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 president’s 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

6. 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

7. 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

9. 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

11. 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

12. 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’

14. 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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