, including cash allocation, in order to increase corporate value. Based on our analysis to date, it appears that management is aware of the 30% foreign shareholding level as a threshold. Once this level is reached, there is a marked tendency to be forced to incorporate the opinions of overseas investors. It is expected that the engagement of overseas investors as a driver will further enhance the profitability and corporate governance of their portfolio companies (which tend to have large market capitalization). Thus, it can be inferred that the gap between companies with large market capitalization and those without will widen more and more.
The Metrical universe of 1,819 companies (March 2024) is divided into six groups by market capitalization (over 5 trillion yen, over 1 trillion yen and under 5 trillion yen, over 500 billion yen and under 1 trillion yen, over 100 billion yen and under 500 billion yen, over 50 billion yen and under 100 billion yen, and under 50 billion yen) for each item of analysis. The median market capitalization is 91,156 million yen. The table below profiles the Metrical universe of 1,819 companies (March 2024) in six groups divided by market capitalization. The group with the largest market capitalization is superior in all values. The group with the second highest market capitalization, where the median foreign shareholding exceeds 30%, is inferred to show high profitability due to the effectiveness of overseas investor engagement. Tobin’s Q is also high in favor of high profitability.
The table below shows the characteristics of board practices in six groups of market capitalization. The Board Practices also confirm the remarkable results. The Metrical CG score, which indicates the overall evaluation of corporate governance practices, is also higher for companies with larger market capitalization. The main evaluation items, the ratio of independent directors, the ratio of female board members, the Nominating Committee score, and the Compensation Committee score, also show that the group with the largest market capitalization has the best values, and the size of the market capitalization is generally consistent with these evaluations. There are several reasons for the superior board practices of companies with larger market capitalizations: one is the improvement in board practices of the larger market capitalization companies in which they invest through the engagement of overseas investors, as noted above. Also, since the formal standards of the Corporate Governance Code are now a requirement of the listing standards for prime market listed companies, prime market listed companies have improved their board practices as those standards have been raised. Companies with relatively small market capitalization that are listed outside of the prime market are not required to comply with such requirements, so their board practice efforts have lagged behind.
The table below shows the characteristics of the Key Actions in six groups of market capitalization. In the Key Actions, the group with the largest market capitalization also shows challenges. The evaluation items in which the group with the largest market capitalization shows significantly better values are the Growth Policy Score, IR Disclosures Score, and Disclosures in English Score. The IR Disclosures Score and Disclosures in English Score confirm the focus on investor relations, partly due to the high foreign ownership ratio. The Growth Policy Score is probably due to the high profitability of the company, which makes it easy to set clear KPIs and present the company’s future growth to investors. On the other hand, the Dividend Policy Score, Cash Holding Score, and Treasury Stocks Retirement Score do not show a clear trend among the groups. This indicates that many companies still face challenges in cash allocation. The larger market capitalization groups have not yet been able to fully return the cash they have accumulated due to their high profitability. There is still plenty of room for these highly profitable companies (often those with large market capitalizations) to raise shareholder returns.
In summary, I have divided the companies into six groups by market capitalization and considered what characteristics and trends are most likely to be observed.
The Metrical universe of 1,819 companies (March 2024) was divided into six groups by market capitalization and analyzed in each category. Companies with larger market capitalizations tend to have higher profitability and valuations, and those companies have higher foreign ownership.
The group with the highest market capitalization in board practices also has a notably superior value. It is not inconceivable that the inclusion of prime market listed companies in the larger market capitalization group could be a factor. However, considering that profitability and board practices, which are of strong interest to overseas investors, have improved together, and that valuations, which are highly correlated with foreign ownership, are also higher for companies with larger market capitalizations, it can be inferred that this is due to the engagement of overseas investors.
In terms of key actions, the group with the largest market capitalization has superior Growth Policy Score, IR Disclosures Score, and Disclosures in English Score. There is ample room to raise shareholder returns, as the company has not yet fully returned the cash it has accumulated due to its high profitability.
If the hypothesis that improvements in profitability and corporate governance practices have been driven by overseas investor engagement is correct, it will take a certain amount of time before the engagement pays off. Thus, it is expected that the gap between the profitability and corporate governance practices of the top and bottom groups in terms of market capitalization will widen further. Put another way, ROE will not easily increase simply because of the TSE’s request. From the perspective of room for improvement, it is expected that some of the companies in the lower market capitalization groups may offer investment opportunities, but they must be long-term investments until the results of the engagement are realized.
http://www.metrical.co.jp/cg-ranking-top100/
Aki Matsumoto, CFA
Please see detail research the following links.
http://www.metrical.co.jp/
Please feel free to contact the below email address if any interest or query.
Aki Matsumoto, CFA
Executive Director
Metrical Inc.
akimatsumoto@metrical.co.jp
http://www.metrical.co.jp/jp-home/