BDTI Directors Roundtable: Discussing the Revised Corporate Governance Code
Tadayasu Nishida, Kenichi Osugi, Sachiko Ichikawa, Masataka Ueda, Nao Makino
Makino (participating remotely)
Nishida: The revised Corporate Governance Code is now in effect. Today, we’d like to discuss the revised Code and have a conversation that conveys BDTI’s message to those currently serving as directors and officers, those who may take on these roles in the future, and those involved in supporting the board as part of the board secretariat.
In the first half, we’ll cover five themes: (1) the role of directors, including the shift from advising management to overseeing it; (2) the role of the corporate secretary; (3) the “comply or explain” approach; (4) director and executive training; and (5) setting the direction of corporate strategy, along with growth investment and capital allocation.
After that, we’d also like to discuss what the key focus should be for the various stakeholders in light of the revised Code, as well as what we would like to see in the next revision.
Ichikawa: First of all, I think we need to go back to the fundamentals: governance is not about “governance for the sake of governance.” The point is to use governance to enhance corporate value. With ROE continuing to struggle, I think we first need to recognize that there is a growing need to improve the effectiveness of the Code itself.
There are three things in the revised Code that particularly stand out to me. The first is that Principle 4-8 makes it much clearer that the role is about oversight rather than advice. The word “advice,” which appeared frequently in the past, appears only once in the revised Code—and has dropped to fourth place in the order of emphasis. I’ve even heard people on the executive side say in discussions that what they expect from outside directors is “advice,” so I think the clearer emphasis on the monitoring board is a welcome change.
But can outside directors alone provide sufficient oversight? Given the continued weakness in ROE, the answer is clearly no. I think the revised Code reflects this recognition to some extent. It introduces the idea of adding functions such as a corporate secretary as a kind of “extra support,” in order to broaden and strengthen the pool of people involved in corporate governance. That’s the second point I’d highlight.
The person who has been advocating this idea is Kelly Waring. She has been emphasizing the need for such a function and has introduced the UK system. Under UK company law, there are qualification requirements for company secretaries, and their role is clearly defined as advising the board on matters relating to corporate governance. By contrast, in Japan’s revised Code, the term “corporate secretary” appears almost as a katakana label, with very little explanation of what the role is actually supposed to involve. I imagine that people who have traditionally served as the board secretariat may also be wondering how they should interpret the function envisioned by the revised Code and how they should develop it. If we get this wrong, we could end up with nothing more than the Japanese name for the board secretariat being replaced by a katakana term.
From the perspective of outside directors, there’s still some uncertainty about whether the board secretariat will really become a reliable partner. But my motto has always been, “Let’s give them the benefit of the doubt and do our best for now.”
I’d like to use this opportunity to strengthen the capabilities of the board secretariat and, in the process, develop more people who can truly be allies to outside directors.
Looking ahead, I think the challenge is to build some consensus in Japan around what this role should actually be, and then establish it as a proper function—so that we don’t end up with the terminology changing while the substance remains the same.
I have my own ideas about how the role could evolve step by step, but perhaps I’ll leave it there for now.
Makino:
I don’t think the revised Code will have a particularly significant impact this time around. That said, when it comes to the corporate secretary, I do have some expectations for the future. The term now appears in Principle 4-14, which notes that the role of the board secretariat becomes particularly important when an outside director serves as chair or when outside directors make up a majority of the board.
What investors are looking for is for the board to become a place where outside directors are not simply “guests,” but where they can take on the role of “hosts” and actually exercise their oversight responsibilities.
Traditionally, the CEO or chair has often chaired the board, while outside directors have tended to be more like “guests,” offering their views when asked. But for outside directors to really become the “hosts,” they need support from the board secretariat to make up for their relative lack of information and the need to navigate the internal processes involved in getting things onto the agenda. I see that need reflected in the term “corporate secretary.”
In particular, I have high expectations for the corporate secretary’s role in setting the agenda for outside directors. The key question is whether outside directors can take the lead in bringing issues to the table that may be less likely to come from management—uncomfortable topics, for example, or reviews of past M&A transactions.
I hope this doesn’t end up being just a matter of adding the term to the Code. I’d like to see the function actually take root and work in practice.
