The Director’s Chair: The Many Roles of the Board Director

A personal perspective from 25 years in risk management

The world is getting smaller, more intense, and risks are amplified for the same reasons. All business operates within interlinked networks we refer to as an eco-system. The business eco-system has similarities to the ones found in nature, notably the mutual interdependence of many ostensibly autonomous participants, the flow of energy, information – and money – and the subtle interplay of supply chains. This interdependence and complexity – as well as the possibility of harmful predators, unanticipated disruptions, man-made or natural – provide a broad set of ongoing challenges for corporate management, in Japan and elsewhere. Collectively, we can categorize these challenges as risk management.

In this essay I will examine the multiple roles and tasks of the independent outside Director in a Japanese company with publicly listed shares, but these observations apply to many senior managers in supervisory roles. There is a saying, where you stand depends on where your sit. The independent Director sits near the top of the company’s decision-making and control apparatus but as a rule does not have executive or functional responsibility. He stands apart from active management in an oversight role. Let’s take a closer look at this role.

In my view, the central task of the Director is to help create and maintain an effective mechanism to safeguard the company’s assets and resources, and in doing so ensure its ability to prosper as an ongoing concern regardless of the state of the economy or global affairs. No individual can or should try to do this alone. Rather the Director should build a base of knowledge, skills and tools so that the broadest number of people have the awareness and ability to make it work.

The assets to be safeguarded include the property and equipment of the firm, the knowledge and other intellectual property, the workforce and talented employees, the money and other financial assets, relationships with vendors and suppliers, the trust and confidence of customers, community and governments, and at the end of the day, that subtle and sometimes fragile asset known as brand equity and reputation.

To manage all these aspects of the business is not as hard as it may sound, for it is the natural inclination of most people in any organization to do so. Most of them typically work in relatively small groups with daily personal interaction, along with routine reporting and oversight. Yet there are of course potential risks even in this daily routine. An on-going risk is the rogue individual who may learn to manipulate the daily operations, which may not get more than cursory oversight. That might include cutting corners on safety procedures, quality of ingredients, kickbacks from suppliers and theft of private data or intellectual property, including corporate espionage. Often the best defence lies in eyes-and-ears and the supporting reporting systems. Data security tools can and should be rigorously applied. (One large robotics company simply does not give employees external email accounts.) Weakest-link analysis and simulations can be used to develop understanding and apply best-practice. Vendors can provide needed tools and personnel but must themselves be vetted as potential incremental source of risk. One could say as a general rule that you must know where all the exits are and who has the keys. Leakage can largely be prevented, or minimized.

Human resources are an area for scrutiny, as a disgruntled employee can create problems even if not dishonest. Employment practices in Japan as elsewhere, can be a minefield, there are an array of issues such as excess overtime, managers using power-harassment and other forms of pressure to get results – or cover-up other problems. Age, gender, ethnicity and social status can create both unintentional or intended discrimination as foreign “interns” are recruited, along with older and other non-regular employees, who mingle with the “full-status” employees who typically enjoy more benefits and job security. Disgruntled employees now have a medium to voice complaints via on-line sites, not just through lawyers and labor unions.

Such personnel dissatisfaction is not always visible, nor can its effects be easily predicted. The internet and instant on-line communications create a range of risk factors. The largest of these is the external hacking attack which is a topic beyond the scope of this essay. But unhappy customers, employees, applicants, community members, even vendors may take to the internet to air their views, favourable or not. That may in turn escalate to unwelcome media attention, and to subtle (or rather more blunt) blacklisting – for example in college recruiting related media.

Criticism of this type creates one source of reputation risk. More often reputation damage comes from product quality failures or disclosure of improper or illegal activities, and Japanese – and increasingly foreign – media reporting in recent years amply illustrate the potential pitfalls from Takata to Toshiba and before them, Toyota Motor. International business presence substantially enlarges the stages on which the company performs. These risk factors are further magnified by the lens of unfamiliar cultures, religions and governmental standards in different regions and countries. (This too is a topic beyond the scope of this short paper but see the discussion of global coumtry risk methodologies below.)

