2014: Translation of Nicholas Benes’ Article on Japan’s New Governance Code, in Nikkei Newspaper’s “Economics Classroom” Column

Nikkei Newspaper, “Economics Classroom” Column (8/8/2014)

( The Corporate Governance Reform Debate – Key Themes )

Independent Directors Should Make Up at Least One-Third of the Board –Promulgate a “Code”that Meets Global Standards

For Effective Boards, Increase the Quality of Directors

By Nicholas Benes, Representative Director, The Board Director
Training Institute of Japan


  • The Corporate Governance Code will increase growth and revitalize capital markets
  • Even information disclosure by firms that do not “comply” will be beneficial to investors
  • Gain international respect for the Code by basing it on the OECD’s Principles

Probably, June 24th, 2014 – the date that the government announced its Revised Growth Strategy – will go down in history as the day when the modernization of corporate governance in Japan began in earnest. This is because the growth strategy set forth “recovery of [corporate] earnings power” as its central pillar, and announced that [for that reason] it would strengthen corporate governance and promulgate a corporate governance code.

Pursuant to the Revised Strategy, the Financial Services Agency (FSA) and the Tokyo Stock Exchange (TSE) will form a joint secretariat to support a Committee of Experts, which will determine the fundamental principles for the Corporate Governance Code by this fall. The government will then assist the TSE in drafting the Code in time for the shareholding meeting season next year.

Of course, everything depends on the final content of the Code and the manner in which it is implemented. But from the standpoint of economic growth and revitalizing capital markets, the new policy could be epoch-making.

For many years, I served on the boards of various Japanese companies, and currently, I lead The Board Director Training institute of Japan (BDTI), a “public interest organization” which provides training to both executive and non-executive (outside) board members. Based on these experiences, I strongly believe that that the new policy presents an opportunity to bring about major changes in corporate governance in Japan.

Four aspects of the new policy are particularly noteworthy. First, the Revised Strategy set forth criteria, by stipulating that ”the Code should reflect actual circumstances at Japanese companies, and must be a Code that is internationally respected.”

Second, the government declared that the Code will adopt the “comply-or-explain” principle, and will thus be reflected in the listing rules of the TSE. This means that its rules will not be compulsory in a legal sense, but companies that do not comply will have to explain their reasons for not complying.

Third, the new policy was based on the “Japan Revival Vision” report compiled the LDP’s “Economic Revival Headquarters” This report included significantly detailed examples of items to be considered for inclusion in the Code, such as “two or more independent directors”.

Fourth, responsibility and accountability for improving the infrastructure for corporate governance in Japan has been clearly shifted from METI, which has strong connections with industrial groups, to the FSA, which has legal duties to protect investors and facilitate capital markets.

These four aspects show that the government truly intends to bring about a full-fledged reform of corporate governance. For example, the Revised Growth Strategy goes as far as to proclaim that its goal is to “aggressively utilize outside directors”. For the government to publicly admit that there are some subjects about which internally-promoted executive directors cannot be expected to properly monitor themselves, essentially means that Japan will now be joining the global debate about improving corporate governance that has been underway in other countries for more than 30 years.

To domestic and international investors alike, this presents a golden opportunity for Japan to transform itself from a “strange country”* that for many years has shut its eyes to corporate governance concepts used around the world, into a “normal country” that prioritizes efficient capital markets and protection of investors. (* An “Alice in Wonderland” nation.)

Today, almost every country in the world except Japan has a corporate governance code, or policies that amount to one. Broadly speaking, one might say that a corporate governance code is a “code of conduct” regarding corporate governance. Almost no country in the world legally requires full compliance with every rule in its “code”. However, most countries prescribe that each company must explain which rules (if any) it does not comply with, and why it does not comply. Japan’s new policy direction, late in coming though it may be, is in line with this international trend.

To investors, this sort of disclosure provides valuable information. It allows them to assess and confirm the governance framework and commitment to governance (“public promises”, as it were) at each firm. Deeper dialogues and information exchanges between investors and companies become possible when firms explain their reasons for not complying. Investors can use such information in deciding which stocks to buy or sell.

