In March 2023, the Tokyo Stock Exchange did something that Japanese regulators almost never do. It named names. It published a list of every company on its Prime and Standard markets trading below 1x book value, and told them publicly to fix it or explain why they could not. Not a guidance note. Not a request for comment. A list. In Japan, where the art of institutional face-saving has been refined over centuries, that was roughly the regulatory equivalent of a thunderclap. The market noticed for about six weeks. Then it moved on. That was a mistake.
The numbers at the time of the directive were genuinely startling. Nearly half of all TSE Prime-listed companies were trading below book value.1 Not distressed companies. Not companies with deteriorating fundamentals. Profitable, cash-generating businesses with net cash balance sheets and decades of operating history, sitting below 1x book because nobody had ever asked them to do anything differently. Management teams had been running these companies for their own continuity, not for their shareholders. Cross-shareholding arrangements between corporates had insulated boards from any external pressure. And the TSE, until that moment, had been essentially complicit in this arrangement.
The structural rot that made this necessary
To understand why the TSE directive matters, you need to understand what Japanese corporate governance actually looked like for most of the postwar era. The keiretsu system, built around stable cross-shareholdings between banks, insurers, and industrial companies, was explicitly designed to insulate management from market discipline. A company would hold shares in its suppliers, its bankers, and its customers, and they would hold shares back. Nobody sold. Nobody complained. The arrangement served everyone at the table, and shareholders who weren't at that table had essentially no recourse.
The consequences compounded over decades. Return on equity at Japanese companies averaged roughly 8% through the 2010s, compared to 15-17% for US peers and 10-12% for European ones.2 Cash piled up on balance sheets because there was no institutional pressure to deploy it. Dividends were token. Buybacks were considered almost indecorous. The prevailing philosophy was that cash reserves were a sign of management prudence, not evidence of capital allocation failure. In a low-growth economy with a strong yen and deflationary psychology baked into every boardroom decision, this made a perverse kind of sense. It also destroyed several decades of shareholder value in plain sight.
The prevailing philosophy was that cash on a balance sheet was a sign of management prudence. It was actually evidence of capital allocation failure accumulated over decades.
What the directive actually changed
The TSE March 2023 directive did three things simultaneously, and the combination is what makes it structurally different from prior reform efforts. First, it created a public accountability mechanism. Companies had to disclose whether they were compliant or non-compliant. In a culture where institutional reputation is currency, this was not trivial. Second, it tied compliance to index eligibility. The TSE made clear that continued listing on the Prime Market, the tier that international institutional investors actually care about, would require engagement with these issues. Third, it implicitly validated activist engagement. By framing below-book valuations as a governance problem rather than a market quirk, the TSE gave external investors a legitimate framework to push for change that management previously had every reason to ignore.
The first wave of corporate responses came quickly, and they were largely cosmetic. Companies announced buybacks. Dividend payout ratios moved up. A handful of cross-shareholding unwinds were disclosed. The market rallied sharply in the first half of 2023, the Nikkei 225 reaching levels not seen since the early 1990s bubble era, and many observers concluded the trade was essentially done.3 It was not done. What happened in 2023 was the easy part. Companies that already had the balance sheet flexibility and the board inclination to act did so quickly. What remains is the harder, slower, more interesting second phase: the companies where entrenched management, complex cross-holdings, or genuine operational issues mean that compliance requires actual structural change, not just a buyback announcement.
Why foreign capital remains underweight
The standard explanation for why Japan has been chronically underweighted in global institutional portfolios is the currency. A fund manager running dollar-denominated assets that has been right on Japanese equities but wrong on the yen has often ended up with nothing to show for it, or worse. This is a legitimate concern. But it obscures a more interesting dynamic that has developed over the past two years.
Foreign ownership of Japanese equities has been rising. The TSE's own data shows foreign investors accounting for roughly 30% of trading volume, and ownership of Prime Market companies by foreign institutions has edged up from the low-to-mid 20s as a percentage toward the upper 20s.4 More tellingly, the composition of foreign buying has shifted. What had been predominantly macro-driven flows, buying the Nikkei as a USD/JPY hedge or a reflation trade, has started to include a more deliberate allocation to the governance story. Global activist funds have been notably more active in Japan over the past 18 months than at any prior period in the market's history.
