Observation from the Shareholder Proposal
On 28th March, 2019, Sanyo Shokai held its AGM and I attended the meeting wearing my 27-year-old trusty old Paul Stuart jacket (made by Sanyo Shokai). Sadly, both of our shareholder proposals were turned down at AGM. Nonetheless, we were encouraged by other positive developments, such as the company proactively expanding its own share-based compensation plan in lieu of our proposal. While there was certainly tension between our respective sides throughout the process, we feel strongly that both parties developed a mutual respect along the way and laid the groundwork to for future constructive discussions.
Throughout the process, we received both declarations of support, as well as constructive criticism from various stakeholders, all of which we have taken to heart. We are inspired by the events that transpired and are grateful to those who have shared their candid thoughts with Hibiki, as well as with Sanyo, who is now stronger as a result. The experience has taught us a few more things about corporate governance in Japan and we would to share four important observations. They relate to the way corporate managers and investors engage in Japan and we believe they can make the country’s capital markets more vibrant.
Our first observation was that making shareholder proposals and being supportive of the management are not mutually exclusive. It is okay to agree on the big picture but disagree on the details. In this particular case, the underlying message we wanted to convey was that while we agreed with management’s efforts and overall direction, we felt that stock-based compensation combined with increased dividends were necessary to create stronger alignment of interests with shareholders for the long run. The management team understood our intentions to be sincere and we consequently felt no antagonism towards us. Even the media found it difficult to stir up conflict, which they are usually quite good at. We encourage both institutional and individual investors alike to make similar shareholder proposals to their investee companies. This can foster constructive public discussions without creating confrontation. Carried out properly, not only would the management and board be given the opportunity to rethink what it means to be a public company, but so would employees, other stakeholders as well as shareholders. We feel that such proposals would be accretive to the future of the companies involved.
The next observation we want to highlight is the importance of voter participation at AGMs. At Sanyo’s previous AGM (March 2018), the percentage of shareholders that exercised their voting rights was 69.4%. On average, in Japan this percentage ranges from 65%~75%, which is less than outstanding. If the ratio of apathetic shareholders increases and the voting rate drops, the influence of stable shareholders (i.e. cross-shareholdings) would rise and threaten healthy corporate governance. This time around, the percentage of shareholders exercising their rights at the March 2019 Sanyo Shokai AGM was 77.4% – an increase of 8% from last year. This illustrates that with a shareholder proposal on the agenda, more shareholders paid attention to the Invitation Notice and proxy votes, which again contributes to better overall corporate governance. The fact that there were more shareholders exercising their voting rights means that more investors are vested in the future of the company, which in turn exerts positive pressure on the management.
Our third observation relates to stock compensation. As you may recall, Sanyo Shokai has suffered losses for three consecutive years. Under such circumstances, we were concerned that proposing stock awards in addition to existing board remuneration would result in adverse reactions from other investors. This is why we created a section on our website detailing the importance of senior management owning more shares, particularly when the company undergoes major turnaround. In all likeliness, our stock compensation proposal was the catalyst for the company to devise its own stock compensation proposal. We felt validated to see that the latter obtained 85% approval from shareholders, despite our own similar proposal being voted down. This suggests that even in Japan, popular opinion on stock-based awards is changing for the better. Regardless of the company’s present business conditions, stock compensation is now deemed as necessary, as it aligns the interests of management with those of shareholders. This is a very welcome development and is well-aligned with the work-style reform that is taking place at large in Japan.
Our final thought pertains to dividends and shareholder returns. We had proposed a doubling of the dividend to 80 yen per share, which garnered 11.5% support and was voted down. On a positive note, we exceeded the minimum threshold required in order to continue making similar proposals at future AGMs – at least 10% of the vote is needed for a shareholder to raise the same proxy in the future. As for the dividend itself, our proposal called for an additional 500-million-yen cash payout. Despite a plan to invest 10 billion yen over the next two years, the scheme was certainly feasible for Sanyo Shokai, a company with 18 billion yen in cash and 13 billion yen in investment securities on its balance sheet. If we look at the metric of DOE (dividend on equity), 80 yen equates to 2% – hardly unreasonable for a going-concern company and is in line with our other portfolio names. Nevertheless, our proposal failed to garner support from most institutional investors and won favor with only one of the major proxy advisors. The key takeaway was that there still lacks consensus amongst investors as to how dividends should be determined.
We would like to offer our own take on dividends. Dividend distributions are nothing more than an outflow of capital from the company to its shareholders and in and of itself, they do not create value. In our view, a company should return capital to shareholders whenever the balance sheet is overcapitalized regardless of current business conditions. Returning capital would help to support the share price in difficult times and bolster ROE as profitability recovers. Such policies of ‘sharing the wealth’ send positive signals to investors and also serve to rally their support if and when management wants to take risks. If management is concerned over the cash leakage associated with dividends, then share buybacks are a viable option, particularly when the stock is depressed. We explained our stance to the Sanyo Shokai board at the AGM – we agree it is difficult to strike a balance between (1) investing for future growth, (2) re-investing in its own shares and (3) paying dividends. It is the responsibility of the board to make thoughtful judgments and communicate their rationale to shareholders. Shareholders subsequently have the right to make their own judgments on whether to support or oppose management. This is one of the core tenets of capitalism and is what the AGM is all about. While it did not work out in our favor this year, we are confident that our proposals have generated a rethink on shareholder returns, not only for the management team but also for other (institutional, corporate and individual) shareholders. We are taking it all in stride and push forward on our journey.
We continue to support Sanyo in its recovery and look forward to future public-forum discussions with management.
Chief Investment Officer
Hibiki Path Advisors Pte. Ltd.