Better Governance Linked to Stronger Fundamentals in Japan
Responding to both investor and regulatory pressure, Japanese companies have improved their governance practices in recent years.1 Could better governance have led to better corporate fundamentals and played a role in supporting the recent rally in Japanese equities?
Higher governance scores correlated with stronger corporate performance
We analyzed five metrics of fundamental performance for companies in the MSCI Japan Index: gross profitability, trailing dividend yield, book-to-price ratio (B/P), earnings-to-price ratio (E/P) and return on equity (ROE). We observed that better-governed companies (based on the MSCI ESG Ratings governance (G) pillar) outperformed their lower-scored peers across all five measures. For example, they had a higher dividend yield and higher gross profitability.
Companies with higher G-pillar scores had a lower B/P but higher E/P, a unique relationship we observed in Japanese companies. Our research also showed that in the rest of the world (proxied by the MSCI ACWI Index), better-governed companies had a lower B/P but also a lower E/P. We believe the positive impact on earnings for Japanese companies could be explained by a higher ROE for those companies with the highest G-pillar scores.
While we cannot know for sure if the move to better governance practices by many Japanese companies was one of the motivations for the recent rally in equities, we found a positive relationship between better governance and stronger corporate performance over the 12 months ending Dec. 29, 2023.
Five performance metrics were positively related to better governance
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1 We assessed governance by the MSCI ESG Ratings G-pillar score, which is an absolute assessment of a company’s overall governance that uses a universally applied 0-10 scale. Starting with a 10, the score is based on the sum of deductions derived from key metrics included in the corporate-governance and corporate-behavior themes.
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