An interview with Shiro Hayashi, director of research and head of Dalton’s Tokyo research office, Dalton Advisory KK.

Japan is experiencing a surge in shareholder proposal filings, both by activists and traditionally passive investors. What’s behind the trend?

The number of shareholder proposals at annual meetings was historically high this year and we saw many more institutional shareholders submit proposals for the first time. But, on the other hand, the support ratio for shareholder proposals overall was not very high, in most cases limited to 30% or less.

One may interpret current support levels as a negative, but our perspective is that proposals are becoming more of an engagement tool, leading to increased communication between investors and portfolio companies. The ability of shareholders to file proposals pressures companies to come up with their own ideas and strengthen their own value creation plans. So, despite the unsatisfactory support for these proposals overall, we are happy to see more proposals make their way onto ballots.

How does Dalton use shareholder proposals as an engagement tool?

In many cases, we tell our portfolio companies ahead of time that there is a chance we will submit a proposal and start a conversation with them. Ahead of this season, we began these communications in December 2022, so we were discussing the original proposal request for six months and working to make our engagement with issuers as constructive as possible.

I am happy to say that we withdrew more than half of the proposals we originally submitted to portfolio companies. In these cases, we made tangible progress in terms of either capital allocation, alignment of financial interests or changes to board structure.

There has been much talk about Cosmo Energy’s poison pill, implemented after activist Yoshiaki Murakami disclosed a 20% stake, and especially how it was approved in a majority-of-minority (MofM) vote from which Murakami was excluded. Could MofM votes become the new weapon of choice against activists in Japan?

Of course, we do not like the idea of MofM votes and are unsupportive of this very creative poison pill which was invented by corporate legal advisors. MofM is an emergency measure which should only be used in special cases. Unless we pay quite a bit of attention to this issue, the barriers to restrict the use of MofM votes could get lower and lower. If it ends ups becoming a discretionary action made by a simple board decision, it will have quite a negative impact on shareholder confidence in the Japanese capital markets.

Dalton has been vocal about the need for board independence and high-quality directors in Japan. What more needs to be done?

Ten years ago, Japanese companies had very few outside directors. But, step by step, they have increased the independence of their boards and I believe the majority of Japanese public companies now have one third or more independent directors. But we don’t want them to stop here. We want them to keep going and achieve a majority of independents. We are also urging portfolio companies to improve the quality of their boards, which includes enhancing board diversity.

How would you define board diversity for Japanese companies?

Having more overseas directors is important, but that depends on the target company. At this moment, we are prioritizing two items, one being female directors and the second being directors with market or investment experience, such as ex-fund managers or analysts. In many cases, Japanese companies have lawyers, accountants and ex-bankers on their board. They may be experts in their field, but that does not mean they are experts in shareholder value creation. We believe Japanese public companies are in short supply of directors with such expertise. The shortage of female director candidates in Japan is also a serious issue.

Looking to next year, are there any other trends we should be keeping an eye on in Japan, as far as proxy voting and activism is concerned?

Cross holdings remain one of the biggest challenges in Japan, which is one reason support levels for some shareholder proposals are low. A positive signal, however, is that the CEOs of companies with significant cross holdings have started to face more serious challenges at annual meetings.

CEO Masaki Miyauchi of Fuji Media, the largest media company in Japan, received only 56% support for his reelection this season. One reason for this was the company’s excessive cross holdings. Being unseated at annual meetings is becoming a real risk in Japan. So, this year, if management gets support of less than 80% for any reason, we expect such companies will accelerate their progress and look to remedy shareholder concerns.