Ueda:
If I were to add one thing, I think we should look at a broader issue: the fact that many executive directors may not fully see themselves as directors, even though I recognize that addressing this in practice is not easy.
I’m also a little concerned that we seem to be hearing less and less about the Stewardship Code. Given the reality that a large majority of shareholders simply vote in favor of management proposals, perhaps there is also a role for BDTI to do more to raise awareness among general shareholders.
I think the introduction of the corporate secretary is a major step forward. But we also need to think more carefully about the reporting line. Under the way most organizations are structured today, the corporate secretary ultimately reports to the CEO. If we leave that structure untouched, simply changing the name of the function won’t really change anything.
In fact, at my previous organization, we had a dedicated corporate secretary, but there were cases where the person ended up caught between the secretary’s role and the executive directors, leaving them unable to really move things forward.
Nishida:
Let’s turn to “comply or explain” next.
Osugi:
The revised Code brings some significant changes in terms of its structure. Under the previous Code, the Supplementary Principles required companies to comply or explain on a wide range of individual, sometimes quite fragmented issues. With the revised Code, the Supplementary Principles have been eliminated, and some of their content has been elevated to the level of Principles. The idea is to take a broader view at the Principle level and, even when a company is in compliance, explain how it is actually putting the Principle into practice.
For some provisions, the previous “Guidance” has also been replaced by what is now called “Interpretive Guidance.”This makes the underlying rationale more explicit—in other words, it explains why companies are being asked to comply with a particular rule in the first place. So, in that sense, the revised Code actually reduces, to some extent, the number of individual items that companies are expected to disclose and explain under the“comply or explain”approach.
If you read the documents published for the various stakeholders carefully, my impression is that the FSA sees a problem with the fact that some listed companies are simply complying with the Code as a matter of form, without really understanding its underlying purpose. My understanding is that this revision is, at least in part, a response to that concern.
The original 2015 Code contained quite a lot of rather dated language reflecting the OECD Principles of Corporate Governance. This time around, the language is much more contemporary and easier to read, reflecting the fact that the Code has now become well established in Japan.
What’s important is to get outside directors and executives themselves to actually read the Code. A CEO doesn’t need to be a governance expert, but they do need to understand the issues and have a genuine commitment to them. Ideally, there should also be someone at the senior executive level—say, a vice president or equivalent—who has a solid understanding of corporate governance.
I also think it’s essential for the board secretariat to develop a good understanding of governance and, based on that knowledge, work closely with the outside directors. My own experience is that if the CEO and other senior executives don’t really understand corporate governance, it’s very difficult to make meaningful progress, no matter what else you try to do.
In that sense, I think it’s significant that the revised Code now addresses succession planning for the CEO more clearly at the Principle level. I hope that, as companies identify and develop the next generation of CEOs, we’ll see more of a process where people
Makino:
We’ve been operating under the “comply or explain” framework for more than ten years now, since 2015. One thing we often hear is that the market has become increasingly polarized: companies that have taken action have done so, while those that haven’t still haven’t. As a result, I believe roughly 40% of the market remains below a PBR of 1.0.
Looking back over the past decade, I think it’s fair to say that the approach of “let’s all read the Code together, improve ROE, and enhance corporate value”has not worked.
The companies where the framework has worked best are those where the top management themselves initially saw governance as something that might, on the surface, “tie their hands,”but ultimately came to understand that it could actually give them greater freedom to manage the company boldly, while also providing access to valuable advice. These are the companies where top management themselves took the initiative to build that kind of framework.
At companies where that mindset has really taken hold at the top, comply or explain has worked reasonably well. I think we’ve also seen some success where outside directors themselves have taken the Code seriously, reading it and putting it into practice as something directly relevant to their own role.
On the other hand, for the many companies that are not under much pressure, I’m not sure it matters how many times we revise the Code—it probably won’t make much difference.
That said, if you look at individual companies, the pressure is increasing. For companies that already have activist investors involved, or whose shares are undervalued and therefore face a potential acquisition risk, putting the Code into practice can serve as a form of peacetime preparation to help avoid trouble when a crisis arises.
The Code is a code, so I don’t think we should expect it to have much enforcement power. But I do hope it can serve as a starting point for companies to look seriously at their own circumstances and consider whether they should put the Code into practice—or whether they should consider going private instead.
