U.S. Board Governance Falls Flat In Japan

Corporate Japan’s fledging movement to adopt an oversight system of a company’s board and committees—much like the type seen at many U.S. corporations—appears to be losing steam, partly thanks to the country’s new Corporation Law—which actually is intended to bolster governance at Japanese businesses.

Many large Japanese companies have a kansayaku, or corporate auditor, who attends board meetings and acts as a watchdog to prevent illegal activities. The Japanese Commercial Code was amended in 2002 to allow companies to change from a corporate auditor to a board-committee system, similar to the structure at American public corporations. The new system called for the board to adopt a concept of negligence liability that clarified its fiduciary responsibility, and allowed the board of directors to make decisions on dividend distribution. It also required an executive from outside the company to serve on the board.

According to the Japan Corporate Auditors Association, about 60 companies jumped on the bandwagon in 2003 to establish board committees, many believing the new system would provide transparency to board activities and therefore appeal to investors. Major Japanese corporations such as Sony Corp. and Toshiba Corp. were among the first to adopt the board-committee system, and influential institutional investors such as the Pension Fund Association endorsed the approach as well.

Since then, however, the number of companies adopting a committee structure has dwindled rapidly. In 2004 and 2005 only about 20 companies made the switch each year, and only 10 have done so this year, according to the JCAA. To date, only about 110 Japanese companies have embraced the committee system. Experts believe amendments to Japan’s Corporation Law enacted earlier this year will further deter any potential converts.

Ueda

“There isn’t much merit for Japanese companies to switch over to a committee system anymore,” says Ryoko Ueda, a research fellow at Japan Investor Relations and Investor Support, a subsidiary of the Mizuho Financial Group. “In fact, you might see less.”

Since the amended Corporation Law went into effect last May, board directors at Japanese companies that employ a corporate-auditor system have had to adopt a liability system just as they would have had to do under a board-committee structure. Also, companies that limit a director’s term to one year can make dividend distributions if investors allow it in their articles of incorporation. In other words, companies that use a corporate auditor now have many of the same rights and responsibilities as those that use a board-committee system—so why make the switch?

Reluntance To Adopt System Evident

Many Japanese companies had been reluctant to adopt a board-committee system in the first place because Japanese law gives less power to those boards compared to how American boards and committees are set up, says Yasuhiro Katohno, operation division manager at JCAA. The main difference: In Japan, when a committee votes on a proposal, it has the final say—not the full board.

“The concern here is, the more you limit an outside board members’ liability, the less they may be of value as they may be able to do less.”

— Professor Noboyuki Demise, Meiji University

That stems from a shortage of talented executives in Japan able to take on the duties of an outside board member, which has led to the compromise of giving more power to board committees so they can have an easier time finding an outside member, Katohno says.

Japanese companies using the board-committee system must set up three committees: compensation, nominating, and auditing. Each committee must have at least three members, and a majority of its members must come from outside the company.

“Japanese companies were concerned whether the board-committee system would really work for them,” Katohno says.

There’s been such concern about recruiting board members and corporate auditors from outside the company that many Japanese companies included proxy measures that would limit their liability for poor execution of their fiduciary duties. A recent survey conducted by the JCAA revealed that 30 to 40 percent of Japanese companies plan to, or already do, limit the liability of outside board members and corporate auditors. Due to several accounting scandals that recently rocked Japan—including the Livedoor fraud—few companies have gone so far as to limit the liability of accounting auditors, although about 8 percent of companies said they plan to, or already do.

Katohno

“It may be a very Japanese thing to add that limitation of liability clause, but it’s really because companies want to make it more inviting for outside members to join their board or become their corporate auditor,” Katohno says.

Critics such as Professor Noboyuki Demise of Meiji University say they can understand the risk of getting caught in a derivative lawsuit when outside executives take a board position. “The concern here is, the more you limit an outside board members’ liability, the less they may be of value as they may be able to do less,” Demise says. “But it’s only been a short time since these changes have kicked in. It remains to be seen what effects these changes will have.”

Another reason companies may be reluctant to adopt the board-committee system: companies operating under such systems in Japan aren’t performing that well. Sony isn’t anywhere near its zenith, and cosmetics manufacturer Kanebo was delisted from the Tokyo Stock Exchange after getting caught for accounting fraud. On the other hand, Toyota Motor Corp. and Sharp Corp. have embraced the corporate-auditor system, and both are doing well.

But even critics say it’s hard to judge whether one system works better than the other.

“I don’t think the board-committee system will disappear,” Ueda says. “I think investors will monitor each companies’ internal control system closely and look for quality.”