Executive Summary:
- Stronger boards, sharper capital allocation: Corporates are becoming more intentional about shareholder returns, with clear, disciplined policies serving as a catalyst for the next wave of reform. Governance is evolving from a box‑ticking exercise into a meaningful, investable advantage.
- Tackling the underutilized balance sheet: Dividend growth in Japan has outpaced the US, Europe and peers since 2003 and buybacks nearly quadrupled to JPY 18trillion in 2025—yet with ~half of non-financials still net cash, unwinding cross-shareholdings and stripping out excess capital can result in meaningful upside.
- Accelerating corporate restructuring: Management teams have sharpened their focus on growth and capital efficiency, driving corporate restructuring. As this momentum builds, protection for minority shareholders remains a key priority.
- From form to substance: Governance failures at previously successful companies show that structure alone cannot ensure effective oversight—active stewardship remains essential.
- In conclusion: Sustaining the shift from "form" to "substance" depends on active stewardship — continuous monitoring and effective engagement by experienced investors — which remains a primary determinant of long-term investment success.
1. Governance Reform in Japan: Stronger Boards, Sharper Capital Allocation — Not Yet Finished
Japanese corporates have raised governance standards, strengthened board structures and become more deliberate on shareholder returns through dividends and buybacks, supported by clear policy and market catalysts. This reform trajectory is anchored by the Stewardship Code and reinforced by the Tokyo Stock Exchange’s (TSE) “Action to Implement Management that is Conscious of Cost of Capital and Stock Price”. Regulators, institutional investors, the TSE and activists have jointly raised expectations on accountability, capital discipline and board effectiveness, shifting governance from a compliance exercise into an investable differentiator.
Board independence and diversity have improved, bringing greater transparency and a wider range of perspectives including insight into capital markets to boardroom discussions.
Capital allocation is increasingly framed against cost of capital and shareholder outcomes, reinforcing a virtuous cycle: stronger fundamentals attract attention, engagement intensifies and incremental inflows support further change. Despite visible progress, the runway for improvement remains substantial: average market return on equity (ROE) is currently around 9.5%1, balance-sheet efficiency still lags global best practices, and further unwinding of cross-shareholding remains a meaningful tailwind. In our view, the next phase should raise capital efficiency through restructuring while protecting long-term resilience through disciplined reinvestment.
The Clearest Evidence of Governance Progress in Japan is the Acceleration in Capital Returns:
Since 2003, Japan’s annualized dividend growth has outpaced the USA, Europe and other Developed Markets, while announced buybacks increased from JPY 4.6trillion in 2017 to JPY 18trillion in 20252 — a near-fourfold rise over seven years. An increasing cohort of companies has committed to reduce on-balance-sheet cash and return excess capital to shareholders, with scope for broader adoption given payout levels remain reasonable versus net income.
Cross-Shareholding Unwind to Drive Further Balance Sheet Rationalization
The Financial Services Agency (FSA) has been pivotal in accelerating the divestment of strategic cross-shareholdings, increasing the pace of balance-sheet rationalization across the market. In FY2024, net unwinding reached JPY 6.8trillion, roughly four times the FY2015 level, and Japan’s three largest insurers have committed to fully divest cross-shareholdings by FY2030 — an inflection point after decades of capital tied to stable-shareholder relationships.
This is a meaningful opportunity as cross-shareholdings still account for roughly 10% of listed market capitalization. In our view, reducing cross-shareholdings to zero could theoretically lift MSCI Japan’s ROE by 2.5%, with larger upside if released capital is redeployed into value-accretive investment or buybacks rather than left idle.
Our engagement3 with Toyota Motor Corporation, a company known for its cross-shareholdings and strong partner relationships, illustrates how meaningful progress can result from consistent, long-term involvement.
Engagement with Toyota Motor Corporation
Our consistent engagement with Toyota Motor Corporation's management, independent directors and auditors has focused on governance and capital efficiency — pressing for a clearer cross-shareholding policy, meaningful reduction in non-strategic holdings, stronger board independence and disciplined capital allocation. We flagged that extensive holdings across suppliers, affiliates and partners weakened capital discipline, reduced transparency and created minority shareholder risks, linking reduction to the company’s ROE roadmap and balance-sheet efficiency. We also raised concerns about the fairness of the price-setting process in the take-private (delisting) of Toyota Industries Corporation as part of the unwind of cross-shareholdings, and called for stronger market engagement and greater transparency, including around decision-making.
Progress is visible: Toyota Motor Corporation has cut non-strategic cross-shareholdings, committed to reviewing group-company holdings, raised board independence to 50%, adopted an audit committee structure, and disclosed an ROE target. Continued monitoring is appropriate, but meaningful steps have been taken.
