SANTA MONICA, CALIFORNIA AND TOKYO, JAPAN – Dalton Investments (“Dalton”) issued the following letter publicly to the management and directors of its portfolio companies to engage them in the following two corporate governance expectations: (1) make a clear commitment to the “Management that is Conscious of Cost of Capital and Stock Price” initiative, as requested by the Tokyo Stock Exchange and (2) continue to work towards the realization of Dalton’s three shareholder proposals: effective capital allocation, strong alignment of interest, and a board with high independence and diversity. Dalton firmly believes that the collective transformation of individual companies will fuel a robust resurgence of the Japanese stock market and economy. The full letter is below.
Dear CEOs, Directors, and IR Managers,
As we approach the end of 2023, we extend our sincere gratitude for your commitment to steering our business towards success. While the global economy has rebounded from the pandemic’s grip, this year also witnessed the emergence of new geopolitical risks in the capital markets. Despite these challenges, we can conclude 2023 with a sense of accomplishment, having generated commendable returns for our asset owner clients. We are deeply appreciative of your dedication to sound business management and fostering open communication with our shareholders.
2023 also marked a year in which the world became increasingly interested in the Japanese stock market. Along with geopolitics, monetary policy, and economic fundamentals factors, we see this greater interest as an indication of heightened expectations for capital market reforms spearheaded by the Tokyo Stock Exchange (TSE), the Ministry of Economy, Trade and Industry (METI), and the Financial Services Agency (FSA).
We have received many inquiries from investors worldwide, asking “What is happening with Japanese managements?” and “Is the reform real this time?” Additionally, we have received many asset owners to Japan who wanted to see the changes firsthand. We extend our heartfelt gratitude to all the companies that graciously accommodated these visits.
Through our ongoing dialogue with listed companies, TSE, METI, and FSA, we have gained a strong conviction that the reforms are genuine. We believe that the formal aspects of Japan’s capital market reforms, which began with the enactment of the Stewardship and Corporate Governance Codes, are now complete, and that 2023 marks the beginning of a full-fledged evolution of the substantive aspects.
To further catalyze this transformation, we would like to make two requests in this letter.
- We request that all our portfolio companies make a clear commitment to the “Management that is Conscious of Cost of Capital and Stock Price” requested by the TSE (hereinafter referred to as “TSE request”).
- We request that you continue to work toward the realization of our three shareholder proposals: effective capital allocation, strong alignment of interest, and a board with high independence and diversity.
About the TSE Request
The TSE request has met with some misinterpretations, with some viewing it as intended only for listed companies with a P/B ratio of below 1x; in reality, it is a meaningful framework for all listed companies.
At the heart of this request lies the concept of accountability for the stock price. While it is a given that listed company managers are aware of stock prices, “awareness” in TSE requests does not mean simply being happy or sad about stock price fluctuations or comparisons with other companies. Instead, it is now the responsibility of the management and board of directors of listed companies to analyze whether the stock price valuation in the market is appropriate and, if not, to understand the underlying factors, and to present and implement solutions based on the analysis.
Our opinion, based on long experience, is that the many Japanese managers and directors hold the traditional view that “management is responsible for business performance, and the market determines the share price”. It is a graceful aesthetic that is typical of the Japanese. However, as we work on the TSE request, we must part ways with such a mindset.
The TSE request is a very innovative and demanding initiative that presents a significant challenge for listed companies. However, we commend the TSE for setting such a high standard for strengthening the Japanese stock market and for their unwavering dedication to implementing these reforms.
We encourage our portfolio companies to comply with this request as role models for listed companies. We would like to be a good partner for you as you work on your TSE request. As the focus of the request is centered on capital markets, we are confident that our collaboration will be more fruitful than ever before, building on concrete proposals that we have previously presented to several companies.
We look forward to sharing clear goals and aligning our efforts with you in this endeavor.
