In my previous article, “How far has corporate governance progressed in 2021 (4),” I discussed the correlation analysis of each measure of corporate governance practices with the respective rates of change in ROA and ROE as of December 2020 and December 2021 for 1,704 companies in the Metrical Universe. The results showed that when corporate governance practices are divided into board practices and key actions, ROA and ROE both showed significant correlations with key actions, but no significant correlations with board practices. ROA and ROE are both significantly correlated with key actions, but not with board practices (see table below). From this, we can infer that in the 2021 analysis period, the increase in company profits and the confidence of good performance did not provide an incentive to improve board practices. We have told you that the company may have had some other motivation to improve board practices.
Metrical has mentioned several times in previous articles that the percentage of independent directors to the total number of directors is a key factor in improving board practices. In this article, I analyzed the correlation between changes in the percentage of independent directors as of December 2020 and December 2021 and the change in each of the corporate governance criteria. As a result, it was confirmed that the changes in Nomination Committee and Compensation Committee scores showed significant positive correlations with the changes in the percentage of independent directors as of December 2020 and December 2021 (see the table below). Other than that, the change in the number of ex-CEO advisors and the growth policy score were negatively correlated with the percentage change in the percentage of independent directors, although the significance level was slightly below 5%. Although these negative correlations did not reach the 5% level of significance, I would like to explore the reasons why these correlations became negative with the change in the ratio of independent directors, and to see if they will become significant in the future.
On the other hand, I am convinced about the Nominating Committee and Compensation Committee scores, which showed a significant positive correlation. As mentioned in my previous articles “How far has corporate governance progressed in 2021 (1)” and “How far has corporate governance progressed in 2021 (2),” I have examined the one-year trends for each evaluation item. As a result, I confirmed that the Corporate Governance Code, which was revised in 2021, had an impact on the improvement of corporate governance of listed companies due to the reorganization of TSE’s market segmentation in April 2022. In other words, the percentage of independent directors and the nomination and compensation committees, which were specifically mentioned in the revised Corporate Governance Code as areas for improvement, improved, while the criteria that were not specifically mentioned in the revised Corporate Governance Code, such as the chairperson of the board of directors, female directors, and takeover defense measures, were little or limited improvement.
This is consistent with the results of the above and the correlation analysis between the percentage change in the ratio of independent directors and the change in each evaluation item of corporate governance practices shown in the table above. Many listed companies, especially those that have chosen to list on the prime market, have been making efforts to improve their corporate governance practices with respect to the appointment of at least one-third of independent outside directors (Principle 4-8) and disclosure of the concept, authority, and role of the independence of committee composition (Supplemental Principle 4-10 (1)), which were referred to in the Corporate Governance Code revised in 2021 for companies listed on the prime market. In addition, there were other matters that the revised Corporate Governance Code required of several prime market listed companies, such as ensuring diversity in the company’s core human resources (Supplemental Principle 2-4 Z(1)) and ensuring diversity in the company’s core human resources (Supplemental Principle 2-4 (1)). However, those that were not mentioned as specific items to be improved or numerical targets can be said to have been left postponed going forward.
The table below shows a matrix of correlations between changes in each of the Corporate Governance Practices criteria. It shows that the measure with the highest number of significant positive correlations is the change in cash holdings score among the key actions. The change in cash holding score was significantly positively correlated with the equity cancellation score, the growth policy score, and the Metrical score. It makes sense to reduce cash and clarify the stock retirement and growth policy. It is also understandable that the corporate governance score (Metrical score) would improve as a result. The next most significant positive correlation was the change in the percentage of independent directors. This confirms that the percentage of independent directors has the most influence on corporate governance among the criteria for evaluating board practices.
Except for the change in the percentage of independent directors, which was significantly and positively correlated with changes in the nomination and compensation committee scores, there were no changes in the board practice measures that were significantly and positively correlated with changes in other measures. While it is impossible to draw conclusions based on a one-year analysis of 2021, much of the improvement in 2021 was due to efforts to improve the percentage of independent directors, nominating committees and compensation committees, which are specifically required of companies listed on the prime market as a result of the revised Corporate Governance Code. There is a “chicken and egg” debate as to whether companies that have improved their business performance and gained more confidence in their corporate management tend to improve their corporate governance, or whether companies that have improved their corporate governance tend to take better key actions and improve their business performance. I will continue to examine whether passive events such as the revision of the Corporate Governance Code will motivate further improvements in corporate governance, or whether more companies will actively improve their corporate governance practices.
The table below shows how much the companies that actually increased their percentage of independent directors improved their nomination committee score and compensation committee score, respectively. Looking at the change in nomination committee score and compensation committee score for each group of changes in the percentage of independent directors, the companies that increased their percentage of independent directors in 2021 improved both their nomination committee score and compensation committee score. This means that of the 1,704 companies in the Metrical Universe, 719 companies (42.2%) that increased their percentage of independent directors improved their respective scores by establishing nominating and compensation committees, having a majority of their committees composed of outside directors, or having their committees chaired by outside directors. As a result of the improvements of the companies exceeded the overall average improvement of the Metrical Universe. This indicates that 42.2% of the 1,704 companies in the Metrical Universe are in compliance with the Corporate Governance Code, which was revised in 2021 and specifically mentions the election of at least one-third of independent outside directors (Principle 4-8) and disclosure of the concept, authority and role of the independence of the committee composition (Supplemental (Principle 4-10(1)).
Aki Matsumoto, CFA
Executive Director
Metrical Inc.
akimatsumoto@metrical.co.jp
http://www.metrical.co.jp/jp-home/