What are "Policy-Shareholdings" in Japan and How Does the Corporate Governance Code Address Them?

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

"Policy shareholdings," or seisaku hoyū kabushiki (政策保有株式), often referred to internationally as cross-shareholdings or strategic shareholdings, have long been a distinctive feature of the Japanese corporate landscape. These are equity stakes that companies hold in other firms, typically business partners, suppliers, customers, or financial institutions, for reasons beyond pure investment returns. While historically seen as a way to cement business relationships and stabilize corporate management, policy shareholdings have faced increasing scrutiny in recent years as part of Japan's broader corporate governance reforms. Japan's Corporate Governance Code (CG Code) has been a key driver in pushing for greater transparency, justification, and ultimately, the reduction of these holdings.

I. Understanding Policy Shareholdings

Definition and Scope:
Policy shareholdings are defined as shares held for purposes other than pure investment. The primary objective is usually to maintain or strengthen business relationships, ensure stable transactions, facilitate joint ventures, or sometimes, to act as a defense against hostile takeovers by creating a network of friendly, stable shareholders. This contrasts with "pure investment shares," which are held solely for financial returns through dividends and capital appreciation. The distinction can sometimes be nuanced, but the intent behind the holding is the critical factor.

Historical Context and Rationale:
The practice of policy shareholdings became widespread in post-World War II Japan for several reasons:

  • Keiretsu Relationships: They were a hallmark of the keiretsu system, where groups of affiliated companies centered around a main bank or a major industrial firm held shares in each other to foster group cohesion and mutual support.
  • Stabilizing Shareholder Base: They provided companies with a stable, long-term shareholder base, less susceptible to short-term market fluctuations or hostile corporate raiders.
  • Strengthening Business Ties: Holding shares in a key supplier, customer, or partner was seen as a way to solidify long-term business commitments, ensure preferential treatment, or facilitate smoother information flow and collaboration.
  • Access to Finance: Banks often held shares in their client companies, and vice versa, as part of a broader financial and business relationship.

Criticisms and Corporate Governance Concerns:
Despite their historical rationale, policy shareholdings have drawn considerable criticism from a corporate governance perspective, particularly from institutional investors:

  • Inefficient Allocation of Capital: Capital tied up in low-yielding policy shareholdings could potentially be used more productively, for instance, invested in core businesses, research and development, returned to shareholders via dividends or buybacks, or used for value-enhancing acquisitions.
  • Management Entrenchment: A large block of shares held by friendly, passive "policy shareholders" can make it difficult for other shareholders to exert influence on management, potentially leading to management entrenchment and a lack of accountability.
  • Reduced Market Discipline: The presence of stable, often non-interfering, shareholders can insulate management from market pressures to improve performance and enhance corporate value.
  • Impediments to Corporate Restructuring and M&A: Interlocking shareholdings can create complexities and obstacles for necessary corporate restructuring or value-creating merger and acquisition activities.
  • Potential Conflicts of Interest in Voting: Companies holding shares in each other might be reluctant to vote against the management proposals of their investee companies, even if such proposals are not in the best interests of all shareholders, for fear of jeopardizing business relationships. This can lead to a "you scratch my back, I'll scratch yours" voting pattern.
  • Depressed Return on Equity (ROE): Holding large amounts of relatively unproductive assets like policy shares on the balance sheet can depress a company's ROE, a key metric for investors.

II. The Corporate Governance Code's Evolving Approach to Policy Shareholdings

Recognizing these concerns, Japan's Corporate Governance Code has progressively tightened its stance on policy shareholdings since its inception in 2015, with significant enhancements in the 2018 and 2021 revisions.

Initial Stance (CG Code 2015):
The original 2015 Code (Principle 1-4) already addressed policy shareholdings, stating that when companies hold listed shares as policy shareholdings, they should disclose their policy thereon. It also required companies to examine and explain the economic rationale and future prospects of their principal holdings annually and to establish and disclose criteria for exercising voting rights.

