June 15, 2009

Japan: Proxy Season Preview

As the proxy season gets underway in Japan – where the majority of companies hold their meetings during the last two weeks of June – defensive measures are the hot topic once again this year. This report is from the RiskMetrics Group:

The most controversial issue of the 2009 Japanese proxy season will continue to be the introduction and renewal of “poison pills” and other types of takeover defenses. In the wake of attempts to take over companies including Hokuetsu Paper, Bull-Dog Sauce, and Sapporo Holdings – as well as the successful proxy challenge at Aderans Holdings – many companies have introduced defensive measures because of fears of being acquired.

However, these fears may be overblown because the difficulties of successfully managing a company after a hostile acquisition will help to ensure that the number of such cases will be limited. Nevertheless, several hundred companies will introduce or renew a poison pill this year. More than one in seven Japanese issuers already have a pill in place as of May 1, according to RiskMetrics data.

Notwithstanding investors’ skepticism toward takeover defenses, companies that have put their pills to a vote usually have had no difficulties in winning approval, thanks to the support of cross-shareholders and other management-friendly parties. One exception is Works Applications, which was forced to withdraw a pill proposal after the company could not garner enough shareholder support.

According to RiskMetrics data, about 30 companies have removed poison pills to date. However, this includes companies where pills became unnecessary due to organizational changes such as becoming listed subsidiaries of larger companies; RiskMetrics data shows that only about 10 companies, including Shiseido, Nissen Holdings, and Rohm, removed pills because they came to believe that the defenses were not in the best interests of shareholders.

Most poison pills introduced in 2005 were so-called “trust-type” plans, where warrants are issued to a trust bank, to be transferred to all shareholders (other than a would-be acquirer) in the event the pill is triggered. These plans require a shareholder vote under Japanese law. Since 2006, the vast majority of poison pills have been so called “advance warning-type” or “advance notice-type” plans. In these cases, the board announces a set of disclosure requirements it expects any bidder to comply with, as well as a waiting period between the submission of this information and the launch of the bid. As long as the bidder complies with these rules, the company “in principle” will take no action to block the bid and allow shareholders to decide. The exceptions are where the bid is judged to be clearly detrimental to shareholders, such as in cases of greenmail, asset stripping, and coercive two-tier offers. Usually, such judgments are made by a “special committee” or “independent committee,” but the committee’s decision is usually subject to being overruled by the board. At some companies, the decisions are made by the board with no committee input at all.

Advance warning-type defenses do not require shareholder approval, although in most cases, companies are choosing to put them to a shareholder vote, as it is believed that doing so will put the company in a stronger position in the event of a lawsuit. However, the primary problem is not the terms of the poison pills themselves – these are often superior to those of U.S. companies due to relatively high trigger thresholds, clear sunset provisions, and an absence of “dead hand” provisions. Rather, the main problem is with Japanese companies’ insider-dominated boards and insufficient disclosure. The presence of a critical mass of independent directors is essential to ensure that a takeover defense is used not merely to entrench management, but contributes to the enhancement of shareholder value.

Notwithstanding management fears, some of the companies implementing pills are in fact not especially vulnerable, because founding families, business partners, or other insiders own more than a third of outstanding shares. This is enough to veto any special resolution, such as an article amendment or a merger, meaning that even if a hostile bidder is able to accumulate a sizable stake in such a company, that bidder will be unable to force any major restructuring moves opposed by the insiders. It is difficult to see what shareholders of such a company stand to gain from a poison pill.

Many of the poison pills introduced in the past few years will be up for renewal in 2009. In evaluating these renewals, investors should examine the company’s share price performance, relative to its peers, since the pill was first put in place. Where the company has underperformed the market, it will be difficult to argue that shareholders have benefited from the pill.

Some companies, while not putting a poison pill on the ballot, will seek to pave the way for the eventual introduction of a pill through measures such as increasing authorized capital. Investors should expect to see other article amendments designed to ward off hostile takeovers, such as the elimination of vacant board seats that could be filled by shareholder nominees, and the tightening of procedures for removing a director.