EDITORIAL: Steady economic growth needs better corporate governance

A growing chorus within the political sphere is calling for a reduction in the income tax and in social insurance contribution burdens.
The opposition Democratic Party for the People, the most vocal proponent of this idea, has adopted the slogan “Increase take-home pay.”
While adjustments to keep pace with inflation and support for low-income, asset-poor individuals are necessary amid rising prices of daily essentials, it is crucial to remember that taxes and social insurance contributions fund vital social programs for the redistribution of wealth.
Therefore, thoughtlessly reducing these rates is inadvisable.
Raising the issue of “take-home pay” necessitates a broader discussion about wealth redistribution and whether companies are fairly distributing the gains from their activities. After remaining stagnant for a quarter-century, real wages have only increased in the last two years.
‘FALLACY OF COMPOSITION’ CONTINUES
Japan’s corporate sector has continued experiencing record levels of earnings, with the Nikkei stock average hitting 40,000 for the first time last year.
However, this strong performance hasn’t created the widespread perception that the economy is on a roll, as personal consumption and capital investment remain sluggish. Real gross domestic product has only recently recovered to pre-COVID-19 levels.
The burst of Japan’s bubble economy in the 1990s had a profound impact, leading companies to drastically reduce employment, facilities and debt.
Now, 30 years later, although the pressures of a strong yen and deflationary environment have eased, the corporate emphasis on cost-cutting to strengthen financial foundations remains largely intact.
This conservative, play-it-safe approach has resulted in companies accumulating substantial cash reserves, but this has not translated into increased wages for workers.
The situation illustrates a potential “fallacy of composition,” where actions that are seemingly rational for each company individually–such as hoarding cash–can collectively lead to reduced consumer spending and suppressed investment, ultimately creating a negative feedback loop that harms the companies’ own long-term prospects.
Twelve years ago, former Prime Minister Shinzo Abe’s second administration promised to break the grip of deflation, unveiling a comprehensive economic plan.
This plan centered on three key pillars: aggressive monetary easing, adaptable fiscal policies and a growth strategy focused on revitalizing private-sector investment.
The administration envisioned a more dynamic and efficient economy by promoting the “metabolism” of industries and the workforce to foster global competitiveness. The administration identified enhanced corporate governance as a cornerstone of this transformation.
LOGIC OF PRIORITIZING SHAREHOLDERS
In general, the strategy was to enhance the influence of shareholders to hold managers accountable. In the government’s Industrial Competitiveness Council, business leaders advocated for stronger pressure from shareholders and greater incentives for management.
Takeshi Niinami, then president of Lawson Inc., emphasized the “importance of activist shareholders” who could instill discipline in companies from the outside in the stock market.
Similarly, Hiroshi Mikitani, then chairman and president of Rakuten Group Inc., called for the use of stock compensation as “incentives for management.”
To promote better corporate governance, the administration introduced guidelines for companies and stewardship codes for institutional investors, aiming to facilitate “constructive dialogue” between investors and management.
This emphasis on shareholder engagement is further reflected in the Tokyo Stock Exchange’s 2023 initiative urging “stock price-conscious management.”
This trend originated in the United States. Agency theory, introduced by the economist Michael Jensen and others in a 1976 paper, posited shareholders as “principals” and managers as “agents,” who are obligated to maximize shareholder value under market discipline.
To align the interests of managers and shareholders, Jensen and his colleagues advocated for stock options and equity-based compensation, a practice that fueled the 1980s acquisition boom and continues to hold sway today.
This approach has been criticized for causing financial recklessness, huge executive compensation and widening inequality.
U.S. economist William Lazonick, in his co-authored book “Predatory Value Extraction,” condemned the ideology of corporate resource allocation known as “maximizing shareholder value” (MSV), stating that MSV is “an ideology of value extraction that, implemented by agency theory, lacks a theory of value creation.”
Lazonick argues that households, as both workers and taxpayers, have not received compensation commensurate with their contributions, and that management has prioritized cost-cutting and shareholder returns over investments in innovation.
This critique may offer valuable insights into the challenges facing the Japanese economy.
TIME TO QUESTION MERITS AND DEMERITS OF REFORM
The push for shareholder value in the 1970s was partly a response to U.S. managers pursuing unnecessary diversification and constructing lavish headquarters.
While acknowledging this context, it is undeniable that corporate governance reforms in Japan have also improved managerial efficiency.
Nevertheless, the following decade witnessed a 2.5-fold increase in shareholder dividends and a sharp rise in share buybacks.
Although the Abe administration’s corporate governance guidelines also emphasized “appropriate collaboration” with employees, trading partners and local communities, it is undeniable that a strong focus on shareholder interests has taken root within Japan’s corporate landscape.
If companies remain solely focused on shareholder returns, the “fallacy of composition” could worsen. The key question is how to achieve balanced economic growth driven by wage increases. It may be time to re-evaluate shareholder-centric corporate management and assess the benefits and evils of corporate governance reform.
Jensen, who proposed the agency theory, passed away last spring at the age of 84. The New York Times described him as an economist “whose evangelizing for stock options, golden parachutes and leveraged buyouts helped reshape modern capitalism and empower Wall Street’s greed-is-good era.”
However, since the 2000s, he also discussed the excesses of myopic financial markets.
“Indeed, it is obvious that we cannot maximize the long-term market value of an organization if we ignore or mistreat any important constituency,” or stakeholders like employees, he said.
What the business world lacked was “integrity,” he said, acknowledging that his ideas had spiraled out of control.
Soon, former U.S. President Donald Trump will return to the White House with his protectionist policies, which could pose a strong headwind for the Japanese economy.
Can a healthy growth model based on fair distribution be rebuilt? The year began with this significant challenge.
–The Asahi Shimbun, Jan. 5
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