Redesigning Corporations: Incentives Matter

By Nicholas Benes
(also published in the Harvard Law School Forum on Corporate Governance) 

The Birth of the Corporation: Public Interest Organizations

The evolution of the modern corporation is the fascinating story of a series of self-serving legal and societal mutations over hundreds of years, which have morphed the original concept and endowed corporations with freedom of activity, rights, and limitations on liability that would shock their original “inventors”.

As we all know, for many years most corporations were established by way of an exceptional “charter” by a sovereign, granted only in specific cases where: (a) large amounts of capital were needed (b) to conduct investments and activities that served public or national interests and had good profit potential, but (c) where the risks were so large that few parties would invest if their risk were not shared with many others and/or limited to the amount of money they invested.

In the 1600s and 1700s, the activities that sovereign nations felt met those requirements were the exploration of foreign lands on the other side of the globe, the creation and administration of colonies there, and conducting lucrative trade on long (and dangerous) sea routes to and from those colonies. Thus, the most well-known early corporations include organizations such as the British East India Company (the original “too-big-to-fail company), The Dutch East India Company, the Hudson’s Bay Company, and companies to construct the Erie Canal.

As the industrial revolution gathered steam, the need to raise large amounts of capital increased many times over. Driven by this need, the immense benefits of corporate status for raising financing became increasingly obvious and desirable to investors and managers: easy stock transferability vs. rewriting partnership agreements, separation of ownership from control, legal personhood that simplified large transactions such as loans and large investments (a single counterparty to deal with and sue), and the possibility of receiving a charter that conferred “limited liability” on shareholders. All of these made it much easier to raise funds in large amounts than any other form of business organization.

Message to JR Kyushu Shareholders

Fir Tree Partners submitted a shareholder proposal nominating me as an outside board director for JR Kyushu. This all began as Fir Tree, the largest and longest holding, active shareholder of JR Kyushu since its IPO, was working in dialogue with the Company to find suitable new board candidates. I accepted the nomination because I believe the current needs of the JR Kyushu board fit well with my previous professional experience as well as my knowledge base. In particular, my experience as both analyst and corporate executive should be helpful as I am in favor of dialogue between investors and companies.

In mid-April, I was surprised to learn that JR Kyushu management, after spending months screening and interviewing the various candidates, ultimately decided to reject all candidates that were under consideration with Fir Tree. At this time, Fir Tree asked us to be their shareholder candidates for this year’s annual meeting. Even though being elected to a board as a shareholder proposal candidate is still rare in Japan, I decided to accept the role because I feel strongly about the importance of good governance and the role of completely independent outside directors. As I learned more about JR Kyushu in the past few months, I have concluded that I can add to the JR Kyushu board the diversity, perspective, and expertise that I have developed as an analyst, fund manager, investor relations professional and corporate executive in charge of governance matters. To this end, I believe I can help JR Kyushu in addressing the current challenges caused by Covid-19 as well as fulfill its full potential.

I would also like to publicly state that I am completely independent from Fir Tree and have told them directly that at all times. Fir Tree approached me through the help of a third-party search firm. I previously knew nobody at Fir Tree. There is no financial arrangement between us. I will remain independent from Fir Tree should I be elected as a director of JR Kyushu. I will consider Fir Tree’s opinions as no more or less important than those of any other shareholder, large or small.

If elected to the JR Kyushu board, I would be completely open minded and unbiased. I would review all board matters carefully in consultation with the other board members, management, and shareholders utilizing both public and non-public information in order to form my own opinions. I would endeavor to make well informed decisions that are best for all stakeholders.

Example of UK Pension Voting Policy – Japan Still Has Far to Go

The London Borough of Camden Pension Fund recently updated its voting guidelines. I thought it might be interesting for Japanese readers to see how detailed such guidelines by foreign pension funds are.  It is interesting to note that if you applied these voting criteria to most Japanese companies, almost none of them would pass muster, and the result we would be that many resolutions (and many directors) would not be approved.  Japan is still far, far behind the level of “stewardship” and expected governance practices in many other countries.

London Borough of Camden Voting Guidelines 2020

Very few pension funds in Japan (none that I know of) have voting policies at anything near this level of detail.

 

GoToData by BDTI: Japanese Disclosure, by All listed Firms, Now Easily Accessible in English!

Why wade through 100+ pages of unusable PDF-formatted Japanese jungle, when you can jump directly to the parts you want, read them in English, and quickly cut and paste both text and tables you want to analyze and compare? Why not save 70% of your time and conveniently review the official source documents submitted by all 3,600+ Japanese listed companies?  Click on the center of the image below to view in full screen “flipbook” mode, and contact us at info@bdti.or.jp if you are interested to know more. Qualifying parties may receive demonstrations and trial accounts.
Ready or not, Japanese disclosure has now entered the age of machine-readable digital data! The dream that I presented to Japanese lawmakers in February of 2014 [1] can now be realized: a world where a Corporate Governance Code requires detailed disclosure of the inner workings of companies’ governance black boxes, and that information is seamlessly available to all investors, thus making it possible for them to do the analysis they must do to be good “stewards”.  As a result, the Stewardship Code will be able to function in reality, not just in theory.

