If there is one thing that separates the current Japanese equity rally from previous false dawns, it is the corporate governance revolution. This is not a government talking point or a consultant’s slide deck. It is a measurable, accelerating change in how Japanese companies allocate capital, return cash to shareholders, and engage with investors.

For overseas investors evaluating the Japan opportunity, understanding this reform is essential. It explains why buybacks are hitting records, why cross-shareholdings are being unwound, and why the valuation gap with the rest of the world is likely to narrow.

The PBR Problem

Price-to-book ratio (PBR) measures a company’s market capitalization relative to its book value — essentially, what investors are willing to pay for each yen of net assets on the balance sheet. A PBR below 1.0 means the market values the company at less than its liquidation value. It is, in effect, saying the company would be worth more broken up than as a going concern.

For decades, a startling proportion of Japanese listed companies traded below book value. As of early 2023, roughly half of all companies on the TSE Prime Market had a PBR below 1.0. For comparison, that figure was under 5% for the S&P 500 and under 20% for European markets.

This was not primarily because Japanese companies were bad businesses. Many were highly profitable, held dominant market positions, and possessed world-class technology. The problem was capital allocation. Japanese companies hoarded cash, maintained extensive cross-shareholdings, paid modest dividends, and delivered structurally low returns on equity.

According to McKinsey’s analysis, Japanese nonfinancial companies today hold over $1 trillion in cash — the highest ratio of cash to market capitalization among developed markets. Many companies still keep 15-25% of their assets in cash or equivalents.

The TSE Intervention

In March 2023, the Tokyo Stock Exchange took an unprecedented step. It published a directive urging all listed companies — but particularly those trading below a PBR of 1.0 — to develop and disclose concrete plans for improving capital efficiency and stock price. The TSE began publicly listing which companies had disclosed such plans and which had not.

This “comply or explain” approach leveraged a uniquely Japanese social mechanism: public visibility and peer pressure. No CEO wanted to be on the list of companies that had failed to respond. The effect was immediate and measurable.

J.P. Morgan’s analysis notes that the directive led to a significant increase in share buybacks in 2024 and that some companies officially committed to reducing their cash balances and returning excess capital. The TSE also delisted 94 companies in 2024 — the highest figure since 2013 and the first-ever net decrease in the total number of listed companies. The exchange is actively curating its market for quality.

The Buyback Boom

The most visible manifestation of reform is the explosion in share buybacks. Nippon.com reports that authorized buybacks totaled ¥14.2 trillion through December 2025, putting FY2025 on track to match or surpass the previous year’s ¥18.7 trillion record — potentially the fifth consecutive record year.

These are not token gestures. Mitsubishi Corporation authorized ¥1 trillion in buybacks. Shin-Etsu Chemical and Fanuc each announced ¥500 billion programs. The scale reflects genuine corporate conviction that capital return is now a strategic priority, not an afterthought.

From a supply-demand perspective, corporate buybacks have become the largest net buyer of Japanese equities. According to QUICK Corp. data, business corporations made cumulative net purchases of ¥8.4 trillion in 2025 through early October, dwarfing both domestic institutional and retail investor flows.

Asset Management One projects buybacks will exceed ¥20 trillion in FY2025, with large volumes expected to continue for several years as major financial institutions — megabanks and large insurers — proceed with cross-shareholding disposals through FY2030.

Cross-Shareholding Unwind

Cross-shareholdings — the web of reciprocal equity stakes that Japanese companies held in each other — have been one of the most persistent drags on governance and capital efficiency. These arrangements tied up capital in assets generating poor returns and insulated management from investor pressure.

According to Nomura, cross-shareholdings now account for roughly 25% of TSE market capitalization, down from approximately 60% in 1990. The pace of reduction has accelerated sharply in recent years, driven by regulatory pressure, governance reforms, and activist investor campaigns.

When a company sells its cross-held stakes, the proceeds frequently flow into buybacks, creating a virtuous cycle: the seller improves its own capital efficiency, the company whose shares were sold often responds with its own buyback to absorb the supply, and both companies’ ROE improves.

The Governance Architecture

The current reform wave did not appear overnight. It is the culmination of a decade-long institutional effort with several key milestones that foreign investors should understand.

The Ito Review in 2014 publicly highlighted Japan’s poor ROE and identified investor engagement as critical to improving capital productivity. The same year, Japan adopted its Stewardship Code, which by its 2020 revision required signatories to vote on every share and make their voting records public.

The Corporate Governance Code, first formulated in 2015, established guidelines for improving corporate value. Its successive revisions have progressively tightened expectations around board independence, capital allocation, and shareholder communication.

The March 2023 TSE directive on PBR improvement was the most impactful intervention yet. In June 2025, the Financial Services Agency published the “Action Programme for Corporate Governance Reform 2025,” specifically targeting cash hoarding and demanding accountability for capital allocation decisions. A further revision of the Corporate Governance Code is scheduled for mid-2026.

