Japanese companies appear to be steadily implementing the corporate governance code introduced by the Tokyo Stock Exchange a year ago, at least in form. Of the 2,018 firms listed on the first and second sections of the TSE, 78 percent say they are now in compliance with at least 90 percent of the principles set under the code, such as having two or more outside directors on their board. But scandals that have embroiled such leading firms as Toshiba Corp. show that mere compliance in form is no proof against management irregularities and wrongdoing. The question remains whether the new rules will actually enhance transparency in management and improve profitability.

Introduction of the TSE’s code was a key feature of the growth strategy of the Abe administration, which is hoping that improved governance of Japanese firms will lure more foreign investors. It sets 73 principles aimed at establishing transparent and quick decision-making mechanisms in the companies, prodding their management to prioritize shareholder interests, and thereby expanding the value and profitability of the firms. Listed companies won’t be punished for not following the principles, but they are required to compile reports to explain why to investors.

According to the TSE, 11 percent of listed firms say they had complied with all of the principles by the end of March. One of the principles requires them to appoint at least two “highly independent” outside board directors to reflect the views of outsiders in their management. So far, 59 percent of all listed companies and 78 percent of the major companies listed on the first section — compared with 48 percent a year earlier — have met the requirements. More than 90 percent have complied with the principle for disclosure of their policy on cross-shareholding.

Another principle calls on companies to schedule their annual shareholders’ meetings appropriately for the convenience of investors. Such meetings have tended to concentrate on certain days in June, making it difficult for people invested in multiple firms to attend. That the proportion of companies that close their books in March holding their shareholders’ meetings on June 29 — the most popular day — has come down to 32 percent from 41 percent last year is seen as an indication that the businesses are starting to comply with this principle.

The surprise resignation of Toshifumi Suzuki as chairman and CEO of Seven & I Holdings Co. in April — after his proposal for a management shake-up at the group’s Seven-Eleven Japan operator was rejected by the company’s board — is cited as an example in which outside directors independent of management played a key role in preventing a governance problem at a major firm. Although there were other factors in play that forced Suzuki’s exit, it was the two outside directors of the company’s board — one of whom was a university professor known as a leading corporate governance expert — that led the last-minute move to thwart the questionable proposal by Suzuki, the charismatic leader who wielded enormous power over the company for years.

If the episode at Seven & I Holdings is an example of corporate governance mechanism that worked, the accounting scandal that has engulfed Toshiba since last year should be remembered as a classic case of a seemingly excellent governance system proving useless to prevent irregularities. Toshiba inflated its pretax profits by more than ¥200 billion over the years from 2008 to 2014 as its management added pressure on employees to set and meet ambitious business targets. The scandal forced the resignation of three successive top executives, reporting of massive losses and a sell-off of various units of the group and job cuts.

Before the scandal broke, Toshiba was widely known as a company that excelled in corporate governance. The firm had four outside directors, who manned an in-house audit board along with the president and a vice president in charge of finances. A third-party probe into the accounting irregularities has shown that the mechanism in place was woefully ineffective.

In a management shake-up to rebuild from the scandal, Toshiba increased the number of outside directors to seven, who now account for a majority of its 11-member board. It remains to be seen whether the sheer increase in numbers will make a difference. The accounting scandal illustrated how installing governance mechanisms is meaningless unless they serve the intended function. Appointing outside directors to a company’s board is often cited as a key to better governance, but just their presence or numbers is not the question. The question is whether the company can tap people qualified to monitor the firm’s inner workings independent of management. Compliance with the corporate governance code will be a good start, but changes in form still need to be backed up by changes in practice.

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