(Interviewer: Nobuyuki Kobayashi)
Things that Limit the Perspectives and Actions of Certified Public Accountants
Kobayashi
Recently, there has been an increase in the number of cases in which certified public accountants are appointed as outside board members. I would like to talk to Mr. Benes, who knows about the realities of governance “in the trenches”, about what kind of skills and mindset that are needed by such CPAs when they are appointed.
Benes
Working as a CPA, ordinarily one would face no particular problems when providing ideas and advice to clients. However, since outside directors who are CPAs are required to be independent, I believe that you have not fulfilled your true role as an outside director if you are not prepared to resign from the company where you serve if that is necessary in an emergency, and if you cannot speak out even if that makes things uncomfortable for the company’s management.
Kobayashi
I also believe that the independence of CPAs is extremely important, but I have a feeling that some aspects have become institutionalized. I think it is really necessary and desirable for me to become an outside director with the courage to quit if the need arises. In this regard, what are your thoughts on the differences in perception between the company and the outside directors?
Benes
In terms of political reality, most outside directors are nominated by executives on the company side. In any case, some CPAs seem to feel that their nomination is a “request” from a “client company.” As a result, they may unconsciously align themselves with the way of thinking of the CEO, who is the leader of the company. There are many people who, – even though they are aware that they are the spokesperson for minority shareholders, unless a serious incident occurs, – make no comments opposing the opinions of the CEO and management regarding corporate strategy, or human resource management, etc. It seems that such persons view their role as a very narrow one, and do not consider governance more broadly.
Kobayashi
Based on what you said just now, if you interpret that you are being selected as an outside director by a company because of your knowledge as a CPA, you may have a tendency to limit the content of what you say to just that aspect, no? CPAs may believe that all they have to do is speak out and fulfill their “role” in their field. Does this mean that an awareness of the responsibilities of outside directors to monitor and supervise all aspects of the company is lacking?
Benes
Certified public accountants have knowledge of the institutional framework involved in the management of a company. However, not all CPAs have experience in managing their own companies. People may mistakenly think that because they have a wealth of knowledge in one area, they can also understand various other aspects and fields of the company. Some people may assume that they are knowledgeable enough because they have frequently worked on topics related to governance, such as internal controls and financial statements. But being an outside director is a never-ending journey. You should be aware that you are always learning.
Japan’s Ingrained Inability to Escape From “Being Convenient for Management”
Benes
Nominating committees and “voluntary” HR advisory committees are frequently created, but only about 20% of them have meaningful discussions. I think the problem is that the CEO is always included as a member. This results in a discussion that only reflects the opinions of the most senior spokesperson for the “client company”. It may be an extreme statement, but the CEO is not required to be a member of the nominating committee. When seeking opinions from internal people such as managing directors and marketing experts, a meeting where people feel that “can’t say something because the CEO is there,” is not workable.
Kobayashi
This seems to be due to the mindset of outside directors, but it may also be because the company’s awareness of governance has not yet reached a certain level. In other words, the company has selected only people on the board of directors who make “safe” statements.
Benes
At present, in the Prime Market in Japan, the average number of directors on a board is about nine or ten, of which four are outside directors. The typical board consists of two former executives, one lawyer, and one CPA, and statistically speaking, about 60% of outside directors are those with prior senior management experience. Many of these executives have had very difficult experiences over the last 30 years and thus have worked hard to avoid and reduce risk as much as possible. I am also concerned about the lack of active promotion of young people to boards. For example, there are many young people who have a lot of overseas experience and experience with internet-related industries. However, this “new era” human capital has not yet been able to participate at the board level. I believe that the general prohibition on holding concurrent positions (兼務の禁止) is preventing this. Overseas, it is possible that that the CEO of GE could be appointed as outside directors of another company.
Kobayashi
I think such efforts are necessary in Japan as well. Looking at the composition of the Board of Directors in Japan, although the executive side has been getting younger recently, the fact that the age of outside directors tends to be 10~20 years older than the executive side on average is becoming a major problem.
Benes
In the U.S., if you are 60-65 years old or older, you are unlikely to be considered as a candidate for an outside director. This is because firms in the U.S. want a good outside director to serve for more than 10 years. On the other hand, many boards in Japan carry implicit, customary terms of office. You become a CEO for 5~6 years, and then an outside director for 4~5 years, or 7 years at the most. Then you move from one company to the next as an outside director. My feeling is that you can only get to know a company well after the second year. Only from that time on, will you be able to make more meaningful contributions. In that sense, it may be that behind the scenes, management is thinking that “it is more convenient to have outside directors who will be gone in 4 to 5 years”.
