Jefferies’ Naomi Fink: “Unrevolutionary Governance”

Key Takeaway: TEPCO’s board may be more independent, but Japan, Inc is still slow to improve broader governance even as Singapore, HK advance

Despite the government’s decision to inject Y1trn into TEPCO (9501, NC), we know that the structural and regulatory reform of the nuclear industry remains incomplete. In context, plans for a more independent board at TEPCO, announced Monday, appears a mild improvement at best. Granted, securing voting rights for the government, was a political victory for DPJ heavyweight Sengoku, who successfully squashed suggestions to retain incumbent president Nishizawa by the outgoing management, who according to Sengoku himself had altogether too much say in succession. Formerly only 2 of 13 outside directors, 7 nominees to the new board off 11 are from outside the firm, including Chairman candidate Shimokobe, and director candidates Sudo (JFE Holdings, Inc), Fujimori (JS Group), Kobayashi (Mitsubishi Chemical). To his credit, Trade Minister Edano, stood up to Japan’s powerful Keidanren, who opposed the state takeover of TEPCO, refused to cooperate in succession planning and coincidentally opposes legally mandatory appointment of at least one independent director. Maybe the news is helping TEPCO rebound within its sector, but there is no evidence as yet that this change is the beginning of a trend.

Japan doesn’t appear poised to apply TEPCO lessons more broadly

That the government placed importance on appointing outside directors at the troubled utility is positive, but might not trigger more preventive reforms. We question the DPJ’s broader commitment to improving corporate governance. Government-affiliated think tank RIETI (Research Institute of Economy, Trade and Industry) released a paper this month that finds that while the appointment of outside directors who hail from an affiliated company correlates positively with firm productivity, independent directors make no statistically significant contribution to productivity. RIETI admits that as 81.2% of directors are insiders; more outsiders are needed. Still, where of those few outside directors “more than half (57.6%) are directors or employees of affiliated companies”, author Morikawa advocates no change. Although “on average” Japanese firms have “an insufficient number of outside directors”, the report concludes, appointment of “purely external” directors may drag on productivity due to the lack of an insider's knowledge of the business. Morikawa prescribes voluntary appointments taking “heterogeneity of companies into consideration” instead of a change in the law. This sounds awfully familiar, akin to Keidanren’s opinion on director independence (diametrically opposed to that of the Asia Corporate Governance Association, which represents many foreign investors in Japan). That the government’s advisors favour case-by-case adjustments rather than sweeping regulatory changes is unrevolutionary and reactive, relegating change to 'after the horse has bolted'. To justify its position, RIETI argues that Sarbanes-Oxley laws may have pressured US companies’ profitability. But the Brookings Institution pointed out back in 2002 that an after-the-fact approach to regulatory reform is costly too. Brookings estimated that Enron cost the US approximately 0.34% of GDP.

Japan lags the region in director training – input to productivity

RIETI’s report does not entertain the possibility that the lower productivity that accompanies appointment of “purely external” directors might be linked to lack of appropriate training. Nicholas Benes of the Board of Director Training Institute strongly opines that Japanese director training pales in comparison to Hong Kong’s recent upgrade to training requirements, plus Singapore’s newly-introduced requirements for mandatory orientation for all new directors on “duties as a director and how to discharge those duties, plus orientation to “ensure that they are familiar with the company's business and governance practices”. In comparison, neither training nor disclosure of (either internal or external) director orientation is a TSE listing criterion.

Naomi Fink *, Japan Equity Strategist


* Jefferies (Japan) Limited

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The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.

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