At a session of the House of Representatives Budget Committee in December 2021, Prime Minister Fumio Kishida referred to the "guidelines" that may be regarded as an instrument of regulation on share repurchases, through which companies return profits to shareholders. The debate over share repurchases is attracting attention as one of the issues in the "new capitalism”.
The argument in favor of regulating share repurchases is supported by a critical view against "shareholder capitalism," a concept advocated mainly in the United States. In the United States, many companies give lucrative compensation packages linked closely to stock prices and return most of their profits to shareholders. What attracts serious attention is cases in which companies issue corporate bonds for the purpose of repurchasing shares, or in which repurchasing shares is implemented in order to raise the stock price to a target level. In such cases, repurchasing shares is expected to entail job cuts and a reduction in capital and research and development (R&D) investments.
Recent studies on the U.S. companies have empirically confirmed the existence of exactly this type of perverse relationship. However, it is premature to insist that Japanese companies also place the same priority on returning profits to shareholders and disregarding the interests of employees and creditors. In fact, in Japan, there have been very few cases in which corporate bond issuance was used to finance a share repurchase program or in which a share repurchase program was abused to exercise stock options at a favorable price.
Even so, concerns might remain about cases in which Japanese companies with high growth potential forego investment in order to undertake share repurchases. However, according to my work with Colin Mayer of Oxford University and Julian Franks of the London Business School, such perverse results were not observed in Japan. Taking listed companies on the Tokyo Stock Exchange 1st section (excluding financial institutions) in FY2001-2018 as an estimation sample, they showed that share repurchases were likely made by companies with high cash holdings, low debt to asset ratios, and low growth opportunities.
The ongoing arguments over share repurchase activity in Japan are disconnected from reality as they are being advanced without an accurate understanding of the share repurchases. In this article, we address the actual circumstances of share repurchase activity among Japanese companies based on our joint research, which comprehensively analyzed share repurchases by Japanese companies.
It was after the amendment of the Commercial Code in 2001 that share repurchases (where companies acquire their own shares) were completely liberalized in Japan. The annual amount of share repurchases on average is equivalent to around 1% of the market capitalization of the Tokyo Stock Exchange. This figure is low compared with the share repurchase ratio in the United States, which may be as high as 5% in peak years. All the same, in the 2005-2008 and 2014-2018 periods, the annual amount of share repurchases in Japan was greater than the amount of capital increases through issuance of new shares. Therefore, there is no doubt that the current equity market has become more than just a place where new money is raised.
While a share repurchase is decided by a resolution of the board of directors, there are various methods of shares repurchase. The first method is open market (auction) repurchases, through which an issuer company purchases its own shares at market price during a pre-determined period. It accounts for around 90% of overall share repurchases in the United States. Meanwhile, the proportion of open-market repurchases in Japan is 49% (see the table below).
The second method is ToSTNeT, which is an unique trading practice in Japan. It accounts for 38% of the total. Under ToSTNeT, which is an off-hours trading system, the initiation of a transaction does not come from an issuer, but a seller. Upon accepting this notification, an issuing company then pre-announces a share repurchase just one day prior to the date of actual transaction and purchases shares before the opening of market trading hours on the date of repurchase. The repurchase price is set at the closing price of the previous day.
The third method is through a tender bidding process, which accounts for 10% of the total. According to financial economics textbooks, management who recognize their companies’ shares as being undervalued are likely to submit a tender bid that sets the repurchase price (offer price) at a premium, thereby sending a signal to the market. However, among the 121 cases of share repurchase using tender procedure in Japan, 89 cases have their offer price with a discount to, rather than a premium above, market price (the discount is 8.1% on average). It is reasonable to assume that the only shareholders who accept an offer price lower than the market price would be those that maintain a business relationship with the issuing company.
We refer to the two types of trading above (ToSTNeT and tender procedure) as “quasi-private transactions” to distinguish them from typical open-market transactions. In the first half of the 2000s, quasi-private trading was widely used to absorb the massive share selloffs by banks. In the 2010s, it in turn provided a means of absorbing shares which had been sold by industrial companies in response to the Corporate Governance Code, which called for the dismantling of cross shareholdings.
