Implications for Credit Ratings: Japan’s Market Transformation and Corporate Reform

Japan’s stock market is undergoing a fundamental transformation that goes beyond short-term cyclical trends, according to June-Yon Kim, Lead Portfolio Manager for Japanese equities at Lazard Asset Management. For decades, Japan’s equity market had been weighed down by deflation and structural inefficiencies. However, this has been followed by a prolonged phase of remarkable transformation, including corporate governance reforms, structural shifts in corporate balance sheets, and increased investment activity. This evolving landscape presents a favorable environment for investors and has significant implications for corporate credit ratings.

Corporate Governance Reform: A Structural Shift

One of the most notable developments in Japan’s market transformation is the corporate governance reform initiated by the Tokyo Stock Exchange (TSE) in January 2023. These reforms have accelerated improvements in how Japanese companies operate, encouraging firms to optimize capital efficiency and prioritize shareholder value. A prime example is Toyota, Japan’s largest corporation, which has actively divested cross-shareholdings and set a sustainable return on equity (ROE) target of 20%.

A direct result of these governance reforms is the record number of share buyback announcements, which doubled in 2024 compared to the previous year. From a credit rating perspective, this trend has a dual impact. On the one hand, stronger corporate governance and capital discipline improve financial stability and long-term creditworthiness. On the other hand, aggressive share buybacks could increase leverage if funded through debt, potentially posing risks to credit ratings for highly leveraged firms.

M&A Activity and Global Expansion

Another sign of Japan’s economic transformation is the surge in mergers and acquisitions (M&A) activity. The takeover bid by Canadian retailer Couche-Tard for Seven & I Holdings, the world’s largest convenience store operator, triggered an aggressive counteroffer from the influential Ito family, backed by major U.S. private equity investors. This incident illustrates the growing willingness of Japanese firms to actively defend or expand their strategic positions.

Additionally, Japanese companies have been expanding their global presence. For instance, Sekisui House recently completed a multi-billion-dollar acquisition in the U.S., propelling it into the top ten homebuilders in the American market. This international expansion has positive credit rating implications, as it diversifies revenue streams and reduces reliance on domestic economic conditions. However, companies engaging in overseas acquisitions must manage integration risks and potential currency fluctuations, which could affect their financial stability.

From Deflation to Inflation: A New Era

For decades, deflation shaped Japanese consumer behavior and corporate strategies. However, this trend is reversing, with rising wages and increasing inflation giving companies stronger pricing power. Nippon Steel, for example, now enjoys higher domestic profit margins than its global competitor ArcelorMittal.

The shift from deflation to inflation carries significant implications for corporate credit ratings. On the positive side, higher inflation allows companies to raise prices and improve profitability, strengthening their financial profiles. However, inflationary pressures may also lead to rising interest rates, increasing borrowing costs for highly leveraged firms. Companies with robust balance sheets and pricing power are likely to benefit, while those with high debt levels could face credit rating downgrades due to higher refinancing risks.

The Role of Retail Investors and Market Liquidity

Long-Term Implications for Credit Ratings

According to June-Yon Kim, investors should focus on Japan’s structural changes rather than short-term macroeconomic trends. The combination of rising corporate profits, improved capital structures, and a stronger emphasis on shareholder value creates a long-term investment opportunity.

For credit ratings, the implications are significant:

• Companies with improved governance, higher profitability, and disciplined capital management are likely to see upward rating pressures.

• Firms engaging in aggressive share buybacks or debt-financed M&A activities may face higher credit risk, depending on their leverage levels.

• The shift from deflation to inflation can strengthen credit profiles for firms with pricing power but could pressure those with high debt exposure.

• Greater retail investor participation and market liquidity support financial stability, indirectly benefiting corporate credit ratings.

Japan has long been underrepresented in global investment portfolios. However, with its transition toward higher profitability and a more shareholder-friendly corporate culture, this may change fundamentally. The convergence of improved corporate practices and attractive valuations positions Japanese equities as one of the most compelling investment opportunities in the coming years—one that credit rating agencies will closely monitor as these structural shifts unfold.