Parent-subsidiary listings and ongoing cross-shareholdings remain a major issue for Japan’s corporate reform. There has been major progress – subsidiary listings peaked at 417 in 2007, with now only about 137 remaining – down 20% year on year. Similarly cross-shareholdings are following a similar trend, albeit at a much more measured pace.
Activist Strategic Capital is seeking to speed up the process through utilizing a little-known legal quirk to increase the pressure on the companies that own these stakes to resolve matters.
The idea is deceptively simple, and builds on the traditional approach. Shame the parent company / cross-holder for not truly getting on board with the corporate governance reform. Make noise and increase the likelihood that institutional shareholders on the parent’s register pick up on that noise and use their own influence to push management toward a resolution that better utilizes their capital.
Strategic’s approach takes another step.
Pursuant to Article 160 of the Companies Act, a company can undertake a targeted repurchase of its own shares (ie from a specific shareholder) if a special resolution is passed at the shareholders meeting. A special resolution requires the approval of 2/3 of the shareholders eligible to vote.
Crucially, the shareholder that is the subject of the targeted repurchase is not allowed to vote on the resolution, due to the potential for use of the measure to extract value from other shareholders.
Strategic proposed such measures at the AGMs of Gungho Online Entertainment, Osaka Steel, Keihanshin Building, and Goldcrest, targeting their major shareholders. None of the resolutions passed – after all 2/3 is a high threshold – but because Nippon Steel’s 55.8% was excluded from the voting at Osaka Steel’s AGM, the resolution achieved 62.6% approval. An embarrassing indictment from minority shareholders of the status quo.
Even if the resolutions had passed, they would not be legally enforceable, simply because the company cannot compel its shareholders to tender their shares. However, if one were to pass, the ball would be in the large shareholder’s court in relation to whether or not to sell – the company is required to buy if it can.
Generally the shareholding company’s shareholders will be asking it to sell its cross-shareholdings. The standard excuse given for not reducing such holdings more quickly is that it requires negotiation with the subject company – which may often be a customer of the shareholder. In the case of parent-child listings, the parent often claims it needs the consent of the child’s management to buy it outright or to sell its shareholding.
The implication in the case of cross-holdings is that the shareholding company could lose business if the matter is not handled delicately. With parent-child listings, the parent often argues that it could be highly disruptive to act without full consent & cooperation. The passage of buyback special resolution would theoretically remove these arguments.
The more relevant implication of these votes though is the embarrassment for the large shareholders and the noise it creates that their own shareholders may pick up on. Cross-shareholdings are falling in part because of pressure from institutional shareholders on large companies. By pushing from below while potentially increasing the pressure from above, Strategic Capital is creating more headaches for slow-moving and recalcitrant management teams.
Some activists have had success in resolving parent-child listings, but the outcomes and their timing are highly uncertain, and the premia paid often too small to warrant the risk. It is not a strategy that has appealed to us at Senjin. We will, however, be eagerly watching to see if Strategic’s approach changes this dynamic.