2. What More Can Be Done? Tackling the Underutilized Balance Sheet and Business Rationalization
Structural over-capitalization remains one of the largest sources of unrealized value in Japan, even as corporates make steady progress in balance-sheet efficiency. Nearly 50% of listed non-financials still hold net cash, far above the mid-teens percentages observed in Europe and the US, signaling that a significant share of corporate capital remains under-utilized. While cash is increasingly being deployed via dividends, buybacks, and selective investment, balance-sheet action alone does not complete the “quality improvement journey” as we separate one-off balance-sheet improvement from business rationalization.
In our view, sustainable valuation improvement typically requires sharper focus on core businesses—exiting structurally weaker activities, reallocating resources toward stronger segments, and tightening return hurdles—so that higher ROE is earned through better operating outcomes as well as capital returns.
~ 50% of non-financial listed Japanese companies are net cash; Reform push has reduced cash as a % of total assets.
Engagement Example3: Balance Sheet Optimization
Recruit Holdings: Recruit, the parent of Indeed, Inc., the global leader in recruitment, planned to reduce the cash balance on its books from JPY 1.1trillion (FY24) to JPY 600billion (FY26) and achieved the target in June 2025, prioritizing product development and share repurchases. Strong cash generation through challenging conditions underscores operational efficiency and resilience.
In the 2026 Corporate Governance Code, revisions were introduced that require companies to address the effective use of business resources, with explicit reference to cash. We have engaged with the TSE to support the intent of the code and asked for continued support in encouraging corporates to strengthen accountability.
Working with the Tokyo Stock Exchange
Our perspective: welcome the intent, strengthen accountability
We supported the Corporate Governance Code’s explicit acknowledgement of assessing whether management resources are deployed effectively toward growth investment. However, as the gap widens between reform leaders and late adopters, we emphasized the need for ongoing monitoring by the exchange.
Raising expectations for Prime Market companies
To keep the momentum going, the TSE indicated that it would continue to raise expectations — particularly for Prime Market companies — while focusing attention on firms pursuing disciplined capital allocation. It also signalled that it does not intend to prevent outcomes in which companies that retain excess cash, remain chronically low-ROE, or fail to reassess resource allocation face a higher cost of capital and may choose to go private.
New guidance to advance capital allocation discipline.
The TSE stated that in April it issued guidance requesting clearer explanations across four areas: (1) medium- to long-term management strategy, (2) capital allocation aligned with the company’s target state or “aspiration,” (3) the appropriateness of assets held, and (4) effective board oversight. It intends to continue updating its casebook and expects more active investor feedback to promote disciplined allocation of business resources among companies.
3. Accelerating Corporate Restructuring
Japanese corporate restructuring is accelerating as companies pursue capital efficiency and core-business focus, fueling M&A and reducing listed subsidiaries. Japan's Ministry of Economy, Trade and Industry’s (METI’s) 2023 takeover guidelines have supported this—promoting industry reorganization and embedding fairness safeguards (e.g., independent board or special committee review) to curb management entrenchment and undue private benefits by acquirers.
In parallel, the TSE is moving toward requiring fairness opinions from special committees for management buyouts (MBOs) and delistings involving controlling shareholders or affiliated parties. While restructuring has lifted valuations in cases such as Sony Group Corporation and Sumitomo Electric Industries, Ltd., several high-profile transactions have raised concerns that minority shareholders can be disadvantaged in group transactions where price discovery and voting standards fail to fully neutralize conflicts.
In the case of Rakuten Group, Inc.'s financial restructuring, shareholders of the listed Rakuten Bank, Ltd. experienced significant dilution followed by a sharp post-announcement share price decline. Although the resolution passed the required two‑thirds threshold, the majority of the votes came from the parent company, so the result might have been different had the parent’s votes been excluded.
Effective minority shareholder protection requires true independence and expertise, clear benchmarks, and transparent valuations. Strong governance must address not only formal requirements but also perceived conflicts and risks.
Against this backdrop, it is encouraging that Japan's Corporate Governance Code now calls for analysis of company-sponsored agenda items that attract significant opposition. Timely, credible regulatory action can strengthen investor engagement and provide essential support for the continued development of Japan's capital markets.
Engagement3 with Rakuten Bank, Ltd.
Our engagement with Rakuten Bank, Ltd. focused on the reorganization of Rakuten Group, Inc.’s fintech business, which raised concerns over minority shareholder protection, director independence, and valuation. Although a special committee was established and met 18 times, it did not adopt majority-of minority (MoM) framework to obtain the necessary approvals from minority shareholders and relied heavily on external advisors without setting independent valuation benchmarks. Some directors' ties to major shareholders and advisors weakened perceived independence, while the committee's focus on earnings per share (EPS) did not fully consider the recovery timeline and synergy risks — potentially burdening minority shareholders with uncertain benefits.
