The Study Group on Investment for Sustainable Value Creation established by Japan’s Ministry of Economy, Trade and Industry (METI), disclosed its minutes in April after three meetings in February and March. The objective of the Group is to find some common foundations for action by companies and investors on two main issues:
1) Measures to effectively utilize various kinds of capital and make decisions on investment for sustainable value creation.
2) Evaluation of information that investors use and proposed improvements for this and better corporate/investor dialogue.
Both measures result from Japan’s Stewardship Code and Corporate Governance Code as institutional frameworks for productive dialogues to establish investors’ fiduciary responsibility. The challenge is to fulfil the requirements defined in the frameworks by moving companies and investors from superficial responses towards real change in the way they conduct their business around mid- to long-term strategies, investment plans and business decisions.
The Group indicated room for improvement on sustainable value creation in Japan. It said, for example, that there had not been enough discussion on corporate investment. Professor Kunio Ito, the Group Chair, is an ambassador to the IIRC (International Integrated Reporting Council) and said the aim should be to incorporate IIRC’s concept of six capitals including human, intellectual, and manufactured capital.
The Group’s secretariat prepared an analysis framework of corporate investment based on six themes: 1) corporate mission as an investment background, 2) megatrends that companies face, 3) mid- and long-term strategies, 4) investment strategy, 5) investment measures, 6) investment payback prospect.
The minutes of its last meeting illustrated that the discussions were mainly from the investor perspectives, wide of the Group’s full objective. Items in the minutes were:
1) Differences in company-investor dialogues between Japan and abroad.
2) Information asymmetry between companies and investors
3) Current state of integrated reporting,4) Disclosure format for non-financial information
5) Track record assessment of corporate investment decisions
6) Expected factors in corporate evaluation except financial and non-financial data
7) Difference in analysts’ capacity between Japan and abroad.
In the few discussions on corporate investment, the Group minutes appear to indicate that past performance of corporate investment decisions would benefit future strategy. Companies should certainly learn from the past. But backward-looking investment evaluation does not always lead to appropriate decisions, even where particular companies have had great numbers. The origin of the Ito Review and the aforementioned institutional governance/stewardship frameworks resulted from lower return on equity versus cost of capital in Japanese companies. Successful investment decisions depend on forward-looking scenarios based on endogenous/exogenous factors. Companies must think carefully about megatrends and their internal capacity to take advantage of them. Psychological barriers have also delayed standardisation of integrated reporting. The minutes report that the introduction of non-financial data disclosure in Japan could lead to a lowering of investor engagement with companies because of the Japanese tendency for full formal compliance. Japan certainly has a long history of rules-based approaches. However the governance trend is moving in the direction of principle-based approaches such as Japan’s Stewardship and Corporate Governance Code. Integrated reporting should be categorised as such, meaning there is no ‘single’ compliance format of reporting. Some standardisation does contribute to efficiency and best practice.
But the lack of effectiveness in Japanese engagement has resulted from investors’ incapacity to analyse current corporate investment strategies. The solution should be education to enable them to create assessment models for corporate investment with reference, for example, to the IIRC’s capitals model.
Kazutaka Kuroda is an ESG Analyst at the Japan Research Institute, Ltd. The views expressed here do not represent those of the Japan Research Institute, Ltd.