Japan Inc needs to start paying for performance

Almost three decades ago, the Texan oilman T. Boone Pickens attempted to charge into a Japanese boardroom. He had accumulated around one-third of the company – worth almost $1 billion at the time – yet a seat at the table eluded him. There was nothing to force the directors to accept him.
Japan Inc has come a long way since Pickens took on Koito Manufacturing Co, a supplier of parts to Toyota Motor Corp. Backed by Prime Minister Shinzo Abe’s economic revival plan and corporate governance reforms, activist investors are circling. Tokyo buzzes with investors and advisers looking to capitalise as they open doors to once insular boardrooms. Yet the opportunity can still be as difficult to grasp as it was for Pickens.
Companies face a demographic crisis with risk-averse leaders, waning productivity growth and in many cases misallocated capital. Threats to their technology leadership are growing, and corporate scandals are multiplying.
The average return on invested capital at Japanese companies is around 7 percent, well below the 11 percent for their peers in the S&P 500 index. Despite increasing buybacks, companies’ cash-to-asset ratios (a measure of the liquidity they hold for a crisis) remain the highest in the world, making it hard to boost returns. One yen of capital doesn’t go as far as it used to.
The great Japan discount continues to hang over the Topix 500 index. The benchmark trades at a 30 percent discount to the S&P 500, based on forward earnings multiples. Japanese companies’ average return on equity is 9.6 percent, against 14.7 percent for those in the US index. The way out of this morass is to align executives’ incentives with companies’ goals. The current stasis is a symptom of Japan’s economic egalitarianism: Nobody wants to be seen getting too rich. The average Japanese CEO is paid less than $1 million, compared with more than 10 times that for the average American boss.
Low pay, and the fact that most CEOs started out as “salary men” (or women) rather than entrepreneurs, means there’s little drive to compete and take tough decisions. So while an American CEO’s compensation package may be more than 70 percent in long-term incentives, and a German leader might get 30 percent, in Japan it’s only around 20 percent. That’s more than in the past: New rules on tax and disclosure plus governance reforms over the past two years have helped. But incentive pay remains below global norms. Meanwhile, executives must disclose compensation above $1 million under the regulations – but to avoid doing so, many are paid just under that threshold.

— Bloomberg

Anjani Trivedi is a Bloomberg Opinion columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He is the author of “Bailout Nation.”