TSE Cash Markets

Activists and other investors are increasingly calling on listed companies to dissolve cross-shareholdings (strategic shareholdings). While cross-shareholdings help to stabilize management, this can also lead to continued unprofitable transactions and weaken management oversight. Cross-shareholdings lead to a deterioration in capital efficiency, and is one of the reasons why Japanese companies are unable to utilize their capital, such as for growth investments, compared to American and European companies.

 

The Nikkei’s “Capital Mayhem” reporting team compiled the stock holdings of the Nikkei 225 companies (as of the end of June) for the fiscal year 2023 (the fiscal year ended April 2023 to the fiscal year ended March 2024) and created a correlation chart of cross-shareholdings among Japanese companies.

 

Cross-shareholding is an old and new theme. The trigger was in 1952, when the predecessor company of Mitsubishi Estate, which owned land in Marunouchi, Tokyo, lost more than 30% of its share to speculators, and various companies in the Mitsubishi Group bought them up at high prices. In the 1960s, international capital movements became freer, and cross-shareholding became widespread as a defense against takeovers by foreign companies.

 

Shareholder composition changes drastically, with foreign corporations now holding more than 30%

 

Such cross-shareholdings have also changed over the past 30 years. From the 1990s to the early 2000s, there was a widespread movement among companies and banks to sell cross-held shares with unrealized gains, due to the deterioration of Japanese companies’ performance caused by the collapse of the bubble economy and the problem of bad loans.

 

Since the mid-2010s, momentum for unwinding cross-shareholdings has increased again amid the trend toward corporate governance reform. According to Nomura Institute of Capital Markets Research, the strategic shareholding ratio of listed company shares in fiscal year 2023 will be 30.8%, down significantly from fiscal year 1990 (69.8%). Overseas institutional investors took over the shares that were sold, and　foreign ownership ratio reaching a record high of 31.8% in fiscal year 2023.

 

However,once cross-shareholdings are made visible, cross-shareholdings with banks and other financial institutions, as well as with regional or origin ties, remain like  “bedrock” that prevents dissolution.

 

Unutilized and hoarded capital

 

Cross-shareholdings have been criticized as making corporate governance a mere formality. There are a lot of  cross-shareholdings with low investment returns, which can lead to a deterioration in capital efficiency. The underlying reason for the low capital efficiency of Japanese companies is the conservative financial management that has been carried out for approximately 30 years.

 

Looking back on the past, during the period of high economic growth up until the early 1970s, companies became increasingly reliant on interest-bearing debt, mainly bank borrowings, and this continued to hover at a high level thereafter. When the bubble burst in the early 1990s and credit became tight, companies began to reduce their debts while building up their own capital.

 

As Japanese companies continued to accumulate capital, their earning power and growth potential did not improve, and they became less attractive as an investment destination from the stock market’s perspective. Return on equity (ROE), which indicates how much profit has been made using the money invested by shareholders, remains stagnant at just under 10%. Even when looking at the growth in capital spending, research and development expenses, and M&A (mergers and acquisitions) over the past 10 years, Japanese companies are lagging behind their American and European counterparts.

 

Request from the Tokyo Stock Exchange, a turning point for management

 

In recent years, the attitude of Japanese companies has finally begun to change. In March 2023, the Tokyo Stock Exchange called for listed companies to take management measures that consider capital costs and stock prices, and as a result, they have begun to move away from a management style that focuses on hoarding capital. To increase corporate value, it is necessary to improve capital efficiency by increasing earning power and returning profits to shareholders, while also increasing growth potential through investments and M&A.

 

Among the companies that have disclosed their capital allocation plans for the next three years, the top 15 companies by most recent market capitalization show that investments make up over 80% of the total, exceeding shareholder returns (just under 20%), indicating that companies are placing emphasis on growth. In addition to making use of accumulated cash and debt, there is likely to be a growing trend to sell cross-shareholding stocks and turn them into investment and return funds.

 

The movement to dissolve cross-shareholdings has also begun to accelerate. Companies affiliated with Toyota Motor Corporation and megabanks have begun to review their policies. Major non-life insurance companies have announced policies to eliminate cross-shareholdings by around 2030. Rie Nishihara of JPMorgan Securities points out, “We have entered the final chapter.” The balance of cross-shareholding stock, estimated at the end of March to be in the 60 trillion-yen range, is expected to be “reduced to 10% to 20% of the current level, which will become a steady level in the future, over the next four to five years.”

 

With rising hopes for capital reform, the Nikkei Stock Average surpassed its bubble-era peak this year, even reaching the 40,000-yen range at one point. Further reforms are essential to meet investor expectations. Cross-shareholdings are reaching their final hurdle.