Code of Conduct
Jul. 10, 2015
Japan’s leader wants to change the way the country does business. Prime Minister Shinzo Abe is urging corporate reform. Without it, Abe says the economy won’t improve. A key plank of the reform program is a code of corporate governance. It took effect last month.
The code is a long list of good management practice. There are two key ones. The first one calls on companies to appoint at least two independent directors to their boards -- a check against management abuse. This also gives investors a voice in decision-making.
The second key code urges companies to disclose their policy on cross-shareholdings. Japanese companies own large stakes in subsidiaries, clients, and banks. That helps them avoid hostile takeovers --- and demanding investors. But it also ties up billions of dollars -- and often for poor returns. The code is not legally binding, but the companies listed on the Tokyo Stock Exchange need to comply. If they don’t, they have to explain why to their investors.
Japanese companies are losing out in the global market. They are less profitable than many competitors. Critics say they are also poorly managed.
The index of ROE or Return on Equity shows how much profit a company generates with the money shareholders have invested. The average for Japanese companies stands at 6 or 7 percent. In the United States, the figure is 16 percent.
The Abe administration wants Japan to catch up by strengthening corporate governance.
One company benefiting from stronger corporate governance is Omron, a leading electronics maker. Four years ago, Omron’s investor relations team started releasing financial goals and strategies. That includes a mid-term target for Return on Investment, or ROE, set at more than 10 percent. It also ensured that a top management change in 2011 was fully explained in the annual report -- including the reasons for choosing the new CEO.
Omron held nearly 1,000 meetings with investors last year. That kind of communication is attracting more individual shareholders and improving the company’s share price. It’s jumped three-fold over the last two years.
"Communication with investors became very smooth,” said Satoshi Ando, Omron’s chief IR officer. “Investors started to understand what Omron is thinking and what we’re aiming at. And that has widened our investor base."
The Abe administration is calling for shareholders to change their attitude as well. It’s urging them to monitor business performance and engage with the companies they have invested in.
Misaki Investment is one institutional investor that is taking the advice. The group’s analysts keep a close eye on the companies in their portfolio. If they spot issues, they come up with a business plan to improve it. They visit companies and present their plans. They call themselves “Working investors”.
"We work together because if the management improves, there’s surely a return,” said Yasunori Nakagami, CEO of Misaki Investment. “We are not typical investors that only buy and sell stocks. We work together for the companies’ benefit."
One company to benefit from Misaki’s oversight is Pigeon, a maker of baby and child care products. It has posted record profits for 6 straight years.
Japan’s falling birthrate posed a serious challenge for Pigeon’s business. Misaki suggested the company strengthen its overseas operation. The investor group also urged managers to work on improving ROE. Today, 60 percent of Pigeon’s sales are made overseas. The China market is especially strong. The company’s stock price has jumped more than six times over the last 5 years.
“Japan’s economy is mature so it needs to improve competitiveness and productivity,” Nakagami said. “We as an institutional invester hope to support companies by boosting earning power.”
Company bosses and investors are starting to see the benefits of stronger corporate governance. But there’s still a long way to go before this translates into a stronger economy.
Nicholas Benes is the head of The Board Director Training Institute of Japan. He’s also the man who first proposed Japan’s corporate governance code. He spoke to Yuko Fukushima, Aki Shibuya, and Sho Beppu in the studio about Japan’s efforts to improve corporate governance.
Fukushima: Omron and Pigeon are clearly success stories but are they rare cases? Can companies in Japan become more competitive just by changing things in the board room?
Benes: I don’t know about all companies but for most companies it probably will. The answer to your question is that change in the board room is what is most necessary in Japan. Because many boards have become rubber-stamping formality exercises here, just achieving the minimum formalities of the law rather than serving as a high-level decision-making organ of the company that decides on crucial capital allocation decisions. Where we should put more money, more robustly or where we should take money away from non-core assets. This function is not being achieved by many companies here.
Shibuya: Having said that, what has been the biggest challenge for you to improve corporate governance?
Benes: I think there are two things. One of them, of course, is the lack of enough independent outside directors and a lack of professional-ness among that group because we don’t have enough so they don’t have enough synergy to improve themselves.
The other of course is when you sit on a Japanese board you become highly aware of this in a crisis, big problem situation. There aren’t enough common skill sets of knowledge and skills that are most necessary for effective directorship. And what I mean by that is knowledge of corporate law, corporate governance best practice, securities law and particularly finance. A lot of Japanese people came up through products development or engineering type trades and they know nothing about finance. They can’t review the financial statements. That is not good when you are trying to plan long-term strategy. That’s why I am doing this non-profit, I’m leading the “Board of Director Training Institute” of Japan. It’s very important to train people entering boards as new members.
Beppu: But if the board focuses too much on investors return wouldn’t that hamper, for example, workers benefits or customers benefits? If you want to show that your company is profitable, some companies might be tempted to just fire workers, so wouldn’t that push the companies to go to seek more short term profits rather than having a longer term strategy?
Benes: Well the corporate governance code itself is very long term in nature. Every other page virtually talks about how the purpose of the code is the long-term sustainable growth of Japanese companies. And that’s the attitude and stance the board should take. So it’s not the code that has a short-term influence. In fact the code, if anything, is trying to overcome the existing tendency of Japanese companies to be short term in fact and not allocate assets away from status quo product lines into new ones more robustly and be too risk-adverse in decision making. If anything, the code is intended to overcome this problem.
Fukushima: Corporate governance is a major pillar of Abenomics. Why corporate governance? There are other big issues, like declining population, allowing foreign workers into the country. Why corporate governance?
Benes: Well there a three ways to grow an economy. You can grow the number of people and the amount of capital or grow productivity. The issues in Japan is we have a declining population so it would be good to grow the the number of people in Japan but that takes a lot of time even if you were to overcome the taboo problems that have to do with discussing immigration in this country it would still take a lot time to increase the number of people. As to capital, we have not too much capital but we have a lot of capital but it’s not productively employed is the problem. We have labor productivity which is still 70 percent of the US level and stagnant. Not growing for 25 years now. So productivity really is where it’s for Japan and it’s the area where we can make the most progress in a short amount of time. In just a year and half we have put in place a corporate governance code which is revolutionary for Japan. It really was the right area for Abenomics to direct its force.