Dalton Issues Letter to Management and Directors of its Portfolio Companies

SANTA MONICA, CALIFORNIA AND TOKYO, JAPAN – Dalton Investments issued the following letter publicly to the management and directors of its portfolio companies to engage them in the following three corporate governance expectations: (1) effective capital allocation, (2) strong alignment of interest between the board of directors/management and shareholders, and (3) board of directors with high independence and diversity. 

The Japanese version of the letter follows the English version.

Dear Management and Directors of our portfolio companies,

With only one month left before year-end, we hope this letter finds you well. While the impact of the ongoing supply chain disruptions and the dizzying effects of inflation, interest rates, and currency values on your operations varies from business to business, the common theme is that 2022 has been a year of constant and difficult business decisions for all of you, even more so than in past years.

What is reassuring is that we have witnessed the great resilience of your businesses. We are very impressed by your ability to maintain operations, review procurement methods, and respond to price revisions and cost reductions in a flexible way to ensure business profitability. As such, we have not felt the need to make meaningful changes in our investments, and there has been almost no change in our portfolio companies from the beginning of the year to the present. We would also like to pay our greatest compliments to those of you who saw the market turmoil as an opportunity to increase corporate value and took the initiative to buy back their own shares.

Looking to the future, even as the financial markets appear to be calming down, the global economy has essentially entered a recession, and 2023 will not be an easy year for businesses. However, we believe that the companies in which we invest are all financially sound and resilient to the changing environment. In fact, we believe that it is often during times of deepening turmoil that opportunities arise to reinvest in your businesses, make acquisitions and engage in share buybacks on attractive terms, accelerating the long-term growth of your company’s value. Our focus as shareholders is on long-term corporate value, allowing us to support management who take action to compound value over the same long-term time horizon.

With the above issues in mind, we will engage with you more actively than ever in the coming year. As has been conveyed in our past dialogues, we would like to reiterate the three expectations we hold for all our portfolio companies: (1) effective capital allocation, (2) strong alignment of interest between the board of directors/management and shareholders, and (3) board of directors with high independence and diversity.

Toward that end, we are pleased to inform you that we will likely be making the following “friendly” shareholder proposals at the General Meeting of Shareholders for the purpose of faster and more effective engagement. We hope that sharing our plan early will allow sufficient time for dialogue with you before next year’s AGM season. Please also note that, because we are sending the same letter to multiple portfolio companies, it may include topics that are not applicable to your company.

ThemesProposals
Effective Capital AllocationBuyback, Dividend, Cash level
Strong Alignment of InterestIntroduction of Stock Ownership Guideline
Board with High Independence and DiversityInclude in the Articles of Incorporation the goal of having a majority of independent directors, including women, on the Board of Directors

We will not be providing additional details on “Effective Capital Allocation” in this letter because the content of our proposal varies greatly depending on the circumstances of each company. The remaining two themes however apply more or less equally to all companies and are elaborated below.

  • Alignment of Interest

Shareholder Proposal: As long as the company is publicly traded, it should include in its Articles of Incorporation the establishment and disclosure of guidelines for directors’ shareholding.

We believe that the greatest weakness of Japanese boards of directors lies in the small shareholdings held by the individual directors and the resulting lack of a shareholder perspective on the board. With the exception of some executives from founding families or the rare early adopters of more aggressive corporate governance practices, the majority of directors’ economic interests are still tied to base remuneration and short-term performance, and there is little correlation between directors’ compensation and the medium- to long-term growth in corporate value.

We understand that stock-based compensation was introduced in the majority of companies, following the Corporate Governance Code and Ministry of Economy, Trade and Industry (“METI”) guidelines, which we consider an excellent development. However, most directors currently receive only 20-30% of total compensation in restricted stock grants, and it seems that very few of the directors have accumulated the level of ownership that would encourage them to share the goals of an owner. We believe that this is due to the lack of a specific target for the desired level of directors’ shareholdings.

Please let us share the reality in other developed countries. In Europe and the U.S., almost all major, listed companies have adopted shareholding guidelines that require a certain amount of shares to be held (and not sold) by the directors and management for a certain period of time in order to share the same goals as shareholders. After a grace period of several years, in most cases, top management is required to hold shares equal to 3-5 times their base compensation, and outside directors are required to hold shares at least equal to the value of their base compensation. We hope that the management of Japanese companies will break free from past norms and aim for a level of ownership that is on par with global standards.

When management’s shareholding reaches five times their annual base compensation, they typically think and act not only as a salaried employee who receives compensation for the time worked, but also as an owner of a company who receives distribution of profits generated by the businesses. Management will be able to make tough business decisions from the perspective of corporate value. Management also will consider investment opportunities as if they were their own. If the stock price is undervalued, they will feel a sense of crisis, and at the same time, more acutely perceive it as an excellent opportunity to buy back shares. In this way, directors and management stand on the same footing as shareholders and share both joys and pains with them, which is what most external pure shareholders, including us, want to see. Of course, having this level of ownership means not only more upside, but also more financial risk for everyone. However, as a manager or director with a heavy fiduciary duty, an individual who cannot commit to this level of risk would not be suitable to serve as a director of a publicly listed company.

