Japan’s tarnished image for corporate governance is undergoing a polish. From its declaration as a key “third arrow” reform for Abenomics, new company law reforms, the launch of a stewardship code for investors, and promised corporate governance code in 2015, the nation’s businesses have been put on notice to improve performance or face the consequences.
After years of incremental change, has corporate governance reform finally reached a tipping point in a country where nearly all directors and CEOs are hired internally, and with few outsiders? The Diplomat’s Anthony Fensom asked Nicholas Benes, head of the Tokyo-based Board Director Training Institute of Japan (BDTI), whether reformers’ optimism was justified.
You’ve described the new corporate governance code as potentially epoch-making – are you confident it will deliver?
Yes, I think this will be epoch-making in the context of Japan. My major points when I proposed this concept were you need to have a deadline, and they do, which is within a year; you need clear criteria, and they’re going to adhere to OECD corporate governance principles; and Japan needs a code which will be well received abroad, and they have announced all of these relatively clear criteria. Importantly, accountability for creating the new code was not given to METI [Ministry of Economy, Trade and Industry], but rather – just as I proposed – was given to the FSA [Financial Services Agency], which is responsible for protecting investors. This is very important.
This is one of a few countries in the world that doesn’t have a corporate governance code; it also is one of the only countries that doesn’t have a set of best practices. In addition, Japan is really the only country of any significance that doesn’t have any rules about director training. So the starting bar is very low, and there is lots of upside.
It used to be that METI was in charge of most of the delicate things to do with corporate governance reform, and what METI would do is compromise between everybody and then go back to Keidanren [Japan’s major business lobby] for sign-off…and that’s why we haven’t had much progress. But now the lead player is not Keidanren, it’s the FSA, which cannot come up with something that’s too back bending to industry because it will be criticized for not protecting investors.
[Minister of Finance Taro] Aso, who is responsible for the FSA, said publicly if we lower taxes and companies increase retained earnings, it won’t do any good at all if they don’t pay it out to shareholders as dividends or stock buybacks, and get it back in the economy. So he’s saying to Keidanren, if they want us to lower taxes, they’re going to have to toe the line on corporate governance.
The government understands that they need to improve productivity here or we have a real debt default crisis looming. When I started 15 years of corporate advocacy, I used to be told you couldn’t use the word productivity, because to Japanese it sounds like “restructuring,” which sounds like you’re firing people. And now we’ve got the Japanese government itself saying that we need productivity and governance is good and connected to productivity. There’s no way you can view this as other than a sea change.
There’s been debate over the number of mandatory outside directors, how do you see this evolving?
I think if we’re lucky, they may use the word “multiple” in the code, so two or more…or even up to a third of the board. And if the code is saying explain why you only have one or two, then the pressure of explaining will be on companies. Even two will allow you to have a committee of those two plus an outside statutory auditor, and that’s a major sea change by itself in Japan.
You don’t have formal, independent nomination and compensation committees in 98 percent of Japanese companies, because you don’t have enough independent outside directors to compose them, and they don’t have a legal system of committees for the most common form of company. So if the code puts in a formal concept of committees, that’s a very major change.
Can we expect more merger and acquisition (M&A) activity as a result of the changes?
The answer is a resounding yes. Japan’s proportion of M&A compared to GDP is about one-fourth or one-fifth the United States or Britain, it’s very low in an economy that needs to be restructured and refocused. One of the reasons it’s so low is that corporate governance in many companies is unable to make the decision to sell a division or subsidiary that’s non-core as soon as it should, so it goes bankrupt or they sell it – if at all – when it’s too late. Those kinds of situations should be prevented if you have more outsiders on the board, and if it’s in part of the corporate governance code that you consider issues like that from an independent and objective standpoint.
Cross-shareholdings have been accused by former Olympus boss Michael Woodford and others of stifling change, are these going to be addressed?