We requested targeted improvements to strengthen future intra-group transactions and outcomes. Specifically, we asked the company to establish a nomination committee so directors—particularly independent/external directors—are better positioned to represent minority shareholder interests; to consider adopting a MoM framework for future transactions by excluding votes from related parties; and to improve disclosure by providing clearer, more detailed valuation assumptions so investors can make better-informed decisions.
Engagement3 Example: Portfolio Restructuring
IHI Corporation: An engineering conglomerate, derives roughly 80% of operating profit from 3 core segments: aircraft engines, defense systems, and nuclear power, yet these segments represent only 50% of invested capital. Progress on transformation initiatives is evident with four divestment announcements this year potentially improving operating margin and return on invested capital. Further simplification will enable more efficient capital allocation to core growth and shareholder returns.
4. From Form to Substance — Form and Function Go Hand in Hand
A decade of sustained engagement by policymakers, companies, and investors has materially strengthened Japanese governance. The push from “form” to “substance” by the Japan Financial Services Agency (JFSA) and TSE has delivered visible improvements – spurring even skeptical management teams and encouraging late adopters to move in a more productive direction. The practical significance is that governance is increasingly judged by outcomes—capital efficiency, accountability, and value creation—rather than by nominal structural compliance.
We would caution, however, that it remains too early to be complacent. Governance failures have also surfaced at companies perceived as successful, e.g. Nidec Corporation, that eroded corporate value and underscored the need for effective oversight and a well-functioning board. Independent directors were in the majority, yet the board lacked sufficient management experience and an adequately robust skill set to restrain the excessive influence of a founder-chairman.
In the most recent revision of the Corporate Governance Code, the emphasis has been placed on ensuring the quality of independent directors. Even though Prime-listed companies had already reached one-third independence, the Code stopped short of calling for majority-independent boards — effectively pausing the reform momentum toward more robust governance structures. The Nidec Corporation case does not suggest that stronger structures are unnecessary; rather, it highlights that structure alone is not enough.
The investment implication is not theoretical: if Japan’s reform agenda is intended to enable bolder risk-taking and proactive investment, then oversight must be strong enough to prevent value-dilutive capital allocation under the banner of “growth.”
Engagement3 with Nidec Corporation
Nidec Corporation’s shares were placed on the TSE’s Special Alert list in October 2025 due to governance failures, including accounting misconduct impacting net profit by JPY 160billion and possible impairment losses up to JPY 250billion. The misconduct was primarily associated by excessive performance pressure from the founder chairman, with oversight lacking depth. Our recommendations focus on strengthening audit committee monitoring, transparency, accountability, shareholder reporting, director training, and considering a shift to a three-committee structure to ensure greater transparency and oversight of the nomination process, all to restore internal controls and comply with TSE requirements.
Example of Performance of Governance Factors in Japan
Using annual returns across MSCI Japan constituents between January 2019 and December 2025, based on equally weighted tercile portfolios, we find that companies embracing corporate governance improvements have delivered positive returns. As the chart shows, the overall picture has strengthened, with broader and more consistent gains across every measure by 2025.
Sustaining the shift from “form” to “substance” requires active stewardship: continuous monitoring and effective engagement by committed, experienced investors and stewardship specialists who can influence governance practices and management behavior. This remains a key driver of long-term investment success.
Conclusion
Japan's governance reform has moved from aspiration to observable outcomes. Since the introduction of the Stewardship Code in 2014, the ecosystem has tightened: boards have strengthened, capital allocation has become more deliberate, and shareholder returns have accelerated. Dividend growth since 2003 has outpaced major Developed Markets and balance-sheet reform is now visible in hard numbers. Landmark commitments by Japan's largest insurers to fully divest cross-shareholdings — suggest that legacy structures are finally breaking. Sony Group Corporation exemplifies the potential of genuine reform: over two decades it has transformed from hardware dependence to content and IP leadership, with bold management changes enabling legacy exits and reinvestment into entertainment — Sony Pictures, Sony Music, and gaming IP — driving cross-platform monetization. Furthermore, the spin-off of Sony Financial Group reinforces the company’s strategic focus.
The next leg is where value creation becomes more selective — and more contested. Japan equity market’s ROE is around 10%, roughly 50% of non-financials are still net cash, and ~10% of market cap remains tied up in cross-holdings, representing a theoretical 2.5% MSCI Japan ROE uplift if eliminated. Minority protections in MBOs and group transactions must continue to mature, and boards must substitute substance for form by upgrading skills and oversight in the wake of cases like Nidec Corporation.
The investor takeaway is clear: Japan's governance journey has shifted from possibility to reality, but incremental returns are expected to accrue to those who practice disciplined stewardship, press for business rationalization and distinguish genuine reformers from box-tickers.