STONY BROOK, NEW YORK – Recently we were treated to a bout of speculation that Shigehisa Takada, the chief executive officer of Takata Corp., would resign after the companies’ faulty and lethal air bags led to a wave of auto recalls. Takada kept his job for the time being. But the focus on the possible resignation exposes deep flaws in Japan’s corporate and political culture — an overemphasis on punishment instead of prevention, and on individuals instead of organizations.
As an example, take the wave of accounting fraud scandals that have swept Japan in the past several years. After Toshiba was found to have overstated profits by about $1.2 billion, CEO Hisao Tanaka resigned, along with eight board members. The same saga unfolded at camera manufacturer Olympus: a $1.7 billion fraud scandal in 2011 led to the chairman’s resignation. The story is always the same.
A similar phenomenon reigns in Japanese politics. Politicians’ standard response to the all-too-frequent corruption scandals is to apologize in public and resign. Witness the recent case of Akira Amari, who left his post as economy minister after it was revealed that he had accepted cash from a construction company allegedly in exchange for favors.
It’s good for leaders to take personal responsibility, of course. There can be no doubt that the Japanese executives and directors who step down from their posts feel a deep sense of shame that will hound them for the rest of their lives. Politicians may not go to jail, but their career ambitions will be curtailed. The problem isn’t — as I sometimes hear people say — that Japanese leaders refuse to lead, or that they get off with only a slap on the wrist.
The reality is that individual punishment — whether public shaming or jail time — just isn’t an effective substitute for efforts to prevent these problems in the first place. Every Japanese executive and politician by now knows the consequences for shady dealings. And yet the steady stream of accounting and corruption scandals continues. The existing incentives are just not doing the job.
Some may suggest that the solution is harsher punishment. Politicians who resign for corruption are often simply appointed to different positions in the future, and executives rarely go to jail for fraud, so there is certainly a lot of room to increase the severity of penalties.
Yet very severe penalties can create a different but unwelcome set of incentives — they make honest leaders more risk-averse. An executive can’t monitor all the accounting at his or her company, and accidents sometimes happen. If those accidents carry the risk of incarceration, executives may become so cautious that they spend more effort monitoring their accounting departments than they do expanding and improving their businesses.
This was a major criticism of the Sarbanes-Oxley Act in the United States, which made CEOs personally accountable for fraud at their companies and imposed harsh legal penalties.
A better method is prevention — improving the incentives for leaders not to allow fraud or take bribes. Implementing better incentives is more about improving the system than punishing the individual.
The answer is improved governance for both companies and government itself. The Financial Services Agency has already released a corporate governance code, which will increase outside membership on company boards. That is good, but the number of outside directors on boards will be too small, so more should be done in this area.
A free news media is also essential for the monitoring companies; unfortunately, Japan has been backsliding in this area. In order to improve public scrutiny of companies, the government needs to stop putting pressure on reporters and media executives to toe the ruling party line. If journalists feel that they can’t criticize the government, they will also naturally tend to avoid criticism of politically connected companies — in other words, of any large company in the country.
Another positive change would be to reduce the hereditary nature of leadership positions. Notice that the chairman of Takata Corp. is named Takada — this is no coincidence, as he is the grandson of the company’s founder. This is par for the course in corporate Japan, and is even more of a problem in politics. Dynastic leaders, rather than those chosen for merit, tend to emphasize continuity over effectiveness. When conditions change, they will be inclined to resist making the big changes necessary to meet the new challenges — and fraud is one way of resisting change. In politics, dynasties preserve long-term patronage arrangements, which pose the risk of evolving into corruption.
So to stop the endless incidents of fraud and corruption, Japan should improve corporate governance, increase press freedom and reduce reliance on dynasties for leadership. These changes will take a lot of time and effort, but Japan has shown a powerful ability to improve its institutions in the past. It can do so again.
Noah Smith is an assistant professor of finance at Stony Brook University and a freelance writer for a number of finance and business publications.