Kobayashi
So when you finally understand the inner workings of the company, your term of office will end, and you will not be able to do accomplish much. In other words, it’s up to management to decide whether they welcome criticism and your pointing out things that they may not want to hear, or whether they want you to leave sooner.
Benes
I think that’s what we mean when we talk about the quality of governance. It is about whether management is willing to humbly accept valid criticism and respect outside directors who are trying their best to fulfill their responsibilities.
The Board of Directors as a Mere Formality: a Place to Approve Management Meetings
Benes
Looking back 15 years ago in Japan, the objective of management in board meetings was “to finish as quickly as possible.” Someone would spend 10 to 15 minutes reciting monthly figures, and it was just a formality, and the materials for the management meetings were used as materials for the board meetings without any changes being made. It seems that this way of thinking about governance at that time is still lingering on in Japan.
Kobayashi
I have heard that there are some companies where the executive side has already seen the board materials at the management meeting and those materials are submitted to the board of directors for approval, which makes the board a ritual that is almost an extension of the management meeting.
Benes
The Management Committee and the Board of Directors are two different meetings, with different purposes and roles. You may attach the materials used for the management meeting as materials for the board meeting, and then we can all read them in advance. But the Board of Directors is not a place to just put your stamp on what was discussed in the management meeting. It is a meeting to identify points that were overlooked at the management meeting, raise issues, and generate new ideas. That’s the kind of mindset we need to cultivate.
Kobayashi
If board meetings become this ceremonial, I feel that outside directors will become more of a “stopper”, like a review body for the proposals presented, and will not play the role of stepping on the accelerator. When it comes to outside board members, there may be cases where they don’t know what to say and think that they can just say something in their own field of expertise to avoid most other issues.
Benes
In my 16 years of experience on various companies’ board of directors, the higher the percentage of non-executive outside directors who actively speak up, the more likely the rest of the board members are to participate and speak and contribute. They may feel the pressure of not wanting to be the only one left out. For example, if there are only two outside directors compared to when there are six, the latter situation will clearly improve the quality of the meeting.
Kobayashi
Doesn’t this mean that a sense of competition naturally develops? When other people speak up and contribute, it stimulates your self-esteem and makes you feel like you have to contribute too, which has a positive effect.
Changes in Governance Will Change the Skills Required of Outside Directors
Benes
In the Prime market, the rule is that more than one-third of the directors will be outside directors in principle, but I think that the next revision will probably shift to asking that the majority of the board be made up of independent outside directors. Already, nearly 20% of companies in the current Prime market meet this criteria. When this happens, the balance of power on the board of directors changes drastically. There will be an increase in the number of cases where the CEO will no longer concurrently serve as the chair, and an independent outside director will become the chair. In addition to one CPA and one lawyer, the composition of the board will change to include more people with management experience, and outside directors with diverse backgrounds will be added. AI experts, HR professionals, and IT and corporate strategy consultants are examples of such candidates. It may also be good to have a foreign manager who is familiar with overseas markets such as India. This will make board discussions more active than ever, and qualified CPAs may feel more comfortable speaking out on topics outside their own field of expertise. On the other hand, if you do not have some knowledge of strategy, organizational theory, and IT, you will not be able to survive the competition. If you remain only in your current role as a CPA, you will eventually be left behind.
Kobayashi
Currently, there are cases where outside directors are a little timid when speaking, wondering whether it is even appropriate to say something. However, in order to generate lively exchanges of opinions at board meetings, traditional outside directors cannot remain as they are. They need to study more outside their own areas of expertise. In that sense, I think it is important to have outside officers with diverse career backgrounds participate, in order to inspire others who attend Board of Directors’ meetings.
Benes
I believe that more than two-thirds of an outside director’s job is to ask questions. Management thoroughly analyzes, considers various options, and compares them. An outside director’s role is to raise questions about whether there are any factors that could lead to failure, what kind of risks there are, and how to respond if something happens. In this regard, when thinking about outside directors who are CPAs, their sense of expertise and pride may be a hindrance. We live in an age where the false humility of saying to yourself that you don’t have full expertise, you’re worthless so it’s better not to participate in this topic, may be regarded as negligence.
