Abenomics improved Japan's corporate governance, but more work remains
The country's corporate boards used to be like a closed village, typically consisting of executives who climbed the corporate ladder within the company and lacking views from outside directors that could be critical for management strategy.
But during the reign of outgoing Prime Minister Shinzo Abe, companies have opened up more to outside scrutiny, thanks to Abenomics’ key policy of prodding companies to strengthen corporate governance and boosting the profitability of firms as a result.
“Compared with the past attempts to enhance corporate governance, the Abe administration’s reform was far more specific and moved things forward” by introducing new guidelines and rules, said Takaaki Wakasugi, the head of the Japan Corporate Governance Research Institute.
“But I think it’s really problematic that many companies are just following the framework. They are not really making efforts to actually strengthen corporate governance,” said Wakasugi, who is also a professor emeritus at the University of Tokyo.
The Abe government put corporate governance in the limelight in 2014, setting it as one of the main agendas in its growth strategy, aiming to ratchet up the return on equity (ROE) of companies and lure foreign investors, who often grumble about weak corporate governance among companies and their low ROE.
Corporate scandals, especially the 2011 accounting fraud by Olympus Corp. that forced out former CEO Michael Woodford after he blew the whistle, were also fueling momentum for stricter corporate governance.
One of the key strategies to strengthen corporate governance was for listed firms to increase the number of independent, outside directors.
The Tokyo Stock Exchange amended its guidelines in 2014, urging listed firms to have at least one independent director on their boards. Later that year, the Companies Act was revised to require companies without external directors to explain the reasoning behind the decision at shareholders meetings.
In 2015, the government and the TSE pressured companies further by issuing a nonbinding Corporate Governance Code. The code prods companies to have at least two independent directors and also stresses the importance of disclosing information regarding risk management and governance, actively communicating with shareholders as well as being monitored by independent eyes.
Then last December, the government again amended the law to finally mandate large companies to appoint independent, outside directors.
These law revisions and guidelines led to a dramatic increase in the number of outside directors.
According to Japan Exchange Group Inc., operator of the Tokyo and Osaka stock exchanges, only 21.5 percent of the companies listed on the first section of Tokyo Stock Exchange had at least two independent directors in 2014, but the figure now stands at 95.3 percent.
Shigeru Matsumoto, managing director at the Japan Association of Corporate Directors (JACD), whose mission is to improve the corporate governance of domestic firms, agrees that reform has indeed progressed under the Abe administration.
When the JACD was launched in 2001, “a lot of companies didn’t really understand the concept of corporate governance. But appointing independent directors has become quite normal now, which is great progress,” said Matsumoto.
Traditionally, Japanese companies tended to appoint directors from within the firm or those that had close ties with company management.
When the country experienced rapid economic growth decades ago, banks financing the firms had a tighter grip on client firms, providing an outside view. Yet since the 1980s, major companies started procuring capital through issuing corporate bonds or new shares, reducing their dependence on banks.
After Japan saw its asset price bubble burst in the early 1990s, banks that had relied on real estate had to scramble to make up for the losses, further diminishing their monitoring power over companies.
Also, because discussions at company board meetings often deal with small matters, such as day-to-day operations that require directors to be familiar with the firm, the board tended to consist of many in-house directors.
JACD’s Matsumoto said the introduction of corporate governance guidelines was effective, establishing the legally nonbinding Corporate Governance Code in 2015 rather than making it mandatory by law from the beginning when the business sector was generally reluctant to accept a shake-up to boards.
“I wasn’t quite sure whether the code would really work, but it did,” he said.
But there’s a loophole.
While more companies now have “outside” directors thanks to the rules and legal framework that have been introduced, “their independence is questionable in many cases, for instance, sending someone from group firms,” Wakasugi said.
According to the Companies Act, companies cannot appoint someone working at their parent firms or subsidiaries as outside directors. But there is no such rule for group companies, so the government should take a stricter stance, Wakasugi said.
For instance, Oasis Management, a Hong Kong-based hedge fund, pressed Mitsubishi Logistics Corp. by proposing independent director candidates at the shareholders meeting last June, although Mitsubishi Logistics had their own nominees.
Since all three nominees by Mitsubishi Logistics were from the Mitsubishi group, they were not truly independent, Oasis claimed. Eventually, Oasis’s proposal was turned down but Mitsubishi Logistics said it would consider appointing someone from outside the group next year.
But when it comes to companies’ profitability — the government’s ultimate goal — the reforms have not produced solid results yet.
Matsumoto said this metric is one indicator of whether corporate governance is really working. The 2014 growth strategy said the government would aim to increase companies’ ROE to a “global standard.”
According to data compiled by Nikkei business daily, the average ROE of TSE first section companies, excluding those running financial institutions, had increased to a little over 10 percent in fiscal 2017, but decreased to 6.7 percent in fiscal 2019, which ended in March, the lowest in seven years. The average ROE of many of S&P 500-listed U.S. companies is around 15 percent or more.
To bolster corporate governance, Matsumoto said company leaders need to face a stricter evaluation system by independent directors while giving more financial incentives when they deliver results.
“Simply put, the evaluation system is not working. … Even when company performance is bad, it is rare that CEOs are replaced in Japan,” said Matsumoto.
He added that it is critical to introduce more generous pay as a performance incentive to motivate top leaders.
Wakasugi of the Japan Corporate Governance Research Institute also stressed the importance of incentive systems, but said it will be a challenging task considering the deeply rooted traditional corporate and social culture.
“In Japan, celebrities or professional players who earn a high salary are respected by the general public. But highly paid CEOs are not,” said Wakasugi, adding that they tend to be criticized for being paid too much.
Moreover, since the seniority salary system has been the norm, CEOs are not used to a performance-based pay system.
While taking these cultural aspects into account, “(the government) needs to think about how to improve corporate governance further,” said Wakasugi.
Shinzo Abe, Abenomics, Japanese economy, corporate governance, Companies Act