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CORPORATE GOVERNANCE

New rules are pushing Japanese corporations to tap more outside directors

Move aims to boost scrutiny of corporate management

by

Staff Writer

More Japanese firms are appointing outside directors to strengthen their corporate governance, pushed by a revised law and new rules that are set to come into effect in the coming months.

Japan has been lagging behind other developed countries in appointing independent directors, partly due to its exclusionist corporate culture stemming from lifetime employment, where those who successfully climb the company ladder become board members.

The issue of outside directors also came under the spotlight after the chairman of furniture retailer Otsuka Kagu launched a proxy fight against his daughter, the president, over control of the company, raising questions about whether corporate governance was working to stop the family battle.

Below are some questions and answers on efforts to get more domestic firms to appoint outside directors.

Are more Japanese firms tapping outside directors?

Yes. In 2010, only 48.2 percent of the 1,672 firms listed in the first section of the Tokyo Stock Exchange had outside directors. In 2014, the figure had jumped to 74.4 percent of 1,816 listed companies, according to the Tokyo-based Japan Association of Corporate Directors (JACD).

In 2013, big-name companies like Toyota Motor Corp. and Kyocera Corp. made headlines when they appointed outside directors for the first time.

Although more companies are appointing outside directors, the number of firms that have two or more of them still remains low.

In 2014, 34.7 percent of the firms had two or more outside directors, up from 26 percent in 2010.

In addition, among the Nikkei 225 firms only 22.6 percent of board members were outside directors in 2014 — a sharp contrast to 84 percent in the U.S., 62 percent in France and 60 percent in England, according to a report compiled by consulting firm Spencer Stuart.

Why are more Japanese firms appointing outside directors?

The main reason is that the government revised the Companies Act, which essentially gives firms little alternative but to appoint outside directors.

The legislation, which takes effect May 1, states that large companies must explain the downsides of appointing outside directors to shareholders if they opt not to acquire any.

The revised law will also make the definition of “outside directors” stricter, so that firms will need to choose more independent directors, as some companies might choose someone closer to them.

For instance, it is currently possible to appoint an executive from a parent company as an outside director, but this option will no longer be possible once the revision takes effect next month.

Similarly, the nonbinding corporate governance code, which was drafted by a panel of experts under the Financial Services Agency and the TSE last year, urges companies listed in the first and second sections of the country’s stock exchanges to have at least two outside directors.

The code, which takes effect in June, also encourages firms to report why they have not appointed outside directors, if they choose not to do so.

Will companies be required to appoint outside directors?

Technically, no. When the law was revised, the key was whether it should make it mandatory for companies to have outside directors. But the law ultimately didn’t make this obligatory.

However, because it is becoming commonly understood that having outside directors is vital to improving corporate governance, “it is actually impossible to explain the downsides of having outside directors, leaving companies with pretty much no choice,” said Shigeru Matsumoto, managing director at JACD, which is made up of company managers, investors and business experts intent on improving the corporate governance of domestic firms.

“(These new rules) are like a wind gust” that is pushing many companies to have outside directors, said Matsumoto.

Why are Japanese firms growing more aware of the importance of corporate governance?

Matsumoto said one factor pushing corporate leaders to change their mindset is Prime Minister Shinzo Abe’s economic growth strategy, which has stressed strengthening corporate governance as key to boosting company earnings.

Based on the growth strategy, Abe’s administration revised the corporate law and drafted the rules — the Stewardship Code for institutional investors and Corporate Governance Code for companies.

Also, the scandal revelations in 2011 that Olympus Corp. had covered up massive investment losses for almost two decades drove home the importance of having proper corporate governance in place to prevent illegal business practices.

And more people came to realize that improved corporate governance would lead to better earnings thanks to Abe’s growth strategy, Matsumoto said.

Why have Japanese firms been reluctant to appoint outside directors?

In a country where lifetime employment is still common, a company’s board of directors — a goal for many ambitious workers — often consists of only those inside the firms.

Because of this culture, Matsumoto said Japanese firms have been reluctant to bring in outsiders who may criticize how a firm is managed or fail to understand the business well enough to be able to make key decisions.

What are the roles of outside directors? Does having them really contribute to improved corporate earnings?

Matsumoto said a primary role of outside directors is to monitor the performance of the firms based on their business plans.

He said outside directors do not have to be experts in particular fields related to company’s businesses, and that’s where many people actually misunderstand their role.

“Outside directors are there to monitor how companies run their business,” he said. “It is the corporate officers’ job to improve companies’ earnings.”

Because outside directors keep an eye on companies’ performance, they can help motivate CEOs to meet their management goals, Matsumoto said.

Still, having outside directors will not automatically improve financial performance and corporate governance.

For instance, a majority of Sony Corp.’s board members are drawn from outside the firm. Although it’s regarded as the first major Japanese company to introduce a corporate officer system, Sony has been struggling in recent years.

In addition, Otsuka Kagu had three outside directors, but the board was unable to prevent the internal family fight between Kumiko Otsuka, president of the firm and Katsuhisa Otsuka, her father and founder of the firm, going to public.

The firm decided to have six outside directors in its 10 board members at the shareholder meeting held last month in an apparent aim to better corporate governance.

Are there enough candidates qualified to become outside directors?

Matsumoto said there are enough candidates.

Outside directors need to be familiar with financial figures in business so they can check if a company is living up to its goals, such as midterm plans.

There are a plenty of former presidents and CEOs of companies suited to be outside directors, while scholars, accountants, lawyers and former bureaucrats can also be good candidates, he said.

As more companies are looking to get outside directors, JACD will be holding training sessions for outside director candidates starting in May.

  • fuzzycuffs

    Another key reason to have outside directors is to spot impropriety. It’s very easy for a group of insiders to keep their collective dirty laundry secret, since they were all involved in making it. This makes outside investors very skeptical whether or not the balance sheets of the firm they plan on investing in are really true.

    This is exactly what happened at Olympus, where the board made up insiders kept a bunch of finances secret, and when the “outsider” CEO brought it to light they fired him.

    So this isn’t about “lifetime employment” culture. This is about keeping the company’s dealings internal and out of the eyes of an outsider. But that also makes outside investments risky, which is why the Abe administration wants to clamp down on such practices.