Ichikawa:
The expression “two wheels of the same cart” was once used to describe the relationship between the Corporate Governance Code and the Stewardship Code. But these days, I sometimes feel that the Corporate Governance Code and activist funds are becoming the two wheels.
Even companies that have continued to manage their businesses without paying much attention to their cost of capital can no longer simply continue doing things their own way as they did in the past. With activist investors and strategic funds out there, it has certainly become easier to make the case that they need to take these issues more seriously. And when activists raise these issues, institutional investors are also, in some cases, being pushed to change the way they engage with companies and exercise their responsibilities.
So, in that sense, I feel that market forces are gradually beginning to have an impact. The market is not powerless, and we are moving away from an environment where companies can simply continue to manage their businesses entirely on their own terms.
Ueda:
To be honest, I have some reservations about the term “activist investor countermeasures.” It suggests that we are focusing on the symptom rather than addressing the underlying issues. If companies are doing what they should be doing in the first place, that should in itself serve as a response to activist investors. I’d like to see that message come through much more clearly.
Nishida:
Next, let’s turn to the topic of director training. I expect the number of independent directors to continue increasing. For companies with a controlling shareholder, the revised Code calls for a majority of the board to be independent directors, while for companies without a controlling shareholder, it also includes language encouraging them to voluntarily move toward having a majority of independent directors. I expect more companies to work toward that goal, and at some point, we may see the shift toward majority-independent boards spread almost like a domino effect.
The revised Code also sets out, at the Principle level, a policy on providing opportunities for directors to further develop their knowledge and skills. Since this policy will be disclosed, I see that as a step forward in some respects. At the same time, I was struck by the fact that, when it comes to what directors are expected to develop their knowledge of, the emphasis is very much on understanding the company’s business, finances, organization, and so on. I wonder whether that alone is sufficient. The individual areas of expertise that each director brings to the board are certainly important, but I also believe that directors need to have a certain level of shared knowledge and skills in corporate governance.
In that sense, I feel that BDTI’s role will become even more important going forward.
Ichikawa:
Simply increasing the number of outside directors is not enough. In practice, there is a great deal of variation in how people approach the role of an outside director, and there is still relatively little in the way of a shared understanding or sense of common purpose among outside directors about what governance should look like and, as a result, how they should conduct themselves.
Of course, they do not all need to think alike. But if the numbers increase without some basic common ground, it could actually lead to unintended problems. In that sense, I think training is extremely important in creating that common found
Principle 4-15 refers to “the company’s business, finances, organization, and so on.” But if the focus is limited to “the company’s” business and so forth, there is a risk that training becomes too company-specific and, at the extreme, ends up being little more than a factory tour. Of course, that kind of training is important too.
What we at BDTI want to emphasize, however, is what comes before that—the training that deepens directors’ understanding of their roles and responsibilities in corporate governance, before getting into the specifics of any particular company.
Ueda:
At the same time, given the number of corporate misconduct cases we’ve seen recently, I think we need to go further in recognizing that outside directors cannot fully discharge their responsibilities unless they have at least a basic understanding of the company’s risk management framework and internal controls, including how these systems are actually structured and operated in practice.
That requires some practical, on-the-ground experience. At a minimum, I don’t think the board can really begin to function effectively unless it has outside directors with the expertise and experience needed to monitor the company’s internal control environment.
Ichikawa:
Perhaps partly because of the audit and supervisory committee system, Japanese companies have not fully transitioned to a systematic internal audit model based on the IIA’s Three Lines Model, with clear second- and third-line functions. Ideally, management should be responsible for comprehensive risk management, with the board overseeing how those risks are managed. It seems fundamentally inappropriate to have a structure in which part of risk management is effectively “left” to the oversight function.
The traditional approach of statutory auditors conducting their own on-site inspections and audits has, in some respects, contributed to creating this kind of structure.
Ueda:
In training for outside directors, I think we should be clearer about their role in checking whether management has established effective processes across the first, second, and third lines. In fact, there are many people on the executive side who are not familiar with the basic concepts of risk management and enterprise risk management (ERM). I think we need not only case studies, but even more fundamentally, a shared foundation of basic knowledge.