The currency remains the conversation stopper in every allocator meeting. But there is a reasonable case that for investors with a genuine multi-year horizon and some tolerance for FX volatility, the governance re-rating potential in Japanese mid-cap equities is one of the few remaining structural alpha opportunities in developed markets. The US market is expensive on virtually every metric. European equities offer macro exposure without the company-level specificity of what is happening in Japan. The governance catalyst in Japan is not a factor that shows up in a Bloomberg screen or an ETF allocation model. It is a company-by-company story that rewards actual research.
The Buffett signal and what it actually meant
Warren Buffett's investment in Japan's five major trading companies starting in 2020, and his subsequent top-ups and comments in 2023, were widely covered as a validation of Japanese equities broadly.5 That framing missed the point. Buffett was not buying Japan as a macro trade. He was buying deeply discounted cash-generating businesses with strong competitive positions, low valuations relative to earnings power, and management teams that were starting to listen to shareholders in ways they had not before. The trading companies, the sogo shosha, are not representative of the broader Japanese market. But what Buffett identified in them, the combination of asset-backed value, improving capital allocation, and governance momentum, is replicable across hundreds of smaller companies that no Berkshire analyst will ever visit.
The more important signal was not that Buffett bought Japan. It was what the trading companies did in response to his engagement. They raised dividends. They bought back shares. They restructured subsidiaries. Management teams who had been politely unresponsive to domestic institutional pressure found themselves suddenly willing to act when a long-term international investor with Buffett's credibility and profile asked the same questions. That dynamic, where external validation accelerates the pace of governance change at companies that were already under pressure from the TSE directive, is playing out across the mid-cap universe in a less visible but equally consequential way.
The unfinished arithmetic
Here is the piece of the Japan governance story that does not get enough attention. The cross-shareholding unwind is still in its early stages. Japanese corporates held an estimated 70 trillion yen or more in cross-shareholdings at the peak. Regulatory pressure from the FSA and the TSE has been pushing these down, and the pace has accelerated meaningfully since 2023. But the amounts remaining are still large, and the process of unwinding creates a specific investable dynamic: when a company sells a cross-held stake, it often simultaneously uses the proceeds for buybacks or dividend increases, and the company whose shares are being sold often sees a price impact from the overhang clearing.
Companies with net cash balance sheets that equal or exceed their market capitalization are not rare in Japan. They exist across industrials, services, and technology. The standard value investor's response to this situation, in any other market, would be immediate. In Japan, the cultural and structural barriers to shareholder return have historically made these positions frustrating exercises in patience. What the TSE directive did was change the institutional context in which management teams make these decisions. It did not eliminate the patience requirement. It shortened the expected wait materially, and it gave investors a legitimate framework for engagement that did not previously exist.
What the second wave looks like
The first wave of governance responders have largely been re-rated. The opportunity now sits in three categories. First, companies in the mid-cap and small-cap space below the top 200 names where foreign ownership is negligible, sell-side coverage is thin or nonexistent, and the governance catalyst is present but not yet priced. Second, companies where the initial response to the TSE directive was cosmetic, a one-time buyback and a press release, but where the underlying balance sheet and earnings quality mean a sustained program of capital return is both feasible and increasingly likely as TSE monitoring of compliance deepens. Third, companies in the process of genuine board reconstruction, adding independent directors, unwinding cross-holdings, and moving toward international accounting standards, where the full re-rating will follow a multi-year governance transition rather than a single announcement.
None of this is a trade for the quarterly-oriented. Japan operates on its own calendar, its own cultural rhythms, and its own definition of urgency. What is encouraging, and this is genuinely new, is that the definition of urgency is shifting. Boards that spent the last thirty years treating shareholder value as a secondary consideration are now operating in an institutional environment where that posture has real consequences. The TSE made that change. Buffett reinforced it. The activists circling are making it permanent. The repricing, from where we sit, has a long way to run.