Japanese companies fall short on governance best practice
Until the early 1990s, Japan’s domestic corporations, banks and insurance companies were the main shareholders of Japanese companies, which meant the widespread practice of cross-holding shares and a limited emphasis on board independence remained the norm.
During the last two decades, however, foreign direct investment has been on the rise and foreign investors are now the largest shareholder group in Japan (around 30 percent by value in 2015), a fact that is forcing Japanese companies to focus on adopting better governance practices that are more aligned with global standards.
Abenomics – the economic revitalization plan Prime Minister Shinzo Abe introduced in 2012 – has reinforced this demand for improved governance standards. The Abenomics growth strategy has included the establishment of Japan’s Stewardship Code and Corporate Governance Code.
The Corporate Governance Code, introduced in March 2015, applies a comply-or-explain approach and outlines 73 principles to guide corporations in establishing corporate governance structures that are more closely aligned with global norms on issues such as shareholder rights, board independence and reporting transparency.
The key principles of this code relate to board and committee structures and call for an increase in the number of independent directors (at least two per board) with the aim of more effective board oversight and fostering an independent and objective viewpoint.
The latest analysis by MSCI ESG Research on board independence shows that, of the 317 companies in the MSCI Japan Index, as of August 16, 2016, 94 percent had appointed two or more external directors, up from 60 percent in 2014. At the same time, the number of Japanese companies with no outside directors fell from 69 to just three.
By the end of December 2015, nearly 2,500 Japanese companies had submitted corporate governance reports in accordance with the 2015 Corporate Governance Code. Of these, 78 percent had reported their compliance with 90 percent of the code’s principles.
Despite this strong record of compliance, however, MSCI ESG Research finds that Japanese governance practices fell short of the standards followed in other developed countries included in the MSCI Kokusai Index during 2016.
Our research finds that a lack of gender diversity, inadequate independent board membership and executive directors’ membership of key board committees (compensation and audit) remain common practice for most Japanese companies. In addition, cross-holdings and poison pills (designed to discourage hostile takeovers), which are key indicators of companies’ ownership and control practices, are still much more common at Japanese firms than at companies in other developed countries.
Given that the average board of a company within the MSCI Japan Index comprises 11 members, the requirement to appoint at least two outside directors does not bring Japanese boards closer to gaining an independent majority.
While Japanese companies have significantly improved their performance on key parameters associated with corporate governance, gender equality and innovation, they still have a considerable distance to cover in order to match global peers.
Linda-Eling Lee is managing director and global head of ESG research at MSCI