Makino:
Recently, I’ve been thinking again about the difference between becoming a statutory auditor and becoming an outside director. At a listed company, I would expect that, generally speaking, there is an environment in which a statutory auditor can carry out their responsibilities properly, because no company should be operating with the aim of engaging in illegal activities. With outside directors, however, I think there are companies where you should think carefully about whether you ought to take the position in the first place. For example, you may meet a CEO whom you respect as a business leader, but after speaking with them, realize that they are not really willing to accept oversight. If you receive an offer from a company whose outside directors are all people who tend to accommodate that kind of management style, I would encourage you to ask yourself whether you should accept the position. If management has no intention of being subject to meaningful oversight, I don’t think an outside director can properly fulfill their responsibilities. In that situation, I believe the more fundamental question is whether you should accept the appointment at all.
There is a tendency to say that being an outside director is an efficient and socially meaningful role, and to encourage people to pursue outside directorships. But in reality, I think it is important to carefully assess the company before accepting an appointment.
In Japan, we have not yet seen many cases where an individual outside director has faced significant personal legal liability. But I believe such cases will eventually arise, and accepting a position without sufficient consideration can create risks for an individual’s career as well.
So I think this is something that needs to be communicated not only as part of the training provided by companies, but also as knowledge that individuals themselves should acquire in order to understand and manage their own career risk. It is important that we share this perspective not only with people who are about to become outside directors, but also with those who are considering or interested in taking on the role.
Ichikawa:
At BDTI’s Advanced Director School, we set aside time for participants to think about what kinds of companies they would be willing to serve as outside directors, and what circumstances might lead them to decline an appointment.
Nishida:
Let’s move on. The revised Code places particular emphasis on the direction of corporate strategy, growth investment, and capital allocation, and the Principles state that the board should explain these matters. What exactly does it mean for the board to “explain”?
Makino:
Capital allocation means allocating management resources—not just financial resources, but human capital as well. Management is responsible for setting the broad direction. What matters is that management puts forward the proposal, the board approves it, and ultimately the board is accountable for explaining and defending the decision.
If an outside director starts weighing in on the details of execution based on their own experience from a previous job, that can easily turn into micromanagement. What matters more is for outside directors to oversee management at the level of capital allocation, ask management to explain and justify its decisions, and be able to discuss those same issues at that level when they engage with investors.
There is another point I would make. Recent policy discussions have placed greater emphasis on growth investment rather than shareholder returns. Suppose a company has ¥10 billion on its balance sheet. If the market is valuing that company at a discount, those ¥10 billion may effectively be worth less than ¥10 billion to shareholders. That is the logic behind returning excess cash to shareholders: they want the money to be taken out of the company and put to better use elsewhere.
On the other hand, if the company can reinvest that ¥10 billion effectively and grow it through compounding to ¥15 billion or ¥20 billion, shareholders would presumably prefer that outcome.
The question is whether companies are sometimes resorting to shareholder returns too readily. For a manager, making growth investments and taking risks means being accountable if those investments fail. In some cases, returning cash to shareholders can become a form of self-preservation: management may feel that as long as they return money to shareholders, shareholders will have little reason to complain and their own position will remain secure.
That is why shareholder returns that appear to be shareholder-friendly can, in fact, serve as a way for management to protect its own position. I would like outside directors to exercise proper oversight and ask whether the shareholder returns being proposed are really the right thing for the company to be doing.
If management says that returning capital is the only option available, then perhaps there is no reason for that management team to remain in place, and a change in leadership should be considered. Similarly, if companies in the same industry simply keep making similar investments to one another, there may come a point when the industry is no longer sustainable as it is, and industry consolidation should be encouraged.
I think outside directors are expected to use discussions about growth investment as an opportunity to ask fundamental questions about whether the current management should remain in place and, ultimately, whether the business itself should continue in its present form.
Osugi:
If an activist investor can bring about changes that increase a company’s value, the value of its own holdings will increase as well, and that can benefit other shareholders too. But when management is resistant to change, shareholder returns can effectively become a way of transferring value to the activist, while actually working against the interests of other shareholders from the perspective of long-term corporate value.
Activist investors are neither inherently good nor bad; they can be either, depending on the circumstances. My sense is that the Japanese government also does not view activists as inherently negative. Rather, I think there is a concern that too many companies are trying to deal with activists through easy or short-term shareholder returns.