About Our Three Proposals
We are proud of the remarkable results we have achieved with the three proposals we have been advocating for since the end of last year. Of course, we are not referring to the approval rate of
shareholder proposals at general shareholders’ meetings. Rather, what we have achieved is that many companies have introduced sophisticated capital policies, structured stock ownership guidelines, and onboarded independent directors with diverse backgrounds after our proposal. We were particularly heartened by the many comments we have received, such as “the meeting provided an opportunity for serious discussion by the board of directors” and “continued dialogue after the shareholders’ meeting,” even though the company’s official announcement to the proposal were to “oppose” the proposal. We sincerely appreciate your thoughtful consideration of our proposals, your willingness to engage in patient dialogue, and your decisions and actions in response to our initiatives.
For those companies that are still in the middle of their deliberations, we will be following up with them at each of our quarterly dialogues. This letter is part of that process, and we kindly request that you review the following proposals and assess our progress thus far.
| Themes | Proposals |
| Effective Capital Allocation | Formulate, disclose, and commit to a quantitative capital policy that includes “an appropriate level of financial assets (or capital structure),” “a specific capital allocation plan for the next three to five years,” and “KPIs including ROIC and ROE and their targets (KGI). As a prerequisite for effective capital allocation, ensure that the board of directors possesses an understanding of the fair value of the company’s shares. Reduce policy shareholdings, aiming for zero in the medium to long term |
| Strong Alignment of Interest | Establish, disclose, and commit to a path towards improving alignment of interest through stock ownership guidelines. Specifically, require directors to accumulate ownership worth 3-5 times their fixed compensation over a reasonable time frame |
| Board with High Independence and Diversity | Mandate that at least half of the board of directors comprise of independent outside directors while seeking to increase diversity by including women and experienced investors |
We have added a sentence to “Effective Capital Allocation” that reads “Reduce policy shareholdings, aiming for zero in the medium to long term”. We have had numerous opportunities to discuss policy
shareholdings with our portfolio companies, and our unequivocal conclusion is that while we understand the significance of the collaboration opportunity, we do not recognize the necessity of holding shares for the sake of collaboration.
Cross-shareholdings can exert an undue influence in ordinary business transactions by (1) violating the arms-length principle and (2) creating a conflict of interest structure between cross-shareholding parties and other shareholders. Policy stockholdings that fail to cover the cost of shareholders’ equity also undermine corporate value as they fall short of the standards set by the “Management that is Conscious of Cost of Equity” initiative. Further, companies with a high policy shareholding ratio are charged an additional cost of capital because investors perceive that management has prioritized self-preservation over shareholder value.
To achieve the high standards requested by the TSE, it is not enough to establish the formalities; it is also essential to create strong economic incentives to achieve them. If the management of the company leads the way by steadily increasing shareholdings (Stock Ownership Guidelines), they will be able to enjoy the economic results of this initiative firsthand. It is not greedy for management and directors to align their interests with those of outside shareholders and enjoy the benefits of increased corporate value together – in fact, this is something that many shareholders expect and welcome.
This year, we have engaged in frequent discussions with the TSE, METI, and FSA, all of whom are promoting reform, to discuss ways to maximize the results of capital market reform. What is most encouraging to us is the passion to make the Japanese capital markets better, that is evident in everyone, from the heads of the organizations to the young people working on the ground.
Unfortunately, the past feedback we have received from many foreign investors is that the Japanese stock market has continued to disappoint them. The primary reason for this sentiment is the lack of substantial change in the overall ROE of listed companies.
However, as we mentioned at the beginning of this letter, we believe that the past reforms have laid an essential foundation for the development of Japan’s capital market infrastructure, and that 2023 marks the beginning of transformative improvements. While some listed companies may have become accustomed to the term “reform” and may have developed a skeptical attitude, we urge you to reconsider your perception and be open to change.
We firmly believe that your diligent efforts to comply with TSE requirements will lead to increased corporate value and your long-term economic success, and that the collective transformation of individual companies will fuel a robust resurgence of the Japanese stock market and economy.
We are considering submitting a shareholder proposal similar to the contents of this letter at next year’s General Shareholder Meetings, with the intention of helping to accelerate your internal deliberations. Our representative in Tokyo will follow up with you as needed. Thank you for your continued support.
Sincerely yours,
James B. Rosenwald III
Co-Founder and Chief Investment Officer
Dalton Investments