Rather than Putting Shareholders First, Japanese Companies Should Prioritize Wages and Capital Spending over Dividends

A Shocking Figure

Hitotsubashi University professor emeritus and economist Itami Hiroyuki published Hyōryū suru Nihon kigyō (Japanese Companies Adrift) in January 2024. This widely discussed book shines a spotlight on how and for what purposes large, listed companies allocate their profits.

According to Itami, the ratio of shareholder dividends to labor costs, which remained largely unchanged at around 6% up through the year 2000, began to rise steeply in 2001 and reached 42.2% in 2021. Dividends also surpassed capital investment for the first time in 2021 (these figures are calculated from the Ministry of Finance Policy Research Institute’s Financial Statements Statistics of Corporations by Industry).

Capital Investment and Shareholder Dividends at Major Firms

Source: Itami Hiroyuki, Hyōryū suru Nihon kigyō (Japanese Companies Adrift)

When Itami repeated his calculations using fiscal 2022 data, the latest data available, a new reality was revealed.

“In the ten years to 2022, the dividends paid by Japan’s large companies increased by 14.1 trillion yen,” he explains. “I divided this increase evenly among capital investment, labor costs, and dividends to calculate the outcome if this money had not all gone to shareholders. The additional amount of capital investment would have brought such spending close to its level immediately after the collapse of the asset bubble in the early 1990s. Additional spending on labor, meanwhile, would have brought labor’s share of national income—the percentage share of value added allocated to labor costs—close to its level in the first half of the 1980s, when the economy was growing stably. In short, Japan’s economy would be functioning well once again as it did in those days.”

In the spring wage offensive of 2024, many large companies agreed to the full amount of wage increases demanded by labor unions. While the wage increase rate reached 5.28% in the initial figures published by the Japanese Trade Union Confederation (Rengō), Itami calls this “barely making up for past stinginess.” To make wage increases sustainable, “the matter should not be neglected; a corporate structure of placing shareholders first must change.” Regarding the wages of small and medium-sized enterprises, he notes, “many SMEs are suppliers to large companies. The trend to accept the pass-through of higher costs must be strengthened.”

Should companies reduce returns to shareholders and increase wages as Itami says, shareholders are likely to react.

“Management should respond by saying, ‘We will also allocate funds for capital spending, and compensate employees so they can develop on the job. Doing so will enable the company to grow. I hope that shareholders will see an investment opportunity in this prospect for growth.’ Using profits to allocate returns to shareholders so they can immediately cash out is not what shareholding is meant to be.”

Why Japanese Companies Came to Put Shareholders First

According to Itami, indicators of companies putting shareholders first increased rapidly from around the year 2000 for large companies.

“Nine years having passed since the collapse of an asset bubble, people were beginning to talk about the ‘lost decade,’ and something had to be done. Meanwhile, after winning the Cold War in the 1990s, the United States was also victorious as a capitalist economy. In an industry renewal meeting held at the Prime Minister’s Office in 2000, business leaders—with the broad support of the media—contended that Japan would founder unless it adopted US-style corporate governance. In this manner, US-style management became a clear trend. Ever since then we’ve seen curious things happening in the economy.”

What surfaced as a pillar of management reform was the concept of corporate governance.

Says Itami: “I believe that the starting point was the entirely correct understanding that management in Japan lacked a disciplinary mechanism. Boards of directors were filled with insiders, none of whom were about to criticize themselves. I fully agree with the view that this was not a good situation. Some of the reforms that were made were appropriate. The Financial Services Agency organized a commission on corporate governance, whose report was published in 2012. It was a good report that stated that a company belongs to its shareholders and to its employees.”

Since then, however, companies increasingly came to prioritize shareholders, he goes on.

“Japan’s stock exchanges and the FSA received this report and transformed it into such policies as a corporate governance code that was established in 2015. In this process, these policies suddenly became guidelines for allocating returns to shareholders and increasing stock prices. US consulting firms were involved to a considerable degree. I wonder whether the United States pressured Japan so that US institutional investors could profit.”

Activist Shareholders

The corporate governance code calls for the increase of return on equity. ROE is a measure of how well a company employs its capital and of how much profit it is realizing.

“The formal reason for emphasizing ROE is to use it as an indicator of whether a company is being properly managed. US companies, however, have been buying back shares for some time now to reduce equity, the denominator in the ROE fraction. Such buybacks increase the stock price by boosting the profit per outstanding share, and shareholders profit as a result.”

This is something to beware, Itami says. “Many people have misused the reform of corporate governance. The activist investors found in many nations are one example. All they do is threaten management and complain so they can profit. For instance, they will say there is no point in having so much equity and urge companies to buy back shares. Rather than a place for companies to raise funds, the stock market has become a place for returning funds to shareholders through dividends and share buybacks.”

Meanwhile, there are companies in the United States, a nation Japan looks to as a role model in this area, that are saying no to the prioritization of shareholders.

“The shareholders of Google and Amazon have never received a dividend since those companies were founded. Their stock prices, however, are extremely high. When Google listed on the New York Stock Exchange, it issued special classes of stock. The stock held by the founders have ten times the voting rights of the other classes of stock. To prevent management from losing control if dividends are not paid, the founders have continued to hold more than 50 percent of voting rights.”

The Decline of Industry Caused by the Curbing of Capital Investment

As a result of prioritizing returns to shareholders, what sorts of problems arose from the curbing of capital spending?

“The global competitiveness of Japanese companies is continuing to decline,” says Itami. “Capital investment is needed in adopting new technology. By reducing this spending, companies are voluntarily weakening their international competitiveness. While the decrease of capital investment after the collapse of the asset bubble was in some sense expected, that it has remained low ever since is a problem. Meanwhile, only dividends have soared in the last twenty years.”

Itami wrote a book about the semiconductor industry in the mid-1990s. “In the book I cheered the industry on by saying, ‘You surpassed the United States and became number one by investing boldly and generously. South Korea is catching up so work a little harder.’ Since then Japanese companies reduced their capital spending and receded. This would not have happened had they worked harder at that time.”

With Japan’s population beginning to shrink, what sort of capital spending is needed? Itami has some ideas:

“What is needed is capital spending directed toward foreign markets. This is how Japan has grown. The best example is the automobile industry. Analysts who point to a declining population as the reason for stagnant capital spending are just making excuses. Had the electrical machinery industry done more to sell household electrical appliances overseas, or invested by concentrating on how to sell their products more cheaply, they would not have fallen to their current wretched state.”

Putting Employees First

The management of Japanese companies has tilted toward putting shareholders first, as in the United States, from around the turn of the century. Is Itami then calling for a return to the twentieth century’s Japanese-style management?

“I get falsely labeled as a conservative when my views are summarized in that way,” he responds. “The practice of management is determined by the multiplication of principle and the environment. If the environment changes, the practice of management must change even if the principle remains the same. The principle should not be putting shareholders first. What should be defended is putting employees first. However, since the environment has changed, Japanese corporate personnel practices like the seniority system or the excessive managerial positions should be scrapped.”

“Management should take the lead in transitioning to putting employees first. With the FSA brandishing its authority unduly, we need more business leaders willing to speak up. The example of Google should be kept in mind.”

(Originally published in Japanese on March 28, 2024. Banner photo: Toshiba decided to delist its shares at an extraordinary meeting of shareholders held in November 2023, in part to exclude activist shareholders opposing management policies. © Jiji.)