A corporate governance cure-all?

A set of new rules unveiled by the Tokyo Stock Exchange requires all companies listed on its First and Second sections to have at least two independent outside directors on their board. The move is in line with the Abe administration’s push to beef up corporate governance as a way of attracting more foreign investors.

The question is whether merely increasing the number of external directors will do the trick of enhancing transparency in corporate management and improving their profitability.

The TSE’s new listing rules will come on the heels of a revision to the Company Law, to take effect in May, that calls on businesses to have at least one outside member on their board — a common practice among companies in Western economies. The TSE listing rules to be implemented in June do not punish companies that fail to comply, but will require them to explain why in their annual corporate governance report to the TSE.

In fact, a growing number of Japanese companies have appointed outside directors to their board following a spate of governance problems that have hit Japan Inc. in recent years, and pressure from foreign institutional investors who have come to hold a growing share of Japanese companies traded on the market.

As of last June, a record 74 percent of firms listed on the TSE’s First Section had at least one such board member. Yet only 34.3 percent of the First Section companies had two or more external directors on their board. The ratio declines even further when companies listed on the Second Section are included.

Business sectors are said to have been reluctant to introduce uniform rules concerning the appointment of outside directors. In drafting a corporate governance code as the basis for the new listing rules, the TSE and the Financial Services Agency reportedly insisted that companies install at least two outside directors on their board and that they have a say enabling them to serve their intended function.

The new rule seems to make sense. Still, the presence or sheer numbers of outside directors may not make a difference. There have been examples of companies with multiple outside directors on their board that became embroiled in major governance scandals or that still performed sluggishly.

What matters more is whether the outside directors — who are tapped by a company’s management and later endorsed by its shareholders — are qualified to do a proper job of overseeing the management of a company independent of the company’s insider interests. This is necessary not only to provide a check against wrongdoings but also to make the company more competitive and profitable, thereby maximizing its overall value.

At present, the people tapped to serve as outside directors tend to be former corporate executives, ex-government officials, scholars, legal professionals and accountants. Retired central government bureaucrats are said to constitute the largest group among them. Some reports state that hundreds of outside-director positions on corporate boards are filled by retired bureaucrats — and some of them are serving at more than one firm.

There is a view that the position of external director constitutes a new kind of amakudari destination for retiring government officials at a time when regulations are tightening against bureaucrats landing post-retirement jobs at government-affiliated institutions.

When the new TSE rules become effective, the roughly 2,400 listed companies will need to newly appoint more than 2,000 people as outside board members — raising concern that the new rule will only result in the creation of yet more lucrative jobs for retired government bureaucrats.

Some may argue that government bureaucrats well-versed in the affairs of the industries to which companies in question belong will be suitable for the job of providing management oversight. But the prospect of those listed firms being overseen by retired government officials — if they are being hired through collusive ties between businesses and bureaucracy — threatens to negate the very purpose of the new rule, which is to enhance management transparency and the profitability of companies through independent oversight.