https://www.wsj.com/articles/SB99349794462429242

June 26, 2001 12:01 am ET

By Nicholas Benes. Mr. Benes is president of JTP Corporation, an investment bank specializing in merger and acquisition advisory services in Japan.

I believe that this nation should commit itself to achieving the goal, before this decade is out, of landing a man on the Moon and returning him safely to the Earth.

— John F. Kennedy, May 25, 1961

he most important thing a national leader can do is to set crucial long-term goals. Japan’s Prime Minister Junichiro Koizumi and the ruling Liberal Democratic Party should take a page from President Kennedy’s leadership book and publicly declare as a national goal the creation of one of the world’s best capital markets by 2010.

And why not? In 2001, Japan is in a survival race to redesign its own “inner space.” If it doesn’t revamp its system of institutional shareholdings, corporate governance and fiduciary duty, the economy is headed for very serious trouble. Long-term malaise over the next 10 years will make the “lost decade” of the 1990s look like a blip.

The hard reality is that these are the root problems from whence most others in Japan stem. Poor corporate governance perpetuates misallocation of resources, slow restructuring and persistent overcapacity. Result: corporate profitability running at less than the cost of capital for decades, and a bank cleanup process that delays and bloats. These in turn weigh down the stock market and pension returns, and reduce tax revenues. Worsening corporate balance sheets and a weakening fiscal position threaten to further drag down the stock market. There is only this vicious circle, with no virtuous “supply-side” counterpart to offset it.

Excessive cross-shareholdings have created a capital market where few institutional investors are free to “vote with their feet” by selling their large positions. Yet even fewer articulate any opinions about management at the companies they keep holding. As a result, there are no true “owners” who act like they care much about shareholder value, except at those firms which are still founder-led.

With no owners raising either voice or stick, corporate governance in Japan doesn’t work. Entrenched “salary-man” managers are conflicted with respect to almost all of the most difficult yet necessary decisions,on such matters as restructuring, mergers and acquisitions, and asset sales. Thus, organizational bottlenecks delay corporate decision making that would remedy the misallocation of resources. Transparency, disclosure and writeoffs are provided only when absolutely required even by Japan’s lax auditors. Unfortunately, the system which was set up in order to render internal managers impervious to most outside forces, is still largely functioning that way.

The Japanese “man on the street” increasingly recognizes that future fiscal pain and lost economic growth will be massive if Japanese capital markets are not redesigned to better fit with the age of global competition and direct finance via securities. Many people also understand that this is exactly what will happen if the political base for business policy making does not widen and diversify beyond its traditional dependence on the Keidanren , the association of Japan’s largest and most prestigious enterprises. But in the absence of a vision that comes from Japan itself rather than other countries, this mounting consciousness remains unchannelled, susceptible to old rhetoric and remedies.

What should Mr. Koizumi and the LDP do? Here are some ideas:

• Declare as an essential national goal the rejuvenation of investment in the Japanese economy by creating one of the best capital markets in the world by 2010 . “Best” means liquid, deep, efficient, transparent, fair and convenient. Take advantage of overwhelming current popular support to specify the exact ways in which key bureaucracies will be required to execute this policy. Explain to all why having better capital markets is so crucial to Japan’s future.
• Articulate policy using words like “transparency,” “fairness” and “responsibility.” Corporate and deregulatory practices based on these concepts should be at the very heart of “structural reform.” But in doing this, avoid using American-sounding words like “corporate governance.”
• Champion a vision for Japan to make its own special contributions to the corporate governance and fiduciary practices of global capital markets . Japan developed its own H2 rocket engine essentially because “unless the technology is truly ‘ours’ we can’t improve it ourselves.” Likewise, it’s time for Japan to do its own research and development in the world of finance or it will forever be a follower.
• Control the Commercial Code reform process as it affects corporate governance directly from the prime minister’s office . This subject is too important to let the career bureaucrats at the Ministry of Justice draft legislation using their closed-shop Legal System Advisory Council and a process that only makes a pretense at transparency and public debate. Obviously, the system will not change if internal directors from self-serving boardrooms and Keidanren offices are once again the main “constituencies” influencing drafting.
• Phase in over five years a requirement for all publicly listed companies to have a substantial majority of board members who are independent “outside” directors . At a 50% requirement, Japan would merely be matching the standard set in Korea over the past few years. Why not shoot for a two-thirds requirement phased in over 10 years? Claims that such directors cannot be found are nonsense, as executive recruitment firms in Tokyo will attest. Some 38% of Japanese companies listed on the Tokyo Stock Exchange now have “outside directors.”
• Require the same firms to create board committees with responsibility for audit, compensation, litigation and nominations . These committees must be composed solely of independent outside directors. Amend the Commercial Code to allow the indemnification or limitation of director liability, within specified limits.
• Pass a “Fund Management Law” to establish a clear definition of “fiduciary duty” spanning across regulatory lines . Include the insurance, mutual-fund and pension-fund management industries. Right now there is only a motley, weak set of rules defining fiduciary duty, adopted separately for each industry. Insurance companies have virtually no clear fiduciary duty at all. And enforcement is almost nonexistent.
• Require all fund managers to exercise their voting rights as shareholders, responsibly and solely in the interests of their beneficiaries, and to keep a record of their actions . Give the Financial Services Administration a healthy budget for enforcement. And give the Ministry of Welfare and Labor a larger budget to enforce its own (stricter) set of rules for corporate pension funds.
• Adopt the FSA’s planned rules to require banks to sell down stockholdings so that their total market value is less than bank capital . This is a step forward that is long overdue. However, abandon the ridiculous proposal to establish a “stock-buying company” with government guarantees in order to soak up the supply that will result from sales by banks. This will only delay the fix that is so urgently needed: the movement of shares to holders who bid the most.
• Instead, increase the allocation of national pension money to equities and require that these funds be entrusted to outside fund managers . Over the next few years, 144 trillion yen ($1.16 trillion) in funds will be shifted to the responsibility of the Ministry of Welfare and Labor. By increasing the equity allocation to 20% from 12% the selling pressure expected from bank sales can be completely offset. But at present, the ministry and its advisors refuse to consider this suggestion. Why? Because they take their fiduciary responsibilities seriously and do not believe corporate governance standards are high enough to justify the risk! The steps suggested above would change this fact. This is the clearest proof that they are necessary.

— From The Asian Wall Street Journal