Outside Directors’ Actions Can Lead the Board of Directors in a Healthy Direction
Benes
Until about 10 years ago, in the United States, the CEO also served as chairman of the board of directors in most companies. However, the lead outside director played a role similar to that of a quasi-chairman, gathering opinions on what issues the outside directors were concerned about and what topics they wanted to discuss, and encouraging them to put these on the agenda. Eventually, there was a movement to have an outside director, rather than the CEO, serve as the chair. Now in the United States, in 60 to 70 percent of cases, an independent chair or lead outside director leads the board of directors in a healthy direction. Fewer than 45% of firms are chaired by the CEO.
Kobayashi
I think this is a very interesting story. I have the impression that in many Japanese companies, the executive team decides which agenda items to present to the board of directors, and the chairman of the board of directors proceeds with the agenda items in a sort of ceremonial manner. I feel that it is necessary to create a role like a lead outside director, and for outside directors to be more involved in the process of proposing agenda items.
Benes
This depends on the attitude of the outside directors, so I think there is a question of responsibility on their part. There are in fact companies that report information such as what the executives are planning for the future, what they are considering, and what they arenow analyzing. This is healthy and naturally leads to a good flow of discussion.
Kobayashi
In that sense, it would be a good idea to hold off-site meetings rather than just holding board meetings as usual. One way to do this would be for outside directors to become more active in demanding the creation of such alternative forums.
Benes
When it comes to corporate value, it is still the shareholders who want it the most. I feel that there are far too few comments at Japanese board meetings about the things shareholders are concerned about, such as what the market expects and what will impact the stock price. I would like outside directors to cultivate more awareness of the dynamics and common sense of capital markets, as well as a sense of how investors view the company.
The Concept of “Board Leadership” Does Not Exist in Japan
Benes
In other countries, there is a term called “board leadership.” This means that in a situation where the majority of the board of directors are outside directors, they can boldly control the board of directors as necessary. They can replace a CEO who does not agree with them, or they can appoint a person other than the president to coordinate a forum for reconsidering the strategy. This cannot be achieved without a relationship of trust between outside directors. In other countries, there is a stronger awareness that outside directors are approved by shareholders. Therefore, when a problem occurs, there is a possibility that the nomination committee will consider the shareholders’ views and not re-nominate them. This is because shareholdings are concerned about “what was that board doing at that time?” It is because of such forces at work that board leadership is possible.
Kobayashi
I feel that people in Japan are not even aware that such a thing exists. What did each director do individually, how much did they contribute, and how is that contribution evaluated? Such topics are very difficult and do not come up very often. If anything, outside directors are treated like customers, and in a sense, it seems like an honorary position. In particular, when a CPA becomes an outside director at one company in the Prime market, there are cases where such a person who has worked for a long time at an auditing firm is treated like that at several other companies as well.
Benes
I worry that an outside director who serves at multiple companies may not be able to focus on one company when a major strategic M&A occurs, or a scandal occurs. If they fail to do so, they may ultimately be held responsible.
Expectations for CPAs’ Skills
Kobayashi
In the disclosure of the Skills Matrix, there are many cases where CPAs are considered to have a set of finance skills in addition to accounting. I understand that this is the image that people have, but the perspectives of accounting and finance are quite different in some areas, and I sometimes feel that there is a gap between the image and reality. I think this is a pretty big issue.
Benes
It is true that accounting is different from finance. In order to be able to say that you know finance or to use it, you need to have some knowledge of accounting. However, you don’t need to know the detailed IFRS rules to understand what most of the numbers mean.
Kobayashi
When CPAs set forth their audit opinions, they may not want to have a “going concern” qualification note. If a CPA with this tendency were to become an outside director, they would probably view the company’s abundant cash reserves as a good thing, from the same perspective as an auditor. There is conflict and a delicate balance between management that emphasizes the going concern of a company and management that is conscious of the cost of capital. I sometimes wonder whether CPAs understand this when they become outside directors.
Benes
In management, it is not enough to have cash; what you use it for is important. If you do not have a vision and a plan for R&D or other areas that you can invest in, shareholders will not be convinced even if you have abundant funds. If you are not going to make a large investment, you will need to back it up from a financial perspective, such as how much cash you will have left and how much working capital you will need to keep the company financially safe.
