On April 1, 2003, revisions to the Commercial Code were enacted that were said to be the most comprehensive changes to the law in the past half century. The amendments involved a major reform of the corporate board system, which had remained untouched for 50 years. Specifically, the revisions pave the way for firms to optionally adopt a "Companies with Committees" system. Regardless of whether they choose to do so or not, the revised Commercial Code serves as a touchstone for Japan's top corporate managers to make a serious choice.
The "Companies with Committees" system enables firms to improve their management monitoring functions by having outside directors play the central role in three committees to handle nomination, compensation and audit set up under the board to take the place of statutory auditors. At the same time, the introduction of corporate executive officers and representative corporate executive officers in place of board members who have no executive authority can accelerate the execution of management.
As of May 2003, 32 companies (or 14, if the 19 Hitachi Group firms are counted as one) have either shifted or said they would shift to the new system by the end of the current fiscal year. According to a January survey conducted by the Japan Association of Corporate Directors of the presidents and chairmen of 130 major member corporations, 27 of the 79 firms that responded said they had adopted or were considering adopting the new system.
Guessing from this, as well as from hearings conducted with top executives, more than 100 firms will have adopted the new system by the end of March 2005, and the figure is likely to grow to some 500 to 600 firms within the next four to five years.
The firms making the shift have common intentions and aims. The following are excerpts from the press releases of five firms explaining why they are adopting the new system.
- Sony Corp. - Sony Corp. will aim to enhance the Sony Group's corporate governance functions by further strengthening corporate governance and improving management transparency of the group through boosting the role of the board as a monitoring body and clarifying executive responsibility and additional transfer of authority.
- Toshiba Corp. - It is a means to further enhance corporate governance by reinforcing supervisory functions and management transparency, and to improve operating agility and flexibility.
- Hitachi Group - The purposes of adopting the new structure are 1.) improving the speed of management, 2.) securing more transparent management practices 3.) serving as part of the group companies' management strategy and 4.) improving global management
- Orix Corp. - The shift to the system ensures a more effective separation of the roles and responsibilities between the decision-making and monitoring function of the board of directors and the executive function of management.
- Aeon Co. - It aims to create a system under which corporate governance with a high degree of transparency and objectivity can be realized through the clear separation of management monitoring and execution and speedy management decisions are made possible with the transfer of a large portion of authority to the corporate executive officer.
The aims of these firms can be summarized in three points - making management more agile, improving management transparency and strengthening group management. First, management can be speeded up by transferring management authority, which had been the prerogative of the board of directors, to the corporate executive officer or the representative corporate executive officer. Second, transparency can be improved by transferring the authority to nominate, audit and compensate board members and executives, which had de facto been held by presidents and chairmen, to the three committees, where the majority of members are outside directors. Third, for firms such as Sony and Toshiba, whose operations are large-scale and global, strengthening group management can be realized by using the new structure to efficiently manage and oversee subsidiaries, affiliates and overseas branches.
Along the same lines as boosting group management, firms such as Konica-Minolta Holdings Inc., Nomura Holdings Inc. and Japan Telecom Holdings Co. probably want to the new system so that they can galvanize corporate governance of the holding company. In the case of Konica-Minolta, one of the aims is to also limit a characteristic practice among companies that have merged - distributing top personnel appointments evenly between each firm. The Hitachi group has also said that it wants to make its management better understood by outsiders.
# # #
If these firms' objectives for their shift are indeed those listed above, it is questionable whether the name for this new system is appropriate. "Company with Committees" is a name that places weight on the element of management transparency and fairness. This was probably the aim of the Justice Ministry's Legislative Council and the Cabinet Legislation Bureau, but if focus had been placed on management speed, mobility and efficiency, the name might have been "Company with Corporate Executive Officers."
There are those in the business world who, perhaps because of its name, misunderstand the new system and think it is a corporate system that only specializes in overseeing management. The flip side of the coin is that the corporate executive officer system will be introduced for the first time in Japan, and that the three committees are set up as monitoring bodies to hedge the risks that may surface when the CEO exercises leadership and aggressively pursues management. The new system is one that gives capable CEOs the means to make swift and clear management decisions and boldly execute them, and the three committees tasked with overseeing the CEO serve as a wall that protects the CEO and other executive officers from the risk of lawsuits.
From this viewpoint, the new system may have been better understood if it was called more precisely, albeit a bit longwinded, "Companies with Executive Officers and Committees" or, to popularize it among the business world, "Companies with Leadership by CEOs."
# # #
Japan's "Companies with Committees" or "Companies with Leadership by CEOs" system is often touted as being based on the American model of corporate governance, but this is not true.