Activist Investors

Activist investors have intensified their campaigns in Japan, and crucially, their reception has improved. What was once considered culturally taboo is increasingly viewed as a legitimate and even welcome force for change. The number of activist campaigns targeting Japanese companies has risen sharply, and management teams are engaging constructively rather than retreating behind defensive barriers.

Hitachi’s transformation is illustrative. In 2008, Hitachi had 22 listed subsidiaries and reported a ¥787 billion loss. Over the following years, the company sold all subsidiaries to private equity firms and industrial buyers, creating a leaner, faster-growing business focused on green energy, rail, and digital services. The stock has appreciated over 18% annually in EUR terms over the past five years. This kind of fundamental business restructuring would have been unthinkable in Japan two decades ago.

JSR Corporation, a global leader in photoresists used for manufacturing leading-edge semiconductors, offers another instructive example. In 2021, the company exited from synthetic rubber manufacturing — a deeply cyclical, low-margin business that was its original foundation (JSR originally stood for Japan Synthetic Rubber). The firm was subsequently acquired by a private equity firm in 2024, demonstrating the growing acceptance of take-private transactions as a path to value creation.

Take-private transactions have reached record levels across the market. Japanese companies are increasingly receptive to private equity buyouts, recognizing that sometimes the best path to value creation runs through delisting and restructuring away from the short-term pressures of public markets. The willingness of boards and management teams to consider these transactions represents a sea change in Japanese corporate culture.

The FSA’s “Action Programme for Corporate Governance Reform 2025” explicitly addresses the cash hoarding problem, signaling that regulatory patience for companies sitting on excessive cash without a clear strategic rationale is wearing thin. Foreign investors are also turning attention to accumulated cash, creating pressure from both the regulatory and investor sides simultaneously.

ROE: The Key Metric

Return on equity remains the single most important metric for evaluating whether Japanese governance reform is succeeding. For decades, Japanese aggregate ROE was capped at roughly 8-10% — well below the 15-20% typical of US companies and 10-12% common in Europe.

The constraint was structural. Strong earnings growth was offset by retained earnings accumulating on the balance sheet, expanding the denominator and suppressing the ratio. Companies earned well but hoarded the proceeds.

This is what buybacks and dividend increases directly address. By returning capital to shareholders rather than accumulating it, companies shrink the equity base and allow ROE to rise toward levels that justify higher valuations.

Janus Henderson notes that Japan’s total shareholder return ratio in FY2024 reached parity with European companies at approximately 60%. If this trend continues — and the institutional pressure ensures it will — the gap between Japanese and Western ROE should continue to narrow.

What This Means for Investors

For overseas investors, the governance revolution creates a multi-year investment theme with several practical implications.

First, the buyback tailwind is structural, not cyclical. Corporate Japan holds over $1 trillion in excess cash. The regulatory framework, governance code revisions, and activist pressure all point in one direction: capital return. This provides sustained demand support for Japanese equities. According to QUICK Corp., business corporations have been the single largest net buyer of Japanese stocks, with cumulative net purchases of ¥8.4 trillion in 2025 through early October alone.

Second, the opportunity is not limited to large caps. While mega-cap buybacks grab headlines, the PBR reform directive applies to all listed companies. Many mid-cap and small-cap companies with strong businesses but lazy balance sheets are undergoing genuine transformation. Active stock selection can capture additional value beyond the index. Companies trading below book value with improving capital allocation plans represent a particularly attractive hunting ground.

Third, the valuation re-rating has further to run. If ROE continues to improve and the valuation discount to global peers narrows, the capital gains potential extends well beyond what earnings growth alone would suggest. A combination of improving fundamentals and multiple expansion is the most powerful setup for equity returns. The gap between Japanese and US P/E ratios — currently around 36% on an ACWI ex-US basis — has significant room to narrow as the quality of Japanese earnings improves.

Fourth, governance reform makes Japan investable for a broader institutional audience. Many global asset managers have historically avoided Japan because of governance concerns. As those concerns dissipate, structural underweights are being reduced, creating incremental demand. Net foreign buying of Japanese equities in 2025 reached its highest level since the early days of Abenomics, according to Nikkei Asia — and this reallocation is likely still in its early stages.

Fifth, the mid-2026 revision of the Corporate Governance Code represents a potential catalyst. While details remain to be finalized, the direction of travel — further pressure on cash hoarding, enhanced board accountability, and greater shareholder engagement — is expected to accelerate the trends already in motion.

The corporate governance revolution is not a promise. It is already happening, and the pace is accelerating. For investors willing to look beyond the familiar comfort of global index funds, Japan’s transformation offers one of the most compelling structural opportunities in developed market equities today.

I am Hyottoko Sennin, a pen name. I have spent 30 years in Japan’s institutional investment industry and currently run a PIPE advisory firm in Tokyo. This article represents my personal views and does not constitute investment advice. Past performance does not guarantee future results. All investments involve risk, including the potential loss of principal. Please consult a qualified financial advisor before making investment decisions.