Outside directors alone won’t help

More Japanese companies are appointing external directors to oversee their management after a seemingly endless series of scandals at leading firms raised doubts about corporate governance in this country. The Abe administration has enacted a revised Company Law that urges, though not requires, large companies to introduce outside directors.

Still, what matters will not be whether companies have outside directors but whether the companies are really serious about putting their management to independent scrutiny by outsiders.

According to the Tokyo Stock Exchange, a record 74 percent of the roughly 1,800 firms listed on its First Section have outside directors on their board, including top-notch companies like Nippon Steel & Sumitomo Metal Corp., Cannon Inc. and Toray Industries. These firms decided to introduce such directors for the first time at this year’s general shareholders’ meetings. The figure has sharply climbed from 46 percent in 2009 and 62 percent last year. About 34 percent of the listed firms have two or more external directors.

The average number of outside directors in a company stands at 1.8. Outside directors have come to account for a majority of board members at some firms like Sony Corp. and Hitachi Ltd.

External directors monitor the management of companies as outsiders not tied to the firms’ insider interests. They are supposed to oversee the management from the standpoint of shareholders, not only to check against wrongdoings but make the firms more competitive and profitable, thereby maximizing the companies’ overall value.

Foreign investors, who now hold 30 percent of the shares of Japanese firms traded at stock exchanges, have long urged the companies to introduce outside directors on their board as a measure to improve the return on their equities, which remains generally lower than among Western firms. The Abe administration is pushing for more external directors at Japanese businesses as a step to lure more foreign capital to the market.

What also prompted the companies to appoint outside directors is the continuing wave of scandals at large firms, such as accounting fraud and coverup of massive financial losses. These wrongdoings often take place or go unaddressed as the company’s management is monopolized by a handful of top executives without independent oversight — which makes a case for appointing external directors to the board.

The revised Company Law fell short of making it mandatory for firms to appoint outside directors, due to objections from business organizations, which argued that the matter should be left to individual firms.

The law requires the management of companies that do not have external directors to explain why to their shareholders, and says that a mandatory requirement for outside directors will be discussed two years later.

The sheer presence of outside directors neither prevents corporate wrongdoing nor works as a recipe for better earnings. Olympus Corp. had three external directors on its board before it admitted in 2011 that the firm had covered up massive losses for years. Mizuho Financial Group, which last year came under fire for lending to members of the underworld, also had three external directors. There is also criticism that many Japanese firms tap people close to their top executives or those linked to companies with which they have business relations and that these external directors provide only a nominal “outside” check on the management.

The question will be whether each company appoints qualified people not linked to its inner interests and whether the firm shares relevant management information with the outside directors so that they can provide an effective oversight.

Unless the companies are ready to make their management more transparent in the first place, the presence of outside directors alone will not help much.