The reform impetus provided by the Olympus scandal has rapidly evaporated, however, with DPJ moves to strengthen corporate governance facing strong opposition from business groups. While revisions to Company Act are expected to reach the Diet in 2013, major changes appear unlikely given the bigger political issues facing the embattled ruling party.
Among other reforms, the DPJ has pushed for the mandatory appointment of external directors by public companies. A Justice Ministry panel also recommended external directors, although without specifying whether they should be compulsory.
Other proposals have included strengthening audit oversight and allowing for multiple shareholder derivative lawsuits against subsidiaries as well as parent companies, along with measures on private placements.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
While outside directors currently sit in the boardrooms of nearly half of all TSE-listed companies, they are in the majority at only 40 firms, including Hitachi, Hoya, Sony and now also Olympus.
The TSE has also urged companies to disclose information on the independence of their outside directors, amid criticism of the appointment of directors from group firms, “main banks” or other partner companies. Current TSE regulations require only the appointment of at least one independent director or auditor.
Yet according to the Nikkei, the Japan Business Federation (Keidanren), Japan Association of Corporate Executives (JACE) and the Japan Chamber of Commerce and Industry have all lobbied against the reform proposals.
“The Japanese economy will lose its international competitiveness if strict regulation is implemented as a result of generalizations based on a few bad apples,” a JACE official was quoted saying.
Another criticism is that mandatory outside directors will erode management autonomy and discourage “lifetime” employees from aiming for seats on the board.
“Outside directors are common in the United States, but in Japan there aren’t so many and companies argue it’s difficult to secure talented candidates,” lawyer Shojima said.
“Employees may also think that even if they work hard for their company, it will be impossible to become a director due to the hiring of outsiders.”
Yet the outside directors on Olympus’ former board failed to aid Woodford, who said companies “need a majority of outside directors and they need to be truly independent.”
Olcott described the effect of having a single outside director as “almost totally useless.”
“It’s very difficult to be the lone non-executive on the board. When you’re surrounded by executives, your ability to question and your willingness to do so is far less compared to a board which is more balanced,” he said.
He said despite the push towards globalization, the number of foreign directors at Japanese companies had barely increased over the past decade. In 2011, there were only 247 out of an estimated 41,000 directors – “a pathetically small number compared to Western countries.”
In appointing its first non-Japanese directors recently, Hitachi chairman Takashi Kawamura told the Nikkei that “boards of directors embracing members with different backgrounds are more likely to discern problems rather than boards controlled by closely knit members.”
JCGR’s Ahmadjian said companies committed to good governance had an incentive to appoint outside directors, along with increasing the available talent pool.
“When Japanese companies say there’s not enough people out there to be independent directors, I don’t believe that’s an excuse because there’s a lot of retired executives around, but just not that many women. It’s really hard for women to combine families and career here still, and not enough is being done about it,” she said.
Nicholas Benes, representative director of the nonprofit Board Director Training Institute of Japan (BDTI), has been an advocate for independent directors along with improved standards.
“The step that would have the biggest impact would be if the TSE required disclosure of corporate policies on director training. Some 85 percent of Japanese boards are made up of internal directors, and these directors often need training the most,” he said.
“You can put all the legal structures in place, but they’re only going to be marginally effective if the internal directors who dominate boards don’t understand their duties and obligations concerning such areas as internal controls, risk management or succession planning.
“Fundamentally, many directors here just don’t know much about the Company Law – all they know is that their boss, the president is sitting at the end of the table, and to them being a director is just a nice promotion.”
Benes said more independent directors were needed partly to improve transparency, and also to enhance the prospects of takeover bids.
“One of the reasons why you need more independence on Japanese company boards and committees is that these are the only people who can judge takeover bids neutrally. Until this happens no hostile takeover will be successful because there won’t be a group of people who are not self-interested to avoid them,” he said.
“It’s likely that the entire Japanese market is undervalued by at least 30 percent due to the lack of a takeover premium.”
Change or decline
While another Olympus-style scandal is difficult to predict, the reformers are hopeful of faster changes to reassure foreign investors and boost investment.
Nevertheless, few are willing to see Japan’s system completely replaced, given current advantages such as employee loyalty, lower executive compensation than in the West and greater incentives for long-term research and development.
Temple University’s Professor Jeff Kingston said the current burst of overseas investment could help drive reform.
“Japanese companies have been on an overseas buying spree over the past year because of the yen’s appreciation and the dim business prospects in Japan. This process of sharply increasing overseas acquisitions potentially could be a force for change, as companies are going to have to adapt to different standards and ways of doing business,” he said.
Analyst Naomi Fink of Jefferies (Japan) said foreign investors were encouraged by recent reforms, although they need not expect overnight change.
“Are foreign investors going to suddenly get an Anglo-Saxon model of corporate governance in Japan overnight? No. But are there visible improvements? Yes,” she said, pointing to moves against sokaiya corporate racketeers and tobashi transactions as examples, along with revised company laws.
“There are a lot of undervalued companies, overseas demand is increasing with U.S. economic data improving and Japanese companies have recovered from the shock of the Tohoku disaster. There are opportunities to be had and foreign investors are coming back,” she said.
Japan’s institutional investors have also started following their foreign counterparts in exerting more scrutiny on board candidates, with major asset managers reportedly planning to vote only for “truly” independent directors.
Ahmadjian said the pace of change would depend on the attitude of Keidanren, the nation’s most powerful business group.
“Keidanren has been responsible for slowing or stopping most corporate governance reform. If they finally realize that their position doesn’t make sense and start promoting reform, it would completely change the situation in Japan,” she said.