Even though some Japanese executives probably wish it were, Japan’s introduction of a more western-style system of corporate governance on April 1 was not an April Fool’s joke. The government is banking on the new system – designed to make Japanese companies more attractive to foreign investors – to bolster the ailing Japanese economy. But resistance to change could hamper success and reduce potential benefits the system could bring to the Nippon economy.
Over the past decade Japan has introduced a range of measures in an effort to stimulate the country’s precarious economy. Some of them have worked better than others. Among the reforms are the introduction of independent auditors for large companies, deregulation of the banking system, and the marginalization of Japan’s yakuza (gangsters whose well-known role as the ‘debt collectors’ was so entrenched in the commercial world it may as well have been statutory).
Now the Japanese government, not one to be left behind, has decided that its next trick is to take a run at revamping the very fashionable area of corporate governance.
Since April 1, most Japanese companies – those with a market capitalization of at least ¥500 mn ($4.2 mn) or total liabilities of at least ¥20 bn ($168 mn) – have had a choice between two governance systems. Companies can remain with what the Asian Corporate Governance Council’s Jamie Allen calls the ‘uniquely Japanese but not very effective’ statutory auditor system, under which a company must appoint at least three statutory auditors (one of which must be independent) and also institute a board of auditors. Alternatively, they can move to the western-style ‘company with committees’ system with nomination, remuneration and audit committees attached to the board, each committee comprising at least three members and a majority of outside directors. With this approach a company is no longer required to have statutory auditors.
Return to glory
Despite its long economic nosedive, Japan is still making top quality products and is on the bleeding edge of technology. The country hankers for a solution to return it to the glory days of 5-10 percent annual growth in the 1960s and 1970s. The government is betting the ‘company with committees’ reforms will bring in hitherto doubtful foreign investors.
Reduced cross-ownership and opening up the market to foreign investors combined to make Japan westernize corporate governance. Traditionally, Japanese banks owned shares in most companies, and had strong control over them. And, in a conflict of interest that would horrify many western investors, a major shareholding bank usually acted as the company auditor and monitored corporate performance.
When the bubble economy burst ten years ago, banks had to liquidate their assets and sell down their stakes. ‘Those corporations whose shares were sold down needed to find new shareholders. Hence the entry of foreign investors into the market,’ says Naoyoshi Kasuga, managing director of the New York Stock Exchange’s Japan office. Investor pressure coupled with the depressed business environment, have been the driving forces behind the government’s decision to allow corporations to introduce the new system.
Gearing up
Notwithstanding the undeniable need for economic reform in Japan (OECD figures put economic growth at a woeful 0.2 per cent in 2002), in the eyes of many of its countrymen, there are very good reasons for sticking with the old system. So far only 30 corporations have signed up for the new system, according to the Japan Investment Forum. Not surprisingly, these are almost exclusively those with large foreign shareholder bases like Sony, Mitsubishi Electric, Hitachi, Toshiba, Konica and Orix. But Hiroshi Komori, senior manager at Sumitomo Trust & Banking, predicts that ‘the other 99 percent will remain with the existing system.’
Resistance to change is coming from a number of quarters. Executives are naturally suspicious of practices introduced by foreigners. And given the involvement of poor corporate governance in the collapse of some big western companies recently, the Japanese have reason to be wary. Why adopt a system proving faulty?
There are concerns that the new system is too arbitrary, with critics arguing that a triumvirate of board committees may not be appropriate for all companies. For some, managing three committees may prove unwieldy. For others, three committees may not be enough. ‘There’s a certain rigidity I find disconcerting,’ says Allen.
The efficacy of parallel systems is another concern. ‘Hanging on to the old system is probably a negative. Is it really a good idea to have two systems?’ Allen wonders. Whether the old system will eventually be superseded by the new one is yet to be determined by the government. But currently there are no plans to phase out the statutory auditor system altogether.
Choosing the right path
Whether or not to adopt the new system largely depends on the corporation’s individual situation. Companies with foreign investors or those seeking foreign investment benefit the most from the changes. By adopting the new system, they are sending a message to the investment community that they are prepared to be more open and objective about their operations. ‘Sony and Hitachi are listed in Japan and on the NYSE. Therefore it’s a serious benefit [for them to adopt the changes],’ Komori remarks. But that benefit doesn’t necessarily translate for smaller companies with a largely domestic shareholder base.
Companies are also unwilling to change because of the lack of qualified, independent directors for the new committees. This is partly due to Japan’s strict definition of independence, which bars anyone who has ever worked for or been associated with the company. ‘The pool is still quite small,’ says Les Hoy, IRO for Japanese conglomerate Orix, adding, ‘How effectively independent directors can act on behalf of all shareholders is one of the real issues.’
The problem is being addressed by new organizations like the Council for Better Corporate Citizenship and the Japan Association for Corporate Directors. The latter has been busy helping companies prepare for the changes. ‘It was set up to provide a venue for directors to learn more about being directors,’ Hoy explains. Around 150 companies are involved in the association, which has been regularly conducting seminars and encouraging members to exchange ideas. Another good resource is the Japan Investment Forum, which posts information about companies’ shareholder meetings and governance practices on its site (japaninvestforum.com).
One company staunchly supporting change is Orix. The financial services group has long hoped for a move to US-style governance and started restructuring its board back in 1999. ‘It has been a continuous process,’ says Hoy. ‘We already have nomination and remuneration committees, although they’re set up as advisory committees and not legally established.’ Orix is now putting together its audit committee to fully comply with the new rules.
Some large companies like Toyota are staying with the current system for now. But, like Orix did prior to new measures, Toyota is introducing other corporate governance reforms to create a hybrid of the two systems. ‘Toyota has elected to use the existing system, but wants to reduce the number of directors from 60 down to ten or 20,’ Komori says. Sixty directors! Imagine running a US or UK company with that size of boardroom. Granted, Japanese boards have traditionally subsumed managerial responsibilities, so it’s possible to think of Japanese boards as including both directorship and the executive function. But even so, managing the interests of boards with such huge numbers remains a challenge. Indeed, having to tell up to 50 of your directors to hit the road is another reason why only a tiny percentage of companies have embraced the governance changes. Getting rid of a huge number of board members, particularly in Japanese society where maintaining one’s status is considered incredibly important, is a delicate matter.
When Orix restructured its board, ‘No-one was removed. Positions generally just changed from director to corporate executive officer,’ says Hoy. Sumitomo’s Komori adds, ‘When Sony decided to adopt the executive officer system, they sent a letter to the directors’ wives telling them the change in title was not a demotion. This is a very sentimental issue.’
Because of the reservations many Japanese have toward the new system, it may only have a limited impact in the short term. ‘We won’t see much change over the next year,’ says Allen. Even foreign investors, while giving tacit approval, are keen to see how the system develops before giving their full endorsement.
Although skeptics pooh-pooh the idea that companies with the committees system can fix Japan’s economic woes, if implemented properly it should increase foreign investors’ confidence in the market and therefore encourage growth. It should also facilitate a further opening of Japan’s capital markets and stimulate merger and acquisition activity. But it’s unlikely to herald Japan’s return as the sumo wrestler of the global markets.
