After Olympus, Can Japan Reform? (from The Diplomat)

Corporate Japan has been rocked in recent months with a spate of major scandals, writes Anthony Fensom. Will it be enough to trigger meaningful reforms? (by Anthony Fensom)

It may have taken a foreign whistleblower named Michael Woodford to force the issue. But with demands for change growing louder in the wake of the Olympus and other scandals, is Japan Inc. finally ready to accept reform?

Activists have been given plenty of ammunition in recent months, with Woodford exposing Olympus’s $1.7 billion accounting fraud following his ousting as chief executive, a scandal at Daio Paper over $140 million in illicit borrowings and a $2 billion pension fund fraud at AIJ Investment Advisors.

Similarly, a culture of collusion between companies and regulators in the so-called “nuclear village” has sparked heated debate over energy policy and shown the need for greater transparency.

According to analysts, a growing fiscal deficit has made the case for reform more pressing, given the risk to government and corporate pensions from an undervalued stock market. Adding to the clamor for change has been pressure from foreign shareholders, more willing than their domestic counterparts to publicly flex their muscles.

Yet judging by those surveyed by The Diplomat, reforms planned next year by the ruling Democratic Party of Japan (DPJ) barely scratch the surface of what needs to be done, with fierce resistance to change by the nation’s major business lobby groups and a mixed response from the Tokyo Stock Exchange (TSE). Notable among the reforms is the requirement that large companies appoint at least one outside director, along with other new rules aimed at strengthening shareholders’ rights.

Although most observers see improvement since the introduction of the new Company Law in 2006, Japan’s standards of corporate governance are still seen as lagging behind those of its Asian rivals.

“Foreign investors may not invest in Japan due to its opaque system of corporate governance,” warned Japanese corporate lawyer, Takao Shojima.

“The Tokyo Stock Exchange used to be one of the three major global centers, but now Hong Kong and Singapore are rising and one of the differences is corporate governance.”

The decline of cross-shareholdings among listed Japanese companies and the corresponding increase in foreign ownership has been cited as a force for change. According to brokerage Nomura Holdings, cross-shareholdings fell to a record low at the end of March 2011 of 11.1 percent of total outstanding shares – the lowest figure since the survey started in 1991.

Similarly, the proportion of Japanese shares held by foreign investors was at 26.7 percent, outweighing the 20.3 percent held by Japan’s 1.12 million individual shareholders, according to the TSE.

Yet for former Olympus boss Woodford, the decline in Japanese cross-shareholdings cannot happen too quickly.

In an interview conducted in early March 2012, he described the system as “an incestuous, cosy club of institutional shareholders.”

“The worst thing for Japan is the cross-shareholdings, because the unwritten rule is you don’t criticize and you don’t sell,” he said.

“It’s also harmful for Japan because it means you have mediocre boards staying there until people die or retire. There’s no hostile takeover within Japan so there’s no creative destruction.”

A 30-year veteran of the Japanese camera and endoscope maker, the Englishman became the first non-Japanese to be appointed Olympus CEO after a successful career with the company in Europe.

Yet Woodford was axed after demanding the resignation of then chairman Tsuyoshi Kikukawa and another executive over payments made for overseas acquisitions which “destroyed over U.S. $1.5 billion in shareholder value.”

Described by the Wall Street Journal as “one of the biggest and longest-running loss-hiding arrangements in Japanese corporate history,” the scandal over the tobashi (loss-hiding) cover-up saw billions of dollars wiped from Olympus’ market value and led to the arrest of Kikukawa and other executives, along with the removal of the entire company board.

Woodford abandoned a campaign to win back a board seat after failing to gain the backing of Japanese institutional investors, despite strong support from foreign shareholders including Southeastern Asset Management. In May, he settled an unfair dismissal claim against the company filed in Britain, reportedly for around 10 million pounds.

His experience sparked debate over the role of foreign executives in driving change at Japanese companies, of which Nissan Motors' Brazilian-born CEO, Carlos Ghosn is the most prominent example.