Cross-shareholdings have declined and over time they should erode more. Some in the LDP [Liberal Democratic Party] think Japan should have policies to more proactively get rid of them, like in Germany where they put together a friendly tax regime for banks to sell cross-shareholdings, and managed to get them down significantly, which had a positive impact on its capital markets. But others think it will destroy stability in shareholdings.
The growth strategy came up with a compromise about increasing disclosure regarding the precise reasons why such shareholdings are held. That by itself will cause a decline, as will the policy of focusing on ROE [return on equity] more.
To what extent will the code look at board diversity, including more female directors?
I think it is unlikely that a reference to diversity will be in the corporate governance code…Japan tends to take a voluntary attitude toward that. The main problem in Japan is you don’t have enough women at senior executive level in the first place, so you won’t have enough people to put on boards with significant executive experience. The government already has a goal to try and encourage companies and the civil service to get to 30 percent of female managers by 2020. I think this will be impossible unless you amend the labor law and improve labor mobility in general.
How about more non-Japanese directors and managers?
They’re still coming up naturally, because you have more globalization and more offshore managers like Mr Woodford rising up through the ranks. And that’s probably one way you’ll get more of these guys on boards here. The smarter companies will also want to appoint foreigners because they want more of a global outlook, experience, and access to a personal network, so you’ll see that happening naturally.
Director training is the main focus of the BDTI – will the new code have much effect on this?
Japan is the only significant market that has no rules about training, notwithstanding the fact that 85 percent of directors are internal. It’s inconceivable that in an education-focused, Confucian society that wants to keep a lot of internal directors on boards, that they’ll have a corporate governance code a year from now that doesn’t require or strongly encourage training.
I think director training is the key lynchpin in corporate governance reform here in many, many ways, not just because a lot of unqualified people are on boards, but because reform accelerates if people really understand what it’s all about and that it’s actually good for their company and themselves.
So the opportunity to create a virtuous cycle where you not only have these reforms and rules and best practices, but you also have people understanding it and learning why it’s useful and best practice, is immense in Japan. There’s no country in the world where the positive upside potential of director training for both insiders and outsiders is so high.
What’s your view on the new stewardship code and its impact?
It’s great to have a stewardship code but Japan did it backwards, because most countries have a corporate governance code first and that via the “comply or explain” principle, induces all this disclosure about what the practices are in each company. And based on that extra disclosure about actual governance practices, which is many times more detailed and robust than what you have now, companies are then able to be good stewards. Institutions are able to look at all that data, analyze it and be better fiduciaries, voting their proxies properly and talking to companies in an efficient, intelligent way.
For institutional investors, actions speak a lot louder than words, and one of the easiest actions they can take to show they’re being a good steward, is to support the concept of director and governance training in Japan. Because at the end of the day, engagement and governance only work when things are self-governed. Supporting this concept of people becoming better board members is the next step in making stewardship real here.
Looking ahead, are you optimistic about the direction of Japan’s corporate governance reforms?
I think these topics being discussed in a national policy document that were not mentionable even two years ago, is a major sea change. It’ll take time, and it will be up and down, but you have a very strong base here.
First of all, there’s a very strong shareholder rights base in the law – shareholders have stronger rights in the law than in the U.S. So there’s this massive latent possibility of shareholder activism that so far has been largely unexercised because of cross-shareholdings, but they’ve come down.
It used to be parties most interested in governance were a motley mass of some foreigners who don’t speak Japanese and don’t go to shareholder meetings and some private individuals, but now you’re going to have this thing called “best practice.” And a lot of discussions at shareholder meetings are naturally going to talk about that best practice – why are you not doing X, Y or Z. And the shareholders here, when they start talking about this stuff, should have an incredibly large impact.
Secondly, Japanese people are very quick about executing stuff; now that it’s national policy, the crane has squawked – the one cry of the crane that makes all the others fly. So the fact that the government has clearly set forth all these concepts in its policy document, is a crucial tipping point.