This is not a picture of Shinzo Abe walking into a bar, but we like how jolly he looks. Photo by Matt Cardy/Getty Images.
Here is a wacky idea for Shinzo Abe, the Prime Minister on a quest to revitalize Japan’s economy: Fly to the UK and have a beer or two with a fellow named Tim Martin.
Martin is the CEO and Chairman of a publicly traded chain of pubs (whose stock I’m not recommending you buy, sell or do anything else with), and he has some very strong opinions on how the UK’s corporate governance code encourages corporate boards to do some things that could lead to lower profits, more firm failures and ignorant decision-making. This makes him an ideal drinking buddy—I mean sounding board—for Abe, who is trying to write a corporate governance code for Japan. Better still, they could record their conversation for all to hear, because I’m fairly certain they’d teach some good lessons for investors.
Corporate governance codes aren’t law—rather, they’re codified sets of ethical standards, principles and ideals companies who are listed in that country should aspire to. Compliance isn’t mandatory, but board members should generally be prepared to write some letters of explanation if they fall short. The EU has a formal code, as do most member states. So do Australia and Canada. The US doesn’t have a single code, but there are dozens between private-sector industry groups, shareholder advocacy groups, unions, institutional investors and legal confederations—and all are fairly consistent in spirit. Japan doesn’t have one, and in its absence, corporate boards haven’t exactly gravitated toward best practices. Abe and most observers think this is a big reason corporate Japan is more bloated, less competitive and less profitable than most of the developed world.
They all have a point. Left to their own devices, Japanese companies have built a tangled web of cross-shareholdings—companies owning big stakes in each other—and basically turned themselves into a big yarn-ball of groupthink. The goal isn’t maximizing profitability and returns to shareholders—it’s preservation. Protecting the firms that symbolized Japan’s emergence and dynamism during the 20th century, preserving their political influence, preserving the corporate culture that gave rise to long working hours and lifetime-employment for the average Salaryman. The status quo is comfy. A shakeup would not be comfy, but it would jolt Japanese firms into competing to stay alive, failing if they can’t compete, and having to constantly one-up innovative upstarts. The sort of capitalist Wild West the US has thrived on for generations.
It’ll probably take more than a corporate governance code to get there, but slashing cross shareholdings, establishing incentives to boost ROI and outlining basic principles to promote competition and transparency would be a start.
This is where Martin comes in—bearing some very salient points about how traditional Dos and Don’ts can force firms to handicap themselves. For example, the UK discourages CEOs from chairing boards, which sounds great for transparency but can, in practice, prevent the most qualified and industry-savvy candidate from running the show—a sensible point, and one shareholders in the US have agreed with. Boards are urged to have a large contingent of unconnected outsiders—people who aren’t in the industry—which could lead to boards making uninformed decisions. In his firm’s latest annual report, Martin observed many board members in his industry aren’t aware pubs face higher alcohol sales tax burdens than supermarkets—a big headwind putting the industry at a relative disadvantage—and therefore weren’t equipped to deal with the issue. Board members are also encouraged to meet multiple times a year with shareholders, but they aren’t prompted to visit business branches and chat with employees and customers, giving them a blind spot to what works and what doesn’t work on the ground. The result, he says, is this: “compliant pub companies had often fared disastrously in comparison with non-compliant ones.”
And it all just makes me think he and Abe would have a good, wide-ranging discussion about how businesses are run, how they should be run, and how regulations and self-regulatory bodies can encourage good, profitable behavior. They would probably also make some jokes, and that would be funny.
Listening in would also be quite useful for investors of the stock-picking sort, because it would highlight some key issues to consider when you’re deciding whether to buy or sell a stock.[i] For many, it’s tempting to look only at numbers: earnings, revenues, stock price movement, dividend yield, corporate debt-to-equity, free cash flow and many others. If the numbers look good, it’s a buy, and if the price and earnings tank, it’s a sell. But this numbers-focused approach is too short-sighted and too backward-looking—it emphasizes the past and often ignores what qualitative or squishy factors influenced past results and how those factors are stacked looking ahead. Corporate management is a big, squishy qualitative factor.
And as both men’s stories highlight, you can’t always determine how well a company is managed simply by weighing it against national norms and assuming conformity is a plus. Keeping tabs on the appointment of officers and election of board members—and weighing their industry experience—is a must. You’ll likely have to fire up the Google machine and scour the Internets for articles in trade publications and management journals to see how officers and board members think—do they embrace innovation and change or fear losing the status quo? Do they want to prevent competition, or do they relish the opportunity to win a race by making newer, better products? You’ll probably have to scrutinize official reports—including all the footnotes and appendixes—to see why a company is run the way it’s run. You might have to infer the logic behind major decisions and do some homework to see whether they’ve accounted for all relevant information—or, going back to Martin’s example, they’ve ignored something as basic as a tax disadvantage.
It all probably sounds like a big, intimidating hassle, but I’m not going to apologize for that—actually, being a hassle is kind of the point! I’ve encountered so, so many folks over the years, both in my personal and professional life, whose stock-picking criteria is either the numbery stuff I mentioned above or opinions like “it’s a good company” or “I know the industry.” Maybe that’s so! But if you don’t look past those very surface-level assumptions and gut feelings, you risk making a sub-optimal short-sighted decision. Supposedly good companies in industries you know go bankrupt, too. So do companies you shop at regularly.[ii] Industries change—U2 just gave its new album away for free to 500 million people because record sales aren’t big moneymakers anymore. If you don’t keep tabs on a firm’s board and execs’ awareness of changes and the forces of creative destruction in their own industry, if you don’t know whether they’re aware of and strategerizing for new headwinds—and, heck, new tailwinds and opportunities—how can you know whether your pick will be rewarding over time?
So yes, stock-picking is hard. And it’s easy to be wrong, so diversifying is paramount—don’t stake your fortunes on one or a few companies or industries, because what if? But that’s a topic for another day.
[i] Don’t take any of this to mean stock-picking is the be-all, end-all for your portfolio’s performance. Studies show the individual companies you own are responsible for only about 10% of returns. Simply being in stocks (or other assets, like bonds, cash and the like) generally accounts for about two-thirds, and the next chunk is largely a function of industry, size and geographic location. So this piece is all about selecting companies within their peer group.