The various reforms of the corporate board undertaken by Japan over the past 10 years are far-reaching. These include - reducing the number of board members, inviting outside directors, introducing the company system, creating the executive officer system, introducing the advisory board, setting up nomination and compensation committees, introducing stock-options, reviewing management reward systems, enhancing compliance and securing internal control systems. While the specifics of these reforms may differ by company, they are all the results of internal reforms that were made possible with the leadership of top management.
The systematization of the Companies with Committees system can be seen as an extension of this movement, a compilation, at least for the moment, of these reforms. In fact, until the Sarbanes-Oxley Act was enacted last year and the listing rules for the New York Stock Exchange were revised, no other country had legislation stipulating that there be three committees to handle nomination, compensation and audit where outside directors were the majority. Therefore, it is no exaggeration to say that the Company with Committees system is - for the moment - the compilation of "Japanese-style" board reforms.
# # #
Let us turn our attention to Toyota Motor Corp. and Canon Inc. - firms the Japanese media view as being the model for everything Japanese. Neither Toyota, which is the best company in Japan with annual profits of more than ¥1 trillion, nor Canon, which has surpassed Sony in terms of market capitalization, have so far said they would adopt the Company with Committees system. It appears that they have no plans to do so any time soon. There are many corporate managers in Japan who think their firms do not need to shift to the new system because Toyota and Canon will not. However, there are few companies among them whose management performance matches the levels of Toyota and Canon. Companies like these should be called "firms that aspire to be Toyota and Canon" and be distinguished from the originals.
Let us remember the aims for shifting to the Companies with Committees system. Firms adopting the new system, like Sony and Toshiba, said they wanted to accelerate management speed, improve management transparency and strengthen group management. Toyota and Canon, which for the time being are unlikely to adopt the new system, probably feel they do not need to do so because they believe they can attain these goals through other means, or have already achieved them to a certain extent. To the author, it seems that paradoxically enough, Toyota and Canon have already adopted the Company with Committees system.
In other words, Toyota and Canon surpass other companies in terms of management agility and efficiency and the extent of its penetration in their group management, and it is producing results. If that were not the case, there is no explanation for such top-class management performance.
The problem lies in transparency. There are two types of transparency. One that exists between employees and executives, or toward major trading partners and important clients - in other words, transparency within an organization that is inward-looking. The other is a transparency toward the outside world - toward capital markets and the general public.
The degree of the first type of transparency at Toyota and Canon is very high. In other words, governance is effectively functioning within the corporate group. Thus it can be said that Toyota and Canon have already achieved two and a half of the three objectives of shifting to the Companies with Committees system. In the case of Toyota, there is another uniqueness. It seems that at Toyota, effective governance is not brought about by ownership as in the case of Ford Motor Co., Fiat SpA and BMW AG but through the involvement of the founding family based on their ties of kinship - in fact, due in part to Japan's socialistic inheritance tax system, the Toyoda family holds no more than 1 percent of the company's outstanding shares. If this is the case, this company's governance structure is more aristocratic than Japanese. And because there are many firms in Japan with a similar governance structure, Toyota serves as a goal for them both from the aspect of kinship and mentality, and this is one reason why we see so many "firms that aspire to be Toyota."
In Japan's case, corporate governance through the bonds of the founding family functions at a level beyond ownership, and society accepts this as a matter of course. But governance without ownership needs to be justified by noblesse oblige, just as in the case of royal families, or a ethical virtue backed by noblesse oblige. Toyota's success was largely thanks to the noble sense of ethics of the leaders of the Toyoda family through the generations, and its present-day prosperity is founded on the fact that they did not let any of their "top hands" pursue shady deals for profit, no matter how able they might have been.
If I were to point out the governance problems related to family control, I would have to say that the success of this system hinges on whether the founding family can constantly live up to the role. If the lineage of ethical virtue is severed, there is no guarantee that even Toyota will not fall from grace and become "a firm aspiring to be Toyota."
Companies that have had to give up corporate governance through the founding family or those where it no longer functions due to changes in the environment must find a means of survival through more popular means. Although it cannot fully replace a ethical virtue or the aristocratic noblesse oblige, one possible substitute is the pursuit of transparency and comprehensibility from an external perspective. Companies with Committees are probably firms where management decided to systemize this noble sense of ethics, being aware of the importance of popularization.
The search for the best board system will continue in Japan, as two axes complement each other - on the one hand, Toyota and Canon, which have chosen to internalize the ethical virtues of their founders and management, and on the other, firms such as Sony and Orix, which have opted to open up that sense of ethical obligation to the outside world.
June 6, 2003
