Global Investing Hot Spots

For investors, Abe offers stability — and a silver lining to Japan’s corporate scandals

Japanese PM Shinzo Abe during his meeting with Danish PM Lars Loekke Rasmussen on July 10, 2017 in Copenhagen, Denmark.
Ole Jensen - Corbis | Getty Images

TOKYO – Sunday's snap parliamentary election offers an important thing for voters and investors abroad: growth and market stability.

Shinzo Abe's ruling party won control of the House of Representatives for another four-year term. Although Japan is under threat from North Korea, another Abe administration is good news since, under his leadership, the economy is humming and the stock market is at a 20-year high.

But hidden behind the economic curtain are a slew of corporate scandals. When Kobe Steel, Japan's third-biggest steelmaker, announced Tuesday that it had faked quality-control data on its products, shock waves propagated through global supply chains. Steel, aluminum and copper products used in everything from Japan's iconic Shinkansen bullet trains made by Hitachi to Toyota cars, Boeing aircraft and even nuclear power plants may have been affected, while the number of companies hit more than doubled to about 500.

The falsification was apparently carried out with the knowledge of quality-control managers and continued for decades, according to a Nikkei report that cites anonymous sources. Kobe Steel admitted that the fudging had been happening for at least 10 years. While the impact remains unclear, some regulators are sounding the alarm: The European Aviation Safety Agency recommended companies suspend buying Kobe Steel products as Japanese authorities investigate. The U.S. Justice Department is now asking the steelmaker's American unit to provide documents related to its products sold to U.S. companies.

On Friday, Kobe Steel said one of its copper plants was under investigation for violating Japanese industry standards. Kobe Steel stock closed down 1.59 percent in Tokyo to close at 868 yen. The shares have slid 36 percent since the scandal broke.

Smart investors look to a company's leadership and processes to make an assessment rather than presuming quality prowess or risk simply because the company is Japanese.
Steven Bleistein
CEO of Relansa

But the cheating comes as Japanese Prime Minister Shinzo Abe, now battling to maintain control in Sunday's election, has pushed Japan Inc. to adhere to new corporate governance rules in an attempt to lure foreign investors. The fact that Abe himself worked at Kobe Steel before he entered politics shows the close ties between industry and government, which can make reforms all the more difficult.

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The governance reforms are aimed at creating corporate structures for "transparent far and timely decision-making" by companies, while institutional investors are encouraged to push management for higher returns and fewer cross-shareholdings.

A long list of fabrications

Kobe Steel is only the latest in a series of corporate scandals that has shaken confidence in brand Japan, renowned for its quality and craftsmanship. Nissan Motor has suspended domestic production of vehicles for the Japanese market and recently recalled 1.2 million vehicles after discovering that unauthorized inspectors had approved them; public broadcaster NHK reported that the practice had been going on for at least 20 years.

Air bag maker Takata declared bankruptcy earlier this year after the largest recall in automotive history, including millions of cars recalled by Toyota, as well as 17 deaths related to faulty air bags around the world. In December 2015, electronics and nuclear power equipment maker Toshiba was slapped with a regulatory fine amid revelations that it overstated net profit by some $1.3 billion over a three-year period; investors have filed more than 30 lawsuits for damages totaling $1.2 billion. Other Japanese brands that have been tarnished in recent years after admitting to faking data include Mitsubishi Motors, Asahi Kasei Construction Materials and Toyo Tire & Rubber.

"A culture of authoritarianism and obedience still pervades the governance of Japanese industry, and unfortunately this allows the most senior executives to act without accountability, and other managers have little experience of being questioned by their subordinates," said Thomas Clarke, director of the Centre for Corporate Governance at Australia's University of Technology Sydney. "Accountability and openness of expression has to become part of contemporary Japanese industry culture."

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But change is hard. Observers had hoped things would improve following one of Japan's largest corporate window-dressing schemes that came to light in 2011, when British-born Michael Woodford, the first foreign CEO of optical equipment maker Olympus, revealed years of falsified financial statements in a $1.7 billion fraud. Woodford, who was fired for asking questions, told Reuters last year that 80 percent of senior business leaders in Japan consider him a traitor to his company.

Corporate, not national, culture

The idea of outside and foreign directors and companies has been floated as one way to reduce malfeasance. Gerhard Fasol, CEO of Tokyo-based M&A advisory firm Eurotechnology Japan, is a board member and part of the supervisory and audit committee of a publicly listed company in Japan. He notes the number of foreign, independent directors at Japanese firms remains very low.

"Such problems occur especially in companies which have a close corporate culture, where the same people work with each other for a long time without external supervision and external input," said Fasol.

"For this reason, recent corporate governance reforms in Japan are very important and have to be taken further — that is, more power and respect is needed for independent or outside board directors, along with a change of mind-set with respect to corporate governance."

He believes the corporate fraud problem is not a cultural issue particular to Japan but a problem of management.

Opportunity for investors

Steven Bleistein agrees. The CEO of Tokyo-based management consultancy Relansa thinks it's dangerous for investors as well as foreign companies operating in Japan to rely on culture as a way to explain what happens in the Japanese business world.

"The danger is presuming that Japanese culture alone somehow protects or imperils your investment," said Bleistein. "For example, Japanese prowess in quality is presumed almost as a Japanese cultural trait. It is not. The quality of Japanese manufacturing is thanks to the imposition of a company's corporate culture of quality imposed by a company's leader, backed up by rigorous processes."

Among the world's five largest developed economies, Japan currently has the lowest price-to-earnings ratio. While by another popular valuation metric — Yale professor Robert Shiller's CAPE ratio — Japan is second highest behind the United States: Its CAPE reading of 27 is well below where it was in 2010, when it was over 38. Japan's lowest CAPE ratio in the past eight years was at mid-year 2016, at 24.

Valuation in 5 largest developed markets

Country stock market CAPE ratio P/E ratio

Source: StarCapital (Data as of 9/30/2017).

"Smart investors look to a company's leadership and processes to make an assessment rather than presuming quality prowess or risk simply because the company is Japanese," said Bleistein. "Right now there are likely a lot of companies in Japan whose processes are perfectly fine but are undervalued because they are Japanese in the wake of the Kobe Steel scandal. Smart investors will go long on those firms."

Bleistein and other observers view the recent scandals in Japan as a sign that transparency is growing amid a lower tolerance for malfeasance.

"Quality and compliance in Japan remain paramount, but in a more transparent corporate environment, companies have learned that they have to come clean on mistakes and misconduct much earlier," says Martin Schulz, a senior research fellow at Tokyo-based Fujitsu Research Institute. "Issues that would have been handled internally before are now becoming public and need to be managed with many more partners. It seems likely that more companies will follow up with governance improvements."

By Tim Hornyak, special to