The Director should also be aware of the potential tension among different stakeholders, and keep an open perspective that looks beyond the confines of business as usual, given the typically narrow or uniform mindset of senior management within the firm, due to the widespread seniority and lifetime employment practice. Contemporary corporate governance practice provides a number of methods to promote more transparency and reduce potential conflict of interest. Large public firms can have problems with divisional factionalism, a cult of strong personality that persists as the charismatic leader retains power and influence well after ceding the CEO post, a yes-man, take no risk attitude, and so on, while smaller firms may have succession issues in an owner-family run company, where a son or other relative gets to jump ranks ahead of other qualified executives.

Technological innovation and the “climate-change” it can create with astonishing speed are a distinct risk – companies that supply components to Apple, for example, can get dropped when an alternative device or components gets selected. (A small metallurgy company in northern Japan has a forlorn lucite plaque in the lobby with the bimetallic “rotary” dial they made for the iPod before Apple went to touch-screen.) One way to push the company “radar screen” over the horizon is to communicate closely with customers, who are likely already assessing alternatives. Consulting and research firms like Gartner can provide helpful foresight, and the Director cannot just rely on in-house technical expertise where pride and prestige – not to speak of development budgets are at stake. My friend Michael Riardon left the firm he created, Gilead Sciences – a Bay Area biotech giant – when his own preferred approach to anti-viral drugs lost out to another well-argued approach by other senior executives – a difficult choice that subsequently appears to have been the correct one.

A final – for the purpose of this short note – area of significant concern for the Director is to understand and when necessary act on that knowledge in the area of mergers and acquisitions, known as M&A. That is true regardless of whether the company is the buyer, or itself the object of a takeover or merger. M&A requires considerable care by everyone in the decision-making process for such corporate action is nearly always “material” in the view of corporate law and extreme caution must be taken to prevent premature or unauthorised leakage of information, given the temptation for others to use it in advance of a standard public announcement to make deals for themselves in the market.

In addition to ensuring confidentiality among all those involved, inside the firm and the many outside experts likely to be engaged as well, the Director needs to work to ensure the proposed deal will enhance value for stakeholders, certainly that the pricing is fair and properly calculated, but also that the deal is appropriate to the firm’s longer-term strategy. Pricing – whether evaluating an offer for the Director’s own firm or a bid for a target firm – is as much art as it is science, and various mathematical models are widely used by independent outside specialists. In recent years, Japanese companies have had a mixed record especially for overseas acquisitions – often paying multiples such as EV/EBITDA that market observers regard as unjustifiably overpriced. In addition to price, getting a good strategic fit is also a challenge. Finance theory tells us acquisitions are made to acquire new customers, new technologies, new market territories, and can generate cost savings by eliminating repetitious costs in administration, procurement and marketing. But any acquisition adds the hurdle of merging company cultures, traditions and perceptions that are magnified across national borders.

Global country-risk assessment is a relatively recent development, driven by multinationals, notably energy and resource companies that have seen the need to expand into frontier and emerging economies that may have unstable or at least relatively unknown political systems. A distinct category of specialist research and consulting firms such as Ian Bremmer’s Eurasia Group provide insight and guidance in navigating potentially hazardous operating terrain in these locations, and the Director should be familiar with – and if necessary – have access to such firms, as with other specialists in finance, accounting and deal-making.

But at the end of the day, the Director must also help guard against complacency, doing nothing is not always the better option to taking on a potentially difficult challenge. Honda Motor was the first of the Japanese automakers to set up manufacturing operations in North America – and few Japanese companies at the time (with the exception of some consumer electronics pioneers like Sony and Sharp) had ventured into making things in America. But Honda and its peers saw that political agitation for what became known as “local-content” laws was growing, and that the cost advantage provided by a relatively low-priced yen against the dollar might evaporate. Honda was and is a cautious put pragmatic company and the search for a suitable location in the US (which we all know in retrospect as Marysville in Ohio) was exhaustive and largely data-driven. (Interestingly, the bilingual staff of the Ohio economic development office advised Honda from the start to urge its Japanese managers to avoid clustering in a Japanese “hamlet” but rather to settle down in different local communities, send their kids to local schools and demonstrate the sort of good-neighbor attitude they also extended to their hiring practices (which in reality were aimed at preventing a strong labor union presence in their workforce.)

