Toyota’s $2bn Denso share sale spurs hopes of governance revolution for Japan

Toyota’s decision to sell part of its $40bn portfolio of stakes in other companies is spurring hopes of similar action across Japan to unwind complex cross-shareholdings and improve corporate governance.

Japan’s most influential industrial company is selling a stake worth close to $2bn in car parts maker Denso, lowering its stake from 24.2 per cent to 20 per cent. The stake is one of a web of interconnected equity holdings that Toyota holds across more than 35 suppliers and affiliate automakers.

While Japanese companies have defended cross-shareholdings as a way to cement business relationships and rebuff hostile takeovers, many outside investors believe they create conflicts of interest and perpetuate a chronic misallocation of capital. Toyota’s change of tack could open the gates for others to follow and lead to big changes in Japan’s corporate landscape, some investors hope.

“We are talking about an almost 100-year-old company here and we have seen considerable changes very recently. Two years ago people would have said there is no way Toyota would sell down their cross-shareholdings like this, and the fact they have done it sends a very clear signal to the rest of Japan,” said Carl Vine, a portfolio manager at M&G, a Toyota shareholder.

Toyota has been considering portfolio sales since 2016 but Denso will be the biggest unwinding so far. In July, Toyota raised nearly ¥250bn ($1.7bn) by selling some of its shares in Japanese telecoms group KDDI.

Masahiro Yamamoto, head of Toyota’s accounting division, indicated that the company would continue to reduce stakes in other partners to 20 per cent — a level that would keep Toyota as a top shareholder while allowing it to account for some of an affiliate’s profits under Japanese accounting rules.

“We don’t want to keep sitting on these assets and we want to use them for investing in growth so that the Toyota group can be stronger,” Yamamoto said, saying the priority was to shift assets to invest in technologies such as electric vehicles and hydrogen.

While Toyota denied its decision to sell its Denso holding was aimed at appeasing governance pressure, its decision coincides with growing signs of assertiveness among investors in Japan. Foreign and domestic funds are increasingly punishing governance laggards and companies with low returns on equity by voting against chief executives at annual shareholder meetings.

Bruce Kirk, Japan strategist at Goldman Sachs, said: “The approval rating decline that the CEOs of some high-profile companies experienced in the latest AGM season has had an effect on the way that a lot of companies are behaving now.

“We are seeing a correlation between management coming under this type of pressure and a willingness to address issues in capital allocation and governance.”

At Toyota’s annual meeting in June the approval rating for chair Akio Toyoda dropped 11 percentage points from the previous year to an unprecedented 84 per cent.

In the same month Fujio Mitarai, chief executive of Canon and former head of Japan’s powerful Keidanren business lobby, won just 50.6 per cent approval as investors punished him for heading an all-male board.

Voting at annual meetings was “becoming a blood sport”, said Nicholas Smith, Japan strategist at CLSA. “Where Toyota goes in terms of responding to that, others will follow.”

Japan has been trying to encourage companies to unwind cross-shareholdings. Since the corporate governance code was compiled in 2015, regulators have required listed companies to explain to investors their reasoning if they are not reducing their stakes. But the habit remains ingrained. Companies on the benchmark Topix index have a median of 11 equity holdings, according to Jefferies, down from 15 a decade ago.

US proxy advisers Glass Lewis and Institutional Shareholder Services have also repeatedly pushed for Japanese companies to reduce their cross-shareholdings. ISS has called for a reduction to below 20 per cent of net assets and Glass Lewis has said companies should aim for below 10 per cent.

Toyota’s cross-shareholdings made up 10.97 per cent of net assets at the end of March this year, versus 11.5 per cent at the same point in 2022.

“We are not saying that Toyota is perfect but it’s a great step forward . . . and other companies should follow suit. They will at least have to have a plan about how they deploy capital,” said Naoko Ueno, a director at Glass Lewis.

Toyota continues to defend capital ties with partners and suppliers as a source of competitiveness. While many of its large holdings are decades old, it has recently built small stakes in smaller rivals Suzuki, Mazda and Subaru as they have sought capital ties with the country’s biggest automaker to survive the shift towards electric vehicles.

“Our loose alliance allows us to be extremely strong when it comes to a long-term battle and that’s what we tell our investors,” Yamamoto said.

Nor has Toyota indicated that it will touch the real core of its network of equity holdings, such as parts suppliers Aisin, where it has a 24.8 per cent stake, and Toyota Boshoku, where it owns 31 per cent, as of the end of March.

Some fund managers said Toyota would need to make more aggressive selldowns of its portfolio to be convincing as a true turning point.

“Is this about reducing the pressure on one AGM vote, or is it the start of the whole cross-shareholding unwind that investors have been waiting for such a long time? I think it is too early to tell,” said Zuhair Khan, who manages the Japan Corporate Governance Long/Short fund for Union Bancaire Privée.

“I want to see a clear sign of Toyota unwinding its holdings in the core group of companies before I could be confident that this is the start of the great revolution.”

Nevertheless, other investors believe Toyota will in time cut back such holdings in core companies.

James Hong, an analyst at Macquarie, said: “It’s true that we are first seeing the loosening of ties at companies like Denso, which are not close family, more like cousins — but I guess that is where you have to start.”