The 2018 Revision:
The 2018 revision of the CG Code further strengthened these requirements. It explicitly called for companies to disclose their policy concerning the reduction of policy shareholdings. The annual board examination was to more specifically verify the appropriateness of the holding's purpose and whether the benefits and risks were commensurate with the company's cost of capital. The disclosure of the content of this verification was also sought.

The 2021 Revision and Current Expectations:
The 2021 revision brought even more rigor to the principles concerning policy shareholdings, reflecting continued investor pressure and a desire to further improve capital efficiency and governance. Key enhancements under the current CG Code (primarily Principle 1-4 and its supplementary principles) include:

  • Clear Policy on Reduction: Companies are expected not just to have a policy on holding these shares, but specifically a policy regarding their reduction, including their thinking on how they will proceed.
  • Rigorous Board Verification of Economic Rationale: The annual board examination of each individual major policy shareholding must be thorough. The Code specifies that the board should verify whether the benefits derived from the holding (e.g., business profits, dividends) and the associated risks comprehensively justify the holding in light of the company's cost of capital. This requires a more quantitative and forward-looking assessment than a simple statement of maintaining business ties.
  • Enhanced Disclosure of Verification: Companies should disclose a summary of the board's specific verification of each major holding, not just a general statement.
  • Non-Impediment to Sale by Investee: A crucial addition (Supplementary Principle 1-4①) states that if a company whose shares are held as policy shareholdings (the "investee") indicates an intention to sell those shares, the holding company should not imply a reduction in business transactions or otherwise try to hinder the sale. This aims to break the cycle of implicit pressure to maintain holdings.
  • Economic Rationality of Transactions with Investees: Supplementary Principle 1-4② stipulates that companies should not engage in transactions with companies in which they hold policy shares if those transactions lack sufficient economic rationality or could harm the interests of the company or its common shareholders. This targets situations where business deals might be maintained primarily to justify the shareholding, rather than on their own economic merits.

III. Key Requirements and Disclosures under the Current CG Code

The current expectations regarding policy shareholdings are multifaceted:

A. Disclosure of Overall Policy (Principle 1-4):
Companies must clearly articulate and disclose their fundamental policy concerning policy shareholdings. This policy should address:

  • Their stance on holding such shares.
  • Their approach and plan for reducing their policy shareholdings over time.
  • How they assess the economic rationale and justification for any remaining holdings.

B. Annual Board Examination and Verification (Principle 1-4):
The board of directors has a direct responsibility to:

  • Annually examine the objectives and economic rationale of each individual major policy shareholding.
  • Specifically verify whether the benefits (both tangible, like dividends and profits from related transactions, and intangible, like strengthening business alliances) and the risks associated with the holding are commensurate with the company's cost of capital. This "cost of capital" comparison is a key element demanding a more financially disciplined assessment.
  • A summary of this verification process and its results for major holdings should be disclosed.

C. Disclosure of Holdings in Financial Reports:
Detailed disclosures are required in statutory financial reports, such as the Annual Securities Report (Yūka Shōken Hōkokusho) for listed companies:

  • A distinction must be made between shares held for pure investment purposes and those held as policy shareholdings.
  • For policy shareholdings in listed stocks, companies must disclose:
    • The number of issues held and the total balance sheet amount.
    • For a specified number of the largest holdings (currently the top 60 by balance sheet amount, or all if fewer than 60):
      • Name of the investee company.
      • Number of shares held.
      • Balance sheet amount.
      • The specific purpose of holding the shares.
      • A quantitative assessment of the benefits derived from holding the shares (e.g., dividends received, profits from transactions with the investee).
      • The summary of the board's verification regarding the holding.
  • Disclosure is also required for shares whose holding purpose has changed from policy to pure investment.

D. Criteria for Exercising Voting Rights (Principle 1-4):
Companies must establish, disclose, and adhere to specific criteria for exercising the voting rights associated with their policy shareholdings. The underlying expectation is that these votes should be cast with due consideration for enhancing the corporate value of both the investee company and the shareholding company itself. Companies should not exercise votes in a manner that could be detrimental to the investee's sustainable growth or their own shareholders' interests, for example, by automatically siding with the investee's management to maintain business relationships without proper scrutiny of proposals. The focus is on making informed decisions that contribute to the medium- to long-term value of the investee.

