The Search for Drivers to Improve Enterprise Value - How to Drive Up Earning Power and the Growth Expectations -

In addition to quantifying non-financial capital, another important key step for companies to achieve sustainable growth is to generate new seeds for growth through effective stakeholder communications. Making the equity spread (an investment indicator) positive, or in other words, making the return on equity (ROE) 8% or more to expand the business and achieve a high profitability greater than the hurdle rate, leads to a cycle allowing further investment. Furthermore, that investment enables employees to take on challenges through growth opportunities, generating new seeds of corporate growth and creating a spread that further increases profitability, thereby earning the trust of investors.

Yanagi said, “What is the value creation story that will be truly approved of by investors? To begin with, the investors are not the only stakeholders. For example, the main approach should be to think about how to communicate about the value of non-financial capital and get long term investors and shareholders to understand it.” He explained that in addition to explaining the value of non-financial capital to outsiders, it also needs to be explained to employees to increase their motivation, making them aware that their efforts lead to enterprise value and are deeply meaningful for society. He also raised some points made by foreign investors, saying, “ESG for Japanese companies is stuck at the level of ESG for the purpose of ESG itself. What is needed is ESG that creates management value. Aren’t Japanese companies often using ESG to hide low PBR and ROE?”

In fact, while the Japan’s rate of voluntary integrated report (IR) disclosure is number one in the world, the PBR and ROE values at least put it at the level of the poorest country among advanced nations.
According to the results of a survey of investors carried out by Yanagi,¹ more than half of respondents answered that “Japanese companies should show proof of the relationship between ESG non-financial capital and enterprise value.” Yanagi explained, “As proven by the survey results of 100 to 200 global investors collected every year for the past 15 years, the point that needs to be appealed to long- term investors are the relationship between non-financial capital and enterprise value.” Saito added, “Japanese companies tend to look at the numbers in single-year increments, so the ability to explain based on the delayed spread effect of initiatives that emerge after several years is an important point.”

Yanagi explained, “Long-termism is a prerequisite of the Yanagi Model, and short-termism destroys that equilibrium. The delayed spread effect is built into the Yanagi Model, and proves an increase in enterprise value five or ten years in the future. It is necessary to explain how enterprise value will be increased through management over the next five or ten years through an evidence-based story of correlation, cause, and effect.

He explained that this is also the antithesis of the short-termist. For example, profits will increase if you cut personnel and R&D expenses. One hedge fund proposes significantly increasing earnings per share (EPS) through excessive reduction of personnel and R&D expenses, but Yanagi believes companies should say no to that. Note that it is not convincing to simply explain that personnel and R&D expenses are “investments for the future” that increase future enterprise value. The Eisai case study of the Yanagi Model proves statistically that personnel and R&D expenses increase PBR in five and ten years respectively. Because academic statistical evidence is available in addition to the R&D pipeline and qualitative personnel explanations, it gains the support of long-term investors. You can provide an explanation based on the delayed spread effect and long-termism.

He explained, “The commitment of top management is important. You will gain support by also engaging with outside directors.” When Yanagi was serving as the CFO of Eisai, he explained the importance of hiring and employee training to the employees at the Financial Labor-Management Council by using the Yanagi Model and impact accounting, in addition to explaining the financial statements, which led to receiving the support of the union and increased employee motivation. He explained, “A company is its people. In the end, employee engagement is the most important.”

As explained above, the purpose of ESG initiatives is not the initiatives themselves, but as investment for corporate growth over the mid- to long- term. By properly explaining to the employees how the company will grow over the next five to ten years, it leads to a positive cycle of explaining the long-term outlook to shareholders.

¹ Ryohei Yanagi, “CFO Policy <3rd Edition>: Value Creation through Financial and Non-Financial Strategy”, CHUOKEIZAI-SHA, 2023

The point to maintain and increase competitiveness is to define the purpose and battlefield of the company, clarify the mechanism for improving enterprise value, manage both extended reproduction and competitiveness, and continuously spiral up (Figure 2).

Omron changed directions to raise profitability by shifting from selling goods to selling solutions for their industrial automation business. It is essential to engage in joint research with top companies in the key industry when selling solutions, while it is also necessary to understand the customer problems.

It is difficult to ever truly understand the customer when just selling parts, so it is important to gain an understanding of the customer by visiting them regularly and increasing sales capabilities. Furthermore, software quality becomes a key word when shifting from selling goods to selling solutions, and solid solutions can be created by increasing and training competitive software engineers and further breaking out of the inhouse mentality to collaborate with partners. As a result of doing that, Omron was able to increase their joint research with top companies in the industry.
Nitto explains, “It is important to have a clear sense of the scenario to show what the root of competitiveness is and what is needed to change that into profits.”

He explains that companies have both deep and surface competitiveness, but that it is important to build deep competitiveness. For example, if a company only pursues the outward numbers regarding the ratio of women managers or the use of reduced working hours for childcare, both felt to contribute to mid- to long- term enterprise value, it will not lead to competitiveness.
Yanagi explains, “Cause and effect and correlation are all required. The Yanagi Model proves that, in the case of Eisai, when the ratio of women managers rises 10%, enterprise value increases seven years later. But to achieve that, it is important to consider what kind of value you want to create by transforming the business processes and culture behind the numbers, such as training and reduced working hours for childcare, support systems, and top leadership mentality.”

And the point from the standpoint of investors is long-term investment. For example, patent and consumer business models have high entry hurdles but also the roots of growth. The same is true for the pharmaceutical company pipeline. The connection with non-financial capital assumes innovation and R&D, and the selection standard and amount of investment on those two factors is what reaches investors.

Yanagi explains, “The non-financial and financial are connected. Excellent products, services, and business models are the root of innovation. But for the governance formation which carries those factors to function properly, in the end it is important to go as far as the purpose thereof and break that down into the spread of the company principles and the actual business. By creating a story for enhancing non-financial capital and achieving it, you can create the roots of competitiveness and barriers to business entry.”
Nitto adds, “One point moving forward will be building competitiveness and speed for business processes.” How can one change their company and create value when seeing the drastic changes in the world? The first step to answering that is to visualize and quantify business value and social value.
Further points are communicating with shareholders and employees about how you will connect with this competitiveness and roots for the future, and investment in transformation including both human and intellectual capital.