”Japan’s Coming Shareholder Revolution” (written in 2001!- perspective from the past)

Here is an article I published in 2001 in the Wall Street Journal, predicting the topic of the title. I stumbled across it again a few weeks ago.  I think it makes interesting reading and lends perspective some 17 years later, so I am republishing now. I suppose the timeline I had in mind in 2001 was 5 or 10 years from them, but certainly not 17 years.  From this, you can see that it taken a lot more work than I envisioned, by many persons and of course not just myself, for Japan to come as far as it has. And I would guesstimate that 85% or more of the forward motion took place just in the past five years since the fall of 2013, when I proposed the concept of a Corporate Governance Code to the government.  Until, the wagon hand not really started rolling yet.

This all shows just how resistant certain parties were, and how scared they were of change. Only huge fiscal deficits creating the urgent need to raise productivity allowed me to propose the governance code and seed a host of other reforms, and that was only possible after an American Chamber “Growth Strategy Task Force” that I had led in 2010 had focused on the need for a coherent, persuasive growth strategy that could enhance productivity growth.  (See: “How Japan’s Corporate Governance Code Was Born” , at https://bdti.or.jp/en/blog/en/cgcodejapanbirth/ .)

But when you think about it, the US and UK have also been working on the topic of “improving corporate governance” for more than 30 years, and no one would say they have achieve perfection. In fact, the glass is half full in a sense, because Japan can learn from the mistakes and good ideas of nations that have preceded it in the quest for better governance. The recent (first) revision of the governance code is significant step forward, and together with the revised stewardship code, will continue the momentum for more “sea changes” in Japan.

(written in February, 2001)
”Japan’s Coming Shareholder Revolution”

“Last month, the Life Insurance Association of Japan published a survey of 561 public companies and 122 institutional investors, focusing on corporate governance and investor relations practices. The results exploded some myths regarding the supposed lack of support for modern corporate governance concepts among institutional shareholders in Japan. Japanese investors are in effect saying: “We want transparency and clear accountability, independent outside directors on boards, and independent board committees.”

The very fact that the survey addressed these topics is a breath of fresh air. Japan’s institutional investor community is weighing in on the emerging debate over corporate governance. It is none too late. Although they should be the most directly motivated constituency, institutional shareholders had been conspicuously quiet. Like most of Japan’s institutional investors, insurance companies have feared a backlash if they took a stance opposed by certain senior executives and politicians. They feared imperiling governmental assistance with industry cleanup, as well as losing insurance and pension business from companies in which they hold stock.

Logic and hard realities are finally coming to the fore. And the investor community will become more vocal as competition heats up in the fund management industry. Investment advisor companies, known as (toshi komon ), compete on the basis of investment returns and prudent decision-making, and do not have other businesses that might fear adverse repercussions.

Direct pressure from the very largest customers is emerging, too. The Pension Fund Association specified in its updated investment guidelines that fund managers must exercise voting and shareholder rights responsibly and in the sole interests of beneficiaries, and document their actions. This means that soon it will no longer be permissible for fiduciaries to simply sign proxy statements and return them in “blank” form, leaving everything up to management. Though binding only with respect to the PFA’s own funds, in fact these guidelines set direction for the entire pension industry. It also appears that the Ministry of Health, Labour and Welfare will lead by example. Its special Advisory Council Subcommittee headed by Professor Takaaki Wakasugi of Tokyo University recently recommended that compliance with this same duty be required of outside managers of government pension funds.

Thus, a rough framework is taking shape for greater participation in governance by institutional investors. Not only domestic investors but also foreign fund managers will be watching this progress against the backdrop of Commercial Code reform. If Japan grants companies greater flexibility to hold treasury stock (in itself, not a bad thing), will it also adopt insider trading rules and disclosure requirements that fairly protect all shareholders when buybacks occur? Will the new Commercial Code make the exercise of voting rights more convenient — through electronic voting, earlier deadlines for release of proxy materials and requiring shareholders meetings on different dates — so that shareholders meetings are something more than five-minute pre-programmed travesties scheduled simultaneously so that few shareholders can attend?