That was also how I read the revised Code, particularly in light of some of the recent initiatives coming out of the Ministry of Economy, Trade and Industry.
Nishida:
With that in mind, let’s move on to what companies should be focusing on most in response to the revised Code.
Ueda:
Even though the wording of the Code has changed, the fundamental goal of corporate governance remains the same.
Ichikawa:
If we’re talking about what has remained unchanged, the key issue is the nomination committee. Having the CEO sit on the nomination committee should be a barrier to conducting an objective succession planning process. Yet this remains the case at the majority of companies, so there still seems to be relatively little recognition of it as a problem.
Makino:
Requests from investors to meet with outside directors will undoubtedly continue to increase. However, the reasons behind those requests vary from investor to investor. Some institutional investors conduct these meetings largely as a matter of obligation, in order to fulfill their accountability to institutions such as GPIF. I have even heard that, from the company’s perspective, these meetings can sometimes feel more like a burden.
On the other hand, investors who genuinely want to engage with the company, including activist investors, tend to focus on issues that have been clarified and given greater emphasis in the revised Code—such as how outside directors are involved in the appointment and removal of the CEO, the board’s approach to capital allocation, and the role played by the lead independent director or equivalent figure.
These are also among the factors investors consider when deciding whether to support or oppose the election of outside directors at shareholder meetings.
I would encourage companies to see the revised Code as a useful tool for anticipating the kinds of questions they may receive from activist investors and thinking through their responses in advance.
Osugi:
The revised Code places greater emphasis than ever on ensuring the “quality” of independent outside directors. There are still many cases where directors meet the formal requirements but are not expected to play a meaningful role in practice. I hope institutional investors and activist investors will take a close look at this when considering the election of outside directors at shareholder meetings.
Ueda:
The term “quality” is ambiguous because it is not clearly defined.
Makino:
Ultimately, I think the most quantitative way to assess whether outside directors are contributing to an increase in corporate value is to look at whether the company’s share price rises over the long term.
On the qualitative side, I would point to things like the ability to maintain an independent position rather than simply going along with management, backed by substantial management experience and knowledge; having the financial independence to maintain that stance; and having the character to speak frankly and say what needs to be said.
I also think there needs to be peer review among outside directors, with changes in board composition made where appropriate based on the results. Once someone becomes an outside director, particularly if they are a prominent business leader, there can be a tendency to hesitate to replace them even when they are not functioning effectively. I think that is a problem we need to address.
Ueda:
BDTI’s training programs address precisely these issues: the quality of outside directors that the Code calls for, as well as how peer review and board effectiveness evaluations should be conducted.
Nishida:
Finally, I’d like to ask whether there are any areas you would like to see improved in the next revision of the Code.
Ueda:
Based on everything we’ve discussed, I think the next step should be to give the nomination committee a stronger statutory basis. There are still many “nomination committees in name only” that lack real substance. I would like to see the next revision address this by strengthening the legal basis and authority of nomination committees, and, building on that, by setting out a clear expectation that independent directors should make up a majority of the board. I think incorporating these points into the Code would be an ideal next step.
Osugi:
If I were to add one thing, it would be to strengthen the requirements around succession planning.
Makino:
This may sound a little cynical, but I think the days when the Code could lead the way and open up new ground are over. With opposition from the business community and other interests, the Code has now become a highly political product. This time around, it also seems to have incorporated concerns relating to national security and other issues.
Precisely because the Code has become so influential, we are now in an era where it is more difficult for the Code to simply articulate ideals or set out what the desired state of corporate governance should look like.
As a result, rather than getting ahead of the curve and setting out an ideal vision, the Code has increasingly become a way of endorsing practices that are already widely accepted in the business community—essentially saying, “This many companies are already doing it, so everyone else should at least make this much effort.”
If the next revision comes in four or five years, and by then having a majority of outside directors has become established practice, I imagine that it will finally be written explicitly into the Code. Even so, I think it would still have a significant impact on companies that have not yet moved to a majority-outside board. So I continue to have high expectations for the Code.
Nishida:
With that, I’d like to bring today’s roundtable to a close, looking ahead to further developments in practice and to the next revision of the Code. Thank you very much for joining us today.