1. Introduction

Up until very recently, discussion of corporate governance was only relevant to certain academics and the IR representatives of listed companies. However, since the Japanese government cited improvements to corporate governance as being a part of its “Abenomics” policy, corporate governance has become a broad-reaching topic that cannot be ignored by listed companies and their executives. Specifically, organizations such as the Financial Services Agency and Tokyo Stock Exchange have formulated the “Stewardship Code” (February 2014) and the “Corporate Governance Code” (June 2015), and listed companies and institutional investors were forced to respond to these codes of conduct.

In these pages, I will not give a detailed explanation of the content of these codes. However, in summary they recommend that listed companies establish multiple highly independent external directors and ensure that these external directors carry out thorough monitoring of the companies’ executives, and that institutional investors (such as pension funds and insurance companies) hold dialog with the companies in which they invest with the aim of encouraging them to improve corporate governance. This approach was advocated around ten years ago by some, but until relatively recently people paid little attention and adopted a “none of your business” approach. However, the “Western-influenced” approach has since been adopted by the Japanese government as policy, and there has been an unprecedented take-up of corporate governance at listed companies, with a peak in June this year (2015) around the time of the general shareholders’ meetings.

Even if this could be described as a “boom,” the impression that I get is that it is the “corporate governance boom” that has engendered mixed feelings on the part of the responsible staff at the respective companies, rather than being the result of willing decisions to follow government policy. In this paper, I want to shed light on these “mixed feelings” and set about creating a brighter future for Japanese companies.

2. Are Japanese companies special?

Scandals are not unusual in the West, but “monitoring models” have been advocated as a way of increasing the legality and profitability of corporate activities and these models have been established and developed. In “monitoring models,” the role of the board of directors is to monitor managers rather than make decisions. Specifically, external directors assess the results of managers and reflect managers’ performance in their appointments and compensation. This approach was first seen in America in the late 1970s and later spread to Western European countries. The approach has now been accepted to a certain extent in Asian countries, with the exception of Japan. However, the approach has not stuck with Japanese business practitioners (who have not been genuinely convinced). Why is this?

I believe this is for the following two reasons: (1) Up until now, Japanese companies have made good use of personnel systems to foster and select managers, and they have been able to control top executives well without relying on external directors; and (2) The mid-career job change market is undeveloped in Japan and companies have tended to be inward-looking. For this reason, it has been difficult to make good use of external directors even when they have been appointed (it has not been possible to paint a picture of external directors as being of actual use to the company).

Specifically, large companies in Japan hire almost all of their employees together as new graduates, gradually develop employees’ skills by giving them experience of numerous workplaces through personnel rotations, and slowly promote them. The small number of mid-career hires means that the team membership is fixed. For this reason, the employees share common interest as a team. Maximizing the benefits and satisfaction of the employees is largely the same thing as maximizing the value of the company. As a result, the employees have an incentive to cooperate and monitor each other. This system functions to a certain extent at the top management level, and it is likely that mutual checks among executive officers of division manager level and higher have acted as a control on company presidents. Let’s refer to this type of mechanism (reason (1) above) as “bottom-up governance.”

At the same time, Japanese society has typically lacked a common “canon” on which to base corporate governance. In the West, students are provided with a liberal arts education at undergraduate faculties (for example, knowledge of the humanities) and practical knowledge at graduate schools. The content of the knowledge provided is standardized to a certain extent, and the students are required to use this knowledge to analyze new problems during lessons. In other words, “knowledge” is standardized and shared, but the conclusions about how to apply this knowledge to specific cases differ from individual to individual. This is why the focus is given to holding debates while sharing an analytical framework. Do Japanese universities (faculties and graduate schools) do anything similar in the arts subjects? Unfortunately, the answer is no.

For this reason, the ability to solve the problems faced by companies in Japan is mainly fostered through OJT (on the job training). This “knowledge” is not shared across different companies, and for this reason each company tends to develop its own “dialects.” At large-scale multi-nationals, these “languages” can differ even between different divisions.

Under these circumstances, even when external directors do participate in the board of directors, it is difficult to utilize them because they do not share the same language (analytical framework) as the company’s own management team. It goes without saying that the situation differs from company to company, but it is safe to assume that the above characteristics have been traditional in Japan.

3. Future Outlook

The characteristics of Japanese companies just described are not something that will change overnight. However, changes such as the diversification of companies and their employees, and the development of Japan’s economy and culture, mean that “bottom-up governance” is gradually stopping functioning.

What Japanese companies need to focus on now is not the appointment of external directors, but the utilization of them. The key to achieving this objective is to ensure a robust control function in respect to the top level management. In order to achieve this, all board members, irrespective of whether they are directors or auditors, or whether they are internal or external board members, need to share knowledge and build tense but cooperative relationships.

Simply imitating the outer appearance of overseas monitoring models is not necessarily the best way forward for all companies. However, it is absolutely necessary for boards of directors to include external directors and to function in a sound manner. Effective methods for achieving this objective include the provision of opportunities for interactive training attended by both internal and external directors and the implementation of “board evaluation” ^[1]. In order to control top level managers, it is also necessary to establish a “division of powers” at companies.

Kenichi Osugi
Professor, Law, Chuo Law School, Chuo University
Areas of specialization: Commercial Code, Companies Act and the Financial Instruments and Exchange Act

Professor Osugi was born in 1967 in Hyogo Prefecture. He graduated from the Faculty of Law, the University of Tokyo in 1990. After working as an assistant at the University of Tokyo and an associate professor at the former Tokyo Metropolitan University, he was appointed to his current position in 2004. He carries out research into contemporary issues in the Companies Act, including venture businesses, business restructuring, corporate acquisitions (mergers and acquisitions) and corporate governance. Publications include, The Companies Act: Second Edition (Kaishaho Dainihan] (coauthored with Yasushi Ito, Wataru Tanaka and Hideyuki Matsui; Yuhikaku, 2011); “The Relationship Between Corporate Law and Financial Regulations with Other Business Regulations” [Kaishaho to Kinyukisei sonotano Gyokisei tono Kankei], Horitsu Jiho Vol. 82, No. 12 (2010); and “Recent Reform of Japan’s Corporate Law in an International Context: Who have Participated in the Reforms, and How?” Japanese Yearbook of International Law Vol. 53 (2010).