It will not be positive for the Japanese stock market if investors conclude that there is only marginal improvement in governance practices. The Nikkei Index is testing 10-year lows again. It is at crucial times like these that Japan suffers most from regulators’ past failure to promote healthy and vibrant capital markets. In Japan’s low-liquidity market, the combined effect of poor market fundamentals, low transparency and shoddy corporate governance can be huge — all on the downside.

The results of the Life Insurance Association’s survey suggest that institutional investors understand the realities and stakes far better than you might think. In pointed fashion, the survey itself is entitled: “Status of the Framework That Can Increase Stock Prices.” Examples of concrete survey data include:

  • A full 83.6% of investors opined that one the most desirable and effective ways to improve corporate governance would be to install outside directors to the board, or add more of them. This was the most popular response by an overwhelming margin. The next most frequent responses given were around 30% for “installing a system for executive officers,” “establishing an executive stock option program,” and “establishing board committees for nominations and compensation.”

Shielded by the anonymity of the survey forum, an impressive 42.2% of corporate managers (the largest group) shared the same view about the desirability of outside directors.

  • As the principal benefit from appointing outside directors, most investors (76.5%) cited “strengthening the board’s monitoring function.” Other common responses included: “access to (the new perspectives) of outsiders” (58.8%); and “stimulating (debate) at board meetings.” Managers shared almost identical views.
  • Japanese institutional investors understand the extreme importance of requiring outside directors who are truly “independent” and carefully defining the term. Fully 93.3% of the respondents who were unsure whether outside directors could be effective cited as their main reason their doubt as to the actual “independence” of the outside directors that might be appointed.

The numbers speak to the challenges ahead that concern investors. Only 31.7% of responding companies have outside directors by any description, and of these companies, the majority have only one on an average board of about 15 members. It is not at all surprising that some investors are skeptical how much impact would be made by merely adding one or two “golf buddies” to act as “outside” directors in name only. Consider the absence of greater numbers, a strict definition of “independence,” facilitative legal structures, governance guidelines from investors, and requirements to disclose governance practices. It will take time and action from both the private and public sectors to establish these.

  • There is divergence between corporate governance practices investors would like to see implemented most and those that managements are actually implementing first. Over each of the past two years, fewer than 13% of companies have shown an increase in the number of outside directors. Progress is also slow with respect to the formation of separate board committees for nominations and compensation. On the other hand, executives have been very quick to install “executive officer” (shikko yakuin ) schemes which retain their nominal “director” titles while limiting their legal liability and reducing the size of the actual board. More than one-third of companies now have such roles, or are planning them, even though 35% of investors do not agree that the executive officers being created will improve corporate governance unless accountability is defined better. Since shikko yakuin do not even have any foundation under the Commercial Code, they do not carry any special legal liability or responsibility.

Management teams have also been quick to establish stock option programs for their own benefit. About 51% of the polled companies now have such option programs, or are planning to install them. This is a good sign, although investors are rightfully concerned about the need to establish clear profit targets and performance criteria for allocating options.

As Japanese corporate governance evolves, what is needed next is for the various ministries and the FSA to clarify, strengthen and enforce the fiduciary responsibilities of pension fund managers the way the Employee Retirement Income Security Act and subsequent regulation did starting in the 1970s in the United States. Right now, there is a lax fiduciary standard for trust banks, there is a different one for investment advisors and virtually none at all for life insurance companies. And there is no legal equivalent to the U.S. Department of Labor’s “Avon Letter” or Interpretive Bulletin #942, which prescribe fiduciary duties to exercise voting and other governance rights solely in the interests of beneficiaries.”

By Nicholas Benes, president of JTP Corporation, an investment bank specializing in merger and acquisition advisory services.  (Since 2009, he has served as Representative Director of BDTI)

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