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Reforms Point to Lasting Change
Corporate governance code key in third arrow of Abenomics

By John Amari

This summer, the ruling Liberal Democratic Party (LDP) announced its revised growth strategy, including a detailed plan to modernize corporate governance practices.

According to the document, this will be achieved through the implementation of a corporate governance code, due to be finalized by spring 2015.

On the same day, the ACCJ’s Foreign Direct Investment (FDI) Committee and the Growth Strategy Task Force published the second viewpoint this year on the topic, “Further Implement Corporate Governance Reform in Japan to Spur Investment and Encourage Sustained Economic Growth.”

The FDI Committee’s first viewpoint in 2014 had, in fact, recommended that a corporate governance code be implemented.

In light of the LDP’s announcements and the recent viewpoints, the ACCJ Journal sat down with Nicholas Benes, chair of the Growth Strategy Task Force, and Kenneth Lebrun, chair of the FDI Committee, to survey Japan’s long journey towards corporate governance reform.

“The Growth Strategy Task Force has been more successful than we dared dream,” Benes began by saying, “in helping the government, particularly legislators, understand the urgent need to raise the productivity of capital and labor in the Japanese economy.”

The critical role played by corporate governance reform in improving productivity was detailed in the Growth Strategy Task Force’s white paper four years ago, and the ACCJ’s position has been further refined in viewpoints almost every year thereafter.

Corporate governance reform has been on the political horizon in Japan since at least 2001 or 2002, but it made a huge advance this year when it became the lead pillar of the third arrow of Abenomics.

As stated in the administration’s policy, the purpose of the planned corporate reforms is to increase the earnings power of Japanese companies, a topic that was never addressed as a major problem in the past.

In May, the LDP’s growth strategy committee proposed sweeping changes to Japan’s outdated corporate structures in its “Japan Revival Vision” document.

Recommended reforms included the establishment of a corporate governance code, installing multiple independent directors, and enhanced disclosure to discourage cross-shareholding—where a publicly traded company holds stock in another publicly traded company.

The revision of the Japan Revitalization Strategy this June followed this framework, clearly stipulating a deadline for implementation of the Corporate Governance Code (next spring), and making it clear that the Financial Services Agency and the Tokyo Stock Exchange will be accountable for ensuring that the code adheres to international corporate governance standards.

Long time coming
For Benes, the LDP’s proposals have been a long time in coming. “Japan is about 20 or 30 years behind the times,” he said, “in mobilizing corporate governance to address systemic weaknesses.

They’ve made some changes, such as those addressing internal control systems, but most of the revisions do not get at the core issues.”

What had been lacking, he continued, was root-and-branch reform, and the whole concept of instilling best practices for boards.

This would involve, for instance, rules requiring the presence of independent directors, and structures enabling them to effectively monitor company executives, as set forth in a corporate governance code.

In part due to the ACCJ’s advocacy work, the corporate governance currents seem to be flowing in the right direction.

According to the new Company Law, if a company refuses to include at least one independent member on its board, it could be required—via a “comply or explain” clause, a feature Benes strongly pushed for—to give a full account of the reasons.

“It’s not just ‘explain’ in the fine print somewhere; it’s explain in the proxy materials and explain in your company report as well.

In addition, the president has to stand up at the shareholder meeting and explain why it’s not possible to have an independent board member, based on the specific circumstances of his company,” Benes added.

The “comply or explain” clause in the Company Law provided a natural opportunity for Benes to propose a corporate governance code based on best practices that would also be enforced via “comply or explain” disclosure.

Such disclosure enhances transparency and the ability of institutional investors to make decisions based on full knowledge of a board’s decision-making processes, thus enabling them to better perform their duties under the new stewardship code.

Benes said these changes have the potential to bring Japan’s corporate governance culture up to date and untangle the historical gridlock caused by vested interests—principally, internal managers keen to keep the status quo, and the “stable shareholders” who support them.

Moreover, Japan’s Revised Growth Strategy specifically states that the new Corporate Governance Code should harmonize with international standards established by the Organisation for Economic Co-operation and Development—principles that should accelerate inward and domestic investment activity, Benes said.

Avenues for growth
Indeed, the changes are a minimum requirement to kick-start the Japanese economy, Benes said.

After all, “there are only three ways to grow an economy: you can grow the number of people (the labor population and the taxpayer population), you can grow the capital you invest in the economy, or you can increase productivity.”

Given Japan’s declining population, its best remaining options are domestic and foreign capital investment, and increased productivity—for instance, via rigorous governance that encourages companies to sell off under-performing divisions on the mergers and acquisitions (M&A) market.

FDI Committee Chair Kenneth Lebrun agrees. “M&A activity is critical for economic growth in Japan. As the Japanese demographic changes, they can’t add more labor to create growth. What they can do is increase productivity by moving assets and labor to the most effective usage, and M&A helps do that.”

Both the LDP’s reforms and the Growth Strategy Task Force’s recommendations have met resistance, however, not least from the Keidanren (Japan Business Federation).

Yet Benes and Lebrun remain optimistic that this time, real change is coming for the country’s corporate governance culture.

As Lebrun said, “What the Abe administration and the LDP have done, is recognize the link between improved corporate governance and economic growth, and I think that’s really a first for Japan.”



John Amari is a consultant, writer, and researcher with experience working for a United Nations agency.