In summary then, a healthy company has a robust and active “defense system” in place to safeguard against the various dangers and risks that lurk in the world today. Not all risks can be predicted or avoided, but a healthy company also has a contingency plan in place on what to do when a crisis erupts. The Director must be familiar with – and have opportunity to practice – the procedures taken under the contingency plan. The risk may be a natural disaster at home or in the world, a terrorist incident, a potentially damaging lawsuit, or revelations about unforeseen malfeasance, say violation by a foreign unit of corruption laws.

Bottom line? Eternal vigilance is the price of liberty, as Churchill put it.

Peter Fuchs @ Rikkyo University, Tokyo
January 2017


The author is professor of business and finance at Rikkyo University, a liberal arts college in Tokyo also known as St. Paul’s. His career spans 25 years as an investment banker, analyst and fund manager mostly with international institutions including Morgan Stanley and Deutsche Bank Securities. During that time he has been engaged in many dimensions of risks management – and in fact, from 1998 to 2000 served as country head of risk analysis solutions at SAS Institute Japan. The company had developed a sophisticated – and costly – program to estimate a bank’s balance-sheet and trading-book risk under adverse scenarios, but working with a small team of quants in Tokyo, Fuchs stumbled on several programming glitches that if left intact could have generated unforseen losses for customers. Software alone cannot assure a system’s safety was the lesson learned.

Prior to joining Morgan Stanley Japan in 1992, he was contacted by a senior manager at Kroll Associates, the corporate detective agency, to provide insights on the likely risks faced by foreign financial institutions from underworld organizations – politely known in Japan as “anti-social elements.” Such groups had been active participants in the bubble economy of the late 1980s, and had likely suffered severe losses – as did most other legitimate participants, as the bubble burst. Though six months later he learned the Kroll client had in fact been Morgan Stanley – which was the target of threats forcing senior executives to carry bullet-proof jackets for some time – he advised Kroll that the more likely threat to foreign institutions came from within, ie. from disgruntled or dishonest employees.

The demise of Barings in early 1995 from disastrous trading losses by a young British prop-trader in Tokyo suggests the advice was right, but the rogue-trader risk not widely understood. For his part, the trader – Nick Leeson – was taking huge bets in the market in a desperate effort to cover his mounting losses, but he too overlooked the risk the Kobe earthquake of January 1995 posed to his “butterfly straddle” all-in wager. Without the devastating quake, he might have skated past safely.

As head of a new business development unit at Shinsei Bank in Tokyo, a few years before the Lehman Crisis unfolded, this author was approached by two young Japanese executives from a recently listed start-up who had fancy business cards with the name of the firm, Livin’ On the Edge (taken from a popular rock hit of the 1980’s). They wanted to borrow “about fifty to sixty million dollars” for as yet unspecified investments. “Our boss, Horie-san, wants to get into M&A.” After a brief follow-up meeting a few days later, Fuchs politely showed them the door. Unfazed they went across town to meet with another Western banker, coincidentally also named Fuchs, at Lehman Bros. In that hot-house risk-taking petrie-dish, they soon raised several hundred million, which Horie promptly put to use in bids for prominent public companies like broadcasters TBS and Fuji Media. But the clock was ticking and their profligate – and likely illicit – risk appetite ended destroying both Lehman and the wanna-be media giant Horie had built – ie. Live Door.

What had begun as a new way to repackage sub-prime mortgages in the U.S. for resale to institutional investors had morphed into a loose money-fueled investment binge that hinged on the delusionary conviction that clever financial engineering had absolved the world of counter-party risk. Even a respected Wall Street chieftain like John Mack, who was chairman of Morgan Stanley at the time noted, “I can’t really say why we ended up with a trillion-dollar balance sheet – but everyone was doing it.” His once chest-thumping global powerhouse had to accept a bailout from Japan’s Mitsubishi Bank (for whom Morgan had sponsored a life-extending convertible bond issue only a decade earlier, in the wake of Japan’s own devastating financial bubble.)

The kingdom, but for a horse, the Falstaffian wit in Shakespeare would have put it.

(Posted at the request of the author, Peter Fuchs.)

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