Move to improve Japanese corporate governance devolves into compliance game

by Yuko Takeo


One day, Japan’s biggest overhaul of rules for companies in decades will make them more efficient. Right now it’s making things worse.

So says Toshiaki Oguchi, part of a group handpicked by the government to give a verdict on how well new codes for investors and businesses are working. Companies are meeting the minimum requirements without giving it enough thought, says Oguchi. Different types of shareholders are taking a uniform approach to pressing businesses to improve profitability, which is wasting everybody’s time, he says.

Prime Minister Shinzo Abe is seeking to strengthen the economy by getting previously silent investors to push cash-hoarding companies to boost returns. The country started a corporate governance code in June after introducing complementary rules for shareholders last year. Return on equity, Abe’s key measure of whether the revamp is working, has plateaued after jumping earlier in his term. Oguchi says it will take time for firms and investors to move from formalities to substance.

“We’re seeing a cookie-cutter approach so far,” says Oguchi, representative director of Governance for Owners Japan KK, an asset manager and provider of stewardship services for institutional investors. “Some shareholders visit companies and merely talk about pedestrian topics,” he says. “Unhelpful engagement eats into companies’ time.”

The 17-member council, chaired by professor Kazuhito Ikeo of Tokyo’s prestigious Keio University, has met twice since August and will continue to convene about once a month. The next meeting is Tuesday. There are no plans to revise the codes until at least the end of next year, Ikeo said on Nov. 12.

Just 68 of the 2,434 companies in the Tokyo Stock Exchange’s two main sections had published governance reports outlining their stance on the 73 principles for companies as of the end of August, according to the bourse. The deadline is the end of December. About 60 percent said they complied with all of them, with 40 percent explaining why they didn’t in some cases.

In 2013, 57 percent of companies on the FTSE 350 Index declared compliance with all principles of the U.K. code, while 36 percent did so in France and 7 percent in Germany. Oguchi’s group published a statement on Oct. 20 saying they needed to check whether the high rate of compliance is accompanied with substance and noting explanations needed more detail.

“Companies’ rate of compliance is too high,” Oguchi said. “There are a lot of things they should be thinking about,” he said. “Compliance itself seems to be turning into the goal.”

There are some positive examples, according to Oguchi. Daito Trust Construction Co., a Tokyo-based builder, gave a detailed response to every principle, which he says will lead to deeper discussion with investors. Hitachi Ltd., which makes everything from washing machines to nuclear reactors, gave more thought than most in its responses, he said. He says he’s worried other companies won’t follow suit and complacency will fester.

Many investors are also complying with the stewardship code without getting beyond formalities, he said. The principles seek to make institutions more hands-on in guiding firms on how to improve capital efficiency and profitability. Some 197 money managers, including the world’s biggest pension fund, had adopted the voluntary rules as of Sept. 11. It’s one thing to sign up, and another to do it right, Oguchi said.

Japanese money managers with different characteristics are taking identical approaches with companies because of a tendency to conform, according to Oguchi. Passive investors who track indexes, for example, aren’t specialists in advising companies, so they should just say so, he said.

“Companies’ time is being drained through talks with investors that won’t help them grow,” Oguchi said. “Engagement in itself shouldn’t be the goal.”

Return on equity, a measure of the profit made from shareholders’ funds, has stalled after jumping earlier in Abe’s term. ROE for companies in the Topix rose to 8.2 percent as of the end of September 2013 from 5.7 percent in the quarter Abe took office, which was about half the global average. Since then it’s fluctuated between 8.1 percent and 8.6 percent.

Progress has been made in appointing independent directors after the corporate governance code called for at least two such board members. Almost half the companies in the Topix had at least two as of July 14, up from 17 percent in 2012, according to the Tokyo bourse.

“If you don’t have the container, you can’t put the soul in it,” Oguchi said. “The box is important.”

While decrying much of the initial response to the codes, Oguchi says it’s an inevitable growing pain in the process of improving corporate governance. The same thing happened in Europe, the birthplace of the comply-or-explain approach, he said.

Getting the most out of this “will probably take a decade,” he said. “We’re still at the start of a new era.”

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