Corporate governance reforms in Japan

1
Corporate governance reforms in Japan

• Toru Umeda
• Professor
• Reitaku University, Japan

2
Main features of the Japanese corporate model in
the 1980s

• Cross-holding of shares among businesses
• Strong government-business ties
• convoy capitalism
• No distinction between execution and supervision
• Debt finance preferred to equity finance
• Seniority and life time employment system

3
Cross-shareholding among industrial groupings
called keiretsu

• - made equity markets illiquid
• - provided a business with a good defense
  against hostile takeovers
• - rendered shareholders passive owners
• As a result, corporate management became
  indifferent to shareholders interest

4
No clear distinction between supervision and
execution

• Few outside directors adopted
• the lack of effective control on the
  presidents power
• Board meeting infrequent, decisions
  rubber-stamped
• Board size tended to be too large for an
  effective decision-making
• These represented the dysfunction of the board in
  controlling management

5
Changes taking place in the last decade

• Shareholdings of banks fell from 21 percent in
  1990 to 5.7 percent in 2003
• Foreign ownership has grown from 7.3 percent in
  1990 to 20.3 percent in 2004
• Shareholders have become more vocal, visible and
  active than before
• Shareholder activism dialogue, proposals, proxy
  voting, and litigation
• SRI movements have been a topic of concern
• Management is increasingly aware of the
  importance of enhancing shareholder value

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Reforms regarding the separation of control and
management

• Legislative amendment efforts made to strengthen
  control management
• Outside auditors, and attempted to mandate
  outside directors, but impacts limited
• A breakthrough May 2002 amendments to the
  Commercial Code, enforced in April 2004
• Paved the way for a large company to opt for an
  American style of corporate governance

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Under the Committee system

• A large company is to
• - do away with corporate auditors
• - instead establish the three committees for
  nomination, compensation and audit, each
  consisting of three directors and more with the
  majority being outside persons
• - introduce the new office of executing
  officers separate from the board,
• responsible for the execution of business
  operations, distinguishing control and management.

8
But in practice

• Only a limited number of companies have shifted
  to the new system 1.2
• Under the conventional auditor system
• more companies introducing a new non-statutory
  corporate officers post,
• - delegating some execution power to such
  officers,
• - slashing the number of directors
• A third, mixed type with no statutory base seems
  gaining force
• One-size-fits-all approach not adopted

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Growing CSR concern focusing various stakeholders

• consumers, customers, employees, local
  communities, and future generations
• Relative positioning the shareholder is part of
  a group of stakeholders
• A survey shows corporate managers put more weight
  on customers than before
• Corporate management is expected to respond to
  stakeholders interest
• Should the concept of shareholder primacy be
  declared dead?

10

• The shareholder primacy concept continues to
  play an important role
• CSR a strategy for a business to gain reputation
  and trust from its stakeholders
• Corporate efforts to respond to demands of the
  other stakeholders serve in theory the interest
  of the shareholder
• CSR efforts will lead to reputation hike, making
  the company more sustainable,
• which ought to serve the interest of the
  shareholder in the long run

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Warning!

• When prompted by short-term profitability or when
  combined with greed, shareholder primacy
  practices could undermine the interest of the
  other stakeholders
• - cutting corners only to jeopardize the
  safety and welfare of employees, consumers
• - degrading the environmental integrity
• This is why shareholder primacy needs to be
  circumscribed
• What should be praised is enlightened
  shareholder primacy, not greed-driven one

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No optimism enlightened shareholder primacy
becoming common

• Market realities short-term greedy players tend
  to prevail, preying on long-term players
• Markets unequipped with mechanisms to deter
  short-term profit seekers from snatching fruits
  which long-term players would share in their
  hands in the long run
• This is the very field where ethical values
  should play critical roles
• integrity, trust and self-restraint

13
Shareholders interest diversified

• The rise of social investors demanding corporate
  management to address social issues including
  human rights practices, effective implementation
  of labor standards, and environmental concerns,
  by sometimes resorting to SRI strategies
• Shareholders interest used to be associated only
  with the financial bottom line
• It now extends to cover the so-called triple
  bottom lines
• This can be called enlightened shareholder
  interest

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• A main concern of corporate governance is
• the sustainability or long-term profitability
  of a company,
• not a short-term maximization of shareholder
  value
• This is where corporate governance concerns meet
  with CSR concerns

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END