February 6, 2003
At the macro level, there is an intense policy debate about how to revitalize Japan's economy, and the latest policy buzzwords include the phrase inflation targeting. At the micro level, an equally important debate about corporate governance rages on amid the historic destruction of investor capital, with buzzwords such as corporate governance and corporate social responsibility.
During the entire Heisei Malaise, Japan's corporate governance system has been unable to prevent a litany of corporate scandals involving anything from the destruction of capital to bribery to investor fraud to the sale of bad milk. For years, banks led corporate governance in Japan, providing a system of controls based on personnel and shareholding ties with companies that were once hailed as a foundation of stable management. But this pillar mechanism of corporate governance in Japan has collapsed amid soaring non-performing loans and systemic financial system fragility.
This is not to say that there has been no effort to re-establish corporate governance. Amendments to the Commercial Code taking effect in April 2003 will allow large companies to opt for American-style corporate governance. Private sector organizations such as the Japan Corporate Governance Forum have set forth guidelines and continue to define and promote best practice corporate governance principles.
Nevertheless the popularity of lectures and seminars on these subjects is misleading. The trend reflects an effort by Japanese companies to take a new look at their operations through a new prism, but it also stems from fears of being blind-sided by new regulations and laws. The Europeans are putting pressure on companies to tighten corporate governance practices. And the US has passed the tough Sarbanes-Oxley Act, which ostensibly makes no distinctions between American and foreign firms issuing securities in the US.
Yet nearly 60% of large companies surveyed by Nikkei have decided not to adopt a US-style corporate governance system. The reluctance stems from the fact that managers do not want to cede power to a committee of outsiders. Japanese firms are skeptical about the US system because it did not prevent their American counterparts from committing crimes, as exemplified by the Enron and WorldCom stories. The provisions of the Sarbanes-Oxley law are especially contentious. Japanese companies have taken strong exception to the requirement for a board-audit committee, because the provisions conflict with the Japanese system of statutory auditors. Should the US SEC insist that foreign issuers adopt these measures, Japanese companies currently listed on US markets would seriously consider de-listing.
Because they were the darlings of Japan's bubble stock market in the 1980s, managers of poorly managed companies continue to wonder why their stock prices are so depressed, why analysts never come to visit them anymore, or why both domestic and foreign individual investors have dropped their stock from portfolios. Abraham Lincoln said, "you can fool all of the people some of the time, and some of the people all of the time, but not all of the people all of the time." Being a stock market darling is not a reliable indicator of good management. Just ask Enron and WorldCom, both former darlings of the US stock market. These managers simply do not realize they now have to compete for capital amid the unwinding of cross-holding relationships that once protected their stock price and provided silent capital.
But, as Fujio Mitarai of Canon observed, simply importing a US corporate governance infrastructure and overlaying it on a Japanese organization will not produce good corporate governance. Unfortunately, many Japanese companies have introduced an array of superficial reforms that do not change the substance. Don't confuse the methodology with the objective. Corporate Japan's problem is not the system per se, but the managers themselves.
It is becoming more common for investors to look beyond the numbers for indications of future performance. Qualitative intangibles are examined, such as quality of management, customer retention, and innovation. Among these, corporate governance, in particular, is gaining weight. Studies show that corporate governance is now an established investment criterion, and that investors are willing to pay a premium for a well-governed company. Perceptive investors look at the core values of the management and the company's commitment to reform. Ironically, RIETI researcher Hiroaki Niihara, in a recent study, found that none of the core skills of the managers at superior Japanese companies had anything to do with pre-determined corporate governance infrastructures.
There will always be a minority of companies in any one country or market that focuses on cash flow profit, their core businesses and capital efficiency, while at the same time recognizing that good corporate governance, business ethics and corporate responsibility have a favorable impact on their long-term performance. But what about those companies that don't get it?
Here, the lack of a credible "exit threat" is a major factor inhibiting self-initiated corporate governance in Japan. But there are signs that the laissez faire era of corporate governance in Japan is finally coming to an end. Money management firms are now being required by public pension funds such as the Public Pension Fund Association to exercise their voting rights. The Association is considering using CalPER's activist tactics as a model for its activities. CalPER's itself has teamed up with SPARX Asset Management to form the Japan Corporate Governance Fund. The Pension Fund Association has expressed an interest in teaming up with CalPERs.
Former MITI official Yoshiaki Murakami and his company M&A Consulting, Inc. have been making hostile bids for Japanese companies since 1999. High net worth individual shareholders are also becoming more activist, initiating lawsuits and aggressively lobbying other shareholders. And foreign "vulture funds" (a misnomer) are active in Japan. There are more third-party organizations measuring the quality of corporate governance, using specialized indices consisting of selected criteria. Finally, employees themselves are learning they need to be more proactive in following their company's performance and questioning management on important issues. Shareholder activism, as someone observed of tennis great John McEnroe's serve, "may not be pretty, but it's effective."
Author, Darrel E. Whitten
Director, The IR Corporation
Tokyo, Japan
whitten@ircorp.co.jp
Editor-in-Chief, Ichiro Araki
Director of Research
Research Institute of Economy, Trade and Industry (RIETI)
e-mail: araki-ichiro@rieti.go.jp
tel: 03-3501-8248 fax: 03-3501-8416
RIETI invites you to visit its English website
[http://www.rieti.go.jp/en/index.html].
The opinions expressed or implied in this paper are solely those of the author, and do not necessarily represent the views of the Ministry of Economy, Trade and Industry (METI), or of the Research Institute of Economy, Trade and Industry (RIETI).