In Japan, only a few companies have implemented directors’ stock ownership guidelines. We hope that by quickly introducing directors’ stock ownership guidelines, company directors will show more concrete commitment to not only passively accepting stock as compensation, but also purchasing it over an appropriate period of time.

  • A diverse and independent board of directors

Shareholder Proposal: As long as the company remains publicly traded, it should include in its Articles of Incorporation the goal of having a majority of independent directors, including women and highly skilled investors/analysts, on its Board of Directors.

We believe that board diversity and independence are essential to the management of today’s listed companies. A board with diversity is able to make management decisions from a wide range of perspectives, including skills, experience, age, nationality, and gender. We recognize that Japanese companies have made great progress in this regard over the past decade. However, we believe that Japanese companies should not settle for the status quo but aim for higher standards. While the required elements of “diversity” vary from company to company, we propose “including women and highly skilled investors and analysts” as a universal and urgent agenda item.

Regarding the appointment of female directors, we fully agree with the statement in the “Practical Guidelines on Corporate Governance Systems” issued by the METI  that “companies with no women on their boards of directors should actively consider appointing female directors, while ensuring the quality of their board members.” We also think that it is wonderful that Prime Minister Kishida stated in his speech at the New York Stock Exchange this past September that “Japan’s future depends on the vitality that women bring to the economy” and that he is “determined to clear away the obstacles that prevent women from taking an active role in the economy.” We hope that this commitment made on the international stage will be realized as soon as possible.

Secondly, we believe that the appointment of “highly experienced and skilled analysts” is an effective way to bring the perspective of outside investors and shareholders to the board of directors, while at the same time contributing to the enhancement of corporate value through sound risk-taking. Although the board of directors of a listed company and investors/shareholders share the same goal of long-term enhancement of corporate value, unfortunately in Japan, they are often perceived as being in opposition to each other. Involving directors with the experience and skills mentioned above in board discussions and decision-making would make the relationship between the board and the stock market more constructive through sound risk-taking, capital allocation and better communication with the market. Often it is explained that bankers and accountants are responsible for the finance portion of the skills matrix, but please understand that, from the perspective of promoting “sound risk-taking“, expertise in accounting and debt markets alone is not sufficient, and that is where the significance of equity market professionals lies.

This is our explanation of our proposals to you. I would like to reiterate that we are always willing to engage in constructive dialogues with you with the goal of long-term enhancement of corporate value. We will not exercise our rights unilaterally when making proposals at the General Meeting of Shareholders, but will determine the pros and cons of such proposals based on sufficient dialogue. We currently have five analysts in Tokyo who are ready to engage in dialogue with you at any time, and I myself, based in the U.S., would like to engage in direct dialogue with you whenever I have the opportunity. I have only visited Japan twice this year, but hope and plan to be more active next year.

Finally, the entire Dalton team would like to thank all of you for your efforts in keeping the company going during the fight against the pandemic that has been going on for nearly three years now. We wish you and your families continued happiness. We wish you all a wonderful Christmas season and a Happy New Year.

Sincerely yours,

James B. Rosenwald III

Co-Founder and Chief Investment Officer

Dalton Investments

Please note that the below is a Japanese translation of the above letter that Dalton Investments sent in English, provided as a courtesy. In the event of any inconsistency between the English language version and the Japanese language version, the meaning of the English language version shall prevail.

IMPORTANT INFORMATION

This letter has been prepared by Dalton Investments and its affiliates (collectively, “Dalton”) for the benefit and use of the original recipients. It does not constitute, and should not be construed as, an offer or solicitation to enter into any transaction regarding any financial instrument, nor should it form the basis of or be relied on in connection with any such transaction.  This letter does not constitute, and should not be construed as, tax, legal, regulatory, accountancy or other specialist or technical advice, or investment advice or personal recommendations, any trading strategy or advice (from an investment perspective) to any person on the suitability of any transaction.

The information in this letter is based on information that Dalton considers reliable, but which Dalton did not verify any of the information.  No representation or warranty is made as to, nor should reliance be placed on, any of that information contained herein being accurate or complete. Neither Dalton nor any of Dalton’s directors, officers or employees accepts any responsibility or liability for any losses or damages that may result from the lack of accuracy or incompleteness of this information. Such persons also do not accept any responsibility or liability for assumptions on which any statements, views, valuations or opinions expressed by Dalton in this letter may be based.

This letter speaks of its date and opinions and views expressed are Dalton’s opinions and views as of such date only. Dalton assumes no obligation to notify or inform any party of any developments or changes occurring after the date of this document that might render its contents untrue or inaccurate in whole or in part.

Any possible transaction or investment referred to herein may involve significant risk. This document has been prepared without regard to the individual circumstances and objectives of persons other than the original recipients who receive it. Other recipients should, without relying on this document, make their own independent decisions regarding to any possible transaction or investment and, if necessary, seek professional advice.

Dalton accepts no liability whatsoever for any reproduction or redistribution, in whole or in part, of this document, by any person other than Dalton.

The distribution of this document in certain jurisdictions may be restricted by law, and recipients into whose possession this comes should inform themselves about, and observe, any such restrictions.