(Note: The numbers below correspondto page numbers in the Powerpoint presentation, which can be downloadedbelow.)
1) Japan has joined the vast majority of nations that have a corporate governance code. I think this is a very good thing, and it bodes well for Japan’s future. In fact, not only will the code be a driver for corporate change, but the code itself is an example that the nature of policymaking in Japan is moving in a very beneficial direction.
We started out in the fall of 2013 with a logjam regarding the Company Law. An advisory committee to the MOJ had been discussing for more than three years, whether or not to require just one outside director on listed company boards. In the past, a very non-optimal compromise would have been reached and that would have been the end of the story.
I then wrote an article in the Wall Street Journal proposing a corporate governance Code as part of Abenomics, in order move past the logjam. Next, I wrote some memos recommending to Dietman Shiozaki that the LDP direct the FSA to oversee the creation of this corporate governance code. Dietman Shiozaki and Shibayama asked me to present my ideas to the LDP’s Japan Economic Revival Headquarters in early 2014.
Now, if you specialize in corporate governance, it is actually not so hard to do what I did. I think about this stuff every day and I am passionate about it. But it is much harder to do what the dietmen, the FSA, the governance code advisory committee, and the Abe administration did. They exercised the political leadership to do the much more difficult work of pushing concepts ahead, adding to them, and turning them into policy reality. I truly respect that, and I commend them for it.
I think this process shows that Japan is moving away from constituency-driven, bureaucrat-proposed, disjointed policymaking, and towards unified policies based on logical analysis of what Japan’s economy needs most. This is a very good thing.
As a result, we now have the concept of soft law “best practices”, guidelines for them, and a much clearer consensus about the need for accountability. We have guidelines for a number of governance techniques — many of which are new to Japan but have been useful elsewhere, such as an expectation of multiple independent directors, the role of a lead independent director, and board self-evaluation. Together with the Stewardship code, Japan now has a foundation that can bring PDCA or “Kaizen” constant improvement techniques to its corporate governance.
2) Said another way, until now the topic of corporate governance practices was largely the province of the lawyers telling you what the Company Law required, at minimum. The minimum corporate formalities. Everything started…and usually stopped there. If something wasn’t actually required by the law, companies felt they had little motivation to do it, even if it was a good practice.
3) As dependence on funding from banks waned in the 80s, this led to insider-controlled boards that gradually lost the ability to make many of the hard decisions. Japanese companies have many strengths, but here is a list of the sort of lack of rigor this led to at many firms.
For instance: the concept that being a director is the same thing as being a manager in a hierarchy, just a senior one….it is hard to criticize one’s ‘senpai’ who ‘promoted” him or her…directors keep their heads low, take little risks, in order to move up the ladder. Most importantly, many boards are more like a meeting of divisional heads, rather than functioning like governing board for monitoring, changing strategic direction, and performance evaluation
As a result, many Japanese boards have lost the ability to make the hard decisions.
As I sat on several boards in the past 15 years, I became convinced that Japan needed a higher level of commonly recognized governance and board practices, and common director sill sets. I can tell you from experience that if everyone around you at the board table is an engineer who cannot understand financial statements well, it may well not be possible to convince them that company seriously could go bankrupt in a few years. And it will be even harder if they do not understand their role as director, and think all they need do is represent the interests of their respective divisions.
4) But now, “best practices” have come to Japan. Kaizen has come to Japanese corporate governance. This sounds simple, but it is a major change here in Japan. Best practice is aspirational. Like management, it something one constantly tries to do better, as opposed to being satisfied with the status quo.The topic is no longer limited by the framework of the hard law
5) I believe the code can be, and will be, a conduit for corporate change. The Growth Strategy set forth in no uncertain terms that it is now national policy to change mindsets and improve corporate governance in order to increase productivity and profitability, including measures such as return on equity. Just as an example of the impact of this, you now see in bookstores two or three times the number of books about ROE or ROIC management, and governance, than you saw two or three years ago.
Probably not at all companies, but at many companies, we can now hope to see an acceleration in their transition from “minimum corporate formality boards” to “real boards”.
6) Here is a list of some of the provisions in the CG Code. It is noteworthy that many of these are new to the discussion in Japan, such as encouraging one-third of the board to be independent directors, director training policy, board evaluation, and executive sessions — meetings that only include outside board members, in order to discuss frankly and coordinate views. Precisely because most Japanese boards will continue to have a minority of independent outsiders on them, it is especially important that they have a forum to frankly share opinions and coordinate their viewpoints. That is what “executive session” 社外者のみの会合）is for. Equally, it is especially important that all directors – not just the external ones – receive training as necessary about the company law, best practices, securities law, finance, and other topics. Related to this, a very important aspect of the code is that it asks companies to disclose their policy with respect to the nomination of board members, and the reasons and criteria that they used in nominating each director or kansayaku candidates.