The concerted focus from the CG Code, coupled with investor engagement, has led to observable trends:

  • Gradual Reduction: Overall, the aggregate amount of policy shareholdings held by Japanese listed companies has been on a declining trend for several years. Companies are increasingly divesting holdings that cannot be economically justified.
  • Increased Scrutiny and Engagement by Investors: Both domestic and international institutional investors, operating under Japan's Stewardship Code, have made policy shareholdings a key engagement topic. They actively question companies on their holdings, push for accelerated reductions, and demand clearer explanations for retained stakes.
  • Influence of Proxy Advisory Firms: Proxy advisors regularly issue voting recommendations concerning director elections and other proposals based on companies' policy shareholding practices. Companies with high levels of policy shareholdings or inadequate disclosure and justification often face negative recommendations against their top management.
  • Proactive Company Reviews: Many companies have become more proactive in reviewing their shareholding portfolios. They are establishing clear internal criteria for holding or divesting these shares and are often setting quantitative targets for reduction.
  • Shift in Rationale Disclosure: Companies are moving away from boilerplate explanations (e.g., "to maintain good business relations") towards more specific and, where possible, quantitative justifications linked to business synergies, joint development, or supply chain stability, and how these benefits outweigh the capital costs. However, fully quantifying intangible benefits remains a challenge.
  • Market Reaction: The market generally reacts positively to announcements of significant reductions in policy shareholdings, viewing it as a sign of improved capital discipline and governance.

Despite progress, the pace of reduction is considered slow by some investors, and the absolute levels remain higher in Japan than in many other developed markets. Recent data from 2023-2024 indicates that while the number of policy-held銘柄 (brands/issues) has decreased, the total value of such holdings may have increased for some companies due to recent stock market appreciation, somewhat masking the underlying reduction efforts in terms of number of shares or percentage of portfolio.

V. Implications and Considerations for US Companies and Investors

The issue of policy shareholdings has several implications for US entities engaging with the Japanese market:

  • Due Diligence Imperative: When considering investments in, partnerships with, or acquisitions of Japanese companies, a thorough analysis of their policy shareholding portfolio and the board's approach to managing these holdings is a critical component of governance due diligence. This includes examining the disclosures in their Corporate Governance Reports and Annual Securities Reports.
  • Engagement Opportunities: For US institutional investors, policy shareholdings present a clear and important area for engagement with Japanese portfolio companies. Questioning the economic rationale, the alignment with cost of capital, and the company's reduction plans can be a constructive way to encourage better capital allocation and governance.
  • Assessing Management Quality and Board Effectiveness: A company's stance on and management of its policy shareholdings can be an indicator of the quality of its management and the effectiveness of its board. A proactive approach to reviewing and reducing unjustified holdings suggests a commitment to enhancing corporate value.
  • Understanding Influence Networks: While diminishing, policy shareholdings can still reflect underlying business alliances and influence networks that might not be immediately apparent. Understanding these can be relevant for competitive analysis or when assessing a company's strategic flexibility.
  • Interpreting Voting Behavior: The criteria a company uses for voting its policy-held shares can offer insights into its own governance philosophy and its relationships with investee companies.

Conclusion

Policy shareholdings, once a deeply entrenched feature of Japan's corporate structure, are now firmly under the spotlight due to sustained corporate governance reforms, spearheaded by the Corporate Governance Code. The Code has progressively mandated greater transparency, more rigorous board oversight, and a clear economic justification (or a plan for reduction) for these holdings. While the "unwinding" of these intricate shareholding networks is a gradual process, the direction of change is clear: Japanese companies are increasingly expected to manage their capital more efficiently and ensure that all assets, including equity stakes in other firms, contribute demonstrably to corporate value. For international stakeholders, monitoring developments in this area remains a key aspect of understanding the evolving dynamics of Japanese corporate governance.