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Tuesday, Jan. 17, 2012
Corporate Japan: woeful lack of outside directors
Japan Inc. is often criticized for its poor corporate governance, especially when it comes to monitoring how top management makes decisions.
The Olympus Corp. scandal, based at the very least on the camera maker being caught covering up massive investment losses over almost two decades, has done nothing to dispel this impression. It has drawn tremendous foreign media attention and raised questions about whether other Japanese blue-chip companies are also engaged in shady practices stemming from their bubble days.
Following are questions and answers about corporate governance in Japan:
What does weak corporate governance mean here?
The general complaint is that Japanese firms lack independent, outside directors. Most board members for a given company come from inside. This creates a cozy internal relationship and closes the doors to outside scrutiny.
On Oct. 27, representatives of several foreign business groups in Japan, including the European Business Council and the American Chamber of Commerce, demanded that the Justice Ministry take measures to compel Japanese firms to improve their governance. A ministry panel has been working to amend the Company Law.
The foreign business bodies told the ministry that many listed Japanese companies are viewed as insider-dominated and out of step with global governance standards, because only directors with close ties to management, the main bank or majority shareholders tend to be appointed.
How does Japan's situation differ from other economies?
According to the Tokyo-based Japan Association of Corporate Directors, whose aim is to improve corporate governance, only 35 percent of the companies listed on the first section of the Tokyo Stock Exchange have outside directors, with 1.8 for any given firm.
Outside directors are supposed to represent shareholders' interests, not the company's. But the legal system does not guarantee that because the Company Law does not prohibit a company from hiring an "outside" director who worked for the parent company or its affiliates.
There are considerably fewer outside directors in Japan than at corporations in other developed countries. The United States, France and Australia, for example, require that outside directors at listed companies make up more than half of their entire boards.
Takeyuki Ishida, vice president of Institutional Shareholder Services K.K., a U.S.-based corporate governance solution provider, said when he goes abroad and tells foreigners about the lack of outside directors in Japanese companies, "our conversation stops for a moment" because they are shocked.
"It's like people who are taking exams are grading the exams by themselves," he said.
How did corporate governance fail at Olympus?
Olympus actually had three outside directors, but in reality had no effective corporate governance.
Michael C. Woodford, who was fired as Olympus chief in October after raising questions about the firm's massive outlays for advisory fees in connection with dubious investments, revelations that subsequently exposed the coverup of huge investment losses, told reporters last month he sent letters to board members, including the outside directors, to get to the bottom of the scandal, but "they did nothing."
The third-party committee the company appointed to investigate the Olympus scandal harshly criticized its board of directors for failing to prevent the wrongdoing committed by the company's top management.
The panel said in its report that the Olympus board was merely a facade, and stocked with yes men.
Why do Japanese companies have insider-heavy boards?
Experts cite various reasons. One is that directors at Japanese companies in general deal with small matters that require thorough knowledge about what's going on in-house.
Companies are thus reluctant to accept outside directors who are not familiar with their business, as they would have to go through the hassle of explaining how decisions are reached.
Ishida noted that Japanese companies hold more board meetings than their U.S. counterparts and deal with "day-to-day matters" that need little discussion.
Japanese corporate culture, including the long-common notion of lifetime employment, also keeps the system closed to outsiders. The use of veteran workers creates a closed-village community within companies, one that doesn't want outsiders coming in and taking away important posts.
How do Japanese companies view their brand of corporate governance?
A JACD survey found that Japanese firms are reluctant to take on independent directors.
Keidanren has said that just increasing outside directors will not necessarily lead to better corporate governance.
It noted that although the U.S. applies strict rules to enhance corporate governance, its financial institutions failed to hold up their end of the bargain and prevent the failure of large institutions.
"Thus it is not reasonable to point to the rules used by a certain country or market as a premise for discussing the corporate governance of Japanese companies," the organization said in its report in 2009.
What other factors could enhance corporate governance in Japan?
Ishida said that the two main pillars of quality corporate governance are "human resources" and "money."
He said the salaries of any given company's president or directors should be more strictly based on the company's performance.
Because executive compensation in Japan rarely changes, directors focus on maintaining the status quo instead of making bold challenges to spur corporate growth. This draws criticism that they are not looking out for the interests of shareholders.
Providing more financial incentives to people in top management would compel them to work harder to improve corporate performance and take shareholders' interests more to heart, said Ishida.
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