[1] 2月6日に自民党の日本経済再生本部の金融調査会に呼ばれて、コードの概念、政策としての位置付け、入れるべき内容の例を「日本経済の復活のため、コーポレート・ガバナンス・コードの早期制定を」というプレゼン資料を使って説明した。その後、議員らにさまざまなアドバイスと提供させていただいた。

Nikkei Asia: Activist Funds Defeated at Kirin and Toshiba Machine

“IFP’s challenge, however, highlighted weaknesses at Kirin, whose expansion has produced mixed results, analysts said. One of the director nominees recommended by IFP, corporate governance expert Nicholas Benes, won 35% of shareholders’ votes despite opposition from Kirin, suggesting some shareholders agreed the board needed more change.

Memo to Shareholders of Kirin HD, from a Director Candidate

Independent Franchise Partners (IFP) has submitted a shareholder proposal nominating Kanako Kikuchi (an experienced global pharmaceutical executive) and myself as independent directors. Glass, Lewis supports electing both of us, but it seems that ISS has “split the baby” and only supports me. If investors could vote for Ms. Kikuchi as well, it would greatly help ensure that the board makes a fully informed, objective and independent assessment of the strategy on an ongoing basis.

Both of us have no past relations with IFP, and take an approach that is completely agnostic and independent of IFP’s dividend proposal. We both believe that if shareholders do not opt for that proposal, – or in any case – it is most prudent to withhold any decisions about the strategy until such time as when we are on the board and can ask questions and are privy to all internal analysis and confidential information. Therefore, we would both join the board with no pre-decision(s) made before knowing all the facts. This is the only logical position to take as a truly independent director. I have informed IFP in no uncertain terms that my philosophy and legal duty is to answer to all shareholders, and that I may well not agree with positions that IFP has taken or may take in the future. IFP has no problem with this.

Many investors may not realize that unless Ms. Kikuchi is elected, there will be no one with global biopharma experience on this board just at the time when that skill set is most needed. Given the company’s proclaimed strategy to “bridge” into health science products (which could be a good one for all I know), this is not wise and is of great concern to me.

CITINDEX 11 : “Our Opinion on Toshiba Machine’s Implementation of Buyout Defense Mechanisms that Do Not Take into Account Shareholder Opinions”

Conclusion paragraph: “We believe that Toshiba Machine’s implementation of its New Buyout Defense Mechanism that does not take into account (but rather opposes) shareholder opinions hinders the development of corporate governance in Japan, which has been built on the efforts of various parties including governmental agencies and self-regulation organizations such as the Ministry of Economy, […]

Correlation and Causation: Good Governance Practices and Firm Performance in Japan

On December 11, 2019, I gave a lecture on BDTI’s analysis about corporate governance practices and and firm performance in Japan. Since then we have added indicators of statistical significance to our materials. To view the entire presentation as translated into English, click here: Presentation to Securities Analyst Association 2019.12.11. Those who read Japanese can read the full speech here, and can download the Japanese version of the presentation materials.

Our methodology is shown on page 23 . Our analysis suggests that the adoption of the following practices leads is followed by (appears to cause) improvements in ROA compared to the average for a firm’s industry over the next two years. Please see the charts on the left side of each page:

  • Adding an nomination committee of some sort (p. 27)
  • Appointing an outside director as the chair of that committee (p. 28)
  • The combination of nomination committee with a board composition with >33% independent directors (p. 30)
  • Adopting a performance-linked compensation plan for executives (p. 29)

Various other factors that appear to correlate with superior performance, are shown on page 22, and page 34. We will explore the direction of causation with some of these later.

Governance Practices and Firm Performance in Japan – Preliminary Analysis of Causation

On December 11, 2019, Nicholas Benes gave a lecture on Corporate Governance Practices and Firm Performance in Japan at the Securities Analysts Association of Japan. It was generally well-received and covered the following topics:

  • An Introduction to BDTI
  • General Trends in Corporate Governance
  • Correlation Analysis on Relationships Between Corporate Governance and Firm Performance, and the Direction of Causation
  • Advice for Investors and Prospects for Future Research
  • Appendix: Preview of our internal corporate governance relational database

Of note were the three main themes that were discussed: (1) There are visible relationships between certain corporate governance practices and financial performance (2) the direction of causation is most important to confirm, and so far, BDTI’s analysis suggests that a number of specific governance practices actually do seem to “cause” improvement rather than simply serve as evidence that management wants to “look good”; and (3) this information is vitally useful for analysts and investors alike, in order to improve the effectiveness of investor engagement that enhances profitability, growth and stock performance in a win-win cycle.