Kobayashi
Recently, activists have been demanding explanations from management as shareholders, sometimes even placing ads in newspapers, at various companies. When I look at their actions, I feel that they have done a lot of research, and that discussions on those topics should be held at board meetings. I feel that there is a lot to learn from their activities.
Benes
Even if one doesn’t agree with all activist methods, I feel that I can appreciate more than 70% of what they are saying. I advise executives to welcome activists as friends if they come and make proposals. “Be open-minded and listen, and don’t take a stance of rejecting them right from the start. Many of these people are also shareholders who have held shares for a surprisingly long time, so you should be humble and you may learn a lot from them.”
The Ability to Quantify Things is a Major Strength of CPAs
Kobayashi
The era of indirect financing has long continued, in which Japan companies borrow money from banks rather than raising funds directly from the market. In other words, compared to other countries, executives do not have a mindset of having to face the market. Banks are creditors rather than investors, so they seek financial safety, so as to be repaid. For this reason, it seems that in Japan, the mindset of not taking risks and just focusing on safety has taken root among both managers and auditors.
Benes
In the case of the United States, about half of publicly traded companies are not profitable. A company that does not make a profit in the short term is considered a bad company in Japan, and the management thinks that it is a shame not to make a profit, and it is criticized by shareholders. However, overseas, if a company has a vision and can appeal to investors by telling an “investment story”, it is not a problem even if it does not have operating profits in the short term. The goal here should be to change to this sort of dynamic capital market with a medium-to-long-term perspective. However, this is not easy to achieve in Japan.
Kobayashi
In terms of ABC grade evaluation, the idea is that you should always get a B or so. The idea is that you should never get a C or a D. There is an aversion on the part of management to short-term declines, and I think the Japanese market perceives it that way too.
Benes
In foreign countries, more than half of the compensation for management is in the form of stock, and in the United States, more than two-thirds is in the form of stock. Most of the compensation is in the form of restricted stock, and even outside directors receive compensation linked to the stock price. This naturally encourages management to take risks. The benefit of receiving compensation in the form of stock is that the board of directors focuses more on shareholder expectations. This encourages good ideas to be proactively put forward from within the company. Since their own compensation depends on the stock price, managers take risks and invest only after thoroughly analyzing how they can maintain an advantage over competitors and how much market share they can gain.
Kobayashi
In terms of risk taking, CPAs have excellent skills in quantifying various phenomena and expressing them in numbers, so there should be a place for them to be active. In other words, rather than looking at risks qualitatively and becoming emotionally negative, they should be able to analyze them quantitatively and make management decisions based on numbers. I think such skills are unique to CPAs.
Benes
Certainly, by statistically quantifying the distribution of risk and presenting various options, it is highly likely that you will be able to make a logical decision that it is better to expand investment even in the face of risks.
It is the Destiny of Outside Directors to Constantly Update Themselves
Benes
I proposed the Corporate Governance Code to the government in 2013, and it was introduced in Japan in 2015. However, it will take a long time for this to truly work. One needs the board to develop a vision based on analysis and create a specific strategy to realize its potential. However, the fundamental problem in Japan companies is that not enough such analysis comes up with from management. It’s easier said than done.
Kobayashi
In light of this situation, outside directors who are CPAs are expected to speak out proactively on all topics, not just in their areas of expertise. Rather than thinking, “I know enough already,” I believe that you should study with the attitude that “there is still a lot I don’t know.”
Benes
This is not just true for CPAs. All outside board members must constantly study and update their knowledge. Just because you’re an expert who knows one aspect of the institutional framework doesn’t mean you’re an “expert director.” I believe that there are many highly motivated and talented CPAs, and I am confident that they will be able to contribute if they continue to improve themselves. Outside directors must remember that they are not just providing advice or ideas to client companies. They are fulfilling the expectations of minority shareholders and other investors.
Interviewee Profile
Nicholas Benes (Representative Director, BDTI):
After 11 years at J.P. Morgan, Nicholas founded JTP Corporation, Ltd. which specialized in M&A advisory services. He is qualified as an attorney in the states of California and New York.
In 2013, as one of the proposers of the Financial Services Agency-led “Corporate Governance Code,” he provided detailed advice on the content of the code to relevant lawmakers and the Financial Services Agency. He currently serves as an independent director on the board of Advantest Corporation (Stock Code: 6857).
Japanese version of the dialogue can be downloaded here.
English text translated by BDTI with permission of The Japanese Institute of Certified Public Accountants.