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ASIA: "The Insight Bureau: Who’s afraid of the US downturn? Many Asia executives don’t seem to be"

ASIA: "The Insight Bureau: Who’s afraid of the US downturn? Many Asia executives don’t seem to be". 3-page column by Maxton and Wong of the Insight Bureau.

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back to index backASIAtalk April,  2005

The changing face of Japanese corporate governance - a farewell to tradition

Traditional Japanese model until the early 90s
On account of their unique business practices, in the past Japanese corporations were considered a breed apart. On account of regulations, most companies relied heavily on banks for their financing. By occasionally inviting ex-bankers from their main bank to join their board, companies would develop strong ties with this bank. Under this main bank” system, they could then afford to virtually disregard the capital market as a source of funding.

Another distinctive practice among Japanese companies was cross-shareholding with business partners – a practice also known as Keiretsu. Often, as much as two thirds of a company's shares would be held by Keiretsu companies to secure business relationships, although these mutual shareholders would not claim dividends.

Turning to the employment system, we find that Japanese companies had their unique lifetime employment system with tenure-based salaries. This created a corporate culture that regarded employees and management as a family.” In keeping with this mindset, in 1999, 27 percent of company executives believed that companies existed for their employees, while only 26 percent believed that companies existed for their shareholders.

With this main bank system, Keiretsu shareholding, and family-like corporate culture, the structures of Japanese corporations were such that they did not seriously have to look after shareholders' interests. Reinforcing this attitude, Japanese companies also maintained unique board structures: Virtually all board members were insiders”, i.e. either current or ex-employees. And while a group of auditors would be responsible for monitoring the board, they would normally have limited authority.

Together, this low emphasis on shareholder value and an insider board with a limited monitoring function inevitably led to weak and underdeveloped corporate governance in Japan.

Fundamental changes in the late 90s
When the economic bubble burst in 1991, this unique model began to erode. Bankruptcies and scandals affecting several major banks forced companies to sell the shares of their main banks for fear of a further price decline. At the same time, deregulation of financing methods in the late 1980s enabled companies to obtain finance through bonds and market-based products. However, in order to use these new financing methods effectively, companies were forced to be sensitive about the financial market's view of their corporate practices. Suddenly corporate ratings were an important metric.

The sharp decline in the price of Japanese stocks started attracting foreign institutional investors who took the place of the main banks and Keiretsu companies, increased their holdings, and began exerting an influence on their investee companies. Stronger pressure from institutional investors and the capital market forced companies to sell their cross-holding stocks in order to achieve a better return on equity (ROE), which in turn increased the stakes and thus the influence of institutional investors.

The employment system too changed significantly. More than ten years of economic stagnation forced Japanese companies to revise their system of lifetime employment with tenure-based salaries. In a survey conducted in 2003, only 18 percent of corporations were committed to retaining tenure-based salaries. In order to cope with the downturn in market demand, companies started employing part-time workers. At the end of 2002, part-time employees accounted for more than 30 percent of those in employment. The family-like employment system is vanishing fast. As a result, the notion of for whom companies exist” has also changed among management. In 2004, corporate executives regarded shareholders as more important than employees (31 percent versus 29 percent).

All of these fundamental changes have forced Japanese corporations to implement stronger corporate governance, or to seek better shareholders' returns and investor relations.

Emerging governance models

In response to these environmental changes, an increasing number of large corporations have been introducing various practices designed to enhance their corporate governance or achieve better corporate performance.

One such practice is board reform. There are two directions of change, one in pursuit of a U.S.-style board structure, and the other enhancing a traditional Japanese structure. Sony is one of the most aggressive companies adopting the U.S. board model. It introduced the first Japanese executive officer system in 1997, and then established three board committees with responsibility for key management decisions (compensation, nomination/dismissal of board members and executive officers, and corporate auditing) and invited external directors to fill more than half the seats these board committees. Other leading companies introducing this U.S.-type structure include Hitachi and Mazda.

On the other hand, there are a handful of large companies that have been trying to strengthen their governance by modifying traditional Japanese models. For example, Toyota introduced neither the (non-board) executive officer system nor the external director system. Instead, it reduced the size of its board of directors by half, and divided the board into two groups, with its seven most senior executives being responsible for management decisions and monitoring, and the remaining board members being responsible for operative management. Other leading companies adopting this enhanced Japanese-style structure include Asahi Brewery and Mitsubishi Chemical.

Based on an analysis conducted by RIETI (the Research Institute of Economy, Trade and Industry) and covering the 723 listed companies, around 17 percent of companies have introduced board reforms – 4 percent adopting the U.S. model, 5 percent the enhanced Japanese model, and the remaining 8 percent a hybrid model.

Emerging Japanese Board Models



U.S.-like (Sony)


Outside directors

Separation of monitoring and management; i.e. board and officers

Jap. enhanced (Toyota)


No outside directors

Board now smaller, but still has both monitoring and management functions



Mix of the above

Another common practice is a change in the compensation system that drives stronger result orientation, i.e. the use of incentives and stock options. Currently around 28 percent of corporations use stock option systems, compared to 9.5 percent just three years ago. In addition, an increasing number of companies are trying to introduce more proactive investor relations practices, i.e. information disclosure.

Lessons from early adapters
How have these new practices affected the business performance of these corporations? The Cabinet Office recently conducted an interesting survey covering 876 major Japanese corporations to discover the correlation between financial performance and corporate governance practices such as board reforms, incentive payments and information disclosure. The findings clearly show that stronger corporate governance delivers better business performance. Companies rated among the top 25 percent in terms of corporate governance posted significantly better financial performance than those rated among the bottom 25 percent.

When we look more closely at the individual corporate governance practices such as board reform, disclosure, etc., we discover some very interesting facts. The first striking finding is that board structure does not affect performance.” Neither the ratio of outside directors nor the size of the board seems to affect corporate performance. This may be because as much as 70 percent of outside directors are not really outsiders. Most externals are sourced from group companies or business partners.

Another finding is that the various board structures (U.S.-style, etc.) do not seem to affect performance either. By contrast, incentive payments and advanced disclosure practices were seen to have a strong positive impact on performance. All in all, the lesson from early adapters is that structures are less important; what counts are concrete governance practices.

In search of best corporate governance practices
In sum, given the fundamental changes in the economic backdrop, it is imperative for Japanese corporations to enhance their corporate governance practices. Some have already started doing so and have been reaping the rewards. At the same time, we have seen that superficial reforms of board structure do not work. Companies should carefully consider how to introduce a more sophisticated mechanism into their board practices to ensure that good governance practices are really applied. As the old Japanese saying puts it: Creating a statue of the Buddha but giving it no soul does not work.”

Source: Egon Zehnder Tokyo - GAI

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