For instance, if a company does not have an independent nominations committee, investors can consider that fact when deciding how to vote their proxies. Similarly, investors can decide whether to approve the election of directors after looking at the company’s disclosure about its policy regarding director training. In other words, this information will have a beneficial impact on decision-making by investors. As a result, companies that investors can trust will be correctly valued by investors, and confidence in Japan’s stock market will increase.

This aspect will also contribute to the efficiency of the “constructive, purposeful dialogues” between institutional investors and portfolio companies that are envisaged by the Japan Stewardship Code, which is a sort of a code of conduct for investors. It is only when investors have received meaningful information from companies that these dialogues and the actual practices of “stewardship”* can occur, particularly inasmuch as stewardship assumes long-term holdings. (* Dedication by fiduciary investment managers.)

Looking forward, in order for Japan’s new corporate governance code to be “internationally well-respected”, what items (at minimum) should the Committee of Experts, the FSA, and the TSE include in it?

A useful reference point is the OECD Principles of Corporate Governance, to which the Revised Strategy explicitly referred as a criteria. The OECD’s Principles have had a major impact on more than 70 countries worldwide. The governance reforms that Germany brought about in 2003 are a typical example.

The Principles are scheduled to be revised by March of next year. However, considering the current situation in Japan, there are many features that Japan should learn from in the present version, in order for Japan’s Code to gain recognition at least at the same level as the Codes of Hong Kong or Singapore. Here, I will introduce some of them, limiting my comments to the major items in the Principles that relate to the board of directors.

[Inserted diagram]

OECD Corporate Governance Principles:

Key Items Related to the Board of Directors

Duties of due care and loyalty
Treat all shareholders equally (equitably)
The board should apply high ethical standards

The board should fulfill key functions (selected items only)

 Selecting, compensating, and monitoring key executives
 Ensuring aformal +transparent board nomination +election process
 Monitoring and modifying the effectiveness of the company’s governance practices

The board should be able to exercise objective independent judgment on corporate affairs

 A sufficient number of non-executive members capable of exercising independent judgment
 The authorities (mandate), composition and working procedures of board committees should be well-defined and disclosed
 Board members should be able to commit themselves to their responsibilities (encouragement of board training and self-evaluation)
Board members should have access to accurate, relevant, and timely information

[End of diagram]

First, the Principles state that “the board should be able to exercise objective independent judgment”. At minimum, in order for the Code to be internationally well-received, it will probably be necessary to require that at least one-third of boards be composed of independent directors, such as is the case in Singapore and Hong Kong. In Japan just as in other countries, it is often difficult for a single person to raise his or her voice and be heard.

The most important role of outside directors is to consider matters involving potential conflicts of interest between shareholders and internal executives (or matters involving issues of latent self-interest), at committees composed solely of independent directors. Examples would include decisions regarding the nomination or compensation of directors, or considering an MBO.

The OECD Principles clearly state that a key function of the board should be “selecting, compensating, and monitoring and when necessary, replacing key executives”. For statutory auditor-style companies, which is the form of governance chosen by most Japanese companies, this sort of “separation of oversight from management” can occur via the mechanism of board committees composed solely of independent directors who are exercising “objective and independent judgment”.

Such committees are essential precisely because internally-promoted executives make up the majority on most boards in Japan. Many of the weak points of Japanese companies that are often pointed out, for example that they “postpone [tough] decisions” or “do not take enough risk”, would probably improve if nomination committees were to select more decisive leaders.

The OECD Principles also specify that “when committees of the board are established, their mandate, composition and working procedures should be well-defined and disclosed.” Inasmuch as committees composed of independent directors are essential in order to preserve neutrality in decision-making, it necessarily follows that companies should ensure transparency with respect to their operation.

Against this background, Japanese companies face major challenges in raising the quality of all of their directors, including both executive and non-executive (outside) directors. The OECD stresses that “board members should be able to commit themselves effectively to their responsibilities.” Before nominating new “internal” directors with no previous board experience and asking shareholders to approve them, companies should make sure those candidates receive comprehensive director training. Similarly, it is time to seriously face up to issues related to the development and education of outside directors as well. Nowadays, their quality and dedication is being questioned.

If the Committee of Experts, the FSA, the TSE, and companies following their movements can meet these requirements while also learning additional aspects from foreign countries, Japan’s future seems bright.


Nicholas E. Benes was born n 1956. He holds a JD-MBA degree from UCLA, and is an Adjunct Professor at the Internation

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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