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Japan Exchange’s Wrath 

Ichiro Suzuki

Japan Exchange Group (JPX), the Tokyo Stock Exchange’s parent, has long been unhappy with low value assigned to Japanese corporations listed in the TSE. Recently JPX has issued a statement that they want to see price-to-book value ratio (PBR) of at least at 1.0. PBR for the Tokyo market as measured by the TOPIX is currently 1.1, far cry from 3.5 commanded by the S&P500. Almost half the listed companies in the TSE are trading under book value, with some of them considerably below it. Corporate Japan in general isn’t given high valuation primarily due for as simple a reason as lack of growth. Over a generation ago, valuation on Japan was considered outrageous when the country’s future looked limitless. After the burst of what turned out to be a bubble at the outset of the 1990s, the Japanese economy not only entered a period of persistent structural readjustments but also began to suffer adverse effects of population decline. Even worse, Japan’s once proud tech sector lost its luster amid the advent of the internet. Drivers of the tech sector have shifted to software from hardware, with which Japan had sparkled. In a few hardware-oriented segments that continued to be essential, such as semiconductors, Japanese corporations slipped from dominance to also ran because of their inability to keep up with massive capital investment requirements. A collection of uncompetitive companies in a land of no growth: this is a sure recipe for low valuation for the stock market of any country. JPX probably understands this and they must be also aware that they have no authority to tell companies to do something to enhance their valuation. Nonetheless, they still issued a statement having been so dissatisfied with the way Corporate Japan is valued. That something appears to include higher R&D expenditure and efforts to raise return of equity to 10% or higher. While it sounds a sensible request, it is still a great deal easier said than done. Higher R&D expenditure doesn’t all of a sudden raise software skills among Japanese engineers. Greater R&D efforts would be good for Japan’s tech sector for a longer term, but that alone wouldn’t create companies that shine as global powerhouse in cloud services, internet security or generative AI, etc. Then, is JPX strongly interested in raising ROE through financial engineering, including leveraging up balance sheets, which is one of the reasons behind Corporate America’s high PBR? It is not certain if this is what JPX wants, but raising ROE through greater asset efficiency would require much stronger drives toward shareholder capitalism. Corporate Japan has tried this before and didn’t embrace it fully. Japanese management has found it very uncomfortable in closing unprofitable divisions right away and laying off people who are not considered productive enough. Though everyone knows that they can’t hold onto lifetime employment practices indefinitely, Japan’s management is struggling to find how to phase it out, hopefully gradually. Recently, management must have been feeling relieved with the rise of stakeholder capitalism on which they have championed for a long time. That doesn’t mean, however, that Corporate Japan is ahead of the times. Stakeholder capitalism has come to receive spotlight after it has become clear to everyone that it has gone too far. A country that is struggling to achieve double digit ROE must not be taking too much pride in where they stand. A few other factors are in play, to hold down Corporate Japan’s valuation. One is sheer hostility toward hostile takeovers in a homogeneous society that is based on harmony of those who live in the ‘village’. Predators who would try to disrupt this comfortable setting through an unsolicited takeover bid would be received with maximum hostility and would meet fierce resistance. This environment strongly discourages Japanese executives not to do it. Then, management doesn’t have a burning desire to take their company private even if they think the shares are grossly undervalued. Excessive social status is attached to a label “listed in the first section of the Tokyo Stock Exchange”. It has always been considered as a stamp that enhances credibility of a company. Toshiba Corp, mired in a decade long troubles with shareholders, once fought fiercely not to be demoted to the TSE’s second section at a time when the company’s mere survival was in question. It matters so much to management. TSE has revamped the exchange this spring, creating the Prime and the Standard markets, replacing First and Second sections though the move has hardly changed the essence of the market. Being in the prime market boosts the company’s social status, without delivering little in substance, especially as opposed to being a privately-held company. Therefore, a number of publicly-listed company still keeps growing in Japan as opposed to a sharp fall in the U.S. since the turn of the 21st century. Financial incentives don’t drive management of Corporate Japan. They simply hesitate to make themselves very wealthy. CEOs are rather content with receiving a couple of million dollars at best for several years, and then retiring in a better fashion than average men on the street. Making an obscene amount of money would raise the eyebrows in the Japanese society and might make them face public bashing. Few executives have the guts to swallow it. Humility and lack of greed are good attributes one may have. Shareholders in general, however, are victims of such high-minded attributes, which makes the stock market persistently undervalued, devoid of dynamism. About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.


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