The recent decision by the MOJ’s Advisory Committee on the Company Law made it clear that for the next ten years or so, in terms of the composition of Japanese boards, the most that investors can expect will be soft-law rules requiring (or encouraging) the appointment of only one independent director at listed companies. Thus, most Japanese boards will remain overwhelmingly dominated by internal executives.
However, this does not mean that governance at all Japanese companies will be poor. Rather it means that there will be an accelerating divergence between: a) sophisticated companies which (of their own volition, or at the suggestion of large investors) appoint multiple qualified independent directors, and/or train their executives so that they possess the full range of skills to fulfill their role of “director” in overseeing management; and b) those companies which attempt to maintain a nontransparent, lockstep policy to “promote” (nominate) internal executives irrespective of their qualifications and mindset as future directors.
As I know from personal experience, Japanese management teams with enough awareness of governance principles, and the right functional skills,can cause their boards to effectively work with a small number of independent directors so as raise value and lower risk. If a high level of knowledge about governance practices, processes and duties is shared by management, this is more likely to occur in Japan than would be the case in North America or Europe because:
Decision-making in Japanese corporations occurs in a “bottom-up” manner more frequently than in Western organizations. As a result, if the middle layer of management knows the importance of serving shareholders, and what they should expect from their seniors on the board in order to maximize the future vitality of the company, such internal expectations tend to filter up and influence the actions of senior executives more than would be the case in a Western company. When the middle managers are promoted, this reinforces the cycle, producing a healthy corporate governance culture and rigorous management. Most successful Japanese companies follow this pattern to some extent.
The capital market in Japan has strong discipline levers because: a) there is full access to the proxy at a small investment-amount hurdle, and it is increasingly being used; b) per-item vote count results at AGMs are now disclosed; and c) Japanese executives are generally not overpaid (1), and in fact it isdifficult for that situation to occur, because all director compensation must be approved in some manner by shareholders. As a result, there is a smaller tendency for executives to “raid the cookie jar” or promote policies that will lead to short-term profit at the expense of long-term value(2).
One should not over-generalize, but when they know what is required and expected of them, Japanese managers are generally diligent and compliant with that standard. Especially when trained by third parties so as provide a reality check that “raises the bar” of expectations to a higher level, a virtuous cycle of mutual expectations can set in. In a sense, executives “monitor” each other, for the sake of the company. This tendency is further enhanced when qualified, dedicated independent outside directors are watching, even if they are small in number.
Because most Japanese boards will continue to be dominated by internally-appointed executives, the key to improving governance quality at Japanese companies is the training, knowledge, and dedication of those executives. The quality of independent outside directors is also very important, but I know from personal experience that there is a limit as to what an INED can do if the “inside” directors do not know enough about (or care enough about) finance and governance principles and are not fully aware of their duties and liabilities as directors. If a small number of INEDs are present but management has deaf ears to good governance, especially when managerial self-interest is at stake the INEDs will be outvoted with respect to decisions that could affect value in a major way. However, a small number of INEDs can be effective if management has the right mindset and knowledge base.
Therefore, in order to accelerate corporate governance improvement in Japan, it is essential that major shareholders of Japanese companies clearly communicate to the market that they consider the governance-related training of a) managers and board candidates; b) by third-party specialists; c) prior to their nomination, to be extremely important because it enhances corporate governance culture and builds necessary skills.
Making a donation and becoming a Special Sponsorof the Board Director Training Institute of Japan (BDTI) is an excellent way to do this. Those doing so will join Fidelity Worldwide Investment, Baillie Gifford, Aflac, Chubb, Ichigo Asset Management, and others in sending a clear message to Japanese companies. ( email@example.com )
BDTIas a Change Agent
The largest barriers to better boards in Japan stem from the fact that historically, most board members (directors and statutory auditors) have been managers promoted from within the firm. This mix is slowly
changing. However, without constructive, practical training provided by third-party professionals, the historical barriers to effectiveness will remain long after the addition of more outside board members, and the quality and effectiveness of those outsiders will remain low. Three barriers must be overcome if Japanese boards are to act as more effective oversight bodies:
There is wide variance in the degree of dedication to, and understanding of, the role and duties of a board member as distinct from those of a senior employee in a collectivist organization. Far too many managers view “becoming a board member” as simply “another managerial promotion, with more authority”. Outside board members, as a distinct minority, tend to fall in line with this hierarchy unless the internal board members (not to mention the outside directors themselves) are aware of what investors and the law expect from them.
Most companies do not provide meaningful training for board members. Many companies provide none at all. But even where training does exist, it is provided in separate “silos” with no mixing of perspectives and the experience of outsiders, after board members are elected rather than before(3). As a result, common knowledge about basic corporate governance concepts does not extend broadly throughout organizations, and is spotty among many of the managers who are supporting the board.
As a result, the four different types of board members – internal and external directors, and internal and external statutory auditors – often do not share “common toolkits” of minimum knowledge about governance and modern management, and do not necessarily share common concepts about their respective roles. Consequently, many boards are formalistic and unsure of their mission, and do not effectively draw upon the talents of outside board members.
BDTI has been designed to help Japan overcome these historical barriers, by:
Providing inexpensive E-Learning modules so that mid-level managers can become familiar with the Company Law and corporate governance, long before they are promoted to the board – thereby making governance topics a part of the standard training regime requiredfor promotion.
Offering group seminars and intensive (one or two-day) director training courses that include all players in the game – all types of members of the board, and from different companies as well – so that they can share and understand each others’ perspectives. BDTI also provides customized for particular companies, upon request.
Giving board members a common “toolkit” of knowledge not only about corporate governance, but also about the leading edge of topics that are the subject of board oversight: risk management, corporate strategy and M&A transactions, multinational organizational design, succession planning, reviewing business units and financial statements, and basic finance. Helping boards understand best practices for discussing and making decisions about these crucial subjects.
Maximizing the legitimacy and impact of training programs, by obtaining approval by the Japanese government as a non-profit “public interest” organization, which is aprestigious accredited status.
With your generous support, BDTI can expand it activities and fulfill its mission to make Japan's boards more active, vital, and attuned to seeking higher returns to shareholders while also supportingother stakeholders.
1If anything, many Japanese companies should raise the level of performance-linked pay for executives.
2For the same reason, different from the West, most corporate governance failures in Japan are not the result of personal greed taking the fore, but rather the result of groupthink or collectivist cover-ups which the players wronglywrongly and/or ineptly thought werejustified in order to protect the company from shame or default.
3The largest companies sometimes have their own training programs, but such programs are just for the internal directors and not statutory auditors or outside directors, and they only focus on providing the minimum required legal and compliance knowledge after the board slate has been elected. Statutory auditors who wish can take courses given by the Statutory Auditors’ Association (they are not required), but those courses focus only on specific accounting, audit and compliance knowledge, and there are no organizations focusing on high-level training for all board members and executives who report to the board.