Why Japanese Boards Will Have to Explain Where Capital Sits

One number dominates discussion of Japanese corporate finance: ¥654.8 trillion of retained earnings, confirmed again in the Ministry of Finance’s FY2025 statistics published on 1 September¹.

It is almost always read as a pile of idle cash. It is not one. Retained earnings is an accumulated equity balance — the Ministry’s own English for 利益剰余金 is “earned surplus” — recording profits that were never distributed, regardless of what they were subsequently spent on. Cash and deposits are a separate line on the other side of the balance sheet. A company that spent every yen of last year’s profit on a factory still adds the retained portion to this figure.

The same release makes the point without needing the distinction explained. In FY2025 retained earnings grew by just 2.7%, down from 6.1% and 8.3% in the two preceding years. Over the same period, dividends rose to ¥45.97 trillion from ¥40.07 trillion — up nearly 15%, lifting the payout ratio from 44.7% to 47.6% — and capital investment reached ¥57.90 trillion, the highest in the 25 years for which the series is comparable. Ordinary profits, at ¥124.83 trillion, were the highest in 66 years¹.

Record profits, record investment, rising distributions, and a stock of retained earnings growing more slowly than at any point in recent years. That is not the picture of a corporate sector sitting on its hands.

Two documents, one day

Which makes what happened on 21 July more interesting. Two instruments were published that day. The Financial Services Agency and the Tokyo Stock Exchange finalised the 2026 revision of the Corporate Governance Code². METI published its Growth Investment Guidance³. Neither is centrally concerned with how much capital companies hold.

The Code revision is structural. Principles have been pared back to the conceptual, with a new layer of interpretive guidance beneath them — the stated aim being to move the Code from form to substance. Within that, the board’s responsibilities are set out with unusual specificity. A board should build a path to the growth the company is aiming at; should explain concretely what it will actually execute in terms of growth investment — capital expenditure, R&D, human capital, intangibles — and review of the business portfolio; and should continuously verify that its allocation of resources matches the strategy it has published².

One phrase in that section deserves attention from anyone who has sat through a Japanese board discussion of surplus assets. Allocation, the Code says, should be considered alongside capital returns, cost of capital, the company’s growth phase — and opportunity cost².

Listed companies must file a governance report addressing the revised Code by the end of July 2027.

What the Code does not say

It does not say companies should hold less cash. The rationale document is explicit, and the explicitness looks deliberate: holding cash and other assets “is not always to be denied”, and maintaining an appropriate level of them is itself part of resource allocation — insofar as the company can explain the necessity and the rationale².

That is a meaningful limit. Resilience has economic value, and a corporate sector that has lived through financial crises, deflation, disasters, a pandemic and supply-chain disruption has reasons for liquidity that do not appear in a valuation model. The obligation the Code creates is not to spend. It is to be able to explain.

Nor is this a campaign for larger shareholder returns, which is how the reform programme is often summarised abroad. The Code says close to the opposite: companies are expected not to behave with a short-term outlook by relying solely on returning capital to shareholders, but to pursue growth investment for medium- and long-term value².

The finding underneath

METI’s guidance is where the argument gets uncomfortable. Working from roughly 2,400 leading global companies and their average annual economic profit over 2020–2024, it compares how capital is distributed within businesses rather than how much of it there is.

In its Japanese sample of 350 companies, about 65% of invested capital sits in segments whose economic profit is negative — where returns fall short of the cost of capital. The equivalent figure is 39% for its 650 US companies and 42% for its 494 European ones. Japan’s value-creating segments generated roughly $78 billion of economic profit over the period; its value-destroying segments removed about $80 billion. The two very nearly cancel³.

Two cautions. This is a sample of large listed companies, not the Japanese corporate sector, and the underlying analysis is METI’s compilation of a commissioned McKinsey study rather than official statistics. And it measures invested capital by segment, not the proportion of companies — 65% of capital is not 65% of firms.

With those caveats, the mechanism it describes is the part that matters. Where the spread between return on invested capital and cost of capital is negative, adding invested capital reduces economic profit³. In those businesses, investing more actively destroys value. It follows that “invest more” and “invest better” are not variations on the same instruction. They can point in opposite directions.

That reframes the record capex figure: more investment is good news only conditional on where it goes. It also explains why policy has moved toward portfolio review, why the Code asks boards to verify allocation continuously rather than periodically, and why a tax deferral on gains from selling non-core businesses — reported in late August as a proposal for next year’s tax package, and not enacted — is being discussed at all⁴.

What is actually being asked

The first phase of Japanese governance reform materially changed board composition, disclosure practice and the language of capital efficiency: independent directors, unwound cross-shareholdings, ROE, cost of capital. It was largely concerned with whether a board was constituted to ask hard questions.

The emerging phase asks a different one, narrower and harder. It asks whether a board can answer a specific question about each thing it owns: why is this capital, this asset, this business still here — and what would have to be true for us to move it?

Eveil View The reform is changing subject. The question is no longer how much capital a Japanese company retains, which never had a useful aggregate answer. It is whether each management team can show that what it holds is worth more where it is than in the best alternative available to it. That is an opportunity-cost test, and the Code now names opportunity cost directly.

That question has no right answer in the abstract. A company that can show why ¥200 billion of liquidity suits its risk profile has answered it. So has one that can explain why a low-return segment is worth holding for reasons its economic profit does not capture. What the reforms make harder is not holding capital. It is holding it without having asked.

What remains uncertain The evidence establishes where policy is heading, not that behaviour has followed. Nothing examined here shows allocation quality improving: METI’s own series has Japanese per-company economic profit slipping back to roughly −$4m on a 2020–24 average, after turning positive in 2015–19. A reporting obligation is not a change in how capital is deployed, and 2027 will test whether boards can explain their allocation — not whether they have altered it.

What to validate next Three questions worth answering before the 2027 report rather than while drafting it. What level of liquidity does our risk profile actually require, and can we show the working? Which segments earn below their cost of capital, and what is the case for still funding them? What would have to become true for us to sell or close one?

Financial resilience remains genuinely valuable. Resilience held without a view of what it costs to hold is something else, and 2027 is when boards will be asked to tell the difference in writing.