“Do you think there’s going to be a large number of foreign executives queuing up to go to [Japan] after what happened to me? I don’t think many will be asked, because a lot of Japanese companies will say that’s what happens when you get a foreigner in,” Woodford said.

‘Everybody’s in cahoots’

Adding to the scandal at Daio Paper, where the company fired its chairman over borrowings reportedly used to pay private gambling debts, the Woodford saga heightened concerns over inadequate corporate governance and a general lack of disclosure from Japan’s entrenched corporate insiders.

However, the jury remains out as to whether Olympus showed a systemic failure of the system, with companies under pressure to increase diversity and “globalize” amid a shrinking domestic market and intensifying international competition.

“It’s not true to say that all Japanese companies have a corporate governance problem. But the views of foreign investors about it are understandable and there’s need for reform,” lawyer Shojima said.

Long-term Japan resident and company director George Olcott agreed, saying that most Japanese businesspeople were appalled by the Olympus scandal.

“I feel it’s a one-off. When I talk to Japanese business leaders they shake their heads and say, ‘What on earth did they think they were doing?’ Not just in how the company was run, but in sacking Woodford summarily when it was obvious there was something very bad going on,” said Olcott, also of the Judge Business School, University of Cambridge.

“Most Japanese people would see that as extremely egregious behavior, although I don’t think it’s a sign of any systemic issues relating to the governance of Japanese companies.”

An independent director of two Japanese companies, manufacturer Nippon Sheet Glass and insurer NKSJ, Olcott said Japanese companies were becoming more responsive to the views of their shareholders, but it was often the foreigners who spoke the loudest.

“One of the tragic things to me is that ‘shareholders’ in the minds of Japanese executives means foreign shareholders. The situation at Olympus was characterized in the Japanese newspapers as what would the foreign shareholders think of this situation – but it should be about all shareholders, and not just the foreigners,” he said.

Corporate Japan has been rocked in recent months with a spate of major scandals, writes Anthony Fensom. Will it be enough to trigger meaningful reforms?

“The general passivity of Japanese institutions is really quite sad, and I hope they will become more interested in the companies in which they are shareholders. It shouldn’t be left to the foreigners to make a noise [about governance].”

Yet corporate governance expert, Prof. Christina Ahmadjian of Hitotsubashi University said the Olympus case reflected a common pathology among Japanese companies.

“You have these executives who were appointed by the people before them. They do everything to cover up the mistakes of their seniors, everybody is in cahoots and they have this sense that we’re protecting the company and the people who came before us,” she said.

“There’s no sense of responsibility towards shareholders or anybody else, and that situation is fairly common.”

Ahmadjian has served as a director of the Japan Corporate Governance Research Institute (JCGR), which has conducted annual surveys on the corporate governance practices of companies listed on the First Section of the TSE with the aim of boosting standards.

In the 2011 survey, Sony, Toshiba and TDK took the top three rankings, with companies with better governance “tending to have more foreign ownership.”

“Companies that have good governance, at least according to our standards, tend to have truly independent directors, are good at communicating with shareholders and other stakeholders and have a clear separation between execution and monitoring. They also have a strong commitment by the CEO and the whole company to good governance,” she said.

While the link between governance and performance has long been debated, a recent study by Nomura Securities has shown a benefit for investors.

According to an April 9 report by the Nikkei, a study by the brokerage’s Kengo Nishiyama found that companies where foreign investors held at least 30 percent of shares had an above-average return on equity (ROE) of 8.5 percent, with the ROE figure for those at least 40 percent owned by institutional investors averaging 8.8 percent.

Nomura also found companies with average ROE exceeding 10 percent and with outside directors posted above-average gains in their market value.

“Since the scandals at Daio Paper and Olympus, retail investors have started steering clear of owner-run companies and firms with long-serving top executives,” the financial daily quoted Securities’ Tatsunori Kawai as saying.

MORE —> Read the rest of the article by Anthony Fensom:

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