7) No corporate governance code is perfect, and although this is a good solid first effort, there are some areas that I think will merit additional work in the future. First of foremost, Japan now needs to set up a regular process and schedule for reviewing the code and refining it. I understand that in Germany, ever year a special commission is required by law to do this. Precisely because most Japanese boards will continue to have a minority of independent outsiders on them, we will need clearer rules for the formation of independent committees to consider matters that are affected by managerial self interest – such as nominations, compensation, board evaluation process, and depending on the case executive evaluation or malfeasance. Lastly, I think the next version of the code needs to require disclosure of all amounts paid to retired board members as “advisors” – soudanyaku or komon, etc. , so as frankly to encourage the abolishment of that system. If that could be done, companies would be freed of what I call “ghosts in the board room” , who want to protect their legacies and affect decisions while bearing no legal responsibility. At the same time it would increase the pool of qualified candidates – experienced managers – available to serve as external board members at firms in unrelated industries.
Likewise, it should be made a “best practice” for companies to encourage their non-director executives (shikkou yakuin) to seek jobs as outside directors at companies in smaller unrelated-industry companies, so as to give them practice and experience in that role before such time as they may be appointed as directors in their own companies. This also would vastly increase the pool of qualified external board members. In effect, it would be a complete “win-win2: zero-cost “OJT” for first-time directors. But right now this is not done because shikkou yakuin are prohibited from taking such positions.
8) But the most important aspect of the new code, is that it sets up a virtuous cycle framework for constant PDCA- style improvement of governance, and market-wide expectations. Japanese style manufacturing “kaizen” has been brought to governance. As reflected by this expression, “two wheels of a cart”, that I used in an article proposing the code in January of 2014, the governance code will result in much more detailed and comparable information about practices at each firm, and the stewardship code requires investors to responsibly react to it. At the same time, a similar internal cycle will exist within companies. They will have clearer, forward looking criteria for selecting new director candidates – perhaps using a “needs matrix.” They are encouraged to allocate capital more wisely and be willing to take on appropriate risks to get better returns; to put in place programs for training; to evaluate executives, directors and the board itself, and then use the results to nominate directors so as to build an even better board. And the board begins the cycle again, affected all the time by actual results and investor feedback.
9) As a result, I believe that Japan will see an increase in dynamic capital allocation strategies – whether it be robust internal investment, M&A, or larger buyback. More differentiation between firms and managers; more performance-linked compensation that can learn from the mistakes of other countries; and a period of continuously refining “best practices” in many areas.
10) The buzz word of the year is “engagement” but this is something that will require time to be effective. Many Japanese fund managers know little about governance, and are unused to “engaging” with companies in a proactive meaningful way. Their experience base comes from decades of not dialoguing deeply with companies at all. Everyone is talking about “engagement”, but few people know what that really entails. Moreover, as an investor, even if know what it means, you can only dialogue deeply with a limited number of firms. At the end of the day, you want to simply make sure the company has a good strategy, excellent management, and a good board in place…and then leave the value creation up to then.
Above all, as the Japanese government has so aptly said, with the corporate governance code, we are talking about changing mindsets. We are talking about that most difficult of challenges in an organization, “behavioral change”. So first and foremost, we have to recognize that this is not easy, and things will take time. As my wife knows all too well about me, behavioral change does not happen overnight. Second, we have to keep in mind that in order to succeed in this difficult quest, companies and investors will have to use any and all methods at their disposal, and mount a concerted effort to change their organizations. More knowledge and awareness is needed by both investors and directors. Particularly in Japanese companies, training has a big role to play in this regard. People study diligently in Japan, and enjoy learning new things that can contribute to their companies. Plus, it is easy for Japanese companies to order internal executives to receive training in advance. These things bode well for the process.
11) I have put some slides here to show what my own organization, The Board Director Training Institute of Japan, is doing to contribute to this part of the equation. We are a special kind of non-profit that has been certified by the Cabinet Office as serving “the public interest” by offering director, pre-director and governance training,and disseminating information about governance. Most of our “students” are sent by companies. We are supported by a number of investing institutions who thereby send a constructive message to companies about the importance of director, as well as about 300 individual donors. Our mission is to improve governance in Japan. If have any questions about what BDTI does and would like to join in that mission, feel free to contact me.