In summary, share repurchases of Japanese companies are not only motivated by textbook purposes such as returning excess cash to shareholders and sending a signal that the current share price is undervalued. Rather, share repurchases in Japan are intended mainly to prevent the shares that are held by friendly shareholders from transferring to unfriendly outsiders. Consequently, share repurchases have played a role in preserving the proportion of long-term shareholders.
Share repurchase involves more than just purchasing the company’s own shares. However, very little consideration has been given to this point in the arguments over share repurchases. Of repurchased shares in the FY2001-2018 period, less than 40% were canceled, while the remaining 60% were held as treasury shares at least temporarily. Treasury shares, which do not provide either voting rights or dividend rights to the company itself, could be flexibly reissued upon a resolution by the board of directors for the purpose of fundraising. Reissued treasury shares account for around 20% of companies’ repurchased shares.
There is a considerable difference between the methods of disposing of treasury shares in Japan and the United States. In the United States, most treasury shares are sold in a secondary offering (resale in the secondary market) or are used for payment in mergers and acquisition (M&A). On the other hand, in Japan, although treasury shares are resold in the secondary market in some cases, the percentage of such cases is slightly less than 30%. As there are market concerns over possible dilution of shares due to secondary offerings, the cumulative abnormal return (CAR) is minus 7.6% on average.
As for the remainder of treasury shares, around 40% are used for private placements. Private placements are mainly underwritten by corporations or used to implement compensation plans for managers and employees. Regarding placements to corporations, issuers asked companies with which they already had capital relationships to underwrite shares in many cases in the 2000s. In recent years, however, there has been an increasing number of cases in which private placement is used to create new strategic alliances. As the market has reacted favorably to the creation of new partnerships, the CAR is 2.4% on average.
Since the allotment of restricted shares as compensation to management was liberalized in 2016, the number of cases in which private placements are used for that purpose has increased rapidly, although the overall value of these remains small. There are also some cases where treasury shares are used for employee stock ownership plans. In summary, private placements have been used to align the interests of insiders (managers and employees) with outside shareholders.
In addition, more than 30% of all treasury shares are used as consideration in M&A deals. Notice that in the United States, treasury shares are usually used as consideration for a stock swap at the time of a large-scale acquisition, but in Japan, they are mainly used for purchasing minority shares of the partially owned subsidiary to gain whole ownership. When we focus on the samples with sufficient repurchase size (more than 1% of shares outstanding), 111 out of the 180 cases are used to make a partially-owned subsidiary into a wholly-owned subsidiary
Assuming that maintaining long-term relationships between companies and coordinating the respective interests among stakeholders are important elements of Prime Minister Kishida’s “new capitalism,” share repurchases, rather than conflicting with the new capitalism, form one of its foundational pillars, as they allow for appropriate disposal of a company’s own shares.
Japanese companies that have implemented share repurchases and disposed of their own shares have done so as a rational choice motivated by two factors: financial factors, and concerns related to the ownership structure. From the viewpoint of financial factors, restricting share repurchases conflicts with the Japanese government’s policy objective since the introduction of “Abenomics,” which is seeking to enhance the return on equity in Japan. From the viewpoint of the ownership structure, restricting share repurchases poses an impediment to the sale of shares that are held for non-financial reasons and therefore is clearly inconsistent with the initiative to dismantle cross shareholdings, which has been advocated under the Corporate Governance Code and promoted by the Tokyo Stock Exchange.
Share repurchases, regardless of whether they are motivated by financial factors or by control concerns, could be abused, so developing guidelines on share repurchases is sensible. However, when deliberating the details of the guidelines, it is essential to give due consideration to the various motivations behind share repurchases in Japan, and consistency with other policy measures, so that the focus is on preventing deviations from fair market rules, rather than on restricting share repurchases themselves.
* Translated by RIETI.