Corporate Governance May 2013

Warning: Reform or Fail

Japan firms need more women board members, outside directors and foreigners to balance power, reform economy and draw FDI

• Concern at slow change of pace
• “Paltry” 1.1% of board are female
• Do firms really want to reform?
• UK has good governance model

Britain is a global leader in the area of corporate governance and there are many lessons that our firms have learned that are also applicable in Japan, according to speakers at a recent symposium organised by The Nippon Foundation.

The speakers expressed concern, however, at the slow pace of change in corporations in a country that is widely considered to be a “special case”. They also questioned whether there is a genuine desire for reform in Japanese boardrooms.

Evidence indicates that investors are increasingly shying away from putting money into firms that fail to have more outside directors on their boards; resist women or foreign nationals joining the highest echelons of their management; are at a disadvantage in global markets, due to an inability to communicate in English; or have not reformed the structure and format of board meetings to make them more efficient.

Firms that are not evolving in these critical areas, the analysts suggested, are not attracting capital and will slip behind their international rivals.

“I have detected a kind of defensiveness in many of the relationships that I have had with Japanese companies”, said Simon Learmount, a lecturer in corporate governance at the University of Cambridge Judge Business School. “I think the one thing that is very important to understand is that long-term investors have an interest in making sure that the companies in which they invest are successful. This should be welcomed with open arms”.

The UK has seen a shift in the concepts behind corporate governance to “a more nuanced and inclusive debate”. This is thanks, in part, to the ongoing examination of the importance of appropriate government in firms, and the implementation of a number of new regulations and recommendations.

For example, the 2010 UK Corporate Governance Code states: “The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company”.

This makes it clear that the directors’ primary duty is to the firm, rather than to shareholders.

Change began in the UK in the wake of financial scandals at firms such as Polly Peck International and Coloroll, which demonstrated just how easy it was to fabricate corporate accounts, Learmount said.

One of the most important conclusions of the Cadbury Committee’s report, issued in 1991, was that there needs to be a balance of power on a firm’s board as well as more external directors.

While there has been progress in this area—more than half the firms listed on the Tokyo Stock Exchange have at least one outside director—this is partly because the exchange stipulates it and firms are merely moving to compliance, said Meryam Omi, head of the environmental, social and governance section at the investment management arm of the British financial services firm Legal & General Group plc.

Japanese firms often state that they wish to appoint an outside director who has experience in the sector in which the firm operates, because they already have a solid understanding of the business. However Omi believes this is a mistake.

“The value of an outside director is in having someone who is completely different and does not think like everyone else on the board”, she said. “They have different solutions and strategic thinking that can be immensely important”.

Christina Ahmadjian, a professor at the Graduate School of Commerce and Management of Hitotsubashi University, was in complete agreement with that way of thinking.

“If you ask a lot of Japanese companies about balance, they will say that the all-insiders model is OK for them”, she said, adding that this approach “is dangerous in Japan”.

“I still can’t figure out who makes the decisions at Japanese companies, on corporate governance or other issues”, she added. If you look at the economy as a whole and compare it to other Asian markets, [you see] the strong hand of government and corporate government organisations [in those markets]. Not in Japan.

“I think what is remarkable is that foreign investors have not had the influence that they expected to have”.

Addressing the issue of female representation in boardrooms here, Omi said it is “a real shame that 50% of the population is under-represented on Japanese boards”.

While women account for 11.1% of board members in developed countries and 7.2% in emerging markets, the figure in Japan is a paltry 1.1%, she pointed out.

Equally important is the question of having foreign nationals in Japanese boardrooms, particularly given that, with a shrinking market at home, firms here increasingly need to look overseas for markets and profits.

Omi pointed out that many firms have fared poorly when setting up in an overseas market because they lacked an understanding of, and experience in, that market. This could be remedied were such firms to have greater foreign representation on their boards.
It is fair to say, she added, that if a Japanese firm wants to succeed in a foreign market, it would help immeasurably were the firm able to show there are outsiders on the board. Moreover, such changes would not go unnoticed by investors.

Omi said she believes that within the next three to five years, at least one-third of the members of Japanese firms’ boards should be independent directors. The need to make this change is most critical in medium-sized and large firms—particularly those with business overseas. The next step would be to increase the proportion of outside directors to 50%.

There needs to be a reconsideration of the actions of boards here; how often they meet, how long they meet, and the formats of their meetings, she added. In addition, outside directors need to be provided with meaningful support and training if they are newcomers to a sector.

But the context of any changes that take place is vitally important in Japan, said Learmount.

“The UK provides a good model of how corporate governance worked for the UK. [The model] is appropriate for the systems that we have in place, our employment, the way our markets work and so on.

“I think that simply looking at UK structures and processes, and then trying to apply them to Japan, would be a mistake”, he added. “It is the principles of the reform that are more important: the inclusiveness of the debate, the ways the recommendations are implemented, the importance of enterprise and strategy.

“This all needs to be debated”, he said. “If we spend too much time just looking at the UK and our examples, it will end in failure. Instead, trying to understand the processes is very important”.