CLSA Benthos Report: “A Handle on Scandal”, Quoting BDTI’s Nicholas Benes

Quotes and Related Sections: There’s no quality control on outside directors and no training requirement

Nicholas Benes of the government-credited Board Director Training Institute of Japan (BDTI) told us “most countries have some sort of rules requiring either director training or the disclosure of company policy about director training. Japan has no rules whatever about training, anywhere. This is stunning when one considers that statutory auditors [監査役] are supposed to be the guard dogs of governance. Their duties are to audit the legality of decisions and the financial statement, yet in order to be elected [statutory auditor] there is no requirement that the candidate know anything or have even studied accounting or law”.

As shown in Figure 7, from New York to Bangladesh, but notably not in Japan, corporate governance codes require training of board members. Comprehensive directors’ training programmes exist in other countries, but until the creation of the government-credited BDTI in 2009, there was nowhere to learn the skills required to be an effective independent director. When Institutional Shareholder Services (ISS) was certifying director training courses in the US, there were around 300 on the list.

In conclusion, therefore, Japanese executives are paid around a twentieth of their US counterparts – not because they don’t want to be paid more but because corporate law gives shareholders a lot more power to limit pay increases than in the US. The performance pay element is small – arguably way too small – and acts as a disincentive for risk-taking. Unexploded bombs, like at Olympus, are likely to be rare, but the systems for detecting fraud are weak. Many companies do not have outside directors, and some of them generate great returns, but investing in them is like driving without a safety belt. The trouble is that the pool of talent for outside directors is small and there are no requirements about competence or training.

Main summary points of the report:

Olympus: execs hid bungles, revealing weaknesses in auditing

Japanese executives aren’t incentivised to take risks, but, when Olympus’s took them and goofed, they revealed weaknesses in the auditing system and why Japan needs more robust whistleblower protection.

Japanese accountants are paid to add numbers, but not check if they make sense. Be suspicious when companies change auditors or use minor ones.

Fraud is hard to spot: whistleblowers are the most potent weapon against it – or would be if Japan’s whistleblower laws weren’t impotent.

Competence of outside directors is more important than quantity

Foreigners are calling for outside directors, but returns from companies without them are frequently better than those with them.

This is because there is absolutely no requirement that Japanese outside directors have any training – or any knowledge of the law or accounting. This, not the‘outside director’ checkbox, should be the focus of questions and demands.

Insider trading around equity offerings: little headway in two years

July’s ANA offering hammered home the message: two years on, we are seeing little headway in rooting out this practice, and the investigation is in danger of petering out with no major arrests. Nor do meaningful changes in the law seem in prospect.

The biggest problem for Japanese corporate governance is lack of investor assertiveness, particularly among domestic investors, which has structural, rather than cultural causes.

CLSA’s CG scoring splits out the good, the bad and the ugly

CLSA has completed its biennial CG scoring. Surprisingly, banks lead on improvements; unsurprisingly, Olympus paces the decliners, and unnecessary equity issuance despite rock bottom interest rates stands out among issues to watch.

(Report by Nicholas Smith )

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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